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, 2018


[   ] 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, a smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.


 

Large Accelerated Filer

Accelerated Filer

Non-accelerated Filer

Smaller Reporting Company

Emerging Growth Company

MGE Energy, Inc.

X

 

 

 

 

Madison Gas and Electric Company

 

 

X

 

 


If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]


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, 2018

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 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.

36

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

51

Item 4. Controls and Procedures.

53

PART II. OTHER INFORMATION.

54

Item 1. Legal Proceedings.

54

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

54

Item 4. Mine Safety Disclosures.

54

Item 6. Exhibits.

55

Signatures - MGE Energy, Inc.

56

Signatures - Madison Gas and Electric Company

57





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' 2017 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 17, as updated by Part I, Item 1. Financial Statements – Note 9 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 assume 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

MGEE Transco

MGEE Transco, LLC

 

 

Other Defined Terms:

 

 

 

ACE

Affordable Clean Energy

AFUDC

Allowance for Funds Used During Construction

ARO

Asset Retirement Obligation

ASU

Accounting Standard Update

ATC

American Transmission Company LLC

ATC Holdco

ATC Holdco, LLC

Blount

Blount Station

BSER

Best System of Emissions Reductions

CAVR

Clean Air Visibility Rule

CCR

Coal Combustion Residual

CNG

Compressed Natural Gas

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

CPP

Clean Power Plan

CSAPR

Cross-State Air Pollution Rule

Dth

Dekatherms, a quantity measure used in respect of natural gas

EGUs

Electric Generating Units

electric margin

Electric revenues less fuel for electric generation and purchase power costs, a non-GAAP measure

Elm Road Units

Elm Road Generating Station

EPA

United States Environmental Protection Agency

FASB

Financial Accounting Standards Board

FERC

Federal Energy Regulatory Commission

FIP

Federal Implementation Plan

Forward Wind

Forward Wind Energy Center

FTR

Financial Transmission Rights

GAAP

Generally Accepted Accounting Principles

gas margin

Gas revenues less cost of gas sold, a non-GAAP measure

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



4





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

NOx

Nitrogen Oxides

PGA

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

PPA

Purchased Power Agreement

PSCW

Public Service Commission of Wisconsin

Riverside

Riverside Energy Center

ROE

Return on Equity

SCR

Selective Catalytic Reduction

SEC

Securities and Exchange Commission

SO2

Sulfur Dioxide

Stock Plan

Direct Stock Purchase and Dividend Reinvestment Plan of MGE Energy

Tax Act

Tax Cuts and Jobs Act

UW

University of Wisconsin at Madison

VIE

Variable Interest Entity

WCCF

West Campus Cogeneration Facility

WEPCO

Wisconsin Electric Power Company, a subsidiary of WEC Energy Group, Inc.

working capital

Current assets less current liabilities

WPL

Wisconsin Power and Light Company, a subsidiary of Alliant Energy 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,

 

 

2018

 

2017

 

2018

 

2017

Operating Revenues:

 

 

 

 

 

 

 

 

    Electric revenues

$

119,388

$

120,761

$

313,537

$

321,540

    Gas revenues

 

18,407

 

18,778

 

106,152

 

101,285

        Total Operating Revenues

 

137,795

 

139,539

 

419,689

 

422,825

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

 

    Fuel for electric generation

 

16,793

 

15,829

 

43,944

 

39,938

    Purchased power

 

13,024

 

15,984

 

43,036

 

48,058

    Cost of gas sold

 

4,921

 

5,094

 

54,109

 

50,109

    Other operations and maintenance

 

44,130

 

42,533

 

131,976

 

131,177

    Depreciation and amortization

 

14,259

 

13,372

 

41,754

 

39,606

    Other general taxes

 

4,870

 

4,730

 

14,653

 

14,509

        Total Operating Expenses

 

97,997

 

97,542

 

329,472

 

323,397

Operating Income

 

39,798

 

41,997

 

90,217

 

99,428

 

 

 

 

 

 

 

 

 

Other income, net

 

4,330

 

4,943

 

13,980

 

12,038

Interest expense, net

 

(5,025)

 

(4,727)

 

(14,547)

 

(14,507)

    Income before income taxes

 

39,103

 

42,213

 

89,650

 

96,959

Income tax provision

 

(9,597)

 

(15,584)

 

(21,792)

 

(35,487)

Net Income

$

29,506

$

26,629

$

67,858

$

61,472

 

 

 

 

 

 

 

 

 

Earnings Per Share of Common Stock

 

 

 

 

 

 

 

 

(basic and diluted)

$

0.85

$

0.77

$

1.96

$

1.77

 

 

 

 

 

 

 

 

 

Dividends per share of common stock

$

0.338

$

0.323

$

0.983

$

0.938

 

 

 

 

 

 

 

 

 

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,

 

 

2018

 

2017

 

2018

 

2017

Net Income

$

29,506

$

26,629

$

67,858

$

61,472

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

    Unrealized gain on available-for-sale

 

 

 

 

 

 

 

 

    securities, net of tax ($- and ($40), and $- and

 

 

 

 

 

 

 

 

    ($127), respectively)

 

-

 

60

 

-

 

189

Comprehensive Income

$

29,506

$

26,689

$

67,858

$

61,661

 

 

 

 

 

 

 

 

 

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,

 

 

 

 

2018

 

2017

 

 

Operating Activities:

 

 

 

 

 

 

    Net income

$

67,858

$

61,472

 

 

    Items not affecting cash:

 

 

 

 

 

 

        Depreciation and amortization

 

41,754

 

39,606

 

 

        Deferred income taxes

 

2,352

 

4,810

 

 

        Provision for doubtful receivables

 

642

 

650

 

 

        Employee benefit plan (credit) cost

 

(1,544)

 

778

 

 

        Equity earnings in ATC

 

(6,113)

 

(7,432)

 

 

        Gain on sale of property

 

-

 

(1,581)

 

 

        Other items

 

31

 

1,103

 

 

    Changes in working capital items:

 

 

 

 

 

 

        Decrease in current assets

 

25,530

 

15,259

 

 

        Increase (decrease) in current liabilities

 

6,026

 

(17,615)

 

 

    Dividends from ATC

 

5,336

 

6,142

 

 

    Cash contributions to pension and other postretirement plans

 

(3,967)

 

(9,717)

 

 

    Other noncurrent items, net

 

527

 

2,671

 

 

            Cash Provided by Operating Activities

 

138,432

 

96,146

 

 

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

 

    Capital expenditures

 

(149,001)

 

(66,286)

 

 

    Capital contributions to investments

 

(4,801)

 

(6,863)

 

 

    Proceeds from sale of property

 

-

 

2,399

 

 

    Other

 

368

 

161

 

 

            Cash Used for Investing Activities

 

(153,434)

 

(70,589)

 

 

 

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

 

    Cash dividends paid on common stock

 

(34,062)

 

(32,502)

 

 

    Repayment of long-term debt

 

(23,330)

 

(33,260)

 

 

    Issuance of long-term debt

 

100,000

 

40,000

 

 

    (Repayments of) proceeds from short-term debt

 

(4,000)

 

7,000

 

 

    Other

 

(659)

 

(366)

 

 

            Cash Provided by (Used for) Financing Activities

 

37,949

 

(19,128)

 

 

 

 

 

 

 

 

 

Change in cash, cash equivalents, and restricted cash

 

22,947

 

6,429

 

 

Cash, cash equivalents, and restricted cash at beginning of period

 

112,094

 

101,633

 

 

Cash, cash equivalents, and restricted cash at end of period

$

135,041

$

108,062

 

 

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

    Significant noncash investing activities:

 

 

 

 

 

 

        Accrued capital expenditures

$

10,991

$

12,469

 

 

 

 

 

 

 

 

 

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

 

2018

 

2017

Current Assets:

 

 

 

 

    Cash and cash equivalents

$

133,855

$

107,952

    Accounts receivable, less reserves of $2,416 and $2,840, respectively

 

41,693

 

42,299

    Other accounts receivable, less reserves of $571 and $335, respectively

 

7,565

 

9,440

    Unbilled revenues

 

20,979

 

31,400

    Materials and supplies, at average cost

 

24,869

 

22,614

    Fuel for electric generation, at average cost

 

6,945

 

8,256

    Stored natural gas, at average cost

 

13,614

 

12,923

    Prepaid taxes

 

12,239

 

26,535

    Regulatory assets - current

 

8,739

 

7,888

    Assets held for sale

 

1,755

 

8,817

    Other current assets

 

8,459

 

12,507

        Total Current Assets

 

280,712

 

290,631

Other long-term receivables

 

3,747

 

4,788

Regulatory assets

 

133,936

 

142,567

Pension and other postretirement benefit asset

 

14,266

 

7,336

Other deferred assets and other

 

8,729

 

731

Property, Plant, and Equipment:

 

 

 

 

    Property, plant, and equipment, net

 

1,350,253

 

1,283,313

    Construction work in progress

 

109,209

 

58,044

        Total Property, Plant, and Equipment

 

1,459,462

 

1,341,357

Investments

 

73,445

 

67,772

        Total Assets

$

1,974,297

$

1,855,182

 

 

 

 

 

LIABILITIES AND CAPITALIZATION

 

 

 

 

Current Liabilities:

 

 

 

 

    Long-term debt due within one year

$

4,527

$

24,452

    Short-term debt

 

-

 

4,000

    Accounts payable

 

50,340

 

47,645

    Accrued interest and taxes

 

5,554

 

5,602

    Accrued payroll related items

 

10,879

 

12,244

    Regulatory liabilities - current

 

7,330

 

5,633

    Derivative liabilities

 

9,350

 

8,180

    Other current liabilities

 

10,509

 

18,758

        Total Current Liabilities

 

98,489

 

126,514

Other Credits:

 

 

 

 

    Deferred income taxes

 

229,197

 

225,130

    Investment tax credit - deferred

 

843

 

918

    Regulatory liabilities

 

171,057

 

154,153

    Accrued pension and other postretirement benefits

 

69,346

 

69,088

    Derivative liabilities

 

26,920

 

33,990

    Other deferred liabilities and other

 

72,064

 

69,041

        Total Other Credits

 

569,427

 

552,320

Capitalization:

 

 

 

 

    Common shareholders' equity

 

811,983

 

778,187

    Long-term debt

 

494,398

 

398,161

        Total Capitalization

 

1,306,381

 

1,176,348

Commitments and contingencies (see Footnote 9)

 

 

 

 

        Total Liabilities and Capitalization

$

1,974,297

$

1,855,182

 

 

 

 

 

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/(Loss)

 

Total

 

 

2017

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - December 31, 2016

34,668

$

34,668

$

316,268

$

372,950

$

202

$

724,088

 

 

Net income

 

 

 

 

 

 

61,472

 

 

 

61,472

 

 

Other comprehensive income

 

 

 

 

 

 

 

 

189

 

189

 

 

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

($0.938 per share)

 

 

 

 

 

 

(32,502)

 

 

 

(32,502)

 

 

Ending balance - September 30, 2017

34,668

$

34,668

$

316,268

$

401,920

$

391

$

753,247

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - December 31, 2017

34,668

$

34,668

$

316,268

$

426,874

$

377

$

778,187

 

 

Cumulative effect of new accounting principle

 

 

 

 

 

 

377

 

(377)

 

-

 

 

Beginning balance - adjusted

 

 

 

 

 

 

427,251

 

-

 

778,187

 

 

Net income

 

 

 

 

 

 

67,858

 

 

 

67,858

 

 

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

($0.983 per share)

 

 

 

 

 

 

(34,062)

 

 

 

(34,062)

 

 

Ending balance - September 30, 2018

34,668

$

34,668

$

316,268

$

461,047

$

-

$

811,983

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

Nine Months Ended

 

 

September 30,

 

September 30,

 

 

2018

 

2017

 

2018

 

2017

Operating Revenues:

 

 

 

 

 

 

 

 

    Electric revenues

$

119,388

$

120,760

$

313,537

$

321,543

    Gas revenues

 

18,407

 

18,779

 

106,152

 

101,294

        Total Operating Revenues

 

137,795

 

139,539

 

419,689

 

422,837

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

 

    Fuel for electric generation

 

16,793

 

15,828

 

43,944

 

39,939

    Purchased power

 

13,024

 

15,985

 

43,036

 

48,061

    Cost of gas sold

 

4,921

 

5,094

 

54,109

 

50,117

    Other operations and maintenance

 

43,987

 

42,331

 

131,175

 

130,389

    Depreciation and amortization

 

14,259

 

13,372

 

