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MGE ENERGY INC - Quarter Report: 2010 September (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, 2010


[ ] 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 53703

(608) 252-7000

www.mgeenergy.com

 

39-2040501

000-1125

 

Madison Gas and Electric Company

(a Wisconsin Corporation)

133 South Blair Street

Madison, Wisconsin 53703

(608) 252-7000

www.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 its corporate Web site, 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 registrant was 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 29, 2010

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.).





Page 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.

5

MGE Energy, Inc.

5

Consolidated Statements of Income (unaudited)

5

Consolidated Statements of Cash Flows (unaudited)

6

Consolidated Balance Sheets (unaudited)

7

Consolidated Statements of Equity (unaudited)

8

Madison Gas and Electric Company

9

Consolidated Statements of Income (unaudited)

9

Consolidated Statements of Cash Flows (unaudited)

10

Consolidated Balance Sheets (unaudited)

11

Consolidated Statements of Equity (unaudited)

12

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

13

Notes to Consolidated Financial Statements (unaudited)

13

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

37

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

58

Item 4. Controls and Procedures.

61

Item 4T. Controls and Procedures.

61

PART II. OTHER INFORMATION.

62

Item 1. Legal Proceedings.

62

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

62

Item 6. Exhibits.

62

Signatures - MGE Energy, Inc.

63

Signatures - Madison Gas and Electric Company

64





Page 2



PART I. FINANCIAL INFORMATION.


Filing Format


This combined quarterly report on 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," 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 following sections of the Registrants' 2009 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 9 in this report; and (b) other factors discussed herein and in other filings with the SEC by the registrants.


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 publicly release 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 Web site maintained by the SEC at http://www.sec.gov, MGE Energy's Web site at http://www.mgeenergy.com, and MGE's Web site at http://www.mge.com. Copies may be obtained from our Web sites free of charge. Information contained on MGE Energy's and MGE's Web sites shall not be deemed incorporated into, or to be a part of, this report.





Page 3



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


ACESA

American Clean Energy and Security Act of 2009

AFUDC

Allowance for funds used during construction

ANPR

Advanced Notice of Proposed Rulemaking

ARO

Asset Retirement Obligation

ASM

Ancillary Services Market

ATC

American Transmission Company, LLC

BACT

Best available control technology

Blount

Blount Station

CAA

Clean Air Act

CAIR

Clean Air Interstate 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

DOE

U.S. Department of Energy

Dth

Dekatherms

Elm Road Units

Elm Road Generating Station

EPA

U.S. Environmental Protection Agency

ERISA

Employee Retirement Income Security Act

ERS

Elm Road Services, LLC

FASB 

Financial Accounting Standards Board

FERC

Federal Energy Regulatory Commission

FTR

Financial Transmission Rights

GCIM

Gas cost incentive mechanism

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

ICR

Information Collection Request

IRS

Internal Revenue Service

kWh

Kilowatt-hour

MACT

Maximum available control technology

MGE

Madison Gas and Electric Company

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

MISO

Midwest Independent System Operator (a regional transmission organization)

MW

Megawatt

MWh

Megawatt-hour

NAAQS

National ambient air quality standard

NO2

Nitrogen dioxide

NOx

Nitrogen oxides

NOI

Notice of Intent

NOV

Notice of Violation

NSPS

New source performance standards

NSR

New Source Review

NYMEX

New York Mercantile Exchange

OPRB

Other postretirement benefits

PCBs

Polychlorinated biphenyls

PGA

Purchased Gas Adjustment clause

PJM

PJM Interconnection, LLC (a regional transmission organization)

PPA

Purchased power agreement

ppb

Parts per billion

ppm

Parts per million

PPACA

Patient Protection and Affordable Care Act

PSCW

Public Service Commission of Wisconsin

PSD

Prevention of Significant Deterioration

RTO

Regional Transmission Organization

SEC

Securities and Exchange Commission

SF6

Sulfur Hexafluoride

SIP

State Implementation Plan

SO2

Sulfur dioxide

Stock Plan

Direct Stock Purchase and Dividend Reinvestment Plan of MGE Energy

UW

University of Wisconsin-Madison

VIE

Variable interest entity

WCCF

West Campus Cogeneration Facility

WDNR

Wisconsin Department of Natural Resources

working capital

Current assets less current liabilities

WPDES

Wisconsin Pollutant Discharge Elimination System

WPL

Wisconsin Power and Light Company

WPSC

Wisconsin Public Service Corporation





Page 4



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,

 

2010

 

2009

 

2010

 

2009

Operating Revenues:


 






Regulated revenues

$127,243

 

$106,878


$393,512


$391,056

Nonregulated revenues

695

 

2,419


3,151


6,941

Total Operating Revenues

127,938

 

109,297


396,663


397,997

 


 






Operating Expenses:


 






Fuel for electric generation

12,622

 

9,917


31,765


27,220

Purchased power

18,603

 

22,736


56,537


68,512

Cost of gas sold

8,300

 

5,876


70,776


88,456

Other operations and maintenance

40,403

 

34,920


120,126


107,650

Depreciation and amortization

9,560

 

10,360


28,263


30,559

Other general taxes

4,098

 

4,379


12,947


13,481

Total Operating Expenses

93,586

 

88,188


320,414


335,878

Operating Income

34,352

 

21,109


76,249


62,119

 


 






Other income, net

2,646

 

2,004


9,314


6,017

Interest expense, net

(4,099)

 

(3,417)


(12,052)


(10,172)

Income before income taxes

32,899

 

19,696


73,511


57,964

Income tax provision

(12,990)

 

(6,974)


(27,790)


(20,397)

Net Income

$19,909

 

$12,722


$45,721


$37,567

 

 

 

 


 


 

Earnings per Share of Common Stock

(basic and diluted)

$0.86

 


$0.55

 

$1.98

 


$1.63

 

 

 

 

 

 

 

 

Dividends per share of common stock

$0.375

 

$0.368

 

$1.112

 

$1.092

 

 

 

 

 

 

 

 

Average Shares Outstanding (basic and diluted)

23,114

 

23,114


23,114


23,055


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





Page 5



MGE Energy, Inc.

Consolidated Statements of Cash Flows (unaudited)

(In thousands)



 

Nine Months Ended

September 30,

 

2010

 

2009

Operating Activities:


 


Net income

$45,721

 

$37,567

Items not affecting cash:


 


Depreciation and amortization

28,263

 

30,559

Deferred income taxes

9,229

 

1,756

Provision for doubtful accounts receivable

1,785

 

2,552

AFUDC - equity funds

(222)

 

(356)

Employee benefit plan expenses

9,068

 

5,558

Equity earnings in ATC

(6,374)

 

(6,112)

Gain on sale of property

(3,129)

 

(69)

Other items

1,870

 

1,662

Changes in working capital:


 


Decrease in current assets

27,514

 

56,764

Decrease in current liabilities

(10,639)

 

(20,672)

Dividend income from ATC

5,000

 

4,656

Cash contributions to pension and other postretirement plans

(15,333)

 

(12,811)

Other noncurrent items, net

4,627

 

3,176

Cash Provided by Operating Activities

97,380

 

104,230

 


 


Investing Activities:


 


Capital expenditures

(43,236)

 

(54,062)

Capital contributions to investments

(583)

 

(2,586)

Proceeds from sale of property

3,334

 

82

Other

(249)

 

(1,396)

Cash Used for Investing Activities

(40,734)

 

(57,962)

 


 


Financing Activities:


 


Issuance of common stock

-

 

6,275

Cash dividends paid on common stock

(25,700)

 

(25,178)

Repayment of long-term debt

(1,111)

 

-

Decrease in short-term debt, net

(16,000)

 

(24,500)

Other

(1,008)

 

51

Cash Used for Financing Activities

(43,819)

 

(43,352)

 


 


Change in Cash and Cash Equivalents

12,827

 

2,916

Cash and cash equivalents at beginning of period

4,704

 

4,106

Cash and cash equivalents at end of period

$17,531

 

$7,022


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





Page 6



MGE Energy, Inc.

Consolidated Balance Sheets (unaudited)

(In thousands)



 

September 30,

2010

 

December 31,

2009

ASSETS


 


 


 


Current Assets:


 


Cash and cash equivalents

$17,531

 

$4,704

Receivable - margin account

2,445

 

3,495

Accounts receivable, less reserves of $3,638 and $3,701, respectively

31,846

 

35,309

Other accounts receivable, less reserves of $615 and $541, respectively

4,941

 

3,041

Unbilled revenues

18,289

 

29,179

Materials and supplies, at average cost

17,939

 

15,931

Fossil fuel

8,290

 

7,870

Stored natural gas, at average cost

27,474

 

27,193

Prepaid taxes

11,009

 

30,036

Regulatory assets - current

2,914

 

-

Other current assets

7,665

 

8,323

Total Current Assets

150,343

 

165,081

Other long-term receivables

2,556

 

2,928

Regulatory assets

115,202

 

113,375

Other deferred assets and other

7,921

 

7,282

Property, Plant, and Equipment:


 


Property, Plant, and Equipment, Net

854,038

 

719,797

Construction work in progress

102,046

 

219,967

Total Property, Plant, and Equipment

956,084

 

939,764

Investments

55,154

 

53,455

Total Assets

$1,287,260

 

$1,281,885

 


 


LIABILITIES AND CAPITALIZATION


 


 


 


Current Liabilities:


 


Long-term debt due within one year

$1,667

 

$1,528

Short-term debt

48,500

 

64,500

Accounts payable

21,996

 

35,839

Accrued interest and taxes

10,787

 

4,028

Deferred income taxes

1,003

 

2

Other current liabilities

18,454

 

21,241

Total Current Liabilities

102,407

 

127,138

Other Credits:


 


Deferred income taxes

147,924

 

139,850

Investment tax credit - deferred

2,159

 

2,394

Regulatory liabilities

21,840

 

18,477

Accrued pension and other postretirement benefits

115,387

 

122,946

Other deferred liabilities and other

56,059

 

48,343

Total Other Credits

343,369

 

332,010

Capitalization:


 


Common shareholders' equity

521,745

 

501,795

Long-term debt

319,739

 

320,942

Total Capitalization

841,484

 

822,737

Commitments and contingencies (see Footnote 9)

-

 

-

Total Liabilities and Capitalization

$1,287,260

 

$1,281,885


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





Page 7



MGE Energy, Inc.

Consolidated Statements of Equity (unaudited)

(In thousands, except per-share amounts)



 

Common Stock

Additional

Paid-in

Capital

Retained

Earnings

Accumulated

Other

Comprehensive

(Loss)/Income

Total

Shares

Value

 







Beginning balance - Dec. 31, 2008

22,905

$22,905

$310,202

$144,904

$191

$478,202

Net income




37,567


37,567

Other comprehensive income/(loss):







Net unrealized loss on investments,

net of $27 tax





(41)

(41)

Common stock dividends declared

($1.092 per share)




(25,178)


(25,178)

Common stock issued, net

209

209

6,066



6,275

Ending Balance - Sept. 30, 2009

23,114

$23,114

$316,268

$157,293

$150

$496,825

 







Beginning balance - Dec. 31, 2009

23,114

$23,114

$316,268

$162,208

$205

$501,795

Net income




45,721


45,721

Other comprehensive income/(loss):







Net unrealized loss on investments,

net of $48 tax





(71)

(71)

Common stock dividends declared

($1.112 per share)




(25,700)


(25,700)

Ending Balance - Sept. 30, 2010

23,114

$23,114

$316,268

$182,229

$134

$521,745


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





Page 8



Madison Gas and Electric Company

Consolidated Statements of Income (unaudited)

(In thousands)



 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

2010

 

2009

 

2010

 

2009

Operating Revenues:


 






Regulated electric revenues

$109,849

 

$91,734


 $279,281


$253,059

Regulated gas revenues

17,394

 

15,144


 114,231


137,997

Nonregulated revenues

695

 

2,419


 3,151


6,941

Total Operating Revenues

127,938

 

109,297


 396,663


397,997

 


 



 



Operating Expenses:


 



 



Fuel for electric generation

12,622

 

9,917


 31,765


27,220

Purchased power

18,603

 

22,736


 56,537


68,512

Cost of gas sold

8,300

 

5,876


 70,776


88,456

Other operations and maintenance

40,147

 

34,805


 119,522


107,060

Depreciation and amortization

9,560

 

10,360


 28,263


30,559

Other general taxes

4,098

 

4,379


 12,947


13,481

Income tax provision

11,993

 

5,947


 24,096


17,287

Total Operating Expenses

105,323

 

94,020


 343,906


352,575

Operating Income

22,615

 

15,277


 52,757


45,422

 


 



 



Other Income and Deductions:


 



 



AFUDC - equity funds

97

 

129


 222


356

Equity earnings in ATC

2,092

 

2,110


 6,374


6,112

Income tax provision

(1,117)

 

(796)


 (3,894)


(2,508)

Other (deductions) income, net

461

 

(198)


 2,716


(406)

Total Other Income and Deductions

1,533

 

1,245


 5,418


3,554

Income before interest expense

24,148

 

16,522


 58,175


48,976

 


 



 



Interest Expense:


 



 



Interest on long-term debt

4,755

 

4,104


 14,028


12,313

Other interest, net

(670)

 

61


 (1,815)


93

AFUDC - borrowed funds

(38)

 

(52)


 (87)


(146)

Net Interest Expense

4,047

 

4,113


 12,126


12,260

Net Income

$20,101

 

$12,409


 $46,049


$36,716

Less: Net Income Attributable to Noncontrolling Interest, net of tax

(5,108)

 

(3,567)


 (15,104)


(10,427)

Net Income Attributable to MGE

$14,993

 

$8,842


 $30,945


$26,289


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





Page 9



Madison Gas and Electric Company

Consolidated Statements of Cash Flows (unaudited)

(In thousands)



 

Nine Months Ended

September 30,

 

2010

 

2009

Operating Activities:


 


Net income

$46,049

 

$36,716

Items not affecting cash:


 


Depreciation and amortization

28,263

 

30,559

Deferred income taxes

9,239

 

1,756

Provision for doubtful accounts receivable

1,785

 

2,552

AFUDC - equity funds

(222)

 

(356)

Employee benefit plan expenses

9,068

 

5,558

Equity earnings in ATC

(6,374)

 

(6,112)

Gain on sale of property

(3,129)

 

(69)

Other items

2,271

 

2,124

Changes in working capital:


 


Decrease in current assets

19,201

 

58,005

Decrease in current liabilities

(1,127)

 

(18,919)

Dividend income from ATC

5,000

 

4,656

Cash contributions to pension and other postretirement plans

(15,333)

 

(12,811)

Other noncurrent items, net

2,532

 

3,217

Cash Provided by Operating Activities

97,223

 

106,876

 


 


Investing Activities:


 


Capital expenditures

(43,236)

 

(54,062)

Capital contributions to investments

(533)

 

(2,486)

Proceeds from sale of property

3,334

 

82

Other

8

 

(188)

Cash Used for Investing Activities

(40,427)

 

(56,654)

 


 


Financing Activities:


 


Cash dividends paid to parent by MGE

(19,553)

 

(12,839)

Distributions to parent from noncontrolling interest

(50,293)

 

(8,031)

Equity contributions received by noncontrolling interest

533

 

2,486

Affiliate financing of Elm Road

(4,193)

 

2,528

Repayment of long-term debt

(1,111)

 

-

Issuance of long-term debt

50,000

 

-

Decrease in short-term debt, net

(19,000)

 

(31,000)

Other

(850)

 

-

Cash Used for Financing Activities

(44,467)

 

(46,856)

 


 


Change in Cash and Cash Equivalents

12,329

 

3,366

Cash and cash equivalents at beginning of period

2,474

 

1,318

Cash and cash equivalents at end of period

$14,803

 

$4,684


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





Page 10



Madison Gas and Electric Company

Consolidated Balance Sheets (unaudited)

(In thousands)



ASSETS

September 30,

2010

 

December 31,

2009

Utility Plant (At Original Cost, in Service):



 

Electric

$833,448


$806,083

Gas

300,057


293,666

Nonregulated

231,896


110,022

Gross plant in service

1,365,401


1,209,771

Less accumulated provision for depreciation

(511,918)


(490,354)

Net plant in service

853,483


719,417

Construction work in progress

102,046


219,967

Total Utility Plant

955,529


939,384

Investment in ATC

53,562


51,656

Other investments

739


897

Total Investments

54,301


52,553

Current Assets:




Cash and cash equivalents

14,803


2,474

Receivable - margin account

2,445


3,495

Accounts receivable, less reserves of $3,638 and $3,701, respectively

31,846


35,279

Affiliate receivables

572


2,572

Other receivables, less reserves of $615 and $541, respectively

4,939


3,038

Unbilled revenues

18,289


29,179

Materials and supplies, at average cost

17,939


15,931

Fossil fuel

8,290


7,870

Stored natural gas, at average cost

27,474


27,193

Prepaid taxes

10,099


18,833

Regulatory assets - current

2,914


-

Other current assets

7,626


8,295

Total Current Assets

147,236


154,159

Other long-term receivables

1,892


2,149

Affiliate receivable long-term

7,546


5,972

Regulatory assets

115,202


113,375

Other deferred assets and other

6,314


5,963

Total Assets

$1,288,020


$1,273,555

CAPITALIZATION AND LIABILITIES




Equity:




Common stockholder's equity

$402,126


$390,782

Noncontrolling interest

144,287


178,943

Total Equity

546,413


569,725

Long-term debt

319,739


272,470

Total Capitalization

866,152


842,195

Current Liabilities:




Long-term debt - due within one year

1,667


-

Short-term debt - commercial paper

14,500


33,500

Accounts payable

21,995


35,826

Affiliate payables

24


4,217

Accrued interest and taxes

22,424


6,125

Accrued payroll related items

8,530


7,870

Deferred income taxes

1,003


2

Other current liabilities

9,687


13,174

Total Current Liabilities

79,830


100,714

Other Credits:




Deferred income taxes

146,591


138,486

Investment tax credit - deferred

2,159


2,394

Regulatory liabilities

21,840


18,477

Accrued pension and other postretirement benefits

115,387


122,946

Other deferred liabilities and other

56,061


48,343

Total Other Credits

342,038


330,646

Commitments and contingencies (see Footnote 9)

-


-

Total Capitalization and Liabilities

$1,288,020


$1,273,555


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




Page 11



Madison Gas and Electric Company

Consolidated Statements of Equity (unaudited)

(In thousands)



 

MGE

Non-

controlling

Interest

Total

Common Stock

Additional

Paid-in

Capital

Retained

Earnings

Accumulated

Other

Comprehensive

Income/(Loss)

Shares

Value

 








Beginning balance - Dec. 31, 2008

17,348

$17,348

$192,417

$164,354

$134

$174,157

$548,410

Net income




26,289


10,427

36,716

Other comprehensive income/(loss):








Net unrealized loss on investments,

net of $42 tax





(63)


(63)

Cash dividends paid to parent by MGE




(12,839)



(12,839)

Equity contribution received by noncontrolling interest






2,486

2,486

Distributions to parent from

noncontrolling interest






(8,031)

(8,031)

Ending balance - Sept. 30, 2009

17,348

$17,348

$192,417

$177,804

$71

$179,039

$566,679

 








Beginning balance - Dec. 31, 2009

17,348

$17,348

$192,417

$180,905

$112

$178,943

$569,725

Net income




30,945


15,104

46,049

Other comprehensive income/(loss):








Net unrealized loss on investments,

net of $32 tax





(48)


(48)

Cash dividends paid to parent by MGE




(19,553)



(19,553)

Equity contribution received by noncontrolling interest






533

533

Distributions to parent from

noncontrolling interest






(50,293)

(50,293)

Ending balance - Sept. 30, 2010

17,348

$17,348

$192,417

$192,297

$64

$144,287

$546,413


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





Page 12



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

Notes to Consolidated Financial Statements (unaudited)

September 30, 2010



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 West Campus and MGE Power Elm Road own electric generating assets and lease those assets to MGE. MGE is considered the primary beneficiary of these entities as a result of these contractual agreements. Both entities are variable interest entities (VIEs) under applicable accounting requirements; therefore, MGE is required to consolidate both entities into its financial results and financial position.


The accompanying consolidated financial statements as of September 30, 2010, 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 2009 Annual Report on Form 10-K, but does not include all disclosures required by accounting principles in the United States of America. These notes should be read in conjunction with the financial statements and the notes on pages 70 through 116 of the 2009 Annual Report on Form 10-K.


2.

Equity and Financing Arrangements.


a.

Common Stock - MGE Energy.


Since June 1, 2009, MGE Energy has been purchasing stock in the open market for issuance pursuant to its Stock Plan rather than issuing new shares.


All MGE Energy common stock shares issued under the Stock Plan are sold pursuant to a registration statement that has been filed with the SEC and is currently effective.


