Form 10-Q


United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q


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


For the quarterly period ended:

September 30, 2014


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


For the transition period from _______________ to _______________


Commission

File No.

 

Name of Registrant, State of Incorporation, Address

of Principal Executive Offices, and Telephone No.

 

IRS Employer

Identification No.

000-49965

 

MGE Energy, Inc.

(a Wisconsin Corporation)

133 South Blair Street

Madison, Wisconsin 53788

(608) 252-7000

mgeenergy.com

 

39-2040501

000-1125

 

Madison Gas and Electric Company

(a Wisconsin Corporation)

133 South Blair Street

Madison, Wisconsin 53788

(608) 252-7000

mge.com

 

39-0444025


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


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

Yes [X] No [ ]


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


 

Large Accelerated Filer

Accelerated Filer

Non-accelerated Filer

Smaller Reporting Company

MGE Energy, Inc.

X

 

 

 

Madison Gas and Electric Company

 

 

X

 


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

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


Number of Shares Outstanding of Each Class of Common Stock as of October 31, 2014

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

Stock Split

3

Where to Find More Information

3

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

4

Item 1. Financial Statements.

6

MGE Energy, Inc.

6

Consolidated Statements of Income (unaudited)

6

Consolidated Statements of Comprehensive Income (unaudited)

6

Consolidated Statements of Cash Flows (unaudited)

7

Consolidated Balance Sheets (unaudited)

8

Consolidated Statements of Common Equity (unaudited)

9

Madison Gas and Electric Company

10

Consolidated Statements of Income (unaudited)

10

Consolidated Statements of Comprehensive Income (unaudited)

10

Consolidated Statements of Cash Flows (unaudited)

11

Consolidated Balance Sheets (unaudited)

12

Consolidated Statements of Common Equity (unaudited)

13

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

14

Notes to Consolidated Financial Statements (unaudited)

14

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

32

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

48

Item 4. Controls and Procedures.

50

PART II. OTHER INFORMATION.

51

Item 1. Legal Proceedings.

51

Item 1A. Risk Factors.

51

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

51

Item 4. Mine Safety Disclosures.

52

Item 6. Exhibits.

52

Signatures - MGE Energy, Inc.

53

Signatures - Madison Gas and Electric Company

54




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' 2013 Annual Report on Form 10-K: Item 1A. Risk Factors, as updated by Part II. Item 1A. Risk Factors in this Report, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, as updated by Part I, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations in this report, and Item 8. Financial Statements and Supplementary Data – Note 18, as updated by Part I, Item 1. Financial Statements – Note 8 in this report, and (b) other factors discussed herein and in other filings made by that registrant with the SEC.


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


Stock Split


On December 20, 2013, MGE Energy's Board of Directors declared a three-for-two stock split of MGE Energy's outstanding shares of common stock, effective in the form of a stock dividend. Shareholders of record at the close of business on January 24, 2014, received one additional share of MGE Energy common stock for every two shares of common stock owned on that date. The additional shares were distributed on February 7, 2014. All share and per share data provided in this report give effect to this stock split.


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 State Energy Services

MGE State Energy Services, LLC

MGE Transco

MGE Transco Investment, LLC

NGV Fueling Services

NGV Fueling Services, LLC

North Mendota

North Mendota Energy & Technology Park, LLC

 

 

Other Defined Terms:

 

 

 

AFUDC

Allowance for Funds Used During Construction

ATC

American Transmission Company LLC

Blount

Blount Station

CA

Certificate of Authority

CAA

Clean Air Act

CAIR

Clean Air Interstate Rule

CAVR

Clean Air Visibility Rule

CCC

Closed Cycle Cooling

CCR

Coal Combustion Residual

Codification

Financial Accounting Standards Board Accounting Standards Codification

Columbia

Columbia Energy Center

Cooling degree days

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

CSAPR

Cross-State Air Pollution Rule

Dth

Dekatherms, a quantity measure used in respect of natural gas

EGUs

Electric Generating Units

Elm Road Units

Elm Road Generating Station

EPA

United States Environmental Protection Agency

FASB

Financial Accounting Standards Board

FTR

Financial Transmission Rights

GHG

Greenhouse Gas

Heating degree days (HDD)

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

IRS

Internal Revenue Service

kWh

Kilowatt-hour, a measure of electric energy produced

MATS

Mercury and Air Toxics Standards

MISO

Midcontinent Independent System Operator (a regional transmission organization)

MW

Megawatt, a measure of electric energy generating capacity

MWh

Megawatt-hour, a measure of electric energy produced

NAAQS

National Ambient Air Quality Standards

NOL

Net Operating Loss

NOV

Notice of Violation

NOx

Nitrogen Oxides

NSPS

New Source Performance Standards



4





PGA

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

PJM

PJM Interconnection, LLC (a regional transmission organization)

PPA

Purchased Power Agreement

PSCW

Public Service Commission of Wisconsin

PSD

Prevention of Significant Deterioration

ROE

Return on Equity

SCR

Selective Catalytic Reduction

SEC

Securities and Exchange Commission

SIP

State Implementation Plan

SO2

Sulfur Dioxide

the State

State of Wisconsin

Stock Plan

Direct Stock Purchase and Dividend Reinvestment Plan of MGE Energy

UW

University of Wisconsin at Madison

VIE

Variable Interest Entity

WCCF

West Campus Cogeneration Facility

WDNR

Wisconsin Department of Natural Resources

WEPCO

Wisconsin Electric Power Company

Working capital

Current assets less current liabilities

WPL

Wisconsin Power and Light Company

WPSC

Wisconsin Public Service Corporation

XBRL

eXtensible Business Reporting Language




5




Item 1. Financial Statements.


MGE Energy, Inc.

Consolidated Statements of Income (unaudited)

(In thousands, except per-share amounts)


 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30,

 

September 30,

 

 

2014

 

2013

 

2014

 

2013

Operating Revenues:

 

 

 

 

 

 

 

 

    Regulated electric revenues

$

 112,869

$

 119,836

$

 308,418

$

 310,176

    Regulated gas revenues

 

 21,404

 

 18,864

 

 163,335

 

 121,373

    Nonregulated revenues

 

 862

 

 1,399

 

 2,392

 

 4,075

        Total Operating Revenues

 

 135,135

 

 140,099

 

 474,145

 

 435,624

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

 

    Fuel for electric generation

 

 9,838

 

 13,950

 

 35,836

 

 34,520

    Purchased power

 

 21,303

 

 21,981

 

 58,779

 

 61,237

    Cost of gas sold

 

 11,039

 

 8,819

 

 107,679

 

 70,259

    Other operations and maintenance

 

 37,587

 

 41,134

 

 118,267

 

 124,670

    Depreciation and amortization

 

 10,376

 

 9,710

 

 30,191

 

 28,864

    Other general taxes

 

 4,872

 

 4,605

 

 14,861

 

 14,049

        Total Operating Expenses

 

 95,015

 

 100,199

 

 365,613

 

 333,599

Operating Income

 

 40,120

 

 39,900

 

 108,532

 

 102,025

 

 

 

 

 

 

 

 

 

Other income, net

 

 2,636

 

 3,750

 

 10,736

 

 9,770

Interest expense, net

 

 (5,141)

 

 (4,605)

 

 (14,550)

 

 (13,937)

    Income before income taxes

 

 37,615

 

 39,045

 

 104,718

 

 97,858

Income tax provision

 

 (14,286)

 

 (14,692)

 

 (39,585)

 

 (37,030)

Net Income

$

 23,329

$

 24,353

$

 65,133

$

 60,828

 

 

 

 

 

 

 

 

 

Earnings Per Share of Common Stock

 

 

 

 

 

 

 

 

(basic and diluted)

$

0.67

$

0.70

$

1.88

$

1.75

 

 

 

 

 

 

 

 

 

Dividends per share of common stock

$

0.283

$

0.272

$

0.826

$

0.799

 

 

 

 

 

 

 

 

 

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,

 

 

2014

 

2013

 

2014

 

2013

Net Income

$

 23,329

$

 24,353

$

 65,133

$

 60,828

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

    Unrealized gain on available-for-sale

 

 

 

 

 

 

 

 

    securities, net of tax ($63 and $24, and $38 and

 

 

 

 

 

 

 

 

    $117, respectively)

 

 95

 

 36

 

 56

 

 176

Comprehensive Income

$

 23,424

$

 24,389

$

 65,189

$

 61,004

 

 

 

 

 

 

 

 

 

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,

 

 

 

 

2014

 

2013

 

 

Operating Activities:

 

 

 

 

 

 

    Net income

$

 65,133

$

 60,828

 

 

    Items not affecting cash:

 

 

 

 

 

 

        Depreciation and amortization

 

 30,191

 

 28,864

 

 

        Deferred income taxes

 

 24,376

 

 32,706

 

 

        Provision for doubtful receivables

 

 1,001

 

 1,551

 

 

        Employee benefit plan expenses

 

 (814)

 

 9,908

 

 

        Equity earnings in ATC

 

 (7,306)

 

 (7,045)

 

 

        Other items

 

 (843)

 

 250

 

 

    Changes in working capital items:

 

 

 

 

 

 

        Decrease in current assets

 

 13,318

 

 15,053

 

 

        Decrease in current liabilities

 

 (7,515)

 

 (5,496)

 

 

    Dividend income from ATC

 

 5,762

 

 5,498

 

 

    Cash contributions to pension and other postretirement plans

 

 (2,449)

 

 (33,919)

 

 

    Debt make-whole premium

 

 -

 

 (6,757)

 

 

    Other noncurrent items, net

 

 118

 

 7,159

 

 

            Cash Provided by Operating Activities

 

 120,972

 

 108,600

 

 

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

 

    Capital expenditures

 

 (66,138)

 

 (92,092)

 

 

    Capital contributions to investments

 

 (1,830)

 

 (1,305)

 

 

    Other

 

 (1,265)

 

 (780)

 

 

            Cash Used for Investing Activities

 

 (69,233)

 

 (94,177)

 

 

 

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

 

    Cash dividends paid on common stock

 

 (28,634)

 

 (27,685)

 

 

    Repayment of long-term debt

 

 (3,069)

 

 (42,000)

 

 

    Issuance of long-term debt

 

 -

 

 85,000

 

 

    Other

 

 (130)

 

 (765)

 

 

            Cash (Used for) Provided by Financing Activities

 

 (31,833)

 

 14,550

 

 

 

 

 

 

 

 

 

Change in cash and cash equivalents

 

 19,906

 

 28,973

 

 

Cash and cash equivalents at beginning of period

 

 68,813

 

 46,357

 

 

Cash and Cash Equivalents at End of Period

$

 88,719

$

 75,330

 

 

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

    Significant noncash investing activities:

 

 

 

 

 

 

        Accrued capital expenditures

$

 6,549

$

 10,473

 

 

 

 

 

 

 

 

 

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

 

2014

 

2013

Current Assets:

 

 

 

 

    Cash and cash equivalents

$

 88,719

$

 68,813

    Accounts receivable, less reserves of $4,056 and $4,219, respectively

 

 35,251

 

 44,890

    Other accounts receivable, less reserves of $448 and $750, respectively

 

 5,365

 

 5,352

    Unbilled revenues

 

 19,929

 

 31,982

    Materials and supplies, at average cost

 

 17,524

 

 16,662

    Fossil fuel

 

 5,121

 

 5,206

    Stored natural gas, at average cost

 

 23,292

 

 13,988

    Prepaid taxes

 

 15,569

 

 19,106

    Regulatory assets - current

 

 4,985

 

 6,377

    Other current assets

 

 9,650

 

 8,225

        Total Current Assets

 

 225,405

 

 220,601

Regulatory assets

 

 100,227

 

 107,166

Pension benefits

 

 17,942

 

 15,071

Other deferred assets and other

 

 7,029

 

 8,046

Property, Plant, and Equipment:

 

 

 

 

    Property, plant, and equipment, net

 

 1,176,592

 

 1,018,809

    Construction work in progress

 

 21,331

 

 141,415

        Total Property, Plant, and Equipment

 

 1,197,923

 

 1,160,224

Investments

 

 71,370

 

 67,952

        Total Assets

$

 1,619,896

$

 1,579,060

 

 

 

 

 

LIABILITIES AND CAPITALIZATION

 

 

 

 

Current Liabilities:

 

 

 

 

    Long-term debt due within one year

$

 4,162

$

 4,102

    Accounts payable

 

 41,871

 

 43,684

    Accrued interest and taxes

 

 4,041

 

 5,661

    Accrued payroll related items

 

 10,305

 

 10,731

    Deferred income taxes

 

 -

 

 1,711

    Regulatory liabilities - current

 

 8,822

 

 13,538

    Derivative liabilities

 

 7,131

 

 7,750

    Other current liabilities

 

 5,824

 

 9,489

        Total Current Liabilities

 

 82,156

 

 96,666

Other Credits:

 

 

 

 

    Deferred income taxes

 

 313,101

 

 284,791

    Investment tax credit - deferred

 

 1,274

 

 1,413

    Regulatory liabilities

 

 21,970

 

 19,792

    Accrued pension and other postretirement benefits

 

 50,339

 

 49,184

    Derivative liabilities

 

 47,820

 

 57,930

    Other deferred liabilities and other

 

 52,947

 

 52,360

        Total Other Credits

 

 487,451

 

 465,470

Capitalization:

 

 

 

 

    Common shareholders' equity

 

 653,985

 

 617,510

    Long-term debt

 

 396,304

 

 399,414

        Total Capitalization

 

 1,050,289

 

 1,016,924

Commitments and contingencies (see Footnote 8)

 

 -

 

 -

        Total Liabilities and Capitalization

$

 1,619,896

$

 1,579,060

 

 

 

 

 

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




8





MGE Energy, Inc.