41,754

 

39,606

    Other general taxes

 

4,870

 

4,730

 

14,653

 

14,509

    Income tax provision

 

9,048

 

14,059

 

19,701

 

32,080

        Total Operating Expenses

 

106,902

 

111,399

 

348,372

 

354,701

Operating Income

 

30,893

 

28,140

 

71,317

 

68,136

 

 

 

 

 

 

 

 

 

Other Income and Deductions:

 

 

 

 

 

 

 

 

    AFUDC - equity funds

 

764

 

310

 

2,023

 

875

    Income tax provision

 

(69)

 

(663)

 

(218)

 

(754)

    Other income, net

 

1,828

 

2,492

 

5,380

 

4,335

        Total Other Income and Deductions

 

2,523

 

2,139

 

7,185

 

4,456

    Income before interest expense

 

33,416

 

30,279

 

78,502

 

72,592

 

 

 

 

 

 

 

 

 

Interest Expense:

 

 

 

 

 

 

 

 

    Interest on long-term debt

 

5,696

 

4,995

 

16,093

 

15,051

    Other interest, net

 

62

 

54

 

317

 

150

    AFUDC - borrowed funds

 

(258)

 

(123)

 

(683)

 

(295)

        Net Interest Expense

 

5,500

 

4,926

 

15,727

 

14,906

Net Income

$

27,916

$

25,353

$

62,775

$

57,686

Less: Net Income Attributable to Noncontrolling

 

 

 

 

 

 

 

 

Interest, net of tax

 

(5,629)

 

(5,439)

 

(16,940)

 

(16,224)

Net Income Attributable to MGE

$

22,287

$

19,914

$

45,835

$

41,462

 

 

 

 

 

 

 

 

 

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

 

Nine Months Ended

 

 

September 30,

 

September 30,

 

 

2018

 

2017

 

2018

 

2017

Net Income

$

27,916

$

25,353

$

62,775

$

57,686

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

    Unrealized loss on available-for-sale

 

 

 

 

 

 

 

 

    securities, net of tax ($- and $5, and $- and

 

 

 

 

 

 

 

 

    $26, respectively)

 

-

 

(7)

 

-

 

(38)

Comprehensive Income

$

27,916

$

25,346

$

62,775

$

57,648

    Less: Comprehensive Income Attributable to

 

 

 

 

 

 

 

 

    Noncontrolling Interest, net of tax

 

(5,629)

 

(5,439)

 

(16,940)

 

(16,224)

Comprehensive Income Attributable to MGE

$

22,287

$

19,907

$

45,835

$

41,424

 

 

 

 

 

 

 

 

 

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,

 

 

 

 

2018

 

2017

 

 

Operating Activities:

 

 

 

 

 

 

    Net income

$

62,775

$

57,686

 

 

    Items not affecting cash:

 

 

 

 

 

 

        Depreciation and amortization

 

41,754

 

39,606

 

 

        Deferred income taxes

 

(580)

 

2,255

 

 

        Provision for doubtful receivables

 

642

 

650

 

 

        Employee benefit plan (credit) cost

 

(1,544)

 

778

 

 

        Gain on sale of property

 

-

 

(1,581)

 

 

        Other items

 

768

 

1,376

 

 

    Changes in working capital items:

 

 

 

 

 

 

       Decrease in current assets

 

24,864

 

14,634

 

 

       Increase (decrease) in current liabilities

 

9,941

 

(16,670)

 

 

    Cash contributions to pension and other postretirement plans

 

(3,967)

 

(9,717)

 

 

    Other noncurrent items, net

 

374

 

2,479

 

 

            Cash Provided by Operating Activities

 

135,027

 

91,496

 

 

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

 

    Capital expenditures

 

(149,001)

 

(66,286)

 

 

    Proceeds from sale of property

 

-

 

1,751

 

 

    Other

 

(680)

 

(45)

 

 

            Cash Used for Investing Activities

 

(149,681)

 

(64,580)

 

 

 

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

 

    Cash dividends paid to parent by MGE

 

-

 

(35,000)

 

 

    Distributions to parent from noncontrolling interest

 

(19,000)

 

(16,500)

 

 

    Repayment of long-term debt

 

(23,330)

 

(33,260)

 

 

    Issuance of long-term debt

 

100,000

 

40,000

 

 

    (Repayments of) proceeds from short-term debt

 

(4,000)

 

7,000

 

 

    Other

 

(659)

 

(315)

 

 

            Cash Provided by (Used for) Financing Activities

 

53,011

 

(38,075)

 

 

 

 

 

 

 

 

 

Change in cash, cash equivalents, and restricted cash

 

38,357

 

(11,159)

 

 

Cash, cash equivalents, and restricted cash at beginning of period

 

10,093

 

16,442

 

 

Cash, cash equivalents, and restricted cash at end of period

$

48,450

$

5,283

 

 

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

    Significant noncash investing activities:

 

 

 

 

 

 

        Accrued capital expenditures

$

10,991

$

12,469

 

 

 

 

 

 

 

 

 

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

 

2018

 

2017

Current Assets:

 

 

 

 

    Cash and cash equivalents

$

47,264

$

5,951

    Accounts receivable, less reserves of $2,416 and $2,840, respectively

 

41,693

 

42,299

    Affiliate receivables

 

686

 

668

    Other accounts receivable, less reserves of $571 and $335, respectively

 

5,856

 

6,984

    Unbilled revenues

 

20,979

 

31,400

    Materials and supplies, at average cost

 

24,869

 

22,614

    Fuel for electric generation, at average cost

 

6,945

 

8,256

    Stored natural gas, at average cost

 

13,614

 

12,923

    Prepaid taxes

 

11,486

 

25,073

    Regulatory assets - current

 

8,739

 

7,888

    Assets held for sale

 

1,755

 

8,817

    Other current assets

 

8,424

 

12,484

        Total Current Assets

 

192,310

 

185,357

Affiliate receivable long-term

 

3,310

 

3,707

Regulatory assets

 

133,936

 

142,567

Pension and other postretirement benefit asset

 

14,266

 

7,336

Other deferred assets and other

 

10,517

 

3,280

Property, Plant, and Equipment:

 

 

 

 

    Property, plant, and equipment, net

 

1,350,281

 

1,283,341

    Construction work in progress

 

109,209

 

58,044

        Total Property, Plant, and Equipment

 

1,459,490

 

1,341,385

Investments

 

415

 

409

        Total Assets

$

1,814,244

$

1,684,041


 

 

 

 

LIABILITIES AND CAPITALIZATION

 

 

 

 

Current Liabilities:

 

 

 

 

    Long-term debt due within one year

$

4,527

$

24,452

    Short-term debt

 

-

 

4,000

    Accounts payable

 

50,315

 

47,614

    Accrued interest and taxes

 

7,409

 

5,558

    Accrued payroll related items

 

10,879

 

12,244

    Regulatory liabilities - current

 

7,330

 

5,633

    Derivative liabilities

 

9,350

 

8,180

    Other current liabilities

 

10,509

 

16,749

        Total Current Liabilities

 

100,319

 

124,430

Other Credits:

 

 

 

 

    Deferred income taxes

 

202,748

 

201,486

    Investment tax credit - deferred

 

843

 

918

    Regulatory liabilities

 

171,057

 

154,153

    Accrued pension and other postretirement benefits

 

69,346

 

69,088

    Derivative liabilities

 

26,920

 

33,990

    Other deferred liabilities and other

 

72,064

 

69,041

        Total Other Credits

 

542,978

 

528,676

Capitalization:

 

 

 

 

    Common shareholder's equity

 

537,707

 

491,872

    Noncontrolling interest

 

138,842

 

140,902

        Total Equity

 

676,549

 

632,774

    Long-term debt

 

494,398

 

398,161

        Total Capitalization

 

1,170,947

 

1,030,935

Commitments and contingencies (see Footnote 9)

 

 

 

 

        Total Liabilities and Capitalization

$

1,814,244

$

1,684,041


 

 

 

 

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



12





Madison Gas and Electric Company

Consolidated Statements of Equity (unaudited)

(In thousands)

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

Non-

 

 

 

Common Stock

 

Paid-in

 

Retained

Comprehensive

Controlling

 

 

 

Shares

 

Value

 

Capital

 

Earnings

Income/(Loss)

Interest

 

Total

2017

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - Dec. 31, 2016

17,348

$

17,348

$

192,417

$

277,300

$

19

$

115,665

$

602,749

Net income

 

 

 

 

 

 

41,462

 

 

 

16,224

 

57,686

Other comprehensive loss

 

 

 

 

 

 

 

 

(38)

 

 

 

(38)

Cash dividends paid to parent

 

 

 

 

 

 

 

 

 

 

 

 

 

by MGE

 

 

 

 

 

 

(35,000)

 

 

 

 

 

(35,000)

Distributions to parent from

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

(16,500)

 

(16,500)

Ending balance - September 30, 2017

17,348

$

17,348

$

192,417

$

283,762

$

(19)

$

115,389

$

608,897

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - Dec. 31, 2017

17,348

$

17,348

$

192,417

$

282,135

$

(28)

$

140,902

$

632,774

Cumulative effect of new accounting principle

 

 

 

 

 

 

(28)

 

28

 

 

 

-

Beginning balance - adjusted

 

 

 

 

 

 

282,107

 

-

 

 

 

632,774

Net income

 

 

 

 

 

 

45,835

 

 

 

16,940

 

62,775

Distributions to parent from

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

(19,000)

 

(19,000)

Ending balance - September 30, 2018

17,348

$

17,348

$

192,417

$

327,942

$

-

$

138,842

$

676,549

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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, 2018



1.

Summary of Significant Accounting Policies.


a.

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 2017 Annual Report on Form 10-K (the 2017 Annual Report on Form 10-K).


The accompanying consolidated financial statements as of September 30, 2018, 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 the 2017 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 54 through 103 of the 2017 Annual Report on Form 10-K.


b.

Cash, Cash Equivalents, and Restricted Cash – MGE Energy and MGE.


The following table presents the components of total cash, cash equivalents, and restricted cash on the consolidated balance sheets.


 

 

 

MGE Energy

 

MGE

 

 

 

 

September 30,

 

December 31,

 

September 30,

 

December 31,

 

 

(In thousands)

 

2018

 

2017

 

2018

 

2017

 

 

Cash and cash equivalents

$

133,855

$

107,952

$

47,264

$

5,951

 

 

Restricted cash

 

406

 

1,635

 

406

 

1,635

 

 

Receivable - margin account

 

780

 

2,507

 

780

 

2,507

 

 

Cash, cash equivalents, and restricted cash

$

135,041

$

112,094

$

48,450

$

10,093

 


Cash Equivalents

MGE Energy and MGE consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.


Restricted Cash

MGE has certain cash accounts that are restricted to uses other than current operations and designated for a specific purpose. MGE's restricted cash accounts include cash held by trustees for certain employee benefits and cash deposits held by third parties. These are included in "Other current assets" on the consolidated balance sheets.


Receivable – Margin Account

Cash amounts held by counterparties as margin collateral for certain financial transactions are recorded as Receivable – margin account in "Other current assets" on the consolidated balance sheets. The costs being hedged are fuel for electric generation, purchased power, and cost of gas sold.




14




The following table presents the retrospective adjustments to cash flow amounts on MGE Energy's and MGE's consolidated statements of cash flows in accordance with the adoption of ASU 2016-18, Restricted Cash.


 

 

 

Nine Months Ended

 

 

(In thousands)

 

September 30, 2017

 

 

Cash provided by operating activities

$

(2,870)

 

 

Cash used for investing activities

 

525

 

 

Change in cash, cash equivalents, and restricted cash

 

(2,345)

 

 

Cash, cash equivalents, and restricted cash at beginning of period

 

5,674

 

 

Cash, cash equivalents, and restricted cash at end of period

$

3,329

 


c.

Capitalized Software Assets – Hosting Arrangements – MGE Energy and MGE.


The FASB issued authoritative guidance of accounting for software in a hosted arrangement. MGE Energy and MGE adopted the authoritative guidance as of September 30, 2018. See Footnote 2.a. for further information.


As of September 30, 2018, and December 31, 2017, the net book value of capitalized costs of internal use software incurred in a hosting arrangement was $6.2 million and $0.5 million, respectively. As of September 30, 2018, accumulated amortization expense is less than $0.1 million. As of December 31, 2017, there was no accumulated amortization expense. Capitalized software assets for hosted arrangements and the related accumulated amortization expense are recorded in "Other deferred assets and other" on the consolidated balance sheets of MGE Energy and MGE.


