Form 10-Q


United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q


[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934


For the quarterly period ended:

September 30, 2013


[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934


For the transition period from _______________ to _______________


Commission

File No.

 

Name of Registrant, State of Incorporation, Address

of Principal Executive Offices, and Telephone No.

 

IRS Employer

Identification No.

000-49965

 

MGE Energy, Inc.

(a Wisconsin Corporation)

133 South Blair Street

Madison, Wisconsin 53788

(608) 252-7000

mgeenergy.com

 

39-2040501

000-1125

 

Madison Gas and Electric Company

(a Wisconsin Corporation)

133 South Blair Street

Madison, Wisconsin 53788

(608) 252-7000

mge.com

 

39-0444025


Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) have been subject to such filing requirements for the past 90 days: Yes [X] No [ ]


Indicate by check mark whether the registrants have submitted electronically and posted on their corporate Web sites, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrants were required to submit and post such files):

Yes [X] No [ ]


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.


 

Large Accelerated Filer

Accelerated Filer

Non-accelerated Filer

Smaller Reporting Company

MGE Energy, Inc.

X

 

 

 

Madison Gas and Electric Company

 

 

X

 


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):

MGE Energy, Inc. and Madison Gas and Electric Company: Yes [ ] No [X]


Number of Shares Outstanding of Each Class of Common Stock as of October 31, 2013

MGE Energy, Inc.

Common stock, $1.00 par value, 23,113,638 shares outstanding.

Madison Gas and Electric Company

Common stock, $1.00 par value, 17,347,894 shares outstanding (all of which are owned beneficially and of record by MGE Energy, Inc.).




1





Table of Contents


PART I. FINANCIAL INFORMATION.

3

Filing Format

3

Forward-Looking Statements

3

Where to Find More Information

3

Definitions, Abbreviations, and Acronyms Used in the Text and Notes of this Report

4

Item 1. Financial Statements.

6

MGE Energy, Inc.

6

Consolidated Statements of Income (unaudited)

6

Consolidated Statements of Comprehensive Income (unaudited)

6

Consolidated Statements of Cash Flows (unaudited)

7

Consolidated Balance Sheets (unaudited)

8

Consolidated Statements of Common Equity (unaudited)

9

Madison Gas and Electric Company

10

Consolidated Statements of Income (unaudited)

10

Consolidated Statements of Comprehensive Income (unaudited)

10

Consolidated Statements of Cash Flows (unaudited)

11

Consolidated Balance Sheets (unaudited)

12

Consolidated Statements of Common Equity (unaudited)

13

MGE Energy, Inc., and Madison Gas and Electric Company

14

Notes to Consolidated Financial Statements (unaudited)

14

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

32

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

46

Item 4. Controls and Procedures.

48

PART II. OTHER INFORMATION.

49

Item 1. Legal Proceedings.

49

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

49

Item 4. Mine Safety Disclosures.

49

Item 6. Exhibits.

49

Signatures - MGE Energy, Inc.

51

Signatures - Madison Gas and Electric Company

52



2




PART I. FINANCIAL INFORMATION.


Filing Format


This combined Form 10-Q is being filed separately by MGE Energy, Inc. (MGE Energy) and Madison Gas and Electric Company (MGE). MGE is a wholly owned subsidiary of MGE Energy and represents a majority of its assets, liabilities, revenues, expenses, and operations. Thus, all information contained in this report relates to, and is filed by, MGE Energy. Information that is specifically identified in this report as relating solely to MGE Energy, such as its financial statements and information relating to its nonregulated business, does not relate to, and is not filed by, MGE. MGE makes no representation as to that information. The terms "we" and "our," as used in this report, refer to MGE Energy and its consolidated subsidiaries, unless otherwise indicated.


Forward-Looking Statements


This report, and other documents filed by MGE Energy and MGE with the Securities and Exchange Commission (SEC) from time to time, contain forward-looking statements that reflect management's current assumptions and estimates regarding future performance and economic conditions—especially as they relate to future load growth, revenues, expenses, capital expenditures, financial resources, regulatory matters, and the scope and expense associated with future environmental regulation. These forward-looking statements are made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Words such as "believe," "expect," "anticipate," "estimate," "could," "should," "intend," "will," and other similar words generally identify forward-looking statements. Both MGE Energy and MGE caution investors that these forward-looking statements are subject to known and unknown risks and uncertainties that may cause actual results to differ materially from those projected, expressed, or implied.


The factors that could cause actual results to differ materially from the forward-looking statements made by a registrant include (a) those factors discussed in the Registrants' 2012 Annual Report on Form 10-K: Item 1A. Risk Factors, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, as updated by Part I, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations in this report, and Item 8. Financial Statements and Supplementary Data – Note 18, as updated by Part I, Item 1. Financial Statements – Note 8 in this report, and (b) other factors discussed herein and in other filings made by that registrant with the SEC.


Readers are cautioned not to place undue reliance on these forward-looking statements, which apply only as of the date of this report. MGE Energy and MGE undertake no obligation to release publicly any revision to these forward-looking statements to reflect events or circumstances after the date of this report.


Where to Find More Information


The public may read and copy any reports or other information that MGE Energy and MGE file with the SEC at the SEC's public reference room at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. These documents also are available to the public from commercial document retrieval services, the website maintained by the SEC at sec.gov, MGE Energy's website at mgeenergy.com, and MGE's website at mge.com. Copies may be obtained from our websites free of charge. Information contained on MGE Energy's and MGE's websites shall not be deemed incorporated into, or to be a part of, this report.




3




Definitions, Abbreviations, and Acronyms Used in the Text and Notes of this Report

Abbreviations, acronyms, and definitions used in the text and notes of this report are defined below.


MGE Energy and Subsidiaries:

 

 

 

CWDC

Central Wisconsin Development Corporation

MAGAEL

MAGAEL, LLC

MGE

Madison Gas and Electric Company

MGE Construct

MGE Construct, LLC

MGE Energy

MGE Energy, Inc.

MGE Power

MGE Power, LLC

MGE Power Elm Road

MGE Power Elm Road, LLC

MGE Power West Campus

MGE Power West Campus, LLC

MGE Transco

MGE Transco Investment, LLC

North Mendota

North Mendota Energy & Technology Park, LLC

 

 

Other Defined Terms:

 

 

 

AFUDC

Allowance for Funds Used During Construction

ATC

American Transmission Company LLC

Blount

Blount Station

CAA

Clean Air Act

CAIR

Clean Air Interstate Rule

CAVR

Clean Air Visibility Rule

Codification

Financial Accounting Standards Board Accounting Standards Codification

Columbia

Columbia Energy Center

Cooling degree days

Measure of the extent to which the average daily temperature is above 65 degrees Fahrenheit, which is considered an indicator of possible increased demand for energy to provide cooling

CSAPR

Cross-State Air Pollution Rule

DOE

United States Department of Energy

Dth

Dekatherms, a quantity measure used in respect of natural gas

EGUs

Electric Generating Units

Elm Road Units

Elm Road Generating Station

EPA

United States Environmental Protection Agency

FASB

Financial Accounting Standards Board

FTR

Financial Transmission Rights

GHG

Greenhouse Gas

Heating degree days (HDD)

Measure of the extent to which the average daily temperature is below 65 degrees Fahrenheit, which is considered an indicator of possible increased demand for energy to provide heating

IRS

Internal Revenue Service

kWh

Kilowatt-hour, a measure of electric energy produced

MATS

Mercury and Air Toxics Standards

MISO

Midcontinent Independent System Operator (a regional transmission organization)

MW

Megawatt, a measure of electric energy generating capacity

MWh

Megawatt-hour, a measure of electric energy produced

NGCC

Natural Gas Combined Cycle

NOV

Notice of Violation

NOx

Nitrogen Oxides

NSPS

New Source Performance Standards

OPRB

Other Postretirement Benefits

PGA

Purchased Gas Adjustment clause, a regulatory mechanism used to reconcile natural gas costs recovered in rates to actual costs

PJM

PJM Interconnection, LLC (a regional transmission organization)

PPA

Purchased power agreement

PSCW

Public Service Commission of Wisconsin

PSD

Prevention of Significant Deterioration



4





SCR

Selective Catalytic Reduction

SEC

Securities and Exchange Commission

SIP

State Implementation Plan

SO2

Sulfur Dioxide

Stock Plan

Direct Stock Purchase and Dividend Reinvestment Plan of MGE Energy

UW

University of Wisconsin at Madison

VIE

Variable Interest Entity

WCCF

West Campus Cogeneration Facility

WDNR

Wisconsin Department of Natural Resources

WEPCO

Wisconsin Electric Power Company

Working capital

Current assets less current liabilities

WPL

Wisconsin Power and Light Company

WPSC

Wisconsin Public Service Corporation




5




Item 1. Financial Statements.


MGE Energy, Inc.