MGE Energy may issue new shares of its common stock through the Stock Plan. For the nine months ended September 30, 2010, MGE Energy did not issue any new shares of common stock under the Stock Plan. However, for the nine months ended September 30, 2009, MGE Energy issued 209,065 new shares of common stock under the Stock Plan for net proceeds of $6.3 million.


b.

Dilutive Shares Calculation - MGE Energy.


MGE Energy does not have any dilutive securities.


c.

Secured Debt - MGE Energy and MGE.


On February 4, 2010, MGE Power Elm Road issued $50 million of 5.04% senior secured notes due February 3, 2040. MGE Power Elm Road distributed the net proceeds from the sale of notes to MGE Energy, which used that distribution to repay existing short-term indebtedness, consisting of bank loans, which were used to finance a portion of the construction of the Elm Road Units. The notes provide for monthly principal and interest payments, which commenced on February 25, 2010, and continue until maturity. The principal payments are level over the life of the notes, for an effective average life of 15 years. The Note Purchase Agreement requires MGE Power Elm Road to maintain a debt service coverage ratio at the end of any calendar quarter of not less than 1.25 to 1.00 for the trailing 12-month period. As of September 30, 2010, MGE Power Elm Road is in compliance with the covenant requirements.


d.

Credit Facilities - MGE Energy and MGE.


On March 30, 2010, MGE's existing credit agreement dated March 31, 2009, which provided MGE with a $20 million committed credit facility, expired. MGE's lines of credit are used as backup to MGE's commercial paper.




Page 13



On July 30, 2010, MGE Energy entered into a Credit Agreement dated as of July 30, 2010, with the lenders named therein and JPMorgan Chase Bank, N.A., as Administrative Agent, providing MGE Energy with a $40 million revolving credit facility. That facility replaced MGE Energy's existing Credit Agreement dated as of August 28, 2009, as amended, which was scheduled to expire on August 27, 2010, and which was terminated on July 30, 2010. The new revolving credit facility will expire on July 30, 2013.


On July 30, 2010, MGE entered into a Credit Agreement dated as of July 30, 2010, with the lenders named therein and JPMorgan Chase Bank, N.A., as Administrative Agent, providing MGE with a $75 million revolving credit facility. That facility replaced MGE's existing Amended and Restated Credit Agreement dated as of December 21, 2005, as amended, which was scheduled to expire on December 21, 2010, and which was terminated on July 30, 2010. The new revolving credit facility will expire on July 30, 2013. On August 27, 2010, MGE entered into an amendment that requires MGE to have a period of at least one day, during any 364-day period, on which the principal amount of all outstanding loans thereunder shall be zero.


The new facilities require the respective borrower to maintain a ratio of its consolidated indebtedness to consolidated total capitalization not to exceed a maximum of 65%. As of September 30, 2010, MGE Energy and MGE are in compliance with the covenant requirements.


3.

Comprehensive Income - MGE Energy and MGE.


Total comprehensive income represents the change in equity during a period from transactions and other events and circumstances from nonowner sources. MGE Energy's and MGE's total comprehensive income is:


(In thousands)

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

2010

 

2009

 

2010

 

2009

MGE Energy

 

 

 

 

 

 

 

Net income

$19,909


$12,722


$45,721


$37,567

Unrealized gain (loss) on available-for-sale securities, net of tax ($6 and $1, and $48 and $27)

9


(1)


(71)


(41)

Total comprehensive income

$19,918


$12,721


$45,650


$37,526

 








MGE








Net income

$20,101


$12,409


$46,049


$36,716

Unrealized gain (loss) on available-for-sale securities, net of tax ($2 and $5, and $32 and $42)

4


(7)


(48)


(63)

Total comprehensive income

$20,105


$12,402


$46,001


$36,653

Less: Comprehensive income attributable to noncontrolling interest

(5,108)


(3,567)


(15,104)


(10,427)

Comprehensive income attributable to MGE

$14,997


$8,835


$30,897


$26,226


4.

Investments - MGE Energy and MGE.


a.

Investment in ATC.


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, through MGE, has a seat on the Board of Directors of ATC. Due to MGE Transco's ability to exercise significant control over management activities, MGE Transco has accounted for its investment in ATC under the equity method of accounting. For the nine months ended September 30, 2010 and 2009, MGE Transco recorded equity earnings from the investment in ATC of $6.4 million (pretax) and $6.1 million (pretax), respectively. Dividend income received from ATC was $5.0 million and $4.7 million for the nine months ended September 30, 2010 and 2009, respectively. During the nine months ended September 30, 2010 and 2009, MGE Transco made capital contributions of $0.5 million and $2.5 million, respectively.


During March 2010, MGE sold a parcel of land in Middleton, Wisconsin to ATC for $2.7 million, resulting in a gain of $2.6 million (pretax). The transaction was approved by the PSCW.





Page 14



At September 30, 2010, 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, 2010 and 2009, is as follows:


(In thousands)

2010

 

2009

Income statement data for the three months ended September 30


 


Operating revenues

$136,889

 

$132,288

Operating expenses

(59,732)

 

(58,743)

Other expense, net

(609)

 

(147)

Interest expense, net

(21,530)

 

(19,595)

Earnings before members' income taxes

$55,018

 

$53,803

MGE Energy's and MGE's equity earnings in ATC

$2,092

 

$2,110

 

 

 

 

Income statement data for the nine months ended September 30

 

 

 

Operating revenues

$414,046

 

$387,536

Operating expenses

(185,067)

 

(172,315)

Other expense, net

(1,428)

 

(276)

Interest expense, net

(63,361)

 

(57,513)

Earnings before members' income taxes

$164,190

 

$157,432

MGE Energy's and MGE's equity earnings in ATC

$6,374

 

$6,112


b.

Other Investments.


MGE Energy and MGE hold available for sale securities in both publicly traded and privately held companies. During the nine months ended September 30, 2010 and 2009, no investments were liquidated.


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 filed an application with its 2009 tax returns to change its tax method of accounting for repairs. This method change accelerated tax deductions for repairs in accordance with Treasury Regulations and case law, as compared to the prior method of claiming tax depreciation on project costs. At September 30, 2010, MGE Energy and MGE have an unrecognized tax benefit in the amount of $4.0 million for the tax uncertainty related to the change in tax method of accounting for repairs.


b.

Effective Tax Rate.


MGE Energy's effective income tax rates for the three and nine months ended September 30, 2010, are 39.5% and 37.8%, respectively, compared to 35.4% and 35.2% for the same periods in 2009; and MGE's effective income tax rate for the three and nine months ended September 30, 2010, are 39.5% and 37.8%, respectively, compared to 35.2% and 35.0% for the same periods in 2009. The increase in effective tax rate is, in part, attributable to a lower wind energy production tax credit and domestic manufacturing deduction.





Page 15



c.

Medicare Part D Subsidy.


On March 23, 2010, the Patient Protection and Affordable Care Act (the PPACA) was enacted. The PPACA effectively changes the tax treatment of federal subsidies paid to sponsors of retiree health benefit plans that provide a benefit that is at least actuarially equivalent to the benefits under Medicare Part D. As a result of the PPACA, these subsidy payments will effectively become taxable in tax years beginning after December 31, 2012. In connection with accounting for Income Taxes, companies are required to reflect the impact of the change in tax law in the period that includes the enactment date of March 23, 2010. MGE anticipates recovery in rates of the incremental tax expense as a result of the legislation. At September 30, 2010, MGE has a regulatory asset of $2.7 million representing the revenue requirement related to PPACA taxes payable, calculated at current statutory rates.


6.

Elm Road - MGE Energy and MGE.


a.

Construction.


MGE Power Elm Road owns an 8.33% ownership interest in each of two 615 MW coal-fired generating units in Oak Creek, Wisconsin. Unit 1 entered commercial operation on February 2, 2010. Unit 2 is under construction, but is expected to enter commercial operation during the fourth quarter of 2010 with a guaranteed contractual in-service date of November 28, 2010. MGE Power Elm Road's sole principal asset is that ownership interest in those generating units. Each owner provides its own financing and reflects its respective portion of the facility and costs in its financial statements. MGE Power Elm Road has leased the Elm Road Units to MGE pursuant to separate facility lease agreements for each unit. These leases were authorized by order of the PSCW in accordance with applicable provisions of Wisconsin law that authorized financing of new generation through facility leases. The PSCW order establishes a cap on the construction costs that may be passed through the lease agreements to MGE and its customers, through rates. Additional costs attributable to force majeure events, as defined in the leases, do not count against this cap but are subject to PSCW review and determination that the costs were prudently incurred.


The estimated share of capital costs for MGE Power Elm Road's ownership interest in both units is approximately $180 million (excluding capitalized interest). At September 30, 2010, $121.9 million related to this project was placed in-service and $55.0 million (excluding capitalized interest) related to this project is reflected in the construction work in progress balance on MGE Energy's and MGE's consolidated balance sheets. MGE Power Elm Road calculates capitalized interest on the Elm Road Units until their respective in-service dates. At September 30, 2010, MGE Power Elm Road recorded a total of $16.2 million in capitalized interest related to the Elm Road Units.


MGE Power Elm Road's interest in the portion of the Elm Road Units in service and the related accumulated depreciation reserves at September 30, 2010, were as follows:


(In thousands)

September 30, 2010

Nonregulated plant

$121,905

Accumulated depreciation

(1,801)

Net plant

$120,104


b.

Consolidation.


In connection with this project, MGE Energy and its subsidiaries entered into various agreements, including facility lease agreements between MGE Power Elm Road (a nonregulated subsidiary of MGE Energy) and MGE with respect to each of the Elm Road Units. The financial terms of the facility leases include a capital structure of 55% equity and 45% long-term debt, a return on equity of 12.7%, a lease term of 30 years, and a 5% lease payment reduction in the first five years.


Based on the nature and terms of the contractual arrangements, MGE absorbs a majority of the expected losses, residual value, or both, associated with the ownership of MGE Power Elm Road and therefore holds a variable interest in MGE Power Elm Road, even though it has no equity interest in MGE Power Elm Road. MGE Energy and MGE consolidate VIEs for which they are the primary beneficiary. MGE has the power to direct the activities that most significantly impact the Elm Road Units' economic performance and is also the party most closely associated with MGE Power Elm Road. As a result, MGE is the primary beneficiary. Accordingly, MGE Power Elm Road has been consolidated in the financial statements of MGE.




Page 16



MGE Energy's share of the equity and net income (through its wholly owned subsidiary MGE Power) of MGE Power Elm Road is classified within the MGE financial statements as noncontrolling interest.


c.

Nonregulated Revenues.


MGE has approval from the PSCW to defer the recovery of the payments made to MGE Power Elm Road for carrying costs during construction of the generating units. MGE estimates that the total carrying costs on the Elm Road project will be approximately $60.4 million. This estimate is subject to change based on changes in interest rates, timing of capital expenditures, and the total project cost.


MGE began collecting the carrying costs in rates in 2006. These amounts are being collected over multiple years. Of these costs, MGE estimates that $16.4 million relates to the capitalized interest and the debt portion of the facility. These costs will be recognized over the period in which the generating units will be depreciated. The remaining $44.0 million is estimated to represent the equity portion and is being recognized over the period allowed for recovery in rates.


During 2010, MGE will recover $16.5 million in electric rates for costs associated with the Elm Road Units. Of this amount, $5.1 million relates to carrying costs. For the nine months ended September 30, 2010, $3.8 million related to the carrying costs were recovered in rates. Of this amount, $0.7 million relates to the debt portion of the facility and was deferred on the consolidated financial statements of MGE Energy and MGE. Since February 2, 2010, when the Elm Road Unit 1 was placed in-service, $0.1 million of the debt portion was recognized. The remaining $1.8 million represents the equity portion and was recognized as nonregulated revenues in the consolidated financial statements of MGE Energy and MGE. Furthermore, an additional $0.9 million was recognized as a true-up of equity during the nine months ended September 30, 2010.


7.

Pension and Postretirement Plans - MGE Energy and MGE.


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


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, 2010 and 2009. A portion of the net periodic benefit cost is capitalized within the consolidated balance sheets. The PSCW allowed MGE to defer the 2009 incremental pension and OPRB costs above the amounts recovered in rates. During the three and nine months ended September 30, 2010, $0.7 million and $2.0 million, respectively, has been recovered in rates.


(In thousands)

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

2010

 

2009

 

2010

 

2009

Pension Benefits

 

 

 

 

 

 

 

Components of net periodic benefit cost:








Service cost

$1,469


$1,349


$4,406


$3,996

Interest cost

2,912


2,970


8,734


8,801

Expected return on assets

(2,848)


(2,293)


(8,541)


(6,793)

Amortization of:








Transition obligation

-


36


-


106

Prior service cost

106


110


318


327

Actuarial loss

839


1,207


2,517


3,575

Net periodic benefit cost

$2,478


$3,379


$7,434


$10,012

 

 







Postretirement Benefits

 







Components of net periodic benefit cost:

 







Service cost

$463


$436


$1,389


$1,307

Interest cost

948


886


2,844


2,659

Expected return on assets

(296)


(208)


(888)


(625)

Amortization of:








Transition obligation

102


97


307


292

Prior service cost

27


65


80


196

Actuarial loss

106


153


316


459

Net periodic benefit cost

$1,350


$1,429


$4,048


$4,288





Page 17



8.

Share-Based Compensation - MGE Energy and MGE.


The MGE Energy Board of Directors approved a Performance Unit Plan on December 15, 2006. Under that 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 2007 through 2009, on January 15, 2010, 17,310 units were granted based on the MGE Energy closing stock price as of that date. These newly-granted units are subject to a five-year graded vesting schedule. On the grant date, MGE Energy and MGE measured the cost of the employee services received in exchange for the award based on the current market value of MGE Energy common stock. The fair value of the awards, including the outstanding awards granted in 2007 through 2009, has been subsequently re-measured at September 30, 2010, as required by applicable accounting principles. Changes in fair value as well as the original grant have been recognized as compensation cost. Since this amount will be re-measured 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 also using the graded vesting method.


During the nine months ended September 30, 2010 and 2009, MGE recorded $0.8 million and $0.7 million, respectively, in compensation expense as a result of this plan. No forfeitures or cash settlements occurred during the aforementioned periods. At September 30, 2010, $0.9 million of these awards were vested.


9.

Commitments and Contingencies.


a.

Environmental - MGE Energy and MGE.


Hazardous materials


On April 7, 2010, the EPA published an Advanced Notice of Proposed Rulemaking (ANPR) for the additional regulation of polychlorinated biphenyls (PCBs). The EPA has indicated that they intend to reassess the use, distribution, marking, and storage for reuse of liquid PCBs in electric and nonelectric equipment. The rule developed as a result of this ANPR may require a phase-out of PCBs in electrical and nonelectrical equipment. MGE has electrical equipment that contains liquid PCBs so any rule that is developed has a potential to affect our capital or operational cost. We will not know the extent, however, until any rule is finalized.


Solid waste


Lenz Oil Site

MGE is listed as a potentially responsible party for a site the EPA has placed on the national priorities Superfund list. The Lenz Oil site in Lemont, Illinois, was used for storing and processing waste oil for several years. This site requires clean up under the Comprehensive Environmental Response, Compensation and Liability Act. A group of companies, including MGE, is currently working on cleaning up the site. Management believes that its share of the final cleanup costs for the Lenz Oil site will not result in any materially adverse effects on MGE's operations, cash flows, or financial position. Insurance may cover a portion of the cleanup costs. Management believes that the cleanup costs not covered by insurance will be recovered in current and future rates. As of December 31, 2009, the EPA has agreed on a remedy for the Lenz Oil site. The remedy included a five-year $2.2 million implementation plan. The EPA has asked all potentially responsible parties to pay upfront for this five-year implementation plan. At September 30, 2010, MGE's portion is less than $0.1 million.


Proposed Regulation of Coal Combustion Byproducts

The EPA published a proposed rule on May 4, 2010, that regulates coal combustion byproducts from the electric generating sector. The proposed regulations may require new or additional monitoring of storage sites, may re-classify ash and other coal combustion byproducts, and may regulate ash storage site structural design. MGE is evaluating the impact of these proposed regulations on our operations. It is not possible to estimate the potential costs associated with the implementation of any of these initiatives at this time.





Page 18



Water quality


MGE is subject to water quality regulations issued by the WDNR. These regulations include discharge standards, which require the use of effluent-treatment processes equivalent to categorical "best practicable" or "best available" technologies under compliance schedules established under the Federal Water Pollution Control Act. The WDNR has published categorical regulations for chemical and thermal discharges from electric-steam generating plants. The regulations limit discharges from MGE's plants into Lake Monona and other Wisconsin waters.


WPDES Thermal Discharge Rule

WDNR rules to regulate thermal effluent discharges from point sources in Wisconsin became effective on October 1, 2010. Any WPDES permit issued after October 1, 2010, will need to meet the revised rule requirements. The rules apply strict standards for thermal discharges into inland lakes, streams, rivers, and the Great Lakes. MGE submitted a thermal analysis with its most recent Blount WPDES permit application that showed thermal impacts within the acceptable limits of the rule. MGE is waiting to hear from the WDNR on their review of the analysis. If the WNDR does not concur with MGE's analysis additional studies could be required. Potential costs at Columbia have not been determined at this time. Based on initial reviews of the current revised rules, we do not expect WCCF or the Elm Road Units to be effected by these rules.


WPDES Phosphorus Nutrient Standards

The WDNR is in the process of developing water quality standards for phosphorus in streams, rivers, and inland lakes, including effluent limitations for dischargers. Blount and WCCF both currently discharge phosphorus under their WPDES permits, and it is likely both facilities may have phosphorus limitations added to their permits. It is unknown what the limitations may be at this time, as the WDNR will calculate the limits based on the status of the receiving water and will take into account all dischargers of phosphorus into each receiving water before setting individual permit limits. The rules will become effective following their publication in the Wisconsin Administrative Code. The Blount WPDES permit renewal application has been submitted to the WDNR. If the phosphorus rules become effective before Blount's WPDES renewal permit is issued (permit issuance is expected in the Spring of 2011) then the newly issued permit will likely include the new phosphorus limits. MGE will not know the full extent of this rule on our operations until the WNDR sets water body-specific and site-specific limits. Because of these uncertainties, we cannot estimate the effect that compliance with developing water quality standards will have on the operation of our generating facilities and our future results of operations, cash flows, and financial position.


WPDES Mercury Discharge Limit

WPDES permit holders in certain industries, including coal-fired electric power plants, are required to meet mercury effluent limits. If permit holders do not meet the mercury limits then they must apply for a variance as part of their next permit renewal with the WDNR. MGE has applied for a mercury variance for Blount as part of its permit renewal, which was submitted in the fall of 2010. If the variance is not approved, MGE may have operational or capital costs associated with meeting the mercury effluent limits when the permit is renewed (in the spring of 2011). Given the uncertainties associated with these proceedings and the time required for their resolution, we cannot predict the eventual outcome of the proceedings or estimate the effect that compliance with developing mercury limits will have on the operation of our generating facilities and our future results of operations, cash flows, and financial position.


Air quality


Air quality regulations promulgated by the EPA and the WDNR in accordance with the Federal Clean Air Act and the Clean Air Act Amendments of 1990 impose restrictions on emission of particulates, sulfur dioxide (SO2), nitrogen oxides (NOx), and other pollutants and require permits for operation of emission sources. These permits have been obtained by MGE and must be renewed periodically.


Various initiatives, including the EPA's proposed Transport Rule, maximum achievable control technology (MACT) standards, new source performance standards (NSPS) and the Clean Air Visibility Rule (also known as the Regional Haze Rule), as well as state mercury emissions limits, may result in additional operating and capital expenditure costs for electric generating units.





Page 19



EPA's Proposed Transport Rule (To Replace the Clean Air Interstate Rule (CAIR))

On July 6, 2010, the EPA issued a proposed initial rule called the "Transport Rule" designed to address ozone and fine particulate air pollution from 31 states in the eastern portion of the United States. The 31 states will need to reduce NOx and SO2 air emissions, which are "pre-cursors" or cause the formation of particulate matter and/or ozone pollution. The proposed rule includes the EPA's preferred option and two alternative approaches to reducing emissions and the EPA is seeking comments on these approaches. The EPA's preferred option uses state emissions budgets and intrastate allowance trading (limited interstate trading will be allowed) to achieve reductions in NOx and SO. The first alternative does not allow any interstate allowance trading and the second alternative does not permit either interstate or intrastate trading, but specifies allowable emission limits for each power plant. In addition, the EPA will require Federal Implementation Plans for those states that significantly contribute to nonattainment or maintaining attainment in neighboring states. Under the proposed rule, states are divided into three categories: (1) those contributing to particulate matter pollution, (2) those contributing to ozone pollution, and (3) those contributing to both. Wisconsin has been identified as a state contributing to particulate matter only and thus will need to control annual SO2 and NOx emissions, but will not need to control ozone-season NOx. MGE is in the process of assessing the impacts that this rule will have on our generation fleet. We expect that our power plants will be affected and we will need either to secure allowances or to implement strategies to reduce NOx and SO2 emissions. The EPA is targeting 2012 for implementation of the Transport Rule.