For the three and nine months ended September 30, 2018, MGE recorded less than $0.1 million of amortization expense related to software assets for hosted arrangements. For the three and nine months ended September 30, 2017, no amortization expense was recorded. These costs are recognized in "Other operations and maintenance" expense in the consolidated statements of income of MGE Energy and MGE and are amortized on a straight-line basis over the estimated useful lives of the assets. Software assets for hosted arrangements have useful lives ranging from five to fifteen years.


2.

New Accounting Standards - MGE Energy and MGE.


a.

Recently Adopted


Revenue from Contracts with Customers.


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. The new standard establishes a five-step model for recognizing and measuring revenue from contracts with customers and replaces existing guidance on revenue recognition. The underlying principle is that an entity will recognize revenue to present the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services.


This authoritative guidance became effective January 1, 2018, and MGE Energy and MGE adopted the standard upon the effective date. Adoption of this standard is permitted under one of two methods: the full retrospective method or the modified retrospective method. MGE Energy and MGE implemented the standard using the modified retrospective method. The cumulative impact of this guidance on our financial statements is not material, except for additional footnote disclosures. See Footnote 3 for further information.


Financial Instruments.


In January 2016, the FASB issued authoritative guidance within the codification's Financial Instruments topic that provides guidance on the recognition and measurement of financial instruments. This authoritative guidance became effective January 1, 2018, and required equity investments to be measured at fair value with changes in fair value recognized in net income rather than in other comprehensive income. As a result of this guidance, MGE Energy and MGE will no longer have other comprehensive



15




income related to equity investments. This standard was applied using a modified retrospective approach, with a cumulative effect adjustment recorded to opening retained earnings as of the beginning of the fiscal year of adoption. As of January 1, 2018, MGE Energy recorded a $0.4 million increase in retained earnings and a corresponding decrease in accumulated other comprehensive income related to equity investments within the scope of this standard. As of January 1, 2018, MGE recorded less than a $0.1 million decrease in retained earnings and a corresponding increase in accumulated other comprehensive income related to equity investments within the scope of this standard.


Restricted Cash.


In November 2016, the FASB issued authoritative guidance within the codification's Statement of Cash Flows topic that provides guidance on the classification and presentation of changes in restricted cash within the statement of cash flows. Under the new guidance, reporting entities are required to explain the changes in the total of restricted and unrestricted cash and cash equivalents when reconciling the beginning and ending balances on the statement of cash flows. Prior to the authoritative guidance, changes in restricted cash were presented as either cash flows from operating, investing, or financing activities within the statement of cash flows based on the nature of the restriction. Reporting entities are now also required to provide a reconciliation from the balance sheet to the statement of cash flows and disclose the nature of the restrictions of cash. This authoritative guidance became effective January 1, 2018. Upon the effective date, MGE Energy and MGE changed the presentation of restricted cash on the consolidated statements of cash flows to reflect the new accounting guidance retrospectively for all periods presented. See Footnote 1.b. for further information.


Pension and Other Postretirement Benefits.


In March 2017, the FASB issued authoritative guidance within the codification's Compensation – Retirement Benefits topic that provides guidance on the presentation of net periodic pension cost and net periodic postretirement benefit cost (together, net benefit cost). This authoritative guidance became effective January 1, 2018. Under the new guidance, the service cost component of net benefit cost is required to be recorded in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside of income from operations. A practical expedient within the standard permits an employer to use the amounts disclosed in its pension and other postretirement benefit plan footnote for prior comparative periods as the estimation basis for applying the retrospective presentation requirements. MGE Energy and MGE have elected to apply the practical expedient. Upon the effective date, MGE Energy and MGE changed the presentation of net benefit cost on the consolidated statements of income to reflect the new accounting guidance retrospectively to all periods presented. For both MGE Energy and MGE, "Other operations and maintenance expense" increased and "Other income, net" increased $1.0 million and $3.0 million for the three and nine months ended September 30, 2017, respectively. The standard also only allows the service cost component to be eligible for capitalization prospectively from the effective date of the pronouncement (whereas under previous GAAP all components of net benefit cost were eligible for capitalization). See Footnote 6 for further information.


Internal-Use Software – Hosting Arrangements.


In August 2018, the FASB issued amended authoritative guidance within the codification's Intangibles – Goodwill and Other – Internal-Use Software topic. The amended authoritative guidance aligns the requirements for capitalizing implementation costs incurred in a cloud computing arrangement (hosting arrangement) that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangement that include an internal-use software license). Costs for implementation activities in the development stage are capitalized depending on the nature of the costs and presented in the same line item on the balance sheet as amounts prepaid for the hosted service. Costs incurred during the preliminary and postimplementation stages are expensed as the activities are performed. The costs capitalized as part of implementation stage should be expensed over the term of the hosting contract, which includes any renewable option periods, and presented in the same line on the income statement as the fees for the associated hosted service.


This amended authoritative guidance will become effective January 1, 2020. Early adoption of the amendment is permitted, including adoption in any interim period. Entities can choose to adopt the new guidance either prospectively, for eligible costs incurred on or after the date this guidance is first applied,



16




or retrospectively. MGE Energy and MGE early adopted these amendments retrospectively as of September 30, 2018. The cumulative impact of this guidance on our financial statement was not material, except for additional footnote disclosures. See Footnote 1.c. for further information.


b.

Recently Issued


Leases.


In February 2016, the FASB issued authoritative guidance within the codification's Leases topic that provides guidance on the classification, recognition, measurement, and disclosure of leases. The new leasing standard establishes that a lease conveys the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration. Under the new guidance, lessees will be required to recognize all leases with terms greater than one year, including operating leases, on the balance sheet by recording a right-of-use asset and lease liability. Prior to the authoritative guidance, only capital leases were recognized on the balance sheet by lessees. The new accounting guidance, as applied by lessors, is materially consistent with current GAAP. In January 2018, the FASB issued authoritative guidance which provided an optional practical expedient to grandfather the accounting for existing and expired land easements not accounted for as a lease under the new authoritative guidance. MGE Energy and MGE plan to adopt this practical expedient.


Management has begun utilizing a bottoms-up approach to analyze the impact of the standard on our lease portfolio. MGE Energy and MGE have been reviewing current accounting policies and procedures to identify potential differences in accounting treatment that would result from applying the requirements of the new standard to our existing lease portfolio. In addition, we are identifying appropriate changes to our business processes, systems, and controls to support recognition and disclosure requirements under the new standard. This authoritative guidance will become effective January 1, 2019, with early adoption permitted. MGE Energy and MGE anticipate adopting the standard upon the effective date. The new leasing standard requires entities to recognize and measure leases at the beginning of the earliest comparative period presented using a modified retrospective approach. MGE Energy and MGE expect to recognize additional lease assets and liabilities for their operating leases under the standard. MGE Energy and MGE are continuing to evaluate the impact of this pronouncement; however, we do not expect that it will have a material impact on our consolidated net income or cash flows.


3.

Revenue - MGE Energy and MGE.


Revenues disaggregated by revenue source were as follows:


 

 

 

Three Months Ended

 

Nine Months Ended

 

 

(In thousands)

 

September 30,

 

September 30,

 

 

Electric revenues

 

2018

 

2017

 

2018

 

2017

 

 

Residential

$

42,371

$

39,905

$

107,847

$

104,892

 

 

Commercial(a)

 

61,638

 

64,036

 

159,264

 

168,921

 

 

Industrial

 

3,668

 

4,555

 

11,193

 

13,286

 

 

Other-retail/municipal

 

9,431

 

10,459

 

26,245

 

29,141

 

 

    Total retail

 

117,108

 

118,955

 

304,549

 

316,240

 

 

Sales to the market

 

1,505

 

1,068

 

6,334

 

3,090

 

 

Other revenues

 

482

 

445

 

1,406

 

1,436

 

 

Adjustments to revenues

 

80

 

181

 

344

 

513

 

 

    Total electric revenues

 

119,175

 

120,649

 

312,633

 

321,279

 

 

 

 

 

 

 

 

 

 

 

 

 

Gas revenues

 

 

 

 

 

 

 

 

 

 

Residential

 

11,916

 

12,121

 

64,087

 

61,164

 

 

Commercial/Industrial(a)

 

5,570

 

5,622

 

38,728

 

36,512

 

 

    Total retail

 

17,486

 

17,743

 

102,815

 

97,676

 

 

Gas transportation

 

829

 

944

 

3,018

 

3,285

 

 

Other revenues

 

92

 

91

 

319

 

324

 

 

    Total gas revenues

 

18,407

 

18,778

 

106,152

 

101,285

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-regulated energy revenues

 

213

 

112

 

904

 

261

 

 

Total Operating Revenue(a)

$

137,795

$

139,539

 

419,689

$

422,825

 


(a)

In 2017, MGE had less than $0.1 million of revenues related to CNG vehicle fuel servicing. No revenue was recognized for fuel servicing by MGE Energy in 2017.



17




Performance Obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account. A contract's transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The majority of MGE Energy's and MGE's contracts have a single performance obligation.


Retail Revenue (Residential, Commercial, Industrial, and Other Retail/Municipal)

Retail revenue of electric and gas utility service represent MGE's core business activities. Tariffs are approved by the PSCW through a rate order and provide MGE's customers with the standard terms and conditions, including pricing terms. The performance obligation to deliver electricity or gas is satisfied over time as the customer simultaneously receives and consumes the commodities provided by MGE. MGE recognizes revenues as the commodity is delivered to customers. Meters are read on a systematic basis throughout the month based on established meter-reading schedules and the customer is subsequently billed for their services. At the end of the month, MGE accrues an estimate for the unbilled amount of commodities delivered to customers. The unbilled revenue estimate is based on daily system demand volumes, weather factors, estimated line losses, estimated customer usage by class, and applicable customer rates.


Utility Cost Recovery Mechanisms

MGE's tariff rates include a provision for fuel cost recovery. The PSCW allows Wisconsin utilities to defer electric fuel-related costs, less excess revenues, that fall outside a symmetrical cost tolerance band. Any over/under recovery of the actual costs in a given year is determined in the following year and is then reflected in future billings to electric retail customers. Over-collection of fuel-related costs that are outside the approved range will be recognized as a reduction of revenue. Prior to adoption of the new revenue recognition guidance, effective January 1, 2018, over-collected fuel-related costs were reflected in "Purchased power" expense. Under-collection of these costs will continue to be recognized in "Purchased power" expense in the consolidated statements of income of MGE Energy and MGE. The cumulative effects of these deferred amounts will be recorded in "Regulatory assets" or "Regulatory liabilities" on the consolidated balance sheets of MGE Energy and MGE until they are reflected in future billings to customers. See Footnote 10.b. for further information.


MGE received a PSCW order in January 2018 to defer the over-collection of income tax expense collected in customer rates as a result of the Tax Cuts and Jobs Act (the Tax Act) reduction in the income tax rate to 21 percent. See Footnote 5 for further information.


MGE has other cost recovery mechanisms. For example, any over-collection of the difference between actual costs incurred and the amount of costs collected from customers is recorded as a reduction of revenue in the period incurred.


Sales to the Market

Sales to the market include energy charges, capacity or demand charges, and ancillary charges represented by wholesale sales of electricity made to third parties who are not ultimate users of the electricity. Most of these sales are spot market transactions on the markets operated by MISO. Each transaction is considered a performance obligation and revenue is recognized in the period in which energy charges, capacity or demand charges, and ancillary services are sold into MISO. MGE reports, on a net basis, transactions on the MISO markets in which it buys and sells power within the same hour to meet electric energy delivery requirements.


Transportation of Gas

MGE has contracts under which MGE provides gas transportation services to customers who have elected to purchase gas from a third party and have the gas delivered via pipelines within MGE's service territory. Revenue is recognized as service is rendered or gas is delivered to customers. Tariffs are approved by the PSCW through a rate order and provide gas transportation customers with the standard terms and conditions, including pricing terms.


4.

Investment in ATC and ATC Holdco - 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, since December 1, 2016, is owned by MGE Energy. ATC Holdco was formed by several members of ATC, including MGE Energy, to pursue electric transmission development and investments outside of Wisconsin. The ownership interest in ATC Holdco is held by MGEE Transco, a wholly-owned subsidiary of MGE Energy.



18




As of September 30, 2018, and December 31, 2017, MGE Transco held a 3.6% ownership interest in ATC. As of September 30, 2018, and December 31, 2017, MGEE Transco held a 4.4% ownership interest in ATC Holdco.


