United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q


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


For the quarterly period ended:

September 30, 2015


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


For the transition period from _______________ to _______________


Commission

File No.

 

Name of Registrant, State of Incorporation, Address

of Principal Executive Offices, and Telephone No.

 

IRS Employer

Identification No.

000-49965

 

MGE Energy, Inc.

(a Wisconsin Corporation)

133 South Blair Street

Madison, Wisconsin 53788

(608) 252-7000

mgeenergy.com

 

39-2040501

000-1125

 

Madison Gas and Electric Company

(a Wisconsin Corporation)

133 South Blair Street

Madison, Wisconsin 53788

(608) 252-7000

mge.com

 

39-0444025


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


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

Yes [X] No [ ]


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


 

Large Accelerated Filer

Accelerated Filer

Non-accelerated Filer

Smaller Reporting Company

MGE Energy, Inc.

X

 

 

 

Madison Gas and Electric Company

 

 

X

 


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

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


Number of Shares Outstanding of Each Class of Common Stock as of October 31, 2015

MGE Energy, Inc.

Common stock, $1.00 par value, 34,668,370 shares outstanding.

Madison Gas and Electric Company

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




1




Table of Contents



PART I. FINANCIAL INFORMATION.

3

Filing Format

3

Forward-Looking Statements

3

Where to Find More Information

3

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

4

Item 1. Financial Statements.

6

MGE Energy, Inc.

6

Consolidated Statements of Income (unaudited)

6

Consolidated Statements of Comprehensive Income (unaudited)

6

Consolidated Statements of Cash Flows (unaudited)

7

Consolidated Balance Sheets (unaudited)

8

Consolidated Statements of Common Equity (unaudited)

9

Madison Gas and Electric Company

10

Consolidated Statements of Income (unaudited)

10

Consolidated Statements of Comprehensive Income (unaudited)

10

Consolidated Statements of Cash Flows (unaudited)

11

Consolidated Balance Sheets (unaudited)

12

Consolidated Statements of Common Equity (unaudited)

13

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

14

Notes to Consolidated Financial Statements (unaudited)

14

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

32

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

49

Item 4. Controls and Procedures.

51

PART II. OTHER INFORMATION.

52

Item 1. Legal Proceedings.

52

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

52

Item 4. Mine Safety Disclosures.

52

Item 6. Exhibits.

52

Signatures - MGE Energy, Inc.

54

Signatures - Madison Gas and Electric Company

55




2




PART I. FINANCIAL INFORMATION.


Filing Format


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


Forward-Looking Statements


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


The factors that could cause actual results to differ materially from the forward-looking statements made by a registrant include (a) those factors discussed in the Registrants' 2014 Annual Report on Form 10-K: Item 1A. Risk Factors, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, as updated by Part I, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations in this report, and Item 8. Financial Statements and Supplementary Data – Note 18, as updated by Part I, Item 1. Financial Statements – Note 8 in this report, and (b) other factors discussed herein and in other filings made by that registrant with the SEC.


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


Where to Find More Information


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



3




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


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


MGE Energy and Subsidiaries:

 

 

 

CWDC

Central Wisconsin Development Corporation

MAGAEL

MAGAEL, LLC

MGE

Madison Gas and Electric Company

MGE Energy

MGE Energy, Inc.

MGE Power

MGE Power, LLC

MGE Power Elm Road

MGE Power Elm Road, LLC

MGE Power West Campus

MGE Power West Campus, LLC

MGE Services

MGE Services, LLC

MGE State Energy Services

MGE State Energy Services, LLC

MGE Transco

MGE Transco Investment, LLC

NGV Fueling Services

NGV Fueling Services, LLC

North Mendota

North Mendota Energy & Technology Park, LLC

 

 

Other Defined Terms:

 

 

 

AFUDC

Allowance for Funds Used During Construction

ARO

Asset Retirement Obligation

ATC

American Transmission Company LLC

BART

Best Available Retrofit Technology

Blount

Blount Station

CAA

Clean Air Act

CAIR

Clean Air Interstate Rule

CAVR

Clean Air Visibility Rule

CCR

Coal Combustion Residual

Codification

Financial Accounting Standards Board Accounting Standards Codification

Columbia

Columbia Energy Center

Cooling degree days

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

CSAPR

Cross-State Air Pollution Rule

CWA

Clean Water Act

Dth

Dekatherms, a quantity measure used in respect of natural gas

EGUs

Electric Generating Units

ELG

Effluent Limitations Guidelines

Elm Road Units

Elm Road Generating Station

EPA

United States Environmental Protection Agency

FASB

Financial Accounting Standards Board

FERC

Federal Energy Regulatory Commission

FTR

Financial Transmission Rights

GHG

Greenhouse Gas

Heating degree days (HDD)

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

IRS

Internal Revenue Service

kWh

Kilowatt-hour, a measure of electric energy produced

MATS

Mercury and Air Toxics Standards

MISO

Midcontinent Independent System Operator (a regional transmission organization)

MW

Megawatt, a measure of electric energy generating capacity

MWh

Megawatt-hour, a measure of electric energy produced

NAAQS

National Ambient Air Quality Standards

NOV

Notice of Violation

NOx

Nitrogen Oxides



4





PGA

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

PJM

PJM Interconnection, LLC (a regional transmission organization)

PM

Particulate Matter

PPA

Purchased Power Agreement

ppb

Parts Per Billion

PSCW

Public Service Commission of Wisconsin

ROE

Return on Equity

SCR

Selective Catalytic Reduction

SEC

Securities and Exchange Commission

SIP

State Implementation Plan

SO2

Sulfur Dioxide

the State

State of Wisconsin

Stock Plan

Direct Stock Purchase and Dividend Reinvestment Plan of MGE Energy

UW

University of Wisconsin at Madison

VIE

Variable Interest Entity

WCCF

West Campus Cogeneration Facility

WDNR

Wisconsin Department of Natural Resources

WEPCO

Wisconsin Electric Power Company

Working capital

Current assets less current liabilities

WPDES

Wisconsin Pollutant Discharge Elimination System

WPL

Wisconsin Power and Light Company

WPSC

Wisconsin Public Service Corporation

XBRL

eXtensible Business Reporting Language




5




Item 1. Financial Statements.


MGE Energy, Inc.

Consolidated Statements of Income (unaudited)

(In thousands, except per-share amounts)


 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30,

 

September 30,

 

 

2015

 

2014

 

2015

 

2014

Operating Revenues:

 

 

 

 

 

 

 

 

    Regulated electric revenues

$

121,453

$

112,869

$

319,174

$

308,418

    Regulated gas revenues

 

17,431

 

21,404

 

108,028

 

163,335

    Nonregulated revenues

 

1,911

 

862

 

5,853

 

2,392

        Total Operating Revenues

 

140,795

 

135,135

 

433,055

 

474,145

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

 

    Fuel for electric generation

 

17,055

 

9,838

 

41,624

 

35,836

    Purchased power

 

18,484

 

21,303

 

62,614

 

58,779

    Cost of gas sold

 

4,299

 

11,039

 

57,868

 

107,679

    Other operations and maintenance

 

38,721

 

37,587

 

120,895

 

118,267

    Depreciation and amortization

 

11,182

 

10,376

 

33,026

 

30,191

    Other general taxes

 

4,877

 

4,872

 

14,951

 

14,861

        Total Operating Expenses

 

94,618

 

95,015

 

330,978

 

365,613

Operating Income

 

46,177

 

40,120

 

102,077

 

108,532

 

 

 

 

 

 

 

 

 

Other income, net

 

2,564

 

2,636

 

7,115

 

10,736

Interest expense, net

 

(5,036)

 

(5,141)

 

(15,135)

 

(14,550)

    Income before income taxes

 

43,705

 

37,615

 

94,057

 

104,718

Income tax provision

 

(15,351)

 

(14,286)

 

(33,946)

 

(39,585)

Net Income

$

28,354

$

23,329

$

60,111

$

65,133

 

 

 

 

 

 

 

 

 

Earnings Per Share of Common Stock

 

 

 

 

 

 

 

 

(basic and diluted)

$

0.82

$

0.67

$

1.73

$

1.88

 

 

 

 

 

 

 

 

 

Dividends per share of common stock

$

0.295

$

0.283

$

0.860

$

0.826

 

 

 

 

 

 

 

 

 

Weighted Average Shares Outstanding

 

 

 

 

 

 

 

 

(basic and diluted)

 

34,668

 

34,668

 

34,668

 

34,668

 

 

 

 

 

 

 

 

 

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


MGE Energy, Inc.

Consolidated Statements of Comprehensive Income (unaudited)

(In thousands)


 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30,

 

September 30,

 

 

2015

 

2014

 

2015

 

2014

Net Income

$

28,354

$

23,329

$

60,111

$

65,133

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

    Unrealized (loss) gain on available-for-sale

 

 

 

 

 

 

 

 

    securities, net of tax ($56 and ($63), and $120 and

 

 

 

 

 

 

 

 

    ($38), respectively)

 

(85)

 

95

 

(180)

 

56

Comprehensive Income

$

28,269

$

23,424

$

59,931

$

65,189

 

 

 

 

 

 

 

 

 

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




6





MGE Energy, Inc.