Ozone NAAQS

On January 6, 2010, the EPA published a proposed rule reconsidering the March 12, 2008 8-hour ozone standard. In this proposed rule, the EPA states their intent to revise both the primary (set for protection of public health) and secondary (set for protection of public welfare and environment) ozone standards. The proposed standards have the potential to put several counties in Wisconsin, including ones where MGE has electric generation, in nonattainment. A nonattainment designation may increase capital or operating costs at MGE facilities. The EPA had an August 31, 2010, target date for final action on this reconsideration. That date has passed with no action and the EPA has not announced a new target date. The proposed rule requires designation recommendations due to the EPA by January 2011 based on 2008 through 2010 monitoring data.


Nitrogen Dioxide NAAQS

On January 22, 2010, the EPA revised its primary nitrogen dioxide (NO2) NAAQS. The EPA expects the states to submit initial recommendations for nonattainment areas by January 2011 using 2008-2010 data. The EPA plans to make final attainment and nonattainment designations by January 2012. The EPA has not changed the secondary NAAQS for NO2, but intends to address potential changes as part of a secondary review. It is unclear at this time how MGE's power plants would be affected by this proposed revision. As of April 12, 2010, any facility's permit renewal or revision application will need to model potential emissions of NO2. Failure to meet thresholds may require a permit applicant to incur capital or operational costs. MGE's Blount permit renewal application is due in the fall of 2011 and MGE will be conducting this NO2 modeling as part of this renewal process.


Sulfur Dioxide NAAQS

On June 22, 2010, the EPA finalized its revised Sulfur Dioxide NAAQS. The rule became effective on August 23, 2010. States are expected to make attainment/nonattainment designations in 2011; however, the ability to designate will be contingent on many steps being in place including modifying and/or adding monitoring sites to many counties, including the counties in which MGE has power plants. Despite the current steps that need to take place to make designations, any facility's PSD application will need to demonstrate compliance with SO2 NAAQS. It is difficult to assess impact on MGE at this time due to the lack of monitoring data and monitoring sites. MGE will continue to evaluate this rule as more information becomes available in Wisconsin.


MACT Standards for Electric Utilities

In late 2009, the EPA sent out an Information Collection Request (ICR) to hundreds of utilities across the United States that have coal and oil-burning electric generating units. The EPA has indicated that they will use the information collected from this ICR to assist in the development of electric generating unit MACT standards. Under this ICR, letters requesting information on pollution control equipment have been received in respect of Blount and Columbia. Elm Road is required to perform testing in addition to responding to the information requests. Facilities were required to provide data to the EPA in the first half of 2010. MGE submitted the ICR data for Blount on April 1, 2010. Given the uncertainties associated with these proceedings and the time required for their resolution, we cannot predict the eventual outcome of the proceedings or estimate the effect that compliance with developing MACT standards will have on the operation of our generating facilities and our future results of operations, cash flows, and financial position.




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EPA Rule on Greenhouse Gas Reporting

On September 22, 2009, the EPA issued its final mandatory greenhouse gas (GHG) reporting rule. Under the final rule, MGE will need to report on GHG emissions from its natural gas distribution system, its electric generating units subject to the EPA's Acid Rain Program and certain of its stationary combustion and electric units during 2010. MGE is collecting the data needed to file the required report on 2010 emissions by March 31, 2011. In 2010, the EPA has proposed additional GHG sources be added to this rule, including sulfur hexafluoride (SF6) and natural gas transport. We are currently evaluating this proposed rule and MGE may need to report on additional GHG sources in our 2011 emissions reporting.


EPA's Prevention of Significant Deterioration and Title V Greenhouse Gas Tailoring Rule

On May 13, 2010, the EPA released its final Prevention of Significant Deterioration (PSD) and Title V Greenhouse Gas "Tailoring Rule." The EPA introduced the Tailoring Rule to address the regulation of stationary sources for GHG emissions. Through this Tailoring Rule, the regulation of GHGs will be accomplished using the EPA's two principal stationary source permitting programs: The pre-construction permitting and the operations permitting (Title V).


The EPA's Tailoring Rule has been designed to "phase in" facilities subject to PSD or Title V permitting (i.e. new facilities and existing facilities with certain qualifying modifications). Beginning in 2011, sources that trigger PSD or Title V permitting requirements based on other, non-GHG emissions will also need to meet PSD or Title V permitting requirements if they exceed 75,000 tons of CO2 equivalents. By 2013, the EPA will require any facilities with emissions above 100,000 tons to meet their respective PSD and/or Title V requirements. By 2016, it is expected that any new or modified facility with emissions of 50,000 tons of CO2 equivalents per year will be subject to the rule. It is understood that PSD requirements for new or modified sources include the requirement that a plant meet Best Available Control Technology (BACT) requirements for any emissions that trigger PSD. The EPA has not provided guidelines on what may be considered BACT. MGE facilities may become subject to this rule if modifications at any facilities trigger PSD or if MGE invests in new facilities that trigger PSD.


Columbia


Title V Operating Permit Petition

In September 2008, the WDNR issued a Title V renewal operating permit to WPL for Columbia. 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. A citizen group petitioned the EPA to object to the issuance of the permit renewal. In October 2009, the EPA issued an order granting in part and denying in part the petition and sent the operating permit back to the WDNR for further review based on the EPA order. The EPA order gave the WDNR 90 days to address the objections and take action on the September 2008 operating permit. On March 22, 2010, the WDNR gave notice to WPL that they intend to initiate an operating permit revision in response to the EPA's order. In July 2010, MGE received a copy of a NOI letter filed by a citizen group against the EPA based on what the group feels is an unreasonable delay in the EPA performing its duties related to the granting or denial of the Columbia air permit. Specifically, the citizen group alleges that because the WDNR has not acted on the EPA's order within 90 days, the EPA must now act on the permit. On September 22, 2010, WDNR acted on the order by issuing a construction permit for public comment. WPL, as the permit holder, filed comments raising a number of concerns and objections to the proposed permit.


Air Permitting Violation Claims

In September 2010, Sierra Club filed in U.S. District Court for the Western District of Wisconsin a complaint against WPL, as owner and operator of Columbia, based on allegations that modifications were made at the facilities without complying with the PSD program requirements, Title V Operating Permit requirements of the CAA and state regulatory counterparts contained within the Wisconsin state implementation plans (SIP) designed to implement the CAA. Neither MGE nor WPSC were named as parties in this litigation. In October 2010, WPL filed a response with the court denying the Sierra Club's allegations.


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 and the Columbia co-owners failed to comply with appropriate pre-construction review and permitting requirements and as a result violated the PSD program requirements, Title V Operating Permit requirements of the CAA and the Wisconsin SIP.





Page 21



In response to similar EPA CAA enforcement initiatives, certain utilities have elected to settle with the EPA, while others have elected to litigate. If the EPA and/or Sierra Club successfully prove their claims that projects completed in the past at Columbia required either state or federal CAA permits, MGE may, under the applicable statutes, be required to pay civil penalties in amounts of up to $37,500 per day for each violation and/or complete actions for injunctive relief. Payment of fines and/or injunctive relief could be included in a settlement outcome. Injunctive relief contained in settlements or court-ordered remedies for other utilities required the installation of pollution control technology, changed operating conditions including use of alternative fuels other than coal, caps for emissions and limitations on generation including retirement of generating units and other supplemental environmental projects. Should similar remedies be required for final resolution of these matters at Columbia, MGE would likely incur additional capital and operating expenditures. MGE is currently reviewing the allegations and is unable to predict their impact on its financial condition or results of operations but believes that an adverse outcome could have a significant effect. MGE and the other co-owners of Columbia are exploring settlement options while WPL is simultaneously defending against these allegations. WPL believes the projects at Columbia were routine or not projected to increase emissions and therefore did not violate the permitting requirements of the CAA.


Certificate of Authority

In April 2009, the Columbia owners filed for a Certificate of Authority with the PSCW requesting authorization of an emissions reduction project as a result of an environmental initiative. A decision from the PSCW is currently expected in the first half of 2011. The operator's current estimates show that MGE's share of the capital expenditures required to comply with this project will be approximately $140 million. According to the current estimate, this project is expected to result in an increase to Columbia's ongoing operating expenses. MGE expects that the costs pertaining to this project will be fully recoverable through rates. The PSCW is permitting MGE to defer pre-certification and pre-construction costs related to compliance with environmental regulations at Columbia. Additionally, MGE is entitled to a carrying cost on the related pre-construction costs at a 100% AFUDC rate. As of September 30, 2010, MGE had incurred $0.9 million (excluding carrying costs) in deferred pre-certification and pre-construction expenditures at Columbia related to this environmental initiative.


Columbia has entered into various contractual commitments with vendors for a small portion of the aforementioned expenditures as well as other Columbia environmental projects. MGE is indirectly a party to these agreements as a result of its joint ownership of Columbia and is also contractually obligated, under the applicable ownership and operating agreements, with respect to any commitments made. MGE has a 22% ownership interest in Columbia. MGE's share of these commitments is less than $0.1 million for 2010. These costs are expected to be capitalized and included in the consolidated balance sheets of MGE Energy and MGE.


b.

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


MGE makes available to qualifying customers a financing program for purchasing and installing 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 August 31, 2011. At September 30, 2010, MGE has outstanding a $3.2 million interest in these receivables. MGE retains the servicing responsibility for these receivables. As of September 30, 2010, the servicing asset recognized by MGE is less than $0.1 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, 2010, 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 customer loan. The following table identifies principal payments for the remainder of 2010 and the next four years.




Page 22




(In thousands)

Year

Principal Payments

2010

$413

2011

621

2012

412

2013

441

2014

256


c.

Other Legal Matters - MGE Energy and MGE.


MGE is involved in various other 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. MGE has accrued for such matters in the financial statements. The ultimate outcome of such matters is uncertain and may have an adverse effect on MGE Energy's and MGE's results of operations, financial position, and cash flows.


d.

Natural Gas Supply Contracts - MGE Energy and MGE.


MGE has natural gas supply commitments which include market-based pricing. Total natural gas supply commitments are estimated to be $14.6 million for the remainder of 2010, and $15.2 million for 2011. Management expects to recover these costs in future customer rates.


e.

Coal Contracts – MGE Energy and MGE.


Fuel procurement for MGE's jointly owned Columbia and Elm Road plants are handled by Alliant and Wisconsin Energy Corporation, respectively, the operating companies. 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. The following table identifies MGE's share, as of September 30, 2010, of the total coal commitments for the Columbia and Elm Road plants for the remainder of 2010 and the next four years.


(In thousands)

Year

Coal Commitments

2010

$12,227

2011

19,929

2012

7,060

2013

3,476

2014

3,476


f.

Smart Grid Investment Grant - MGE Energy and MGE.


MGE has been approved by the U.S. Department of Energy (DOE) under the federal stimulus program for a $5.5 million grant for smart grid projects. The DOE grant requires MGE to match the grant funding, bringing the total cost of the proposed projects to more than $11 million. The proposed projects will install technologies to boost efficiency, enhance service and improve reliability for customers. The stimulus grant will help fund the following projects: advanced metering infrastructure, plug-in hybrid electric vehicles support, and distribution management. In the third quarter, MGE entered into agreements to purchase $2.5 million in smart grid related products. As of September 30, 2010, MGE has spent $0.1 million related to these projects.


10.

Blount Station - MGE Energy and MGE.


In 2006, MGE announced a plan to reduce capacity at Blount from 190 MW to 100 MW by the end of 2011. As part of the plan, coal use at Blount will be discontinued. MGE has determined that certain employee positions will be eliminated as a result of this plan.





Page 23



In March 2009, MGE received notification from MISO that in order to meet national electric system reliability standards, MGE will need to keep Blount available at its full capacity until MISO declares that the 90 MW are no longer needed for system reliability. Currently, MGE estimates the reduction in capacity will occur in 2013. The transition from burning coal to burning only natural gas will still occur by the end of 2011. After the transition, the entire plant will be operated exclusively on natural gas. MGE is working with MISO to develop a detailed agreement for this continued operation, which among other things will include a mechanism for cost recovery.


In January 2010, MGE announced it will change its primary fuel at Blount from coal to natural gas. Coal will become the secondary fuel at Blount. This switch to natural gas as a primary fuel occurred in March 2010. As a result of this change, certain employee positions were eliminated and severance benefits in 2010 totaled $0.5 million. These severance benefits were accelerated into 2010 from 2011, but are expected to be offset by lower payroll charges in 2010.


MGE has entered into agreements providing severance benefits to employees affected by the exit plan. These benefits are being recognized ratably over the expected future service period of the employees. Total benefits expected to be paid are as follows: $0.3 million in 2012 and $0.3 million in 2013. Total benefits paid as of September 30, 2010, were $1.1 million.


MGE continues to recover in rates the costs associated with the severance benefits at Blount in the year of expected cash payment. The severance charges to be recovered in rates have been deferred and recognized on the consolidated balance sheet of MGE Energy and MGE as a regulatory asset.


The following table presents the activity in the restructuring accrual from December 31, 2009, through September 30, 2010:


(In thousands)

 

Balance at December 31, 2009

$769

Additional expense, net

 71

Cash payments during the period

(625)

Balance at September 30, 2010

$215


The exit plan has also resulted in accelerated depreciation for the Blount assets expected to be retired in 2011 and 2013. The majority of these assets are being recovered in rates over a four-year period that began in 2008, with the remaining balance recovered by the end of 2013. For both the nine months ended September 30, 2010 and 2009, $2.5 million of accelerated depreciation expense had been recognized and recovered in rates each year.


11.

Asset Retirement Obligations - MGE Energy and MGE.


a.

Conditional Asset Retirement Obligations.


MGE recorded an obligation for the fair value of its legal liability for asset retirement obligations (AROs) associated with removing an electric substation, a combustion turbine generating unit, wind generating facilities, and photovoltaic generating facilities, all of which are located on property not owned by MGE Energy and MGE and would be removed upon the ultimate end of the lease. The significant conditional AROs identified by MGE included the costs of abandoning in place gas services and mains, the abatement and disposal of equipment and buildings contaminated with asbestos and polychlorinated biphenyls, and the proper disposal and removal of tanks. Changes in management's assumptions regarding settlement dates, settlement methods, or assigned probabilities could have had a material effect on the liabilities recorded by MGE at September 30, 2010, as well as the regulatory asset recorded.


MGE also may have AROs relating to the removal of various assets, such as certain electric and gas distribution facilities. These facilities are generally located on property owned by third parties, on which MGE is permitted to operate by lease, permit, easement, license, or service agreement. The AROs associated with these facilities cannot be reasonably determined due to the indeterminate life of the related agreements.


In February 2010, MGE Power Elm Road recorded an obligation for the fair value of its legal liability for AROs associated with the demolition and removal of the Elm Road Units. Provisions for these demolition and removal costs are included in the facility lease agreements. At September 30, 2010, this liability is estimated at $0.1 million and is included in other deferred liabilities.





Page 24



The following table shows costs as of December 31, 2008 and 2009, and changes to the asset retirement obligations through September 30, 2010. Amounts include conditional AROs.


(In thousands)

(a)

Original Asset

Retirement

Obligation

 

(b)

Accumulated

Accretion

 

(c)

(a + b)

Asset

Retirement

Obligation

Balance, December 31, 2008

$5,345

 

$9,649

 

$14,994

Changes through December 31, 2009

707

 

812

 

1,519

Balance, December 31, 2009

$6,052

 

$10,461

 

$16,513

Changes through September 30, 2010

847

 

830

 

1,677

Balance, September 30, 2010

$6,899

 

$11,291

 

$18,190


b.

Non-ARO Costs.


Accumulated costs of removal that are non-ARO obligations are classified within the financial statements as regulatory liabilities. At September 30, 2010, and December 31, 2009, there were $11.9 million and $12.2 million of these costs recorded as regulatory liabilities within the financial statements, respectively.


12.

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, with changes in the fair value of derivative instruments to be recorded in current earnings or deferred in accumulated other comprehensive income (loss), depending on whether a derivative is designated as, and is effective as, a hedge. 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 two 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, 2010

 

December 31, 2009

Commodity derivative contracts

553,275 MWh

 

647,560 MWh

Commodity derivative contracts

8,670,000 Dth

 

6,530,000 Dth

FTRs

4,269 MW

 

3,003 MW


c.

Financial Statement Presentation.


MGE Energy and MGE offset fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) against fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting agreement. At September 30, 2010, and December 31, 2009, MGE Energy and MGE had $3.2 million and $0.4 million, respectively, in cash collateral that was netted against the net derivative positions with counterparties.





Page 25



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 and PJM markets, 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, 2010, the cost basis of exchange traded derivatives and FTRs exceeded their fair value by $2.9 million. At September 30, 2009, the cost basis of exchange traded derivatives and FTRs exceeded their fair value by $2.8 million.


MGE enters into futures and basis swaps to take advantage of physical and financial arbitrage opportunities between supply basins and pricing spreads between future months' gas supply. Under the incentive mechanism within the PGA clause, MGE shareholders have the ability to receive a set percentage of the benefits or loss from these deals if certain thresholds are achieved. The portion related to the shareholders is reflected in other comprehensive income and the portion related to customers is reflected as a regulatory asset/liability depending on whether they are in a net loss/gain position. At September 30, 2010, none of these instruments were outstanding. At September 30, 2009, the cost basis of these financial instruments exceeded their fair value by less than $0.1 million.


MGE has also entered into a ten-year purchased power agreement which provides MGE with firm capacity and energy during a base term from June 1, 2012, through May 31, 2022. The agreement also allows MGE the option to purchase power during a period of time preceding that base term as well as 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 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, 2010 and 2009 reflects a loss position of $17.7 million and $12.6 million, respectively. The actual fuel cost will be recognized in purchased power expense in the month of purchase.


The following table summarizes the fair value of the derivative instruments on the 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 cash 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 cash collateral.


 

Asset Derivatives

Liability Derivatives

(In thousands)

Balance Sheet Location

Fair Value

Balance Sheet Location

Fair Value

September 30, 2010

Commodity derivative contracts

Other current assets

$299

Other current liabilities

$3,520

Commodity derivative contracts

Other deferred charges

51

Other deferred liabilities

69

FTRs

Other current assets

308

Other current liabilities

-

Ten-year PPA

NA

NA

Other deferred liabilities

17,720


December 31, 2009

Commodity derivative contracts

Other current assets

$1,357

Other current liabilities

$1,728

Commodity derivative contracts

Other deferred charges

89

Other deferred liabilities

94

FTRs

Other current assets

649

Other current liabilities

-

Ten-year PPA

NA

NA

Other deferred liabilities

12,815





Page 26



The following tables summarize the unrealized and realized gains (losses) related to the derivative instruments on the balance sheet and the income statement for the three and nine months ended September 30 (a).


 

2010

 

2009

(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 June 30,

$17,345

 

$1,030

 

$17,370

 

$2,542

Change in unrealized loss (gain)

4,055

 

-

 

5,344

 

-

Realized loss reclassified to a deferred account

(572)

 

572

 

(1,575)

 

1,575

Realized loss reclassified to income statement

(177)

 

(399)

 

(5,737)

 

(2,388)

Balance at September 30,

 $20,651

 

$1,203

 

$15,402

 

$1,729

 



 





Nine Months Ended September 30



 





Balance at January 1,

$12,542

 

$1,334

 

$14,007

 

$4,466

Change in unrealized loss (gain)

10,731

 

-

 

27,789

 

-

Realized loss reclassified to a deferred account

(1,381)

 

1,381

 

(12,728)

 

12,728

Realized loss reclassified to income statement

(1,241)

 

(1,512)

 

(13,666)

 

(15,465)

Balance at September 30,

$20,651

 

$1,203

 

$15,402

 

$1,729


 

Realized losses (gains):

(In thousands)

Regulated

gas revenues

Fuel for electric

generation/

purchased power

Cost of

gas sold

Three Months Ended September 30, 2010




Commodity derivative contracts

$-

$573

$(128)

FTRs

-

131

-

Ten-year PPA

-

-

-

 




Three Months Ended September 30, 2009




Commodity derivative contracts

$-

$8,150

$(18)

FTRs

-

(7)

-

Ten-year PPA

-

-

-

 




Nine Months Ended September 30, 2010




Commodity derivative contracts

$-

$2,276

$481

FTRs

-

(4)

-

Ten-year PPA

-

-

-

 




Nine Months Ended September 30, 2009




Commodity derivative contracts

$84

$20,566

$7,870

FTRs

-

611

-

Ten-year PPA

-

-

-


(a) 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 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-) once MGE begins purchasing energy under the contract in 2012. 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 under the PPA. Certain counterparties extend MGE a credit limit. If MGE exceeds these limits, the counterparties may require collateral to be posted. As of September 30, 2010, no counterparties are in a net liability position. As of December 31, 2009, certain counterparties were in a net liability of less than $0.1 million.