MGE Transco and MGEE Transco have accounted for their investments in ATC and ATC Holdco, respectively, under the equity method of accounting. Equity earnings from investments are recorded as "Other income" on the consolidated statements of income of MGE Energy. For the three and nine months ended September 30, 2018 and 2017, MGE Transco recorded the following:


 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

 

September 30,

 

September 30,

 

 

(In thousands)

 

2018

 

2017

 

2018

 

2017

 

 

Equity earnings from investment in ATC

$

1,672

$

2,338

$

6,113

$

7,432

 

 

Dividends from ATC(a)

 

1,581

 

2,070

 

4,540

 

4,070

 

 

Capital contributions to ATC

 

533

 

710

 

2,308

 

3,018

 


(a)

MGE Transco recorded a $2.3 million and $2.1 million dividend receivable from ATC as of December 31, 2017 and 2016, respectively. A cash dividend was received in January of each of the proceeding years. MGE Transco recorded a $1.6 million dividend receivable from ATC as of September 30, 2018. A cash dividend was received in October 2018.


ATC Holdco was formed in December 2016. In the near term, it is expected that ATC Holdco will be pursuing transmission development opportunities that typically have long development and investment lead times before becoming operational. During the three and nine months ended September 30, 2018, MGEE Transco recorded capital contributions of $0.1 million and $0.3 million, respectively, to ATC Holdco. During the nine months ended September 30, 2017, MGEE Transco recorded capital contributions of $0.7 million to ATC Holdco. During the three months ended September 30, 2017, MGEE Transco recorded no capital contributions to ATC Holdco.


In October 2018, MGE Transco made a $0.5 million capital contribution to ATC and MGEE Transco made a $0.1 million contribution to ATC Holdco.


ATC's summarized financial data for the three and nine months ended September 30, 2018 and 2017, is as follows:


 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

 

September 30,

 

September 30,

 

 

(In thousands)

 

2018

 

2017

 

2018

 

2017

 

 

Operating revenues

$

170,341

$

171,123

$

501,276

$

522,402

 

 

Operating expenses

 

(87,959)

 

(85,372)

 

(264,326)

 

(251,042)

 

 

Other income, net

 

439

 

1,272

 

2,070

 

3,043

 

 

Interest expense, net

 

(27,754)

 

(28,440)

 

(82,411)

 

(81,690)

 

 

Earnings before members' income taxes

$

55,067

$

58,583

$

156,609

$

192,713

 


MGE receives transmission and other related services from ATC. During the three and nine months ended September 30, 2018, MGE recorded $7.2 million and $21.7 million, respectively, for transmission services received compared to $7.3 million and $21.9 million for the comparable periods in 2017. MGE also provides a variety of operational, maintenance, and project management services for ATC, which is reimbursed by ATC. As of September 30, 2018, and December 31, 2017, MGE had a receivable due from ATC of $0.1 million and $0.2 million, respectively.


5.

Taxes - MGE Energy and MGE.


Effective Tax Rate.


On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act. The Tax Act makes broad and complex changes to the U.S. tax code, including the reduction in the U.S. federal corporate tax rate from 35 to 21 percent, effective January 1, 2018. MGE Energy and MGE recorded a provisional decrease in deferred tax assets and deferred tax liabilities as of December 31, 2017. In accordance with Staff Accounting Bulletin 118, any subsequent adjustment to these amounts will be recorded in the fourth quarter of 2018 when the analysis is complete. No adjustments have been recorded during 2018. Beginning January 1, 2018, MGE began amortizing the regulated utility excess

deferred taxes recognized using a normalization method of accounting. For the three and nine months ended



19




September 30, 2018, MGE recognized $0.7 million and $1.9 million, respectively, of excess deferred taxes as a reduction of revenue and a corresponding increase in a regulatory liability. The amount and timing of the cash impacts will depend on the period over which certain income tax benefits are provided to customers, which will be determined by the PSCW.


Customer rates approved for 2018 reflect an income tax rate of 35 percent. In January 2018, the PSCW issued an order directing Wisconsin investor-owned utilities to defer the over-collection of income tax expense as a result of the decrease in tax rate to 21 percent. The PSCW issued an order in May 2018 to return to customers the estimated 2018 over-collection of income tax expense. The decision includes a one-time bill credit on customer bills to reflect the estimate of the over-collection for January through June 2018, along with a monthly volumetric bill credit which began in July 2018 and continues through the remainder of 2018 for the estimated remaining annual amount. As of September 30, 2018, MGE returned $5.9 million to customers through bill credits. Any over/under recovery of the actual costs will be subject to the PSCW's review in a future rate case. As of September 30, 2018, MGE has deferred $2.6 million as a regulatory liability and recorded a corresponding reduction in operating revenues for over-collection of income tax expense (net of customer bill credits).


The consolidated income tax provision differs from the amount computed by applying the statutory federal income tax rate to income before income taxes, as follows:


 

 

MGE Energy

 

MGE

 

 

Three Months Ended September 30,

2018

 

2017

 

2018

 

2017

 

 

Statutory federal income tax rate

21.0 %

 

35.0 %

 

21.0 %

 

35.0 %

 

 

State income taxes, net of federal benefit

6.3 %

 

5.2 %

 

6.2 %

 

5.1 %

 

 

Amortized investment tax credits

(0.1)%

 

(0.3)%

 

(0.1)%

 

(0.4)%

 

 

Credit for electricity from wind energy

(0.3)%

 

(1.1)%

 

(0.2)%

 

(1.1)%

 

 

Domestic manufacturing deduction

-%

 

(1.5)%

 

-%

 

(1.4)%

 

 

AFUDC equity, net

(0.6)%

 

(0.1)%

 

(0.6)%

 

(0.1)%

 

 

Amortization of utility excess deferred tax - tax reform(a)

(1.8)%

 

-%

 

(1.8)%

 

-%

 

 

Other, net, individually insignificant

-%

 

(0.3)%

 

0.1 %

 

(0.4)%

 

 

Effective income tax rate

24.5 %

 

36.9 %

 

24.6 %

 

36.7 %

 

 

 

 

 

 

 

 

 

 

 

 

 

MGE Energy

 

MGE

 

 

Nine Months Ended September 30,

2018

 

2017

 

2018

 

2017

 

 

Statutory federal income tax rate

21.0 %

 

35.0 %

 

21.0 %

 

35.0 %

 

 

State income taxes, net of federal benefit

6.3 %

 

5.2 %

 

6.2 %

 

5.1 %

 

 

Amortized investment tax credits

(0.1)%

 

(0.3)%

 

(0.1)%

 

(0.4)%

 

 

Credit for electricity from wind energy

(0.3)%

 

(1.3)%

 

(0.3)%

 

(1.4)%

 

 

Domestic manufacturing deduction

-%

 

(1.6)%

 

-%

 

(1.7)%

 

 

AFUDC equity, net

(0.8)%

 

(0.2)%

 

(0.8)%

 

(0.2)%

 

 

Amortization of utility excess deferred tax - tax reform(a)

(1.8)%

 

-%

 

(2.0)%

 

-%

 

 

Other, net, individually insignificant

-%

 

(0.2)%

 

0.1 %

 

(0.1)%

 

 

Effective income tax rate

24.3 %

 

36.6 %

 

24.1 %

 

36.3 %

 


(a)

Included are impacts of the Tax Act for the regulated utility for excess deferred taxes recognized using a normalization method of accounting.


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 components of net periodic benefit cost, other than the service cost component, are recorded in "Other income, net" on the consolidated statements of income. The service cost component is recorded in "Other operations and maintenance" on the consolidated statements of income. Prior to January 1, 2018, a portion of all net periodic benefit cost components were capitalized within the consolidated balance sheets. The FASB issued authoritative guidance within the codification's Compensation-Retirement Benefits topic that, beginning January 1, 2018, only allows the service cost component of net periodic benefit cost to be eligible for capitalization within the consolidated balance sheets. MGE has regulatory treatment and recognizes regulatory assets or liabilities for timing differences between when net periodic benefit costs are recovered and when costs are recognized.



20




The following table presents the components of net periodic benefit costs recognized for the three and nine months ended September 30, 2018 and 2017.


 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

 

September 30,

 

September 30,

 

 

(In thousands)

 

2018

 

2017

 

2018

 

2017

 

 

Pension Benefits

 

 

 

 

 

 

 

 

 

 

Components of net periodic benefit cost:

 

 

 

 

 

 

 

 

 

 

    Service cost

$

1,431

$

1,351

$

4,292

$

4,043

 

 

    Interest cost

 

3,215

 

3,168

 

9,645

 

9,481

 

 

    Expected return on assets

 

(6,560)

 

(5,762)

 

(19,680)

 

(17,244)

 

 

Amortization of:

 

 

 

 

 

 

 

 

 

 

    Prior service credit

 

(11)

 

(4)

 

(33)

 

(12)

 

 

    Actuarial loss

 

1,319

 

1,594

 

3,958

 

4,769

 

 

Net periodic benefit (credit) cost

$

(606)

$

347

$

(1,818)

$

1,037

 

 

 

 

 

 

 

 

 

 

 

 

 

Postretirement Benefits

 

 

 

 

 

 

 

 

 

 

Components of net periodic benefit cost:

 

 

 

 

 

 

 

 

 

 

    Service cost

$

320

$

315

$

962

$

944

 

 

    Interest cost

 

653

 

678

 

1,959

 

2,034

 

 

    Expected return on assets

 

(808)

 

(722)

 

(2,424)

 

(2,165)

 

 

Amortization of:

 

 

 

 

 

 

 

 

 

 

    Transition obligation

 

1

 

1

 

2

 

2

 

 

    Prior service credit

 

(667)

 

(667)

 

(2,001)

 

(2,001)

 

 

    Actuarial loss

 

122

 

190

 

366

 

570

 

 

Net periodic benefit (credit) cost

$

(379)

$

(205)

$

(1,136)

$

(616)

 


7.

Equity and Financing Arrangements - MGE Energy.


a.

Common Stock.


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 three and nine months ended September 30, 2018 and 2017, MGE Energy did not issue any new shares of common stock under the Stock Plan.


b.

Dilutive Shares Calculation.


MGE Energy does not have any stock option or stock award programs or any dilutive securities.


c.

Long-term Debt - MGE Energy and MGE.


In July 2018, MGE issued $20 million of new long-term unsecured debt carrying an interest rate of 4.24% per annum over its 35-year term and $20 million of new long-term unsecured debt carrying an interest rate of 4.34% per annum over its 40-year term. In September 2018, MGE issued $60 million of new long-term unsecured debt carrying an interest rate of 4.19% per annum over its 30-year term. MGE used the net proceeds from these debt financings to assist with financing capital expenditures, such as the Saratoga Wind Farm, and to refinance $20 million of long-term debt which matured in September 2018. The covenants of the new long-term unsecured debt are substantially consistent with MGE's existing unsecured long-term debt.


8.

Share-Based Compensation - MGE Energy and MGE.


Under MGE Energy's Director Incentive Plan and its Performance Unit Plan, non-employee directors and eligible employees, respectively, 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 performance period set in the award.




21




In 2018, 5,810 units were granted under the Director Incentive Plan and are subject to a three-year graded vesting schedule, and 17,830 units were granted under the Performance Unit Plan and are subject to a five-year graded vesting schedule. On the grant date, the cost of the director or employee services received in exchange for a performance unit award is measured based on the current market value of MGE Energy common stock. The fair value of the awards is remeasured quarterly, including as of September 30, 2018, as required by applicable accounting standards. Changes in fair value as well as the original grant are recognized as compensation cost. Since this amount is remeasured throughout the vesting period, the compensation cost is subject to variability.


For nonretirement eligible employees under the Performance Unit Plan, 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 as retirement eligibility accelerates vesting.


During the three and nine months ended September 30, 2018, MGE recorded $0.3 million and $1.3 million, respectively, in compensation expense as a result of awards under the plans compared to $0.3 million and $1.0 million for the comparable periods in 2017. In January 2018, cash payments of $1.6 million were distributed relating to awards that were granted under the plans. No forfeitures of units occurred during the three and nine months ended September 30, 2018 and 2017. As of September 30, 2018, $5.5 million of outstanding awards are vested. Of this amount, no cash settlements have occurred as cash payments are only made at the end of the period covered by the awards.


9.

Commitments and Contingencies.


a.

Environmental - MGE Energy and MGE.