Consolidated Statements of Cash Flows (unaudited)

(In thousands)


 

 

 

Nine Months Ended

 

 

 

 

September 30,

 

 

 

 

2015

 

2014

 

 

Operating Activities:

 

 

 

 

 

 

    Net income

$

60,111

$

65,133

 

 

    Items not affecting cash:

 

 

 

 

 

 

        Depreciation and amortization

 

33,026

 

30,191

 

 

        Deferred income taxes

 

7,370

 

24,376

 

 

        Provision for doubtful receivables

 

(78)

 

1,001

 

 

        Employee benefit plan expenses

 

2,500

 

(814)

 

 

        Equity earnings in ATC

 

(6,568)

 

(7,306)

 

 

        Other items

 

(154)

 

(843)

 

 

    Changes in working capital items:

 

 

 

 

 

 

        Decrease in current assets

 

39,034

 

13,318

 

 

        Decrease in current liabilities

 

(18,231)

 

(7,515)

 

 

    Dividend income from ATC

 

4,732

 

5,762

 

 

    Cash contributions to pension and other postretirement plans

 

(12,460)

 

(2,449)

 

 

    Other noncurrent items, net

 

13,373

 

118

 

 

            Cash Provided by Operating Activities

 

122,655

 

120,972

 

 

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

 

    Capital expenditures

 

(52,311)

 

(66,138)

 

 

    Capital contributions to investments

 

(785)

 

(1,830)

 

 

    Other

 

(85)

 

(1,265)

 

 

            Cash Used for Investing Activities

 

(53,181)

 

(69,233)

 

 

 

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

 

    Cash dividends paid on common stock

 

(29,816)

 

(28,634)

 

 

    Repayment of long-term debt

 

(3,128)

 

(3,069)

 

 

    Repayment of short-term debt

 

(7,000)

 

-

 

 

    Other

 

(1,018)

 

(130)

 

 

            Cash Used for Financing Activities

 

(40,962)

 

(31,833)

 

 

 

 

 

 

 

 

 

Change in cash and cash equivalents

 

28,512

 

19,906

 

 

Cash and cash equivalents at beginning of period

 

65,755

 

68,813

 

 

Cash and Cash Equivalents at End of Period

$

94,267

$

88,719

 

 

 

 

 

 

 

 

 

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

 




7





MGE Energy, Inc.

Consolidated Balance Sheets (unaudited)

(In thousands)


 

 

September 30,

December 31,

ASSETS

 

2015

 

2014

Current Assets:

 

 

 

 

    Cash and cash equivalents

$

94,267

$

65,755

    Accounts receivable, less reserves of $3,418 and $4,329, respectively

 

35,507

 

41,614

    Other accounts receivable, less reserves of $702 and $420, respectively

 

6,549

 

7,610

    Unbilled revenues

 

21,252

 

31,262

    Materials and supplies, at average cost

 

19,258

 

17,121

    Fossil fuel

 

14,195

 

8,098

    Stored natural gas, at average cost

 

16,998

 

21,036

    Prepaid taxes

 

14,507

 

38,910

    Regulatory assets - current

 

9,331

 

8,360

    Deferred income taxes - current

 

-

 

3,482

    Other current assets

 

9,916

 

10,711

        Total Current Assets

 

241,780

 

253,959

Regulatory assets

 

155,469

 

156,823

Other deferred assets and other

 

10,028

 

7,018

Property, Plant, and Equipment:

 

 

 

 

    Property, plant, and equipment, net

 

1,207,520

 

1,189,077

    Construction work in progress

 

25,015

 

19,029

        Total Property, Plant, and Equipment

 

1,232,535

 

1,208,106

Investments

 

74,016

 

71,760

        Total Assets

$

1,713,828

$

1,697,666

 

 

 

 

 

LIABILITIES AND CAPITALIZATION

 

 

 

 

Current Liabilities:

 

 

 

 

    Long-term debt due within one year

$

4,245

$

4,182

    Short-term debt

 

-

 

7,000

    Accounts payable

 

35,854

 

41,655

    Accrued interest and taxes

 

3,996

 

5,086

    Accrued payroll related items

 

10,141

 

11,241

    Deferred income taxes

 

945

 

-

    Regulatory liabilities - current

 

4,376

 

-

    Derivative liabilities

 

8,880

 

6,901

    Other current liabilities

 

5,821

 

13,931

        Total Current Liabilities

 

74,258

 

89,996

Other Credits:

 

 

 

 

    Deferred income taxes

 

345,127

 

342,045

    Investment tax credit - deferred

 

1,094

 

1,223

    Regulatory liabilities

 

24,467

 

22,715

    Accrued pension and other postretirement benefits

 

78,879

 

90,201

    Derivative liabilities

 

48,070

 

46,560

    Other deferred liabilities and other

 

60,476

 

50,269

        Total Other Credits

 

558,113

 

553,013

Capitalization:

 

 

 

 

    Common shareholders' equity

 

689,374

 

659,401

    Long-term debt

 

392,083

 

395,256

        Total Capitalization

 

1,081,457

 

1,054,657

Commitments and contingencies (see Footnote 8)

 

-

 

-

        Total Liabilities and Capitalization

$

1,713,828

$

1,697,666

 

 

 

 

 

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




8





MGE Energy, Inc.

Consolidated Statements of Common Equity (unaudited)

(In thousands, except per-share amounts)


 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

 

 

 

 

Common Stock

 

Paid-in

 

Retained

 

Comprehensive

 

 

 

 

 

Shares

 

Value

 

Capital

 

Earnings

 

Income

 

Total

 

 

2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - December 31, 2013

34,668

$

34,668

$

316,268

$

266,197

$

377

$

617,510

 

 

Net income

 

 

 

 

 

 

65,133

 

 

 

65,133

 

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

56

 

56

 

 

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

($0.826 per share)

 

 

 

 

 

 

(28,634)

 

 

 

(28,634)

 

 

Cash in lieu of fractional shares related

 

 

 

 

 

 

 

 

 

 

 

 

 

to stock split

 

 

 

 

 

 

(80)

 

 

 

(80)

 

 

Ending balance - September 30, 2014

34,668

$

34,668

$

316,268

$

302,616

$

433

$

653,985

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2015

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - December 31, 2014

34,668

$

34,668

$

316,268

$

308,007

$

458

$

659,401

 

 

Cumulative effect of new accounting

 

 

 

 

 

 

 

 

 

 

 

 

 

principle (see Footnote 4)

 

 

 

 

 

 

(142)

 

 

 

(142)

 

 

Beginning balance - Adjusted

 

 

 

 

 

 

307,865

 

 

 

659,259

 

 

Net income

 

 

 

 

 

 

60,111

 

 

 

60,111

 

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

(180)

 

(180)

 

 

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

($0.860 per share)

 

 

 

 

 

 

(29,816)

 

 

 

(29,816)

 

 

Ending balance - September 30, 2015

34,668

$

34,668

$

316,268

$

338,160

$

278

$

689,374

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 




9





Madison Gas and Electric Company

Consolidated Statements of Income (unaudited)

(In thousands)


 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

 

 

2015

 

2014

 

2015

 

2014

Operating Revenues:

 

 

 

 

 

 

 

 

    Regulated electric revenues

$

121,460

$

112,875

$

319,191

$

308,435

    Regulated gas revenues

 

17,435

 

21,410

 

108,039

 

163,351

    Nonregulated revenues

 

1,911

 

862

 

5,853

 

2,392

        Total Operating Revenues

 

140,806

 

135,147

 

433,083

 

474,178

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

 

    Fuel for electric generation

 

17,057

 

9,841

 

41,630

 

35,843

    Purchased power

 

18,488

 

21,307

 

62,624

 

58,790

    Cost of gas sold

 

4,302

 

11,045

 

57,879

 

107,695

    Other operations and maintenance

 

38,561

 

37,309

 

120,269

 

117,593

    Depreciation and amortization

 

11,170

 

10,364

 

32,991

 

30,156

    Other general taxes

 

4,877

 

4,872

 

14,951

 

14,861

    Income tax provision

 

14,401

 

13,338

 

31,218

 

36,180

        Total Operating Expenses

 

108,856

 

108,076

 

361,562

 

401,118

Operating Income

 

31,950

 

27,071

 

71,521

 

73,060

 

 

 

 

 

 

 

 

 

Other Income and Deductions:

 

 

 

 

 

 

 

 

    AFUDC - equity funds

 

206

 

255

 

501

 

3,306

    Equity in earnings in ATC

 

2,398

 

2,423

 

6,568

 

7,306

    Income tax provision

 

(977)

 

(984)

 

(2,763)

 

(3,390)

    Other income, net

 

(73)

 

(111)

 

(288)

 

(351)

        Total Other Income and Deductions

 

1,554

 

1,583

 

4,018

 

6,871

    Income before interest expense

 

33,504

 

28,654

 

75,539

 

79,931

 

 

 

 

 

 

 

 

 

Interest Expense:

 

 

 

 

 

 

 

 

    Interest on long-term debt

 

5,123

 

5,225

 

15,410

 

15,714

    Other interest, net

 

37

 

44

 

52

 

