10-Q 1 form10q.htm WPSC FORM 10-Q 3/31/10 form10q.htm
 
______________________________________________________________________________
______________________________________________________________________________

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 March 31, 2010

OR

[ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission
File Number
Registrant; State of Incorporation;
Address; and Telephone Number
IRS Employer
Identification No.
     
1-3016
WISCONSIN PUBLIC SERVICE CORPORATION
(A Wisconsin Corporation)
700 North Adams Street
P. O. Box 19001
Green Bay, WI  54307-9001
800-450-7260
39-0715160

Indicate by check mark whether the registrant (1) has 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) has been subject to such filing requirements for the past 90 days.

Yes [X ]   No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [  ]   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 the 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 [X]
Smaller reporting company [  ]


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

Yes [  ]   No [X]


Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

 
Common stock, $4 par value,
23,896,962 shares outstanding at
May 5, 2010

______________________________________________________________________________
______________________________________________________________________________

 
 
 

 


WISCONSIN PUBLIC SERVICE CORPORATION
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2010
TABLE OF CONTENTS
 
   
Page
     
 
COMMONLY USED ACRONYMS
2
     
 
FORWARD-LOOKING STATEMENTS
3
     
PART I.
FINANCIAL INFORMATION
5
     
Item 1.
FINANCIAL STATEMENTS (Unaudited)
5
     
 
Condensed Consolidated Statements of Income
5
 
Condensed Consolidated Balance Sheets
6
 
Condensed Consolidated Statements of Capitalization
7
 
Condensed Consolidated Statements of Cash Flows
8
     
 
CONDENSED NOTES TO FINANCIAL STATEMENTS OF
 
 
      Wisconsin Public Service Corporation and Subsidiary
9 – 22
     
     
Page
 
 
Note 1
Financial Information
9
 
 
Note 2
Cash and Cash Equivalents
9
 
 
Note 3
Risk Management Activities
9
 
 
Note 4
Restructuring Expense
11
 
 
Note 5
Short-Term Debt and Lines of Credit
11
 
 
Note 6
Asset Retirement Obligations
12
 
 
Note 7
Income Taxes
12
 
 
Note 8
Commitments and Contingencies
13
 
 
Note 9
Guarantees
18
 
 
Note 10
Employee Benefit Plans
18
 
 
Note 11
Variable Interest Entities
18
 
 
Note 12
Fair Value
19
 
 
Note 13
Miscellaneous Income
20
 
 
Note 14
Regulatory Environment
21
 
 
Note 15
Segments of Business
21
 
     
Management's Discussion and Analysis of Financial Condition and Results of Operations
23 – 33
     
Quantitative and Qualitative Disclosures About Market Risk
34
     
Controls and Procedures
35
     
OTHER INFORMATION
36
     
Item 1.
Legal Proceedings
36
     
Item 1A.
Risk Factors
36
     
Item 6.
Exhibits
36
     
 
37
 

 
     
   
Page
 
38
   
4.1
Forty-First Supplemental Indenture, dated as of December 18, 2008
   
4.2
42nd Supplemental Indenture, dated as of April  25, 2010
   
12
Computation of Ratio of Earnings to Fixed Charges and Ratio of Earnings to Fixed Charges and Preferred Stock Dividend Requirements
   
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act and Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 for Wisconsin Public Service Corporation
   
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act and Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 for Wisconsin Public Service Corporation
   
32
Written Statement of the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 for Wisconsin Public Service Corporation


Commonly Used Acronyms
   
AFUDC
Allowance for Funds Used During Construction
ASC
Accounting Standards Codification
ATC
American Transmission Company LLC
EPA
United States Environmental Protection Agency
FASB
Financial Accounting Standards Board
GAAP
United States Generally Accepted Accounting Principles
IBS
Integrys Business Support, LLC
IRS
United States Internal Revenue Service
MISO
Midwest Independent Transmission System Operator, Inc.
MPSC
Michigan Public Service Commission
N/A
Not Applicable
NYMEX
New York Mercantile Exchange
PSCW
Public Service Commission of Wisconsin
SEC
United States Securities and Exchange Commission
SFAS
Statement of Financial Accounting Standards
WDNR
Wisconsin Department of Natural Resources
WPS
Wisconsin Public Service Corporation
WRPC
Wisconsin River Power Company

 
 
-2-

 

Forward-Looking Statements

In this report, WPS and its subsidiary make statements concerning expectations, beliefs, plans, objectives, goals, strategies, and future events or performance.  Such statements are "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended.  Forward-looking statements are subject to assumptions and uncertainties; therefore, actual results may differ materially from those expressed or implied by such forward-looking statements.  Although WPS and its subsidiary believe that these forward-looking statements and the underlying assumptions are reasonable, they cannot provide assurance that such statements will prove correct.

Forward-looking statements include, among other things, statements concerning management's expectations and projections regarding earnings, regulatory matters, fuel costs, sources of electric energy supply, coal and natural gas deliveries, remediation costs, environmental and other capital expenditures, liquidity and capital resources, trends, estimates, completion of construction projects, and other matters.

Forward-looking statements involve a number of risks and uncertainties.  Some risks that could cause results to differ from any forward-looking statement include those described in Item 1A of WPS's Annual Report on Form 10-K for the year ended December 31, 2009, as may be amended or supplemented in Part II, Item 1A of this report.  Other factors include:

Resolution of pending and future rate cases and negotiations (including the recovery of deferred costs) and other regulatory decisions impacting WPS;
The impact of recent and future federal and state regulatory changes, including legislative and regulatory initiatives regarding deregulation and restructuring of the electric and natural gas utility industries, changes in environmental and other regulations, including but not limited to, greenhouse gas emissions, energy efficiency mandates, renewable energy standards, and reliability standards, and changes in tax and other laws and regulations to which WPS and its subsidiary are subject;
Current and future litigation and regulatory investigations, enforcement actions or inquiries, including but not limited to, manufactured gas plant site cleanup, third-party intervention in permitting and licensing projects, and compliance with Clean Air Act requirements at generation plants;
The impacts of changing financial market conditions, credit ratings, and interest rates on the liquidity and financing efforts of WPS and its subsidiary;
The risks associated with changing commodity prices (particularly natural gas and electricity) and the available sources of fuel and purchased power, including their impact on margins;
Resolution of audits or other tax disputes with the IRS, Wisconsin Department of Revenue, Michigan Department of Treasury, or other revenue agencies;
The effects, extent, and timing of additional competition or regulation in the markets in which WPS and its subsidiary operate;
Investment performance of employee benefit plan assets and the related impact on future funding requirements;
Changes in technology, particularly with respect to new, developing, or alternative sources of generation;
Effects of and changes in political and legal developments, as well as economic conditions and the related impact on customer demand;
Potential business strategies, including acquisitions and construction or disposition of assets or businesses, which cannot be assured to be completed timely or within budgets;
The direct or indirect effects of terrorist incidents, natural disasters, or responses to such events;
The effectiveness of risk management strategies, the use of financial and derivative instruments, and the ability to recover costs from customers in rates associated with the use of those strategies and financial instruments;
The risk of financial loss, including increases in bad debt expense, associated with the inability of WPS's and its subsidiary's counterparties, affiliates, and customers to meet their obligations;
Customer usage, weather and other natural phenomena, in particular the effect of weather on natural gas and electricity sales after certain limits have been exceeded under the decoupling mechanisms at WPS;
Contributions to earnings by non-consolidated equity method and other investments, which may vary from projections;
The effect of accounting pronouncements issued periodically by standard-setting bodies; and
Other factors discussed elsewhere herein and in other reports filed by WPS and/or Integrys Energy Group from time to time with the SEC.
 
-3-


 
Except to the extent required by the federal securities laws, WPS and its subsidiary undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

 
-4-

 
 

             
PART 1. FINANCIAL INFORMATION
 
             
Item 1. Financial Statements
           
             
WISCONSIN PUBLIC SERVICE CORPORATION
 
             
             
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
 
Three Months Ended
 
   
March 31
 
(Millions)
 
2010
   
2009
 
             
Operating revenues
           
Electric
  $ 305.6     $ 299.4  
Natural gas
    161.4       188.8  
Total operating revenues
    467.0       488.2  
                 
Electric production fuels
    59.0       45.5  
Purchased power
    68.8       86.5  
Natural gas purchased for resale
    96.2       126.0  
Operating and maintenance expense
    112.1       103.7  
Depreciation and amortization expense
    28.6       26.4  
Taxes other than income taxes
    12.5       12.7  
Operating income
    89.8       87.4  
                 
Miscellaneous income
    2.8       4.0  
Interest expense
    (13.7 )     (12.5 )
Other expense
    (10.9 )     (8.5 )
                 
Income before taxes
    78.9       78.9  
Provision for income taxes
    30.6       28.8  
Net income
    48.3       50.1  
                 
Preferred stock dividend requirements
    0.8       0.8  
Net income attributed to common shareholder
  $ 47.5     $ 49.3  
                 
The accompanying condensed notes are an integral part of these statements.
               
                 

 
 
-5-

 


             
WISCONSIN PUBLIC SERVICE CORPORATION
 
             
             
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
 
March 31
   
December 31
 
(Millions)
 
2010
   
2009
 
             
Assets
           
Cash and cash equivalents
  $ 76.9     $ 6.0  
Accounts receivable and accrued unbilled revenues, net of reserves of $5.8 and $5.0, respectively
    198.5       203.6  
Receivables from related parties
    6.5       8.1  
Inventories
    46.7       70.1  
Assets from risk management activities
    1.9       5.0  
Regulatory assets
    26.6       40.5  
Materials and supplies, at average cost
    25.3       24.8  
Prepaid federal income tax
    -       30.6  
Prepaid gross receipts tax
    30.0       39.0  
Other current assets
    9.2       12.9  
Current assets
    421.6       440.6  
                 
Property, plant, and equipment, net of accumulated depreciation of $1,204.8 and $1,182.0, respectively
    2,365.7       2,379.8  
Regulatory assets
    380.4       362.0  
Receivables from related parties
    10.4       10.5  
Goodwill
    36.4       36.4  
Other long-term assets
    82.4       82.0  
Total assets
  $ 3,296.9     $ 3,311.3  
                 
Liabilities and Shareholders' Equity
               
Short-term debt
  $ 10.0     $ 17.0  
Accounts payable
    90.0       109.0  
Payables to related parties
    14.2       26.5  
Liabilities from risk management activities
    2.8       2.5  
Regulatory liabilities
    33.3       44.4  
Customer credit balances
    15.9       28.2  
Acrrued taxes
    10.8       3.2  
Accrued interest
    15.0       8.0  
Other current liabilities
    30.6       33.9  
Current liabilities
    222.6       272.7  
                 
Long-term debt to parent
    9.2       9.3  
Long-term debt
    871.0       870.9  
Deferred income taxes
    312.7       294.2  
Deferred investment tax credits
    9.5       9.8  
Regulatory liabilities
    236.1       234.2  
Environmental remediation liabilities
    75.1       75.3  
Pension and other postretirement benefit obligations
    262.9       258.6  
Payables to related parties
    8.8       9.0  
Other long-term liabilities
    100.7       98.1  
Long-term liabilities
    1,886.0       1,859.4  
                 
Commitments and contingencies
               
                 
Preferred stock - $100 par value; 1,000,000 shares authorized; 511,882 shares issued and outstanding
    51.2       51.2  
Common stock - $4 par value; 32,000,000 shares authorized; 23,896,962 shares issued and outstanding
    95.6       95.6  
Additional paid-in capital
    626.9       640.2  
Retained earnings
    414.6       392.2  
Total liabilities and shareholders' equity
  $ 3,296.9     $ 3,311.3  
                 
The accompanying condensed notes are an integral part of these statements.
               