MGE Energy and MGE are subject to frequently changing local, state, and federal regulations concerning air quality, water quality, land use, threatened and endangered species, hazardous materials handling, and solid waste disposal. These regulations affect the manner in which they conduct their operations, the costs of those operations, as well as capital and operating expenditures. Several of these environmental rules are subject to legal challenges, reconsideration and/or other uncertainties. 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. Management believes compliance costs will be recovered in future rates based on previous treatment of environmental compliance projects. These initiatives, proposed rules, and court challenges include:


The EPA's published water effluent limitations guidelines and standards for steam electric power plants, which focus on the reduction of metals and other pollutants in wastewater from new and existing power plants, such as the coal-burning plants at Columbia and the Elm Road Units.


The EPA's cooling water intake rules, which require cooling water intake structures at electric power plants, such as our WCCF, Blount, and Columbia plants, to 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.


Greenhouse Gas (GHG) reduction guidelines and approval criteria established under the Clean Air Act for states to use in developing plans to control GHG emissions from existing fossil fuel-fired electric generating units (EGUs). In 2015, the EPA finalized the Clean Power Plan (CPP) which directed states to submit plans to reduce GHG emissions from the electric generation sector. In February 2016, the U.S. Supreme Court stayed implementation of the CPP and the stay remains in effect. In October 2017, the EPA issued a proposed rule to repeal the CPP. In August 2018, the EPA proposed the Affordable Clean Energy (ACE) rule which would replace the CPP, if successfully implemented. The ACE proposal directs states to submit plans to the EPA for approval that implement standards of performance (called Best System of Emissions Reductions, or BSER) for individual EGUs over 25 MW. ACE defines BSER as on-site, heat-rate efficiency improvements, whereas the CPP defines BSERs using carbon dioxide emission performance rates. Simple cycle units such as our smaller combustion units, and combined cycle units such as our WCCF are exempt from the proposed rule. If a state fails to prepare a plan, or their plan is not approved by the EPA a federal implementation plan (FIP) will be issued for that state. The proposed ACE as it is currently written has the potential to impact our Blount Generating Station, Columbia, and Elm Road Units.




22




MGE cannot yet determine with any certainty the impact of the proposed ACE rule on our operations. MGE previously determined that if the CPP were to be implemented in its present form, it would have a material impact on MGE. MGE will continue to monitor developments with the proposed ACE rule and the CPP rule and litigation.


The EPA's rule to regulate ambient levels of ozone through the 2015 Ozone National Ambient Air Quality Standards (NAAQS). On May 1, 2018, EPA issued a final rule which designated the northeast portion of Milwaukee County as being in nonattainment with this NAAQS. The Elm Road Units are located in Milwaukee County, yet outside the designated nonattainment area. In August 2018, several environmental groups, the City of Chicago and the State of Illinois filed federal lawsuits challenging the EPA's attainment designation decisions, including the partial Milwaukee County designation as being too narrow and not sufficiently protective. MGE is monitoring the outcome of this lawsuit and how it may affect our Elm Road Units in Milwaukee County. At this time MGE expects that the 2015 Ozone NAAQS will not have a material effect on its existing plants based on final designations.


The State of Wisconsin has joined a lawsuit filed by several states challenging the EPA's 2015 Ozone NAAQS, alleging that the new standard is not attainable and the EPA is not properly considering background levels in setting its ozone attainment levels. The lawsuit is ongoing; however, the significance of the challenge, as it might relate to MGE, is now diminished with the final ozone attainment designations.


Rules regulating nitrogen oxide (NOx) and sulfur dioxide (SO2) emissions, including the Cross State Air Pollution Rule (CSAPR), CSAPR Update Rule and Clean Air Visibility Rule (CAVR). At this time, regulatory obligations, compliance strategies, and costs remain unclear due to uncertainties surrounding the ongoing implementation of Phase II of CSAPR and the continued legal challenges surrounding CSAPR, the CSAPR Update Rule and CAVR.


The EPA's Coal Combustion Residuals Rule (CCR), which regulates coal ash from burning coal for the purpose of generating electricity as a solid waste, and defines what ash use activities would be considered generally exempt beneficial reuse of coal ash. The CCR rule also regulates landfills, ash ponds, and other surface impoundments used for coal combustion residuals by regulating their design, location, monitoring, and operation. Review of our Elm Road Units has indicated that the costs to comply with this rule are not expected to be significant. Columbia's operator has completed a review of their system and has determined that an onsite ash pond will need to be closed and replaced with a dry ash handling system. The dry ash handling system installation is planned for 2020-2021. In July 2018, the EPA published a final rule that included amendments to the CCR (which include the allowance of alternative performance standards for landfills and surface impoundments, revised risk-based groundwater protection standards, and an extension of the deadline by which certain facilities must cease the placement of waste in CCR units). In August 2018, the Court of Appeals for the D.C. Circuit vacated parts of the CCR for not being sufficiently protective of the environment. It is unclear how the EPA will respond to that decision. MGE will continue to monitor potential rule modifications to assess potential impacts on our operations.


In 2015, MGE recorded an asset retirement obligation for its share of the legal liability associated with the effect of the CCR. Actual costs of compliance may be different than the amount recorded due to potential changes in compliance strategies that will be used, as well as other potential cost estimate changes.


b.

Legal Matters - MGE Energy and MGE.


MGE is involved in various legal matters that are being defended and handled in the normal course of business. MGE maintains accruals for such costs that are probable of being incurred and subject to reasonable estimation. The accrued amount for these matters is not material to the financial statements. MGE does not expect the resolution of these matters to have a material adverse effect on its consolidated results of operations, financial condition, or cash flows.




23




c.

Purchase Contracts - MGE Energy and MGE.


MGE Energy and MGE have entered into various commodity supply, transportation, and storage contracts to meet their obligations to deliver electricity and natural gas to customers. Management expects to recover these costs in future customer rates. The following table shows future commitments related to purchase contracts as of September 30, 2018:


 

(In thousands)

 

2018

 

2019

 

2020

 

2021

 

2022

 

Thereafter

 

 

Coal(a)

$

6,716

$

21,188

$

8,434

$

828

$

-

$

-

 

 

Natural gas supply(b)

 

12,245

 

13,287

 

-

 

-

 

-

 

-

 

 

Saratoga wind(c)

 

1,006

 

858

 

2,266

 

1,775

 

1,784

 

4,459

 

 

Other

 

1,772

 

502

 

502

 

502

 

502

 

502

 

 

 

$

21,739

$

35,835

$

11,202

$

3,105

$

2,286

$

4,961

 


(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.


(b)

These commitments include market-based pricing.


(c)

In December 2017, the PSCW authorized construction of a 66MW wind farm, consisting of 33 turbines, located near Saratoga, Iowa. MGE received specific approval to recover 100% AFUDC on the project. As of September 30, 2018, MGE has incurred $66.5 million of capital expenditures. After tax, MGE has recognized $0.6 million and $1.3 million, respectively, in AFUDC equity related to this project for the three and nine months ended September 30, 2018. Construction of the project is expected to be completed by early 2019, with an estimated capital cost of $108 million.


d.

Other Commitments - MGE Energy.


In September 2018, MGE Energy entered into two subscription agreements to invest in nonpublic venture capital funds. From time to time, these funds make capital calls to their investors. MGE Energy has committed to contribute $2.3 million in capital for such capital calls. The timing of these capital calls is dependent on the needs of the funds and is therefore uncertain at this time.


10.

Rate Matters - MGE Energy and MGE.


a.

Rate Proceedings.


In July 2018, MGE filed an application with the PSCW to adjust electric and gas rates for 2019 and 2020. MGE filed its application through a settlement agreement between MGE and intervening parties in the rate case, subject to PSCW approval. The settlement proposal would decrease electric rates by 1.94% in 2019. This amount is subject to change based on the final outcome of MGE's 2019 Fuel Cost Plan. MGE will maintain this rate level for 2020, with the exception that MGE will file a 2020 Fuel Cost Plan in 2019 and MGE's electric rates will be adjusted accordingly. The decrease reflects the ongoing tax impacts of the Tax Act and the addition of lower-cost renewable generation capacity. The settlement agreement increases gas rates by 1.06% in 2019 and 1.46% in 2020. The requested gas increase covers infrastructure costs. It also reflects the impacts of the Tax Act. The return on common stock equity for 2019 and 2020 will be 9.8% based on a capital structure consisting of 56.6% common equity in 2019 and 56.1% common equity in 2020.


In December 2016, the PSCW authorized MGE, effective January 1, 2017, to decrease 2017 rates for retail electric customers by 0.8% or $3.3 million on an annual basis and to increase rates for retail gas customers by 1.9% or $3.1 million on an annual basis. The decrease in retail electric rates was attributable to declining fuel and purchased power costs. The increase in retail gas rates covers costs associated with MGE's natural gas system infrastructure improvements. The authorized return on common stock equity for 2017 was 9.8% based on a capital structure consisting of 57.2% common equity.


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 in the following year and is then reflected in future billings to electric retail customers. The fuel rules bandwidth is currently set at plus or minus 2%.



24




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 July 2017, the PSCW issued a final order in the fuel rules proceedings requiring MGE to refund additional fuel savings realized during 2015 and 2016 to its retail electric customers over a one-month period. In October 2017, MGE returned $6.2 million to customers through bill credits.


In December 2017, the PSCW approved a surcharge for 2018 electric fuel-related costs. The surcharge will increase electric retail revenue in 2018 by $0.5 million or 0.1%.


In August 2018, the PSCW issued a final decision in the fuel rules proceedings for MGE to refund $4.2 million of additional fuel savings realized during 2017 to its retail electric customers over a one-month period in October 2018. There was no change to the refund in the fuel rules proceedings from the amount MGE deferred as of December 31, 2017.


As of September 30, 2018, MGE has deferred $7.2 million of 2018 fuel savings. The 2018 fuel savings will be subject to the PSCW's annual review of 2018 fuel costs, expected to be completed in 2019. As of December 31, 2017, MGE had deferred $4.2 million of 2017 fuel savings.


11.

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, the derivatives are recognized in the consolidated balance sheets at fair value. MGE's financial 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 depending on whether the derivative is in a net loss or net gain position, respectively. 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, 2018

 

December 31, 2017

 

 

Commodity derivative contracts

482,450 MWh

 

552,310 MWh

 

 

Commodity derivative contracts

8,557,000 Dth

 

5,460,000 Dth

 

 

FTRs

3,681 MW

 

2,226 MW

 

 

PPA

2,200 MW

 

2,650 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 financial transmission rights (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



25




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. As of September 30, 2018, and December 31, 2017, the fair value of exchange traded derivatives and FTRs exceeded their cost basis by $1.6 million and $0.2 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 as of September 30, 2018, and December 31, 2017, reflects a loss position of $36.3 million and $42.2 million, respectively. The actual cost will be recognized in purchased power expense in the month of purchase.


The following table summarizes the fair value of the derivative instruments on the 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, instruments are netted with the same counterparty under a master netting agreement as well as the netting of collateral. As of September 30, 2018, and December 31, 2017, the receivable margin account balance of $0.8 million and $2.5 million, respectively, is shown net of any collateral posted against derivative positions.


 

 

 

Derivative

 

Derivative

 

 

 

 

(In thousands)

 

Assets

 

Liabilities

 

Balance Sheet Location

 

 

September 30, 2018

 

 

 

 

 

 

 

 

Commodity derivative contracts(a)

$

1,363

$

232

 

Other current assets

 

 

Commodity derivative contracts(a)

 

86

 

55

 

Other deferred charges

 

 

FTRs

 

478

 

-

 

Other current assets

 

 

PPA

 

N/A

 

9,350

 

Derivative liability (current)

 

 

PPA

 

N/A

 

26,920

 

Derivative liability (long-term)

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

Commodity derivative contracts(a)

$

566

$

603

 

Derivative liability (current)(b)

 

 

Commodity derivative contracts(a)

 

110

 

190

 

Derivative liability (long-term)

 

 

FTRs

 

329

 

-

 

Other current assets

 

 

PPA

 

N/A

 

8,180

 

Derivative liability (current)

 

 

PPA

 

N/A

 

33,990

 

Derivative liability (long-term)

 


(a)

As of December 31, 2017, collateral of $0.1 million was posted against and netted with derivative liability positions on the consolidated balance sheets. No collateral was posted against derivative positions as of September 30, 2018.


(b)

As of December 31, 2017, MGE presented $0.1 million as other current assets on the consolidated balance sheets.