52

    AFUDC - borrowed funds

 

(67)

 

(84)

 

(163)

 

(1,090)

        Net Interest Expense

 

5,093

 

5,185

 

15,299

 

14,676

Net Income

$

28,411

$

23,469

$

60,240

$

65,255

Less: Net Income Attributable to Noncontrolling

 

 

 

 

 

 

 

 

Interest, net of tax

 

(6,633)

 

(6,653)

 

(19,812)

 

(19,784)

Net Income Attributable to MGE

$

21,778

$

16,816

$

40,428

$

45,471

 

 

 

 

 

 

 

 

 

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


Madison Gas and Electric Company

Consolidated Statements of Comprehensive Income (unaudited)

(In thousands)


 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

 

 

2015

 

2014

 

2015

 

2014

Net Income

$

28,411

$

23,469

$

60,240

$

65,255

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

    Unrealized (loss) gain on available-for-sale

 

 

 

 

 

 

 

 

    securities, net of tax ($19 and ($29), and $92 and

 

 

 

 

 

 

 

 

    $36, respectively)

 

(28)

 

43

 

(137)

 

(54)

Comprehensive Income

$

28,383

$

23,512

$

60,103

$

65,201

    Less: Comprehensive Income Attributable to

 

 

 

 

 

 

 

 

    Noncontrolling Interest, net of tax

 

(6,633)

 

(6,653)

 

(19,812)

 

(19,784)

Comprehensive Income Attributable to MGE

$

21,750

$

16,859

$

40,291

$

45,417

 

 

 

 

 

 

 

 

 

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




10





Madison Gas and Electric Company

Consolidated Statements of Cash Flows (unaudited)

(In thousands)


 

 

 

Nine Months Ended

 

 

 

 

September 30,

 

 

 

 

2015

 

2014

 

 

Operating Activities:

 

 

 

 

 

 

    Net income

$

60,240

$

65,255

 

 

    Items not affecting cash:

 

 

 

 

 

 

        Depreciation and amortization

 

32,991

 

30,156

 

 

        Deferred income taxes

 

4,510

 

23,811

 

 

        Provision for doubtful receivables

 

(78)

 

1,001

 

 

        Employee benefit plan expenses

 

2,500

 

(814)

 

 

        Equity earnings in ATC

 

(6,568)

 

(7,306)

 

 

        Other items

 

234

 

(446)

 

 

    Changes in working capital items:

 

 

 

 

 

 

       Decrease in current assets

 

46,806

 

13,258

 

 

       Decrease in current liabilities

 

(15,876)

 

(5,457)

 

 

    Dividend income from ATC

 

4,732

 

5,762

 

 

    Cash contributions to pension and other postretirement plans

 

(12,460)

 

(2,449)

 

 

    Other noncurrent items, net

 

13,076

 

(24)

 

 

            Cash Provided by Operating Activities

 

130,107

 

122,747

 

 

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

 

    Capital expenditures

 

(52,311)

 

(66,138)

 

 

    Capital contributions to investments

 

(533)

 

(1,420)

 

 

    Other

 

(90)

 

(1,087)

 

 

            Cash Used for Investing Activities

 

(52,934)

 

(68,645)

 

 

 

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

 

    Cash dividends paid to parent by MGE

 

(20,000)

 

(26,500)

 

 

    Distributions to parent from noncontrolling interest

 

(12,007)

 

(17,778)

 

 

    Equity contribution received by noncontrolling interest

 

3,053

 

1,420

 

 

    Repayment of long-term debt

 

(3,128)

 

(3,069)

 

 

    Repayment of short-term debt

 

(7,000)

 

-

 

 

    Other

 

(682)

 

-

 

 

            Cash Used for Financing Activities

 

(39,764)

 

(45,927)

 

 

 

 

 

 

 

 

 

Change in cash and cash equivalents

 

37,409

 

8,175

 

 

Cash and cash equivalents at beginning of period

 

4,562

 

14,808

 

 

Cash and Cash Equivalents at End of Period

$

41,971

$

22,983

 

 

 

 

 

 

 

 

 

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

 




11





Madison Gas and Electric Company

Consolidated Balance Sheets (unaudited)

(In thousands)


 

 

September 30,

December 31,

ASSETS

 

2015

 

2014

Current Assets:

 

 

 

 

    Cash and cash equivalents

$

41,971

$

4,562

    Accounts receivable, less reserves of $3,418 and $4,329, respectively

 

35,507

 

41,614

    Affiliate receivables

 

602

 

7,112

    Other accounts receivable, less reserves of $702 and $420, respectively

 

6,490

 

7,524

    Unbilled revenues

 

21,252

 

31,262

    Materials and supplies, at average cost

 

19,258

 

17,121

    Fossil fuel

 

14,195

 

8,098

    Stored natural gas, at average cost

 

16,997

 

21,035

    Prepaid taxes

 

13,418

 

39,103

    Regulatory assets - current

 

9,331

 

8,360

    Deferred income taxes - current

 

-

 

1,271

    Other current assets

 

9,881

 

10,683

        Total Current Assets

 

188,902

 

197,745

Affiliate receivable long-term

 

4,898

 

5,295

Regulatory assets

 

155,469

 

156,823

Other deferred assets and other

 

7,908

 

4,977

Property, Plant, and Equipment:

 

 

 

 

    Property, plant, and equipment, net

 

1,206,828

 

1,188,351

    Construction work in progress

 

25,015

 

19,029

        Total Property, Plant, and Equipment

 

1,231,843

 

1,207,380

Investments

 

70,533

 

68,402

        Total Assets

$

1,659,553

$

1,640,622


 

 

 

 

LIABILITIES AND CAPITALIZATION

 

 

 

 

Current Liabilities:

 

 

 

 

    Long-term debt due within one year

$

4,245

$

4,182

    Short-term debt

 

-

 

7,000

    Accounts payable

 

35,847

 

41,654

    Accrued interest and taxes

 

3,950

 

5,039

    Accrued payroll related items

 

10,141

 

11,241

    Deferred income taxes

 

946

 

-

    Regulatory liabilities - current

 

4,376

 

-

    Derivative liabilities

 

8,880

 

6,901

    Other current liabilities

 

5,600

 

11,350

        Total Current Liabilities

 

73,985

 

87,367

Other Credits:

 

 

 

 

    Deferred income taxes

 

337,233

 

334,773

    Investment tax credit - deferred

 

1,094

 

1,223

    Regulatory liabilities

 

24,467

 

22,715

    Accrued pension and other postretirement benefits

 

78,879

 

90,201

    Derivative liabilities

 

48,070

 

46,560

    Other deferred liabilities and other

 

60,475

 

50,267

        Total Other Credits

 

550,218

 

545,739

Capitalization:

 

 

 

 

    Common shareholder's equity

 

506,720

 

486,571

    Noncontrolling interest

 

136,547

 

125,689

        Total Equity

 

643,267

 

612,260

    Long-term debt

 

392,083

 

395,256

        Total Capitalization

 

1,035,350

 

1,007,516

Commitments and contingencies (see Footnote 8)

 

-

 

-

        Total Liabilities and Capitalization

$

1,659,553

$

1,640,622


 

 

 

 

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



12





Madison Gas and Electric Company

Consolidated Statements of Common Equity (unaudited)

(In thousands)


 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

Non-

 

 

 

Common Stock

 

Paid-in

 

Retained

Comprehensive

Controlling

 

 

 

Shares

 

Value

 

Capital

 

Earnings

Income

Interest

 

Total

2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - Dec. 31, 2013

17,348

$

17,348

$

192,417

$

247,534

$

192

$

118,963

$

576,454

Net income

 

 

 

 

 

 

45,471

 

 

 

19,784

 

65,255

Other comprehensive loss

 

 

 

 

 

 

 

 

(54)

 

 

 

(54)

Cash dividends paid to parent

 

 

 

 

 

 

 

 

 

 

 

 

 

by MGE

 

 

 

 

 

 

(26,500)

 

 

 

 

 

(26,500)

Equity contribution received by

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

1,420

 

1,420

Distributions to parent from

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

(17,778)

 

(17,778)

Ending balance - September 30, 2014

17,348

$

17,348

$

192,417

$

266,505

$

138

$

122,389

$

598,797

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2015

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - Dec. 31, 2014

17,348

$

17,348

$

192,417

$

276,662

$

144

$

125,689

$

612,260

Cumulative effect of new accounting

 

 

 

 

 

 

 

 

 

 

 

 

 

principle (see Footnote 4)

 

 

 

 

 

 

(142)

 

 

 

 

 

(142)

Beginning balance - Adjusted

 

 

 

 

 

 

276,520

 

 

 

 

 

612,118

Net income

 

 

 

 

 

 

40,428

 

 

 

19,812

 

60,240

Other comprehensive loss

 

 

 

 

 

 

 

 

(137)

 

 

 

(137)

Cash dividends paid to parent

 

 

 

 

 

 

 

 

 

 

 

 

 

by MGE

 

 

 

 

 

 

(20,000)

 

 

 

 

 

(20,000)

Equity contribution received by

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

3,053

 

3,053

Distributions to parent from

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

(12,007)

 

(12,007)

Ending balance - September 30, 2015

17,348

$

17,348

$

192,417

$

296,948

$

7

$

136,547

$

643,267

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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




13




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

Notes to Consolidated Financial Statements (unaudited)

September 30, 2015



1.