Consolidated Statements of Common Equity (unaudited)

(In thousands, except per-share amounts)


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

 

 

 

 

Common Stock

 

Paid-in

 

Retained

 

Comprehensive

 

 

 

 

 

Shares

 

Value

 

Capital

 

Earnings

 

Income

 

Total

 

 

2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - December 31, 2012

 34,668

$

 34,668

$

 316,268

$

 228,399

$

 94

$

 579,429

 

 

Net income

 

 

 

 

 

 

 60,828

 

 

 

 60,828

 

 

Other comprehensive income

 

 

 

 

 

 

 

 

 176

 

 176

 

 

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

($ 0.799 per share)

 

 

 

 

 

 

 (27,685)

 

 

 

 (27,685)

 

 

Ending balance - September 30, 2013

 34,668

$

 34,668

$

 316,268

$

 261,542

$

 270

$

 612,748

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - December 31, 2013

 34,668

$

 34,668

$

 316,268

$

 266,197

$

 377

$

 617,510

 

 

Net income

 

 

 

 

 

 

 65,133

 

 

 

 65,133

 

 

Other comprehensive income

 

 

 

 

 

 

 

 

 56

 

 56

 

 

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

($0.826 per share)

 

 

 

 

 

 

 (28,634)

 

 

 

 (28,634)

 

 

Cash in lieu of fractional shares related

 

 

 

 

 

 

 

 

 

 

 

 

 

to stock split

 

 

 

 

 

 

 (80)

 

 

 

 (80)

 

 

Ending balance - September 30, 2014

 34,668

$

 34,668

$

 316,268

$

 302,616

$

 433

$

 653,985

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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,

 

 

2014

 

2013

 

2014

 

2013

Operating Revenues:

 

 

 

 

 

 

 

 

    Regulated electric revenues

$

 112,875

$

 119,836

$

 308,435

$

 310,176

    Regulated gas revenues

 

 21,410

 

 18,864

 

 163,351

 

 121,373

    Nonregulated revenues

 

 862

 

 1,399

 

 2,392

 

 4,075

        Total Operating Revenues

 

 135,147

 

 140,099

 

 474,178

 

 435,624

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

 

    Fuel for electric generation

 

 9,841

 

 13,950

 

 35,843

 

 34,520

    Purchased power

 

 21,307

 

 21,981

 

 58,790

 

 61,237

    Cost of gas sold

 

 11,045

 

 8,819

 

 107,695

 

 70,259

    Other operations and maintenance

 

 37,309

 

 40,990

 

 117,593

 

 124,133

    Depreciation and amortization

 

 10,364

 

 9,710

 

 30,156

 

 28,864

    Other general taxes

 

 4,872

 

 4,605

 

 14,861

 

 14,049

    Income tax provision

 

 13,338

 

 13,798

 

 36,180

 

 34,237

        Total Operating Expenses

 

 108,076

 

 113,853

 

 401,118

 

 367,299

Operating Income

 

 27,071

 

 26,246

 

 73,060

 

 68,325

 

 

 

 

 

 

 

 

 

Other Income and Deductions:

 

 

 

 

 

 

 

 

    AFUDC - equity funds

 

 255

 

 852

 

 3,306

 

 2,178

    Equity in earnings in ATC

 

 2,423

 

 2,340

 

 7,306

 

 7,045

    Income tax provision

 

 (984)

 

 (880)

 

 (3,390)

 

 (2,802)

    Other income, net

 

 (111)

 

 407

 

 (351)

 

 118

        Total Other Income and Deductions

 

 1,583

 

 2,719

 

 6,871

 

 6,539

    Income before interest expense

 

 28,654

 

 28,965

 

 79,931

 

 74,864

 

 

 

 

 

 

 

 

 

Interest Expense:

 

 

 

 

 

 

 

 

    Interest on long-term debt

 

 5,225

 

 4,910

 

 15,714

 

 14,757

    Other interest, net

 

 44

 

 5

 

 52

 

 (31)

    AFUDC - borrowed funds

 

 (84)

 

 (281)

 

 (1,090)

 

 (718)

        Net Interest Expense

 

 5,185

 

 4,634

 

 14,676

 

 14,008

Net Income

$

 23,469

$

 24,331

$

 65,255

$

 60,856

Less: Net Income Attributable to Noncontrolling

 

 

 

 

 

 

 

 

Interest, net of tax

 

 (6,653)

 

 (6,861)

 

 (19,784)

 

 (20,547)

Net Income Attributable to MGE

$

 16,816

$

 17,470

$

 45,471

$

 40,309

 

 

 

 

 

 

 

 

 

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,

 

 

2014

 

2013

 

2014

 

2013

Net Income

$

 23,469

$

 24,331

$

 65,255

$

 60,856

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

    Unrealized gain (loss) on available-for-sale

 

 

 

 

 

 

 

 

    securities, net of tax (($29) and ($33), and $36 and

 

 

 

 

 

 

 

 

    ($52), respectively)

 

 43

 

 49

 

 (54)

 

 77

Comprehensive Income

$

 23,512

$

 24,380

$

 65,201

$

 60,933

    Less: Comprehensive Income Attributable to

 

 

 

 

 

 

 

 

    Noncontrolling Interest, net of tax

 

 (6,653)

 

 (6,861)

 

 (19,784)

 

 (20,547)

Comprehensive Income Attributable to MGE

$

 16,859

$

 17,519

$

 45,417

$

 40,386

 

 

 

 

 

 

 

 

 

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,

 

 

 

 

2014

 

2013

 

 

Operating Activities:

 

 

 

 

 

 

    Net income

$

 65,255

$

 60,856

 

 

    Items not affecting cash:

 

 

 

 

 

 

        Depreciation and amortization

 

 30,156

 

 28,864

 

 

        Deferred income taxes

 

 23,811

 

 31,467

 

 

        Provision for doubtful receivables

 

 1,001

 

 1,551

 

 

        Employee benefit plan expenses

 

 (814)

 

 9,908

 

 

        Equity earnings in ATC

 

 (7,306)

 

 (7,045)

 

 

        Other items

 

 (446)

 

 652

 

 

    Changes in working capital items:

 

 

 

 

 

 

       Decrease in current assets

 

 13,258

 

 14,599

 

 

       Decrease in current liabilities

 

 (5,457)

 

 (4,911)

 

 

    Dividend income from ATC

 

 5,762

 

 5,498

 

 

    Cash contributions to pension and other postretirement plans

 

 (2,449)

 

 (33,919)

 

 

    Debt make-whole premium

 

 -

 

 (6,757)

 

 

    Other noncurrent items, net

 

 (24)

 

 7,063

 

 

            Cash Provided by Operating Activities

 

 122,747

 

 107,826

 

 

 

 

 

 

 

 

 

Investing Activities:

 

 

 

 

 

 

    Capital expenditures

 

 (66,138)

 

 (92,092)

 

 

    Capital contributions to investments

 

 (1,420)

 

 (1,065)

 

 

    Other

 

 (1,087)

 

 (678)

 

 

            Cash Used for Investing Activities

 

 (68,645)

 

 (93,835)

 

 

 

 

 

 

 

 

 

Financing Activities:

 

 

 

 

 

 

    Cash dividends paid to parent by MGE

 

 (26,500)

 

 -

 

 

    Distributions to parent from noncontrolling interest

 

 (17,778)

 

 (21,148)

 

 

    Equity contribution received by noncontrolling interest

 

 1,420

 

 1,065

 

 

    Repayment of long-term debt

 

 (3,069)

 

 (42,000)

 

 

    Issuance of long-term debt

 

 -

 

 85,000

 

 

    Other

 

 -

 

 (668)

 

 

            Cash (Used for) Provided by Financing Activities

 

 (45,927)

 

 22,249

 

 

 

 

 

 

 

 

 

Change in cash and cash equivalents

 

 8,175

 

 36,240

 

 

Cash and cash equivalents at beginning of period

 

 14,808

 

 6,350

 

 

Cash and Cash Equivalents at End of Period

$

 22,983

$

 42,590

 

 

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

    Significant noncash investing activities:

 

 

 

 

 

 

        Accrued capital expenditures

$

 6,549

$

 10,473

 

 

 

 

 

 

 

 

 

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

 

2014

 

2013

Current Assets:

 

 

 

 

    Cash and cash equivalents

$

 22,983

$

 14,808

    Accounts receivable, less reserves of $4,056 and $4,219, respectively

 

 35,251

 

 44,890

    Affiliate receivables

 

 609

 

 534

    Other accounts receivable, less reserves of $448 and $750, respectively

 

 5,290

 

 5,274

    Unbilled revenues

 

 19,929

 

 31,982

    Materials and supplies, at average cost

 

 17,524

 

 16,662

    Fossil fuel

 

 5,121

 

 5,206

    Stored natural gas, at average cost

 

 23,292

 

 13,988

    Prepaid taxes

 

 20,390

 

 23,934

    Regulatory assets - current

 

 4,985

 

 6,377

    Other current assets

 

 9,546

 

 8,197

        Total Current Assets

 

 164,920

 

 171,852

Affiliate receivable long-term

 

 5,428

 

 5,825

Regulatory assets

 

 100,227

 

 107,166

Pension benefits

 

 17,942

 

 15,071

Other deferred assets and other

 

 4,987

 

 6,138

Property, Plant, and Equipment:

 

 

 

 

    Property, plant, and equipment, net

 

 1,175,695

 

 1,017,877

    Construction work in progress

 

 21,331

 

 141,415

        Total Property, Plant, and Equipment

 

 1,197,026

 

 1,159,292

Investments

 

 68,172

 

 65,299

        Total Assets

$

 1,558,702

$

 1,530,643


 

 

 

 

LIABILITIES AND CAPITALIZATION

 

 

 

 

Current Liabilities:

 

 

 

 

    Long-term debt due within one year

$

 4,162

$

 4,102

    Accounts payable

 

 41,861

 

 43,684

    Accrued interest and taxes

 

 3,774

 

 6,040

    Accrued payroll related items

 

 10,305

 

 10,731

    Deferred income taxes

 

 1,143

 

 2,723

    Regulatory liabilities - current

 

 8,822

 

 13,538

    Derivative liabilities

 

 7,131

 

 7,750

    Other current liabilities

 

 5,495

 

 6,446

        Total Current Liabilities

 

 82,693

 

 95,014

Other Credits:

 

 

 

 

    Deferred income taxes

 

 306,559

 

 279,085

    Investment tax credit - deferred

 