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, 2010, no counterparties have defaulted.




Page 27



13.

Regional Transmission Organizations - MGE Energy and MGE.


MISO is a FERC approved RTO that is required to provide real-time energy services and a market based mechanism for transmission congestion management. MISO maintains a bid-based energy market. MGE offers substantially all of its generation on the MISO market and purchases much of its load requirement from the MISO market in accordance with the MISO Tariff. In January 2009, MISO implemented and MGE began participating in the ancillary services market (ASM). The ASM is an extension of the existing energy market in which MISO assumes the responsibility of maintaining sufficient generation reserves. Previously, MGE was responsible for providing its own reserves. In the ASM, MISO will provide the reserves for MGE's load, and MGE may offer to sell reserves from its generating units. In addition to this market change, MISO took on various balance authority functions. In June 2009, MISO implemented and MGE began participating in the voluntary capacity auction. The voluntary capacity auction provides an optional monthly forum for buyers and sellers of aggregate planning resource credits to interact. Load serving entities may participate in the voluntary capacity auction to potentially obtain the necessary aggregate planning resource credits to meet their planning reserve margin requirement. Generator owners may participate to sell any excess aggregate planning resource credits that are not needed.


Additionally, MGE is a member of PJM. PJM is also an RTO. PJM is a neutral and independent party that coordinates and directs the operation of the region's transmission grid, administers a competitive wholesale electricity market, and plans regional transmission expansion improvements to maintain grid reliability and relieve congestion. MGE has one purchase power agreement, for 50 MW, that is affected by this market.


MGE reports on a net basis transactions on the MISO and PJM markets in which it buys and sells power within the same hour to meet electric energy delivery requirements. This treatment resulted in a $31.6 million and $16.1 million reduction to sales for resale and purchased power expense for the three months ended September 30, 2010 and 2009, respectively, and a $75.0 million and $51.5 million reduction to sales for resale and purchased power expense for the nine months ended September 30, 2010 and 2009, respectively.


14.

Rate Matters - MGE Energy and MGE.


a.

Rate proceedings.


In April 2010, MGE filed an application with the PSCW requesting a 9.4% increase to electric rates and a 2.0% increase to gas rates. The proposed electric increase is intended to cover costs for MGE's share of the new Elm Road Units, new environmental equipment at Columbia, and transmission reliability enhancements. We have requested that these rates become effective January 1, 2011.


In December 2009, the PSCW authorized MGE to increase 2010 rates for retail electric customers by 3.3% or $11.9 million, while gas rates decreased 0.74% or $1.5 million. The increase in retail electric rates was driven by costs for MGE's share of the Elm Road Units and transmission reliability enhancements. Pursuant to the provisions of this rate order, the fuel rules bandwidth effective January 1, 2010, will be plus or minus 2%. See below for further description of fuel rules. Authorized return on common stock equity was set at 10.4% based on a 55.3% utility common equity.


In December 2008, under a limited reopener, the PSCW authorized MGE to decrease 2009 rates for retail electric customers by 0.74% or $2.7 million, while gas rates remain unchanged from 2008. The decrease in retail electric rates was driven by a decrease in fuel and purchased power costs, a decrease in Elm Road Units costs and a decrease in ATC transmission costs. The PSCW also approved deferred accounting for incremental pension and other postretirement benefit costs above the levels currently included in rates. Pursuant to the provisions of this rate order, the fuel rules bandwidth effective January 1, 2009, was plus or minus 2%.


b.

Fuel rules.


Actual electric fuel costs are subject to reconciliation to the amount approved by the PSCW in MGE's rate order covering the applicable period. Known as "fuel rules," the process can produce a fuel surcharge for MGE or require MGE to make a refund in the form of a credit, to the extent that the actual fuel costs are outside a range higher or lower than the level authorized by the PSCW in that rate order.


Under fuel rules, MGE can apply for a fuel surcharge if its actual electric fuel costs exceed 102% of the electric fuel costs allowed in its latest rate order. Conversely, MGE can be required to provide a fuel credit to its customers if actual electric fuel costs are less than 98% of the electric fuel costs allowed in that order.




Page 28



The PSCW authorized an interim fuel credit in May 2009 as a result of decreased actual electric fuel costs. The order was subject to refund with interest at 10.8%. The interim fuel credit resulted in a $4.6 million reduction in customer revenues. In April 2010, the PSCW authorized a refund of $0.3 million of over collected 2009 fuel costs and accrued interest via a one-time credit, which was applied to customers' April 2010 bills. As of September 30, 2010, MGE's fuel costs are within the range authorized by the PSCW in the most recent rate order; therefore, no accruals were necessary.


As a result of lower-than-expected fuel and purchased power costs in 2008, a fuel refund was approved by the PSCW. To account for this refund, MGE recorded a $5.5 million reduction to other electric revenues in the twelve months ended December 31, 2008. In March 2009, the PSCW completed their audit of the 2008 electric fuel costs and issued a final order, which applied this refund to customers' accounts in March 2009.


c.

Purchased Gas Adjustment Clause.


MGE's natural gas rates are subject to a fuel adjustment clause designed to recover or refund the difference between the actual cost of purchased gas and the amount included in rates. Differences between the amounts billed to customers and the actual costs recoverable are deferred and recovered or refunded in future periods by means of prospective monthly adjustments to rates. At September 30, 2010, and December 31, 2009, MGE had over collected $4.6 million and $7.6 million, respectively. These amounts were recorded in other current liabilities on the Consolidated Balance Sheet.


15.

Fair Value of Financial Instruments - MGE Energy and MGE.


a.

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


At September 30, 2010, and December 31, 2009, the carrying amount of cash, cash equivalents, and outstanding commercial paper approximates fair market value due to the short maturity of those investments and obligations. The estimated fair market value of MGE's long-term debt is based on quoted market prices at September 30, 2010, and December 31, 2009. The estimated fair market value of MGE Energy's and MGE's financial instruments are as follows:


 

September 30, 2010

 

December 31, 2009

(In thousands)

Carrying

Amount

 

Fair

Value

 

Carrying

Amount

 

Fair

Value

MGE Energy

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

Cash and cash equivalents

$17,531

 

$17,531

 

$4,704

 

$4,704

Liabilities:


 


 


 


Short-term debt - bank loans

34,000

 

34,000

 

31,000

 

31,000

Short-term debt - commercial paper

14,500

 

14,500

 

33,500

 

33,500

Long-term debt*

322,389

 

367,906

 

323,500

 

339,557

 


 


 


 


MGE


 


 


 


Assets:


 


 


 


Cash and cash equivalents

14,803

 

14,803

 

2,474

 

2,474

Liabilities:


 


 


 


Short-term debt - commercial paper

14,500

 

14,500

 

33,500

 

33,500

Long-term debt*

322,389

 

367,906

 

273,500

 

289,557


*Includes long-term debt due within one year.


b.

Recurring Fair Value Measurements.


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.





Page 29



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.


The following tables present 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, 2010

(In thousands)

Total

Level 1

Level 2

Level 3

MGE Energy

 

 

 

 

Assets:

 

 

 

 

Exchange-traded investments

$416

$416

$-

$-

Total Assets

$416

$416

$-

$-

Liabilities:





Derivatives, net (a)

$20,651

$1,453

$-

$19,198

Deferred compensation

1,466

1,466

-

-

Total Liabilities

$22,117

$2,919

$-

$19,198

 

 

 



MGE

 

 



Assets:





Exchange-traded investments

$248

$248

$-

$-

Total Assets

$248

$248

$-

$-

Liabilities:





Derivatives, net (a)

$20,651

$1,453

$-

$19,198

Deferred compensation

1,466

1,466

-

-

Total Liabilities

$22,117

$2,919

$-

$19,198


(a) These amounts are shown gross and exclude $3.2 million of cash collateral that was netted against net derivative positions with counterparties.


 

Fair Value as of December 31, 2009

(In thousands)

Total

Level 1

Level 2

Level 3

MGE Energy

 

 

 

 

Assets:

 

 

 

 

Exchange-traded investments

$535

$535

$-

$-

Total Assets

$535

$535

$-

$-

Liabilities:





Derivatives, net (b)

$12,541

$(506)

$-

$13,047

Deferred compensation

1,342

1,342

-

-

Total Liabilities

$13,883

$836

$-

$13,047

 

 

 



MGE

 

 



Assets:





Exchange-traded investments

$327

$327

$-

$-

Total Assets

$327

$327

$-

$-

Liabilities:





Derivatives, net (b)

$12,541

$(506)

$-

$13,047

Deferred compensation

1,342

1,342

-

-

Total Liabilities

$13,883

$836

$-

$13,047


(b) These amounts are shown gross and exclude $0.4 million of cash collateral that was netted against net derivative positions with counterparties.


No transfers were made in or out of Level 1 or Level 2 for the nine months ended September 30, 2010.


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





Page 30



Derivatives include exchange-traded derivative contracts, over-the-counter party 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 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 with markets with similar exchange traded transactions. The ten-year purchased power agreement (see Footnote 12) was valued using an internally-developed pricing model and therefore classified as Level 3. The model includes both observable and unobservable inputs. Inputs to the model require significant management judgment and estimation. The model uses a forward power pricing curve based on exchange-traded contracts in the electric futures market. As described above, the market prices from this source have insufficient volumes and are classified as Level 3 in the fair value hierarchy. To project future prices beyond the period in which these quoted market prices are available, MGE calculates the price based on forward gas prices and an implied heat rate. MGE 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 incorporates discounting, credit, and model risks. 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.


Cash and cash equivalents include investments with maturities of less than three months that are traded in active markets and deposit accounts and are therefore classified as Level 1.


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 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, and are therefore based upon observable market data and classified as Level 1.


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.


(In thousands)

2010

 

2009

Three Months Ended September 30

 

 

 

Balance as of June 30,

$(17,604)


$(16,838)

Realized and unrealized gains (losses):




Included in regulatory liabilities (assets)

(1,594)


38

Included in other comprehensive income

-


-

Included in earnings

(306)


(5,737)

Included in current assets

-


-

Purchases, sales, issuances, and settlements, net

306


5,737

Transfers in and/or out of Level 3

-


-

Balance as of September 30,

$(19,198)


$(16,800)

Total gains (losses) included in earnings attributed to the change in unrealized gains (losses) related to assets and liabilities held at September 30, (c)  

$-


$-

 

 

 

 

Nine Months Ended September 30

 

 

 

Balance as of January 1,

$(13,047)


$(9,219)

Realized and unrealized gains (losses):




Included in regulatory liabilities (assets)

(6,151)


(7,581)

Included in other comprehensive income

-


-

Included in earnings

(1,409)


(13,663)

Included in current assets

-


-

Purchases, sales, issuances, and settlements, net

1,409


13,663

Transfers in and/or out of Level 3

-


-

Balance as of September 30,

$(19,198)


$(16,800)

Total gains (losses) included in earnings attributed to the change in unrealized gains (losses) related to assets and liabilities held at September 30, (c)  

$-


$-





Page 31



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 during the three and nine months ended September 30, 2010 and 2009, for both MGE Energy and MGE. (c).


(In thousands)

Purchased Power Expense

Cost of Gas Sold Expense

Regulated Gas Revenues

Total gains (losses) included in earnings for the

three months ended September 30, 2010

$(311)

$5

$-

Total gains (losses) included in earnings for the

three months ended September 30, 2009

$(5,734)

$(3)

$-

 




Total gains (losses) included in earnings for the

nine months ended September 30, 2010

$(1,389)

$(20)

$-

Total gains (losses) included in earnings for the

nine months ended September 30, 2009

$(13,825)

$91

$71


(c) 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. A portion of MGE's derivative contracts fall under the incentive mechanism within the PGA clause and shareholders have the ability to receive a set percentage of the benefit or loss from these deals if certain thresholds are achieved. Under these derivatives, only the gains or losses associated with customers are subject to regulatory deferral. The remaining shareholder portion is reflected in other comprehensive income. As a result of the above described treatment, there are no unrealized gains or losses that flow through earnings.


16.

New Accounting Pronouncements - MGE Energy and MGE.


a.

Consolidation of Variable Interest Entities.


In June 2009, the FASB issued authoritative guidance within the Codification's Consolidation topic regarding variable-interest entities. This guidance amends the criteria used to determine which entity, if any, has a controlling financial interest in a VIE. It replaces the quantitative calculation of risks and rewards with a qualitative approach focused on identifying which entity (1) has the power to direct the activities of a VIE that most significantly impact the VIE's economic performance and (2) has the obligation to absorb losses of the VIE or the right to receive benefits from the VIE. This guidance also requires ongoing assessments of whether an entity is the primary beneficiary of a VIE. This authoritative guidance became effective for interim and annual reporting periods that began after November 15, 2009. The Company evaluated its VIE's and determined this authoritative guidance did not have a material impact. MGE Power West Campus and MGE Power Elm Road continue to be a VIE's under applicable accounting requirements; therefore, MGE continues to consolidate both entities into its financial results and financial position.


b.

Transfers and Servicing of Financial Assets.


In June 2009, the FASB issued authoritative guidance within the Codification's Transfers and Servicing topic regarding accounting for transfers of financial assets. This statement removes the concept of a qualifying special-purpose entity from authoritative guidance on accounting for transfers and servicing of financial assets and extinguishments of liabilities. This statement also removes the exception for qualifying special-purpose entities from authoritative guidance on consolidation of variable interest entities. The authoritative guidance became effective for fiscal years ending after November 15, 2009. The Company evaluated its shared savings program under the new guidance and determined it did not have any financial impact or impose any additional disclosure requirement.





Page 32



c.

Fair Value Measurements and Disclosures.


In January 2010, the FASB issued authoritative guidance within the Codification's Fair Value Measurements and Disclosures topic that provides guidance on additional disclosures about fair value measurements. This authoritative guidance became effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010. The authoritative guidance effective beginning January 1, 2010, did not have any financial impact, but required additional disclosures. See Footnote 15 for additional information. The authoritative guidance effective beginning January 1, 2011 will not have a material financial impact, but will require additional disclosures.


17.

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.


Sales between our electric and gas segments are based on PSCW approved tariffed rates. Additionally, intersegment operations related to the leasing arrangement between our electric segment and MGE Power West Campus/MGE Power Elm Road are based on terms previously approved by the PSCW. Consistent with internal reporting, management has presented the direct financing capital lease between MGE and MGE Power West Campus and MGE and MGE Power Elm Road based on actual lease payments allowed to be recovered in rates. Lease payments made by MGE to MGE Power West Campus and MGE Power Elm Road are shown as operating expenses. The lease payments received by MGE Power West Campus and MGE Power Elm Road from MGE are shown as lease income in interdepartmental revenues. The depreciation expense associated with the WCCF and Elm Road Units is reflected in the nonregulated energy segment.


See MGE Energy's and MGE's 2009 Annual Report on Form 10-K for additional discussion of each of these segments.





Page 33



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


MGE Energy

(In thousands)

Electric

Gas

Nonregulated Energy

Transmission Investment

All Others

Consolidation/ Elimination Entries

Consolidated Total

Three months ended September 30, 2010


 

 

 

 

 

 

Operating revenues

$109,849

$17,394

$695

$-

$-

$-

$127,938

Interdepartmental revenues

161

4,509

8,011

-

-

(12,681)

-

Total operating revenues

110,010

21,903

8,706

-

-

(12,681)

127,938

Depreciation and amortization

(6,888)

(1,309)

(1,363)

-

-

-

(9,560)

Other operating expenses

(73,469)

(22,948)

(35)

-

(255)

12,681

(84,026)

Operating income (loss)

29,653

(2,354)

7,308

-

(255)

-

34,352

Other income (deductions), net

435

123

-

2,091

(3)

-

2,646

Interest expense, net

(2,646)

(746)

(655)

-

(52)

-

(4,099)

Income (loss) before taxes

27,442

(2,977)

6,653

2,091

(310)

-

32,899

Income tax (provision) benefit

(10,874)

1,305

(2,670)

(870)

119

-

(12,990)

Net income (loss)

$16,568

$(1,672)

$3,983

$1,221

$(191)

$-

$19,909

 








Three months ended September 30, 2009








Operating revenues

$91,734

$15,144

$2,419

$-

$-

$-

 $109,297

Interdepartmental revenues

167

1,240

3,725

-

-

(5,132)

-

Total operating revenues

91,901

16,384

6,144

-

-

(5,132)

109,297

Depreciation and amortization

(7,241)

(2,433)

(686)

-

-

-

(10,360)

Other operating expenses

(66,155)

(16,661)

(30)

-

(114)

5,132

(77,828)

Operating income (loss)

18,505

(2,710)

5,428

-

(114)

-

21,109

Other income (deductions), net

(53)

(15)

-

2,110

(38)

-

2,004

Interest (expense) income, net

(2,684)

(757)

(672)

-

696

-

(3,417)

Income (loss) before taxes

15,768

(3,482)

4,756

2,110

544

-

19,696

Income tax (provision) benefit

(5,257)

1,270

(1,909)

(847)

(231)

-

(6,974)

Net income (loss)

$10,511

$(2,212)

 $2,847

 $1,263

 $313

 $-

 $12,722

 








Nine months ended September 30, 2010








Operating revenues

$279,281

$114,231

$3,151

$-

$-

$-

$396,663

Interdepartmental revenues

398

10,353

22,631

-

-

(33,382)

-

Total operating revenues

279,679

124,584

25,782

-

-

(33,382)

396,663

Depreciation and amortization

(20,520)

(3,884)

(3,859)

-

-

-

(28,263)

Other operating expenses

(212,274)

(112,554)

(101)

-

(604)

33,382

(292,151)

Operating income (loss)

46,885

8,146

21,822

-

(604)

-

76,249

Other income (deductions), net

2,372

669

(104)

6,374

3

-

9,314

Interest (expense) income, net

(7,874)

(2,221)

(2,031)

-

74

-

(12,052)

Income (loss) before taxes

41,383

6,594

19,687

6,374

(527)

-

73,511

Income tax (provision) benefit

(15,175)

(2,336)

(7,890)

(2,589)

200

-

(27,790)

Net income (loss)

$26,208

$4,258

$11,797

$3,785

$(327)

$-

$45,721

 








Nine months ended September 30, 2009








Operating revenues

$253,059

$137,997

$6,941

$-

$-

$-

 $397,997

Interdepartmental revenues

397

5,175

11,172

-

-

(16,744)

-

Total operating revenues

253,456

143,172

18,113

-

-

(16,744)

397,997

Depreciation and amortization

(21,392)

(7,109)

(2,058)

-

-

-

(30,559)

Other operating expenses

(197,702)

(123,672)

(98)

(1)

(590)

16,744

(305,319)

Operating income (loss)

34,362

12,391

15,957

(1)

(590)

-

62,119

Other income (deductions), net

(39)

(11)

-

6,112

(45)

-

6,017

Interest (expense) income, net

(7,997)

(2,256)

(2,007)

-

2,088

-

(10,172)

Income before taxes

26,326

10,124

13,950

6,111

1,453

-

57,964

Income tax provision

(7,771)

(3,972)

(5,599)

(2,453)

(602)

-

(20,397)

Net income

$18,555

 $6,152

 $8,351

 $3,658

 $851

 $-

 $37,567





Page 34



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


MGE

(In thousands)

Electric

Gas

Nonregulated Energy

Transmission Investment

Consolidation/ Elimination Entries

Consolidated Total

Three months ended September 30, 2010







Operating revenues

$109,849

$17,394

$695

$-

$-

$127,938

Interdepartmental revenues

161

4,509

8,011

-

(12,681)

-

Total operating revenues

110,010

21,903

8,706

-

(12,681)

127,938

Depreciation and amortization

(6,888)

(1,309)

(1,363)

-

-

(9,560)

Other operating expenses*

(84,150)

(21,589)

(2,705)

-

12,681

(95,763)

Operating income (loss)*

18,972

(995)

4,638

-

-

22,615

Other income, net*

243

69

-

1,221

-

1,533

Interest expense, net

(2,646)

(746)

(655)

-

-

(4,047)

Net income (loss)

16,569

(1,672)

3,983

1,221

-

20,101

Less: Net income attributable to noncontrolling interest, net of tax

-

-

-

-

(5,108)

(5,108)