Basis of Presentation - MGE Energy and MGE.


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


MGE Power Elm Road and MGE Power West Campus own electric generating assets and lease those assets to MGE. Both entities are variable interest entities under applicable authoritative accounting guidance. MGE is considered the primary beneficiary of these entities as a result of contractual agreements. As a result, MGE has consolidated MGE Power Elm Road and MGE Power West Campus. See Footnote 2 of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, of MGE Energy's and MGE's 2014 Annual Report on Form 10-K.


The accompanying consolidated financial statements as of September 30, 2015, and for the three and nine months ended, are unaudited, but include all adjustments that MGE Energy and MGE management consider necessary for a fair statement of their respective financial statements. All adjustments are of a normal, recurring nature except as otherwise disclosed. The year-end consolidated balance sheet information was derived from the audited balance sheet appearing in MGE Energy's and MGE's 2014 Annual Report on Form 10-K, but does not include all disclosures required by accounting principles generally accepted in the United States of America. These notes should be read in conjunction with the financial statements and the notes on pages 52 through 101 of the 2014 Annual Report on Form 10-K.


2.

Equity and Financing Arrangements.


a.

Common Stock - MGE Energy.


MGE Energy sells shares of its common stock through its Stock Plan. Those shares may be newly issued shares or shares that MGE Energy has purchased in the open market for resale to participants in the Stock Plan. All sales under the Stock Plan are covered by a shelf registration statement that MGE Energy filed with the SEC. For both the nine months ended September 30, 2015 and 2014, MGE Energy did not issue any new shares of common stock under the Stock Plan.


b.

Dilutive Shares Calculation - MGE Energy.


MGE Energy does not hold any dilutive securities.


c.

Credit Facilities - MGE Energy and MGE.


On June 1, 2015, MGE Energy and MGE entered into new revolving credit agreements, and terminated their existing revolving credit agreements.


MGE Energy entered into a Credit Agreement with an aggregate commitment of $50 million (MGE Energy Credit Agreement) with various financial institutions, as lenders, and JPMorgan Chase Bank, N.A., as administrative agent. Also, MGE entered into two revolving credit agreements: a Credit Agreement with an aggregate commitment of $60 million (MGE JPM Credit Agreement) with various financial institutions, as lenders, and JPMorgan Chase Bank, N.A., as administrative agent, and a Credit Agreement with an aggregate commitment of $40 million (MGE USB Credit Agreement) with various financial institutions, as lenders, and U.S. Bank National Association, as administrative agent. The MGE Energy Credit Agreement, the MGE JPM Credit Agreement, and the MGE USB Credit Agreement are collectively referred to as the Credit Agreements. As of September 30, 2015, neither MGE Energy nor MGE had any borrowings outstanding under the Credit Agreements, and MGE had no commercial paper outstanding.




14




The Credit Agreements have a term expiring on June 1, 2020. Borrowings under the Credit Agreements may bear interest at a rate based upon either a "floating rate" or a "Eurodollar Rate" adjusted for statutory reserve requirements, plus an adder based upon the credit ratings assigned to MGE's senior unsecured long-term debt securities. The "floating rate" is calculated on a daily basis as the highest of a prime rate, a Federal Funds effective rate plus 0.5% per annum, or a Eurodollar Rate for a one-month interest period plus 1%. The "floating rate" adder ranges from zero to 0.125%. The "Eurodollar Rate" is calculated as provided in the Credit Agreements. The "Eurodollar Rate" adder ranges from 0.625% to 1.125%.


3.

Investment in ATC - MGE Energy and MGE.


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


MGE Transco has accounted for its investment in ATC under the equity method of accounting. For the nine months ended September 30, 2015 and 2014, MGE Transco recorded the following:


 

 

 

Nine Months Ended

September 30,

 

 

 

 

 

 

(In thousands)

 

2015

 

2014

 

 

Equity in earnings from investment in ATC

$

6,568

$

7,306

 

 

Dividends received from ATC

 

4,732

 

5,762

 

 

Capital contributions to ATC

 

533

 

1,420

 


MGE Transco's investment in ATC as of September 30, 2015, and December 31, 2014, was $70.0 million and $67.7 million, respectively. On October 30, 2015, MGE Transco made a $0.2 million capital contribution to ATC.


At September 30, 2015, MGE is the majority owner, and MGE Energy, the holding company, is the minority owner of MGE Transco. MGE Energy's proportionate share of the equity and net income of MGE Transco is classified within the MGE financial statements as noncontrolling interest.


ATC's summarized financial data for the three and nine months ended September 30, 2015 and 2014, is as follows:


 

 

 

Three Months Ended

September 30,

 

Nine Months Ended

September 30,

 

 

 

 

 

 

 

(In thousands)

 

2015

 

2014

 

2015

 

2014

 

 

Operating revenues

$

164,515

$

163,643

$

482,043

$

486,970

 

 

Operating expenses

 

(78,059)

 

(76,561)

 

(238,336)

 

(229,589)

 

 

Other income, net

 

585

 

693

 

566

 

1,403

 

 

Interest expense, net

 

(23,655)

 

(22,204)

 

(72,310)

 

(66,442)

 

 

Earnings before members' income taxes

$

63,386

$

65,571

$

171,963

$

192,342

 


4.

Chattel Paper Agreements - MGE Energy and MGE.


MGE makes available to qualifying customers a financing program for the purchase and installation of energy-related equipment that will provide more efficient use of utility service at the customer's property. The energy-related equipment installed at the customer sites is used to secure the customer loans. MGE is a party to a chattel paper purchase agreement with a financial institution under which it can sell or finance an undivided interest with recourse, in up to $10.0 million of the financing program receivables, until July 31, 2016. The length of the MGE guarantee to the financial institution varies from one to ten years depending on the term of the underlying customer loan. The loan balances outstanding at September 30, 2015, approximate the fair value of the energy-related equipment acting as collateral. MGE accounts for these agreements as secured borrowings.




15




Prior to the Transfers and Servicing Asset authoritative accounting guidance that became effective in 2015, these agreements were treated as off-balance sheet arrangements. Beginning January 1, 2015, these agreements are included as assets and liabilities in the consolidated balance sheet. As of September 30, 2015, assets (other accounts receivable and other deferred assets) and liabilities (accounts payable and other deferred liabilities) increased approximately $3.8 million as a cumulative result of the guidance. In addition, the cumulative effect of this guidance resulted in a $0.1 million reduction in retained earnings.


As of September 30, 2015, the remaining contractual maturities of the chattel paper agreements were as follows:


 

(In thousands)

 

2015

 

2016

 

2017

 

2018

 

Thereafter

 

Total

 

 

Repurchase-to-Maturity Transactions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Loans

$

132

$

735

$

472

$

504

$

1,963

$

3,806

 


5.

Taxes - MGE Energy and MGE.


MGE Energy's effective income tax rates for the three and nine months ended September 30, 2015, were 35.1% and 36.1%, respectively, compared to 38.0% and 37.8% for the same periods in 2014. MGE's effective income tax rates for the three and nine months ended September 30, 2015, were 35.1% and 36.1%, respectively, compared to 37.9% and 37.8% for the same periods in 2014. The decrease in the effective tax rates is due in part to a higher domestic manufacturing deduction, offset by lower AFUDC equity earnings in 2015.


6.

Pension and Other Postretirement Plans - MGE Energy and MGE.


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


The following table presents the components of MGE Energy's and MGE's net periodic benefit costs recognized for the three and nine months ended September 30, 2015 and 2014. A portion of the net periodic benefit cost is capitalized within the consolidated balance sheets.


 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

 

September 30,

 

September 30,

 

 

(In thousands)

 

2015

 

2014

 

2015

 

2014

 

 

Pension Benefits

 

 

 

 

 

 

 

 

 

 

Components of net periodic (benefit) cost:

 

 

 

 

 

 

 

 

 

 

    Service cost

$

1,878

$

1,536

$

5,715

$

4,609

 

 

    Interest cost

 

3,594

 

3,367

 

10,936

 

10,102

 

 

    Expected return on assets

 

(5,930)

 

(5,467)

 

(18,045)

 

(16,402)

 

 

Amortization of:

 

 

 

 

 

 

 

 

 

 

    Prior service cost

 

6

 

51

 

18

 

152

 

 

    Actuarial loss

 

1,393

 

180

 

4,240

 

539

 

 

Net periodic (benefit) cost

$

941

$

(333)

$

2,864

$

(1,000)

 

 

 

 

 

 

 

 

 

 

 

 

 

Postretirement Benefits

 

 

 

 

 

 

 

 

 

 

Components of net periodic (benefit) cost:

 

 

 

 

 

 

 

 

 

 

    Service cost

$

194

$

241

$

580

$

722

 

 

    Interest cost

 

392

 

564

 

1,176

 

1,691

 

 

    Expected return on assets

 

(355)

 

(478)

 

(1,063)

 

(1,432)

 

 

Amortization of:

 

 

 

 

 

 

 

 

 

 

    Transition obligation

 

-

 

1

 

1

 

2

 

 

    Prior service benefit

 

(337)

 

(487)

 

(1,009)

 

(1,462)

 

 

    Actuarial loss

 

133

 

28

 

397

 

86

 

 

Net periodic (benefit) cost

$

27

$

(131)

$

82

$

(393)

 


7.