 1,274

 

 1,413

    Regulatory liabilities

 

 21,970

 

 19,792

    Accrued pension and other postretirement benefits

 

 50,338

 

 49,184

    Derivative liabilities

 

 47,820

 

 57,930

    Other deferred liabilities and other

 

 52,947

 

 52,357

        Total Other Credits

 

 480,908

 

 459,761

Capitalization:

 

 

 

 

    Common shareholder's equity

 

 476,408

 

 457,491

    Noncontrolling interest

 

 122,389

 

 118,963

        Total Equity

 

 598,797

 

 576,454

    Long-term debt

 

 396,304

 

 399,414

        Total Capitalization

 

 995,101

 

 975,868

Commitments and contingencies (see Footnote 8)

 

 -

 

 -

        Total Liabilities and Capitalization

$

 1,558,702

$

 1,530,643


 

 

 

 

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




12





Madison Gas and Electric Company

Consolidated Statements of Common Equity (unaudited)

(In thousands)


 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

Non-

 

 

 

Common Stock

 

Paid-in

 

Retained

Comprehensive

Controlling

 

 

 

Shares

 

Value

 

Capital

 

Earnings

Income

Interest

 

Total

2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - Dec. 31, 2012

 17,348

$

 17,348

$

 192,417

$

 223,527

$

 4

$

 117,470

$

 550,766

Net income

 

 

 

 

 

 

 40,309

 

 

 

 20,547

 

 60,856

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 77

 

 

 

 77

Equity contribution received by

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

 1,065

 

 1,065

Distributions to parent from

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

 (21,148)

 

 (21,148)

Ending balance - September 30, 2013

 17,348

$

 17,348

$

 192,417

$

 263,836

$

 81

$

 117,934

$

 591,616

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - Dec. 31, 2013

 17,348

$

 17,348

$

 192,417

$

 247,534

$

 192

$

 118,963

$

 576,454

Net income

 

 

 

 

 

 

 45,471

 

 

 

 19,784

 

 65,255

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 (54)

 

 

 

 (54)

Cash dividends paid to parent

 

 

 

 

 

 

 

 

 

 

 

 

 

by MGE

 

 

 

 

 

 

 (26,500)

 

 

 

 

 

 (26,500)

Equity contribution received by

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

 1,420

 

 1,420

Distributions to parent from

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

 (17,778)

 

 (17,778)

Ending balance - September 30, 2014

 17,348

$

 17,348

$

 192,417

$

 266,505

$

 138

$

 122,389

$

 598,797

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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, 2014



1.

Basis of Presentation - MGE Energy and MGE.


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


MGE Power Elm Road and MGE Power West Campus own electric generating assets and lease those assets to MGE. Both entities are variable interest entities under applicable authoritative guidance. MGE is considered the primary beneficiary of these entities as a result of contractual agreements. As a result, MGE has consolidated MGE Power Elm Road and MGE Power West Campus. See Footnote 2 of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, of MGE Energy's and MGE's 2013 Annual Report on Form 10-K.


The accompanying consolidated financial statements as of September 30, 2014, and for the three and nine months ended, are unaudited, but include all adjustments that MGE Energy and MGE management consider necessary for a fair statement of their respective financial statements. All adjustments are of a normal, recurring nature except as otherwise disclosed. The year-end consolidated balance sheet information was derived from the audited balance sheet appearing in MGE Energy's and MGE's 2013 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 57 through 100 of the 2013 Annual Report on Form 10-K.


On December 20, 2013, MGE Energy's Board of Directors declared a three-for-two stock split of MGE Energy's common stock in the form of a stock dividend. The additional shares were distributed February 7, 2014, to all shareholders of record as of January 24, 2014. All shares and per share data provided in this report give effect to this stock split.


2.

Equity and Financing Arrangements.


a.

Common Stock - MGE Energy.


MGE Energy sells shares of its common stock through its Stock Plan. Those shares may be newly issued shares or shares that MGE Energy has purchased in the open market for resale to participants in the Stock Plan. All sales under the stock plan are covered by a shelf registration statement that MGE Energy filed with the SEC. For both the nine months ended September 30, 2014 and 2013, MGE Energy did not issue any new shares of common stock under the Stock Plan.


b.

Dilutive Shares Calculation - MGE Energy.


MGE Energy does not hold any dilutive securities.


3.

Investment in ATC - MGE Energy and MGE.


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




14




MGE Transco has accounted for its investment in ATC under the equity method of accounting. For the nine months ended September 30, 2014 and 2013, MGE Transco recorded the following:


 

 

 

Nine Months Ended

 

 

 

 

September 30,

 

 

(In thousands)

 

2014

 

2013

 

 

Equity in earnings from investment in ATC

$

7,306

$

7,045

 

 

Dividends received from ATC

 

5,762

 

5,498

 

 

Capital contributions to ATC

 

1,420

 

1,065

 


On October 31, 2014, MGE Transco made an additional $0.4 million capital contribution to ATC.

 

MGE Transco's investment in ATC as of September 30, 2014, and December 31, 2013, was $67.5 million and $64.5 million, respectively.


At September 30, 2014, MGE is the majority owner, and MGE Energy, the holding company, is the minority owner of MGE Transco. MGE Energy's proportionate share of the equity and net income of MGE Transco is classified within the MGE financial statements as noncontrolling interest.


ATC's summarized financial data for the three and nine months ended September 30, 2014 and 2013, is as follows:


 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

 

September 30,

 

September 30,

 

 

(In thousands)

 

2014

 

2013

 

2014

 

2013

 

 

Operating revenues

$

 163,643

$

 160,480

$

 486,970

$

 464,345

 

 

Operating expenses

 

 (76,561)

 

 (77,595)

 

 (229,589)

 

 (217,240)

 

 

Other income, net

 

 693

 

 917

 

 1,403

 

 585

 

 

Interest expense, net

 

 (22,204)

 

 (21,136)

 

 (66,442)

 

 (63,232)

 

 

Earnings before members' income taxes

$

 65,571

$

 62,666

$

 192,342

$

 184,458

 


4.

Columbia Environmental Project Construction - MGE Energy and MGE.


MGE and two other utilities jointly own Columbia, a coal-fired generating facility. WPL is the plant operator and permit holder, and owns 46.2% of Columbia. WPSC owns a 31.8% interest, and MGE owns a 22% interest, in Columbia. In early 2011, the PSCW issued a Certificate and Order authorizing the construction of scrubbers and baghouses and associated equipment on Columbia Units 1 and 2 to reduce SO2 and mercury emissions. The modifications to Unit 2 were placed into service in April 2014, and the modifications to Unit 1 were placed into service in July 2014. The scrubbers and baghouses are expected to support compliance obligations for current and anticipated air quality regulations, including CAIR, CSAPR, MATS, and the Wisconsin Mercury Rule. As of September 30, 2014, $138.6 million of the capitalized project was transferred from Construction work in progress to Property, plant, and equipment on MGE's balance sheet related to Units 1 and 2 being placed into service. This total amount consisted of $128.8 million of capital expenditures and $9.8 million of AFUDC. MGE's share of various contractual commitments entered for the project as of September 30, 2014, is $5.5 million. For the three months ended September 30, 2014 and 2013, MGE has recognized after tax $0.1 million and $0.8 million, respectively, in AFUDC equity related to this project. For the nine months ended September 30, 2014 and 2013, MGE has recognized after tax $3.0 million and $1.9 million, respectively, in AFUDC equity related to this project.


MGE expects that the costs pertaining to this project will be fully recoverable through rates. For 2014, the PSCW authorized MGE 100% AFUDC on this project during construction. For 2013, the PSCW authorized MGE a 50% current return (included in customer rates) and the remaining 50% as AFUDC.


5.

Taxes - MGE Energy and MGE.


MGE Energy's effective income tax rates for the three and nine months ended September 30, 2014, were 38.0% and 37.8%, respectively, compared to 37.6% and 37.8% for the same periods in 2013. MGE's effective income tax rates for the three and nine months ended September 30, 2014, were 37.9% and 37.8%, respectively, compared to 37.6% and 37.8% for the same periods in 2013. The net increase in the three month effective tax rate is attributable to less AFUDC equity earned during the three month period in 2014 compared to 2013.




15




6.

Pension and Other Postretirement Plans - MGE Energy and MGE.


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


The following table presents the components of MGE Energy's and MGE's net periodic benefit costs recognized for the three and nine months ended September 30, 2014 and 2013. A portion of the net periodic benefit cost is capitalized within the consolidated balance sheets.


 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

 

September 30,

 

September 30,

 

 

(In thousands)

 

2014

 

2013

 

2014

 

2013

 

 

Pension Benefits

 

 

 

 

 

 

 

 

 

 

Components of net periodic (benefit) cost:

 

 

 

 

 

 

 

 

 

 

    Service cost

$

 1,536

$

 1,924

$

 4,609

$

 5,764

 

 

    Interest cost

 

 3,367

 

 3,178

 

 10,102

 

 9,521

 

 

    Expected return on assets

 

 (5,467)

 

 (4,764)

 

 (16,402)

 

 (14,273)

 

 

Amortization of:

 

 

 

 

 

 

 

 

 

 

    Prior service cost

 

 51

 

 79

 

 152

 

 237

 

 

    Actuarial loss

 

 180

 

 2,011

 

 539

 

 6,023

 

 

Net periodic (benefit) cost

$

 (333)

$

 2,428

$

 (1,000)

$

 7,272

 

 

 

 

 

 

 

 

 

 

 

 

 

Postretirement Benefits

 

 

 

 

 

 

 

 

 

 

Components of net periodic (benefit) cost:

 

 

 

 

 

 

 

 

 

 

    Service cost

$

 241

$

 594

$

 722

$

 1,781

 

 

    Interest cost

 

 564

 

 966

 

 1,691

 

 2,898

 

 

    Expected return on assets

 

 (478)

 

 (542)

 

 (1,432)

 

 (1,626)

 

 

Amortization of:

 

 

 

 

 

 

 

 

 

 

    Transition obligation

 

 1

 

 -

 

 2

 

 2

 

 

    Prior service (benefit) cost

 

 (487)

 

 28

 

 (1,462)

 

 83

 

 

    Actuarial loss

 

 28

 

 310

 

 86

 

 930

 

 

Net periodic (benefit) cost

$

 (131)

$

 1,356

$

 (393)

$

 4,068

 


7.

Share-Based Compensation - MGE Energy and MGE.


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


In addition to units granted in 2009 through 2013, on February 21, 2014, 21,991 units were granted based on the MGE Energy closing stock price as of that date. These units are subject to a five-year graded vesting schedule and reflect the three-for-two stock split declared December 20, 2013. On the grant date, MGE Energy and MGE measure the cost of the employee services received in exchange for a performance unit award based on the current market value of MGE Energy common stock. The fair value of the awards has been subsequently re-measured at September 30, 2014, as required by applicable accounting standards. Changes in fair value have been recognized as compensation cost. Since this amount is re-measured quarterly throughout the vesting period, the compensation cost is subject to variability.


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


In December 2013, a Director Incentive Plan was approved for the non-employee members of the Board of Directors. This plan is similar to MGE Energy's Performance Unit Plan for eligible employees described above. Under the plan, a non-employee director can receive performance units that entitle the holder to receive a cash payment equal to the value of a designated number of shares of MGE Energy's common stock, plus dividend payments, at the end of the set performance period. The units are subject to a three-year graded vesting schedule. In January 2014, unit awards of 4,683 (post-split) were granted to the non-employee Directors. For accounting purposes, the awards will be measured similarly to the employee unit awards.




16




During the nine months ended September 30, 2014 and 2013, MGE recorded $0.9 million and $1.1 million, respectively, in compensation expense as a result of the plans. In January 2014, cash payments of $1.2 million were distributed relating to awards that were granted in 2009. No forfeitures occurred during the nine months ended September 30, 2014 or 2013. At September 30, 2014, $3.7 million of outstanding awards are vested.


8.

Commitments and Contingencies - MGE Energy and MGE.


a.

Environmental.