                 
 

 
-6-

 


                       
WISCONSIN PUBLIC SERVICE CORPORATION
 
                       
                       
CONDENSED CONSOLIDATED STATEMENTS OF CAPITALIZATION (Unaudited)
   
March 31
   
December 31
 
(Millions, except share amounts)
   
2010
   
2009
 
                       
Common stock equity
                   
Common stock - $4 par value; 32,000,000 shares authorized;
             
  23,896,962 shares outstanding
    $ 95.6     $ 95.6  
Additional paid-in capital
      626.9       640.2  
Retained earnings
            414.6       392.2  
Total common stock equity
      1,137.1       1,128.0  
                           
Preferred stock
                       
Cumulative; $100 par value; 1,000,000 shares authorized
                 
  with no mandatory redemption -
                 
                           
 
Series
   
Shares Outstanding
                 
    5.00 %     131,916       13.2       13.2  
    5.04 %     29,983       3.0       3.0  
    5.08 %     49,983       5.0       5.0  
    6.76 %     150,000       15.0       15.0  
    6.88 %     150,000       15.0       15.0  
Total preferred stock
              51.2       51.2  
                               
Long-term debt to parent
                 
 
Series
   
Year Due
                 
    8.76 %  
2015
      3.7       3.8  
    7.35 %  
2016
      5.5       5.5  
Total long-term debt to parent
      9.2       9.3  
                               
Long-term debt
                         
  First Mortgage Bonds
                         
 
Series
   
Year Due
                 
    7.125 %  
2023
      0.1       0.1  
  Senior Notes
                         
 
Series
   
Year Due
                 
    6.125 %  
2011
      150.0       150.0  
    4.875 %  
2012
      150.0       150.0  
    3.95 %  
2013
      22.0       22.0  
    4.80 %  
2013
      125.0       125.0  
    6.375 %  
2015
      125.0       125.0  
    5.65 %  
2017
      125.0       125.0  
    6.08 %  
2028
      50.0       50.0  
    5.55 %  
2036
      125.0       125.0  
Total First Mortgage Bonds and Senior Notes
      872.1       872.1  
Unamortized discount on long-term debt, net
      (1.1 )     (1.2 )
Total long-term debt
              871.0       870.9  
Total capitalization
            $ 2,068.5     $ 2,059.4  
                               
                               
The accompanying condensed notes are an integral part of these statements.
         
                               
 
 

 
-7-

 


             
WISCONSIN PUBLIC SERVICE CORPORATION
 
             
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
Three Months Ended
 
   
March 31
 
(Millions)
 
2010
   
2009
 
             
Operating Activities
           
Net income
  $ 48.3     $ 50.1  
Adjustments to reconcile net income to net cash provided by operating activities
               
Depreciation and amortization expense
    28.6       26.4  
Recoveries and refunds of regulatory assets and liabilities
    2.9       3.0  
Deferred income taxes and investment tax credit
    18.9       23.9  
Bad debt expense
    0.9       2.1  
Pension and other postretirement expense
    7.1       2.5  
Pension and other postretirement contributions
    (0.4 )     (0.4 )
Equity income, net of dividends
    -       (0.5 )
Other, net
    (13.2 )     (8.4 )
Changes in working capital
               
Collateral on deposit
    (1.9 )     (3.9 )
Accounts receivable and accrued unbilled revenue
    4.9       39.4  
Inventories
    24.5       57.0  
Prepaid federal income taxes
    30.6       0.5  
Other current assets
    19.2       15.1  
Accounts payable
    (21.7 )     (27.4 )
Other current liabilities
    (7.8 )     7.4  
Net cash provided by operating activities
    140.9       186.8  
                 
Investing Activities
               
Capital expenditures
    (23.4 )     (46.5 )
Proceeds from sale of property, plant, and equipment
    0.5       0.6  
Other
    0.7       -  
Net cash used for investing activities
    (22.2 )     (45.9 )
                 
Financing Activities
               
Short-term debt - net
    (7.0 )     (50.0 )
Payments of long-term debt
    (0.1 )     (0.1 )
Dividends to parent
    (24.9 )     (24.2 )
Return of capital to parent
    (15.0 )     -  
Preferred stock dividends
    (0.8 )     (0.8 )
Other
    -       (0.1 )
Net cash used for financing activities
    (47.8 )     (75.2 )
Net change in cash and cash equivalents
    70.9       65.7  
Cash and cash equivalents at beginning of period
    6.0       9.0  
Cash and cash equivalents at end of period
  $ 76.9     $ 74.7  
                 
                 
The accompanying condensed notes are an integral part of these statements.
               
                 
 
 

 
-8-

 

WISCONSIN PUBLIC SERVICE CORPORATION AND SUBSIDIARY
CONDENSED NOTES TO FINANCIAL STATEMENTS
March 31, 2010

NOTE 1--FINANCIAL INFORMATION

The condensed consolidated financial statements of WPS have been prepared pursuant to the rules and regulations of the SEC for Quarterly Reports on Form 10-Q and in accordance with GAAP.  Accordingly, these condensed consolidated financial statements do not include all of the information and footnotes required by GAAP for annual financial statements.  These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes in the WPS Annual Report on Form 10-K for the year ended December 31, 2009.

The condensed consolidated financial statements are unaudited, but, in management's opinion, include all adjustments (which, unless otherwise noted, include only normal recurring adjustments) necessary for a fair presentation of such financial statements.  Financial results for this interim period are not necessarily indicative of results that may be expected for any other interim period or for the year ending December 31, 2010.

NOTE 2--CASH AND CASH EQUIVALENTS

Short-term investments with an original maturity of three months or less are reported as cash equivalents.

The following is supplemental disclosure to the WPS Condensed Consolidated Statements of Cash Flows:

   
Three Months Ended March 31
 
(Millions)
 
2010
   
2009
 
Cash paid for interest
  $ 5.0     $ 5.4  
Cash (received) paid for income taxes
    (28.6 )     1.5  

Construction costs funded through accounts payable and treated as non-cash investing activities totaled $4.4 million and $11.7 million at March 31, 2010, and 2009, respectively.

NOTE 3--RISK MANAGEMENT ACTIVITIES

WPS uses derivative instruments to manage commodity costs.  None of these derivatives are designated as hedges for accounting purposes.  The derivatives include financial derivative contracts (NYMEX futures and options), and financial transmission rights used by the electric utility segment to manage electric transmission congestion costs.  The NYMEX futures and options were used by both the electric and natural gas utility segments to mitigate the risks associated with the market price volatility of natural gas costs and the costs of gasoline and diesel fuel used by WPS's utility vehicles.

In the three months ended March 31, 2010, WPS identified additional classes of risk management assets and liabilities as a result of the implementation of FASB Accounting Standards Update (ASU) 2010-06, "Fair Value Measurements and Disclosures (Topic 820), Improving Disclosures about Fair Value Measurements."  As required, this ASU was only applied for the quarter ended March 31, 2010, and therefore, prior periods do not reflect the expanded disclosure requirements.
 
-9-


The following tables show WPS's assets and liabilities from risk management activities.

     
March 31, 2010
 
(Millions)
Balance Sheet Presentation *
 
Assets
   
Liabilities
 
Financial transmission rights
Current
  $ 1.7     $ 0.4  
Natural gas contracts
Current
    0.1       2.4  
Natural gas contracts
Other Long-term
    -       0.1  
Petroleum product contracts
Current
    0.1       -  
Total commodity contracts
Current
  $ 1.9     $ 2.8  
Total commodity contracts
Other Long-term
    -       0.1  
Total
    $ 1.9     $ 2.9  

*
All derivatives are recognized on the balance sheet at their fair value unless they qualify for the normal purchases and sales exception.  WPS continually assesses its contracts designated as normal and will discontinue the treatment of these contracts as normal if the required criteria are no longer met.  Assets and liabilities from risk management activities are classified as current or long-term based upon the maturities of the underlying contracts.

     
December 31, 2009
 
(Millions)
Balance Sheet Presentation *
 
Assets
   
Liabilities
 
Commodity contracts
Current
  $ 5.0     $ 2.5  

*
All derivatives are recognized on the balance sheet at their fair value unless they qualify for the normal purchases and sales exception.  WPS continually assesses its contracts designated as normal and will discontinue the treatment of these contracts as normal if the required criteria are no longer met.  Assets and liabilities from risk management activities are classified as current or long-term based upon the maturities of the underlying contracts.

Derivative instruments are entered into in accordance with the terms of the risk management plans approved by WPS's Board of Directors and by the PSCW or the MPSC.  Most energy-related physical and financial derivatives at WPS qualify for regulatory deferral.  These derivatives are marked to fair value; the resulting risk management assets are offset with regulatory liabilities or decreases to regulatory assets, and risk management liabilities are offset with regulatory assets or decreases to regulatory liabilities.  Management believes any gains or losses resulting from the eventual settlement of these derivative instruments will be refunded to or collected from customers in rates.

The tables below show the unrealized gains (losses) recorded related to derivatives at WPS.