Consolidated Statements of Income (unaudited)

(In thousands, except per-share amounts)


 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

 

 

2013

 

2012

 

2013

 

2012

Operating Revenues:

 

 

 

 

 

 

 

 

    Regulated electric revenues

$

119,836

$

118,914

$

310,176

$

305,189

    Regulated gas revenues

 

18,864

 

16,587

 

121,373

 

92,235

    Nonregulated revenues

 

1,399

 

2,337

 

4,075

 

6,894

        Total Operating Revenues

 

140,099

 

137,838

 

435,624

 

404,318

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

 

    Fuel for electric generation

 

13,950

 

16,395

 

34,520

 

36,727

    Purchased power

 

21,981

 

18,102

 

61,237

 

54,962

    Cost of gas sold

 

8,819

 

7,389

 

70,259

 

50,035

    Other operations and maintenance

 

41,134

 

41,975

 

124,670

 

126,202

    Depreciation and amortization

 

9,710

 

9,706

 

28,864

 

29,042

    Other general taxes

 

4,605

 

4,383

 

14,049

 

13,937

        Total Operating Expenses

 

100,199

 

97,950

 

333,599

 

310,905

Operating Income

 

39,900

 

39,888

 

102,025

 

93,413

 

 

 

 

 

 

 

 

 

Other income, net

 

3,750

 

2,856

 

9,770

 

7,975

Interest expense, net

 

(4,605)

 

(4,849)

 

(13,937)

 

(14,717)

    Income before income taxes

 

39,045

 

37,895

 

97,858

 

86,671

Income tax provision

 

(14,692)

 

(14,253)

 

(37,030)

 

(32,711)

Net Income

$

24,353

$

23,642

$

60,828

$

53,960

 

 

 

 

 

 

 

 

 

Earnings Per Share of Common Stock

 

 

 

 

 

 

 

 

(basic and diluted)

$

1.05

$

1.02

$

2.63

$

2.33

 

 

 

 

 

 

 

 

 

Dividends per share of common stock

$

0.408

$

0.395

$

1.198

$

1.161

 

 

 

 

 

 

 

 

 

Weighted Average Shares Outstanding

 

 

 

 

 

 

 

 

(basic and diluted)

 

23,114

 

23,114

 

23,114

 

23,114



MGE Energy, Inc.

Consolidated Statements of Comprehensive Income (unaudited)

(In thousands)


 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

 

 

2013

 

2012

 

2013

 

2012

Net Income

$

24,353

$

23,642

$

60,828

$

53,960

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

    Unrealized gain (loss) on available-for-sale

 

 

 

 

 

 

 

 

    securities, net of tax ($24 and $5, and $117 and

 

 

 

 

 

 

 

 

    $24, respectively)

 

36

 

(8)

 

176

 

35

Comprehensive Income

$

24,389

$

23,634

$

61,004

$

53,995


The accompanying notes are an integral part of the above unaudited consolidated financial statements.




6





MGE Energy, Inc.

Consolidated Statements of Cash Flows (unaudited)

(In thousands)


 

 

Nine Months Ended

September 30,

 

 

 

 

2013

 

2012

Operating Activities:

 

 

 

 

    Net income

$

60,828

$

53,960

    Items not affecting cash:

 

 

 

 

        Depreciation and amortization

 

28,864

 

29,042

        Deferred income taxes

 

32,706

 

54,602

        Provision for doubtful receivables

 

1,551

 

1,537

        Employee benefit plan expenses

 

9,908

 

13,815

        Equity earnings in ATC

 

(7,045)

 

(6,764)

        Other items

 

250

 

1,632

    Changes in working capital items:

 

 

 

 

        Decrease (increase) in current assets

 

15,053

 

(9,002)

        Decrease in current liabilities

 

(5,496)

 

(13,418)

    Dividend income from ATC

 

5,498

 

5,300

    Cash contributions to pension and other postretirement plans

 

(33,919)

 

(24,336)

    Debt make-whole premium

 

(6,757)

 

-

    Other noncurrent items, net

 

7,159

 

9,518

            Cash Provided by Operating Activities

 

108,600

 

115,886

 

 

 

 

 

Investing Activities:

 

 

 

 

    Capital expenditures

 

(92,092)

 

(65,909)

    Capital contributions to investments

 

(1,305)

 

(1,988)

    Other

 

(780)

 

(291)

            Cash Used for Investing Activities

 

(94,177)

 

(68,188)

 

 

 

 

 

Financing Activities:

 

 

 

 

    Cash dividends paid on common stock

 

(27,685)

 

(26,820)

    Repayment of long-term debt

 

(42,000)

 

(30,000)

    Issuance of long-term debt

 

85,000

 

28,000

    Other

 

(765)

 

(844)

            Cash Provided by (Used for) Financing Activities

 

14,550

 

(29,664)

 

 

 

 

 

Change in cash and cash equivalents

 

28,973

 

18,034

Cash and cash equivalents at beginning of period

 

46,357

 

41,169

Cash and Cash Equivalents at End of Period

$

75,330

$

59,203


 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

    Significant noncash investing activities:

 

 

 

 

        Accrued capital expenditures

$

10,473

$

7,649


The accompanying notes are an integral part of the unaudited consolidated financial statements.




7





MGE Energy, Inc.

Consolidated Balance Sheets (unaudited)

(In thousands)


 

September 30,

December 31,

ASSETS

 

2013

 

2012

Current Assets:

 

 

 

 

    Cash and cash equivalents

$

75,330

$

46,357

    Receivable - margin account

 

1,357

 

1,818

    Accounts receivable, less reserves of $3,959 and $3,885, respectively

 

37,442

 

41,386

    Other accounts receivable, less reserves of $822 and $931, respectively

 

8,271

 

6,746

    Unbilled revenues

 

20,290

 

28,262

    Materials and supplies, at average cost

 

17,023

 

16,997

    Fossil fuel

 

6,388

 

6,367

    Stored natural gas, at average cost

 

18,004

 

14,980

    Prepaid taxes

 

12,722

 

19,520

    Regulatory assets - current

 

8,689

 

10,327

    Deferred income taxes - current

 

-

 

23,483

    Other current assets

 

8,349

 

6,694

        Total Current Assets

 

213,865

 

222,937

Regulatory assets

 

213,068

 

218,853

Other deferred assets and other

 

6,436

 

7,075

Property, Plant, and Equipment:

 

 

 

 

    Property, plant, and equipment, net

 

1,012,281

 

975,053

    Construction work in progress

 

131,096

 

98,411

        Total Property, Plant, and Equipment

 

1,143,377

 

1,073,464

Investments

 

66,965

 

64,595

        Total Assets

$

1,643,711

$

1,586,924

 

 

 

 

 

LIABILITIES AND CAPITALIZATION

 

 

 

 

Current Liabilities:

 

 

 

 

    Long-term debt due within one year

$

4,082

$

3,013

    Accounts payable

 

39,532

 

43,518

    Accrued interest and taxes

 

4,041

 

4,296

    Accrued payroll related items

 

9,819

 

10,063

    Deferred income taxes

 

969

 

-

    Regulatory liabilities - current

 

4,622

 

-

    Derivative liabilities

 

9,310

 

9,270

    Other current liabilities

 

6,337

 

5,637

        Total Current Liabilities

 

78,712

 

75,797

Other Credits:

 

 

 

 

    Deferred income taxes

 

278,899

 

270,410

    Investment tax credit - deferred

 

1,466

 

1,520

    Regulatory liabilities

 

25,757

 

24,538

    Accrued pension and other postretirement benefits

 

133,730

 

162,835

    Derivative liabilities

 

59,710

 

63,320

    Other deferred liabilities and other

 

52,249

 

50,584

        Total Other Credits

 

551,811

 

573,207

Capitalization:

 

 

 

 

    Common shareholders' equity

 

612,748

 

579,429

    Long-term debt

 

400,440

 

358,491

        Total Capitalization

 

1,013,188

 

937,920

Commitments and contingencies (see Footnote 8)

 

-

 

-

        Total Liabilities and Capitalization

$

1,643,711

$

1,586,924


The accompanying notes are an integral part of the above unaudited consolidated financial statements.




8





MGE Energy, Inc.

Consolidated Statements of Common Equity (unaudited)

(In thousands, except per-share amounts)


 

Common Stock

 

Additional

Paid-in

Capital

 

Retained

Earnings

 

Accumulated

Other

Comprehensive

Income

 

Total

 

 

 

 

 

 

 

 

 

 

 

Shares

 

Value

 

 

 

 

2012

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - December 31, 2011

23,114

$

23,114

$

316,268

$

211,458

$

112

$

550,952

Net income

 

 

 

 

 

 

53,960

 

 

 

53,960

Other comprehensive income

 

 

 

 

 

 

 

 

35

 

35

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

($1.161 per share)

 

 

 

 

 

 

(26,820)

 

 

 

(26,820)

Ending balance - September 30, 2012

23,114

$

23,114

$

316,268

$

238,598

$

147

$

578,127

 

 

 

 

 

 

 

 

 

 

 

 

2013

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - December 31, 2012

23,114

$

23,114

$

316,268

$

239,953

$

94

$

579,429

Net income

 

 

 

 

 

 

60,828

 

 

 

60,828

Other comprehensive income

 

 

 

 

 

 

 

 

176

 

176

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

($1.198 per share)

 

 

 

 

 

 

(27,685)

 

 

 

(27,685)

Ending balance - September 30, 2013

23,114

$

23,114

$

316,268

$

273,096

$

270

$

612,748


The accompanying notes are an integral part of the above unaudited consolidated financial statements.