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


·

The President's announced plan and directive to the EPA to regulate carbon pollution, or greenhouse gas (GHG) emissions, from new and existing electric power generation units, and the EPA's related proposed GHG New Source Performance Standards (NSPS) (see below for additional information on the NSPS rule).


·

Rules to regulate NOx and SO2 emissions, including the EPA's Cross State Air Pollution Rule (CSAPR) (see below for recent developments with CSAPR). An environmental group has sought federal appellate court review of the EPA's Clean Air Visibility Rule (CAVR) to address regional haze. Both the pending challenges to CSAPR and the appellate court review of CAVR make the nature of compliance requirements uncertain.


·

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


·

The EPA's cooling water intake rules. The EPA issued a final rule for existing facilities in May 2014. The final rule is discussed below.


·

The EPA's proposed 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 from coal-burning plants such as Columbia and the Elm Road Units.


·

The EPA's ongoing review of several National Ambient Air Quality Standards (NAAQS), including the potential lowering of the ozone NAAQS and its proposed requirements for air agencies to characterize sulfur dioxide air quality for purposes of implementing the 1-hour SO2 NAAQS. This approach focuses on large sources of SO2 emissions and proposes area designations to be made in two rounds (2017 and 2020). The proposed rule gives states broad discretion in its implementation. The final rule is expected late in 2014. MGE will be reviewing the rule for potential impacts on its operations.


The matters in the bullet points above are discussed further in Footnote 18.d. of Notes to Consolidated Financial Statements under Item 8, Financial Statements and Supplementary Data, of MGE Energy's and MGE's 2013 Annual Report on Form 10-K. In addition to the developments noted above, the following discussion is an update to the current status of environmental matters set forth in that Footnote.


EPA's Final 316(b) Rule Governing Water Intake Systems at Electric Generating Facilities

In August 2014, the EPA published its Phase II and III Rules pursuant to Section 316(b) of the Clean Water Act, which governs cooling water intake structures located at large existing power plant and industrial facilities. The 316(b) Rule requires these facilities to implement methods for reducing fish impingement by their water intakes using one of seven options, including closed cycle cooling (CCC) systems.


Our WCCF facility already employs a CCC system as defined under the Rule. The Columbia plant may need to address multiple intake structures. Our Blount plant has conducted studies regarding options for compliance with this rule. The exact requirements at Blount and Columbia, however, will not be known until those sites' permits are modified to account for this rule. Nonetheless, MGE expects that the 316(b) Rule will not have material effects on its existing plants.




17




EPA's Cross-State Air Pollution Rule (CSAPR) Upheld by the Supreme Court

On April 29, 2014, the US Supreme Court issued a decision reversing the D.C. Circuit Court's decision that had vacated CSAPR and remanding the matter back to the D.C. Circuit for further proceedings. At that time CSPAR remained subject to an order of the D.C. Circuit that stayed its implementation. On October 23, 2014, the D.C. Circuit lifted its stay of CSAPR and set a briefing schedule to resolve issues remaining in the lawsuit. The court also set the briefing schedule for ongoing litigation with oral arguments scheduled for March 2015. The State of Wisconsin has filed a motion with the D.C. Circuit Court reiterating its contention that Wisconsin be removed from CSAPR and may be a part of the court's briefing and oral argument schedule. With several issues undecided and court proceedings extending into 2015, there is remaining uncertainty as to whether MGE's facilities will be required to meet the CSAPR mandates and, if so, the deadline for achieving compliance. The Clean Air Interstate Rule (CAIR) remains in effect for the time being. See MGE Energy's and MGE's 2013 Annual Report on Form 10K for additional information on the legal proceedings associated with these environmental matters.


With CSAPR now reinstated, it will require (once implemented) that qualifying power plants meet SO2 and NOx allocations or purchase them on the market. MGE has been monitoring our overall compliance options, particularly at our Columbia power plant as we awaited installation and testing of SO2 controls. With the 2014 installation of SO2 pollution controls at Columbia, we will likely meet or exceed the allocations for Columbia based on the CSAPR allocations in the current rule (see Footnote 4 for information regarding the Columbia environmental construction project and below in this Footnote for information regarding our consent decree). MGE expects that the costs pertaining to meeting CSAPR and the consent decree requirements will be fully recoverable through rates. We will continue to monitor and evaluate the D.C. Circuit Court remand proceedings and the implementation of the rule by the EPA and WDNR.


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

On June 2, 2014, the EPA released proposed guidelines for states to use in developing plans to control GHG emissions from existing fossil fuel fired electric generating units (EGUs). The proposed rule was published in the Federal Register on June 17, 2014.


The EPA's proposal seeks to reduce GHG emissions from EGUs by a national average of 30% by 2030 as measured from a 2005 baseline. Each state is given its own emission reduction targets to meet this goal. These targets are expressed as a "rate-based" emission average to be achieved by the combined fleet of EGUs within the state. States would be expected to make "meaningful progress" towards these reductions by 2020 and to meet their respective targets by 2030.


The EPA's proposal establishes guidelines for states and encourages the use of four "building blocks" for achieving these reductions. These "building blocks" are: (1) increasing the efficiency of EGUs; (2) re-dispatching of gas-fired generation at the expense of coal; (3) expanding the use of low and no carbon power sources, such as wind, nuclear and solar; and (4) improving demand side energy efficiency to reduce electric use.


The EPA is taking comments on the proposed rule through December 1, 2014. The rule is expected to be finalized by June 2015. States will then have up to two years to prepare compliance plans. This rule could have significant impacts on EGUs. MGE is reviewing the proposal at this time.


Coal Combustion Residual Rule

The EPA's proposed Coal Combustion Residual (CCR) Rule is anticipated to be finalized in December 2014. The final CCR Rule will regulate disposal and management of ash and other coal combustion byproducts as a waste under the EPA's solid waste rules.


Columbia


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


Columbia Environmental Project

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




18




Columbia Clean Air Act Litigation

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


In April 2013, WPL, as owner-operator, along with the other owners of Columbia, entered into a consent decree with the EPA and the Sierra Club to resolve these claims, while admitting no liability. In June 2013, the consent decree was approved and entered by the Court. The consent decree requires installation of the following emission controls at Columbia: SO2 scrubbers and baghouses at Columbia Units 1 and 2 by December 31, 2014, which have now been installed, and an SCR system at Columbia Unit 2 by December 31, 2018. In addition, the consent decree establishes emission rate limits for SO2, NOx, and particulate matter for Columbia Units 1 and 2. The consent decree also includes annual plant-wide emission caps for SO2 and NOx for Columbia. MGE also paid approximately $0.2 million as its share of a civil penalty and will complete approximately $0.6 million in environmental mitigation projects. MGE intends to seek recovery in rates of the costs associated with its compliance with the terms of the final consent decree and currently expects to recover any material compliance costs.


b.

Chattel Paper Agreement and Other Guarantees.


MGE makes available to qualifying customers a financing program for the purchase and installation of energy-related equipment that will provide more efficient use of utility service at the customer's property. MGE is party to a chattel paper purchase agreement with a financial institution under which it can sell or finance an undivided interest with recourse, in up to $10.0 million of the financing program receivables, until July 31, 2015. At September 30, 2014, MGE had sold a $4.1 million interest in these receivables. MGE retains the servicing responsibility for these receivables. As of September 30, 2014, the servicing asset recognized by MGE is $0.2 million.


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


MGE would be required to perform under its guarantee if a customer defaulted on its loan. The energy-related equipment installed at the customer sites is used to secure the customer loans. The loan balances outstanding at September 30, 2014, approximate the fair value of the energy-related equipment acting as collateral. The length of the MGE guarantee to the financial institution varies from one to ten years depending on the term of the underlying customer loan. Principal payments for the remainder of 2014 and the next four years on the loans are:


 

(In thousands)

 

2014

 

2015

 

2016

 

2017

 

2018

 

 

Chattel Paper

$

 108

$

 921

$

 841

$

 438

$

 374

 


c.

Legal Matters.


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




19




d.

Purchase Contracts.


MGE Energy and MGE have entered into various commodity supply, transportation, and storage contracts to meet their obligations to deliver electricity and natural gas to customers. As of September 30, 2014, the future commitments related to these purchase contracts were as follows:


 

(In thousands)

 

2014

 

2015

 

2016

 

2017

 

2018

 

 

Coal(a)

$

 11,950

$

 18,439

$

 10,765

$

 5,073

$

 2,710

 

 

Natural gas

 

 

 

 

 

 

 

 

 

 

 

 

    Transportation & storage(b)

 

 5,234

 

 18,073

 

 9,937

 

 272

 

 191

 

 

    Supply(c)

 

 16,951

 

 16,070

 

 -

 

 -

 

 -

 

 

Purchase power(d)

 

 12,665

 

 48,964

 

 49,633

 

 50,132

 

 51,153

 

 

Other

 

 16,102

 

 -

 

 -

 

 -

 

 -

 

 

 

$

 62,902

$

 101,546

$

 70,335

$

 55,477

$

 54,054

 


(a)

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


(b)

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


(c)

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


(d)

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


e.

Elm Road - MGE Energy and MGE.


The warranty periods for both of the Elm Road Units have expired. During 2013, WEPCO and Bechtel (the construction contractor for the Elm Road Units) were working through the outstanding warranty claims. The warranty claim for the costs incurred to repair steam turbine corrosion damage identified on both units was resolved through a binding arbitration in June 2013. Final acceptance of the Elm Road Units occurred in June 2013 after all requirements stated in the contract with Bechtel were satisfied. In April 2014, an additional warranty claim was resolved that did not have a material impact on our financial statements. The parties continue to work through one potential remaining warranty claim.


9.

Derivative and Hedging Instruments - MGE Energy and MGE.


a.

Purpose.


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




20




b.

Notional Amounts.


The gross notional volume of open derivatives is as follows:


 

 

September 30, 2014

 

December 31, 2013

 

 

Commodity derivative contracts

447,570 MWh

 

458,660 MWh

 

 

Commodity derivative contracts

6,555,000 Dth

 

3,750,000 Dth

 

 

FTRs

3,104 MW

 

1,984 MW

 


c.

Financial Statement Presentation.


MGE purchases and sells exchange-traded and over-the-counter options, swaps, and future contracts. These arrangements are primarily entered into to help stabilize the price risk associated with gas or power purchases. These transactions are employed by both MGE's gas and electric segments. Additionally, as a result of the firm transmission agreements that MGE holds on electricity transmission paths in the MISO market, MGE holds FTRs. An FTR is a financial instrument that entitles the holder to a stream of revenues or charges based on the differences in hourly day-ahead energy prices between two points on the transmission grid. The fair values of these instruments are offset with a corresponding regulatory asset/liability depending on whether they are in a net loss/gain position. Depending on the nature of the instrument, the gain or loss associated with these transactions will be reflected as cost of gas sold, fuel for electric generation, or purchased power expense in the delivery month applicable to the instrument. At September 30, 2014, and December 31, 2013, the fair value of exchange traded derivatives and FTRs exceeded their cost basis by $2.3 million and $1.8 million, respectively.


MGE is a party to a ten-year purchased power agreement that provides MGE with firm capacity and energy during a base term from June 1, 2012, through May 31, 2022. The agreement also allows MGE an option to extend the contract after the base term. The agreement is accounted for as a derivative contract and is recognized at its fair value on the consolidated balance sheet. However, the derivative qualifies for regulatory deferral and is recognized with a corresponding regulatory asset or liability depending on whether the fair value is in a loss or gain position. The fair value of the contract at September 30, 2014, and December 31, 2013, reflects a loss position of $54.9 million and $65.7 million, respectively. The actual fuel cost will be recognized in purchased power expense in the month of purchase and collected in rates.


The following table summarizes the fair value of the derivative instruments on the consolidated balance sheet. All derivative instruments in this table are presented on a gross basis and are calculated prior to the netting of instruments with the same counterparty under a master netting agreement as well as the netting of collateral. For financial statement purposes, MGE Energy and MGE have netted instruments with the same counterparty under a master netting agreement as well as the netting of collateral. At September 30, 2014, MGE Energy and MGE had the right to reclaim collateral (a receivable) of $0.6 million.