26




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 Sheets

 

Collateral Posted Against Derivative Positions

 

Net Amount Presented in Balance Sheets

 

 

September 30, 2018

 

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

1,449

$

(287)

$

-

$

1,162

 

 

FTRs

 

478

 

-

 

-

 

478

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

676

$

(654)

$

-

$

22

 

 

FTRs

 

329

 

-

 

-

 

329

 


 

Offsetting of Derivative Liabilities

 

 

(In thousands)

 

Gross Amounts

 

Gross Amounts Offset in Balance Sheets

 

Collateral Posted Against Derivative Positions

 

Net Amount Presented in Balance Sheets

 

 

September 30, 2018

 

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

287

$

(287)

$

-

$

-

 

 

PPA

 

36,270

 

-

 

-

 

36,270

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

793

$

(654)

$

(139)

$

-

 

 

PPA

 

42,170

 

-

 

-

 

42,170

 


The following tables summarize the unrealized and realized gains (losses) related to the derivative instruments on the consolidated balance sheets as of September 30, 2018 and 2017, and the consolidated statements of income for the three and nine months ended September 30, 2018 and 2017.


 

 

2018

 

 

2017

(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,

$

36,924

$

640

 

$

45,316

$

618

Unrealized gain

 

(2,007)

 

-

 

 

(1,277)

 

-

Realized (loss) gain reclassified to a deferred account

 

(316)

 

316

 

 

(313)

 

313

Realized gain (loss) reclassified to income statement

 

29

 

(62)

 

 

(1,450)

 

(57)

Balance at September 30,

$

34,630

$

894

 

$

42,276

$

874

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30:

 

 

 

 

 

 

 

 

 

Balance at January 1,

$

41,958

$

806

 

$

49,281

$

230

Unrealized gain

 

(5,906)

 

-

 

 

(3,698)

 

-

Realized (loss) gain reclassified to a deferred account

 

(837)

 

837

 

 

(935)

 

935

Realized loss reclassified to income statement

 

(585)

 

(749)

 

 

(2,372)

 

(291)

Balance at September 30,

$

34,630

$

894

 

$

42,276

$

874




27





 

 

Realized Losses (Gains)

 

 

2018

 

 

2017

(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

$

(145)

$

-

 

$

362

$

18

FTRs

 

(150)

 

-

 

 

(224)

 

-

PPA

 

328

 

-

 

 

1,351

 

-

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30:

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

39

$

637

 

$

764

$

227

FTRs

 

(625)

 

-

 

 

(1,349)

 

-

PPA

 

1,283

 

-

 

 

3,021

 

-


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, 2018, 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, 2018, no counterparties were in a net liability position. As of December 31, 2017, certain counterparties were in a net liability position of $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, 2018, no counterparties have defaulted.


12.

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.


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 long-term debt is based on quoted market prices for similar financial instruments. Since long-term debt is not traded in an active market, it is classified as Level 2.




28




The estimated fair market value of financial instruments are as follows:


 

 

 

September 30, 2018

 

December 31, 2017

 

 

(In thousands)

 

Carrying Amount

 

Fair Value

 

Carrying Amount

 

Fair Value

 

 

MGE Energy

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

    Cash and cash equivalents

$

133,855

$

133,855

$

107,952

$

107,952

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

    Short-term debt - commercial paper

 

-

 

-

 

4,000

 

4,000

 

 

    Long-term debt(a)

 

503,553

 

523,075

 

426,883

 

475,282

 

 

 

 

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

    Cash and cash equivalents

$

47,264

$

47,264

$

5,951

$

5,951

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

    Short-term debt - commercial paper

 

-

 

-

 

4,000

 

4,000

 

 

    Long-term debt(a)

 

503,553

 

523,075

 

426,883

 

475,282

 


(a)

Includes long-term debt due within one year. Excludes debt issuance costs and unamortized discount of $4.6 million and $4.3 million as of September 30, 2018, and December 31, 2017, respectively.


b.

Recurring Fair Value Measurements.


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


 

 

 

Fair Value as of September 30, 2018

 

 

(In thousands)

 

Total

 

Level 1

 

Level 2

 

Level 3

 

 

MGE Energy

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

1,927

$

824

$

-

$

1,103

 

 

    Exchange-traded investments

 

1,005

 

1,005

 

-

 

-

 

 

    Total Assets

$

2,932

$

1,829

$

-

$

1,103

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

36,557

$

140

$

-

$

36,417

 

 

    Deferred compensation

 

2,985

 

-

 

2,985

 

-

 

 

    Total Liabilities

$

39,542

$

140

$

2,985

$

36,417

 

 

 

 

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

1,927

$

824

$

-

$

1,103

 

 

    Exchange-traded investments

 

70

 

70

 

-

 

-

 

 

    Total Assets

$

1,997

$

894

$

-

$

1,103

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

36,557

$

140

$

-

$

36,417

 

 

    Deferred compensation

 

2,985

 

-

 

2,985

 

-

 

 

    Total Liabilities

$

39,542

$

140

$

2,985

$

36,417

 

 

 

 

 

 

 

 

 

 

 

 



29





 

 

 

Fair Value as of December 31, 2017

 

 

(In thousands)

 

Total

 

Level 1

 

Level 2

 

Level 3

 

 

MGE Energy

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

1,005

$

278

$

-

$

727

 

 

    Exchange-traded investments

 

792

 

792

 

-

 

-

 

 

    Total Assets

$

1,797

$

1,070

$

-

$

727

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net(b)

$

42,963

$

210

$

-

$

42,753

 

 

    Deferred compensation

 

3,065

 

-

 

3,065

 

-

 

 

    Total Liabilities

$

46,028

$

210

$

3,065

$

42,753

 

 

 

 

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

1,005

$

278

$

-

$

727

 

 

    Exchange-traded investments

 

64

 

64

 

-

 

-

 

 

    Total Assets

$

1,069

$

342

$

-

$

727

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net(b)

$

42,963

$

210

$

-

$

42,753

 

 

    Deferred compensation

 

3,065

 

-

 

3,065

 

-

 

 

    Total Liabilities

$

46,028

$

210

$

3,065

$

42,753

 


(b)

These amounts are shown gross and exclude $0.1 million of collateral that was posted against derivative positions with counterparties as of December 31, 2017.


No transfers were made in or out of Level 1 or Level 2 for the nine months ended September 30, 2018.


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


Derivatives include exchange-traded derivative contracts, over-the-counter transactions, a 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 considered unobservable and classified as Level 3. Transactions done with an over-the-counter party are on inactive markets and are therefore classified as Level 3. These transactions are valued based on quoted prices from markets with similar exchange-traded transactions. FTRs are priced based upon monthly auction results for identical or similar instruments in a closed market with limited data available and are therefore classified as Level 3.


The purchased power agreement (see Footnote 11) 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. 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.




30




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


 

 

 

Model Input

 

Significant Unobservable Inputs

 

September 30, 2018

 

December 31, 2017

 

Basis adjustment:

 

 

 

 

 

    On peak

 

91.9%

 

92.3%

 

    Off peak

 

93.2%

 

94.1%

 

Counterparty fuel mix:

 

 

 

 

 

    Internal generation

 

50% - 75%

 

55% - 75%

 

    Purchased power

 

50% - 25%

 

45% - 25%


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


The following table summarizes the changes in Level 3 commodity derivative assets and liabilities measured at fair value on a recurring basis.


 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30,

 

September 30,

(In thousands)

 

2018

 

2017

 

2018

 

2017

Beginning balance

$

(37,332)

$

(45,605)

$

(42,026)

$

(50,305)

Realized and unrealized gains (losses):

 

 

 

 

 

 

 

 

    Included in regulatory assets

 

2,018

 

2,846

 

6,711

 

7,547

    Included in other comprehensive income

 

-

 

-

 

-

 

-

    Included in earnings

 

26

 

(1,478)

 

(434)

 

(2,614)

    Included in current assets

 

(25)

 

(14)

 

(496)

 

(111)

Purchases

 

5,736

 

6,299

 

17,602

 

18,481

Sales

 

-

 

-

 

-

 

-

Issuances

 

-

 

-

 

-

 

-

Settlements

 

(5,737)

 

(4,807)

 

(16,671)

 

(15,757)

Transfers in and/or out of Level 3

 

-

 

-

 

-

 

-

Balance as of September 30,

$

(35,314)

$

(42,759)

$

(35,314)

$

(42,759)

Total gains (losses) included in earnings attributed to

 

 

 

 

 

 

 

 

the change in unrealized gains (losses) related to

 

 

 

 

 

 

 

 

assets and liabilities held at September 30,(c)

$

-

$

-

$

-

$

-


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 (c).


 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

 

September 30,

 

September 30,

 

 

(In thousands)

 

2018

 

2017

 

2018

 

2017

 

 

Purchased Power Expense

$

26

$

(1,460)

$

(637)

$

(2,377)

 

 

Cost of Gas Sold Expense

 

-

 

(18)

 

203

 

(237)

 

 

Total

$

26

$

(1,478)

$

(434)

$

(2,614)

 


(c)

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.




31




13.

Joint Plant Ownership - MGE Energy and MGE.


a.

Columbia.


In 2016, MGE and WPL negotiated an amendment to the existing Columbia joint operating agreement that has been approved by the PSCW. Under the terms of the amendments, MGE has reduced its obligation to pay certain capital expenditures (other than SCR-related expenditures) at Columbia in exchange for a proportional reduction in MGE's ownership in Columbia. On January 1 of each year from 2017 through 2019 and then on June 1, 2020, the ownership percentage is adjusted through a partial sale based on the amount of capital expenditures foregone. In June 2017, the FERC approved the ownership transfer in Columbia, effective January 1, 2017.


During 2017, MGE accrued $8.8 million of 2017 foregone capital expenditures as part of the ownership transfer agreement with WPL. As of December 31, 2017, MGE classified $8.8 million of Columbia assets as held-for-sale on the consolidated balance sheets. In January 2018, MGE reduced its ownership interest in Columbia from 20.4% to 19.4% as a result of the partial sale of plant assets to WPL.


During the three and nine months ended September 30, 2018, MGE accrued $0.4 million and $1.8 million, respectively, of 2018 foregone capital expenditures as part of the ownership transfer agreement. As of September 30, 2018, MGE classified $1.8 million of Columbia assets as held-for-sale on the consolidated balance sheets. The assets recognized as held-for-sale are covered by the ownership transfer agreement relating to the sale of plant assets to WPL, and are expected to be sold and transferred in January 2019.


b.

Forward Wind.


In April 2018, MGE, along with two other utilities, purchased the Forward Wind Energy Center (Forward Wind), which consists of 86 wind turbines located in Wisconsin with a total capacity of 129 MWs. The aggregate purchase price was approximately $174 million, of which MGE's proportionate share is 12.8%, or approximately $23 million. The purchase of Forward Wind replaced an existing purchase power agreement, under which MGE purchased 12.8% of the facility's energy output.


MGE Energy and MGE are required to record a liability for the fair value of an asset retirement obligation (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, 2018, MGE recorded an obligation of $1.6 million for the fair value of its legal liability for AROs associated with Forward Wind. 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.


14.

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 the 2017 Annual Report on Form 10-K for additional discussion of each of these segments.