Share-Based Compensation - MGE Energy and MGE.


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




16




On February 20, 2015, 18,948 units were granted based on the MGE Energy closing stock price as of that date. Units are subject to a five-year graded vesting schedule. On the grant date, MGE Energy and MGE measure the cost of the employee services received in exchange for a performance unit award based on the current market value of MGE Energy common stock. The fair value of the awards has been subsequently re-measured at September 30, 2015, as required by applicable accounting standards. Changes in fair value have been recognized as compensation cost. Since this amount is re-measured quarterly throughout the vesting period, the compensation cost is subject to variability.


For nonretirement eligible employees, stock based compensation costs are accrued and recognized using the graded vesting method. Compensation cost for retirement eligible employees or employees that will become retirement eligible during the vesting schedule are recognized on an abridged horizon.


In December 2013, a Director Incentive Plan was approved for the non-employee members of the Board of Directors. This plan is similar to MGE Energy's Performance Unit Plan for eligible employees described above. Under the plan, a non-employee director can receive performance units that entitle the holder to receive a cash payment equal to the value of a designated number of shares of MGE Energy's common stock, plus dividend payments, at the end of the set performance period. The units are subject to a three-year graded vesting schedule. In January 2015, 3,794 units were granted. For accounting purposes, the awards will be measured similarly to the employee unit awards.


During the nine months ended September 30, 2015 and 2014, MGE recorded $0.4 million and $0.9 million, respectively, in compensation expense as a result of awards under the plans. In January 2015, cash payments of $1.3 million were distributed relating to awards that were granted in 2010. During the nine months ended September 30, 2015, MGE recorded a $0.2 million gain on 4,676 units forfeited. No forfeitures occurred during the nine months ended September 30, 2014. At September 30, 2015, $4.2 million of outstanding awards are vested, and of this amount no cash settlements have occurred.


8.

Commitments and Contingencies - MGE Energy and MGE.


a.

Environmental.


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


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

In September 2015, the EPA released its final rule setting Effluent Limitations Guidelines (ELG) for the steam electric power generating industry. The ELG rule establishes federal limits on the amount of metals and other pollutants that can be discharged in wastewater from new and existing steam electric generation plants. The ELG rule mostly covers pollutants that are captured by certain air pollution control and via wet ash handling systems at coal-burning power plants with units greater than 50 megawatt (MW) generation capacity. Although we are still reviewing the ELG rule, we anticipate that some equipment upgrades may be necessary at the Columbia and Elm Road plants to comply with the new discharge standards. The rule will go into effect in 2018 and will be applied to Wisconsin-based power plants as they renew their WPDES permits.


MGE cannot accurately estimate the costs associated with the ELG rule without a more thorough evaluation. However, management believes that any compliance costs will be recovered in future rates based on previous treatment of environmental compliance projects.


EPA Cooling Water Intake Rules (Section 316(b))

Section 316(b) of the Clean Water Act (CWA) requires that the cooling water intake structures at electric power plants meet best available technology standards so that mortality from entrainment (drawing aquatic life into a plant's cooling system) and impingement (trapping aquatic life on screens) are reduced. The EPA finalized its 316(b) rule for existing facilities in 2014. Section 316(b) requirements are implemented in Wisconsin through modifications to plants' WPDES permits, which govern plant wastewater discharges. WDNR is currently developing rules to implement the EPA 316(b) rule.



17




Our WCCF facility already employs a system that meets the 316(b) rule. Our Blount plant has conducted studies showing that it will likely be in compliance with this rule when its WPDES permit is renewed in 2017. The operator of our Columbia plant plans to conduct an intake study to demonstrate compliance with the 316(b) rule and/or identify design criteria needed to meet the new rule requirements prior to Columbia's 2017 WPDES permit renewal. The exact requirements at Blount and Columbia, however, will not be known until the WDNR finalizes its rule, approves the plant operators' approach, and those sites' WPDES permits are modified to account for this rule. Nonetheless, MGE expects that the 316(b) rule will not have material effects on its existing plants.


EPA's Greenhouse Gas (GHG) Reduction Guidelines under the Clean Air Act 111(d) Rule

On August 3, 2015, the EPA finalized its Clean Power Plan rule setting guidelines for states to use in developing plans to control GHG emissions from existing fossil fuel-fired electric generating units (EGUs) and systems. When fully implemented in 2030, the Clean Power Plan is projected to reduce GHG emissions from this sector by 32 percent below 2005 levels. States are given up to three years to submit a plan to meet the reduction goals and are expected to meet interim goals starting in 2022 and the final goal in 2030. Implementation of the rule is expected to have a direct impact on coal and natural gas fired generating units, including possible changes in dispatch and additional operating costs.


On October 23, 2015, several states, including Wisconsin, and several state regulatory bodies filed a joint petition seeking to have the U.S. Court of Appeals for the District of Columbia Circuit stay the effectiveness of the Clean Power Plant rule, which would otherwise become effective on December 22, 2015, and seeking expedited review of the petitioners' challenges to the legality of the adoption of the rule.


MGE is evaluating the rule and its requirements. Given the pending legal proceedings and the need for a yet-to-be-developed state implementation plan or federal implementation plan, the nature and timing of any final requirements is subject to uncertainty. If the rule remains substantially in its present form, it is expected to have a material impact on MGE.


National Ambient Air Quality Standards (NAAQS)

The EPA's NAAQS regulations have been developed to set ambient levels of six pollutants to protect sensitive populations (primary NAAQS) and the environment (secondary NAAQS) from the negative effects of exposure to these pollutants at higher levels. MGE is following developments for several NAAQS, including for particulate matter, nitrogen dioxide, sulfur dioxide, and ozone. Further discussion on sulfur dioxide and ozone NAAQS follows. For additional information on the NAAQS process, see Footnote 18.d. of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, of MGE Energy's and MGE's 2014 Annual Report on Form 10-K.


Sulfur Dioxide (SO2) NAAQS

The EPA's new 1-hour SO2 NAAQS has been in place since 2010 and initial attainment/nonattainment designations by states were due in 2013. However, the EPA was sued by environmental groups for not making these designations in a timely and proper manner. In March 2015, the EPA entered into a court-approved consent decree requiring 1-hour SO2 attainment/nonattainment area designations to be completed in three phases extending out until 2020. In August 2015, the EPA published its data requirements rule that lays out expectations, designation process options, and timeframes for states and tribes to meet. Under this new rule, states must submit their first designation proposals in July 2016 for those areas that contain large stationary sources of SO2 (sources that emit over a threshold mass of SO2, and/or over a threshold emissions rate). These proposals must identify one of the following options for demonstrating attainment with the 1-hour SO2 NAAQS: modeling of SO2 emissions; monitoring of SO2 emissions; or limiting large stationary sources to 2,000 ton per year of SO2 emissions by January 13, 2017. The EPA must make final designation determinations for these areas between 2017 and 2020 depending on the area.


In March 2015, MGE's Columbia plant was identified in the Federal Register as meeting the criteria of a large stationary source of SO2 (based on 2012 data). As such, the State of Wisconsin must submit an attainment/nonattainment area designation plan for Columbia County (the county in which the Columbia plant is located). Since the 2012 data was collected, Columbia has installed pollution control equipment that has lowered its total SO2 emissions and its SO2 emissions rate. However, we will not know with any certainty if Columbia County will be determined to be in attainment until the State of Wisconsin completes its attainment/nonattainment demonstration and the EPA approves it. The outcome of this designation may have an adverse effect on the operation of the Columbia plant. MGE will monitor and participate in developments with the Columbia County designation process. Management believes compliance costs will be recovered in future rates based on previous treatment of environmental compliance projects.



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Ozone NAAQS

In October 2015, the EPA revised the primary and secondary ozone NAAQS, lowering each to 70 ppb. Based on current ozone monitoring data, it appears that Milwaukee County (where our Elm Road Units are located) may not attain the lowered standards. Current ozone monitoring data suggests that Dane and Columbia Counties (where our WCCF/Blount and Columbia Units are located, respectively) will meet the new ozone NAAQS. Nonetheless, final attainment designations for these three counties will be based upon air monitoring data for years 2014-2016 and must be approved by EPA. Once these designations are complete, the State of Wisconsin will develop implementation plans for each county designated as nonattainment, which could affect plant operations within the nonattainment counties. These implementation plans are not expected to be finalized until 2017 at the earliest. MGE will continue to monitor developments, attainment designations, and state actions and implementation plans.


EPA's Cross-State Air Pollution Rule

In July 2011, the EPA finalized its Cross-State Air Pollution Rule (CSAPR) as a court-ordered replacement for its Clean Air Interstate Rule (CAIR) that had been remanded in 2008. CSAPR is an interstate air pollution transport rule designed to reduce ozone and fine particulate matter (PM2.5) air levels in areas that the EPA has determined are being affected by pollution from neighboring and upwind states.