 

 

Asset Derivatives

 

Liability Derivatives

(In thousands)

 

Balance Sheet Location

 

Fair Value

 

Balance Sheet Location

 

Fair Value

September 30, 2014

 

 

 

 

 

 

 

 

Commodity derivative contracts

 

Other current assets

$

 1,507

Derivative liability (current)

$

 532

Commodity derivative contracts

 

Other deferred charges

 

 48

 

Derivative liability (long-term)

 

 4

FTRs

 

Other current assets

 

 1,237

 

Derivative liability (current)

 

 -

Ten-year PPA

 

N/A

 

N/A

 

Derivative liability (current)

 

 7,120

Ten-year PPA

 

N/A

 

N/A

 

Derivative liability (long-term)

 

 47,820

 

 

 

 

 

 

 

 

 

December 31, 2013

 

 

 

 

 

 

 

 

Commodity derivative contracts

 

Other current assets

$

 1,356

 

Derivative liability (current)

$

 51

Commodity derivative contracts

 

Other deferred charges

 

 167

 

Derivative liability (long-term)

 

 48

FTRs

 

Other current assets

 

 363

 

Derivative liability (current)

 

 -

Ten-year PPA

 

N/A

 

N/A

 

Derivative liability (current)

 

 7,750

Ten-year PPA

 

N/A

 

N/A

 

Derivative liability (long-term)

 

 57,930




21




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


 

Offsetting of Derivative Assets

 

 

(In thousands)

 

Gross amounts

 

Gross amounts offset in balance sheet

 

Collateral posted against derivative positions

 

Net amount presented in balance sheet

 

 

September 30, 2014

 

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

 1,555

$

 (525)

$

 -

$

 1,030

 

 

FTRs

 

 1,237

 

 -

 

 -

 

 1,237

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2013

 

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

 1,523

$

 (99)

$

 (175)

$

 1,249

 

 

FTRs

 

 363

 

 -

 

 -

 

 363

 


 

Offsetting of Derivative Liabilities

 

 

(In thousands)

 

Gross amounts

 

Gross amounts offset in balance sheet

 

Collateral posted against derivative positions

 

Net amount presented in balance sheet

 

 

September 30, 2014

 

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

 536

$

 (525)

$

 -

$

 11

 

 

Ten-year PPA

 

 54,940

 

 -

 

 -

 

 54,940

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2013

 

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

 99

$

 (99)

$

 -

$

 -

 

 

Ten-year PPA

 

 65,680

 

 -

 

 -

 

 65,680

 


The following tables summarize the unrealized and realized gains (losses) related to the derivative instruments on the consolidated balance sheet at September 30, 2014 and 2013, and the consolidated income statement for the three and nine months ended September 30, 2014 and 2013.


 

 

2014

 

 

2013

(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,

$

 48,853

$

 676

 

$

 66,649

$

 658

Change in unrealized loss

 

 5,329

 

 -

 

 

 2,330

 

 -

Realized gain (loss) reclassified to a deferred

 

 

 

 

 

 

 

 

 

account

 

 (314)

 

 314

 

 

 (275)

 

 275

Realized gain (loss) reclassified to income

 

 

 

 

 

 

 

 

 

statement

 

 (1,184)

 

 (249)

 

 

 (621)

 

 (111)

Balance at September 30,

$

 52,684

$

 741

 

$

 68,083

$

 822

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30:

 

 

 

 

 

 

 

 

 

Balance at January 1,

$

 63,893

$

 411

 

$

 72,329

$

 574

Change in unrealized gain

 

 (18,090)

 

 -

 

 

 (1,330)

 

 -

Realized gain (loss) reclassified to a deferred

 

 

 

 

 

 

 

 

 

account

 

 1,120

 

 (1,120)

 

 

 (953)

 

 953

Realized gain (loss) reclassified to income

 

 

 

 

 

 

 

 

 

statement

 

 5,761

 

 1,450

 

 

 (1,963)

 

 (705)

Balance at September 30,

$

 52,684

$

 741

 

$

 68,083

$

 822




22





 

 

Realized losses (gains)

 

 

2014

 

 

2013

(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

$

 480

$

 (18)

 

$

 (7)

$

 -

FTRs

 

 (97)

 

 -

 

 

 (387)

 

 -

Ten-year PPA

 

 1,068

 

 -

 

 

 1,126

 

 -

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30:

 

 

 

 

 

 

 

 

 

Commodity derivative contracts

$

 (5,376)

$

 (1,367)

 

$

 (523)

$

 608

FTRs

 

 (929)

 

 -

 

 

 (896)

 

 -

Ten-year PPA

 

 461

 

 -

 

 

 3,479

 

 -


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


The ten-year PPA has a provision that may require MGE to post collateral if MGE's debt rating falls below investment grade (i.e., below BBB-). The amount of collateral that it may be required to post varies from $20.0 million to $40.0 million, depending on MGE's nominated capacity amount. As of September 30, 2014, no collateral has been posted. Certain counterparties extend MGE a credit limit. If MGE exceeds these limits, the counterparties may require collateral to be posted. As of September 30, 2014, certain counterparties were in a net liability of less than $0.1 million. As of December 31, 2013, no counterparties were in a net liability position.


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, 2014, no counterparties have defaulted.


10.

Rate Matters - MGE Energy and MGE.


a.

Rate Proceedings.


On April 17, 2014, MGE filed an application with the PSCW requesting a 2.8% increase to electric rates and a 2.3% decrease to gas rates for 2015. MGE has requested escrow accounting treatment for transmission related costs starting in 2015. This treatment will allow MGE to reflect any differential between costs reflected in rates and actual costs incurred in its next rate case filing. The proposed electric rate increases cover costs associated with the construction of emission-reduction equipment at Columbia and improvements and reliability of the state's electric transmission system.


During the rate case proceeding, certain updates have been made to reflect changing conditions from the initial filing. Those updates include increased costs for fuel and purchased power costs primarily related to coal delivery costs, lower transmission costs due to favorable FERC decisions on cost allocations for system reliability payments, and increased costs to reflect current market conditions for pension and post-retirement benefit costs. Incorporating the revisions would adjust the electric rate increase from 2.8% to 4.3% and adjust the gas rate decrease from 2.3% to 1.4%. A PSCW decision is expected by the end of 2014.


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




23




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


b.

Fuel Rules.


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


As of September 30, 2014, MGE did not defer any 2014 electric fuel-related savings/costs that are outside the range authorized by the PSCW. As part of the rate freeze plan authorized by the PSCW for 2014, $4.7 million of the approximately $6.2 million associated with the 2012 fuel rule surplus credit was amortized against purchased power expense during the nine months ended September 30, 2014. The 2013 fuel rule surplus credit of $6.7 million was returned to customers in October 2014.


11.

Fair Value of Financial Instruments - MGE Energy and MGE.


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


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


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


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


a.

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


At September 30, 2014, and December 31, 2013, the carrying amount of cash and cash equivalents approximates fair market value due to the short maturity of those investments and obligations. The estimated fair market value of MGE Energy's and MGE's long-term debt is based on quoted market prices for similar financial instruments at September 30, 2014, and December 31, 2013. Since long-term debt is not traded in an active market, it is classified as Level 2. The estimated fair market value of MGE Energy's and MGE's financial instruments are as follows:




24





 

 

 

September 30, 2014

 

 

December 31, 2013

 

 

(In thousands)

 

Carrying Amount

 

Fair Value

 

 

Carrying Amount

 

Fair Value

 

 

MGE Energy

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

    Cash and cash equivalents

$

 88,719

$

 88,719

 

$

 68,813

$

 68,813

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

    Long-term debt*

 

 400,724

 

 443,203

 

 

 403,793

 

 432,010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

    Cash and cash equivalents

$

 22,983

$

 22,983

 

$

 14,808

$

 14,808

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

    Long-term debt*

 

 400,724

 

 443,203

 

 

 403,793

 

 432,010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

*Includes long-term debt due within one year.

 

 

 

 

 

 

 

 


b.

Recurring Fair Value Measurements.


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


 

 

 

Fair Value as of September 30, 2014

 

 

(In thousands)

 

Total

 

Level 1

 

Level 2

 

Level 3

 

 

MGE Energy

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

 2,267

$

 417

$

 -

$

 1,850

 

 

    Exchange-traded investments

 

 886

 

 886

 

 -

 

 -

 

 

    Total Assets

$

 3,153

$

 1,303

$

 -

$

 1,850

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

 54,951

$

 -

$

 -

$

 54,951

 

 

    Deferred compensation

 

 2,705

 

 -

 

 2,705

 

 -

 

 

    Total Liabilities

$

 57,656

$

 -

$

 2,705

$

 54,951

 

 

 

 

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

 2,267

$

 417

$

 -

$

 1,850

 

 

    Exchange-traded investments

 

 341

 

 341

 

 -

 

 -

 

 

    Total Assets

$

 2,608

$

 758

$

 -

$

 1,850

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

 54,951

$

 -

$

 -

$

 54,951

 

 

    Deferred compensation

 

 2,705

 

 -

 

 2,705

 

 -

 

 

    Total Liabilities

$

 57,656

$

 -

$

 2,705

$

 54,951

 

 

 

 

 

 

 

 

 

 

 

 



25





 

 

 

Fair Value as of December 31, 2013

 

 

(In thousands)

 

Total

 

Level 1

 

Level 2

 

Level 3

 

 

MGE Energy

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net(a)

$

 1,787

$

 735

$

 -

$

 1,052

 

 

    Exchange-traded investments

 

 792

 

 792

 

 -

 

 -

 

 

    Total Assets

$

 2,579

$

 1,527

$

 -

$

 1,052

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

 65,680

$

 -

$

 -

$

 65,680

 

 

    Deferred compensation

 

 2,364

 

 -

 

 2,364

 

 -

 

 

    Total Liabilities

$

 68,044

$

 -

$

 2,364

$

 65,680

 

 

 

 

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net(a)

$

 1,787

$

 735

$

 -

$

 1,052

 

 

    Exchange-traded investments

 

 431

 

 431

 

 -

 

 -

 

 

    Total Assets

$

 2,218

$

 1,166

$

 -

$

 1,052

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

    Derivatives, net

$

 65,680

$

 -

$

 -

$

 65,680

 

 

    Deferred compensation

 

 2,364

 

 -

 

 2,364

 

 -

 

 

    Total Liabilities

$

 68,044

$

 -

$

 2,364

$

 65,680

 

 

 

 

 

 

 

 

 

 

 

 

 

(a)   These amounts are shown gross and exclude $0.2 million of collateral that was

 

 

        posted against derivative positions with counterparties as of  December 31, 2013.

 


No transfers were made in or out of Level 1 or Level 2 for the nine months ended September 30, 2014.


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


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


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


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



26




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


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


 

 

 

Model Input

 

Significant Unobservable Inputs

 

September 30, 2014

 

December 31, 2013

 

Basis adjustment:

 

 

 

 

 

    On peak

 

97.5%

 

94.2%

 

    Off peak

 

94.4%

 

92.6%

 

Counterparty fuel mix:

 

 

 

 

 

    Internal generation

 

50% - 70%

 

50% - 70%

 

    Purchased power

 

50% - 30%

 

50% - 30%


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


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


 

 

Three Months Ended

 

Nine Months Ended

 

 

September 30,

 

September 30,

(In thousands)

 

2014

 

2013

 

2014

 

2013

Beginning balance

$

 (49,349)

$

 (66,856)

$

 (64,628)

$

 (72,346)

Realized and unrealized gains (losses):

 

 

 

 

 

 

 

 

    Included in regulatory liabilities (assets)

 

 (3,752)

 

 (1,472)

 

 11,528

 

 4,018

    Included in other comprehensive income

 

 -

 

 -

 

 -

 

 -

    Included in earnings

 

 (1,419)

 

 (174)

 

 5,837

 

 (2,034)

    Included in current assets

 

 -

 

 (38)

 

 (89)

 

 (94)

Purchases

 

 6,371

 

 6,052

 

 19,900

 

 17,709

Sales

 

 -

 

 -

 

 (60)

 

 (2)

Issuances

 

 -

 

 -

 

 -

 

 -

Settlements

 

 (4,952)

 

 (5,840)

 

 (25,589)

 

 (15,579)

Transfers in and/or out of Level 3

 

 -

 

 -

 

 -

 

 -

Balance as of September 30,

$

 (53,101)

$

 (68,328)

$

 (53,101)

$

 (68,328)

Total gains (losses) included in earnings attributed to

 

 

 

 

 

 

 

 

the change in unrealized gains (losses) related to

 

 

 

 

 

 

 

 

assets and liabilities held at September 30,(b)

$

 -

$

 -

$

 -

$

 -


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


 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

 

September 30,

 

September 30,

 

 

(In thousands)

 

2014

 

2013

 

2014

 

2013

 

 

Purchased Power Expense

$

 (1,411)

$

 (174)

$

 5,845

$

 (2,034)

 

 

Cost of Gas Sold Expense

 

 (8)

 

 -

 

 (8)

 

 -

 

 

Total

$

 (1,419)

$

 (174)

$

 5,837

$

 (2,034)

 


(b)

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



27




12.