Net income (loss) attributable to MGE

$16,569

$(1,672)

$3,983

$1,221

$(5,108)

$14,993

 







Three months ended September 30, 2009







Operating revenues

$91,734

$15,144

$2,419

$-

$-

 $109,297

Interdepartmental revenues

167

1,240

3,725

-

(5,132)

-

Total operating revenues

91,901

16,384

6,144

-

(5,132)

109,297

Depreciation and amortization

(7,241)

(2,433)

(686)

-

-

(10,360)

Other operating expenses*

(71,451)

(15,402)

(1,939)

-

5,132

(83,660)

Operating income (loss)*

13,209

(1,451)

3,519

-

-

15,277

Other income (deductions), net*

(14)

(4)

-

1,263

-

1,245

Interest expense, net

(2,684)

(757)

(672)

-

-

(4,113)

Net income (loss)

10,511

(2,212)

2,847

1,263

-

12,409

Less: Net income attributable to noncontrolling interest, net of tax

-

-

-

-

(3,567)

(3,567)

Net income (loss) attributable to MGE

 $10,511

 $(2,212)

 $2,847

 $1,263

$(3,567)

 $8,842

 







Nine months ended September 30, 2010







Operating revenues

$279,281

$114,231

$3,151

$-

$-

$396,663

Interdepartmental revenues

398

10,353

22,631

-

(33,382)

-

Total operating revenues

279,679

124,584

25,782

-

(33,382)

396,663

Depreciation and amortization

(20,520)

(3,884)

(3,859)

-

-

(28,263)

Other operating expenses*

(226,431)

(114,603)

(7,991)

-

33,382

(315,643)

Operating income*

32,728

6,097

13,932

-

-

52,757

Other income (deductions), net*

1,355

382

(104)

3,785

-

5,418

Interest expense, net

(7,874)

(2,221)

(2,031)

-

-

(12,126)

Net income

26,209

4,258

11,797

3,785

-

46,049

Less: Net income attributable to noncontrolling interest, net of tax

-

-

-

-

(15,104)

(15,104)

Net income attributable to MGE

$26,209

$4,258

$11,797

$3,785

$(15,104)

$30,945

 







Nine months ended September 30, 2009







Operating revenues

$253,059

$137,997

$6,941

$-

$-

 $397,997

Interdepartmental revenues

397

5,175

11,172

-

(16,744)

-

Total operating revenues

253,456

143,172

18,113

-

(16,744)

397,997

Depreciation and amortization

(21,392)

(7,109)

(2,058)

-

-

(30,559)

Other operating expenses*

(205,430)

(127,632)

(5,697)

(1)

16,744

(322,016)

Operating income (loss)*

26,634

8,431

10,358

(1)

-

45,422

Other income (deductions), net*

(82)

(23)

-

3,659

-

3,554

Interest expense, net

(7,997)

(2,256)

(2,007)

-

-

(12,260)

Net income

18,555

6,152

8,351

3,658

-

36,716

Less: Net income attributable to noncontrolling interest, net of tax

-

-

-

-

(10,427)

(10,427)

Net income attributable to MGE

 $18,555

 $6,152

 $8,351

 $3,658

$(10,427)

 $26,289


*Amounts are shown net of the related tax expense, consistent with the presentation on the consolidated MGE Income Statement.





Page 35



18.

Subsequent Events - MGE Energy and MGE.


ATC Capital Contribution


On October 29, 2010, MGE Transco made a voluntary $0.2 million capital contribution to ATC.





Page 36



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


General


MGE Energy is an investor-owned public utility holding company operating through subsidiaries in five business segments:


·

Electric utility operations, conducted through MGE,

·

Gas utility operations, conducted through MGE,

·

Nonregulated energy operations, conducted through MGE Power and its subsidiaries,

·

Transmission investments, representing our equity investment in ATC, and

·

All other, which includes corporate operations and services as well as certain construction services.


Our principal subsidiary is MGE, which generates and distributes electric energy, distributes natural gas, and represents a majority portion of our assets, liabilities, revenues, and expenses. MGE generates and distributes electricity to approximately 138,000 customers in Dane County, Wisconsin, including the city of Madison, and purchases and distributes natural gas to approximately 142,000 customers in the Wisconsin counties of Columbia, Crawford, Dane, Iowa, Juneau, Monroe, and Vernon.


Our nonregulated energy operations own interests in new electric generating capacity that is leased to MGE. The ownership/leasing structure was adopted under applicable state regulatory guidelines for MGE's participation in these generation facilities, consisting principally of a stable return on the equity investment in the new generation facilities over the term of the related leases. The nonregulated energy operations include partial ownership of a cogeneration project on the UW-Madison campus and an undivided 8.33% ownership interest in each of two 615 MW generating units being constructed in Oak Creek, Wisconsin, one of which entered commercial operation on February 2, 2010, and the other of which is expected to enter commercial operation in the fourth quarter of 2010. MGE operates the cogeneration project, and a third party operates the units in Oak Creek. Due to the nature of MGE's participation in these facilities, the results of our nonregulated operations are also consolidated into MGE's consolidated financial position and results of operations under applicable accounting standards.


Our primary focus today and for the foreseeable future is our core utility customers at MGE as well as creating long-term value for shareholders. MGE continues to face the challenge of providing its customers with reliable power at competitive prices. MGE plans to meet this challenge by investing in more efficient generation projects, including renewable energy sources. In the future, MGE will continue to focus on growing earnings while controlling operating and fuel costs. MGE will continue to maintain safe and efficient operations in addition to providing customer value. We believe it is critical to maintain a strong credit standing consistent with financial strength in MGE as well as the parent company in order to accomplish these goals.


Overview


We earn our revenue and generate cash from operations by providing electric and natural gas utility services, including electric power generation and electric power and gas distribution. The earnings and cash flows from the utility business are sensitive to various external factors, including:


·

Weather, and its impact on customer sales of electricity and gas,

·

Economic conditions, including current business activity and employment and their impact on customer demand,

·

Regulation and regulatory issues,

·

Energy commodity prices,

·

Equity price risk pertaining to pension related assets,

·

Credit market conditions, including interest rates and our debt credit rating,

·

Environmental laws and regulations, including pending environmental rule changes,

·

Construction risk in connection with the remaining Elm Road generating unit,


and other factors listed in "Item 1A. Risk Factors" of our 2009 Annual Report on Form 10-K.





Page 37



For the three months ended September 30, 2010, MGE Energy's earnings were $19.9 million or $0.86 per share compared to $12.7 million or $0.55 per share for the same period in the prior year. MGE's earnings for the three months ended September 30, 2010, were $15.0 million compared to $8.8 million for the same period in the prior year. For the nine months ended September 30, 2010, MGE Energy's earnings were $45.7 million or $1.98 per share compared to $37.6 million or $1.63 per share for the same period in the prior year. MGE's earnings for the nine months ended September 30, 2010, were $30.9 million compared to $26.3 million for the same period in the prior year.


MGE Energy's income was derived from our business segments as follows:


(In thousands)

Three Months Ended September 30,

 

Nine Months Ended September 30,

Business Segment:

2010

 

2009

 

2010

 

2009

Electric Utility

$16,568

 

$10,511


$26,208


$18,555

Gas Utility

(1,672)

 

(2,212)


4,258


6,152

Nonregulated Energy

3,983

 

2,847


11,797


8,351

Transmission Investment

1,221

 

1,263


3,785


3,658

All Other

(191)

 

313


(327)


851

Net Income

$19,909

 

$12,722


$45,721


$37,567


Our net income during the three months ended September 30, 2010, primarily reflects the effects of the following factors:


·

A 19.8% increase in electric revenues reflecting increased customer demand primarily as a result of warmer-than-normal weather, particularly when compared to the cooler-than-normal weather of the prior period. Cooling degree days (a measure for determining the impact of weather during the cooling season) increased by 181% compared to the prior period.


·

Higher nonregulated energy revenues are attributable to Elm Road Unit 1 entering commercial operation in February 2010.


Our net income during the nine months ended September 30, 2010, primarily reflects the effects of the following factors:


·

The electric and gas utilities reflect a one-time $2.6 million (pretax) gain on a sale of property to ATC during March 2010 and a one-time $0.5 million (pretax) gain on sale of property during September 2010.


·

A 10.4% increase in electric revenues reflecting increased customer demand primarily as a result of warmer-than-normal weather, particularly when compared to the cooler-than-normal weather of the prior period. Cooling degree days (a measure for determining the impact of weather during the cooling season) increased by 124% compared to the prior period.


·

A 17.2% decrease in gas sales reflecting lower customer demand due to a milder winter. Heating degree days (a measure for determining the impact of weather during the heating season) decreased by 12% compared to the prior period. In addition, in 2009, the gas utility received the benefit of $1.9 million (pretax) from capacity release revenues and commodity savings as a result of GCIM.


·

Higher nonregulated energy revenues are attributable to Elm Road Unit 1 entering commercial operation in February 2010.


During 2010, the following events occurred:


Elm Road Units: On February 2, 2010, Elm Road Unit 1 entered commercial operation, and Elm Road Unit 2 is expected to enter commercial operation in the fourth quarter of 2010 with a guaranteed contractual in-service date of November 28, 2010. On February 4, 2010, our subsidiary, MGE Power Elm Road, which owns an ownership interest in those Units, issued $50 million of its 5.04% senior secured notes to refinance a portion of the costs of those Units. The proceeds of those notes were used to repay borrowings under MGE Energy's credit facilities.


ATC: MGE Transco contributed $0.5 million for voluntary capital contributions to ATC for the nine months ended September 30, 2010.





Page 38



2011 Rate Filing: On April 22, 2010, MGE filed an application with the PSCW requesting a 9.4% increase to electric rates and a 2.0% increase to gas rates. The proposed electric increase is intended to cover costs for MGE's share of the Elm Road Units, new environmental equipment at Columbia, and transmission reliability enhancements. We have requested that these rates become effective January 1, 2011.

 

Smart Grid Investment Grant: MGE has been approved by the U.S. Department of Energy (DOE) under the federal stimulus program for a $5.5 million grant for smart grid projects. The DOE grant requires MGE to match the grant funding, bringing the total cost of the proposed projects to more than $11 million. The proposed projects will install technologies to boost efficiency, enhance service and improve reliability for customers. The stimulus grant will help fund the following projects: advanced metering infrastructure, plug-in hybrid electric vehicles support, and distribution management. In the third quarter, MGE entered into agreements to purchase $2.5 million in smart grid related products. As of September 30, 2010, MGE has spent $0.1 million related to these projects.


In the near term, several items may affect us, including:


General economic conditions: Economic conditions both inside and outside our service area are expected to continue to affect the level of demand for our utility services and may affect the collection of our accounts receivable and the creditworthiness of counterparties with whom we do business. We have in place lines of credit aggregating $195 million for MGE Energy (including MGE) and $75 million for MGE to address our liquidity needs.

 

Elm Road Unit: Elm Road Unit 2 is expected to enter commercial operation in the fourth quarter of 2010 with a guaranteed contractual in-service date of November 28, 2010.


Environmental Initiatives: There are proposed legislation, rules and initiatives involving matters related to air emissions, water effluent and greenhouse gases, all of which affect generation plant capital expenditures and operating costs as well as future operational planning. Such legislation and rulemaking could significantly affect the costs of owning and operating fossil-fueled generating plants, such as Columbia and Elm Road, from which we derive approximately 34% of our electricity generating capacity. We would expect to seek recovery of any such costs in rates; however, it is difficult to estimate the amount of such costs due to the uncertainty as to the timing and form of the legislation and rules, and the scope and time of the recovery of costs in rates. In addition, MGE is a party to litigation surrounding the alleged failure, among other things, to obtain necessary air permits and implement necessary emission controls associated with activities previously undertaken at Columbia. MGE is currently reviewing the allegations and is unable to predict their impact on its financial condition or results of operations, but believes that an adverse outcome could have a significant effect.


The following discussion is based on the business segments as discussed in Footnote 17.


Three Months Ended September 30, 2010 and 2009


Electric Utility Operations - MGE Energy and MGE


Electric sales and revenues


The following table compares MGE's electric revenues and electric kWh sales by customer class for each of the periods indicated:


 

Revenues

 

Sales (kWh)

(In thousands, except cooling degree days)

Three Months Ended September 30,

 

Three Months Ended September 30,

2010

2009

% Change

 

2010

2009

% Change

Residential

$38,156

$29,896

27.6%


250,849

200,426

25.2%

Commercial

56,380

50,535

11.6%


507,997

476,672

6.6%

Industrial

5,357

3,615

48.2%


70,072

54,084

29.6%

Other - retail/municipal

10,628

9,118

16.6%


124,983

116,641

7.2%

Total retail

110,521

93,164

18.6%


953,901

847,823

12.5%

Sales for resale

625

526

18.8%


2,676

234

1043.6%

Other revenues

(1,297)

(1,956)

33.7%


-

-

-

Total

$109,849

 $91,734

19.7%


956,577

848,057

12.8%

 








Cooling degree days (normal 436)





623

222

180.6%





Page 39



Electric operating revenues increased $18.1 million or 19.7% for the three months ended September 30, 2010, due to the following:

(In millions)

 

Three months ended September 30, 2010


Volume

$12.3

Rate changes

5.1

Other revenues

0.7

Total

$18.1


·

Volume. During the three months ended September 30, 2010, there was a 12.5% increase in total retail sales volumes compared to the same period in the prior year, reflecting the warmer-than-normal weather experienced in the current period compared to the cooler-than-normal weather experienced in the prior period.


·

Rates changes. Rates charged to retail customers for the three months ended September 30, 2010, were 5.4% or $5.1 million higher than those charged during the same period in the prior year.


In December 2009, the PSCW authorized MGE to increase 2010 rates for retail electric customers by 3.3% or $11.9 million, while gas rates decreased 0.74% or $1.5 million. The increase in retail electric rates is driven by costs for MGE's share of the Elm Road Units and transmission reliability enhancements. In May 2009, MGE implemented a credit of $0.00204 per kWh, due to a decrease in actual electric fuel costs. During the three months ended September 30, 2009, $1.6 million had been credited to electric customers.


·

Other revenues. Other electric revenues increased $0.7 million for the three months ended September 30, 2010, compared to the same period in the prior year.


Other electric revenues reflect the elimination of WCCF and Elm Road carrying costs that were collected in electric rates, which are recognized as nonregulated energy operating revenues in our Nonregulated Energy Operations segment. The amount eliminated was $1.8 million and $2.7 million for the three months ended September 30, 2010 and 2009, respectively.


During the three months ended September 30, 2010, MGE recovered in electric rates the costs associated with the lease payments for Elm Road Unit 2. These amounts have been deferred on MGE's balance sheet until the lease term commences. For the three months ended September 30, 2010, a $0.5 million reduction to other revenues was recorded to defer these revenues. This reduction was offset by a $0.5 million recognition in other revenues of previously deferred amounts.


Electric fuel and purchased power


Purchased power expense decreased by $4.1 million or 18.2% during the three months ended September 30, 2010, compared to the same period in the prior year. This decrease in expense reflects a $2.5 million or 12.0% decrease in the volume of power purchased from third parties and a $1.6 million or 7.0% decrease in the per-unit cost of purchased power. The decrease in purchased power expense is driven by Elm Road Unit 1 becoming operational in February 2010 and increased production at Columbia.


The expense for fuel for electric generation increased $2.7 million or 27.3% during the three months ended September 30, 2010, compared to the same period in the prior year, reflecting higher electric generation at Elm Road and Columbia.


Electric operating and maintenance expenses


Electric operating and maintenance expenses increased $4.3 million during the three months ended September 30, 2010, compared to the same period in 2009. The following changes contributed to the net change:


(In millions)

 

Three months ended September 30, 2010


Increased administrative and general costs

$1.8

Increased transmission costs

1.4

Increased distribution expenses

0.7

Increased customer account expenses

0.4

Total

$4.3




Page 40



For the three months ended September 30, 2010, increased administrative and general costs were primarily due to increased pension costs and the amortization of deferred pension expenses from 2009. These pension costs were deferred, as permitted by PSCW order, and recovery in rates began in 2010. Increased transmission costs were primarily due to network service fees pertaining to ATC. Distribution expenses increased mainly as a result of increased overhead and underground line expenses. Customer account expenses increased due to higher uncollectible accounts expense.


Electric depreciation expense


Electric depreciation expense decreased $0.4 million for the three months ended September 30, 2010, when compared to the same period in the prior year. This decrease was a result of new depreciation rates becoming effective for 2010.


Gas Utility Operations - MGE Energy and MGE


Gas deliveries and revenues


The following table compares MGE's gas revenues and gas therms delivered by customer class during each of the periods indicated:


 

Revenues

 

Therms Delivered

(In thousands, except HDD and average rate per therm of retail customer)

Three Months Ended September 30,

 

Three Months Ended September 30,

2010

2009

% Change

 

2010

2009

% Change

Residential

$8,080

$7,885

2.5%


5,526

6,089

(9.2)%

Commercial/industrial

8,314

6,599

26.0%


14,450

13,125

10.1%

Total retail

16,394

14,484

13.2%


19,976

19,214

4.0%

Gas transportation

484

538

(10.0)%


6,524

6,733

(3.1)%

Other revenues

516

122

323.0%


-

-

-

Total

$17,394

 $15,144

14.9%


26,500

25,947

2.1%

Heating degree days (normal 180)




 

151

170

(11.2)%

Average rate per therm of retail customer

$0.821

$0.754

8.9%

 

 




Gas revenues increased $2.3 million or 14.9% for the three months ended September 30, 2010. These changes are related to the following factors:


(In millions)

 

Three months ended September 30, 2010


Gas costs/rates

$1.3

Gas deliveries

0.6

Transportation and other effects

0.4

Total

$2.3


·

Gas costs/rates. The average retail rate per therm for the three months ended September 30, 2010, increased 8.9% compared to the same period in 2009 as a result of higher natural gas costs.


·

Retail gas deliveries. For the three months ended September 30, 2010, retail gas deliveries increased 4.0% compared to the prior period.


·

Transportation and other revenues. Transportation and other revenues increased a total of $0.4 million primarily due to the impact of the MGE GCIM in 2010.


Under MGE's GCIM, if actual gas commodity savings and capacity release revenues are above or below a benchmark set by the PSCW, then MGE's gas sales service customers and shareholders share in any increased costs or savings per percentages set by the PSCW. For the three months ended September 30, 2010, shareholders received a benefit of $0.4 million from capacity release revenues and commodity savings under GCIM. For the three months ended September 30, 2009, shareholders did not receive a benefit.


Cost of gas sold


For the three months ended September 30, 2010, cost of gas sold increased by $2.4 million, compared to the same period in the prior year. The cost per therm of natural gas increased 35.6%, which resulted in $2.2 million of increased expense. In addition, a 4.1% increase in volume of gas purchased resulted in $0.2 million of increased expense.




Page 41



Gas operating and maintenance expenses


Gas operating and maintenance expenses increased $1.0 million for the three months ended September 30, 2010, compared to the same period a year ago. The following changes contributed to the net change:


(In millions)

 

Three months ended September 30, 2010


Increased administrative and general costs

$1.2

Decreased distribution expenses

(0.2)

Total

 $1.0


For the three months ended September 30, 2010, increased administrative and general costs were primarily due to increased pension costs and the amortization of deferred pension expenses from 2009. These pension costs were deferred and recovery in rates began in 2010.


Gas depreciation expense


Gas depreciation expense decreased $1.1 million for the three months ended September 30, 2010, when compared to the same period in the prior year. This decrease was a result of new depreciation rates becoming effective for 2010.


Nonregulated Energy Operations - MGE Energy and MGE


Nonregulated energy operating revenues


Operating revenues from nonregulated energy operations increased $2.6 million for the three months ended September 30, 2010, when compared to the same period in the prior year, reflecting the delivery of, and commencement of commercial operations at Elm Road Unit 1 in February 2010. Operating revenues from nonregulated energy operations for the three months ended September 30, 2010 and 2009, were $8.0 million and $3.7 million, respectively, related to leasing arrangements between MGE and MGE Power West Campus and MGE and MGE Power Elm Road. The increase largely reflects the commencement of lease payments on Elm Road Unit 1, which began when the Unit entered commercial operation. Upon consolidation, these interdepartmental revenues are eliminated.


MGE also received approval from the PSCW to collect carrying costs expected to be incurred by MGE Power Elm Road during construction of the Elm Road Units. MGE estimates that the total carrying costs on the Elm Road Units will be approximately $60.4 million. A portion of this amount is being recognized over the period recovered in rates and a portion is being deferred and will be recognized over the period in which the facility is depreciated. See Footnote 6.c. for additional information regarding these carrying charges. For the three months ended September 30, 2010 and 2009, MGE Power Elm Road recognized $1.0 million and $2.1 million, respectively, related to carrying costs on the Elm Road Units.