(Millions)
Financial Statement Presentation
 
Three Months Ended
March 31, 2010
 
Financial transmission rights
Balance Sheet – Regulatory assets (current)
  $ 0.8  
Financial transmission rights
Balance Sheet – Regulatory liabilities (current)
    (2.1 )
Natural gas contracts
Balance Sheet – Regulatory assets (current)
    (0.7 )
Natural gas contracts
Balance Sheet – Regulatory assets (long-term)
    (0.2 )
Natural gas contracts
Balance Sheet – Regulatory liabilities (current)
    (0.2 )

(Millions)
Financial Statement Presentation
 
Three Months Ended
March 31, 2009
 
Commodity contracts
Balance Sheet – Regulatory assets (current)
  $ (1.7 )
Commodity contracts
Balance Sheet – Regulatory assets (long-term)
    (0.3 )
Commodity contracts
Balance Sheet – Regulatory liabilities (current)
    (2.7 )
Commodity contracts
Income Statement – Natural gas purchased for resale
    0.2  
 
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WPS had the following notional volumes of outstanding derivative contracts:

   
March 31, 2010
   
December 31, 2009
 
Commodity
 
Purchases
   
Other Transactions
   
Purchases
   
Other Transactions
 
Natural gas (millions of therms)
    23.1       N/A       54.6       N/A  
Financial transmission rights(millions of kilowatt-hours)
    N/A       2,196.6       N/A       4,306.0  
Petroleum products (barrels)
    11,266       N/A       15,144       N/A  

The following table shows WPS's cash collateral positions:

(Millions)
 
March 31, 2010
   
December 31, 2009
 
Cash collateral provided to others
  $ 3.2     $ 1.9  

NOTE 4--RESTRUCTURING EXPENSE

In an effort to permanently remove costs from its operations, Integrys Energy Group developed a strategy at the end of 2009 that included a reduction in the workforce supporting WPS as well as Integrys Energy Group’s other subsidiaries.  In connection with this strategy, an insignificant amount of employee-related restructuring costs were expensed on the Condensed Consolidated Statements of Income for the three months ended March 31, 2010.

The following table summarizes the activity related to these restructuring costs:

(Millions)
 
Three Months Ended
March 31, 2010
 
Accrued restructuring costs at beginning of period
  $ 10.7  
Restructuring costs accrued during the period
    0.5 *
Cash payments
    (3.5 )
Payments to IBS for allocated restructuring costs
    (3.4 )
Accrued restructuring costs at end of period
  $ 4.3  

*
$0.3 million of these restructuring costs are being billed to certain companies in accordance with provisions in the operating agreements with these companies that allow WPS to recover a portion of its administrative and general expenses.

NOTE 5--SHORT-TERM DEBT AND LINES OF CREDIT

WPS's outstanding short-term borrowings consisted of sales of commercial paper and short-term notes.

(Millions, except percentages)
 
March 31, 2010
   
December 31, 2009
 
Commercial paper outstanding
    -     $ 7.0  
Average discount rate on outstanding commercial paper
    -       0.22 %
Short-term notes payable outstanding
  $ 10.0     $ 10.0  
Average interest rate on outstanding short-term notes payable
    0.18 %     0.18 %

The table below presents WPS's average amount of short-term borrowings outstanding based on daily outstanding balances during the quarters ended March 31:

(Millions)
 
2010
   
2009
 
Average amount of commercial paper outstanding
  $ 0.3     $ 12.7  
Average amount of short-term notes payable outstanding
    10.0       10.0  
 
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WPS manages its liquidity by maintaining adequate external financing commitments.  The information in the table below relates to WPS's short-term debt, lines of credit, and remaining available capacity:

(Millions)
Maturity
 
March 31, 2010
   
December 31, 2009
 
Revolving credit facility (1)
6/02/10
  $ 115.0     $ 115.0  
Revolving short-term notes payable (2)
11/13/10
    10.0       10.0  
                   
Total short-term credit capacity
      125.0       125.0  
                   
Less:
                 
Letters of credit issued inside credit facilities
      3.2       3.2  
Loans outstanding under credit agreements and notes payable
      10.0       10.0  
Commercial paper outstanding
      -       7.0  
                   
Available capacity under existing agreements
    $ 111.8     $ 104.8  

(1)      In April 2010, WPS entered into a new revolving credit agreement to provide support for its commercial paper borrowing program.  Upon entering into the new agreement, the maturing facility was terminated.  The new revolving credit agreement allows for borrowings up to $115.0 million and will mature on April 23, 2011.  WPS intends to request authority to enter into a multi-year credit agreement from the PSCW, and if granted, the credit facility will mature on April 23, 2013.
 
(2)      This note is renewed every six months and is used for general corporate purposes.

At March 31, 2010, WPS was in compliance with all financial covenants related to outstanding short-term debt.  WPS's revolving credit agreement contains financial and other covenants, including but not limited to, a requirement to maintain a debt to total capitalization ratio not to exceed 65%, excluding non-recourse debt.  Failure to meet these covenants beyond applicable grace periods could result in accelerated due dates and/or termination of the agreement.

NOTE 6--ASSET RETIREMENT OBLIGATIONS

The following table shows changes to the asset retirement obligations of WPS through March 31, 2010.  All asset retirement obligations are recorded as other long-term liabilities on the Condensed Consolidated Balance Sheets.

(Millions)
     
Asset retirement obligations at December 31, 2009
  $ 17.8  
Accretion
    0.3  
Asset retirement obligations at March 31, 2010
  $ 18.1  

NOTE 7--INCOME TAXES

WPS's effective tax rate for the quarters ended March 31, 2010, and 2009, was 38.8% and 36.5%, respectively.

WPS calculates its provision for income taxes based on an interim effective tax rate that reflects its projected annual effective tax rate before certain discrete items.

The effective tax rate for the quarter ended March 31, 2010 was higher than the federal tax rate of 35%, primarily due to the elimination of the deductibility of prescription drug payments to retirees, to the extent those payments will be offset by the receipt of the Medicare Part D subsidy, as mandated in the federal Patient Protection and Affordable Care Act and Health Care and Education Reconciliation Act of 2010 (HCR).  As a result of the legislation, WPS expensed $4.5 million of deferred income tax benefits during the quarter ended March 31, 2010, which were previously recognized as a reduction in provision for income taxes. This additional provision for income taxes will not reoccur in future periods.  Also contributing to the higher effective tax rate was the impact of state income taxes, partially offset by an increase in wind production tax credits in 2010.
 
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For the quarter ended March 31, 2010, there was no significant change in WPS’s liability for unrecognized tax benefits.

NOTE 8--COMMITMENTS AND CONTINGENCIES

General

Amounts ultimately paid as penalties, or eventually determined to be paid in lieu of penalties, may not be deductible for income tax purposes. 

Commodity Purchase Obligations and Purchase Order Commitments

WPS routinely enters into long-term purchase and sale commitments that have various quantity requirements and durations.  WPS has obligations to distribute and sell electricity and natural gas to customers and expects to recover costs related to these obligations in future customer rates.

The obligations described below are as of March 31, 2010.

WPS's electric utility segment has obligations related to coal supply and transportation that extend through 2016 and total $246.6 million, obligations of $1,097.1 million for either capacity or energy related to purchased power that extend through 2027, and obligations for other commodities totaling $9.8 million, which extend through 2013.
WPS's natural gas utility segment has obligations related to natural gas supply and transportation contracts totaling $418.7 million, some of which extend through 2024.
WPS also has commitments in the form of purchase orders issued to various vendors, which totaled $239.2 million and relate to normal business operations, including construction projects.

Environmental

Clean Air Act New Source Review Issues

Weston and Pulliam Plants:
On November 18, 2009, the EPA issued a Notice of Violation (NOV) to WPS alleging violations of the New Source Review requirements of the Clean Air Act (CAA).  Specifically, the allegations relate to requirements for certain projects undertaken at Pulliam and Weston from 1994 to 2009.  WPS has evaluated the NOV, including an analysis of the allegations as well as options for resolution with the EPA, and has met with the EPA to discuss a possible resolution.  WPS continues to review the allegations but is currently unable to predict the impact on its condensed consolidated financial statements.

Columbia Plant:
On October 10, 2009, WPS, along with its co-owners, received from the Sierra Club a Notice of Intent (NOI) to file a civil lawsuit based on allegations that major modifications were made at the Columbia generation station without complying with the CAA.  Specifically, the allegations suggest that Prevention of Significant Deterioration (PSD) permits that imposed Best Available Control Technology (BACT) limits on emissions should have been obtained for the Columbia generation station, which is jointly owned by Wisconsin Power and Light (WP&L), Madison Gas and Electric Company (MG&E), and WPS, and operated by WP&L.  The NOI also covers similar allegations related to another generation station solely owned by WP&L.  WPS is reviewing the allegations but is currently unable to predict the impact on its condensed consolidated financial statements.

WP&L, on behalf of itself and the joint owners, sent a Notice of Deficiency to the Sierra Club regarding the NOI.  In response, the Sierra Club filed a Supplemental NOI on December 14, 2009, purporting to correct the deficiencies.  WP&L is in receipt of the Sierra Club’s initial demand and is in the process of analyzing the allegations, as well as the demand, and has begun discussions with the Sierra Club.
 
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Edgewater Plant:
On December 11, 2009, WPS, along with its co-owners, received from the Sierra Club a copy of an NOI to file a civil lawsuit against the EPA based on the EPA's failure to take actions against the co-owners and operator of the Edgewater generation station based upon allegations of failure to comply with the CAA.  Specifically, the allegations suggest that PSD permits that imposed BACT limits on emissions from the facilities should have been obtained for Edgewater.  Edgewater is jointly owned by WP&L, WE Energies (Unit 5) and WPS (Unit 4), and operated by WP&L.  WP&L is in the process of analyzing the Sierra Club's actions.  WPS is reviewing the allegations but is currently unable to predict the impact on its condensed consolidated financial statements.

On December 21, 2009, WPS, along with its co-owners, received from the Sierra Club an NOI to file a civil lawsuit based on allegations that major modifications were made at the Edgewater generation station without complying with the PSD and Title V Operating Permit requirements of the CAA.  Specifically, the allegations suggest that PSD permits that imposed BACT limits on emissions from the facilities should have been obtained for Edgewater.  WP&L is in the process of analyzing the allegations and has begun discussions with the Sierra Club.  WPS is reviewing the allegations but is currently unable to predict the impact on its condensed consolidated financial statements.

Columbia and Edgewater Plants:
On December 14, 2009, the EPA issued an NOV to WP&L relative to its Nelson Dewey Plant and to WP&L and the other joint owners of the Columbia and Edgewater generation stations alleging violations of New Source Review requirements of the CAA for certain projects undertaken at those plants.  The joint owners met with the EPA to begin discussions on a possible resolution and have received the EPA’s initial demand. WP&L is the operator of these plants and, along with the joint owners, is in the process of analyzing the NOV and the EPA’s initial demand.  WPS is also reviewing the allegations but is currently unable to predict the impact on its condensed consolidated financial statements.

EPA Settlements with Other Utilities:
In response to the EPA's CAA enforcement initiative, several utilities elected to settle with the EPA, while others are in litigation.  The fines and penalties (including the cost of supplemental environmental projects) associated with settlements involving comparably-sized facilities to Weston and Pulliam range between $7 million and $30 million.  The regulatory interpretations upon which the lawsuits or settlements are based may change based on future court decisions made in the pending litigation.