New Accounting Pronouncements - MGE Energy and MGE.


a.

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


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


b.

Presentation of an Unrecognized Tax Benefit.


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


c.

Revenue from Contracts with Customers.


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


d.

Transfers and Servicing Assets.


In June 2014, the FASB issued authoritative guidance within the Codification's Transfers and Servicing topic that provides guidance on the accounting and disclosures for repurchase-to-maturity transactions, securities lending transactions, and repurchase financings. This authoritative guidance will become effective January 1, 2015. The authoritative guidance will change the accounting for the Chattel Paper program. Prior to adoption of the standard, Chattel Paper was treated as an off-balance sheet arrangement. Upon adoption, assets and liabilities will increase approximately $4.0 million and additional disclosures will be required. The cumulative impact of this guidance on our financial statements is not expected to be material.


13.

Segment Information - MGE Energy and MGE.


MGE Energy operates in the following business segments: electric utility, gas utility, nonregulated energy, transmission investment, and all other. See MGE Energy's and MGE's 2013 Annual Report on Form 10-K for additional discussion of each of these segments.




28




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


(In thousands)

MGE Energy

 

Electric

 

Gas

 

Non- Regulated Energy

 

Transmission Investment

 

All Others

 

Consolidation/ Elimination Entries

 

Consolidated Total

Three Months Ended September 30, 2014

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

 112,869

$

 21,404

$

 862

$

 -

$

 -

$

 -

$

 135,135

Interdepartmental revenues

 

 156

 

 1,614

 

 10,674

 

 -

 

 -

 

 (12,444)

 

 -

Total operating revenues

 

 113,025

 

 23,018

 

 11,536

 

 -

 

 -

 

 (12,444)

 

 135,135

Depreciation and amortization

 

 (6,931)

 

 (1,575)

 

 (1,858)

 

 -

 

 (12)

 

 -

 

 (10,376)

Other operating expenses

 

 (74,573)

 

 (22,199)

 

 (35)

 

 -

 

 (276)

 

 12,444

 

 (84,639)

Operating income (loss)

 

 31,521

 

 (756)

 

 9,643

 

 -

 

 (288)

 

 -

 

 40,120

Other income, net

 

 136

 

 8

 

 -

 

 2,423

 

 69

 

 -

 

 2,636

Interest (expense) income, net

 

 (2,832)

 

 (808)

 

 (1,545)

 

 -

 

 44

 

 -

 

 (5,141)

Income (loss) before taxes

 

 28,825

 

 (1,556)

 

 8,098

 

 2,423

 

 (175)

 

 -

 

 37,615

Income tax (provision) benefit

 

 (10,758)

 

 651

 

 (3,251)

 

 (963)

 

 35

 

 -

 

 (14,286)

Net income (loss)

$

 18,067

$

 (905)

$

 4,847

$

 1,460

$

 (140)

$

 -

$

 23,329

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2013

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

 119,836

$

 18,864

$

 1,399

$

 -

$

 -

$

 -

$

 140,099

Interdepartmental revenues

 

 172

 

 2,757

 

 10,660

 

 -

 

 -

 

 (13,589)

 

 -

Total operating revenues

 

 120,008

 

 21,621

 

 12,059

 

 -

 

 -

 

 (13,589)

 

 140,099

Depreciation and amortization

 

 (6,425)

 

 (1,497)

 

 (1,788)

 

 -

 

 -

 

 -

 

 (9,710)

Other operating expenses

 

 (82,414)

 

 (21,485)

 

 (33)

 

 (1)

 

 (145)

 

 13,589

 

 (90,489)

Operating income (loss)

 

 31,169

 

 (1,361)

 

 10,238

 

 (1)

 

 (145)

 

 -

 

 39,900

Other income, net

 

 1,166

 

 92

 

 -

 

 2,340

 

 152

 

 -

 

 3,750

Interest (expense) income, net

 

 (2,309)

 

 (729)

 

 (1,596)

 

 -

 

 29

 

 -

 

 (4,605)

Income (loss) before taxes

 

 30,026

 

 (1,998)

 

 8,642

 

 2,339

 

 36

 

 -

 

 39,045

Income tax (provision) benefit

 

 (11,021)

 

 751

 

 (3,469)

 

 (939)

 

 (14)

 

 -

 

 (14,692)

Net income (loss)

$

 19,005

$

 (1,247)

$

 5,173

$

 1,400

$

 22

$

 -

$

 24,353

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2014

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

 308,418

$

 163,335

$

 2,392

$

 -

$

 -

$

 -

$

 474,145

Interdepartmental revenues

 

 401

 

 7,130

 

 32,017

 

 -

 

 -

 

 (39,548)

 

 -

Total operating revenues

 

 308,819

 

 170,465

 

 34,409

 

 -

 

 -

 

 (39,548)

 

 474,145

Depreciation and amortization

 

 (19,909)

 

 (4,700)

 

 (5,547)

 

 -

 

 (35)

 

 -

 

 (30,191)

Other operating expenses

 

 (229,286)

 

 (144,907)

 

 (105)

 

 -

 

 (672)

 

 39,548

 

 (335,422)

Operating income (loss)

 

 59,624

 

 20,858

 

 28,757

 

 -

 

 (707)

 

 -

 

 108,532

Other (deductions) income, net

 

 2,999

 

 (44)

 

 -

 

 7,306

 

 475

 

 -

 

 10,736

Interest (expense) income, net

 

 (7,571)

 

 (2,429)

 

 (4,676)

 

 -

 

 126

 

 -

 

 (14,550)

Income (loss) before taxes

 

 55,052

 

 18,385

 

 24,081

 

 7,306

 

 (106)

 

 -

 

 104,718

Income tax provision

 

 (19,602)

 

 (7,378)

 

 (9,665)

 

 (2,924)

 

 (16)

 

 -

 

 (39,585)

Net income (loss)

$

 35,450

$

 11,007

$

 14,416

$

 4,382

$

 (122)

$

 -

$

 65,133

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2013

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

 310,176

$

 121,373

$

 4,075

$

 -

$

 -

$

 -

$

 435,624

Interdepartmental revenues

 

 410

 

 10,449

 

 31,924

 

 -

 

 -

 

 (42,783)

 

 -

Total operating revenues

 

 310,586

 

 131,822

 

 35,999

 

 -

 

 -

 

 (42,783)

 

 435,624

Depreciation and amortization

 

 (19,139)

 

 (4,357)

 

 (5,368)

 

 -

 

 -

 

 -

 

 (28,864)

Other operating expenses

 

 (235,390)

 

 (111,494)

 

 (96)

 

 (1)

 

 (537)

 

 42,783

 

 (304,735)

Operating income (loss)

 

 56,057

 

 15,971

 

 30,535

 

 (1)

 

 (537)

 

 -

 

 102,025

Other income, net

 

 2,226

 

 69

 

 -

 

 7,045

 

 430

 

 -

 

 9,770

Interest (expense) income, net

 

 (7,028)

 

 (2,166)

 

 (4,814)

 

 -

 

 71

 

 -

 

 (13,937)

Income (loss) before taxes

 

 51,255

 

 13,874

 

 25,721

 

 7,044

 

 (36)

 

 -

 

 97,858

Income tax (provision) benefit

 

 (18,148)

 

 (5,844)

 

 (10,209)

 

 (2,837)

 

 8

 

 -

 

 (37,030)

Net income (loss)

$

 33,107

$

 8,030

$

 15,512

$

 4,207

$

 (28)

$

 -

$

 60,828




29




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


(In thousands)

MGE

 

Electric

 

Gas

 

Nonregulated Energy

 

Transmission Investment

 

Consolidation/ Elimination Entries

 

Consolidated Total

Three Months Ended September 30, 2014

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

 112,875

$

 21,410

$

 862

$

 -

$

 -

$

 135,147

Interdepartmental revenues

 

 150

 

 1,608

 

 10,674

 

 -

 

 (12,432)

 

 -

Total operating revenues

 

 113,025

 

 23,018

 

 11,536

 

 -

 

 (12,432)

 

 135,147

Depreciation and amortization

 

 (6,931)

 

 (1,575)

 

 (1,858)

 

 -

 

 -

 

 (10,364)

Other operating expenses*

 

 (85,314)

 

 (21,544)

 

 (3,286)

 

 -

 

 12,432

 

 (97,712)

Operating income (loss)*

 

 20,780

 

 (101)

 

 6,392

 

 -

 

 -

 

 27,071

Other income, net*

 

 119

 

 4

 

 -

 

 1,460

 

 -

 

 1,583

Interest expense, net

 

 (2,832)

 

 (808)

 

 (1,545)

 

 -

 

 -

 

 (5,185)

Net income (loss)

 

 18,067

 

 (905)

 

 4,847

 

 1,460

 

 -

 

 23,469

Less: Net income attributable to

 

 

 

 

 

 

 

 

 

 

 

 

 noncontrolling interest, net of tax

 

 -

 

 -

 

 -

 

 -

 

 (6,653)

 

 (6,653)

Net income (loss) attributable to MGE

$

 18,067

$

 (905)

$

 4,847

$

 1,460

$

 (6,653)

$

 16,816

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended September 30, 2013

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

 119,836

$

 18,864

$

 1,399

$

 -

$

 -

$

 140,099

Interdepartmental revenues

 

 172

 

 2,757

 

 10,660

 

 -

 

 (13,589)

 

 -

Total operating revenues

 

 120,008

 

 21,621

 

 12,059

 

 -

 

 (13,589)

 

 140,099

Depreciation and amortization

 

 (6,425)

 

 (1,497)

 

 (1,788)

 

 -

 

 -

 

 (9,710)

Other operating expenses*

 

 (93,481)

 

 (20,748)

 

 (3,502)

 

 (1)

 

 13,589

 

 (104,143)

Operating income (loss)*

 

 20,102

 

 (624)

 

 6,769

 

 (1)

 

 -

 

 26,246

Other income, net*

 

 1,212

 

 106

 

 -

 

 1,401

 

 -

 

 2,719

Interest expense, net

 

 (2,309)

 

 (729)

 

 (1,596)

 

 -

 

 -

 

 (4,634)

Net income (loss)

 

 19,005

 

 (1,247)

 

 5,173

 

 1,400

 

 -

 

 24,331

Less: Net income attributable to

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest, net of tax

 

 -

 

 -

 

 -

 

 -

 

 (6,861)

 

 (6,861)

Net income (loss) attributable to MGE

$

 19,005

$

 (1,247)

$

 5,173

$

 1,400

$

 (6,861)

$

 17,470

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2014

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

 308,435

$

 163,351

$

 2,392

$

 -

$

 -

$

 474,178

Interdepartmental revenues

 

 384

 

 7,114

 

 32,017

 

 -

 

 (39,515)

 

 -

Total operating revenues

 

 308,819

 

 170,465

 

 34,409

 

 -

 

 (39,515)

 

 474,178

Depreciation and amortization

 

 (19,909)

 

 (4,700)

 

 (5,547)

 

 -

 

 -

 

 (30,156)

Other operating expenses*

 

 (248,525)

 

 (152,182)

 

 (9,770)