9





Madison Gas and Electric Company

Consolidated Statements of Income (unaudited)

(In thousands)


 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

 

 

2013

 

2012

 

2013

 

2012

Operating Revenues:

 

 

 

 

 

 

 

 

    Regulated electric revenues

$

119,836

$

118,914

$

310,176

$

305,189

    Regulated gas revenues

 

18,864

 

16,587

 

121,373

 

92,235

    Nonregulated revenues

 

1,399

 

2,337

 

4,075

 

6,894

        Total Operating Revenues

 

140,099

 

137,838

 

435,624

 

404,318

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

 

    Fuel for electric generation

 

13,950

 

16,395

 

34,520

 

36,727

    Purchased power

 

21,981

 

18,102

 

61,237

 

54,962

    Cost of gas sold

 

8,819

 

7,389

 

70,259

 

50,035

    Other operations and maintenance

 

40,990

 

41,766

 

124,133

 

125,320

    Depreciation and amortization

 

9,710

 

9,706

 

28,864

 

29,042

    Other general taxes

 

4,605

 

4,384

 

14,049

 

13,938

    Income tax provision

 

13,798

 

13,669

 

34,237

 

30,273

        Total Operating Expenses

 

113,853

 

111,411

 

367,299

 

340,297

Operating Income

 

26,246

 

26,427

 

68,325

 

64,021

 

 

 

 

 

 

 

 

 

Other Income and Deductions:

 

 

 

 

 

 

 

 

    AFUDC - equity funds

 

852

 

514

 

2,178

 

978

    Equity in earnings in ATC

 

2,340

 

2,280

 

7,045

 

6,764

    Income tax provision

 

(880)

 

(587)

 

(2,802)

 

(2,555)

    Other income, net

 

407

 

(77)

 

118

 

(207)

        Total Other Income and Deductions

 

2,719

 

2,130

 

6,539

 

4,980

    Income before interest expense

 

28,965

 

28,557

 

74,864

 

69,001

 

 

 

 

 

 

 

 

 

Interest Expense:

 

 

 

 

 

 

 

 

    Interest on long-term debt

 

4,910

 

5,065

 

14,757

 

15,335

    Other interest, net

 

5

 

25

 

(31)

 

(116)

    AFUDC - borrowed funds

 

(281)

 

(209)

 

(718)

 

(398)

        Net Interest Expense

 

4,634

 

4,881

 

14,008

 

14,821

Net Income

$

24,331

$

23,676

$

60,856

$

54,180

Less Net Income Attributable to Noncontrolling Interest, net of tax

 

(6,861)

 

(6,153)

 

(20,547)

 

(18,305)

Net Income Attributable to MGE

$

17,470

$

17,523

$

40,309

$

35,875



Madison Gas and Electric Company

Consolidated Statements of Comprehensive Income (unaudited)

(In thousands)


 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

 

 

2013

 

2012

 

2013

 

2012

Net Income

$

24,331

$

23,676

$

60,856

$

54,180

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

    Unrealized gain (loss) on available-for-sale

 

 

 

 

 

 

 

 

    securities, net of tax ($33 and $5, and $52 and

 

 

 

 

 

 

 

 

    $20, respectively)

 

49

 

(7)

 

77

 

(30)

Comprehensive Income

$

24,380

$

23,669

$

60,933

$

54,150

    Less: Comprehensive Income Attributable to

 

 

 

 

 

 

 

 

    Noncontrolling Interest, net of tax

 

(6,861)

 

(6,153)

 

(20,547)

 

(18,305)

Comprehensive Income Attributable to MGE

$

17,519

$

17,516

$

40,386

$

35,845


The accompanying notes are an integral part of the above unaudited consolidated financial statements.



10





Madison Gas and Electric Company

Consolidated Statements of Cash Flows (unaudited)

(In thousands)


 

 

Nine Months Ended

September 30,

 

 

 

2013

 

2012

 

Operating Activities:

 

 

 

 

 

    Net income

$

60,856

$

54,180

 

    Items not affecting cash:

 

 

 

 

 

        Depreciation and amortization

 

28,864

 

29,042

 

        Deferred income taxes

 

31,467

 

53,984

 

        Provision for doubtful receivables

 

1,551

 

1,537

 

        Employee benefit plan expenses

 

9,908

 

13,815

 

        Equity earnings in ATC

 

(7,045)

 

(6,764)

 

        Other items

 

652

 

2,028

 

    Changes in working capital items:

 

 

 

 

 

        Decrease (increase) in current assets

 

14,599

 

(10,446)

 

        Decrease in current liabilities

 

(4,911)

 

(14,052)

 

    Dividend income from ATC

 

5,498

 

5,300

 

    Cash contributions to pension and other postretirement plans

 

(33,919)

 

(24,336)

 

    Debt make-whole premium

 

(6,757)

 

-

 

    Other noncurrent items, net

 

7,063

 

9,281

 

            Cash Provided by Operating Activities

 

107,826

 

113,569

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

    Capital expenditures

 

(92,092)

 

(65,909)

 

    Capital contributions to investments

 

(1,065)

 

(1,775)

 

    Other

 

(678)

 

(271)

 

            Cash Used for Investing Activities

 

(93,835)

 

(67,955)

 

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

    Cash dividends paid to parent by MGE

 

-

 

(13,456)

 

    Distributions to parent from noncontrolling interest

 

(21,148)

 

(15,500)

 

    Equity contribution received by noncontrolling interest

 

1,065

 

1,775

 

    Repayment of long-term debt

 

(42,000)

 

(30,000)

 

    Issuance of long-term debt

 

85,000

 

28,000

 

    Other

 

(668)

 

(795)

 

            Cash Provided by (Used for) Financing Activities

 

22,249

 

(29,976)

 

 

 

 

 

 

 

Change in cash and cash equivalents

 

36,240

 

15,638

 

Cash and cash equivalents at beginning of period

 

6,350

 

13,898

 

Cash and Cash Equivalents at End of Period

$

42,590

$

29,536

 


 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

    Significant noncash investing activities:

 

 

 

 

 

        Accrued capital expenditures

$

10,473

$

7,649

 


The accompanying notes are an integral part of the unaudited consolidated financial statements.




11





Madison Gas and Electric Company

Consolidated Balance Sheets (unaudited)

(In thousands)

 

September 30,

December 31,

ASSETS

 

2013

 

2012

Current Assets:

 

 

 

 

    Cash and cash equivalents

$

42,590

$

6,350

    Receivable - margin account

 

1,357

 

1,818

    Accounts receivable, less reserves of $3,959 and $3,885, respectively

 

37,442

 

41,386

    Affiliate receivables

 

532

 

634

    Other accounts receivable, less reserves of $822 and $931, respectively

 

8,220

 

6,732

    Unbilled revenues

 

20,290

 

28,262

    Materials and supplies, at average cost

 

17,023

 

16,997

    Fossil fuel

 

6,388

 

6,367

    Stored natural gas, at average cost

 

18,004

 

14,980

    Prepaid taxes

 

17,334

 

23,561

    Regulatory assets - current

 

8,689

 

10,327

    Deferred income taxes - current

 

-

 

23,305

    Other current assets

 

8,310

 

6,670

        Total Current Assets

 

186,179

 

187,389

Affiliate receivable long-term

 

5,957

 

6,354

Regulatory assets

 

213,068

 

218,853

Other deferred assets and other

 

4,695

 

6,540

Property, Plant, and Equipment:

 

 

 

 

    Property, plant, and equipment, net

 

1,012,150

 

974,549

    Construction work in progress

 

131,096

 

98,411

        Total Property, Plant, and Equipment

 

1,143,246

 

1,072,960

Investments

 

64,287

 

61,555

        Total Assets

$

1,617,432

$

1,553,651


 

 

 

 

LIABILITIES AND CAPITALIZATION

 

 

 

 

Current Liabilities:

 

 

 

 

    Long-term debt due within one year

$

4,082

$

3,013

    Accounts payable

 

39,532

 

43,517

    Affiliate payables

 

40

 

767

    Accrued interest and taxes

 

4,056

 

4,248

    Accrued payroll related items

 

9,819

 

10,063

    Deferred income taxes

 

1,379

 

-

    Regulatory liabilities - current

 

4,622

 

-

    Derivative liabilities

 

9,310

 

9,270

    Other current liabilities

 

6,166

 

4,491

        Total Current Liabilities

 

79,006

 

75,369

Other Credits:

 

 

 

 

    Deferred income taxes

 

273,456

 

266,231

    Investment tax credit - deferred

 

1,466

 

1,520

    Regulatory liabilities

 

25,757

 

24,538

    Accrued pension and other postretirement benefits

 

133,730

 

162,835

    Derivative liabilities

 

59,710

 

63,320

    Other deferred liabilities and other

 

52,251

 

50,581

        Total Other Credits

 

546,370

 

569,025

Capitalization:

 

 

 

 

    Common shareholder's equity

 

473,682

 

433,296

    Noncontrolling interest

 

117,934

 

117,470

        Total Equity

 

591,616

 

550,766

    Long-term debt

 

400,440

 

358,491

        Total Capitalization

 

992,056

 

909,257

Commitments and contingencies (see Footnote 8)

 

-

 

-

        Total Liabilities and Capitalization

$

1,617,432

$

1,553,651


The accompanying notes are an integral part of the above unaudited consolidated financial statements.



12





Madison Gas and Electric Company

Consolidated Statements of Common Equity (unaudited)

(In thousands)


 

Common Stock

 

Additional

Paid-in

Capital

 

Retained

Earnings

Accumulated

Other

Comprehensive

(Loss)/Income

Non-

Controlling

Interest

 

Total

 

 

 

 

 

 

 

 

 

Shares

 

Value

 

 

 

2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - Dec. 31, 2011

17,348

$

17,348

$

192,417

$

203,114

$

47

$

114,351

$

527,277

Net income

 

 

 

 

 

 

35,875

 

 

 

18,305

 

54,180

Other comprehensive loss

 

 

 

 

 

 

 

 

(30)

 

 

 

(30)

Cash dividends paid to parent

 

 

 

 

 

 

 

 

 

 

 

 

 

by MGE

 

 

 

 

 

 

(13,456)

 

 

 

 

 

(13,456)

Equity contribution received by

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

1,775

 

1,775

Distributions to parent from

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

(15,500)

 

(15,500)

Ending balance - September 30, 2012

17,348

$

17,348

$

192,417

$

225,533

$

17

$

118,931

$

554,246

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - Dec. 31, 2012

17,348

$

17,348

$

192,417

$

223,527

$

4

$

117,470

$

550,766

Net income

 

 

 

 

 

 

40,309

 

 

 

20,547

 

60,856

Other comprehensive income

 

 

 

 

 

 

 

 

77

 

 

 

77

Equity contribution received by

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

1,065

 

1,065

Distributions to parent from

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

(21,148)

 

(21,148)

Ending balance - September 30, 2013

17,348

$

17,348

$

192,417

$

263,836

$

81

$

117,934

$

591,616


The accompanying notes are an integral part of the above unaudited consolidated financial statements.