CSAPR has been the subject of extensive litigation. That litigation had delayed implementation and created uncertainty, however, the most recent D.C. Circuit ruling clears the way for CSAPR to be fully implemented in Wisconsin. Some uncertainty remains as to the ozone season NOx budget for Wisconsin. In late 2014, the EPA tolled CSAPR's original compliance deadlines by three years and MGE's affected facilities must now meet their Phase I reduction obligations in 2015 and Phase II in 2017. MGE anticipates meeting its CSAPR requirements at all of our affected facilities by applying reductions achieved from recent pollution control installations and early reduction efforts. We do not anticipate this rule to have a significant impact on MGE.


Clean Air Visibility Rule (CAVR)

Columbia may be subject to the best available retrofit technology (BART) regulations, a subsection of the EPA's Clean Air Visibility Rule (CAVR), which may require pollution control retrofits. Columbia's pollution control upgrades and the EPA's stance that compliance with the CSAPR equals compliance with BART should mean that Columbia will not need to do additional work to meet BART requirements. At this time, however, the BART regulatory obligations, compliance strategies, and costs remain uncertain due to the legal uncertainty surrounding CSAPR.


EPA's Coal Combustion Residuals Rule

In December 2014, the EPA finalized its Disposal of Coal Combustion Residuals from Electric Utilities (CCR) rule. The rule became effective on October 19, 2015. It provides that coal ash will be regulated as a solid waste, and defines what ash use activities would be considered generally exempt beneficial reuse of coal ash. The rule also regulates landfills, ash ponds, and other surface impoundments for coal combustion residuals by regulating their design, location, monitoring, and operation. Landfills and impoundments that cannot meet design criteria will need to formally close within defined timeframes.


The Columbia and Elm Road Units co-owners and plant operators are evaluating the final rule to determine what changes may be necessary at those facilities and the associated timeframes. We anticipate that some design and operational changes may need to be made at these facilities. Review of our Elm Road facility has indicated that the costs to comply with this rule are not expected to be significant. We are still evaluating the rule's full effects at Columbia, however, Columbia's operator has developed a preliminary implementation schedule for meeting the various deadlines spelled out in the rule. Management believes compliance costs will be recovered in future rates based on previous treatment of environmental compliance projects.


Columbia


Based upon current available information, compliance with various environmental requirements and initiatives is expected to result in significant additional operating and capital expenditures at Columbia as noted below.




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Columbia Clean Air Act Litigation

Columbia is a coal-fired generating station operated by WPL in which WPL, WPSC, and MGE have ownership interests. In December 2009, the EPA sent a Notice of Violation (NOV) to MGE as one of the co-owners of Columbia. The NOV alleged that WPL and the Columbia co-owners failed to comply with appropriate pre-construction review and permitting requirements and, as a result, violated the Prevention of Significant Deterioration program requirements, Title V Operating Permit requirements of the CAA, and the Wisconsin SIP. In April 2013, the EPA filed a lawsuit against the co-owners of Columbia asserting similar allegations. In September 2010 and April 2013, the Sierra Club filed civil lawsuits against WPL alleging violations of the CAA at Columbia and other Wisconsin facilities operated by WPL. In June 2013, the court approved and entered a consent decree entered by the EPA, Sierra Club, and the co-owners of Columbia to resolve these claims, while admitting no liability. One of the requirements of the consent decree requires installation of a SCR system at Columbia Unit 2 by December 31, 2018. Installation of the SCR has been approved by the PSCW. MGE's share of the projected cost for the SCR system is approximately $19-$29 million. In addition, the consent decree establishes emission rate limits for SO2, NOx, and particulate matter and annual plant-wide emission caps for SO2 and NOx. MGE intends to seek recovery in future rates of the costs associated with its compliance with the terms of the final consent decree and currently expects to recover any material compliance costs.


b.

Legal Matters.


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


c.

Purchase Contracts.


MGE Energy and MGE have entered into various commodity supply, transportation, and storage contracts to meet their obligations to deliver electricity and natural gas to customers. As of September 30, 2015, the future commitments related to these purchase contracts were as follows:


 

(In thousands)

 

2015

 

2016

 

2017

 

2018

 

2019

 

 

Coal(a)

$

6,211

$

21,639

$

10,664

$

6,560

$

3,850

 

 

Natural gas

 

 

 

 

 

 

 

 

 

 

 

 

    Transportation & storage(b)

 

5,229

 

18,117

 

17,983

 

17,901

 

16,971

 

 

    Supply(c)

 

10,704

 

11,127

 

-

 

-

 

-

 

 

 

$

22,144

$

50,883

$

28,647

$

24,461

$

20,821

 


(a)

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


(b)

MGE's natural gas transportation and storage contracts require fixed monthly payments for firm supply pipeline transportation and storage capacity. The pricing components of the fixed monthly payments for the transportation and storage contracts are established by FERC but may be subject to change.


(c)

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


d.

Asset Retirement Obligation.


MGE Energy and MGE are required to record a liability for the fair value of an ARO to be recognized in the period in which it is incurred if it can be reasonably estimated. The offsetting associated asset retirement costs are capitalized as a long-lived asset and depreciated over the asset's useful life. As of September 30, 2015, MGE recorded an obligation of $2.3 million for the fair value of its legal liability for asset retirement obligations (AROs) associated with the effect of the final Coal Combustion Residual Rule at Columbia. MGE has regulatory treatment and recognizes regulatory assets or liabilities for the timing differences between when we recover legal AROs in rates and when those costs would actually be recognized.




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9.

Derivative and Hedging Instruments - MGE Energy and MGE.


a.

Purpose.


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


b.

Notional Amounts.


The gross notional volume of open derivatives is as follows:


 

 

September 30, 2015

 

December 31, 2014

 

 

Commodity derivative contracts

343,560 MWh

 

448,000 MWh

 

 

Commodity derivative contracts

6,547,500 Dth

 

4,405,000 Dth

 

 

FTRs

3,286 MW

 

1,854 MW

 


c.

Financial Statement Presentation.


MGE purchases and sells exchange-traded and over-the-counter options, swaps, and future contracts. These arrangements are primarily entered into to help stabilize the price risk associated with gas or power purchases. These transactions are employed by both MGE's gas and electric segments. Additionally, as a result of the firm transmission agreements that MGE holds on electricity transmission paths in the MISO market, MGE holds FTRs. An FTR is a financial instrument that entitles the holder to a stream of revenues or charges based on the differences in hourly day-ahead energy prices between two points on the transmission grid. The fair values of these instruments are offset with a corresponding regulatory asset/liability depending on whether they are in a net loss/gain position. Depending on the nature of the instrument, the gain or loss associated with these transactions will be reflected as cost of gas sold, fuel for electric generation, or purchased power expense in the delivery month applicable to the instrument. At September 30, 2015, and December 31, 2014, the cost basis of exchange traded derivatives and FTRs exceeded their fair value by $0.4 million and $1.6 million, respectively.


MGE is a party to a purchased power agreement that provides MGE with firm capacity and energy during a base term from June 1, 2012, through May 31, 2022. The agreement also allows MGE an option to extend the contract after the base term. The agreement is accounted for as a derivative contract and is recognized at its fair value on the consolidated balance sheets. However, the derivative qualifies for regulatory deferral and is recognized with a corresponding regulatory asset or liability depending on whether the fair value is in a loss or gain position. The fair value of the contract at September 30, 2015, and December 31, 2014, reflects a loss position of $57.0 million and $53.4 million, respectively. The actual cost will be recognized in purchased power expense in the month of purchase.




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The following table summarizes the fair value of the derivative instruments on the consolidated balance sheets. All derivative instruments in this table are presented on a gross basis and are calculated prior to the netting of instruments with the same counterparty under a master netting agreement as well as the netting of collateral. For financial statement purposes, MGE Energy and MGE have netted instruments with the same counterparty under a master netting agreement as well as the netting of collateral. At September 30, 2015, MGE Energy and MGE had the right to reclaim collateral (a receivable) of $0.8 million.


 

 

Asset Derivatives

 

Liability Derivatives

(In thousands)

 

Balance Sheet Location

 

Fair Value

 

Balance Sheet Location

 

Fair Value

September 30, 2015

 

 

 

 

 

 

 

 

Commodity derivative contracts

 

Other current assets

$

375

Derivative liability (current)

$

1,196

Commodity derivative contracts

 

Other deferred charges

 

65

 

Derivative liability (long-term)

 

62

FTRs

 

Other current assets

 

370

 

Derivative liability (current)

 

-

PPA

 

N/A

 

N/A

 

Derivative liability (current)

 

8,880

PPA

 

N/A

 

N/A

 

Derivative liability (long-term)

 

48,070

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

Commodity derivative contracts

 

Other current assets

$

130

 

Derivative liability (current)

$

2,262

Commodity derivative contracts

 

Other deferred charges

 

93

 

Derivative liability (long-term)

 

171

FTRs

 

Other current assets

 

642

 

Derivative liability (current)

 

-

PPA

 

N/A

 

N/A

 

Derivative liability (current)

 

6,870

PPA

 

N/A

 

N/A

 

Derivative liability (long-term)

 

46,560


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


 

Offsetting of Derivative Assets

 

 

(In thousands)

 

Gross amounts

 

Gross amounts offset in balance sheet

 

Collateral posted against derivative positions

 

Net amount presented in balance sheet

 

 

September 30, 2015

 

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

440

$

(431)

$

-

$

9

 

 

FTRs

 

370

 

-

 

-

 

370

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

223

$

(223)

$

-

$

-

 

 

FTRs

 

642

 

-

 

-

 

642

 


 

Offsetting of Derivative Liabilities

 

 

(In thousands)

 

Gross amounts

 

Gross amounts offset in balance sheet

 

Collateral posted against derivative positions

 

Net amount presented in balance sheet

 

 

September 30, 2015

 

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

1,258

$

(431)

$

(827)

$

-

 

 

PPA

 

56,950

 

-

 

-

 

56,950

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

2,433

$

(223)

$

(2,179)

$

31

 

 

PPA

 

53,430

 

-

 

-

 

53,430

 




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The following tables summarize the unrealized and realized gains (losses) related to the derivative instruments on the consolidated balance sheets at September 30, 2015 and 2014, and the consolidated income statements for the three and nine months ended September 30, 2015 and 2014.