 

 -

 

 39,515

 

 (370,962)

Operating income*

 

 40,385

 

 13,583

 

 19,092

 

 -

 

 -

 

 73,060

Other (deductions) income, net*

 

 2,636

 

 (147)

 

 -

 

 4,382

 

 -

 

 6,871

Interest expense, net

 

 (7,571)

 

 (2,429)

 

 (4,676)

 

 -

 

 -

 

 (14,676)

Net income

 

 35,450

 

 11,007

 

 14,416

 

 4,382

 

 -

 

 65,255

Less: Net income attributable to

 

 

 

 

 

 

 

 

 

 

 

 

 noncontrolling interest, net of tax

 

 -

 

 -

 

 -

 

 -

 

 (19,784)

 

 (19,784)

Net income attributable to MGE

$

 35,450

$

 11,007

$

 14,416

$

 4,382

$

 (19,784)

$

 45,471

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2013

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

 310,176

$

 121,373

$

 4,075

$

 -

$

 -

$

 435,624

Interdepartmental revenues

 

 410

 

 10,449

 

 31,924

 

 -

 

 (42,783)

 

 -

Total operating revenues

 

 310,586

 

 131,822

 

 35,999

 

 -

 

 (42,783)

 

 435,624

Depreciation and amortization

 

 (19,139)

 

 (4,357)

 

 (5,368)

 

 -

 

 -

 

 (28,864)

Other operating expenses*

 

 (253,566)

 

 (117,346)

 

 (10,305)

 

 (1)

 

 42,783

 

 (338,435)

Operating income (loss)*

 

 37,881

 

 10,119

 

 20,326

 

 (1)

 

 -

 

 68,325

Other income, net*

 

 2,254

 

 77

 

 -

 

 4,208

 

 -

 

 6,539

Interest expense, net

 

 (7,028)

 

 (2,166)

 

 (4,814)

 

 -

 

 -

 

 (14,008)

Net income

 

 33,107

 

 8,030

 

 15,512

 

 4,207

 

 -

 

 60,856

Less: Net income attributable to

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest, net of tax

 

 -

 

 -

 

 -

 

 -

 

 (20,547)

 

 (20,547)

Net income attributable to MGE

$

 33,107

$

 8,030

$

 15,512

$

 4,207

$

 (20,547)

$

 40,309

 

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




30




The following table shows segment information for MGE Energy's and MGE's assets and capital expenditures:


 

 

Utility

 

 

Consolidated

(In thousands)

MGE Energy

 

Electric

 

Gas

 

Assets not Allocated

 

 

Nonregulated Energy

 

Transmission Investment

 

All Others

 

Consolidation/ Elimination Entries

 

Total

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2014

$

 914,839

$

 263,688

$

 30,962

 

$

 307,599

$

 67,476

$

 443,898

$

 (408,566)

$

 1,619,896

December 31, 2013

 

 899,257

 

 265,694

 

 19,853

 

 

 288,116

 

 64,504

 

 431,436

 

 (389,800)

 

 1,579,060

Capital Expenditures:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2014

$

 50,033

$

 14,599

$

 -

 

$

 1,506

$

 -

$

 -

$

 -

$

 66,138

Year ended Dec. 31, 2013

 

 100,146

 

 15,554

 

 -

 

 

 3,347

 

 -

 

 -

 

 -

 

 119,047


 

 

Utility

 

 

Consolidated

(In thousands)

MGE

 

Electric

 

Gas

 

Assets not Allocated

 

 

Nonregulated Energy

 

Transmission Investment

 

Elimination Entries

 

Total

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2014

$

 917,503

$

 262,237

$

 30,778

 

$

 286,600

$

 67,476

$

 (5,892)

$

 1,558,702

December 31, 2013

 

 899,257

 

 265,694

 

 19,853

 

 

 288,066

 

 64,504

 

 (6,731)

 

 1,530,643

Capital Expenditures:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended September 30, 2014

$

 50,033

$

 14,599

$

 -

 

$

 1,506

$

 -

$

 -

$

 66,138

Year ended Dec. 31, 2013

 

 100,146

 

 15,554

 

 -

 

 

 3,347

 

 -

 

 -

 

 119,047




31




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

·

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 141,000 customers in Dane County, Wisconsin, including the city of Madison, and purchases and distributes natural gas to approximately 147,000 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 our 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 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 of electricity and gas,

·

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,

·

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 2013 Annual Report on Form 10-K and in this report.


For the three months ended September 30, 2014, MGE Energy's earnings were $23.3 million or $0.67 per share compared to $24.4 million or $0.70 per share for the same period in the prior year. MGE's earnings for the three months ended September 30, 2014, were $16.8 million compared to $17.5 million for the same period in the prior year.


For the nine months ended September 30, 2014, MGE Energy's earnings were $65.1 million or $1.88 per share compared to $60.8 million or $1.75 per share for the same period in the prior year. MGE's earnings for the nine months ended September 30, 2014, were $45.5 million compared to $40.3 million for the same period in the prior year.




32




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


 

 

 

Three Months Ended

 

Nine Months Ended

 

 

(In thousands)

 

September 30,

 

September 30,

 

 

Business Segment:

 

2014

 

2013

 

2014

 

2013

 

 

    Electric Utility

$

 18,067

$

 19,005

$

 35,450

$

 33,107

 

 

    Gas Utility

 

 (905)

 

 (1,247)

 

 11,007

 

 8,030

 

 

    Nonregulated Energy

 

 4,847

 

 5,173

 

 14,416

 

 15,512

 

 

    Transmission Investments

 

 1,460

 

 1,400

 

 4,382

 

 4,207

 

 

    All Other

 

 (140)

 

 22

 

 (122)

 

 (28)

 

 

    Net Income

$

 23,329

$

 24,353

$

 65,133

$

 60,828

 


Our net income during the three months ended September 30, 2014, compared to the same period in the prior year primarily reflects the effects of the following factors:


·

Electric net income decreased due to a 4.4% decrease in electric retail sales reflecting lower customer demand. Cooling degree days (a measure for determining the impact of weather during the cooling season) decreased by 25.1% compared to the prior year. In addition, AFUDC equity decreased $0.7 million (after tax) related to the Columbia environmental project compared to the same period in the prior year. The Columbia units were placed into service in April 2014 and July 2014. The decrease in electric retail sales was partially offset by savings from operating and maintenance expenditures.


·

Lower non-regulated revenues in 2014 due to the approved recovery, as part of the WEPCO 2013 Wisconsin rate case, of certain one-time force majeure costs associated with the Elm Road Units including a one-time cumulative adjustment for prior periods all recognized in 2013.


Our net income during the nine months ended September 30, 2014, primarily reflects the effects of the following factors:


·

Electric net income increased due to a $1.1 million (after tax) increase in AFUDC equity related to the Columbia environmental project compared to the same period in the prior year. In addition, operating and maintenance expenditures decreased compared to the prior period.


·

Gas net income increased due to a 14.6% increase in gas retail sales reflecting higher customer demand due to a colder winter. The average temperatures in January and February were 11.5 degrees and 12.5 degrees, respectively, compared to 21.8 degrees and 21.3 degrees in the prior year. Heating degree days (a measure for determining the impact of weather during the heating season) increased by 9.2% compared to the prior year. In addition, operating and maintenance expenditures decreased over the prior year.


·

Lower non-regulated revenues in 2014 due to the approved recovery, as part of the WEPCO 2013 Wisconsin rate case, of certain one-time force majeure costs associated with the Elm Road Units including a one-time cumulative adjustment for prior periods all recognized in 2013.


During the first nine months of 2014, the following events occurred:


Columbia Environmental Project: In early 2011, the PSCW authorized the construction of air emission reduction systems and associated equipment on Columbia Units 1 and 2. These systems and equipment for Unit 2 and Unit 1 were placed into service in April 2014 and July 2014, respectively. As of September 30, 2014, $128.8 million of the capitalized project (excluding carrying costs) was transferred from Construction work in progress to Property, plant, and equipment on MGE's balance sheet related to Unit 1 and Unit 2 being placed into service. MGE has accumulated $7.9 million of capital expenditures and recognized $3.0 million (after tax) in AFUDC equity related to this project for the nine months ended September 30, 2014.


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


2015 Rate Filing: On April 17, 2014, MGE filed an application with the PSCW requesting a 2.8% increase to electric rates and a 2.3% decrease to gas rates for 2015. MGE has requested escrow accounting treatment for transmission related costs starting in 2015. This treatment will allow MGE to reflect any differential between the costs reflected in rates and actual costs incurred in its next rate case filing. The proposed electric rate increases cover costs associated with the construction of emission-reduction equipment at Columbia and improvements and reliability of the state's electric transmission system.



33




During the rate case proceeding, certain updates have been made to reflect changing conditions from the initial filing. Those updates include increased costs for fuel and purchased power costs primarily related to coal delivery costs, lower transmission costs due to favorable FERC decisions on cost allocations for system reliability payments, and increased costs to reflect current market conditions for pension and post-retirement benefit costs. Incorporating the revisions would adjust the electric rate increase from 2.8% to 4.3% and adjust the gas rate decrease from 2.3% to 1.4%. A PSCW decision is expected by the end of 2014.


Environmental Initiatives: There are proposed legislation, 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. Such legislation and rulemaking could significantly affect the costs of owning and operating fossil-fueled generating plants, such as Columbia and Elm Road, from which we derive approximately 44% of our electric generating capacity. 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. In addition, the Columbia owners, including MGE, resolved claims surrounding the alleged failure, among other things, to obtain necessary air permits and implement necessary emission controls associated with past activities at Columbia, which will require the installation of additional emission controls at Columbia. See Columbia discussion in Footnote 8.a. in the Notes to Consolidated Financial Statements.


Pension and Other Postretirement Benefit Costs: Costs for pension and other postretirement benefits are affected by actual investment returns on the assets held for those benefits and by the discount rate, which is sensitive to interest rates, used to calculate those benefits. Interest rates have declined since the end of 2013 that could cause discount rates used to value the pension and postretirement benefit obligations to decline. A new set of mortality tables, which are used to develop actuarial estimates, was finalized by the Society of Actuaries in October 2014. The changes in the value of the plan assets, the discount rate, and the mortality tables are not expected to have an impact on the income statement for 2014. However, these changes may increase benefit costs in future years. MGE expects any changes in the cost for employee benefit plans will be factored into future rate actions.


Coal Supplies: Coal supplies at our principal coal-fired generating plants have been affected since the beginning of 2014 by railroad transportation constraints affecting the availability and scheduling of coal transport trains. Reduced on-site supplies could impact the generation available from these units and increase the use of relatively more expensive forms of internal generation or market purchases of external generation from third parties. See Risk Factors in Part II, Item 1A of this report for additional information.


ATC Return on Equity: Several parties have filed a complaint with FERC seeking to reduce the base return on equity (ROE) of MISO and numerous other MISO transmission owners, including ATC, "due to changes in the capital markets." The complaint alleges that the MISO ROE should not exceed 9.15%, the equity components of hypothetical capital structures should be restricted to 50%, and the relevant incentive ROE adders should be discontinued. MISO's base ROE is 12.38% and ATC's base ROE is 12.2%. We derived approximately 7% of our net income for the nine months ended September 30, 2014, from our investment in ATC.


General Economic Conditions: Economic conditions both inside and outside our service area are expected to continue to affect the level of demand for our utility services and may affect the collection of our accounts receivable and the creditworthiness of counterparties with whom we do business. We have in place lines of credit aggregating $150 million for MGE Energy (including MGE) and $100 million for MGE to address our liquidity needs. As of September 30, 2014, there were no borrowings outstanding under our lines of credit.


The following discussion is based on the business segments as discussed in Footnote 13 of the Notes to Consolidated Financial Statements.