13





MGE Energy, Inc., and Madison Gas and Electric Company

Notes to Consolidated Financial Statements (unaudited)

September 30, 2013



1.

Basis of Presentation - MGE Energy and MGE.


This report is a combined report of MGE Energy and MGE. References in this report to "MGE Energy" are to MGE Energy, Inc. and its subsidiaries. References in this report to "MGE" are to Madison Gas and Electric Company.


MGE Power Elm Road and MGE Power West Campus own electric generating assets and lease those assets to MGE. Both entities are variable interest entities under applicable authoritative guidance. MGE is considered the primary beneficiary of these entities as a result of contractual agreements. As a result, MGE has consolidated MGE Power Elm Road and MGE Power West Campus. See Footnote 2 of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, of MGE Energy's and MGE's 2012 Annual Report on Form 10-K.


The accompanying consolidated financial statements as of September 30, 2013, and for the three and nine months ended, are unaudited, but include all adjustments that MGE Energy and MGE management consider necessary for a fair statement of their respective financial statements. All adjustments are of a normal, recurring nature except as otherwise disclosed. The year-end consolidated balance sheet information was derived from the audited balance sheet appearing in MGE Energy's and MGE's 2012 Annual Report on Form 10-K, but does not include all disclosures required by accounting principles generally accepted in the United States of America. These notes should be read in conjunction with the financial statements and the notes on pages 51 through 104 of the 2012 Annual Report on Form 10-K.


2.

Equity and Financing Arrangements.


a.

Common Stock - MGE Energy.


MGE Energy purchases stock in the open market for issuance pursuant to its Stock Plan. All MGE Energy common stock issued under the Stock Plan is sold pursuant to a registration statement that has been filed with the SEC and is currently effective.


MGE Energy can issue new shares of its common stock through the Stock Plan. For both the nine months ended September 30, 2013 and 2012, MGE Energy did not issue any new shares of common stock under the Stock Plan.


b.

Dilutive Shares Calculation - MGE Energy.


MGE Energy does not hold any dilutive securities.


c.

Credit Facilities - MGE Energy and MGE.


On June 19, 2013, each of MGE Energy and MGE entered into an amendment to its existing credit agreement dated as of July 30, 2010, with various financial institutions, as lenders, and JPMorgan Chase Bank, N.A., as administrative agent. In the case of MGE Energy, the principal purposes of the amendment are to increase the revolving credit facility to $50 million from $40 million and to extend the expiration date of the credit agreement to July 31, 2017 from July 31, 2015. In the case of MGE, the principal purposes of the amendment are to increase the revolving credit facility to $100 million from $75 million and to extend the expiration date of the credit agreement to July 31, 2017 from July 31, 2015. In addition, both amendments lowered the adders used in the determination of the interest rates under the existing credit agreements. As a result of the amendments, the existing credit agreements for both of MGE Energy and MGE carry interest at either (i) a "floating rate," plus an adder ranging from zero to 0.125%, depending upon the credit ratings assigned to MGE's senior unsecured long-term debt securities; or (ii) a "Eurodollar Rate," plus an adder ranging from 0.675% to 1.125%, depending upon the credit ratings assigned to MGE's senior unsecured long-term debt securities. The "floating rate" is calculated on a daily basis as the highest of a prime rate, a Federal Funds effective rate plus 0.5% per annum, or a Eurodollar Rate for a one month interest



14




period plus 1%. The "Eurodollar Rate" is calculated as provided in the credit agreements for the selected interest period. As of September 30, 2013, neither MGE Energy nor MGE had any borrowings outstanding under their respective credit agreements and MGE had no commercial paper outstanding.


d.

Long-term Debt - MGE Energy and MGE.


On July 18, 2013, MGE issued $20 million in principal amount of 4.42% senior notes, Series A, due July 15, 2043 and $20 million in principal amount of 4.47%, senior notes, Series B, due July 15, 2048. The Notes were issued pursuant to a Note Purchase Agreement with several note purchasers. The Notes are unsecured and are not issued under, or governed by, MGE's Indenture dated as of September 1, 1998, which governs MGE's Medium-Term Notes. MGE used the net proceeds from the sale of the Notes to redeem on July 18, 2013, $20 million of its 5.26% Medium-Term Notes due September 29, 2017, and to make a $20 million partial redemption of its 5.59% Senior Notes due September 11, 2018. MGE paid a redemption price equal to the principal amount of the notes that were redeemed, plus accrued interest to the redemption date, plus a make-whole premium equal to $3.2 million and $3.6 million, for the 5.26% Medium-Term Notes due September 29, 2017 and 5.59% Senior Notes due September 11, 2018, respectively. The make-whole premiums are treated as a regulatory asset and will be amortized over the life of the Series A and Series B Notes. Any interest savings in 2013 will be deferred. There is $20 million principal amount of the 5.59% Senior Notes remaining outstanding after the redemption.


The Note Purchase Agreement under which the Series A and Series B Notes were issued also includes the issuance on September 16, 2013, of $30 million in principal amount of 3.09% Senior Notes, Series C, due September 15, 2023 and $15 million of 3.29% Senior Notes, Series D, due September 15, 2026. The Series C Notes and the Series D Notes carry interest rates of 3.09% per annum and 3.29% per annum, respectively. The proceeds of the Notes are expected to be used to help finance the Columbia environmental project.


3.

Investment in ATC - MGE Energy and MGE.


ATC owns and operates electric transmission facilities primarily in Wisconsin. MGE received an interest in ATC when it, like other Wisconsin electric utilities, contributed its electric transmission facilities to ATC. That interest is presently held by MGE Transco, which is jointly owned by MGE Energy and MGE.


MGE Transco has accounted for its investment in ATC under the equity method of accounting. For the nine months ended September 30, 2013 and 2012, MGE Transco recorded equity earnings from the investment in ATC of $7.0 million and $6.8 million, respectively. Dividends received from ATC were $5.5 million and $5.3 million for the nine months ended September 30, 2013 and 2012, respectively. In addition, during the nine months ended September 30, 2013 and 2012, MGE Transco made $1.1 million and $1.8 million in capital contributions to ATC, respectively. On October 31, 2013, MGE Transco made a $0.4 million capital contribution to ATC.

 

MGE Transco's investment in ATC as of September 30, 2013, and December 31, 2012, was $63.6 million and $61.0 million, respectively.


At September 30, 2013, MGE is the majority owner, and MGE Energy, the holding company, is the minority owner of MGE Transco. MGE Energy's proportionate share of the equity and net income of MGE Transco is classified within the MGE financial statements as noncontrolling interest.


ATC's summarized financial data for the three and nine months ended September 30, 2013 and 2012, is as follows:


 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

(In thousands)

 

2013

 

2012

 

2013

 

2012

Operating revenues

$

160,480

$

150,303

$

464,345

$

450,136

Operating expenses

 

(77,595)

 

(68,813)

 

(217,240)

 

(210,139)

Other income (expense), net

 

917

 

(5)

 

585

 

(832)

Interest expense, net

 

(21,136)

 

(20,983)

 

(63,232)

 

(61,260)

Earnings before members' income taxes

$

62,666

$

60,502

$

184,458

$

177,905




15




4.

Columbia Environmental Project Construction - MGE Energy and MGE.


MGE and two other utilities jointly own Columbia, a coal-fired generating facility. WPL is the plant operator and permit holder, and owns 46.2% of Columbia. WPSC owns a 31.8% interest, and MGE owns a 22% interest, in Columbia. In early 2011, the PSCW issued a Certificate and Order authorizing the construction of scrubbers and bag houses and associated equipment on Columbia Units 1 and 2 to reduce SO2 and mercury emissions. The scrubbers and bag houses are expected to support compliance obligations for current and anticipated air quality regulations, including CAIR, CAIR's eventual replacement, the Mercury and Air Toxics Standards (MATS), and the Wisconsin Mercury Rule. The operator's current estimate shows that MGE's share of the capital expenditures required for this project is approximately $140 million. As of September 30, 2013, MGE had accumulated $113.6 million (excluding carrying costs) related to its share of the project, which is reflected in the Construction Work in Progress balance on MGE Energy's and MGE's consolidated balance sheets. MGE's share of the capital expenditures associated with the Columbia environmental project is expected to be approximately $12 million for the remainder of 2013 and $14 million in 2014. These amounts may change as a result of modifications to the project estimate or timing differences. MGE's share of various contractual commitments entered for the project as of September 30, 2013, is $24.4 million. For the three months ended September 30, 2013 and 2012, MGE has recognized after tax $0.8 million and $0.4 million, respectively, in AFUDC equity related to this project. For the nine months ended September 30, 2013 and 2012, MGE has recognized after tax $1.9 million and $0.7 million, respectively, in AFUDC equity related to this project.


MGE expects that the costs pertaining to this project will be fully recoverable through rates. For 2012, the PSCW authorized MGE 100% AFUDC on this project during construction. Beginning in 2013, similar to MGE's other utility construction projects, the PSCW authorized MGE a 50% current return (included in customer rates) and the remaining 50% as AFUDC.


5.

Taxes - MGE Energy and MGE.


a.

Accounting for Uncertainty in Income Taxes.


MGE Energy and MGE account for the difference between the tax benefit amount taken on prior year tax returns, or expected to be taken on a current year tax return, and the tax benefit amount recognized in the financial statements as an unrecognized tax benefit.


MGE Energy has adopted a tax method of accounting to accelerate tax deductions for repairs. MGE Energy and MGE have an unrecognized tax benefit at September 30, 2013, and December 31, 2012, in the amount of $2.3 million and $3.2 million, respectively, for the tax uncertainty related to the change in tax method of accounting for repairs. The reduction in unrecognized tax benefits is due to the Internal Revenue Service completing the examination of tax periods 2007-2009 with no adverse adjustments to these positions.


b.