 

 

2015

 

 

2014

(In thousands)

 

Current and long-term regulatory asset

 

Other current assets

 

 

Current and long-term regulatory asset

 

Other current assets

Three Months Ended September 30:

 

 

 

 

 

 

 

 

 

Balance at July 1,

$

56,048

$

455

 

$

48,853

$

676

Unrealized loss (gain)

 

4,036

 

-

 

 

5,329

 

-

Realized (loss) gain reclassified to a deferred

 

 

 

 

 

 

 

 

 

account

 

(408)

 

408

 

 

(314)

 

314

Realized (loss) gain reclassified to income

 

 

 

 

 

 

 

 

 

statement

 

(2,278)

 

(91)

 

 

(1,184)

 

(249)

Balance at September 30,

$

57,398

$

772

 

$

52,684

$

741

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30:

 

 

 

 

 

 

 

 

 

Balance at January 1,

$

54,998

$

1,001

 

$

63,893

$

411

Unrealized loss (gain)

 

8,514

 

-

 

 

(18,090)

 

-

Realized (loss) gain reclassified to a deferred

 

 

 

 

 

 

 

 

 

account

 

(1,700)

 

1,700

 

 

1,120

 

(1,120)

Realized (loss) gain reclassified to income

 

 

 

 

 

 

 

 

 

statement

 

(4,414)

 

(1,929)

 

 

5,761

 

1,450

Balance at September 30,

$

57,398

$

772

 

$

52,684

$

741


 

 

Realized losses (gains)

 

 

2015

 

 

2014

(In thousands)

 

Fuel for electric generation/ purchased power

 

Cost of gas sold

 

 

Fuel for electric generation/ purchased power

 

Cost of gas sold

Three Months Ended September 30:

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

862

$

(17)

 

$

480

$

(18)

FTRs

 

(233)

 

-

 

 

(97)

 

-

PPA

 

1,757

 

-

 

 

1,068

 

-

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30:

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

1,860

$

1,742

 

$

(5,376)

$

(1,367)

FTRs

 

(607)

 

-

 

 

(929)

 

-

PPA

 

3,348

 

-

 

 

461

 

-


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


The PPA has a provision that may require MGE to post collateral if MGE's debt rating falls below investment grade (i.e., below BBB-). The amount of collateral that it may be required to post varies from $20.0 million to $40.0 million, depending on MGE's nominated capacity amount. As of September 30, 2015, no collateral is required to be, or has been, posted. Certain counterparties extend MGE a credit limit. If MGE exceeds these limits, the counterparties may require collateral to be posted. As of September 30, 2015, and December 31, 2014, certain counterparties were in a net liability of less than $0.1 million.


Nonperformance of counterparties to the non-exchange traded derivatives could expose MGE to credit loss. However, MGE enters into transactions only with companies that meet or exceed strict credit guidelines, and it monitors these counterparties on an ongoing basis to mitigate nonperformance risk in its portfolio. As of September 30, 2015, no counterparties have defaulted.




23




10.

Rate Matters - MGE Energy and MGE.


a.

Rate Proceedings.


In July 2015, the PSCW approved MGE's request to extend the current accounting treatment for transmission related costs through 2016, conditioned upon MGE not filing a base rate case for 2016. This treatment would allow MGE to reflect any differential between transmission costs reflected in rates and actual costs incurred in its next rate case filing.


On December 23, 2014, the PSCW authorized MGE to increase 2015 rates for retail electric customers by 3.8% or $15.4 million and to decrease gas rates by 2.0% or $3.8 million. The increase in retail electric rates cover costs associated with the construction of emission-reduction equipment at Columbia, improvements and reliability of the state's electric transmission system, fuel and purchased power related to coal delivery costs, partially offset by lower cost as a result of market conditions for pension and postretirement benefit costs. The authorized return on common stock equity is 10.2%.


The PSCW also approved changes to customer rates and rate design for gas service that became effective January 1, 2015. Gas rate design consists of a fixed monthly customer charge and a variable charge tied to actual usage, in addition to the separate charge for natural gas commodity costs (PGA). The change shifted more of the rate recovery to the monthly charge, reflecting the related fixed costs of providing gas services, and reduced the variable usage-based charge. Thus, gas net income is expected to be more evenly distributed during the year and less sensitive to weather. A similar, but much smaller rate design shift was also approved for electric rates.


On July 26, 2013, the PSCW authorized MGE to freeze electric and natural gas rates at 2013 levels for 2014. The order authorized 100% AFUDC on the Columbia scrubber construction project and deferral of increased costs related to ATC and MISO network upgrade fees. As part of the rate freeze plan authorized by the PSCW, effective January 1, 2014, approximately $6.3 million associated with a 2012 fuel rule surplus credit was required to be refunded to customers and was amortized in 2014. The fuel credit accrued interest at MGE's weighted cost of capital. The authorized return on common stock equity was unchanged at 10.3%.


b.

Fuel Rules.


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


In August 2015, the PSCW approved on an interim basis MGE's application to implement a fuel credit associated with its fuel savings for 2015. The fuel credit established a mechanism to return the fuel savings to electric customers via a bill credit during the period from September 1, 2015, to December 31, 2015. The fuel credit was based on $5.9 million of actual fuel savings deferred through June 30, 2015. Approximately $2.7 million is expected to be returned to customers through December 31, 2015. The application further proposes a fuel credit to cover expected fuel savings for 2016 in the amount of approximately $5.0 million based on anticipated fuel costs. The actual fuel savings will depend upon the completion of the annual PSCW fuel cost audits for 2015 and 2016.


As of September 30, 2015, MGE has deferred $7.6 million of 2015 electric fuel-related savings that are outside the range authorized by the PSCW. In September 2015, MGE returned $0.7 million of total electric fuel-related savings on customer bills. As part of the rate freeze plan authorized by the PSCW for 2014, $4.7 million of the approximately $6.3 million associated with the 2012 fuel rule credit was amortized against purchased power expense during the nine months ended September 30, 2014.




24




c.

Purchased Gas Adjustment Clause.


MGE's natural gas rates are subject to a fuel adjustment clause designed to recover or refund the difference between the actual cost of purchased gas and the amount included in rates. Differences between the amounts billed to customers and the actual costs recoverable are deferred and recovered or refunded in future periods by means of prospective monthly adjustments to rates. At September 30, 2015, and December 31, 2014, MGE had over collected $1.1 million and $1.2 million, respectively, which was recorded in other current liabilities on the consolidated balance sheets.


11.

Fair Value of Financial Instruments - MGE Energy and MGE.


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


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


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


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


a.

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


At September 30, 2015, and December 31, 2014, the carrying amount of cash, cash equivalents, and outstanding commercial paper approximates fair market value due to the short maturity of those investments and obligations. The estimated fair market value of MGE Energy's and MGE's long-term debt is based on quoted market prices for similar financial instruments at September 30, 2015, and December 31, 2014. Since long-term debt is not traded in an active market, it is classified as Level 2. The estimated fair market value of MGE Energy's and MGE's financial instruments are as follows:


 

 

 

September 30, 2015

 

 

December 31, 2014

 

 

(In thousands)

 

Carrying Amount

 

Fair Value

 

 

Carrying Amount

 

Fair Value

 

 

MGE Energy

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

    Cash and cash equivalents

$

94,267

$

94,267

 

$

65,755

$

65,755

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

    Short-term debt - commercial paper

 

-

 

-

 

 

7,000

 

7,000

 

 

    Long-term debt*

 

396,562

 

446,176

 

 

399,690

 

457,420

 

 

 

 

 

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

    Cash and cash equivalents

$

41,971

$

41,971

 

$

4,562

$

4,562

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

    Short-term debt - commercial paper

 

-

 

-

 

 

7,000

 

7,000

 

 

    Long-term debt*

 

396,562

 

446,176

 

 

399,690

 

457,420

 

 

 

 

 

 

 

 

 

 

 

 

 

 

*Includes long-term debt due within one year.

 

 

 

 

 

 

 

 




25




b.

Recurring Fair Value Measurements.