If the EPA brings a claim against WPS, and if it were determined by a court that historic projects at WPS's Pulliam and Weston plants required either a state or federal CAA permit, WPS may, under the applicable statutes, be required, in order to resolve any such claim, to:

shut down any unit found to be operating in non-compliance,
install additional pollution control equipment and/or impose emission limitations,
pay a fine, and/or
conduct a supplemental environmental project.

In addition, under the CAA, citizen groups may pursue a claim.  Except as noted above for the Columbia and Edgewater plants, WPS has no notice of such a claim.
 
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Weston Air Permits

In November 2004, the Sierra Club filed a petition with the WDNR under Section 285.61 of the Wisconsin Statutes seeking a contested case hearing on the construction permit issued for the Weston 4 generation station, which was a necessary predicate to plant construction under the pertinent air emission regulations (hereinafter referred to as the "Weston 4 air permit").  In February 2006, the administrative law judge affirmed the Weston 4 air permit with changes to the emission limits for sulfur dioxide and nitrogen oxide from the coal-fired boiler and particulate from the cooling tower.  The changes, which were implemented by the WDNR in a revised permit issued on March 28, 2007, set limits that were more stringent than those originally set by the WDNR (hereinafter referred to as the "March 28, 2007 permit language").

On April 27, 2007, the Sierra Club filed a second petition requesting a contested case hearing regarding the March 28, 2007 permit language, which was granted by the WDNR.  Both parties subsequently moved for summary judgment.  In a decision issued on November 8, 2007, the administrative law judge granted WPS's motion for summary judgment in that proceeding, upholding the March 28, 2007 permit language.  The Sierra Club filed petitions with the Dane County Circuit Court on April 27, 2007, and November 14, 2007, for judicial review of the Weston 4 air permit and the underlying proceedings before the administrative law judge.  These two judicial review proceedings were consolidated by the court.  On February 12, 2009, the court upheld the administrative law judge's final order, which affirmed the WDNR's actions.  The Sierra Club appealed this decision and the parties have completed filing briefs and are awaiting the appellate court's decision.

These activities did not stay the construction and startup of the Weston 4 facility or the administrative law judge's decision on the Weston 4 air permit.  WPS believes that it has substantial defenses to the Sierra Club's challenges.  Until the Sierra Club's challenges are finally resolved, WPS will not be able to make a final determination of the probable cost impact, if any, of compliance with any changes to the Weston 4 air permit on its future costs.

In December 2008, an NOV was issued to WPS by the WDNR alleging various violations of the air permits for Weston 4, as well as Weston 1 and 2.  The alleged violations include an exceedance of the carbon monoxide and volatile organic compound limits at Weston 4, exceedances of the hourly sulfur dioxide limit in ten three-hour periods during startup/shutdown and during one separate event at Weston 4, and two that address baghouse operation at Weston 1 and 2.  On July 22, 2009, an NOV was issued to WPS by the WDNR alleging violations of the opacity limits during two six-minute periods (one each at Weston 2 and 4) and of the sulfur dioxide average limit during one three-hour period at Weston 4. An NOV was issued to WPS in September 2009 relating to one event involving baghouse operation at Weston 1 and 2 that occurred in December 2008.  A fourth NOV was issued on December 14, 2009, for a clerical error involving pages missing from a quarterly report.  Corrective actions have been taken for the events in the four NOVs.  An enforcement conference was held on January 7, 2009, for the December 2008 NOV and on August 26, 2009, for the July 2009 NOV.  Discussions with the WDNR on the severity classification of the events continue.  Management believes it is likely that the WDNR will refer the NOVs to the state Justice Department for enforcement.  Management does not believe that these matters will have a material adverse impact on the condensed consolidated financial statements of WPS.

In early November 2006, it came to the attention of WPS that previous ambient air quality computer modeling done by the WDNR for the Weston facility (and other nearby air sources) did not take into account the emissions from the existing Weston 3 facility for purposes of evaluating air quality increment consumption under the required PSD.  WPS believes it has undertaken and completed corrective measures to address any identified modeling issues and anticipates issuance of a revised Title V permit that will resolve this issue.  WPS currently is not able to make a final determination of the probable cost impact of this issue, if any.
 
-15-


Columbia Air Permit

The renewal of the Title V air permit for the Columbia generation station, jointly owned by WP&L, MG&E, and WPS and operated by WP&L, was issued by the WDNR on September 2, 2008.  On October 8, 2009, the EPA issued an order objecting to the Title V air permit.  The order responds to a petition filed by the Sierra Club and determined that a project in 2006 to replace the economizer, final superheater, and related components on Unit 1 should have been permitted as a "major modification."  The order directs the WDNR to resolve the EPA's objections within 90 days and "terminate, modify, or revoke and reissue" the Title V permit accordingly.  As of March 22, 2010, the WDNR has reopened the permit to address the EPA’s order and, although final resolution is unknown, potential outcomes could include a revised permit.

Mercury and Interstate Air Quality Rules

Mercury

The State of Wisconsin's mercury rule, Chapter NR 446, requires a 40% reduction from the 2002 through 2004 baseline mercury emissions in Phase I, beginning January 1, 2010, through the end of 2014.  In Phase II, which begins in 2015, electric generating units above 150 megawatts will be required to reduce mercury emissions by 90%.  Reductions can be phased in and the 90% target can be delayed until 2021 if additional sulfur dioxide and nitrogen oxide reductions are implemented.  By 2015, electric generating units above 25 megawatts but less than 150 megawatts must reduce their mercury emissions to a level defined by the BACT rule.  As of March 31, 2010, WPS estimates capital costs of approximately $19 million for Phase I and Phase II, which includes estimates for both wholly owned and jointly owned plants, to achieve the required reductions.  The capital costs are expected to be recovered in future rate cases.  Because of the vacatur of the federal mercury control and monitoring rule in February 2008, the EPA is reviewing options for a new rulemaking to address hazardous air pollutants, including mercury, and is expected to issue a draft rule in 2011.

Sulfur Dioxide and Nitrogen Oxide

The EPA issued the Clean Air Interstate Rule (CAIR) in 2005.  CAIR was originally intended to reduce sulfur dioxide and nitrogen oxide emissions from utility boilers located in 29 states, including Wisconsin.  The first phase of CAIR required about a 50% reduction beginning in 2009 for nitrogen oxide and beginning in 2010 for sulfur dioxide.  The second phase required about a 65% reduction in emissions of both pollutants by 2015.  The State of Wisconsin's rule to implement CAIR, which incorporates the cap and trade approach, has been forwarded to the EPA for final review.

On July 11, 2008, the Court of Appeals issued a decision vacating CAIR, the EPA appealed, and in December 2008, the Court of Appeals reversed the CAIR vacatur and CAIR was reinstated.  The Court of Appeals directed the EPA to address the deficiencies noted in its July 11, 2008 ruling, and the EPA has indicated they expect to issue a draft revised CAIR rule for comment in 2010.  As a result of the Court of Appeals' decision, CAIR is in place for 2010.  WPS has not acquired any nitrogen oxide allowances for vintage years beyond 2010 other than those allocated by the EPA and does not expect any material impact as a result of the vacatur and subsequent reinstatement of CAIR.

The reinstatement of CAIR also affected the status of the Best Available Retrofit Technology (BART) rule, which is a rule that addresses regional haze and visibility.  The WDNR is evaluating whether air quality improvements under CAIR will be adequate to demonstrate compliance with BART.

For planning purposes, it is still assumed that additional sulfur dioxide and nitrogen oxide controls will be needed on existing units.  The installation of any controls will need to be scheduled as part of WPS's long-term maintenance plan for its existing units.  As such, controls may need to be installed before 2015. On a preliminary basis, and assuming controls are still required, WPS estimates capital costs of $596 million, which includes estimates for both wholly owned and WPS’s share of jointly owned plants, in order to meet an assumed 2015 compliance date.  This estimate is based on costs of current control
 
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technology and current information regarding the final state and federal rules.  The capital costs are anticipated to be recovered in future rate cases.

Manufactured Gas Plant Remediation

WPS operated facilities in the past at multiple sites for the purpose of manufacturing and storing manufactured gas.  In connection with manufacturing and storing manufactured gas, waste materials were produced that may have resulted in soil and groundwater contamination at these sites.  Under certain laws and regulations relating to the protection of the environment, WPS is required to undertake remedial action with respect to some of these materials.

WPS is responsible for the environmental impacts at ten manufactured gas plant sites located in Wisconsin and Michigan.  All are former regulated utility sites and are being remediated, with costs charged to existing ratepayers at WPS.  WPS estimated and accrued for $75.1 million of future undiscounted investigation and cleanup costs for all sites as of March 31, 2010.  WPS may adjust these estimates in the future, contingent upon remedial technology, regulatory requirements, remedy determinations, and any claims of natural resource damages.  WPS recorded a regulatory asset of $74.2 million, which is net of insurance recoveries received of $19.4 million, related to the expected recovery of both deferred expenditures and estimated future expenditures as of March 31, 2010.  Under current PSCW policies, WPS may not recover carrying costs associated with the cleanup expenditures.

WPS entered into a settlement agreement with the EPA in May 2006, transferring jurisdiction over six of the manufactured gas plant sites from the state to the EPA Superfund Alternative Sites Program.  Under the EPA's program, the remedy decisions at these sites will be based on risk-based criteria typically used at Superfund sites.  In addition, WPS completed the transfer of the Sheboygan Camp Marina site from state jurisdiction to the EPA in January 2007.  Three of WPS's manufactured gas plant sites remain under state jurisdiction.

WPS is coordinating the investigation and cleanup of its manufactured gas plant sites subject to EPA jurisdiction under what is called a "multi-site" program.  This program involves prioritizing the work to be done at the sites, preparation and approval of documents common to all of the sites, and utilization of a consistent approach in selecting remedies.

Management believes that any costs incurred for environmental activities relating to former manufactured gas plant operations that are not recoverable through contributions from other entities or from insurance carriers have been prudently incurred and are, therefore, recoverable through rates for WPS.  Accordingly, management believes that the costs incurred in connection with former manufactured gas plant operations will not have a material adverse effect on the condensed consolidated financial statements of WPS.