Effective Tax Rate.


MGE Energy's and MGE's effective income tax rate for the three and nine months ended September 30, 2013, are 37.6% and 37.8%, respectively, compared to 37.6% and 37.7% for the same periods in 2012.


c.

Final Tangible Property Regulations.


In September 2013, the IRS and Treasury Department released final regulations under Sections 162(a) and 263(a) on the deduction and capitalization of expenditures related to tangible property, replacing the 2011 temporary regulations issued in December 2011. The final regulations did not have a material impact on MGE Energy's and MGE's consolidated financial statements.


6.

Pension and Other Postretirement Plans - MGE Energy and MGE.


MGE maintains qualified and nonqualified pension plans, health care, and life insurance benefits. Additionally, MGE has defined contribution 401(k) benefit plans.




16




The following table presents the components of MGE Energy's and MGE's net periodic benefit costs recognized for the three and nine months ended September 30, 2013 and 2012. A portion of the net periodic benefit cost is capitalized within the consolidated balance sheets.


 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

(In thousands)

 

2013

 

2012

 

2013

 

2012

Pension Benefits

 

 

 

 

 

 

 

 

Components of net periodic benefit cost:

 

 

 

 

 

 

 

 

    Service cost

$

1,924

$

1,871

$

5,764

$

5,613

    Interest cost

 

3,178

 

3,236

 

9,521

 

9,711

    Expected return on assets

 

(4,764)

 

(3,917)

 

(14,273)

 

(11,756)

Amortization of:

 

 

 

 

 

 

 

 

    Prior service cost

 

79

 

111

 

237

 

333

    Actuarial loss

 

2,011

 

2,058

 

6,023

 

6,177

Net periodic benefit cost

$

2,428

$

3,359

$

7,272

$

10,078

 

 

 

 

 

 

 

 

 

Postretirement Benefits

 

 

 

 

 

 

 

 

Components of net periodic benefit cost:

 

 

 

 

 

 

 

 

    Service cost

$

594

$

626

$

1,781

$

1,879

    Interest cost

 

966

 

1,089

 

2,898

 

3,267

    Expected return on assets

 

(542)

 

(421)

 

(1,626)

 

(1,263)

Amortization of:

 

 

 

 

 

 

 

 

    Transition obligation

 

-

 

103

 

2

 

309

    Prior service cost

 

28

 

27

 

83

 

81

    Actuarial loss

 

310

 

601

 

930

 

1,802

Net periodic benefit cost

$

1,356

$

2,025

$

4,068

$

6,075


The PSCW allowed MGE to defer the 2009 incremental pension and OPRB costs above the amounts recovered in rates. During both the three months ended September 30, 2013 and 2012, $0.3 million has been recovered in rates. During both the nine months ended September 30, 2013 and 2012, $0.9 million has been recovered in rates. These costs are not reflected in the table above.


7.

Share-Based Compensation - MGE Energy and MGE.


Under MGE Energy's Performance Unit Plan, eligible participants may receive performance units that entitle the holder to receive a cash payment equal to the value of a designated number of shares of MGE Energy's common stock, plus dividend equivalent payments thereon, at the end of the set performance period.


In addition to units granted in 2009 through 2012, on February 15, 2013, 15,256 units were granted based on the MGE Energy closing stock price as of that date. These units are subject to a five-year graded vesting schedule. On the grant date, MGE Energy and MGE measure the cost of the employee services received in exchange for a performance unit award based on the current market value of MGE Energy common stock. The fair value of the awards has been subsequently re-measured at September 30, 2013, as required by applicable accounting standards. Changes in fair value have been recognized as compensation cost. Since this amount is re-measured quarterly throughout the vesting period, the compensation cost is subject to variability.


For nonretirement eligible employees, stock based compensation costs are accrued and recognized using the graded vesting method. Compensation cost for retirement eligible employees or employees that will become retirement eligible during the vesting schedule are recognized on an abridged horizon. In the event of a bona fide retirement, not followed by work for a competitor, the executive will receive full vesting credit for each outstanding award.


During the nine months ended September 30, 2013 and 2012, MGE recorded $1.1 million and $1.4 million, respectively, in compensation expense as a result of the Performance Unit Plan. In January 2013, cash payments of $1.0 million were distributed relating to awards that were granted in 2008 and became payable under the Performance Unit Plan. No forfeitures occurred during the nine months ended September 30, 2013 or 2012. At September 30, 2013, $3.6 million of outstanding awards are vested.




17




8.

Commitments and Contingencies.


a.

Environmental - MGE Energy and MGE.


MGE Energy and MGE are subject to frequently changing local, state, and federal regulations concerning air quality, water quality, land use, threatened and endangered species, hazardous materials handling, and solid waste disposal. These regulations affect the manner in which they conduct their operations, the costs of those operations, as well as capital and operating expenditures. Regulatory initiatives, proposed rules, and court challenges to adopted rules, have the potential to have a material effect on our capital expenditures and operating costs. These initiatives, proposed rules, and court challenges include:


·

The President's announced plan and directive to the EPA to regulate carbon pollution, or GHG emissions, from new and existing electric power generation, which is discussed below.


·

Rules to regulate NOx and SO2 emissions, including the EPA's Cross State Air Pollution Rule (CSAPR), which is currently vacated as a result of a federal appellate court ruling; and Wisconsin's plan for implementing the EPA's Clean Air Visibility Rule (CAVR). In June 2013, the U.S. Supreme Court indicated that it would review the CSAPR appellate court ruling. The Sierra Club has sought federal appellate court review of Wisconsin's implementation plan for CAVR. Both the vacation of CSAPR and the appellate court review of Wisconsin's implementation plan for CAVR make the nature of compliance requirements uncertain.


·

Rules to regulate mercury and similar emissions, including Wisconsin's adopted Mercury Rule and the EPA's adopted Mercury and Air Toxics Standards.


·

The EPA's proposed cooling water intake rules. The EPA issued a proposed Phase II rule and alternative compliance strategies for existing facilities in April 2011 and has announced that it intends to release the final rule in November 2013.


The matters in the second, third, and fourth bullet points are discussed further in Footnote 18.e. in MGE Energy's and MGE's 2012 Annual Report on Form 10-K. In addition to the developments noted above, the following discussion is an update to the current status of environmental matters set forth in that Footnote.


Water Quality


EPA's Proposed Effluent Limitations Guidelines and Standards for Steam Electric Power Generating Point Source Category

In June 2013, the EPA published a proposed rule focusing on the reduction of metals and other pollutants in wastewater from new and existing coal-burning electric generation plants. The proposed rule is technology-driven in that specific technologies may need to be installed and sites that already have these technologies will be deemed to meet the requirements of the rule. The proposed rule as written will likely affect Columbia and the Elm Road Units. The EPA has announced that it plans to finalize the rule by May 22, 2014 and that it expects the rule to affect power plants as they renew their water discharge permits beginning in July 2017. We are currently evaluating the rule's specific impacts at these sites and will not know the full extent of those impacts until the rule is finalized.


Air Quality


Greenhouse Gas Regulation


President Obama's Executive Order Regarding Climate Change and his Directive to the EPA Regarding Power Sector Pollution Standards

In June 2013, President Obama introduced his "National Climate Action Plan." The plan consists of planned federal actions and directives to several federal agencies, including the EPA, on a range of activities and policies designed to reduce greenhouse gas emissions in the United States. The directive to the EPA, which President Obama provided to the EPA in a memo, to develop carbon pollution standards for the electric power sector, has the greatest potential effect on MGE's operations. See the GHG New Performance Standards discussion below for additional details.




18




GHG New Source Performance Standards (NSPS)

In a June 2013 directive, President Obama instructed the EPA to re-propose greenhouse gas standards for new power plants by September 20, 2013, based on comments received on their original rule proposal issued in March 2012, and to finalize those standards in a timely manner. The EPA met the President's directive and published revised proposed standards for new power plants in September 2013, that would require, if finalized, that new coal-fired units and small natural gas units meet carbon dioxide emission levels significantly below current levels.


The June 2013 directive also instructed the EPA to propose standards, regulations or guidelines for modified, reconstructed and existing power plants under Sections 111(b) and 111(d) of the Clean Air Act no later than June 2014 and to finalize those standards by June 2015. The directive further instructs the EPA to require states to submit implementation plans for this rule by June 30, 2016. The Directive asks the EPA to aim to develop a market-based approach towards carbon reduction, promote cleaner technologies while keeping energy options diverse, work with other government agencies to keep energy affordable and improve energy efficiencies, and engage States, the power industry, and the other key stakeholders in establishing and implementing strategies for greenhouse gas reductions.


While it is too early to predict with any certainty the specific costs that MGE will incur with implementation of a greenhouse gas reduction rule introduced under Section 111 of the Clean Air Act, it is reasonable to assume that costs of implementation of this rule could be significant depending on the approach taken.


Columbia


MGE and two other utilities jointly own Columbia, a coal-fired generating facility, which accounts for 225 MW (29%) of MGE's net summer generating capability. WPL is the plant operator and permit holder, and owns 46.2% of Columbia. Wisconsin Public Service Corporation (WPSC) owns a 31.8% interest, and MGE owns a 22% interest in Columbia. Based upon current available information, compliance with various environmental requirements and initiatives is expected to result in significant additional operating and capital expenditures at Columbia as noted below.


Columbia Environmental Project

See Footnote 4 for information regarding the Columbia environmental construction project.