32




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


(In thousands)

MGE Energy

 

Electric

 

Gas

 

Nonregulated Energy

 

Transmission Investment

 

All Others

 

Consolidation/ Elimination Entries

 

Consolidated Total

Three Months Ended September 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

119,175

$

18,407

$

213

$

-

$

-

$

-

$

137,795

Interdepartmental revenues

 

(20)

 

4,219

 

9,912

 

-

 

-

 

(14,111)

 

-

Total operating revenues

 

119,155

 

22,626

 

10,125

 

-

 

-

 

(14,111)

 

137,795

Depreciation and amortization

 

(9,864)

 

(2,534)

 

(1,861)

 

-

 

-

 

-

 

(14,259)

Other operating expenses

 

(77,847)

 

(19,824)

 

(36)

 

(4)

 

(138)

 

14,111

 

(83,738)

Operating income (loss)

 

31,444

 

268

 

8,228

 

(4)

 

(138)

 

-

 

39,798

Other income, net

 

1,763

 

829

 

-

 

1,620

 

118

 

-

 

4,330

Interest (expense) income, net

 

(3,217)

 

(963)

 

(1,320)

 

-

 

475

 

-

 

(5,025)

Income before taxes

 

29,990

 

134

 

6,908

 

1,616

 

455

 

-

 

39,103

Income tax (provision) benefit

 

(7,306)

 

42

 

(1,852)

 

(441)

 

(40)

 

-

 

(9,597)

Net income

$

22,684

$

176

$

5,056

$

1,175

$

415

$

-

$

29,506

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

120,649

$

18,778

$

112

$

-

$

-

$

-

$

139,539

Interdepartmental revenues

 

(110)

 

3,892

 

11,130

 

-

 

-

 

(14,912)

 

-

Total operating revenues

 

120,539

 

22,670

 

11,242

 

-

 

-

 

(14,912)

 

139,539

Depreciation and amortization

 

(9,256)

 

(2,258)

 

(1,858)

 

-

 

-

 

-

 

(13,372)

Other operating expenses(a)

 

(79,506)

 

(19,324)

 

(50)

 

(9)

 

(193)

 

14,912

 

(84,170)

Operating income (loss)

 

31,777

 

1,088

 

9,334

 

(9)

 

(193)

 

-

 

41,997

Other income (deductions), net(a)

 

2,060

 

742

 

-

 

2,258

 

(117)

 

-

 

4,943

Interest (expense) income, net

 

(2,760)

 

(795)

 

(1,371)

 

-

 

199

 

-

 

(4,727)

Income (loss) before taxes

 

31,077

 

1,035

 

7,963

 

2,249

 

(111)

 

-

 

42,213

Income tax (provision) benefit

 

(11,175)

 

(351)

 

(3,196)

 

(906)

 

44

 

-

 

(15,584)

Net income (loss)

$

19,902

$

684

$

4,767

$

1,343

$

(67)

$

-

$

26,629

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

312,633

$

106,152

$

904

$

-

$

-

$

-

$

419,689

Interdepartmental revenues

 

(234)

 

12,059

 

29,579

 

-

 

-

 

(41,404)

 

-

Total operating revenues

 

312,399

 

118,211

 

30,483

 

-

 

-

 

(41,404)

 

419,689

Depreciation and amortization

 

(28,817)

 

(7,374)

 

(5,563)

 

-

 

-

 

-

 

(41,754)

Other operating expenses

 

(228,957)

 

(99,251)

 

(113)

 

(12)

 

(789)

 

41,404

 

(287,718)

Operating income (loss)

 

54,625

 

11,586

 

24,807

 

(12)

 

(789)

 

-

 

90,217

Other income, net

 

5,055

 

2,347

 

-

 

5,908

 

670

 

-

 

13,980

Interest (expense) income, net

 

(9,036)

 

(2,689)

 

(4,002)

 

-

 

1,180

 

-

 

(14,547)

Income before taxes

 

50,644

 

11,244

 

20,805

 

5,896

 

1,061

 

-

 

89,650

Income tax provision

 

(11,492)

 

(2,788)

 

(5,638)

 

(1,611)

 

(263)

 

-

 

(21,792)

Net income

$

39,152

$

8,456

$

15,167

$

4,285

$

798

$

-

$

67,858

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

321,279

$

101,285

$

261

$

-

$

-

$

-

$

422,825

Interdepartmental revenues

 

(334)

 

11,708

 

33,307

 

-

 

-

 

(44,681)

 

-

Total operating revenues

 

320,945

 

112,993

 

33,568

 

-

 

-

 

(44,681)

 

422,825

Depreciation and amortization

 

(27,341)

 

(6,703)

 

(5,562)

 

-

 

-

 

-

 

(39,606)

Other operating expenses(a)

 

(233,714)

 

(93,817)

 

(153)

 

(9)

 

(779)

 

44,681

 

(283,791)

Operating income (loss)

 

59,890

 

12,473

 

27,853

 

(9)

 

(779)

 

-

 

99,428

Other income (deductions), net(a)

 

3,708

 

1,502

 

-

 

7,242

 

(414)

 

-

 

12,038

Interest (expense) income, net

 

(8,337)

 

(2,399)

 

(4,170)

 

-

 

399

 

-

 

(14,507)

Income (loss) before taxes

 

55,261

 

11,576

 

23,683

 

7,233

 

(794)

 

-

 

96,959

Income tax (provision) benefit

 

(18,753)

 

(4,576)

 

(9,505)

 

(2,909)

 

256

 

-

 

(35,487)

Net income (loss)

$

36,508

$

7,000

$

14,178

$

4,324

$

(538)

$

-

$

61,472


(a)

Reflects retrospective application of new accounting pronouncement related to pension and other postretirement benefits, see Footnote 2 for further information.




33




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


(In thousands)

MGE

 

Electric

 

Gas

 

Nonregulated Energy

 

Consolidation/ Elimination Entries

 

Consolidated Total

 

Three Months Ended September 30, 2018

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

119,175

$

18,407

$

213

$

-

$

137,795

 

Interdepartmental revenues

 

(20)

 

4,219

 

9,912

 

(14,111)

 

-

 

Total operating revenues

 

119,155

 

22,626

 

10,125

 

(14,111)

 

137,795

 

Depreciation and amortization

 

(9,864)

 

(2,534)

 

(1,861)

 

-

 

(14,259)

 

Other operating expenses(b)

 

(85,127)

 

(19,739)

 

(1,888)

 

14,111

 

(92,643)

 

Operating income(b)

 

24,164

 

353

 

6,376

 

-

 

30,893

 

Other income, net(b)

 

1,737

 

786

 

-

 

-

 

2,523

 

Interest expense, net

 

(3,217)

 

(963)

 

(1,320)

 

-

 

(5,500)

 

Net income

 

22,684

 

176

 

5,056

 

-

 

27,916

 

Less: Net income attributable to

 

 

 

 

 

 

 

 

 

 

 

 noncontrolling interest, net of tax

 

-

 

-

 

-

 

(5,629)

 

(5,629)

 

Net income attributable to MGE

$

22,684

$

176

$

5,056

$

(5,629)

$

22,287

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2017

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

120,648

$

18,779

$

112

$

-

$

139,539

 

Interdepartmental revenues

 

(109)

 

3,891

 

11,130

 

(14,912)

 

-

 

Total operating revenues

 

120,539

 

22,670

 

11,242

 

(14,912)

 

139,539

 

Depreciation and amortization

 

(9,256)

 

(2,258)

 

(1,858)

 

-

 

(13,372)

 

Other operating expenses(a), (b)

 

(90,164)

 

(19,529)

 

(3,246)

 

14,912

 

(98,027)

 

Operating income(b)

 

21,119

 

883

 

6,138

 

-

 

28,140

 

Other income, net(a), (b)

 

1,543

 

596

 

-

 

-

 

2,139

 

Interest expense, net

 

(2,760)

 

(795)

 

(1,371)

 

-

 

(4,926)

 

Net income

 

19,902

 

684

 

4,767

 

-

 

25,353

 

Less: Net income attributable to

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest, net of tax

 

-

 

-

 

-

 

(5,439)

 

(5,439)

 

Net income attributable to MGE

$

19,902

$

684

$

4,767

$

(5,439)

$

19,914

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2018

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

312,633

$

106,152

$

904

$

-

$

419,689

 

Interdepartmental revenues

 

(234)

 

12,059

 

29,579

 

(41,404)

 

-

 

Total operating revenues

 

312,399

 

118,211

 

30,483

 

(41,404)

 

419,689

 

Depreciation and amortization

 

(28,817)

 

(7,374)

 

(5,563)

 

-

 

(41,754)

 

Other operating expenses(b)

 

(240,333)

 

(101,938)

 

(5,751)

 

41,404

 

(306,618)

 

Operating income(b)

 

43,249

 

8,899

 

19,169

 

-

 

71,317

 

Other income, net(b)

 

4,939

 

2,246

 

-

 

-

 

7,185

 

Interest expense, net

 

(9,036)

 

(2,689)

 

(4,002)

 

-

 

(15,727)

 

Net income

 

39,152

 

8,456

 

15,167

 

-

 

62,775

 

Less: Net income attributable to

 

 

 

 

 

 

 

 

 

 

 

 noncontrolling interest, net of tax

 

-

 

-

 

-

 

(16,940)

 

(16,940)

 

Net income attributable to MGE

$

39,152

$

8,456

$

15,167

$

(16,940)

$

45,835

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2017

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

321,282

$

101,294

$

261

$

-

$

422,837

 

Interdepartmental revenues

 

(337)

 

11,699

 

33,307

 

(44,669)

 

-

 

Total operating revenues

 

320,945

 

112,993

 

33,568

 

(44,669)

 

422,837

 

Depreciation and amortization

 

(27,341)

 

(6,703)

 

(5,562)

 

-

 

(39,606)

 

Other operating expenses(a), (b)

 

(251,879)

 

(98,227)

 

(9,658)

 

44,669

 

(315,095)

 

Operating income(b)

 

41,725

 

8,063

 

18,348

 

-

 

68,136

 

Other income, net(a), (b)

 

3,120

 

1,336

 

-

 

-

 

4,456

 

Interest expense, net

 

(8,337)

 

(2,399)

 

(4,170)

 

-

 

(14,906)

 

Net income

 

36,508

 

7,000

 

14,178

 

-

 

57,686

 

Less: Net income attributable to

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest, net of tax

 

-

 

-

 

-

 

(16,224)

 

(16,224)

 

Net income attributable to MGE

$

36,508

$

7,000

$

14,178

$

(16,224)

$

41,462

 


(a)

Reflects retrospective application of new accounting pronouncement related to pension and other postretirement benefits, see Footnote 2 for further information.


(b)

Amounts are shown net of the related tax expense, consistent with the presentation on the MGE Consolidated Statements of Income.



34




The following table shows segment information for assets and capital expenditures:


 

 

Utility

 

 

Consolidated

(In thousands)

MGE Energy

 

Electric

 

Gas

 

Assets not Allocated

 

 

Non-regulated Energy

 

Transmission Investment

 

All Others

 

Consolidation/ Elimination Entries

 

Total

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2018

$

1,141,370

$

345,349

$

64,016

 

$

264,735

$

64,722

$

472,740

$

(378,635)

$

1,974,297

December 31, 2017

 

1,043,181

 

344,337

 

26,345

 

 

270,384

 

61,783

 

485,548

 

(376,396)

 

1,855,182

Capital Expenditures:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended Sept. 30, 2018

$

122,108

$

22,406

$

-

 

$

4,487

$

-

$

-

$

-

$

149,001

Year ended Dec. 31, 2017

 

77,353

 

26,847

 

-

 

 

3,931

 

-

 

-

 

-

 

108,131


 

 

Utility

 

 

Consolidated

(In thousands)

MGE

 

Electric

 

Gas

 

Assets not Allocated

 

 

Non-regulated Energy

 

Elimination Entries

 

Total

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2018

$

1,141,370

$

345,349

$

64,016

 

$

264,685

$

(1,176)

$

1,814,244

December 31, 2017

 

1,043,181

 

344,337

 

26,345

 

 

270,334

 

(156)

 

1,684,041

Capital Expenditures:

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended Sept. 30, 2018

$

122,108

$

22,406

$

-

 

$

4,487

$

-

$

149,001

Year ended Dec. 31, 2017

 

77,353

 

26,847

 

-

 

 

3,931

 

-

 

108,131




35





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


General


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


·

Regulated electric utility operations, conducted through MGE,

·

Regulated gas utility operations, conducted through MGE,

·

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

·

Transmission investments, representing our equity investment in ATC and ATC Holdco, and

·

All other, which includes corporate operations and services.


Our principal subsidiary is MGE, which generates and distributes electric energy, distributes natural gas, and represents a majority portion of our assets, liabilities, revenues, and expenses. MGE generates and distributes electricity to approximately 151,000 customers in Dane County, Wisconsin, including the city of Madison, and purchases and distributes natural gas to approximately 158,000 customers in the Wisconsin counties of Columbia, Crawford, Dane, Iowa, Juneau, Monroe, and Vernon.


Our nonregulated energy operations own interests in electric generating capacity that is leased to MGE. The ownership/leasing structure was adopted under applicable state regulatory guidelines for MGE's participation in these generation facilities, consisting principally of a stable return on the equity investment in the new generation facilities over the term of the related leases. The nonregulated energy operations include an ownership interest in two coal-fired generating units in Oak Creek, Wisconsin and a partial ownership of a cogeneration project on the UW-Madison campus. A third party operates the units in Oak Creek, and MGE operates the cogeneration project. Due to the nature of MGE's participation in these facilities, the results of MGE Energy's nonregulated operations are also consolidated into MGE's consolidated financial position and results of operations under applicable accounting standards.


Executive Overview


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


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


·

Weather, and its impact on customer sales,

·

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

·

Regulation and regulatory issues, and their impact on the timing and recovery of costs,

·

Energy commodity prices, including natural gas prices,

·

Equity price risk pertaining to pension related assets,

·

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

·

Environmental laws and regulations, including adopted and pending environmental rule changes, and

·

Other factors listed in "Item 1A. Risk Factors" in our 2017 Annual Report on Form 10-K.