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


 

 

 

Fair Value as of September 30, 2015

 

 

(In thousands)

 

Total

 

Level 1

 

Level 2

 

Level 3

 

 

MGE Energy

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

379

$

-

$

-

$

379

 

 

    Exchange-traded investments

 

627

 

627

 

-

 

-

 

 

    Total Assets

$

1,006

$

627

$

-

$

379

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net(a)

$

57,777

$

316

$

-

$

57,461

 

 

    Deferred compensation

 

3,160

 

-

 

3,160

 

-

 

 

    Total Liabilities

$

60,937

$

316

$

3,160

$

57,461

 

 

 

 

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

379

$

-

$

-

$

379

 

 

    Exchange-traded investments

 

122

 

122

 

-

 

-

 

 

    Total Assets

$

501

$

122

$

-

$

379

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net(a)

$

57,777

$

316

$

-

$

57,461

 

 

    Deferred compensation

 

3,160

 

-

 

3,160

 

-

 

 

    Total Liabilities

$

60,937

$

316

$

3,160

$

57,461

 

 

 

 

 

 

 

 

 

 

 

 


 

 

 

Fair Value as of December 31, 2014

 

 

(In thousands)

 

Total

 

Level 1

 

Level 2

 

Level 3

 

 

MGE Energy

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

642

$

-

$

-

$

642

 

 

    Exchange-traded investments

 

927

 

927

 

-

 

-

 

 

    Total Assets

$

1,569

$

927

$

-

$

642

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net(a)

$

55,640

$

1,012

$

-

$

54,628

 

 

    Deferred compensation

 

2,832

 

-

 

2,832

 

-

 

 

    Total Liabilities

$

58,472

$

1,012

$

2,832

$

54,628

 

 

 

 

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

642

$

-

$

-

$

642

 

 

    Exchange-traded investments

 

350

 

350

 

-

 

-

 

 

    Total Assets

$

992

$

350

$

-

$

642

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net(a)

$

55,640

$

1,012

$

-

$

54,628

 

 

    Deferred compensation

 

2,832

 

-

 

2,832

 

-

 

 

    Total Liabilities

$

58,472

$

1,012

$

2,832

$

54,628

 


(a)

These amounts are shown gross and exclude $0.8 million and $2.2 million of collateral that was posted against derivative positions with counterparties as of September 30, 2015, and December 31, 2014, respectively.


No transfers were made in or out of Level 1 or Level 2 for the nine months ended September 30, 2015.


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




26




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


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


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


This model is prepared by members of MGE's Energy Accounting department. On a quarterly basis, management in the Energy Supply and Finance departments review the assumptions, inputs, and fair value measurements.


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


 

 

 

Model Input

 

Significant Unobservable Inputs

 

September 30, 2015

 

December 31, 2014

 

Basis adjustment:

 

 

 

 

 

    On peak

 

97.4%

 

98.1%

 

    Off peak

 

95.4%

 

95.0%

 

Counterparty fuel mix:

 

 

 

 

 

    Internal generation

 

60% - 75%

 

50% - 70%

 

    Purchased power

 

40% - 25%

 

50% - 30%


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




27




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


 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30,

 

September 30,

(In thousands)

 

2015

 

2014

 

2015

 

2014

Beginning balance

$

(56,194)

$

(49,349)

$

(53,986)

$

(64,628)

Realized and unrealized gains (losses):

 

 

 

 

 

 

 

 

    Included in regulatory liabilities (assets)

 

(888)

 

(3,752)

 

(3,096)

 

11,528

    Included in other comprehensive income

 

-

 

-

 

-

 

-

    Included in earnings

 

(2,285)

 

(1,419)

 

(4,497)

 

5,837

    Included in current assets

 

-

 

-

 

-

 

(89)

Purchases

 

6,364

 

6,371

 

17,497

 

19,900

Sales

 

-

 

-

 

34

 

(60)

Issuances

 

-

 

-

 

-

 

-

Settlements

 

(4,079)

 

(4,952)

 

(13,034)

 

(25,589)

Transfers in and/or out of Level 3

 

-

 

-

 

-

 

-

Balance as of September 30,

$

(57,082)

$

(53,101)

$

(57,082)

$

(53,101)

Total gains (losses) included in earnings attributed to

 

 

 

 

 

 

 

 

the change in unrealized gains (losses) related to

 

 

 

 

 

 

 

 

assets and liabilities held at September 30,(b)

$

-

$

-

$

-

$

-


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


 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

 

September 30,

 

September 30,

 

 

(In thousands)

 

2015

 

2014

 

2015

 

2014

 

 

Purchased Power Expense

$

(2,302)

$

(1,411)

$

(4,515)

$

5,845

 

 

Cost of Gas Sold Expense

 

17

 

(8)

 

18

 

(8)

 

 

Total

$

(2,285)

$

(1,419)

$

(4,497)

$

5,837

 


(b)

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


12.

New Accounting Pronouncements - MGE Energy and MGE.


a.

Transfers and Servicing Assets.


In June 2014, the FASB issued authoritative guidance within the Codification's Transfers and Servicing topic that provides guidance on the accounting and disclosures for repurchase-to-maturity transactions, securities lending transactions, and repurchase financings. This authoritative guidance became effective January 1, 2015. The authoritative guidance changed the accounting for the Chattel Paper program and required additional disclosures. Prior to adoption of the standard, Chattel Paper was treated as an off-balance sheet arrangement. See Footnote 4 for additional information.


b.

Revenue from Contracts with Customers.


In May 2014, the FASB issued authoritative guidance within the Codification's Revenue Recognition topic that provides guidance on the recognition, measurement, and disclosure of revenue from contracts with customers. This authoritative guidance was scheduled to become effective January 1, 2017. In July 2015, the FASB deferred the effective date to January 1, 2018. MGE Energy and MGE are currently assessing the impact this pronouncement will have on their financial statements.




28




c.

Consolidations.


In February 2015, the FASB issued authoritative guidance within the Codification's Consolidation topic that provides guidance on the evaluation of certain legal entities for consolidation purposes. This authoritative guidance will become effective January 1, 2016. The impact of this guidance on our financial statements is not expected to be material.


d.

Debt Issuance Costs.


In April 2015, the FASB issued authoritative guidance within the Codification's Interest topic that provides guidance on the presentation of debt issuance costs in financial statements. This authoritative guidance will become effective January 1, 2016. The authoritative guidance changes the presentation of debt issuance costs on the balance sheet from an asset to a direct deduction from the related debt liability. The impact of this guidance on our financial statements is not expected to be material.


e.

Cloud Computing Arrangements.


In April 2015, the FASB issued authoritative guidance within the Codification's Software topic that provides guidance on the accounting treatment of cloud computer arrangements. This authoritative guidance will become effective January 1, 2016. The authoritative guidance provides criteria for determining whether a cloud computing arrangement contains a software license that should be accounted for as internal-use software. The impact of this guidance on our financial statements is not expected to be material.


f.

Inventory Measurement.


In July 2015, the FASB issued authoritative guidance within the Codification's Inventory topic that provides guidance on the subsequent measurement of inventory. This authoritative guidance will become effective January 1, 2017. The authoritative guidance changes the subsequent measurement of inventory from the lower of cost or market to the lower of cost or net realizable value. MGE Energy and MGE are currently assessing the impact this pronouncement will have on their financial statements.


13.

Segment Information - MGE Energy and MGE.


MGE Energy operates in the following business segments: electric utility, gas utility, nonregulated energy, transmission investment, and all other. See MGE Energy's and MGE's 2014 Annual Report on Form 10-K for additional discussion of each of these segments.




29




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


(In thousands)

MGE Energy

 

Electric

 

Gas

 

Non- Regulated Energy

 

Transmission Investment

 

All Others

 

Consolidation/ Elimination Entries

 

Consolidated Total

Three Months Ended September 30, 2015

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

121,453

$

17,431

$

1,911

$

-

$

-

$

-

$

140,795

Interdepartmental revenues

 

163

 

3,855

 

9,866

 

-

 

-

 

(13,884)

 

-

Total operating revenues

 

121,616

 

21,286

 

11,777

 

-

 

-

 

(13,884)

 

140,795

Depreciation and amortization

 

(7,584)

 

(1,714)

 

(1,872)

 

-

 

(12)

 

-

 

(11,182)

Other operating expenses

 

(80,202)

 

(16,906)

 

(36)

 

(15)

 

(161)

 

13,884

 

(83,436)

Operating income (loss)

 

33,830

 

2,666

 

9,869

 

(15)

 

(173)

 

-

 

46,177

Other (deductions) income, net

 

141

 

(7)

 

-

 

2,397

 

33

 

-

 

2,564

Interest (expense) income, net

 

(2,798)

 

(804)

 

(1,491)

 

-

 

57

 

-

 

(5,036)

Income (loss) before taxes

 

31,173

 

1,855

 

8,378

 

2,382

 

(83)

 

-

 

43,705

Income tax (provision) benefit

 

(10,321)

 

(732)

 

(3,362)

 

(962)

 

26

 

-

 

(15,351)

Net income (loss)

$

20,852

$

1,123

$

5,016

$

1,420

$

(57)

$

-

$

28,354

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2014