Greenhouse Gases

WPS is evaluating both the technical and cost implications that may result from future state, regional, or federal greenhouse gas regulatory programs.  This evaluation indicates it is probable that any regulatory program that caps emissions or imposes a carbon tax will increase costs for WPS and its customers.  The greatest impact is likely to be on fossil fuel-fired generation, with a less significant impact on natural gas storage and distribution operations.  Efforts are underway within the utility industry to find a feasible method for capturing carbon dioxide from pulverized coal-fired units and to develop cleaner ways to burn coal.  The use of alternate fuels is also being explored by the industry, but there are many cost and availability issues. Recently, efforts have been initiated to develop state and regional greenhouse gas programs, to create federal legislation to limit carbon dioxide emissions, and to create national or state renewable portfolio standards.  Some examples of these efforts are the Waxman-Markey bill, which passed the United States House of Representatives, and the Kerry-Boxer draft bill, which was introduced in the United States Senate.  In addition, in April 2009, the EPA declared carbon dioxide and several other greenhouse gases to be a danger to public health and welfare, which is the first step towards the EPA potentially regulating greenhouse gases under the CAA.  A risk exists that such legislation or regulation
 
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will increase the cost of energy.  However, WPS believes the capital expenditures being made at its generation units are appropriate under any reasonable mandatory greenhouse gas program and that future expenditures related to control of greenhouse gas emissions or renewable portfolio standards by WPS will be recoverable in rates.  WPS will continue to monitor and manage potential risks and opportunities associated with future greenhouse gas legislative or regulatory actions.

NOTE 9--GUARANTEES

The following table shows outstanding guarantees at WPS:

         
Expiration
 
(Millions)
 
Total Amounts
Committed at
March 31, 2010
   
Less Than
1 Year
   
Over 1 Year
 
Standby letters of credit (1)
  $ 3.3     $ 3.3     $ -  
Other guarantee (2)
    0.5       -       0.5  
Total guarantees
  $ 3.8     $ 3.3     $ 0.5  

(1)
At WPS's request, financial institutions have issued standby letters of credit for the benefit of third parties that have extended credit to WPS.  These amounts are not reflected on the Condensed Consolidated Balance Sheets.

(2)
Issued for workers compensation coverage in Michigan.  This amount is not reflected on the Condensed Consolidated Balance Sheets.

NOTE 10--EMPLOYEE BENEFIT PLANS

The following table shows the components of WPS's net periodic benefit cost for the three months ended March 31:

   
Pension Benefits
   
Other Benefits
 
(Millions)
 
2010
   
2009
   
2010
   
2009
 
Service cost
  $ 2.7     $ 2.5     $ 1.7     $ 1.3  
Interest cost
    9.2       9.4       3.7       3.6  
Expected return on plan assets
    (9.7 )     (10.0 )     (3.5 )     (3.5 )
Amortization of prior service cost (credit)
    1.2       1.1       (0.9 )     (0.9 )
Amortization of net actuarial loss
    1.4       0.1       0.5       0.1  
Regulatory deferral *
    1.1       (0.8 )     (0.3 )     (0.4 )
Net periodic benefit cost
  $ 5.9     $ 2.3     $ 1.2     $ 0.2  

*
The PSCW authorized recovery for net increased 2009 pension costs and a refund to customers for net decreased 2009 other postretirement benefit costs as part of the limited rate case re-opener for 2010.  Amortization and recovery/refund of these costs will occur throughout 2010.

WPS records transition obligations, prior service costs (credits), and net actuarial losses that have not yet been recognized as a component of net periodic benefit cost as net regulatory assets.

Contributions to the plans are made in accordance with legal and tax requirements and do not necessarily occur evenly throughout the year.  For the three months ended March 31, 2010, contributions made to the pension and other postretirement benefit plans were not significant.  WPS expects to contribute $19.8 million to its pension plans and $10.7 million to its other postretirement benefit plans during the remainder of 2010.

NOTE 11--VARIABLE INTEREST ENTITIES

Effective January 1, 2010, WPS implemented SFAS No. 167, "Amendments to FASB Interpretation No. 46 (R)" (now incorporated as part of the Consolidation Topic of the FASB ASC).  WPS has a variable
 
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interest in an entity through a power purchase agreement relating to the cost of fuel.  In this case, WPS has considered which interest holder has the power to direct the activities that most significantly impact the economics of the variable interest entity; this interest holder is considered the primary beneficiary of the entity and is required to consolidate the entity.  For a variety of reasons, including the length of the remaining term of the contract compared with the remaining life of the plant and the fact that WPS does not have the power to direct the operations of the facility, WPS has determined it is not the primary beneficiary of this variable interest entity.

As of March 31, 2010, the carrying amount of assets and liabilities on the Condensed Consolidated Balance Sheets that relate to the involvement with the variable interest entity are related to working capital accounts and represent the amounts owed by WPS for the current deliveries of power.  WPS has not provided or guaranteed any debt or equity support, liquidity arrangements, performance guarantees or other commitments associated with these contracts.  There is no significant potential exposure to loss as a result of its involvement with the variable interest entity.

NOTE 12--FAIR VALUE

Fair Value Measurements

In the three months ended March 31, 2010, WPS identified additional classes of risk management assets and liabilities as a result of the implementation of FASB Accounting Standards Update (ASU) 2010-06, "Fair Value Measurements and Disclosures (Topic 820), Improving Disclosures about Fair Value Measurements."  As required, this ASU was only applied for the quarter ended March 31, 2010, and therefore, prior periods do not reflect the expanded disclosure requirements.

The following tables show WPS's assets and liabilities that were accounted for at fair value on a recurring basis, categorized by level within the fair value hierarchy.

   
March 31, 2010
 
(Millions)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Risk management assets
                       
Financial transmission rights
  $ -     $ -     $ 1.7     $ 1.7  
Natural gas contracts
    0.1       -       -       0.1  
Petroleum products contracts
    0.1       -       -       0.1  
Total
  $ 0.2     $ -     $ 1.7     $ 1.9  
                                 
Risk management liabilities
                               
Financial transmission rights
  $ -     $ -       0.4     $ 0.4  
Natural gas contracts
    2.5       -       -       2.5  
Total
  $ 2.5     $ -     $ 0.4     $ 2.9  

   
December 31, 2009
 
(Millions)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
Risk management assets
  $ 0.7     $ -     $ 4.3     $ 5.0  
Risk management liabilities
    1.3       -     $ 1.2     $ 2.5  

WPS determined the fair values above using a market based approach that incorporates observable market inputs where available, and internally developed inputs where observable market data is not readily available.  For the unobservable inputs, consideration is given to the assumptions that market participants would use in valuing the asset or liability.  These factors include not only the credit standing of the counterparties involved, but also the impact of WPS's nonperformance risk on its liabilities.

The risk management assets and liabilities listed in the tables include NYMEX futures and options, and financial contracts used to manage transmission congestion costs in the MISO market accounted for as derivatives under the Derivatives and Hedging Topic of the FASB ASC.  NYMEX contracts are valued
 
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using the NYMEX end-of-day settlement price, which is a Level 1 input.  The valuation for financial transmission rights is derived from historical data from MISO, which is considered a Level 3 input.  For more information on WPS's derivative instruments, see Note 3, "Risk Management Activities."  There were no transfers between the levels of the fair value hierarchy during the three months ended March 31, 2010.

The following table sets forth a reconciliation of changes in the fair value of financial transmission rights, which are categorized as Level 3 measurements:

   
Three Months Ended March 31
 
(Millions)
 
2010
   
2009
 
Balance at beginning of period
  $ 3.1     $ 2.7  
Net realized loss included in earnings
    (0.3 )     (1.7 )
Net unrealized loss recorded as regulatory
     assets or liabilities
    (2.0 )     (0.2 )
Net purchases and settlements
    0.5       0.4  
Balance at end of period
  $ 1.3     $ 1.2  

Unrealized gains and losses on financial transmission rights are deferred as regulatory assets or liabilities. Therefore, these fair value measurements have no impact on earnings.  Realized gains and losses on financial transmission rights, as well as the related transmission congestion costs, are recorded in purchased power on the Condensed Consolidated Statements of Income.

Fair Value of Financial Instruments

The following table shows the financial instruments included on WPS's Condensed Consolidated Balance Sheets that are not recorded at fair value.

   
March 31, 2010
   
December 31, 2009
 
(Millions)
 
Carrying
 Amount
   
Fair
Value
   
Carrying
 Amount
   
Fair
Value
 
Long-term debt
  $ 871.0     $ 916.9     $ 870.9     $ 909.9  
Preferred stock
    51.2       46.6       51.2       44.4  

The fair values of long-term debt are estimated based on the quoted market price for the same or similar issues, or on the current rates offered to WPS for debt of the same remaining maturity.  The fair values of preferred stock are estimated based on quoted market prices when available, or by using a perpetual dividend discount model.

Due to the short-term nature of cash and cash equivalents, accounts receivable, accounts payable, notes payable, and outstanding commercial paper, the carrying amount approximates fair value.

NOTE 13--MISCELLANEOUS INCOME

WPS's total miscellaneous income was as follows:

   
Three Months Ended March 31
 
(Millions)
 
2010
   
2009
 
Equity earnings on investments
  $ 2.7     $ 2.8  
Equity AFUDC
    0.2       1.4  
Other
    (0.1 )     (0.2 )
Total miscellaneous income
  $ 2.8     $ 4.0  
 
-20-


 
NOTE 14--REGULATORY ENVIRONMENT

Wisconsin

2011 Rate Case

On April 1, 2010, WPS filed an application with the PSCW to increase retail electric and natural gas rates $64.2 million (6.9%) and $5.0 million (1.2%), respectively, with rates effective January 1, 2011.  The filing includes a request for an 11.25% return on common equity and a common equity ratio of 53.62% in its regulatory capital structure.  The proposed retail electric and natural gas rate increases for 2011 are being driven by decreased sales due primarily to the ongoing economic recession and increased energy efficiency efforts by customers, the amortization in 2011 of deferred amounts under WPS’s electric Revenue Stabilization Mechanism, and increased payments to the Wisconsin Focus on Energy program.

2010 Rates

On December 22, 2009, the PSCW issued a final written order for WPS authorizing an electric rate increase of $18.2 million, offset by an $18.2 million refund of 2009 and 2008 fuel costs, and a retail natural gas rate increase of $13.5 million, effective January 1, 2010.  Based on an order issued on April 1, 2010, the remaining $10.0 million of the 2008 and 2009 fuel cost over-collections, plus interest of $1.3 million, will be refunded to customers based on April 2010 sales.  As of March 31, 2010, the remaining balance of the 2008 and 2009 fuel cost over-collections to be refunded to customers in 2010 was $24.4 million, which has been recorded as a short-term regulatory liability.  Fuel cost over/under-recovery impacts related to the Weston 4 power plant exfoliation issue remain open for 2008 and 2009 and have been delayed to a future rate proceeding.