For the three months ended September 30, 2018, MGE Energy's earnings were $29.5 million or $0.85 per share compared to $26.6 million or $0.77 per share for the same period in the prior year. MGE's earnings for the three months ended September 30, 2018, were $22.3 million compared to $19.9 million for the same period in the prior year.




36




For the nine months ended September 30, 2018, MGE Energy's earnings were $67.9 million or $1.96 per share compared to $61.5 million or $1.77 per share for the same period in the prior year. MGE's earnings for the nine months ended September 30, 2018, were $45.8 million compared to $41.5 million for the same period in the prior year.


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


 

 

 

Three Months Ended

 

Nine Months Ended

 

 

(In millions)

 

September 30,

 

September 30,

 

 

Business Segment:

 

2018

 

2017

 

2018

 

2017

 

 

    Electric Utility

$

22.6

$

19.9

$

39.1

$

36.5

 

 

    Gas Utility

 

0.2

 

0.7

 

8.5

 

7.0

 

 

    Nonregulated Energy

 

5.1

 

4.8

 

15.2

 

14.2

 

 

    Transmission Investments

 

1.2

 

1.3

 

4.3

 

4.3

 

 

    All Other

 

0.4

 

(0.1)

 

0.8

 

(0.5)

 

 

    Net Income

$

29.5

$

26.6

$

67.9

$

61.5

 


Our net income during the three and nine months ended September 30, 2018, compared to the same period in the prior year primarily reflects the effects of the following factors:


Electric Utility

For the three and nine months ended September 30, 2018, electric operating income increased primarily as a result of more favorable weather conditions in the current year. The average temperature in August 2018 was 72 degrees compared to 67 degrees in August 2017.


Gas Utility

For the nine months ended September 30, 2018, gas operating income increased primarily related to an increase in gas retail sales reflecting higher customer demand resulting from colder weather experienced in April 2018 compared to the same period in the prior year and an increase in retail customers. The average temperature in April 2018 was 38 degrees compared to 50 degrees in April 2017. For the three months ended September 30, 2018, gas operating income was relatively flat.


During the first nine months of 2018, the following events occurred:


Tax Reform: On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act. The Tax Act makes broad and complex changes to the U.S. tax code, including the reduction in the U.S. federal corporate tax rate from 35 to 21 percent, effective January 1, 2018.


Customer rates approved for 2018 reflect an income tax rate of 35 percent. In January 2018, the PSCW issued an order directing Wisconsin investor-owned utilities to defer the over-collection of income tax expense as a result of the decrease in tax rate to 21 percent. The PSCW issued an order in May 2018 to return to customers the estimated 2018 over-collection of income tax expense. As of September 30, 2018, MGE returned $5.9 million to customers through bill credits. Any over/under recovery of the actual costs will be subject to the PSCW's review in a future rate case. As of September 30, 2018, MGE has deferred $2.6 million as a regulatory liability and recorded a corresponding reduction in operating revenues for over-collection of income tax expense (net of customer bill credits).


Saratoga Wind Farm: In December 2017, the PSCW authorized construction of a 66MW wind farm, consisting of 33 turbines, located near Saratoga, Iowa. MGE received specific approval to recover 100% AFUDC on the project. As of September 30, 2018, MGE has incurred $66.5 million of capital expenditures. After tax, MGE has recognized $0.6 million and $1.3 million, respectively, in AFUDC equity related to this project for the three and nine months ended September 30, 2018. Construction of the project is expected to be completed by early 2019, with an estimated capital cost of $108 million.


Forward Wind: In April 2018, MGE, along with two other utilities, purchased the Forward Wind Energy Center, which consists of 86 wind turbines located in Wisconsin with a total capacity of 129 MWs. The aggregate purchase price was approximately $174 million of which MGE's proportionate share is 12.8%, or approximately $23 million. The purchase of the Forward Wind Energy Center replaced an existing purchase power agreement, under which MGE purchased 12.8% of the facility's energy output.




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Columbia: MGE and WPL have negotiated an amendment to the existing Columbia joint operating agreement, effective January 1, 2017, under which MGE has reduced its obligation to pay certain capital expenditures (other than SCR-related expenditures) at Columbia in exchange for a proportional reduction in MGE's ownership in Columbia. On January 1 of each year from 2017 through 2019 and then on June 1, 2020, the ownership percentage is adjusted through a partial sale based on the amount of capital expenditures foregone. As of September 30, 2018, and December 31, 2017, MGE classified $1.8 million and $8.8 million, respectively, of Columbia assets as held-for-sale on the consolidated balance sheets. In January 2018, MGE reduced its ownership interest in Columbia from 20.4% to 19.4% as a result of the partial sale of plant assets to WPL.


Deferred Fuel Costs – Subject to Refund: As of September 30, 2018, MGE has deferred $7.2 million of 2018 fuel savings. These costs will be subject to the PSCW's annual review of 2018 fuel costs, expected to be completed in 2019.


Debt Issuance: MGE issued $40 million of long-term unsecured debt in July 2018 and $60 million of long-term unsecured debt in September 2018. The proceeds of these debt financings were used to assist with the financing of additional capital expenditures, such as the Saratoga Wind Farm, and refinanced $20 million of long-term debt that matured in September 2018. The covenants of these debt issues are substantially consistent with MGE's existing unsecured long-term debt.


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


2017 Annual Fuel Proceeding: In August 2018, the PSCW issued a final decision in the fuel rules proceedings for MGE to refund $4.2 million of additional fuel savings realized during 2017 to its retail electric customers over a one-month period in October 2018. There was no change to the refund in the fuel rules proceedings from the amount MGE deferred as of December 31, 2017.


2019/2020 Rate Change Settlement: In July 2018, MGE filed an application with the PSCW to adjust electric and gas rates for 2019 and 2020. MGE filed its application through a settlement agreement between MGE and intervening parties in the rate case, subject to PSCW approval. The settlement proposal would decrease electric rates by 1.94% in 2019. This amount is subject to change based on the final outcome of MGE's 2019 Fuel Cost Plan. MGE will maintain this rate level for 2020, with the exception that MGE will file a 2020 Fuel Cost Plan in 2019 and MGE's electric rates will be adjusted accordingly. The decrease reflects the ongoing tax impacts of the Tax Act and the addition of lower-cost renewable generation capacity. The settlement agreement increases gas rates by 1.06% in 2019 and 1.46% in 2020. The requested increase covers infrastructure costs. It also reflects the impacts of the Tax Act.


Tax Reform: Pursuant to the Tax Act, deferred income tax balances as of December 31, 2017, were remeasured to reflect the decrease in corporate tax rate. A $130.5 million regulatory liability was recorded given that changes in income taxes are generally passed through in customer rates for the regulated utility. The amount and timing of the cash impacts will depend on the period over which certain income tax benefits are provided to customers, which will be determined by the PSCW. A portion of the regulatory liability will be returned to customers using a normalization method of accounting.


ATC Return on Equity: Several parties have filed complaints with the FERC seeking to reduce the ROE used by MISO transmission owners, including ATC. Any change to ATC's ROE could result in lower equity earnings and distributions from ATC in the future. We derived approximately 6.3% and 7.2% of our net income for the nine months ended September 30, 2018 and 2017, respectively, from our investment in ATC. See "Other Matters" below for additional information concerning ATC.


Environmental Initiatives: There are proposed legislative rules and initiatives involving matters related to air emissions, water effluent, hazardous materials, and greenhouse gases, all of which affect generation plant capital expenditures and operating costs as well as future operational planning. At present, it is unclear how the changes in the Presidential and EPA administrations may affect existing, pending or new legislative or rulemaking proposals or regulatory initiatives. Such legislation and rulemaking could significantly affect the costs of owning and operating fossil-fueled generating plants, such as Columbia and the Elm Road Units, from which we derive approximately 42% of our electric generating capacity as of September 30, 2018. We would expect to seek and receive recovery of any such costs in rates; however, it is difficult to estimate the amount of such costs due to the uncertainty as to the timing and form of the legislation and rules, and the scope and time of the recovery of costs in rates, which may lag the incurrence of those costs.




38




EPA's Greenhouse Gas (GHG) Rule Under the Clean Air Act: In August 2018, the EPA proposed the Affordable Clean Energy (ACE) rule for states to use to develop plans to control GHG emissions from existing fossil fuel-fired electric generating units (EGUs). The proposed rule applies to EGUs greater than 25 MW in size with exemptions for simple cycle and combined cycle generators. It has the potential to impact our Blount Generating Station, Columbia Power Plant, and Elm Road Units. The ACE proposed rule directs states to submit implementation plans to the EPA for approval that implement standards of performance (referred to as Best System of Emissions Reductions, or BSER) for individual EGUs. If a state fails to prepare a plan, or their plan is not approved by the EPA, a federal implementation plan (FIP) will be issued for that state. The ACE has been designed as a replacement to the EPA's Clean Power Plan (CPP), which also regulated GHGs. The EPA finalized the CPP in 2015. In February 2016, the U.S. Supreme Court stayed implementation of the CPP and the stay remains in effect. In October 2017, the EPA issued a proposed rule to repeal the CPP. MGE will continue to monitor developments with the proposed ACE rule and CPP rule and litigation. The ACE rule is not final, and we are still evaluating the potential impacts. It is difficult to say with any certainty how the ACE will affect our operations. MGE previously determined that if the CPP were to be implemented in its present form, it would have a material impact on MGE.


Columbia: MGE will reduce its obligation to pay certain capital expenditures (other than SCR-related expenditures) at Columbia in exchange for a proportional reduction in MGE's ownership in Columbia. By June 2020, MGE's ownership in Columbia is forecasted to be approximately 19%, a decrease of 3% from the 22% ownership interest held by MGE on January 1, 2016.


Future Generation - Riverside: During the first quarter of 2016, MGE entered into an agreement with WPL under which MGE may acquire up to 50 MW of capacity in a gas-fired generating plant to be constructed by WPL at its Riverside Energy Center in Beloit, Wisconsin, during the five-year period following the in-service date of the plant. The plant is expected to be completed by early 2020.


Future Generation - Utility Solar: In May 2018, MGE and Wisconsin Public Service Corporation filed a joint application with the PSCW to seek approval to acquire 300 MW of solar generating capacity from two large solar projects in Wisconsin. MGE's combined ownership share of the two projects is expected to be 100 MW. If approved by the PSCW, construction of the projects is expected to begin in 2019. MGE's share of the total cost is expected to be approximately $130 million.


The following discussion is based on the business segments as discussed in Footnote 14 of the Notes to Consolidated Financial Statements in this Report.


Results of Operations


Results of operations include financial information prepared in accordance with GAAP and electric and gas margins, both which are non-GAAP measures. Electric margin (electric revenues less fuel for electric generation and purchase power costs) and gas margin (gas revenues less cost of gas sold) are non-GAAP measures because they exclude nonregulated operating revenues used in the calculation of the most comparable GAAP measure, operating income; other operations and maintenance expense, depreciation and amortization expense, and other general taxes expense and thus are not measures determined in accordance with GAAP.


Management believes that electric and gas margins provide a meaningful basis for evaluating and managing utility operations since fuel for electric generation, purchase power costs, and cost of gas sold are passed through to customers in current rates. As a result, management uses electric and gas margins internally when assessing the operating performance of our segments. The presentation of utility electric and gas margins herein is intended to provide supplemental information for investors regarding operating performance. These electric and gas margins may not be comparable to how other entities calculate utility electric and gas margin or similar measures. Furthermore, these measures are not intended to replace operating income as determined in accordance with GAAP as an indicator of operating performance.




39




Three Months Ended September 30, 2018 and 2017


The following table provides a calculation of electric and gas margins (non-GAAP), along with a reconciliation to the most comparable GAAP measure, operating income:


 

 

 

Three Months Ended September 30,

 

 

(In millions)

 

2018

 

2017

 

$ Change

 

 

Electric revenues

$

119.2

$

120.6

$

(1.4)

 

 

Fuel for electric generation

 

16.8

 

15.8

 

1.0

 

 

Purchased power

 

13.0

 

16.0

 

(3.0)

 

 

    Total Electric Margins

 

89.4

 

88.8

 

0.6

 

 

 

 

 

 

 

 

 

 

 

Gas revenues

 

18.4

 

18.8

 

(0.4)

 

 

Cost of gas sold

 

4.9

 

5.1

 

(0.2)

 

 

    Total Gas Margins

 

13.5

 

13.7

 

(0.2)