Title V Operating Permit Petition

As discussed in Footnote 18.e. in MGE Energy's and MGE's 2012 Annual Report on Form 10-K, the WDNR's renewal of WPL's Title V operating permit for Columbia has been the subject of litigation initiated by a citizen group. On February 4, 2013, the parties involved dismissed the litigation without prejudice. The resolution of the Clean Air Act litigation, discussed below, included resolution of the citizen group's challenge to the renewal of the Columbia Title V operating permit. By letter dated July 30, 2013, the EPA withdrew its proposal that WPL apply to the EPA for the issuance of the renewed Columbia Title V permit. MGE believes the permits currently in effect for Columbia remain in effect at this time and will now be renewed by the WDNR. MGE continues to follow these developments and is unable to predict the outcome of this matter and its impact on its operations or financial condition.


Columbia Clean Air Act Litigation

In December 2009, the EPA sent a notice of violation (NOV) to MGE as one of the co-owners of Columbia. The NOV alleges that WPL, as owner-operator, and the other co-owners failed to comply with appropriate pre-construction review and permitting requirements and, as a result, violated the PSD program requirements, the Title V operating permit requirements of the CAA and the Wisconsin State Implementation Plan (SIP). In April 2013, the EPA filed a lawsuit against the co-owners of Columbia asserting similar allegations. In September 2010 and April 2013, Sierra Club filed lawsuits against WPL alleging violations of the CAA at Columbia and other WPL-operated Wisconsin facilities.


In April 2013, WPL, as owner-operator, along with the other owners of Columbia, entered into a consent decree with the EPA and the Sierra Club to resolve these claims, while admitting no liability. In June 2013, the consent decree was approved and entered by the Court. The consent decree requires installation of the following emission controls at Columbia: scrubbers and baghouses at Columbia Units 1 and 2 by December 31, 2014, and an SCR system at Columbia Unit 2 by December 31, 2018. In addition, the consent decree establishes emission rate limits for SO2, nitrogen oxide (NOx), and particulate matter for Columbia Units 1 and 2. The consent decree also includes annual plant-wide emission caps for SO2 and NOx for



19




Columbia. MGE also paid approximately $0.2 million as its share of a civil penalty and will complete approximately $0.6 million in environmental mitigation projects. MGE intends to seek recovery in rates of the costs associated with its compliance with the terms of the final consent decree and currently expects to recover any material compliance costs.


b.

Chattel Paper Agreement and Other Guarantees - MGE Energy and MGE.


MGE makes available to qualifying customers a financing program for the purchase and installation of energy-related equipment that will provide more efficient use of utility service at the customer's property. MGE is party to a chattel paper purchase agreement with a financial institution under which it can sell or finance an undivided interest with recourse, in up to $10.0 million of the financing program receivables, until July 31, 2014. At September 30, 2013, MGE has outstanding a $5.0 million interest in these receivables. MGE retains the servicing responsibility for these receivables. As of September 30, 2013, the servicing asset recognized by MGE is $0.3 million.


MGE accounts for servicing rights under the amortization method. Initial determination of the servicing asset fair value is based on the present value of the estimated future cash flows. The discount rate is based on the PSCW authorized weighted cost of capital.


MGE would be required to perform under its guarantee if a customer defaulted on its loan. The energy-related equipment installed at the customer sites is used to secure the customer loans. The loan balances outstanding at September 30, 2013, approximate the fair value of the energy-related equipment acting as collateral. The length of the MGE guarantee to the financial institution varies from one to ten years depending on the term of the underlying customer loan. Principal payments for the remainder of 2013 and the next four years on the loans are:


(In thousands)

 

2013

 

2014

 

2015

 

2016

 

2017

Chattel Paper

$

213

$

621

$

937

$

862

$

455


c.

Legal Matters - MGE Energy and MGE.


MGE is involved in various legal matters that are being defended and handled in the normal course of business. MGE maintains accruals for such costs that are probable of being incurred and subject to reasonable estimation. The accrued amount for these matters is not material to the financial statements.


d.

Purchase Contracts - MGE Energy and MGE.


MGE Energy and MGE have entered into various commodity supply, transportation, and storage contracts to meet their obligations to deliver electricity and natural gas to customers. As of September 30, 2013, the future commitments related to these purchase contracts were as follows:


(In thousands)

 

2013

 

2014

 

2015

 

2016

 

2017

Coal(a)

$

7,407

$

17,705

$

9,921

$

3,770

$

1,040

Natural gas supply(b)

 

14,549

 

13,601

 

-

 

-

 

-

Purchase power(c)

 

49,397

 

49,262

 

47,776

 

48,795

 

49,816

Other

 

1,691

 

-

 

-

 

-

 

-

 

$

73,044

$

80,568

$

57,697

$

52,565

$

50,856


(a)

Total coal commitments for the Columbia and Elm Road Units, including transportation. Fuel procurement for MGE's jointly owned Columbia and Elm Road Units are handled by WPL and WEPCO, respectively, who are the operators of those facilities. If any minimum purchase obligations must be paid under these contracts, management believes these obligations would be considered costs of service and recoverable in rates.


(b)

These commitments include market-based pricing. Management expects to recover these costs in future customer rates.


(c)

MGE has several purchase power agreements to help meet future electric supply requirements. Management expects to recover these costs in future customer rates.




20




9.

Derivative and Hedging Instruments - MGE Energy and MGE.


a.

Purpose.


As part of its regular operations, MGE enters into contracts, including options, swaps, futures, forwards, and other contractual commitments, to manage its exposure to commodity prices and gas revenues. To the extent that these contracts are derivatives, MGE assesses whether or not the normal purchases or normal sales exclusion applies. For contracts to which this exclusion cannot be applied, MGE Energy and MGE recognize such derivatives in the consolidated balance sheets at fair value. The majority of MGE's derivative activities are conducted in accordance with its electric and gas risk management program, which is approved by the PSCW and limits the volume MGE can hedge with specific risk management strategies. The maximum length of time over which cash flows related to energy commodities can be hedged is four years. If the derivative qualifies for regulatory deferral, the derivatives are marked to fair value and are offset with a corresponding regulatory asset or liability. The deferred gain or loss is recognized in earnings in the delivery month applicable to the instrument. Gains and losses related to hedges qualifying for regulatory treatment are recoverable in gas rates through the PGA or in electric rates as a component of the fuel rules mechanism.


b.

Notional Amounts.


The gross notional volume of open derivatives is as follows:


 

September 30, 2013

 

December 31, 2012

Commodity derivative contracts

300,195 MWh

 

444,650 MWh

Commodity derivative contracts

5,970,000 Dth

 

1,980,000 Dth

FTRs

3,099 MW

 

2,670 MW


c.

Financial Statement Presentation.


MGE Energy and MGE offset fair value amounts recognized for the right to reclaim collateral (a receivable) or the obligation to return collateral (a payable) against fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting agreement.


MGE purchases and sells exchange-traded and over-the-counter options, swaps, and future contracts. These arrangements are primarily entered into to help stabilize the price risk associated with gas or power purchases. These transactions are employed by both MGE's gas and electric segments. Additionally, as a result of the firm transmission agreements that MGE holds on transmission paths in the MISO market, MGE holds FTRs. An FTR is a financial instrument that entitles the holder to a stream of revenues or charges based on the differences in hourly day-ahead energy prices between two points on the transmission grid. The fair values of these instruments are reflected as a regulatory asset/liability depending on whether they are in a net loss/gain position. Depending on the nature of the instrument, the gain or loss associated with these transactions will be reflected as cost of gas sold, fuel for electric generation, or purchased power expense in the delivery month applicable to the instrument. At September 30, 2013, and December 31, 2012, the fair value of exchange traded derivatives and FTRs exceeded their cost basis by $0.9 million and $0.3 million, respectively.


MGE is a party to a ten-year purchased power agreement that provides MGE with firm capacity and energy during a base term from June 1, 2012, through May 31, 2022. The agreement also allows MGE an option to extend the contract after the base term. The agreement is accounted for as a derivative contract and is recognized at its fair value on the consolidated balance sheet. However, the derivative qualifies for regulatory deferral and is recognized with a corresponding regulatory asset or liability depending on whether the fair value is in a loss or gain position. The fair value of the contract at September 30, 2013, and December 31, 2012, reflects a loss position of $69.0 million and $72.6 million, respectively. The actual fuel cost will be recognized in purchased power expense in the month of purchase.




21




The following table summarizes the fair value of the derivative instruments on the consolidated balance sheet. All derivative instruments in this table are presented on a gross basis and are calculated prior to the netting of instruments with the same counterparty under a master netting agreement as well as the netting of collateral. For financial statement purposes, MGE Energy and MGE have netted instruments with the same counterparty under a master netting agreement as well as the netting of collateral.


 

Asset Derivatives

 

Liability Derivatives

(In thousands)

Balance Sheet Location

 

Fair Value

 

Balance Sheet Location

 

Fair Value

September 30, 2013

 

 

 

 

 

 

 

Commodity derivative contracts

Other current assets

$

608

Derivative liability (current)

$

213

Commodity derivative contracts

Other deferred charges

 

32

 

Derivative liability (long-term)

 

18

FTRs

Other current assets

 

528

 

Derivative liability (current)

 

-

Ten-year PPA

N/A

 

N/A

 

Derivative liability (current)

 

9,310

Ten-year PPA

N/A

 

N/A

 

Derivative liability (long-term)

 

59,710

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

Commodity derivative contracts

Other current assets

$

365

 

Derivative liability (current)

$

394

Commodity derivative contracts

Other deferred charges

 

95

 

Derivative liability (long-term)

 

11

FTRs

Other current assets

 

206

 

Derivative liability (current)

 

-

Ten-year PPA

N/A

 

N/A

 

Derivative liability (current)

 

9,270

Ten-year PPA

N/A

 

N/A

 

Derivative liability (long-term)

 

63,320


The following tables show the effect of netting arrangements for recognized derivative assets and liabilities that are subject to a master netting arrangement or similar arrangement on the balance sheet.