Nonregulated depreciation expense


Nonregulated depreciation expense increased $0.7 million for the three months ended September 30, 2010, compared to the same period in the prior year. This additional depreciation is related to the commencement of commercial operations at Elm Road unit 1 in February 2010.


Nonregulated energy interest expense, net


For both the three months ended September 30, 2010 and 2009, interest expense, net at the nonregulated energy operations segment was $0.7 million. Interest expense at the nonregulated energy segment for both the three months ended September 30, 2010 and 2009, includes interest expense incurred on $50 million of borrowings at MGE Power West Campus, which were long-term and fixed rate during both periods, and $50 million of borrowings at MGE Power Elm Road, which were long-term and fixed rate during 2010.


Included in the 2009 nonregulated interest expense is interdepartmental interest expense and capitalized interest at MGE Power Elm Road. During the three months ended September 30, 2009, MGE Power Elm Road was charged $0.8 million in interest expense by Corporate on funds borrowed for the Elm Road project. This expense is eliminated upon consolidation for MGE Energy only. The interest expense at MGE Power Elm Road is offset in capitalized interest.





Page 42



During the three months ended September 30, 2009, MGE Power Elm Road recorded less than $0.1 million in interest income on cash advanced to ERS for construction of transmission equipment and work done by ATC related to the Elm Road Units. No interest income on cash advanced to ERS was recorded during the three months ended September 30, 2010.


Transmission Investment Operations - MGE Energy and MGE


Transmission investment other income


For the three months ended September 30, 2010 and 2009, other income at the transmission investment segment was $2.1 million. The transmission investment segment holds our interest in ATC, and its income reflects our equity in the earnings of ATC.


All Other Nonregulated Operations - MGE Energy


All other interest income, net


All other interest expense, net for the three months ended September 30, 2010, was less than $0.1 million. All other interest income, net for the three months ended September 30, 2009, was $0.7 million. Interest expense for the three months ended September 30, 2010, represents less than $0.1 million in interest expense on short-term debt. Interest income for the three months ended September 30, 2009, represents $0.8 million in interdepartmental interest income from MGE Power Elm Road, partially offset by $0.1 million in interest expense on short-term debt. The interdepartmental interest income is eliminated upon consolidation.


Consolidated Income Taxes - MGE Energy and MGE


MGE Energy's effective income tax rate for the three months ended September 30, 2010, is 39.5% compared to 35.4% for the same period in 2009, and MGE's effective income tax rate for the three months ended September 30, 2010, is 39.5% compared to 35.2% for the same period in 2009. The increase in effective tax rate percentages is, in part, attributable to a lower wind energy production tax credit and a lower domestic manufacturing deduction.


Noncontrolling Interest, Net of Tax - MGE


The noncontrolling interest, net of tax, reflects the accounting required for MGE Energy's interest in the WCCF and Elm Road Units. MGE Energy owns 100% of MGE Power West Campus and MGE Power Elm Road; however, due to the leasing arrangements for these projects with MGE, the entities are considered VIEs and their results are consolidated with those of MGE, the primary beneficiary of the VIEs. Also included in noncontrolling interest, net of tax, is MGE Energy's interest in MGE Transco.


For the three months ended September 30, 2010, MGE Energy (through its wholly owned subsidiary MGE Power) earned $1.9 million and $2.8 million, net of tax, for its interest in MGE Power West Campus and MGE Power Elm Road, respectively. Additionally, MGE Energy earned $0.4 million, net of tax, for its interest in MGE Transco for the three months ended September 30, 2010. These amounts are recorded as noncontrolling interest expense, net of tax, on MGE's consolidated statement of income.


For the three months ended September 30, 2009, MGE Energy (through its wholly owned subsidiary MGE Power) had earned $1.9 million and $1.3 million, net of tax, for its interest in MGE Power West Campus and MGE Power Elm Road, respectively. Additionally, MGE Energy had earned $0.4 million, net of tax, for its interest in MGE Transco for the three months ended September 30, 2009. These amounts are recorded as noncontrolling interest expense, net of tax, on MGE's consolidated statement of income.





Page 43



Nine Months Ended September 30, 2010 and 2009


Electric Utility Operations - MGE Energy and MGE


Electric sales and revenues


The following table compares MGE's electric revenues and electric kWh sales by customer class for each of the periods indicated:


 

Revenues

 

Sales (kWh)

(In thousands, except cooling degree days)

Nine Months Ended September 30,

 

Nine Months Ended September 30,

2010

2009

% Change

 

2010

2009

% Change

Residential

$94,467

$82,778

14.1%


635,071

579,721

9.5%

Commercial

145,926

134,486

8.5%


1,378,110

1,343,321

2.6%

Industrial

15,658

13,048

20.0%


203,967

192,016

6.2%

Other - retail/municipal

26,817

23,486

14.2%


323,169

305,725

5.7%

Total retail

282,868

253,798

11.5%


2,540,317

2,420,783

4.9%

Sales for resale

1,574

1,490

5.6%


21,110

3,618

483.5%

Other revenues

(5,161)

(2,229)

(131.5)%


-

-


Total

$279,281

$253,059

10.4%


2,561,427

2,424,401

5.7%

 








Cooling degree days (normal 610)





825

368

124.2%


Electric operating revenues increased $26.2 million or 10.4% for the nine months ended September 30, 2010, due to the following:


(In millions)

 

Nine months ended September 30, 2010


Volume

$13.3

Rate changes

10.3

Fuel refund (2009)

5.5

Other revenues

(2.9)

Total

$26.2


·

Volume. During the nine months ended September 30, 2010, there was a 4.9% increase in total retail sales volumes compared to the same period in the prior year, reflecting the warmer-than-normal weather experienced in the current period compared to the cooler-than-normal weather experienced in the prior period.


·

Rates changes. Rates charged to retail customers for the nine months ended September 30, 2010, were 4.0% or $10.3 million higher than those charged during the same period in the prior year.


In December 2009, the PSCW authorized MGE to increase 2010 rates for retail electric customers by 3.3% or $11.9 million, while gas rates decreased 0.74% or $1.5 million. The increase in retail electric rates is driven by costs for MGE's share of the Elm Road Units and transmission reliability enhancements. Pursuant to the provisions of this rate order, the authorized return on common stock equity was set at 10.4% based on a 55.3% utility common equity.


In May 2009, MGE implemented a credit of $0.00204 per kWh, due to a decrease in actual electric fuel costs. During the nine months ended September 30, 2009, $2.5 million had been credited to electric customers.


·

Fuel Refund. As a result of lower than expected fuel and purchased power costs in 2008, a fuel refund was approved. The PSCW issued a final order approving the refund amount of $5.5 million, which was applied to customers' accounts in March 2009. This refund reduced revenues for the nine months ended September 30, 2009.


·

Other revenues. Other electric revenues decreased $2.9 million for the nine months ended September 30, 2010, compared to the same period in the prior year.


During the nine months ended September 30, 2009, MGE recorded $5.5 million in other electric revenues to offset the impact of the 2008 fuel refund. Offsetting this adjustment, as a result of lower than expected fuel costs pertaining to 2009, a $1.2 million projected refund was accrued as of September 30, 2009.





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Other electric revenues reflect the elimination of WCCF and Elm Road carrying costs that were collected in electric rates, which are recognized as nonregulated energy operating revenues in our Nonregulated Energy Operations segment. The amount eliminated was $5.2 million and $8.1 million for the nine months ended September 30, 2010 and 2009, respectively.


During the nine months ended September 30, 2010, MGE began recovering in electric rates the costs associated with the lease payments for Elm Road Unit 2. These amounts have been deferred on MGE's balance sheet until the lease term commences. At September 30, 2010, a $2.0 million reduction to other revenues was recorded to defer these revenues. This was partially offset by a $0.5 million recognition in other revenues of previously deferred amounts. This reduction is reflected as a regulatory liability on the consolidated balance sheet.


Electric fuel and purchased power


Purchased power expense decreased by $12.0 million or 17.5% during the nine months ended September 30, 2010, compared to the same period in the prior year. This decrease in expense reflects an $11.9 million or 17.4% decrease in the volume of power purchased from third parties. The decrease in purchased power expense is driven by Elm Road Unit 1 becoming operational in February 2010 and increased production at Columbia.


The expense for fuel for electric generation increased $4.5 million or 16.7% during the nine months ended September 30, 2010, compared to the same period in the prior year, reflecting higher electric generation at Elm Road and Columbia.


Electric operating and maintenance expenses


Electric operating and maintenance expenses increased $10.6 million during the nine months ended September 30, 2010, compared to the same period in 2009. The following changes contributed to the net change:


(In millions)

 

Nine months ended September 30, 2010


Increased administrative and general costs

$4.6

Increased transmission costs

3.7

Increased distribution expenses

1.2

Increased production costs

1.1

Total

$10.6


For the nine months ended September 30, 2010, increased administrative and general costs were primarily due to increased pension costs and the amortization of deferred pension expenses from 2009. These pension costs were deferred and recovery in rates began in 2010. Transmission costs increased primarily due to network service fees pertaining to ATC. Distribution expenses increased mainly as a result of increased overhead and underground line expenses. Production costs increased due to Elm Road Unit 1 becoming operational in February 2010.


Electric depreciation expense


Electric depreciation expense decreased $0.9 million for the nine months ended September 30, 2010, when compared to the same period in the prior year. This decrease was a result of new depreciation rates becoming effective for 2010.


Gas Utility Operations - MGE Energy and MGE


Gas deliveries and revenues


The following table compares MGE's gas revenues and gas therms delivered by customer class during each of the periods indicated:




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Revenues

 

Therms Delivered

(In thousands, except HDD and average rate per therm of retail customer)

Nine Months Ended September 30,

 

Nine Months Ended September 30,

2010

2009

% Change

 

2010

2009

% Change

Residential

$63,309

$76,066

(16.8)%


57,204

65,772

(13.0)%

Commercial/industrial

48,054

57,455

(16.4)%


67,634

75,352

(10.2)%

Total retail

111,363

133,521

(16.6)%


124,838

141,124

(11.5)%

Gas transportation

1,788

2,116

(15.5)%


25,753

27,410

(6.0)%

Other revenues

1,080

2,360

(54.2)%


-

-

-

Total

$114,231

 $137,997

(17.2)%


150,591

168,534

(10.6)%

Heating degree days (normal 4,516)




 

4,217

4,765

(11.5)%

Average rate per therm of retail customer

$0.892

$0.946

(5.7)%

 

 




Gas revenues decreased $23.8 million or 17.2% for the nine months ended September 30, 2010. These changes are related to the following factors:


(In millions)

 

Nine months ended September 30, 2010


Gas deliveries

$(14.6)

Gas costs/rates

(7.6)

Transportation and other effects

(1.6)

Total

$(23.8)


·

Retail gas deliveries. For the nine months ended September 30, 2010, retail gas deliveries decreased 11.5% compared to the same period in 2009 as a result of milder weather during the winter months.


·

Gas costs/rates. The average retail rate per therm for the nine months ended September 30, 2010, decreased 5.7% compared to the same period in 2009 as a result of significantly lower natural gas costs.


·

Transportation and other revenues. Transportation and other revenues decreased a total of $1.6 million primarily due to an increase in income realized under GCIM.


Under MGE's GCIM, if actual gas commodity savings and capacity release revenues are above or below a benchmark set by the PSCW, then MGE's gas sales service customers and shareholders share in any increased costs or savings per percentages set by the PSCW. For the nine months ended September 30, 2010 and 2009, shareholders received a benefit of $0.7 million and $1.9 million, respectively, from capacity release revenues and commodity savings under the GCIM.


Cost of gas sold


For the nine months ended September 30, 2010, cost of gas sold decreased by $17.7 million, compared to the same period in the prior year. The volume of gas purchased decreased 10.2% which resulted in $9.0 million of reduced expense. In addition, a 10.9% decrease in the cost per therm of natural gas resulted in $8.7 million of reduced expense.


Gas operating and maintenance expenses


Gas operating and maintenance expenses increased $1.9 million for the nine months ended September 30, 2010, compared to the same period a year ago. The following changes contributed to the net change:


(In millions)

 

Nine months ended September 30, 2010


Increased administrative and general costs

$3.2

Decreased customer accounts expenses

(0.7)

Decreased customer service costs

(0.3)

Decreased distribution expenses

(0.3)

Total

 $1.9


For the nine months ended September 30, 2010, increased administrative and general costs were primarily due to increased pension costs and the amortization of deferred pension expenses from 2009. These pension costs were deferred and recovery in rates began in 2010. Customer accounts decreased due to lower uncollectible accounts expense.




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Gas depreciation expense


Gas depreciation expense decreased $3.2 million for the nine months ended September 30, 2010, when compared to the same period in the prior year. This decrease was a result of new depreciation rates becoming effective for 2010.


Other Income, Net


For the nine months ended September 30, 2010, other income, net for the electric and gas segments increased by $3.1 million, compared to the same period in the prior year. This increase is primarily due to a one-time $2.6 million gain on a sale of property to ATC during March 2010 and a one-time $0.5 million gain on a sale of property during September 2010.


Nonregulated Energy Operations - MGE Energy and MGE


Nonregulated energy operating revenues


Operating revenues from nonregulated energy operations increased $7.7 million for the nine months ended September 30, 2010, when compared to the same period in the prior year, reflecting the delivery of, and commencement of commercial operations at, Elm Road Unit 1 in February 2010. Operating revenues from nonregulated energy operations for the nine months ended September 30, 2010 and 2009, was $22.6 million and $11.2 million, respectively, related to leasing arrangements between MGE and MGE Power West Campus and MGE and MGE Power Elm Road. The increase largely reflects the commencement of lease payments on Elm Road Unit 1. Upon consolidation, these interdepartmental revenues are eliminated.


MGE also received approval from the PSCW to collect carrying costs expected to be incurred by MGE Power Elm Road during construction of the Elm Road Units. MGE estimates that the total carrying costs on the Elm Road Units will be approximately $60.4 million. A portion of this amount is being recognized over the period recovered in rates and a portion is being deferred and will be recognized over the period in which the facility is depreciated. See Footnote 6.c. for additional information regarding these carrying charges. For the nine months ended September 30, 2010 and 2009, MGE Power Elm Road recognized $3.8 million and $6.1 million, respectively, related to carrying costs on the Elm Road Units.


Nonregulated depreciation expense


Nonregulated depreciation expense increased $1.8 million for the nine months ended September 30, 2010, compared to the same period in the prior year. This additional depreciation is related to the commencement of commercial operations at Elm Road Unit 1 in February 2010.


Nonregulated energy interest expense, net


For the nine months ended September 30, 2010 and 2009, interest expense, net at the nonregulated energy operations segment was $2.0 million. Interest expense at the nonregulated energy segment for both the nine months ended September 30, 2010 and 2009, includes interest expense incurred on $50 million of borrowings at MGE Power West Campus, which were long-term and fixed rate during both periods, and $50 million of borrowings at MGE Power Elm Road, which were long-term and fixed-rate during 2010.


Included in the nonregulated interest expense is interdepartmental interest expense and capitalized interest at MGE Power Elm Road. During the nine months ended September 30, 2010 and 2009, MGE Power Elm Road was charged $0.3 million and $2.5 million, respectively, in interest expense by Corporate on funds borrowed for the Elm Road project. This expense is eliminated upon consolidation for MGE Energy only. The interest expense at MGE Power Elm Road is offset in capitalized interest.


During the nine months ended September 30, 2009, MGE Power Elm Road recorded less than $0.1 million in interest income on cash advanced to ERS for construction of transmission equipment and work done by ATC related to the Elm Road Units. No interest income on cash advanced to ERS was recorded during the nine months ended September 30, 2010.





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Transmission Investment Operations - MGE Energy and MGE


Transmission investment other income


For the nine months ended September 30, 2010 and 2009, other income at the transmission investment segment was $6.4 million and $6.1 million, respectively. The transmission investment segment holds our interest in ATC, and its income reflects our equity in the earnings of ATC.


All Other Nonregulated Operations - MGE Energy


All other interest income, net


All other interest income, net for the nine months ended September 30, 2010 and 2009, was $0.1 million and $2.1 million, respectively. Interest income for the nine months ended September 30, 2010, represents $0.3 million in interdepartmental interest income from MGE Power Elm Road, partially offset by $0.2 million in interest expense on short-term debt. Interest income for the nine months ended September 30, 2009, represents $2.5 million in interdepartmental interest income from MGE Power Elm Road, partially offset by $0.4 million in interest expense on short-term debt. The interdepartmental interest income is eliminated upon consolidation.


Consolidated Income Taxes - MGE Energy and MGE


MGE Energy's effective income tax rate for the nine months ended September 30, 2010, is 37.8% compared to 35.2% for the same period in 2009, and MGE's effective income tax rate for the nine months ended September 30, 2010, is 37.8% compared to 35.0% for the same period in 2009. The increase in effective tax rate percentages is, in part, attributable to a lower wind energy production tax credit and a lower domestic manufacturing deduction.


Noncontrolling Interest, Net of Tax - MGE


The noncontrolling interest, net of tax, reflects the accounting required for MGE Energy's interest in the WCCF and Elm Road Units. MGE Energy owns 100% of MGE Power West Campus and MGE Power Elm Road; however, due to the leasing arrangements for these projects with MGE, the entities are considered VIEs and their results are consolidated with those of MGE, the primary beneficiary of the VIEs. Also included in noncontrolling interest, net of tax, is MGE Energy's interest in MGE Transco.


For the nine months ended September 30, 2010, MGE Energy (through its wholly owned subsidiary MGE Power) earned $5.7 million and $8.1 million, net of tax, for its interest in MGE Power West Campus and MGE Power Elm Road, respectively. Additionally, MGE Energy earned $1.3 million, net of tax, for its interest in MGE Transco for the nine months ended September 30, 2010. These amounts are recorded as noncontrolling interest expense, net of tax, on MGE's consolidated statement of income.


For the nine months ended September 30, 2009, MGE Energy (through its wholly owned subsidiary MGE Power) had earned $5.7 million and $3.7 million, net of tax, for its interest in MGE Power West Campus and MGE Power Elm Road, respectively. Additionally, MGE Energy had earned $1.1 million, net of tax, for its interest in MGE Transco for the nine months ended September 30, 2009. These amounts are recorded as noncontrolling interest expense, net of tax, on MGE's consolidated statement of income.


Contractual Obligations and Commercial Commitments - MGE Energy and MGE


There were no material changes, other than from the normal course of business, to MGE Energy's and MGE's contractual obligations (representing cash obligations that are considered to be firm commitments) and commercial commitments (representing commitments triggered by future events) during the nine months ended September 30, 2010, except as noted below. Further discussion of the contractual obligations and commercial commitments is included in Footnote 9 of this filing and Footnote 18 and "Contractual Obligations and Commercial Commitments for MGE Energy and MGE" under "Management's Discussion and Analysis of Financial Condition and Results of Operations" in MGE Energy's and MGE's 2009 Annual Report on Form 10-K.





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Columbia Environmental Matters - MGE Energy and MGE


As of September 30, 2010, MGE's share of various contractual commitments with vendors for environmental expenditures at Columbia is estimated to be $0.1 million for the remainder of 2010. These costs are expected to be capitalized and included in the consolidated balance sheet of MGE. See "Environmental Matters - Columbia" below for additional information regarding expected environmental expenditures at Columbia.


Natural Gas Supply Contracts - MGE Energy and MGE


MGE has natural gas supply commitments which include market-based pricing. Total natural gas supply commitments are estimated to be $14.6 million for the remainder of 2010, and $15.2 million for 2011. Management expects to recover these costs in future customer rates.


Coal Contracts - MGE Energy and MGE


Fuel procurement for MGE's jointly owned Columbia and Elm Road plants are handled by Alliant and Wisconsin Energy Corporation, respectively, the operating companies. 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. The following table identifies MGE's share, as of September 30, 2010, of the total coal commitments for the Columbia and Elm Road plants for the remainder of 2010 and the next four years.


(In thousands)

Year

Coal Commitments

2010

$12,227

2011

19,929

2012

7,060

2013

3,476

2014

3,476


Smart Grid Investment Grant - MGE Energy and MGE


MGE has been approved by the U.S. Department of Energy (DOE) under the federal stimulus program for a $5.5 million grant for smart grid projects. The DOE grant requires MGE to match the grant funding, bringing the total cost of the proposed projects to more than $11 million. The proposed projects will install technologies to boost efficiency, enhance service and improve reliability for customers. The stimulus grant will help fund the following projects: advanced metering infrastructure, plug-in hybrid electric vehicles support, and distribution management. In the third quarter, MGE entered into agreements to purchase $2.5 million in smart grid related products. As of September 30, 2010, MGE has spent $0.1 million related to these projects.