2009 Rates

On December 30, 2008, the PSCW issued a final written order for WPS authorizing no change in retail electric rates from the fuel surcharge adjusted rates authorized effective July 4, 2008, and a $3.0 million decrease in retail natural gas rates.  The PSCW also approved a decoupling mechanism as a four-year pilot program.  The mechanism allows WPS to defer and recover or refund in future rate proceedings all or a portion of the differences between the actual and authorized margin per customer impact of variations in volumes.  The annual deferral or refund is limited to $14.0 million for electric service and $8.0 million for natural gas service.  The mechanism does not adjust for changes in volume resulting from changes in customer count and also does not cover large commercial and industrial customers.

NOTE 15--SEGMENTS OF BUSINESS

At March 31, 2010, WPS reported three segments.  WPS manages its reportable segments separately due to their different operating and regulatory environments.  Its principal business segments are the regulated electric utility operations and the regulated natural gas utility operations.  The Other segment includes nonutility activities, including equity earnings from WPS's investments in WRPC and WPS Investments, LLC, which holds an interest in ATC.
 
-21-


The table below presents information for the respective periods pertaining to WPS's reportable segments:

   
Regulated Utilities
                   
Segments of Business
 (Millions)
 
Electric
Utility
   
Natural Gas
Utility
   
Total
Utility
   
Other
   
Reconciling Eliminations
   
WPS
Consolidated
 
                                     
Three Months Ended
March 31, 2010
                                   
Operating revenues
  $ 305.5     $ 161.4     $ 466.9     $ 0.5     $ (0.4 )   $ 467.0  
Depreciation and amortization expense
    22.8       5.8       28.6       0.1       (0.1 )     28.6  
Miscellaneous income
    0.1       -       0.1       2.7       -       2.8  
Interest expense
    10.0       2.6       12.6       1.1       -       13.7  
Provision for income taxes
    15.6       14.7       30.3       0.3       -       30.6  
Preferred stock dividend requirements
    0.6       0.2       0.8       -       -       0.8  
Net income attributed to common shareholder
    24.7       21.3       46.0       1.5       -       47.5  
                                                 
Three Months Ended
March 31, 2009
                                               
Operating revenues
  $ 299.4     $ 188.8     $ 488.2     $ 0.4     $ (0.4 )   $ 488.2  
Depreciation and amortization expense
    20.9       5.5       26.4       0.1       (0.1 )     26.4  
Miscellaneous income
    0.9       0.5       1.4       2.6       -       4.0  
Interest expense
    9.7       2.5       12.2       0.3       -       12.5  
Provision for income taxes
    14.0       14.1       28.1       0.7       -       28.8  
Preferred stock dividend requirements
    0.6       0.2       0.8       -       -       0.8  
Net income attributed to common shareholder
    25.2       22.4       47.6       1.7       -       49.3  


 
-22-

 


Management's Discussion and Analysis of Financial Condition and Results of Operations
   

The following discussion should be read in conjunction with the accompanying condensed consolidated financial statements and related notes and WPS‘s Annual Report on Form 10-K for the year ended December 31, 2009.

SUMMARY

WPS, a wholly owned subsidiary of Integrys Energy Group, Inc., is a regulated electric and natural gas utility.  WPS derives revenues primarily from the purchase, production, distribution, and sale of electricity and the purchase, distribution, and sale of natural gas to retail customers.  WPS also provides wholesale electric service to numerous utilities and cooperatives for resale.

RESULTS OF OPERATIONS

First Quarter 2010 Compared with First Quarter 2009

         
Change in
 
   
Three Months Ended March 31
   
2010 Over
 
(Millions)
 
2010
   
2009
   
2009
 
Electric utility operations
  $ 24.7     $ 25.2       (2.0 )%
Natural gas utility operations
    21.3       22.4       (4.9 )%
Other operations
    1.5       1.7       (11.8 )%
                         
Net income attributed to common shareholder
  $ 47.5     $ 49.3       (3.7 )%

Earnings Summary

WPS recognized net income attributed to common shareholder of $47.5 million for the quarter ended March 31, 2010, compared with $49.3 million for the same quarter in 2009.  Significant factors contributing to the $1.8 million decrease in earnings were as follows (and are discussed in more detail thereafter).

·
Net income attributed to common shareholder at the regulated electric utility segment decreased $0.5 million, driven by a $4.9 million after-tax increase in operating expenses, primarily related to increases in employee benefit costs, electric transmission expense, and customer assistance expense.  Federal health care legislation enacted in March 2010 also had a non-recurring $3.5 million negative impact on electric earnings as a result of an increase in provision for income taxes, since payments for retiree prescription drugs subject to a federal subsidy will no longer be deductible under the new legislation.  The decrease in regulated electric utility segment earnings was partially offset by a $6.2 million after-tax increase in margin, primarily related to lower fuel and purchased power costs incurred during the first quarter of 2010, compared with fuel and purchased power cost recovery rates set in 2009 (which WPS was allowed to retain as part of its limited rate case re-opener for 2010), as well as a retail rate increase.
 
-23-

 
 
·
Net income attributed to common shareholder at the regulated natural gas utility segment decreased $1.1 million, driven by a $1.8 million after-tax decrease in margin related to lower quarter-over-quarter volumes, net of decoupling.  The cap for decoupling was reached prior to the end of the first quarter.  An operating expense increase of $1.4 million after-tax, primarily related to higher customer assistance expense, a non-recurring $1.0 million increase in provision for income taxes related to new health care legislation, which eliminated the deductibility of payments for retiree prescription drugs subject to a federal subsidy, and a $0.4 million after-tax decrease in AFUDC also contributed to the decrease in earnings.  A $3.6 million after-tax increase in margin related to a new rate order, effective January 1, 2010, partially offset the net decrease in earnings.

Regulated Electric Utility Segment Operations

         
Change in
 
   
Three Months Ended March 31
   
2010 Over
 
(Millions, except heating degree days)
 
2010
   
2009
   
2009
 
                   
Revenues
  $ 305.5     $ 299.4       2.0 %
Fuel and purchased power costs
    128.0       132.2       (3.2 )%
Margins
    177.5       167.2       6.2 %
                         
Operating and maintenance expense
    92.9       86.7       7.2 %
Depreciation and amortization expense
    22.8       20.9       9.1 %
Taxes other than income taxes
    11.0       11.0       - %
                         
Operating income
    50.8       48.6       4.5 %
                         
Miscellaneous income
    0.1       0.9       (88.9 )%
Interest expense
    (10.0 )     (9.7 )     3.1 %
Other expense
    (9.9 )     (8.8 )     12.5 %
                         
Income before taxes
  $ 40.9     $ 39.8       2.8 %
                         
Sales in kilowatt-hours
                       
 Residential
    719.1       763.9       (5.9 )%
 Commercial and industrial
    1,894.7       1,860.4       1.8 %
 Wholesale
    1,167.1       1,069.5       9.1 %
 Other
    9.7       9.8       (1.0 )%
   Total sales in kilowatt-hours
    3,790.6       3,703.6       2.3 %
                         
Weather
                       
 Heating degree days
    3,444       3,971       (13.3 )%

First Quarter 2010 Compared with First Quarter 2009

Revenues

Regulated electric utility segment revenues increased $6.1 million quarter-over-quarter, driven by:

·
An approximate $8 million increase in opportunity sales, made possible by a combination of an increase in available capacity (which resulted from lower residential, small commercial and industrial, and contracted wholesale sales), and low-cost generation at Weston 4.
   
·
An approximate $5 million increase due to a 7.0% increase in sales volumes to large commercial and industrial customers related to changes in plant operations, which WPS attributes mainly to improving general economic conditions.
   
·
An approximate $2 million increase in revenues related to the retail electric rate increase effective January 1, 2010.
 
-24-

 
   
·
These increases in regulated electric utility segment revenues were partially offset by:
   
 
-
An approximate $7 million decrease in revenues from wholesale customers due to a decrease in contracted sales volumes and fuel costs.  The decrease in fuel costs caused a decrease in per-unit revenues because commodity costs are passed directly through to these customers in rates.
     
 
-
An approximate $2 million decrease in revenues, net of decoupling, due to a 4.4% decrease in sales volumes to residential and small commercial and industrial customers primarily related to warmer quarter-over-quarter weather during the heating season, as evidenced by the decrease in heating degree days.  In the first quarter of 2010, an $11.3 million benefit from electric decoupling (which is subject to an annual $14.0 million cap) was recorded, compared with $5.6 million in the first quarter of 2009.

Margins

Regulated electric utility segment margins increased $10.3 million quarter-over-quarter, driven by:

·
An approximate $8 million increase related to lower fuel and purchased power costs incurred in the first quarter of 2010 compared with fuel and purchased power cost recovery rates set in 2009, which WPS was allowed to retain as part of its limited rate case re-opener for 2010.
   
·
An approximate $2 million increase related to the retail electric rate increase effective January 1, 2010.

Operating Income

Operating income at the regulated electric utility segment increased $2.2 million quarter-over-quarter, driven by the $10.3 million increase in electric margins, partially offset by an $8.1 million increase in operating expenses.

The increase in operating expenses was the result of:

·
A $4.0 million increase in employee benefit costs, primarily related to an increase in pension and other postretirement benefit expenses, driven by the amortization of negative investment returns from 2008, and a decrease in the discount rate utilized in the most recent valuation.
   
·
A $3.5 million increase in electric transmission expense.
   
·
A $3.0 million increase in customer assistance expense related to payments made to the Focus on Energy program, which aims to help residents and businesses install cost-effective, energy efficient, and renewable energy products.
   
·
A $1.9 million increase in depreciation and amortization expense, primarily related to the Crane Creek Wind Farm being placed in service for accounting purposes in December 2009.
   
·
These increases were partially offset by a $3.0 million decrease in electric maintenance expense, primarily related to a greater number of planned outages at the generation plants during the first quarter of 2009, compared with the first quarter of 2010.

Other Expense

Other expense at the regulated electric utilities increased $1.1 million, driven by a $1.0 million decrease in AFUDC related to the Crane Creek Wind Farm.
 