Offsetting of Derivative Assets

 

 

Gross amounts

 

Gross amounts

offset in

balance sheet

 

Collateral

posted against

derivative positions

 

Net amount

presented in

balance sheet

 

 

 

 

 

(In thousands)

 

 

 

 

September 30, 2013

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

 640

$

 (231)

$

 -   

$

 409

FTRs

 

 528

 

 -   

 

 -   

 

 528

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

 460

$

 (405)

$

 -   

$

 55

FTRs

 

 206

 

 -   

 

 -   

 

 206


Offsetting of Derivative Liabilities

 

 

Gross amounts

 

Gross amounts

offset in

balance sheet

 

Collateral

posted against

derivative positions

 

Net amount

presented in

balance sheet

 

 

 

 

 

(In thousands)

 

 

 

 

September 30, 2013

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

 231

$

 (231)

$

 -   

$

 -   

Ten-year PPA

 

 69,020

 

 -   

 

 -   

 

 69,020

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

 405

$

 (405)

$

 -   

$

 -   

Ten-year PPA

 

 72,590

 

 -   

 

 -   

 

 72,590




22




The following tables summarize the unrealized and realized gains and losses related to the derivative instruments on the consolidated balance sheet at September 30, 2013 and 2012, and the consolidated income statement for the three and nine months ended September 30, 2013 and 2012.


 

 

2013

 

 

2012

(In thousands)

 

Current and long-term regulatory asset

 

Other current assets

 

 

Current and long-term regulatory asset

 

Other current assets

Three Months Ended September 30:

 

 

 

 

 

 

 

 

 

Balance at July 1,

$

66,649

$

658

 

$

79,362

$

718

Change in unrealized loss (gain)

 

2,330

 

-

 

 

(468)

 

-

Realized loss reclassified to a deferred account

 

(275)

 

275

 

 

(223)

 

223

Realized loss reclassified to income

 

 

 

 

 

 

 

 

 

statement

 

(621)

 

(111)

 

 

(3,414)

 

(161)

Balance at September 30,

$

68,083

$

822

 

$

75,257

$

780

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30:

 

 

 

 

 

 

 

 

 

Balance at January 1,

$

72,329

$

574

 

$

42,356

$

1,604

Change in unrealized loss (gain)

 

(1,330)

 

-

 

 

42,633

 

-

Realized loss reclassified to a deferred account

 

(953)

 

953

 

 

(3,103)

 

3,103

Realized loss reclassified to income

 

 

 

 

 

 

 

 

 

statement

 

(1,963)

 

(705)

 

 

(6,629)

 

(3,927)

Balance at September 30,

$

68,083

$

822

 

$

75,257

$

780


 

 

Realized losses (gains)

 

 

Regulated

gas revenues

 

Fuel for electric

generation/

purchased power

 

Cost of

gas sold

 

 

 

 

(In thousands)

 

 

 

Three Months Ended September 30, 2013:

 

 

 

 

 

 

Commodity derivative contracts

$

-

$

(7)

$

-

FTRs

 

-

 

(387)

 

-

Ten-year PPA

 

-

 

1,126

 

-

 

 

 

 

 

 

 

Three Months Ended September 30, 2012:

 

 

 

 

 

 

Commodity derivative contracts

$

-

$

176

$

-

FTRs

 

-

 

(256)

 

-

Ten-year PPA

 

-

 

3,655

 

-

 

 

 

 

 

 

 

Nine Months Ended September 30, 2013:

 

 

 

 

 

 

Commodity derivative contracts

$

-

$

(523)

$

608

FTRs

 

-

 

(896)

 

-

Ten-year PPA

 

-

 

3,479

 

-

 

 

 

 

 

 

 

Nine Months Ended September 30, 2012:

 

 

 

 

 

 

Commodity derivative contracts

$

-

$

2,685

$

3,090

FTRs

 

-

 

(93)

 

-

Ten-year PPA

 

-

 

4,874

 

-


MGE's commodity derivative contracts, FTRs, and ten-year PPA are subject to regulatory deferral. These derivatives are marked to fair value and are offset with a corresponding regulatory asset or liability. Realized gains and losses are deferred on the consolidated balance sheet and are recognized in earnings in the delivery month applicable to the instrument. As a result of the above described treatment, there are no unrealized gains or losses that flow through earnings.


The ten-year PPA has a provision that may require MGE to post collateral if MGE's debt rating falls below investment grade (i.e., below BBB-). The amount of collateral that it may be required to post varies from $20.0 million to $40.0 million, depending on MGE's nominated capacity amount. As of September 30, 2013, no collateral has been posted. Certain counterparties extend MGE a credit limit. If MGE exceeds these limits, the counterparties may require collateral to be posted. As of September 30, 2013, and December 31, 2012, no counterparties were in a net liability position.



23




Nonperformance of counterparties to the non-exchange traded derivatives could expose MGE to credit loss. However, MGE enters into transactions only with companies that meet or exceed strict credit guidelines, and it monitors these counterparties on an ongoing basis to mitigate nonperformance risk in its portfolio. As of September 30, 2013, no counterparties have defaulted.


10.

Rate Matters - MGE Energy and MGE.


a.

Rate Proceedings.


On July 26, 2013, the PSCW authorized MGE to freeze electric and natural gas rates at 2013 levels for 2014. The order includes authorizing 100% AFUDC on the Columbia scrubber construction project and deferral of increased costs related to ATC and MISO Schedule 26 fees. As part of the rate freeze plan authorized by the PSCW, effective January 1, 2014 approximately $6.2 million associated with a 2012 fuel rule surplus credit will not be required to be refunded to customers and will be amortized in 2014. The fuel credit will accrue interest at MGE's weighted cost of capital. The authorized return on equity will remain unchanged at 10.3%.


On December 14, 2012, the PSCW authorized MGE to increase 2013 rates for retail electric customers by 3.8% or $14.9 million and to increase gas rates by 1.0% or $1.6 million. The change in retail electric rates was driven by costs for new environmental equipment at Columbia, final construction costs for the Elm Road Units, transmission reliability enhancements, and purchased power costs. The authorized return on common stock equity remains unchanged at 10.3%.


On December 15, 2011, under a limited reopener of MGE's last rate order, the PSCW authorized MGE to increase 2012 rates for retail electric customers by 4.3% or $15.7 million and to increase gas rates by 0.3% or $0.6 million. The change in retail electric rates was driven by MGE's electric fuel and purchased power costs, increased transmission costs, an update to the Elm Road Units' costs, and an increase for energy efficiency programs. The PSCW also approved deferral of CSAPR costs.


b.

Fuel Rules.


Fuel rules require the PSCW and Wisconsin utilities to defer electric fuel-related costs that fall outside a symmetrical cost tolerance band around the amount approved for a utility in its most recent base rate proceedings. Any over/under recovery of the actual costs is determined on an annual basis and will be adjusted in future billings to electric retail customers. The fuel rules bandwidth is currently set at plus or minus 2%. Under fuel rules, MGE would defer costs, less any excess revenues, if its actual electric fuel costs exceeded 102% of the electric fuel costs allowed in its latest rate order. Excess revenues are defined as revenues in the year in question that provide MGE with a greater return on common equity than authorized by the PSCW in MGE's latest rate order. Conversely, MGE is required to defer the benefit of lower costs if actual electric fuel costs were less than 98% of the electric fuel costs allowed in that order. As of September 30, 2013, MGE has deferred $4.4 million (to be returned to customers in a future period) of 2013 electric fuel-related savings that are outside the range authorized by the PSCW.


11.

Fair Value of Financial Instruments - MGE Energy and MGE.


Fair value is defined as the price that would be received to sell an asset or would be paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The standard clarifies that fair value should be based on the assumptions market participants would use when pricing the asset or liability including assumptions about risk. The standard also establishes a three level fair value hierarchy based upon the observability of the assumptions used and requires the use of observable market data when available. The levels are:


Level 1 - Pricing inputs are quoted prices within active markets for identical assets or liabilities.


Level 2 - Pricing inputs are quoted prices within active markets for similar assets or liabilities; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations that are correlated with or otherwise verifiable by observable market data.


Level 3 - Pricing inputs are unobservable and reflect management's best estimate of what market participants would use in pricing the asset or liability.




24




a.

Fair Value of Financial Assets and Liabilities Recorded at the Carrying Amount.


At September 30, 2013, and December 31, 2012, the carrying amount of cash and cash equivalents approximates fair market value due to the short maturity of those investments and obligations. The estimated fair market value of MGE Energy's and MGE's long-term debt is based on quoted market prices for similar financial instruments at September 30, 2013, and December 31, 2012. Since the long-term debt is not traded in an active market, it is classified as Level 2. The estimated fair market value of MGE Energy's and MGE's financial instruments are as follows:


 

 

September 30, 2013

 

 

December 31, 2012

 

 

Carrying

Amount

 

Fair

Value

 

 

Carrying

Amount

 

Fair

Value

(In thousands)

 

 

 

 

MGE Energy

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

    Cash and cash equivalents

$

75,330

$

75,330

 

$

46,357

$

46,357

Liabilities:

 

 

 

 

 

 

 

 

 

    Long-term debt*

 

404,805

 

445,247

 

 

361,805

 

427,456

 

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

    Cash and cash equivalents

$

42,590

$

42,590

 

$

6,350

$

6,350

Liabilities:

 

 

 

 

 

 

 

 

 

    Long-term debt*

 

404,805

 

445,247

 

 

361,805

 

427,456


*Includes long-term debt due within one year.

 

 

 

 

 

 

 


b.

Recurring Fair Value Measurements.


The following table presents the balances of assets and liabilities measured at fair value on a recurring basis for MGE Energy and MGE.