Secured Debt - MGE Energy and MGE


On February 4, 2010, MGE Power Elm Road issued $50 million of 5.04% senior secured notes due February 3, 2040. MGE Power Elm Road distributed the net proceeds from the sale of notes to MGE Energy, which used that distribution to repay existing short-term indebtedness, consisting of bank loans, which were used to finance a portion of the construction of the Elm Road Units. The notes provide for monthly principal and interest payments, which commenced on February 25, 2010, and continuing until maturity. The principal payments are level over the life of the notes, for an effective average life of 15 years. The Note Purchase Agreement requires MGE Power Elm Road to maintain a debt service coverage ratio at the end of any calendar quarter of not less than 1.25 to 1.00 for the trailing 12-month period. As of September 30, 2010, MGE Power Elm Road is in compliance with the covenant requirements.


Credit Facilities - MGE Energy and MGE


On July 30, 2010, MGE Energy entered into a Credit Agreement dated as of July 30, 2010, with the lenders named therein and JPMorgan Chase Bank, N.A., as Administrative Agent, providing MGE Energy with a $40 million revolving credit facility. That facility replaced MGE Energy's existing Credit Agreement dated as of August 28, 2009, as amended, which was scheduled to expire on August 27, 2010, and which was terminated on July 30, 2010. The new revolving credit facility will expire on July 30, 2013.




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On July 30, 2010, MGE entered into a Credit Agreement dated as of July 30, 2010, with the lenders named therein and JPMorgan Chase Bank, N.A., as Administrative Agent, providing MGE with a $75 million revolving credit facility. That facility replaced MGE's existing Amended and Restated Credit Agreement dated as of December 21, 2005, as amended, which was scheduled to expire on December 21, 2010, and which was terminated on July 30, 2010. The new revolving credit facility will expire on July 30, 2013. On August 27, 2010, MGE entered into an amendment that requires MGE to have a period of at least one day, during any 364-day period, on which the principal amount of all outstanding loans thereunder shall be zero.


On March 30, 2010, MGE's existing credit agreement dated March 31, 2009, which provided MGE with a $20 million committed credit facility, expired. MGE's lines of credit are used as backup to MGE's commercial paper.


Liquidity and Capital Resources


Cash Flows


The following summarizes cash flows during the nine months ended September 30, 2010 and 2009, respectively:


 

MGE Energy

 

MGE

(In thousands)

2010

 

2009

 

2010

 

2009

Cash provided by/(used for):




 




Operating activities

$97,380


$104,230

 

$97,223


$106,876

Investing activities

(40,734)


(57,962)

 

(40,427)


(56,654)

Financing activities

(43,819)


(43,352)

 

(44,467)


(46,856)


Cash Provided by Operating Activities


MGE Energy


MGE Energy's consolidated net cash provided by operating activities is derived mainly from the electric and gas operations of its principal subsidiary, MGE.


Cash provided by operating activities for the nine months ended September 30, 2010, was $97.4 million, a decrease of $6.9 million when compared to the same period in the prior year primarily due to working capital changes.


Working capital accounts resulted in $16.9 million in cash provided by operating activities for the nine months ended September 30, 2010, primarily due to decreased prepaid taxes (a result of a tax methodology change for accounting of repairs) and decreased unbilled revenues, partially offset by decreased accounts payable. Working capital accounts resulted in $36.1 million in cash provided by operating activities for the nine months ended September 30, 2009, primarily due to decreased receivables, decreased inventories (due to lower natural gas costs), and decreased unbilled revenues, partially offset by decreased accounts payable.


MGE Energy's net income increased $8.2 million for the nine months ended September 30, 2010, when compared to the same period in the prior year.


Pension contribution resulted in an additional $2.5 million in cash used by operating activities for the nine months ended September 30, 2010, when compared to the same period in the prior year. These contributions were made to comply with the Employee Retirement Income Security Act (ERISA) and the Pension Protection Act of 2006, and additional contributions were at management's discretion.


MGE


Cash provided by operating activities for the nine months ended September 30, 2010, was $97.2 million, a decrease of $9.7 million when compared to the same period in the prior year primarily due to working capital changes.


Working capital accounts resulted in $18.1 million in cash provided by operating activities for the nine months ended September 30, 2010, primarily due to increased accrued taxes, decreased unbilled revenues, and decreased prepaid taxes (a result of a tax methodology change for accounting of repairs), partially offset by decreased accounts payable. Working capital accounts resulted in $39.1 million in cash provided by operating activities for the nine months ended September 30, 2009, primarily due to decreased receivables, decreased inventories (due to lower natural gas costs), and decreased unbilled revenues, partially offset by decreased accounts payable.




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Net income increased $9.3 million for the nine months ended September 30, 2010, when compared to the same period in the prior year.


Pension contribution resulted in an additional $2.5 million in cash used by operating activities for the nine months ended September 30, 2010, when compared to the same period in the prior year. These contributions were made to comply with ERISA and the Pension Protection Act of 2006, and additional contributions were at management's discretion.


Cash Used for Investing Activities


MGE Energy


MGE Energy's cash used for investing activities decreased $17.2 million for the nine months ended September 30, 2010, when compared to the same period in the prior year.


Capital expenditures for the nine months ended September 30, 2010, were $43.2 million. This amount represents a $10.8 million decrease from the expenditures made in the same period in the prior year. This decrease is related to decreased construction activity of $5.8 million related to the Elm Road Units, a decrease of $4.2 million in other utility capital expenditures, and a decrease of $0.8 million related to the Top of Iowa III wind generation project.


Additionally, proceeds of $2.7 million were received for a one time sale of property to ATC in March 2010 and $0.6 million were received for a one time sale of property in September 2010.


MGE


MGE's cash used for investing activities decreased $16.2 million for the nine months ended September 30, 2010, when compared to the same period in the prior year.


Capital expenditures for the nine months ended September 30, 2010, were $43.2 million. This amount represents a $10.8 million decrease from the expenditures made in the same period in the prior year. This decrease is related to decreased construction activity of $5.8 million related to the Elm Road Units, a decrease of $4.2 million in other utility capital expenditures, and a decrease of $0.8 million related to the Top of Iowa III wind generation project.


Additionally, proceeds of $2.7 million were received for a one time sale of property to ATC in March 2010 and $0.6 million were received for a one time sale of property in September 2010.


Cash Used for Financing Activities


MGE Energy


Cash used for MGE Energy's financing activities was $43.8 million for the nine months ended September 30, 2010, compared to $43.4 million of cash used for MGE Energy's financing activities for the nine months ended September 30, 2009.


MGE Energy received $6.3 million in cash proceeds as the result of stock issued pursuant to the Stock Plan during the nine months ended September 30, 2009. No proceeds were received in 2010.


As of June 1, 2009, MGE Energy began purchasing stock in the open market for its Stock Plan rather than issuing new shares. All MGE Energy common stock shares under the Stock Plan are sold pursuant to a registration statement that has been filed with the SEC and is currently effective.


For the nine months ended September 30, 2010, dividends paid were $25.7 million compared to $25.2 million for same period in the prior year. This increase was a result of higher dividends per share ($1.112 vs. $1.092) and an increase in the number of shares outstanding.


For the nine months ended September 30, 2010, net short-term debt repayments were $16.0 million compared to $24.5 million for the same period in the prior year.





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MGE


During the nine months ended September 30, 2010, cash used for MGE's financing activities was $44.5 million compared to $46.9 million of cash used for MGE's financing activities in the same period in the prior year.


For the nine months ended September 30, 2010, net short-term debt repayments were $19.0 million compared to $31.0 million for the same period in the prior year.


Dividends paid from MGE to MGE Energy were $19.6 million for the nine months ended September 30, 2010, compared to $12.8 million for the same period in the prior year.


On February 4, 2010, MGE Power Elm Road issued $50.0 million of long-term debt. The proceeds from the financing were distributed to MGE Energy, which had been using its short-term credit facilities to help finance the Elm Road Units. As a result, distributions to parent from noncontrolling interest increased $42.3 million.


In addition, for the nine months ended September 30, 2010, affiliate financing of the Elm Road Units decreased by $6.7 million.


Capitalization Ratios


MGE Energy's capitalization ratios were as follows:


 

MGE Energy

 

September 30, 2010

 

December 31, 2009

Common shareholders' equity

 58.5%


 56.4%

Long-term debt*

36.1%


 36.3%

Short-term debt

5.4%


 7.3%


* Includes the current portion of long-term debt.


MGE Energy's and MGE's Capital Requirements


MGE Energy's and MGE's liquidity are primarily affected by their capital requirements. During the nine months ended September 30, 2010, capital expenditures for MGE Energy and MGE totaled $43.2 million, which included $32.4 million of capital expenditures for utility operations and $10.5 million of capital expenditures for the Elm Road Units.


Credit Ratings


MGE Energy's and MGE's access to the capital markets, including, in the case of MGE, the commercial paper market, and their respective financing costs in those markets, may depend on the credit ratings of the entity that is accessing the capital markets.


None of MGE Energy's or MGE's borrowings are subject to default or prepayment as a result of a downgrading of credit ratings, although a downgrading of MGE's credit ratings could increase fees and interest charges under both MGE Energy's and MGE's credit agreements.


Environmental Matters


The following discussion is limited to updates or developments in environmental matters that occurred during the nine months ended September 30, 2010. Further discussion of environmental matters is included in MGE Energy's and MGE's 2009 Annual Report on Form 10-K and Footnote 9.a. of Notes to Consolidated Financial Statements in this Report.





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Columbia


MGE and two other utilities jointly own Columbia, a coal-fired generating facility, which accounts for 225 MW (28%) of MGE's net generating capability. 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 and may affect those expenditures at other MGE generating facilities. In April 2009, the Columbia owners requested authorization from the PSCW for an emissions reduction project as a result of an environmental initiative. A decision from the PSCW is currently expected in the first quarter of 2011. The operator's current estimates show that MGE's share of the capital expenditures required to comply with this project will be approximately $140 million. According to the current estimate, this project is expected to result in an increase to Columbia's ongoing operating expenses. MGE expects that the costs pertaining to this project will be fully recoverable through rates.


Title V Operating Permit Petition

In September 2008, the WDNR issued a Title V renewal operating permit to WPL for Columbia. 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. A citizen group petitioned the EPA to object to the issuance of the permit renewal. In October 2009, the EPA issued an order granting in part and denying in part the petition and sent the operating permit back to the WDNR for further review based on the EPA order. The EPA order gave the WDNR 90 days to address the objections and take action on the September 2008 operating permit. On March 22, 2010, the WDNR gave notice to WPL that they intend to initiate an operating permit revision in response to the EPA's order. In July 2010, MGE received a copy of an NOI letter filed by a citizen group against the EPA based on what the group feels is an unreasonable delay in the EPA performing its duties related to the granting or denial of the Columbia air permit. Specifically, the citizen group alleges that because the WDNR has not acted on the EPA's order within 90 days, the EPA must now act on the permit. On September 22, 2010, WDNR, acted on the Order by issuing a construction permit for public comment. WPL, as the permit holder, filed comments raising a number of concerns and objections to the proposed permit.


Air Permitting Violation Claims

In September 2010, Sierra Club filed in U.S. District Court for the Western District of Wisconsin a complaint against WPL, as owner and operator of Columbia, based on allegations that modifications were made at the facilities without complying with the PSD program requirements, Title V Operating Permit requirements of the CAA and state regulatory counterparts contained within the Wisconsin state implementation plans (SIP) designed to implement the CAA. Neither MGE nor WPSC were named as parties in this litigation. In October 2010, WPL filed a response with the court denying the Sierra Club's allegations.


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 and the Columbia co-owners failed to comply with appropriate pre-construction review and permitting requirements and as a result violated the PSD program requirements, Title V Operating Permit requirements of the CAA and the Wisconsin SIP.


In response to similar EPA CAA enforcement initiatives, certain utilities have elected to settle with the EPA, while others have elected to litigate. If the EPA and/or Sierra Club successfully prove their claims that projects completed in the past at Columbia required either state or federal CAA permits, MGE may, under the applicable statutes, be required to pay civil penalties in amounts of up to $37,500 per day for each violation and/or complete actions for injunctive relief. Payment of fines and/or injunctive relief could be included in a settlement outcome. Injunctive relief contained in settlements or court-ordered remedies for other utilities required the installation of pollution control technology, changed operating conditions including use of alternative fuels other than coal, caps for emissions and limitations on generation including retirement of generating units and other supplemental environmental projects. Should similar remedies be required for final resolution of these matters at Columbia, MGE would likely incur additional capital and operating expenditures. MGE is currently reviewing the allegations and is unable to predict their impact on its financial condition or results of operations but believes that an adverse outcome could have a significant effect. MGE and the other co-owners of Columbia are exploring settlement options while WPL is simultaneously defending against these allegations. WPL believes the projects at Columbia were routine or not projected to increase emissions and therefore did not violate the permitting requirements of the CAA.


Air quality


Air quality regulations promulgated by the EPA and the WDNR in accordance with the CAA and the Clean Air Act Amendments of 1990 impose restrictions on emission of particulates, sulfur dioxide (SO2) nitrogen oxides (NOx) and other pollutants and require permits for operation of emission sources. These permits have been obtained by MGE and must be renewed periodically.




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Various initiatives, including the EPA's proposed Transport Rule, maximum achievable control technology (MACT) standards, new source performance standards (NSPS) and the Clean Air Visibility Rule (also known as the Regional Haze Rule), as well as state mercury emissions limits, are expected to result in additional operating and capital expenditure costs for electric generating units.


EPA's Proposed Transport Rule (To Replace the Clean Air Interstate Rule (CAIR))

On July 6, 2010, the EPA issued a proposed initial rule called the "Transport Rule" designed to address ozone and fine particulate air pollution from 31 states in the eastern portion of the United States. The 31 states will need to reduce NOx and SO2 air emissions, which are "pre-cursors" or cause the formation of particulate matter and/or ozone pollution. The proposed rule includes the EPA's preferred option and two alternative approaches to reducing emissions and the EPA is seeking comments on these approaches. The EPA's preferred option uses state emissions budgets and intrastate allowance trading (limited interstate trading will be allowed) to achieve reductions in NOx and SO. The first alternative does not allow any interstate allowance trading and the second alternative does not permit either interstate or intrastate trading, but specifies allowable emission limits for each power plant. In addition, the EPA will require Federal Implementation Plans for those states that significantly contribute to nonattainment or maintaining attainment in neighboring states. Under the proposed rule, states are divided into three categories: (1) those contributing to particulate matter pollution, (2) those contributing to ozone pollution, and (3) those contributing to both. Wisconsin has been identified as a state contributing to particulate matter only and thus will need to control annual SO2 and NOx emissions, but will not need to control ozone-season NOx. MGE is in the process of assessing the impacts that this rule will have on our generation fleet. We expect that our power plants will be affected and we will need to either secure allowances or implement strategies to reduce NOx and SO2 emissions. The EPA is targeting 2012 for implementation of the Transport Rule.


National Ambient Air Quality Standards


Ozone NAAQS

On January 6, 2010, the EPA published a proposed rule reconsidering the March 12, 2008 8-hour ozone standard. In this proposed rule, the EPA states their intent to revise both the primary (set for protection of public health) and secondary (set for protection of public welfare and environment) ozone standards. These proposed standards have the potential to put several counties in Wisconsin, including ones where MGE has electric generation, in nonattainment. A nonattainment designation may increase capital or operating costs at MGE facilities. The EPA had an August 31, 2010, target date for final action on this reconsideration. That date has passed with no action and the EPA has not announced a new target date. The proposed rule requires designation recommendations due to the EPA by January 2011 based on 2008 through 2010 monitoring data.


Nitrogen Dioxide NAAQS

On January 22, 2010, the EPA revised its primary Nitrogen Dioxide (NO2) NAAQS. The EPA expects the states to submit initial recommendations for nonattainment areas by January 2011 using 2008-2010 data. The EPA plans to make final attainment and nonattainment designations by January 2012. The EPA has not changed the secondary NAAQS for NO2, but intends to address potential changes as part of a secondary review. It is unclear at this time how MGE's power plants would be affected by this proposed revision. As of April 12, 2010, any facility's permit renewal or revision application will need to model potential emissions of NO2. Failure to meet thresholds may require a permit applicant to incur capital or operational costs. MGE's Blount permit renewal application is due in the fall of 2011 and MGE will be conducting this NO2 modeling as part of this renewal process.


Sulfur Dioxide NAAQS

On June 22, 2010, the EPA finalized its revised Sulfur Dioxide NAAQS. The rule became effective on August 23, 2010. States are expected to make attainment/nonattainment designations in 2011; however, the ability to designate will be contingent on many steps being in place including modifying and/or adding monitoring sites to many counties, including the counties in which MGE has power plants. Despite the current steps that need to take place to make designations, any facility's PSD application will need to demonstrate compliance with SO2 NAAQS. It is difficult to assess impact on MGE at this time due to the lack of monitoring data and monitoring sites. MGE will continue to evaluate this rule as more information becomes available in Wisconsin.





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Global climate change


MGE produces GHG emissions, primarily from the fossil fuel generating facilities it utilizes to meet customers' energy needs, as well as from its natural gas pipeline system and fleet vehicles. Climate change and the regulatory response to it could significantly affect our operations in a number of ways, including increased operating costs and capital expenditures, restrictions on energy supply options, permitting difficulties and emission limits. However, the financial consequences of this compliance cannot be determined until final legislation and/or regulations are passed. MGE management would expect to seek and receive rate recovery of such compliance costs, yet the probability and specific impact of such regulation cannot be reasonably estimated at this time. MGE will continue to monitor proposed climate change legislation and regulation. MGE is already addressing GHG emissions through voluntary actions.


EPA's Determination of Endangerment from Greenhouse Gases

On December 15, 2009, the EPA finalized a finding that six GHGs, when emitted from new motor vehicles and new motor vehicle engines, contribute to greenhouse gas air pollution and endanger public health and welfare under CAA Section 202(a). This endangerment finding allowed for the creation of emission standards of GHGs from mobile sources, which were finalized by the EPA on March 31, 2010. Now that GHG emissions are regulated under the Clean Air Act, stationary source emissions of GHGs may be regulated as well, such as from electric generating utilities. MGE is already addressing its GHGs through voluntary actions, and MGE will continue to monitor proposed GHG legislation and regulatory developments.


EPA's Prevention of Significant Deterioration and Title V Greenhouse Gas Tailoring Rule

On May 13, 2010, the EPA released its final Prevention of Significant Deterioration and Title V Greenhouse Gas "Tailoring Rule." The EPA introduced the Tailoring Rule to address the regulation of stationary sources for GHG emissions. Through this Tailoring Rule the regulation of GHGs will be accomplished using EPA's two principal stationary source permitting programs: The pre-construction permitting and the operations permitting (Title V).


The EPA's Tailoring Rule has been designed to "phase in" facilities subject to PSD or Title V permitting (i.e. new facilities and existing facilities with certain qualifying modifications). Beginning in 2011, sources that trigger PSD or Title V permitting requirements based on other, non-GHG emissions will also need to meet PSD or Title V permitting requirements if they exceed 75,000 tons of CO2 equivalents. By 2013, the EPA will require any facilities with emissions above 100,000 tons to meet their respective PSD and/or Title V requirements. By 2016, it is expected that any new or modified facility with emissions of 50,000 tons of CO2 equivalents per year will be subject to the rule. It is understood that PSD requirements for new or modified sources include the requirement that a plant meet best available control technology (BACT) requirements for any emissions that trigger PSD. The EPA has not provided guidelines on what may be considered BACT. MGE facilities may become subject to this rule if modifications at any facilities trigger PSD or if MGE invests in new facilities that trigger PSD.


Proposed Climate Change Legislation

Numerous bills have been introduced in Congress that address climate change from different perspectives, including direct regulation of GHG emissions and the establishment of Federal Renewable Portfolio Standards. It is currently unknown when Congress will resume discussion of legislation containing climate change provisions.


The State of Wisconsin continues to consider GHG reductions through the implementation of recommendations made by Governor Doyle's Global Warming Task Force (July 2008 report). MGE participated as an active member of the Task Force. A number of state administrative proceedings have been commenced to implement some of the recommendations. Proposed Wisconsin legislation, known as "the Clean Energy Jobs Act," was introduced to address some of the recommendations, including increases in energy efficiency efforts and renewable energy portfolio standards, but the bill was not enacted. See Part I, Item 1. Business, "Environmental - Global Climate Change" in our 2009 Form 10-K annual report for additional information regarding the Task Force recommendations and the proposed legislation.


In addition, Wisconsin signed on to the Midwestern GHG Reduction Accord - an accord designed to develop a Midwestern GHG reduction program. Actions taken to adopt the Accord provisions in Wisconsin would require additional implementing action within the state.