-25-


Regulated Natural Gas Utility Segment Operations

         
Change in
 
   
Three Months Ended March 31
   
2010 Over
 
(Millions, except heating degree days)
 
2010
   
2009
   
2009
 
                   
Revenues
  $ 161.4     $ 188.8       (14.5 )%
Natural gas purchased for resale
    96.2       126.0       (23.7 )%
Margins
    65.2       62.8       3.8 %
                         
Operating and maintenance expense
    19.0       16.9       12.4 %
Depreciation and amortization expense
    5.8       5.5       5.5 %
Taxes other than income taxes
    1.6       1.7       (5.9 )%
                         
Operating income
    38.8       38.7       0.3 %
                         
Miscellaneous income
    -       0.5       (100.0 )%
Interest expense
    (2.6 )     (2.5 )     4.0 %
Other expense
    (2.6 )     (2.0 )     30.0 %
                         
Income before taxes
  $ 36.2     $ 36.7       (1.4 )%
                         
Throughput in therms
                       
 Residential
    100.3       117.6       (14.7 )%
 Commercial and industrial
    56.2       67.2       (16.4 )%
 Interruptible
    2.8       2.5       12.0 %
 Interdepartmental
    3.3       2.0       65.0 %
 Transport
    102.8       110.9       (7.3 )%
   Total sales in therms
    265.4       300.2       (11.6 )%
                         
Weather
                       
 Heating degree days
    3,444       3,971       (13.3 )%

First Quarter 2010 Compared with First Quarter 2009

Revenues

Regulated natural gas utility segment revenue decreased $27.4 million quarter-over-quarter, resulting primarily from:

·
An approximate $22 million decrease in revenue as a result of lower natural gas throughput volumes, driven by:
     
 
-
An approximate $20 million decrease as a result of warmer quarter-over-quarter weather during the first quarter heating season, evidenced by the 13.3% decrease in heating degree days.
     
 
-
An approximate $8 million decrease related to lower overall volumes, including residential customer volumes, resulting from customer conservation and efficiency efforts.  Lower volumes were also experienced by commercial and industrial customers, resulting from reduced demand related to changes in customers' plant operations, which WPS attributed to the general economic slowdown.
     
 
-
A partially offsetting approximate $7 million positive quarter-over-quarter impact of a decoupling mechanism for residential and small commercial and industrial customers.  Under decoupling, WPS is allowed to defer the difference between the actual and rate case authorized delivery charge components of margin from certain customers and adjust future rates in accordance with rules applicable to each jurisdiction.
 
-26-

 
     
·
An approximate $12 million decrease in revenue as a result of an approximate 12% decrease in the average per-unit cost of natural gas sold during the quarter ended March 31, 2010, compared with the same quarter in 2009.  Prudently incurred natural gas commodity costs are passed directly through to customers in current rates.
     
·
The decrease in revenue was partially offset by an approximate $6 million increase in revenue resulting from the PSCW's final rate order for a retail natural gas distribution rate increase that was effective January 1, 2010.  See Note 14, "Regulatory Environment," for more information on this rate order.

Margins

Regulated natural gas utility segment margin increased $2.4 million quarter-over-quarter, driven by:

·
An approximate $6 million positive impact resulting from the new rate order, effective January 1, 2010.
   
·
The increase in margin was partially offset by an approximate $3 million decrease in margin resulting from the 11.6% decrease in natural gas throughput volumes attributed to warmer quarter-over-quarter weather, customer conservation and efficiency efforts, and the negative impact of the general economic slowdown.  This decrease in margin includes an approximate $7 million positive quarter-over-quarter impact from a decoupling mechanism, which includes an annual $8.0 million cap for the deferral of any excess or shortfall from the rate case authorized margin.  This cap was reached prior to the end of the first quarter of 2010, negatively impacting WPS's natural gas margin quarter-over-quarter by
$1.1 million.  Additionally, no decoupling deferral can be recorded at WPS if there are any shortfalls from authorized margin for the remainder of 2010.

Operating Income

Operating income at the regulated natural gas utility segment increased $0.1 million quarter-over-quarter, driven by the $2.4 million increase in natural gas margin, partially offset by a $2.1 million increase in operating and maintenance expenses.  The increase in operating and maintenance expense was driven by an increase in customer assistance expense related to payments made to the Focus on Energy program, which aims to help residents and businesses install cost-effective, energy efficient, and renewable energy products.

Other Expense

Other expense at the regulated natural gas utility segment increased $0.6 million, driven by a decrease in AFUDC related to the construction of natural gas laterals for connection to the Guardian II pipeline that were placed in service in February 2009.

Other Segment Operations

         
Change in
 
   
Three Months Ended March 31
   
2010 Over
 
(Millions)
 
2010
   
2009
   
2009
 
                   
Operating income
  $ 0.2     $ 0.1       100.0 %
Other income
    1.6       2.3       (30.4 )%
                         
Income before taxes
  $ 1.8     $ 2.4       (25.0 )%

First Quarter 2010 Compared with First Quarter 2009

Income before taxes for other segment operations decreased $0.6 million, driven by a $0.9 million increase in interest expense on deferred compensation plans.
 
-27-


Provision for Income Taxes
       
   
Three Months Ended March 31
 
   
2010
   
2009
 
Effective Tax Rate
    38.8 %     36.5 %

First Quarter 2010 Compared with First Quarter 2009

The higher effective tax rate for the quarter ended March 31, 2010, compared with the same quarter in 2009, was driven by the elimination of the deductibility of prescription drug payments to retirees, to the extent those payments will be offset by the receipt of the Medicare Part D subsidy, as mandated in the recently passed federal health legislation.  See "Other Future Considerations – Federal Health Care Reform" for more information.  As a result of the legislation, WPS expensed $4.5 million of deferred income tax benefits during the quarter ended March 31, 2010, which were previously recognized as a reduction of provision for income taxes.  This additional provision for income taxes will not reoccur in future periods.  The 2010 effective tax rate has also been adjusted to reflect an additional provision for income taxes of $0.6 million related to current year expected retiree benefits.  The increase in the effective tax rate was partially offset by an increase in wind production tax credits in 2010.

LIQUIDITY AND CAPITAL RESOURCES

WPS believes that its cash balances, liquid assets, operating cash flows, access to debt markets and available borrowing capacity provide adequate resources to fund ongoing operating requirements and future capital expenditures related to expansion of existing businesses and development of new projects.  However, WPS’s operating cash flows and access to capital markets can be impacted by macroeconomic factors outside of its control.  In addition, WPS's borrowing costs can be impacted by its short-term and long-term debt ratings assigned by independent credit rating agencies.

Operating Cash Flows

During the quarter ended March 31, 2010, net cash provided by operating activities was $140.9 million, compared with $186.8 million for the same quarter in 2009.  The $45.9 million quarter-over-quarter decrease in net cash provided by operating activities was largely driven by a $40.3 million decrease in cash provided by working capital, primarily due to a $34.5 million quarter-over-quarter decrease in cash generated from accounts receivable and accrued unbilled revenues, and a $32.5 million quarter-over-quarter decrease in cash generated by inventories, both driven by a larger decrease in natural gas prices during the first quarter of 2009, compared with the first quarter of 2010.  Partially offsetting these changes was the quarter-over-quarter change in federal income tax payments.

Investing Cash Flows

Net cash used for investing activities was $22.2 million during the quarter ended March 31, 2010, compared with $45.9 million for the same quarter in 2009.  The $23.7 million quarter-over-quarter decrease in net cash used for investing activities was primarily driven by a $23.1 million quarter-over-quarter decrease in cash used to fund capital expenditures (discussed below).
 
-28-


Capital Expenditures

Capital expenditures by business segment for the quarter ended March 31 were as follows:

Reportable Segment (millions)
 
2010
   
2009
   
Change
 
Electric utility
  $ 19.3     $ 40.5     $ (21.2 )
Natural gas utility
    4.1       6.0       (1.9 )
WPS consolidated
  $ 23.4     $ 46.5     $ (23.1 )

The decrease in capital expenditures at the electric utility segment for the quarter ended March 31, 2010, compared with the same quarter in 2009, was mainly due to decreased expenditures related to the Crane Creek Wind Farm project, which was placed in service for accounting purposes in December 2009.

Financing Cash Flows

Net cash used for financing activities was $47.8 million during the quarter ended March 31, 2010, compared with $75.2 million for the same quarter in 2009.  The $27.4 million quarter-over-quarter decrease in net cash used for financing activities was primarily driven by a $43.0 million quarter-over-quarter decrease in the repayment of short-term borrowings, mainly due to the generation of more cash from operating activities in 2009 compared with 2010, offset by $15.0 million in return of capital payments to Integrys Energy Group during the quarter ended March 31, 2010.

Significant Financing Activities

WPS had no outstanding commercial paper borrowings at March 31, 2010, and 2009.  WPS had other outstanding short-term debt of $10.0 million at March 31, 2010, and 2009.

Credit Ratings

The current credit ratings for WPS are listed in the table below.

 
Standard & Poor's
Moody's
   Issuer credit rating
   First mortgage bonds
   Senior secured debt
   Preferred stock
   Commercial paper
   Credit facility
 A-
N/A
A
BBB
A-2
N/A
A2
A1
A1
Baa1
P-1
A2

Credit ratings are not recommendations to buy or sell securities and are subject to change, and each rating should be evaluated independently of any other rating.

On January 26, 2010, Standard and Poor's revised the outlook for Integrys Energy Group and all of its subsidiaries to "stable" from "negative."  The revised outlook reflected Integrys Energy Group's decision to retain a selected portion of its nonregulated operations, which resulted in a revision to Integrys Energy Group's business risk profile to "strong" from "excellent."  The revised outlook also reflected Integrys Energy Group’s improved financial measures and decreasing regulatory risk, which resulted in a change in its financial risk profile to "significant" from "aggressive."

On June 9, 2009, Moody's lowered the issuer credit rating for WPS from "A1" to "A2."  Moody's also lowered the senior secured debt and first mortgage bonds ratings for WPS from "Aa3" to "A1" and the preferred stock rating from "A3" to "Baa1."  Additionally, Moody's lowered the credit facility rating from "A1" to "A2."  According to Moody's, the downgrades reflect the risk that WPS's internal cash flow could be pressured to support Integrys Energy Group's continuing cash needs and that near-term financial metrics will be negatively impacted by reduced demand for energy.
 
-29-


On March 5, 2009, Standard & Poor's lowered the issuer credit rating for WPS from "A" to "A-."  According to Standard and Poor's, the downgrade reflects Integrys Energy Group's weak financial measures that do not support an "A" category credit profile.  Standard and Poor's also stated that the downgrade reflects the changes to Integrys Energy Group's business and financial risk profiles.  Standard & Poor's revised Integrys Energy Group's business risk profile to "excellent" from "strong" and changed its financial risk profile to "aggressive" from "intermediate."  The change in the business risk profile reflected the strategy change with respect to Integrys Energy Services and helped to moderate the downgrade.  Additionally, Standard & Poor's lowered the senior secured debt rating for WPS from "A+" to "A" and the preferred stock rating from "BBB+" to "BBB."

Future Capital Requirements and Resources

Contractual Obligations

The following table shows the contractual obligations of WPS, including its subsidiary, as of March 31, 2010.