 

 

Fair Value as of September 30, 2013

(In thousands)

 

Total

 

Level 1

 

Level 2

 

Level 3

MGE Energy

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

    Exchange-traded investments

$

613

$

613

$

-

$

-

    Total Assets

$

613

$

613

$

-

$

-

Liabilities:

 

 

 

 

 

 

 

 

    Derivatives, net

$

68,083

$

(245)

$

-

$

68,328

    Deferred compensation

 

2,253

 

-

 

2,253

 

-

    Total Liabilities

$

70,336

$

(245)

$

2,253

$

68,328

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

    Exchange-traded investments

$

246

$

246

$

-

$

-

    Total Assets

$

246

$

246

$

-

$

-

Liabilities:

 

 

 

 

 

 

 

 

    Derivatives, net

$

68,083

$

(245)

$

-

$

68,328

    Deferred compensation

 

2,253

 

-

 

2,253

 

-

    Total Liabilities

$

70,336

$

(245)

$

2,253

$

68,328

 

 

 

 

 

 

 

 

 




25





 

 

Fair Value as of December 31, 2012

(In thousands)

 

Total

 

Level 1

 

Level 2

 

Level 3

MGE Energy

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

    Exchange-traded investments

$

320

$

320

$

-

$

-

    Total Assets

$

320

$

320

$

-

$

-

Liabilities:

 

 

 

 

 

 

 

 

    Derivatives, net

$

72,329

$

(17)

$

-

$

72,346

    Deferred compensation

 

2,010

 

-

 

2,010

 

-

Total Liabilities

$

74,339

$

(17)

$

2,010

$

72,346

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

    Exchange-traded investments

$

117

$

117

$

-

$

-

    Total Assets

$

117

$

117

$

-

$

-

Liabilities:

 

 

 

 

 

 

 

 

    Derivatives, net

$

72,329

$

(17)

$

-

$

72,346

    Deferred compensation

 

2,010

 

-

 

2,010

 

-

    Total Liabilities

$

74,339

$

(17)

$

2,010

$

72,346


No transfers were made in or out of Level 1 or Level 2 for the nine months ended September 30, 2013.


Investments include exchange-traded investment securities valued using quoted prices on active exchanges and are therefore classified as Level 1.


Derivatives include exchange-traded derivative contracts, over-the-counter transactions, a ten-year purchased power agreement, and FTRs. Most exchange-traded derivative contracts are valued based on unadjusted quoted prices in active markets and are therefore classified as Level 1. A small number of exchange-traded derivative contracts are valued using quoted market pricing in markets with insufficient volumes and are therefore classified as Level 3. Transactions done with an over-the-counter party are on inactive markets and are therefore classified as Level 3. These transactions are valued based on quoted prices from markets with similar exchange traded transactions. FTRs are priced based upon monthly auction results for identical or similar instruments in a closed market with limited data available and are therefore classified as Level 3.


The ten-year purchased power agreement (see Footnote 9) was valued using an internally-developed pricing model and therefore is classified as Level 3. The model projects future market energy prices and compares those prices to the projected power costs to be incurred under the contract. Inputs to the model require significant management judgment and estimation. Future energy prices are based on a forward power pricing curve using exchange-traded contracts in the electric futures market, where such exchange-traded contracts exist, and upon calculations based on forward gas prices, where such exchange-traded contracts do not exist. A basis adjustment is applied to the market energy price to reflect the price differential between the market price delivery point and the counterparty delivery point. The historical relationship between the delivery points is reviewed and a discount (below 100%) or premium (above 100%) is derived. This comparison is done for both peak times when demand is high and off peak times when demand is low. If the basis adjustment is lowered, the fair value measurement will decrease and if the basis adjustment is increased, the fair value measurement will increase.


The projected power costs anticipated to be incurred under the purchased power agreement are determined using many factors, including historical generating costs, future prices, and expected fuel mix of the counterparty. An increase in the projected fuel costs would result in a decrease in the fair value measurement of the purchased power agreement. A significant input that MGE estimates is the counterparty's fuel mix in determining the projected power cost. MGE also considers the assumptions that market participants would use in valuing the asset or liability. This consideration includes assumptions about market risk such as liquidity, volatility, and contract duration. The fair value model uses a discount rate that incorporates discounting, credit, and model risks.




26




This model is prepared by members of MGE's Energy Supply group. It is reviewed on a quarterly basis by management in Energy Supply and Finance to review the assumptions, inputs, and fair value measurements.


The following table presents the significant unobservable inputs used in the pricing model.


Significant Unobservable Inputs

 

Model Input

Basis adjustment:

 

 

    On peak

 

99.7%

    Off peak

 

97.9%

Counterparty fuel mix:

 

 

    Internal generation

 

50 % - 70 %

    Purchased power

 

50 % - 30 %


The deferred compensation plan allows participants to defer certain cash compensation into a notional investment account. These amounts are included within other deferred liabilities in the consolidated balance sheets of MGE Energy and MGE. The notional investments earn interest based upon the semiannual rate of U.S. Treasury Bills having a 26 week maturity increased by 1% compounded monthly with a minimum annual rate of 7%, compounded monthly. The notional investments are based upon observable market data, however, since the deferred compensation obligations themselves are not exchanged in an active market, they are classified as Level 2.


The following table summarizes the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for both MGE Energy and MGE.


 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

(In thousands)

 

2013

 

2012

 

2013

 

2012

Beginning balance,

$

(66,856)

$

(79,580)

$

(72,346)

$

(40,661)

Realized and unrealized gains (losses):

 

 

 

 

 

 

 

 

    Included in regulatory liabilities (assets)

 

(1,472)

 

3,465

 

4,018

 

(35,455)

    Included in other comprehensive income

 

-

 

-

 

-

 

-

    Included in earnings

 

(174)

 

(3,422)

 

(2,034)

 

(6,659)

    Included in current assets

 

(38)

 

-

 

(94)

 

(77)

Purchases

 

6,052

 

5,864

 

17,709

 

7,764

Sales

 

-

 

45

 

(2)

 

77

Issuances

 

-

 

-

 

-

 

-

Settlements

 

(5,840)

 

(2,487)

 

(15,579)

 

(1,104)

Transfers in and/or out of Level 3

 

-

 

-

 

-

 

-

Balance as of September 30,

$

(68,328)

$

(76,115)

$

(68,328)

$

(76,115)

Total gains (losses) included in earnings attributed to

the change in unrealized gains (losses) related to assets

and liabilities held at September 30,(a)

 

-

 

-

 

-

 

-

 

 

 

 

$

$

$

$


The following table presents total realized and unrealized gains (losses) included in income for Level 3 assets and liabilities measured at fair value on a recurring basis for both MGE Energy and MGE(a).


 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

(In thousands)

 

2013

 

2012

 

2013

 

2012

Purchased Power Expense

$

(174)

$

(3,422)

$

(2,034)

$

(6,659)

Cost of Gas Sold Expense

 

-

 

-

 

-

 

-

Regulated Gas Revenues

 

-

 

-

 

-

 

-

Total

$

(174)

$

(3,422)

$

(2,034)

$

(6,659)


(a)

MGE's exchange-traded derivative contracts, over-the-counter party transactions, ten-year purchased power agreement, and FTRs are subject to regulatory deferral. These derivatives are therefore marked to fair value and are offset with a corresponding regulatory asset or liability.




27




12.

New Accounting Pronouncements - MGE Energy and MGE.


a.

Presentation of Comprehensive Income.


In February 2013, the FASB issued authoritative guidance within the Codification's Comprehensive Income topic that provides guidance on the reporting of amounts reclassified out of accumulated other comprehensive income. Reclassification adjustments will be presented either on the financial statement where income is presented or as a separate disclosure in the notes to the financial statements. This authoritative guidance became effective January 1, 2013. The authoritative guidance had no effect on our financial statement presentation or notes to the financial statements.


b.

Disclosures about Offsetting Assets and Liabilities.


In December 2011, the FASB issued authoritative guidance within the Codification's Balance Sheet topic that provides guidance on disclosures about offsetting assets and liabilities. The new disclosure requirements mandate that entities disclose both gross and net information for instruments and transactions eligible for offset in the balance sheet as well as instruments and transactions subject to a master netting arrangement. In addition, the standard requires disclosure of collateral received and posted in connections with a master netting arrangement. On January 31, 2013, the FASB issued additional authoritative guidance which clarified the scope of disclosures about offsetting assets and liabilities. The revised guidance limits the scope of the new balance sheet offsetting disclosures to derivatives, repurchase agreements, and securities lending transactions to the extent that they are (1) offset in the financial statements or (2) subject to an enforceable master netting arrangement or similar agreement. This authoritative guidance became effective January 1, 2013. The authoritative guidance did not have a financial impact, but required additional disclosures. See Footnote 9 for additional information.


c.

Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date.


In February 2013, the FASB issued authoritative guidance within the Codification's Balance Sheet topic that provides guidance on the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date. This authoritative guidance will become effective January 1, 2014. The authoritative guidance will not have a financial or disclosure impact.


d.

Presentation of an Unrecognized Tax Benefit.


In July 2013, the FASB issued authoritative guidance within the Codification's Income Statement topic that provides guidance on the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exist. The authoritative guidance was issued to eliminate diversity in practice by providing guidance on the presentation of unrecognized tax benefits. This authoritative guidance will become effective January 1, 2014. The authoritative guidance will not have a financial statement or disclosure impact, unless MGE Energy or its subsidiaries are in a net operating loss position. We do not expect to be in a net operating loss position in 2014.


13.

Segment Information - MGE Energy and MGE.


MGE Energy operates in the following business segments: electric utility, gas utility, nonregulated energy, transmission investment, and all other. See MGE Energy's and MGE's 2012 Annual Report on Form 10-K for additional discussion of each of these segments.



28




The following tables show segment information for MGE Energy's operations for the indicated periods:


(In thousands)

MGE Energy

 

Electric

 

Gas

 

Non-

Regulated

Energy

 

Transmission

Investment

 

All

Others

 

Consolidation/