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Water quality


MGE is subject to water quality regulations issued by the WDNR. These regulations include discharge standards, which require the use of effluent-treatment processes equivalent to categorical "best practicable" or "best available" technologies under compliance schedules established under the Federal Water Pollution Control Act. The WDNR has published categorical regulations for chemical and thermal discharges from electric-steam generating plants. The regulations limit discharges from MGE's plants into Lake Monona and other Wisconsin waters.


WPDES Thermal Discharge Rule

WDNR rules to regulate thermal effluent discharges from point sources in Wisconsin became effective on October 1, 2010. Any WPDES permit issued after October 1, 2010, will need to meet the revised rule requirements. The proposed rules apply strict standards for thermal discharges into inland lakes, streams, rivers, and the Great Lakes. MGE submitted a thermal analysis with its most recent Blount WPDES permit application that showed the thermal impacts were within the acceptable limits of the rule. MGE is waiting to hear from the WDNR on their review of the analysis. If the WNDR does not concur with MGE's analysis, additional studies could be required. Potential costs at Columbia have not been determined at this time. Based on initial reviews of the current revised rules, we do not expect WCCF or the Elm Road Units to be effected by these rules.


WPDES Phosphorus Nutrient Standards

The WDNR is in the process of developing water quality standards for phosphorus in streams, rivers, and inland lakes, including effluent limitations for dischargers. Blount and WCCF both currently discharge phosphorus under their WPDES permits, and it is likely both facilities may have phosphorus limitations added to their permits. It is unknown what the limitations may be at this time, as the WDNR will calculate the limits based on the status of the receiving water and will take into account all dischargers of phosphorus into each receiving water before setting individual permit limits. The rules will become effective following their publication in the Wisconsin Administrative Code. The Blount WPDES permit renewal application has been submitted to the WDNR. If the phosphorus rules become effective before Blount's WPDES renewal permit is issued (permit issuance is expected in the Spring of 2011) then the newly issued permit will likely include the new phosphorus limits. MGE will not know the full extent of this rule on our operations until the WNDR sets water body-specific and site-specific limits. Because of these uncertainties, we cannot estimate the effect that compliance with developing water quality standards will have on the operation of our generating facilities and our future results of operations, cash flows, and financial position.


WPDES Mercury Discharge Limit

WPDES permit holders in certain industries, including coal-fired electric power plants, are required to meet mercury effluent limits. If permit holders do not meet the mercury limits, then they must apply for a variance as part of their next permit renewal with the WDNR. MGE has applied for a mercury variance for Blount as part of its permit renewal, which was submitted in the fall of 2010. If the variance is not approved, MGE may have operational or capital costs associated with meeting the mercury effluent limits when the permit is renewed (in the spring of 2011). Given the uncertainties associated with these proceedings and the time required for their resolution, we cannot predict the eventual outcome of the proceedings or estimate the effect that compliance with developing mercury limits will have on the operation of our generating facilities and our future results of operations, cash flows, and financial position.


Solid waste


Potential Regulation of Coal Combustion Byproducts

The EPA published a proposed rule on May 4, 2010, that regulates coal combustion byproducts from the electric generating sector. The proposed regulations may require new or additional monitoring of storage sites, may re-classify ash and other coal combustion byproducts, and may regulate ash storage site structural design. MGE is evaluating the impact of these proposed regulations on our operations. It is not possible to estimate the potential costs associated with the implementation of any of these initiatives at this time.


Hazardous Materials


On April 7, 2010, the EPA published an Advanced Notice of Proposed Rulemaking (ANPR) for the additional regulation of polychlorinated biphenyls (PCBs). The EPA has indicated that they intend to reassess the use, distribution, marking, and storage for reuse of liquid PCBs in electric and nonelectric equipment. The rule developed as a result of this ANPR may require a phase-out of PCBs in electrical and nonelectrical equipment. MGE has electrical equipment that contains liquid PCBs so any rule that is developed has a potential to affect our capital or operational cost. We will not know the extent, however, until any rule is finalized.





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Blount Station


In 2006, MGE announced a plan, subject to certain conditions, that includes discontinuing coal use by the end of 2011 at Blount. The original plan contemplated that the plant would continue to run on natural gas but would be reduced from its current approximate 190 MW capacity to 100 MW when coal burning is discontinued. MGE determined that certain employee positions would be eliminated as a result of this exit plan.


In March 2009, MGE received notification from MISO that in order to meet national electric system reliability standards, MGE will need to keep Blount available at its full capacity until MISO declares that the 90 MW are no longer needed for system reliability. To comply with the MISO directive, MGE will delay plans for retiring 90 MW of generation equipment at Blount. The transition from burning coal to burning only natural gas will still occur by the end of 2011. After 2011, the entire plant will be operated exclusively on natural gas. MGE is working with MISO to develop a detailed agreement for this continued operation, which among other things will include a mechanism for cost recovery. MGE management also began working on an implementation plan.


In January 2010, MGE announced it will change its primary fuel at Blount from coal to natural gas. Coal will become the secondary fuel at Blount. This switch to natural gas as a primary fuel occurred in March 2010. As a result of this change, certain employee positions were eliminated and severance benefits in 2010 totaled $0.5 million. These severance benefits were accelerated into 2010 from 2011, but are expected to be offset by lower payroll charges in 2010.


MGE has entered into agreements providing severance benefits to employees affected by the exit plan. Estimated benefits expected to be paid are as follows: $0.3 million in 2012 and $0.3 million in 2013. MGE will recover in rates the costs associated with the discontinuance of coal at Blount. As such, the severance charges, in 2012 and 2013, for these employees have been deferred and recognized on the consolidated balance sheet of MGE Energy and MGE as a regulatory asset.


Other Regulatory Matters


Rate filing


On April 22, 2010, MGE filed an application with the PSCW requesting a 9.4% increase to electric rates and a 2.0% increase to gas rates. The proposed electric increase is intended to cover costs for MGE's share of the Elm Road Units, new environmental equipment at Columbia and transmission reliability enhancements. We have requested that these rates become effective January 1, 2011.


Wisconsin Fuel Rules


In May 2010, Wisconsin's governor signed 2009 Assembly Bill 600 into law as Act 403. The new law requires the PSCW and Wisconsin utilities to automatically defer electric fuel-related costs that fall outside a symmetrical cost tolerance band. Any over/under recovery of the deferred costs is determined on an annual basis and will be adjusted in future billings to its electric retail customers. In August 2010, the PSCW proposed new fuel rules pursuant to this legislation, which are subject to review and comment by the Wisconsin legislature. The new fuel rules are expected to be effective January 1, 2011.


New Accounting Principles


See Footnote 16 for discussion of new accounting pronouncements.





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Item 3. Quantitative and Qualitative Disclosures About Market Risk.


MGE Energy and MGE are potentially exposed to market risk associated with interest rates, commodity prices, weather, and equity returns. MGE currently has no exposure to foreign currency risk. MGE manages some risk exposure through risk management policies and the use of derivative instruments. MGE's risk management policy prohibits speculative trading transactions. The recent uncertainty in the capital and credit markets has adversely affected the United States and global economies. Additional detail can be found in the Management Discussion and Analysis section of MGE Energy's and MGE's 2009 Annual Report on Form 10-K under "Recent Developments in the Capital and Credit Markets."


Weather Risk


MGE's sales forecasts, used to establish rates, are set by the PSCW based upon estimated temperatures, which approximate 20-year historical averages. MGE's electric revenues are sensitive to the summer cooling season and, to some extent, to the winter heating season. A significant portion of MGE's gas system demand is driven by heating. MGE's gas and electric revenues are collected under a combination of fixed and volumetric rates set by the PSCW based on "normal weather." As a result of weather-sensitive demand and volumetric rates, a portion of MGE's revenue is at risk. MGE may use weather derivatives, pursuant to its risk management program, to reduce the impact of weather volatility.


MGE may also be impacted by extreme weather conditions. Such conditions may restrict the operation of, or may damage, operating assets or may negatively impact the price of commodity and other costs.


A summary of actual weather information in the utility segment's service territory during the three and nine months ended September 30, 2010, as measured by degree days, may be found in results of operations in this Report.


Commodity Price Risk


MGE has commodity price risk exposure with respect to the price of natural gas, electricity, coal, emission credits, and oil. MGE employs established policies and procedures to reduce the market risks associated with changing commodity prices. MGE's commodity risks are somewhat mitigated by the current ratemaking process in place for recovering electric fuel cost, purchased energy costs, and the cost of natural gas. MGE's electric fuel costs are subject to fuel rules established by the PSCW.


MGE's electric operations burn natural gas in several of its peaking power plants or as a supplemental fuel at several coal-fired plants and, in many cases, the cost of purchased power is tied to the cost of natural gas. MGE bears significant regulatory risk for the recovery of such fuel and purchased power costs when they are higher than the base rate established in its current rate structure.


Under the electric fuel rules, MGE would be required to make a refund to customers if the fuel rules costs fall outside the lower end of the range and would be allowed to request a surcharge if the fuel rules costs exceeded the upper end of the range. The range is defined by the PSCW and has been modified throughout the years based on market conditions and other relevant factors. Currently, MGE is subject to a plus or minus 2% range. MGE assumes the risks and benefits of variances that are within the 2% bandwidth. For 2010, fuel and purchased power costs included in MGE's base fuel rates are $102.0 million. See Footnote 14.b. for additional information. MGE's gas segment is governed by the purchased gas adjustment clause (PGA). Under the PGA, MGE is able to pass through to customers the cost of gas, subject to certain limited incentives.


MGE also reduces price risk caused by market fluctuations via physical contracts and financial derivative contracts, including futures, swaps, options, forwards, and other contractual commitments. The maximum length of time over which cash flows related to energy commodities can be hedged is two years.


MGE has financial gas and electric commodity contracts to hedge commodity price risk in the gas and electric segments. These contracts are primarily comprised of exchange-traded option and future contracts. MGE also holds FTRs which are used to hedge the risk of increased congestion charges. At September 30, 2010, the cost basis of these instruments exceeded their fair value by $2.9 million. Under the PGA clause and electric fuel rules, MGE may include in the costs of fuel (natural gas or power) the costs and benefits of the aforementioned fuel price risk management tools. Because these costs/benefits are recoverable, the related unrealized loss/gain has been deferred on the balance sheet as a regulatory asset/liability.





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MGE has also entered into futures and basis swaps to take advantage of physical and financial arbitrage opportunities between supply basins and pricing spreads between future months' gas supply. Until thresholds have been achieved, ratepayers receive 100% of the benefits or loss from these deals. If certain thresholds are achieved, MGE shareholders have the ability to receive 40% of the benefits or loss from these deals whereas ratepayers have the ability to receive 60% of the benefits or loss from these deals. At September 30, 2010, none of these instruments were outstanding.


MGE has also entered into a ten-year purchased power agreement which provides MGE with firm capacity and energy beginning June 1, 2012, and ending on May 31, 2022 (the "base term"). The agreement also allows MGE the option to purchase power during a period of time preceding the base term as well as an option to extend the contract after the base term. The agreement is a derivative contract and is recognized at its fair value on the balance sheet. The fair value of the contract at September 30, 2010, reflects a loss position of $17.7 million.


MGE's energy contracts are valued using readily available NYMEX pricing data.


Interest Rate Risk


Both MGE Energy and MGE have short-term borrowings at varying interest rates. MGE issues commercial paper for its short-term borrowings, while MGE Energy draws from its current credit facility to meet its short-term borrowing needs. Borrowing levels vary from period to period depending upon capital investments and other factors. Future short-term interest expense and payments will reflect both future short-term interest rates and borrowing levels. MGE Energy and MGE manage interest rate risk by limiting their variable rate exposure and continually monitoring the effects of market changes on interest rates. MGE is not exposed to changes in interest rates on a substantial portion of its long-term debt until that debt matures and is refinanced at market rates.


Equity Price Risk - Pension-Related Assets


MGE currently funds its liabilities related to employee benefits through trust funds. These funds, which include investments in debt and equity securities, are managed by various investment managers. Changes in market value of these investments can have an impact on the future expenses related to these liabilities. The value of employee benefit plans trusts' assets have increased in value by approximately 4.3% during the nine months ended September 30, 2010.


Regulatory Recovery Risk


MGE's electric operations burn natural gas in several of its peak power plants or as supplemental fuel at several coal-fired plants and, in many cases, the cost of purchased power is tied to the cost of natural gas. MGE bears significant regulatory risk for the recovery of such fuel and purchased power costs when costs are higher than the base rate established in its current rate structure.


Credit Risk - Counterparty


Credit risk is the loss that may result from counterparty nonperformance. MGE is exposed to credit risk primarily through its merchant energy business. MGE uses credit policies to manage its credit risk, which includes utilizing an established credit approval process, monitoring counterparty limits, employing credit mitigation measures such as collateral or prepayment arrangements, and using netting agreements.


Due to the possibility of extreme volatility in the prices of energy commodities and derivatives, the market value of contractual positions with individual counterparties could exceed established credit limits or collateral provided by those counterparties. If such a counterparty were then to fail to perform its obligations under its contract (for example, fail to deliver the electricity MGE originally contracted for), MGE could sustain a loss that could have a material impact on its financial results.


Additionally, if a counterparty were to default and MGE were to liquidate all contracts with that entity, MGE's credit loss would include the loss in value of mark-to-market contracts; the amount owed for settled transactions; and additional payments, if any, to settle unrealized losses on accrual contracts. As of September 30, 2010, no counterparties have defaulted.





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MGE is obligated to provide service to all electric and gas customers within its respective franchised territories. MGE's franchised electric territory includes a 316 square-mile area in Dane County, Wisconsin, and MGE's franchised gas territory includes a service area covering 1,631 square miles in Wisconsin. Based on results for the year ended December 31, 2009, no one customer constituted more than 9% of total operating revenues for MGE Energy and MGE. Credit risk for electric and gas is managed by MGE's credit and collection policies, which are consistent with state regulatory requirements.


Cash, cash equivalents, and customer accounts receivable are the financial instruments that potentially subject MGE Energy and MGE to concentrations of credit risk. MGE Energy and MGE place their cash and cash equivalents with high credit-quality financial institutions. MGE has limited concentrations of credit risk from customer accounts receivable because of the large number of customers and relatively strong economy in its service territory.





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Item 4. Controls and Procedures.


During the third quarter of 2010, MGE Energy's management, including the principal executive officer and principal financial officer, evaluated its disclosure controls and procedures related to the recording, processing, summarization, and reporting of information in its periodic reports that it files with the SEC. These disclosure controls and procedures have been designed to ensure that material information relating to MGE Energy, including its subsidiaries, is accumulated and made known to MGE Energy's management, including these officers, by other employees of MGE Energy and its subsidiaries as appropriate to allow timely decisions regarding required disclosure, and that this information is recorded, processed, summarized, evaluated, and reported, as applicable, within the time periods specified in the SEC's rules and forms. Due to the inherent limitations of control systems, not all misstatements may be detected. These inherent limitations include the realities that judgments in decision making can be faulty and breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. Also, MGE Energy does not control or manage certain of its unconsolidated entities and thus, its access and ability to apply its procedures to those entities is more limited than is the case for its consolidated subsidiaries.


As of September 30, 2010, MGE Energy's principal executive officer and the principal financial officer concluded that its disclosure controls and procedures were effective to accomplish their objectives. MGE Energy intends to continually strive to improve its disclosure controls and procedures to enhance the quality of its financial reporting.


During the quarter ended September 30, 2010, there were no changes in MGE Energy's internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, MGE Energy's internal control over financial reporting.


Item 4T. Controls and Procedures.


During the third quarter of 2010, MGE's management, including the principal executive officer and principal financial officer, evaluated its disclosure controls and procedures related to the recording, processing, summarization, and reporting of information in its periodic reports that it files with the SEC. These disclosure controls and procedures have been designed to ensure that material information relating to MGE, including its subsidiaries, is accumulated and made known to MGE's management, including these officers, by other employees of MGE and its subsidiaries as appropriate to allow timely decisions regarding required disclosure, and that this information is recorded, processed, summarized, evaluated, and reported, as applicable, within the time periods specified in the SEC's rules and forms. Due to the inherent limitations of control systems, not all misstatements may be detected. These inherent limitations include the realities that judgments in decision making can be faulty and breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. Also, MGE does not control or manage certain of its unconsolidated entities and thus, its access and ability to apply its procedures to those entities is more limited than is the case for its consolidated subsidiaries.


As of September 30, 2010, MGE's principal executive officer and the principal financial officer concluded that its disclosure controls and procedures were effective to accomplish their objectives. MGE intends to continually strive to improve its disclosure controls and procedures to enhance the quality of its financial reporting.


During the quarter ended September 30, 2010, there were no changes in MGE's internal control over financial reporting that materially affected, or are reasonable likely to materially affect, MGE's internal control over financial reporting.





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PART II. OTHER INFORMATION.


Item 1. Legal Proceedings.


MGE Energy and MGE


MGE Energy and MGE from time to time are involved in various legal proceedings that are handled and defended in the ordinary course of business. While MGE Energy and MGE are unable to predict the outcome of these matters, management does not believe, based upon currently available facts, that the ultimate resolution of any of such proceedings would have a material adverse effect on their overall financial condition or results of operations except as disclosed in MGE Energy's and MGE's 2009 Annual Report on Form 10-K.


Also see Footnote 9a and 9c for a description of several proceedings involving MGE.


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


Issuer Purchases of Equity Securities

Period

Total Number

of

Shares Purchased

Average Price Paid

per Share

Total Number of Shares

Purchased as Part of

Publicly Announced

Plans or Programs*

Maximum Number (or

Approximate Dollar

Value) of Shares That

May Yet Be Purchased

Under the Plans or

Programs*

July 1-31, 2010

 41,450

 $36.98

-

-

August 1-31, 2010

 34,340

 37.25

-

-

September 1-30, 2010

 73,450

 38.80

-

-

Total

 149,240

 $37.94

-

-


*Under the Stock Plan, common stock shares deliverable to plan participants may be either newly issued shares or shares purchased on the open market, as determined from time to time by MGE Energy. In June 2009, MGE Energy switched to using open market purchases to provide shares to meet obligations to participants in the Stock Plan. The shares are purchased on the open market through a securities broker-dealer and then are reissued under the Stock Plan as needed to meet share delivery requirements. The volume and timing of share repurchases in the open market depends upon the level of dividend reinvestment and optional share purchases being made from time to time by plan participants. As a result, there is no specified maximum number of shares to be repurchased and no specified termination date for the repurchases. All shares issued through the Stock Plan, whether newly issued or reissued following open market purchases, are issued and sold pursuant to a registration statement that was filed with the SEC and is currently effective.


Item 6. Exhibits.


12

Statement regarding computation of ratio of earnings to fixed charges for Madison Gas and Electric Company.


Certifications Pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities and Exchange Act of 1934 as to the Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, filed by the following officers for the following companies:


31.1

Filed by Gary J. Wolter for MGE Energy, Inc.

31.2

Filed by Jeffrey C. Newman for MGE Energy, Inc.

31.3

Filed by Gary J. Wolter for Madison Gas and Electric Company

31.4

Filed by Jeffrey C. Newman for Madison Gas and Electric Company


Certifications Pursuant to Section 1350 of Chapter 63 of Title 18 United States Code (Sarbanes-Oxley Act of 2002) as to the Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, filed by the following officers for the following companies:


32.1

Filed by Gary J. Wolter for MGE Energy, Inc.

32.2

Filed by Jeffrey C. Newman for MGE Energy, Inc.

32.3

Filed by Gary J. Wolter for Madison Gas and Electric Company

32.4

Filed by Jeffrey C. Newman for Madison Gas and Electric Company




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Signatures - MGE Energy, Inc.


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.



 

MGE ENERGY, INC.

 

 

 

 

 

 

Date: November 4, 2010

/s/ Gary J. Wolter

 

Gary J. Wolter

Chairman, President and Chief Executive Officer

(Duly Authorized Officer)

 

 

 

 

 

 

Date: November 4, 2010

/s/ Jeffrey C. Newman

 

Jeffrey C. Newman

Vice President, Chief Financial Officer, Secretary and Treasurer

(Chief Financial and Accounting Officer)





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Signatures - Madison Gas and Electric Company


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.



 

MADISON GAS AND ELECTRIC COMPANY

 

 

 

 

 

 

Date: November 4, 2010

/s/ Gary J. Wolter

 

Gary J. Wolter

Chairman, President and Chief Executive Officer

(Duly Authorized Officer)

 

 

 

 

 

 

Date: November 4, 2010

/s/ Jeffrey C. Newman

 

Jeffrey C. Newman

Vice President, Chief Financial Officer, Secretary and Treasurer

(Chief Financial and Accounting Officer)






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