         
Payments Due By Period
 
(Millions)
 
Total Amounts
Committed
   
2010
   
2011 to 2012
   
2013 to 2014
   
2015 and Thereafter
 
                               
Long-term debt principal and interest
       payments (1)
  $ 1,268.9     $ 36.3     $ 383.2     $ 202.6     $ 646.8  
Operating lease obligations
    25.5       2.7       4.5       2.6       15.7  
Commodity purchase obligations (2)
    1,772.2       252.5       575.2       432.4       512.1  
Purchase orders (3)
    239.2       235.0       2.9       1.3       -  
Pension and other postretirementfunding obligations (4)
    257.8       30.5       89.1       54.5       83.7  
Total contractual cash obligations
  $ 3,563.6     $ 557.0     $ 1,054.9     $ 693.4     $ 1,258.3  

(1)
Represents bonds and notes issued by WPS.  WPS records all principal obligations on the balance sheet.

(2)
The costs of commodity purchase obligations are expected to be recovered in future customer rates.

(3)
Includes obligations related to normal business operations and large construction obligations.

(4)
Obligations for pension and other postretirement benefit plans, other than the Integrys Energy Group Retirement Plan, cannot be estimated beyond 2012.

The table above does not reflect payments related to the manufactured gas plant remediation liability of $75.1 million at March 31, 2010, as the amount and timing of payments are uncertain.  WPS anticipates incurring costs annually to remediate these sites, but management believes that any costs incurred for environmental activities relating to former manufactured gas plant operations that are not recoverable through contributions from other entities or from insurance carriers have been prudently incurred and are, therefore, recoverable through rates.  See Note 8, "Commitments and Contingencies," for more information about environmental liabilities.  In addition, the table does not reflect any payments for the March 31, 2010, liability related to uncertain tax positions, as the amount and timing of payments are uncertain.  See Note 7, "Income Taxes," for more information about this liability.
 
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Capital Requirements

Estimated construction expenditures for WPS for the three-year period 2010 through 2012 are listed below.

(Millions)
     
   Environmental projects
  $ 164.1  
   Electric and natural gas distribution projects
    150.9  
   Electric and natural gas delivery and customer service projects
    59.1  
   Other projects
    108.0  
Total capital expenditures
  $ 482.1  

All projected capital and investment expenditures are subject to periodic review and may vary significantly from the estimates depending on a number of factors, including, but not limited to, industry restructuring, regulatory constraints, market volatility, and economic trends.

Capital Resources

As of March 31, 2010, WPS was in compliance with all covenants related to outstanding short-term and long-term debt and expects to be in compliance with all such debt covenants for the foreseeable future.

See Note 5, "Short-Term Debt and Lines of Credit," for more information on WPS's credit facilities and other short-term credit agreements, including short-term debt covenants.

WPS's long-term debt obligations contain covenants related to payment of principal and interest when due and various financial reporting obligations.  Failure to comply with these covenants could result in an event of default, which, if not cured or waived, could result in acceleration of outstanding debt obligations.

WPS plans to meet its capital requirements for the period 2010 through 2012 primarily through internally generated funds (net of forecasted dividend payments), debt financings, and equity infusions from Integrys Energy Group.  WPS plans to maintain current debt to equity ratios at appropriate levels to support current credit ratings and corporate growth.  Management believes WPS has adequate financial flexibility and resources to meet its future needs.

Under an existing shelf registration statement, WPS may issue up to $250.0 million of senior debt securities with amounts, prices and terms to be determined at the time of future offerings.  In December 2008, WPS issued $125.0 million of 6.375%, 7-year Senior Notes under this shelf registration statement.

Other Future Considerations

Customer Usage

Due to the general economic slowdown and the increased focus on energy efficiency, sales volumes excluding the impact of weather have been decreasing at WPS.  The PSCW approved the implementation of decoupling on a four-year trial basis, effective January 1, 2009, for WPS's natural gas and electric residential and small commercial and industrial sales.  Decoupling allows WPS to adjust rates going forward to recover or refund differences between the actual and authorized margin per customer impact of variations in volumes.  The mechanism does not adjust for changes in volume resulting from changes in customer count.  This decoupling mechanism includes an annual $14.0 million cap for electric service and an annual $8.0 million cap for natural gas service.  The cap for natural gas service was reached in the first quarter of 2010, and WPS had $2.7 million remaining under the cap for electric service at the end of the first quarter of 2010.
 
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Weston 4 Operating Issue

In the fourth quarter of 2008, the supercritical boiler at WPS's Weston 4 power plant experienced several forced outages related to significant oxidation and subsequent exfoliation within the superheater outlet tubes and the reheater.  The additional maintenance costs incurred to date relative to repairing and returning the superheater and reheater to service have been covered by the boiler's manufacturer.  WPS temporarily reduced the main steam operating temperature of the boiler to address this issue from a short-term perspective, resulting in reduced output.  The reduced output from Weston 4 required replacement purchased power to meet WPS's supply requirements.  WPS subsequently raised the steam operating temperature back to initial design level.  WPS is reviewing potential options to resolve this issue with the boiler manufacturer, including a technological solution and an extended warranty.  WPS, working with the manufacturer, has been able to manage the exfoliation issue thus far.  WPS expects to increase the time between outages for exfoliation purposes over the next several years.  The PSCW has not yet acted on the fuel cost over/under recovery impacts related to this issue.  For more information, see Note 14, "Regulatory Environment."

Climate Change

Recently, efforts have been initiated to develop state and regional greenhouse gas programs, to create federal legislation to limit carbon dioxide emissions and to create national or state renewable portfolio standards.  Some examples of these efforts are the Waxman-Markey bill, which passed the United States House of Representatives, and the Kerry-Boxer draft bill, which was introduced in the United States Senate.  In addition, in April 2009, the EPA declared carbon dioxide and several other greenhouse gases to be a danger to public health and welfare, which is the first step towards the EPA potentially regulating greenhouse gases under the Clean Air Act.  A risk exists that such legislation or regulation will increase the cost of energy.  However, WPS believes the capital expenditures being made at its generation units are appropriate under any reasonable mandatory greenhouse gas program and that future expenditures related to control of greenhouse gas emissions or renewable portfolio standards by its regulated electric utilities will be recoverable in rates.  WPS will continue to monitor and manage potential risks and opportunities associated with future greenhouse gas legislative or regulatory actions.

All of WPS’s generation and distribution facilities are located in the upper Midwest region of the United States.  The same is true for all of WPS’s customers’ facilities.  The physical risks posed by climate change for these areas are not expected to be significant at this time.  Ongoing evaluations will be conducted as more information on the extent of such physical changes becomes available.

Federal Health Care Reform

In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 (HCR) were signed into law.  HCR contains various provisions that will affect the cost of providing health care coverage to active and retired employees of WPS and their dependents.  Although these provisions become effective at various times over the next 10 years, some provisions that affect the cost of providing benefits to retirees will be reflected starting in 2010.

Most notably, there is a provision of HCR that, beginning in 2013, eliminates the tax deduction for employer-paid postretirement prescription drug charges to the extent those charges will be offset by the receipt of a federal Medicare Part D subsidy.  As a result, WPS was required to eliminate a portion of its deferred tax asset related to postretirement benefits.  The total amount of the deferred tax asset that was reduced for the loss of the deduction was $4.5 million, all of which flowed through to income as a component of income tax expense in the first quarter of 2010.  This additional provision for income taxes will not reoccur in future periods.  WPS intends to seek recovery in rates of the income impact of this tax law change related to regulated utility operations, but at this time is not able to predict how much will ultimately be recovered in rates.
 
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Other provisions of HCR include the elimination of annual and lifetime maximum benefits, elimination of pre-existing condition restrictions, an excise tax on high-cost health plans, changes to the Medicare Part D prescription drug program, and numerous other changes.  WPS is currently evaluating what other impacts the health care legislation may have on its future results of operations, cash flows or financial positions, and if plan structure changes are necessary for its health care programs.
 
Wisconsin Fuel Rules
 
Assembly Bill (AB) 600 was introduced to streamline the current fuel rule administered by the PSCW.  This bill currently awaits action by the Governor of Wisconsin.  The current fuel rule results in regulatory lag and hampers the ability of the PSCW to respond to rapid changes in fuel costs.  AB 600 provides for deferral of any change in approved fuel costs in excess of 2% of the fuel costs.  Prior to these new rules becoming effective, the PSCW must initiate a rule-making to revise the current fuel rule.  As a result, the effective date of the new rules is uncertain.

CRITICAL ACCOUNTING POLICIES

WPS has reviewed its critical accounting policies for new critical accounting estimates and other significant changes.  WPS found that the disclosures made in its Annual Report on Form 10-K for the year ended December 31, 2009, are still current and that there have been no significant changes.


 
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Item 3.     Quantitative and Qualitative Disclosures About Market Risk

WPS's market risks have not changed materially from the market risks reported in its 2009 Annual Report on Form 10-K.
 

 
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Item 4.     Controls and Procedures

WPS's management, with the participation of WPS's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of WPS's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this report and has concluded that, as of the end of such period, WPS's disclosure controls and procedures were effective to ensure that information required to be disclosed by WPS in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and is accumulated and communicated to its management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control

There were no changes in the internal control over financial reporting of WPS (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended March 31, 2010, that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting.

 
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PART II.      OTHER INFORMATION

Item 1.     Legal Proceedings

For information on material legal proceedings and matters related to WPS and its subsidiary, see Note 8, "Commitments and Contingencies."

Item 1A.     Risk Factors

There were no material changes in the risk factors previously disclosed in Part I, Item 1A of WPS’s 2009 Annual Report on Form 10-K, which was filed with the SEC on February 26, 2010.

Item 6.     Exhibits

The documents listed in the Exhibit Index are attached as exhibits or incorporated by reference herein.


 
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant, Wisconsin Public Service Corporation, has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
Wisconsin Public Service Corporation
   
   
   
Date:  May 5, 2010
/s/ Diane L. Ford                                                                         
Diane L. Ford
Vice President and Corporate Controller
 
(Duly Authorized Officer and Chief Accounting Officer)


 
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WISCONSIN PUBLIC SERVICE CORPORATION
EXHIBIT INDEX TO FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2010
 
 
Exhibit No.
Description
   
4.1
Forty-First Supplemental Indenture, dated as of December 18, 2008
   
4.2
42nd Supplemental Indenture, dated as of April 25, 2010
   
12
Computation of Ratio of Earnings to Fixed Charges and Ratio of Earnings to Fixed Charges and Preferred Stock Dividend Requirements
   
31.1
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act and Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 for Wisconsin Public Service Corporation
   
31.2
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act and Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 for Wisconsin Public Service Corporation
   
32
Written Statement of the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 for Wisconsin Public Service Corporation
   




 
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