34




Three Months Ended September 30, 2014 and 2013


Electric Utility Operations - MGE Energy and MGE


Electric sales and revenues


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


 

 

Revenues

 

Sales (kWh)

(In thousands, except cooling degree days)

 

Three Months Ended September 30,

 

Three Months Ended September 30,

 

2014

 

2013

 

% Change

 

2014

 

2013

 

% Change

Residential

$

 37,455

$

 40,578

 

 (7.7)%

 

 217,677

 

 238,046

 

 (8.6)%

Commercial

 

 60,127

 

 62,582

 

 (3.9)%

 

 488,310

 

 502,924

 

 (2.9)%

Industrial

 

 5,513

 

 5,612

 

 (1.8)%

 

 65,145

 

 66,366

 

 (1.8)%

Other-retail/municipal

 

 10,958

 

 11,952

 

 (8.3)%

 

 118,311

 

 123,221

 

 (4.0)%

    Total retail

 

 114,053

 

 120,724

 

 (5.5)%

 

 889,443

 

 930,557

 

 (4.4)%

Sales to the market

 

 179

 

 465

 

 (61.5)%

 

 508

 

 8,038

 

 (93.7)%

Adjustments to revenues

 

 (1,363)

 

 (1,353)

 

 (0.7)%

 

 -

 

 -

 

 -  %

    Total

$

 112,869

$

 119,836

 

 (5.8)%

 

 889,951

 

 938,595

 

 (5.2)%

 

 

 

 

 

 

 

 

 

 

 

 

 

Cooling degree days (normal 477)

 

 

 

 

 

 

 

387

 

517

 

(25.1)%


Electric operating revenues decreased $7.0 million or 5.8% for the three months ended September 30, 2014, compared to the same period in 2013, due to the following:


 

(In millions)

 

 

 

 

Volume

$

(5.3)

 

 

Other

 

(1.4)

 

 

Sales to the market

 

(0.3)

 

 

Total

$

(7.0)

 


In July 2013, the PSCW authorized MGE to freeze 2014 rates at 2013 levels for retail electric customers.


·

Volume. During the three months ended September 30, 2014, there was a 4.4% decrease in total retail sales volumes compared to the same period in the prior year driven by cooler than normal weather.


·

Other. During the three months ended September 30, 2014, other items affecting electric operating revenues decreased $1.4 million primarily attributable to a decrease in demand charges and lower monthly on-peak sales.


·

Sales to the market. Sales to the market represent wholesale sales made to third parties who are not ultimate users of the electricity. These sales may include spot market transactions on the markets operated by MISO and PJM. These sales may also include bilateral sales to other utilities or power marketers. Generating units are dispatched by MISO based on cost considerations as well as reliability of the system. Sales to the market typically occur when MGE has more generation and purchases online than are needed for its own system demand. The excess electricity is then sold to others in the market. For the three months ended September 30, 2014, market volumes decreased compared to the same period in the prior year, reflecting decreased opportunities for sales; however, market settlement resulted in higher revenue per kWh for the three months ended September 30, 2014, reflecting higher market prices.


Electric fuel and purchased power


Electric fuel and purchased power costs reflect a decrease in internal generation volumes offset by an increase in the volume of purchased power when compared to the prior period. Adjustments related to the regulatory recovery for fuel costs, known as fuel rules, moderated the effects of that increased volume. These items are explained below.




35




Fuel for electric generation

The expense for fuel for internal electric generation decreased $4.1 million during the three months ended September 30, 2014, compared to the same period in the prior year, due to the following:


 

(In millions)

 

 

 

 

Decrease in volume

$

(4.9)

 

 

Increase in per-unit cost

 

0.8

 

 

Total

$

(4.1)

 


This decrease in expense reflects a 34.9% decrease in internal generated volume delivered to the system primarily as a result of reduced generation at Columbia to reduce coal use in order to maintain inventory levels, partially offset by an 8.2% increase in per-unit cost of internal electric generation.


Purchased power

Purchased power expense decreased $0.7 million during the three months ended September 30, 2014, compared to the same period in the prior year, due to the following:


 

(In millions)

 

 

 

 

Increase in volume

$

10.0

 

 

Decrease in per-unit cost

 

(5.1)

 

 

Fuel Rules Adjustments

 

 

 

 

    Decrease in recorded fuel rule surplus credit

 

(4.0)

 

 

    Amortization of 2012 fuel rule surplus credits

 

(1.6)

 

 

Total

$

(0.7)

 


The decrease in expense reflects an 18.2% decrease in the per-unit cost of purchased power and a 55.5% increase in the volume of power purchased from third parties primarily as a result of the reduced generation at Columbia.


Under fuel rules, MGE is required to defer electric fuel-related costs that fall outside a 2% cost tolerance band around the amount used in the most recent rate proceeding. Any fuel rules adjustments are reflected in purchased power expense. Cost savings that may be returned to customers are recorded as an increase to purchased power expense, and higher costs that MGE is entitled to recover, after adjustment for excess revenues, are recorded as a reduction to purchased power expense. Any over/under recovery of the deferred costs is determined on an annual basis and adjusted in future billings to customers. During the three months ended September 30, 2014, MGE amortized $1.6 million of the 2012 fuel rule surplus credits. No fuel-related cost savings were deferred during the current period, as compared to $4.0 million of cost savings (surplus credit) in the prior period.


Electric operating and maintenance expenses


Electric operating and maintenance expenses decreased $3.1 million during the three months ended September 30, 2014, compared to the same period in 2013. The following changes contributed to the net change:


 

(In millions)

 

 

 

 

Decreased administrative and general costs

$

(1.5)

 

 

Decreased transmission costs

 

(0.8)

 

 

Decreased customer accounts costs

 

(0.3)

 

 

Decreased production expenses

 

(0.3)

 

 

Decreased distribution expenses

 

(0.2)

 

 

Total

$

(3.1)

 


For the three months ended September 30, 2014, decreased administrative and general costs are primarily due to decreased pension and other postretirement benefit costs.




36




Gas Utility Operations - MGE Energy and MGE


Gas deliveries and revenues


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


 

 

Revenues

 

Therms Delivered

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

 

Three Months Ended September 30,

 

Three Months Ended September 30,

 

2014

 

2013

 

% Change

 

2014

 

2013

 

% Change

Residential

$

 9,507

$

 8,794

 

 8.1 %

 

 6,105

 

 5,676

 

 7.6 %

Commercial/Industrial

 

 11,188

 

 9,343

 

 19.7 %

 

 18,714

 

 17,789

 

 5.2 %

    Total retail

 

 20,695

 

 18,137

 

 14.1 %

 

 24,819

 

 23,465

 

 5.8 %

Gas transportation

 

 608

 

 593

 

 2.5 %

 

 7,127

 

 6,937

 

 2.7 %

Other revenues

 

 101

 

 134

 

 (24.6)%

 

 -

 

 -

 

 -  %

    Total

$

 21,404

$

 18,864

 

 13.5 %

 

 31,946

 

 30,402

 

 5.1 %

Heating degree days (normal 172)

 

 

 

 

 

 

 

165

 

 157

 

5.1 %

Average rate per therm of

 

 

 

 

 

 

 

 

 

 

 

 

retail customer

$

0.834

$

0.773

 

7.9 %

 

 

 

 

 

 


Gas revenues increased $2.5 million or 13.5% for the three months ended September 30, 2014, compared to the same period in 2013. These changes are related to the following factors:


 

(In millions)

 

 

 

 

Rate/PGA changes

$

1.5

 

 

Volume

 

1.0

 

 

Total

$

2.5

 


·

Rate/PGA changes. The average retail rate per therm for the three months ended September 30, 2014, increased 7.9% compared to the same period in 2013, reflecting higher natural gas commodity costs. MGE recovers the cost of natural gas in its gas segment through the purchased gas adjustment clause (PGA). Under the PGA, MGE is able to pass through to its gas customers the cost of gas.


·

Volume. For the three months ended September 30, 2014, retail gas deliveries increased 5.8% compared to the same period in 2013, as a result of colder weather compared to warmer weather in the prior year.

 

Cost of gas sold


For the three months ended September 30, 2014, cost of gas sold increased by $2.2 million, compared to the same period in the prior year. The cost per therm of natural gas increased 17.8%, which resulted in $1.7 million of increased expense. The volume of gas purchased increased 6.2%, which resulted in $0.5 million of increased expense.


Gas operating and maintenance expenses


Gas operating and maintenance expenses decreased by $0.6 million for the three months ended September 30, 2014, compared to the same period in 2013. The following changes contributed to the net change:


 

(In millions)

 

 

 

 

Decreased administrative and general costs

$

(0.7)

 

 

Decreased production expenses

 

(0.1)

 

 

Decreased customer service costs

 

(0.1)

 

 

Increased distribution expenses

 

0.3

 

 

Total

$

(0.6)

 


For the three months ended September 30, 2014, decreased administrative and general costs are primarily due to decreased pension and other postretirement benefit costs.




37




Nonregulated Energy Operations - MGE Energy and MGE


For the three months ended September 30, 2014 and 2013, net income at the nonregulated energy operations segment was $4.8 million and $5.2 million, respectively. The nonregulated energy operations are conducted through MGE Energy's subsidiaries: MGE Power Elm Road and MGE Power West Campus, which have been formed to own and lease electric generating capacity to assist MGE.


Results reflect the recovery of force majeure costs associated with the construction of the Elm Road Units. In December 2012, as part of WEPCO's (the operator and primary owner of the Elm Road Units) 2013 Wisconsin rate case, the PSCW determined that 100% of the construction costs for the Elm Road Units were prudently incurred, and approved the recovery in rates of more than 99.5% of the force majeure costs. The recovery of the force majeure costs began in 2013, including a one-time cumulative adjustment pertaining to affected periods prior to the PSCW order. The portion pertaining to prior periods was fully reflected in 2013 results.


Transmission Investment Operations - MGE Energy and MGE


Transmission investment other income


For the three months ended September 30, 2014 and 2013, other income at the transmission investment segment was $2.4 million and $2.3 million, respectively. The transmission investment segment holds our interest in ATC, and its income reflects our equity in the earnings of ATC. See Footnote 3 of the Notes to Consolidated Financial Statements for additional information concerning ATC and summarized financial information regarding ATC.


Consolidated Income Taxes - MGE Energy and MGE


MGE Energy's effective income tax rate for the three months ended September 30, 2014 and 2013, was 38.0% and 37.6%, respectively. MGE's effective income tax rate for the three months ended September 30, 2014 and 2013, was 37.9% and 37.6%, respectively. The net increase is attributable to less AFUDC equity earned during the three month period in 2014 compared to 2013.


Noncontrolling Interest, Net of Tax - MGE


The noncontrolling interest, net of tax, reflects the accounting required for MGE Energy's interest in MGE Power Elm Road (the Elm Road Units) and MGE Power West Campus (WCCF). MGE Energy owns 100% of MGE Power Elm Road and MGE Power West Campus; however, due to the contractual agreements for these projects with MGE, the entities are considered VIEs and their results are consolidated with those of MGE, the primary beneficiary of the VIEs. Also included in noncontrolling interest, net of tax, is MGE Energy's interest in MGE Transco, which holds our investment in ATC. The following table shows MGE Energy's noncontrolling interest, net of tax, reflected on MGE's consolidated statement of income:


 

 

 

Three Months Ended

 

 

 

 

September 30,

 

 

(In millions)

 

2014

 

2013

 

 

MGE Power Elm Road

$

4.1

$

4.3

 

 

MGE Power West Campus

 

1.9

 

1.9

 

 

MGE Transco

 

0.7

 

0.6

 




38




Nine Months Ended September 30, 2014 and 2013


Electric Utility Operations - MGE Energy and MGE


Electric sales and revenues


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


 

 

Revenues

 

Sales (kWh)

(In thousands, except cooling degree days)

 

Nine Months Ended September 30,

 

Nine Months Ended September 30,

 

2014

 

2013

 

% Change

 

2014

 

2013

 

% Change

Residential

$

 102,698

$

 104,020

 

 (1.3)%

 

 616,775

 

 624,877

 

 (1.3)%

Commercial

 

 163,992

 

 164,024

 

 (0.0)%

 

 1,394,272

 

 1,382,151

 

 0.9 %

Industrial

 

 15,141

 

 15,283

 

 (0.9)%

 

 186,085

 

 189,882

 

 (2.0)%

Other-retail/municipal

 

 28,543

 

 30,322

 

 (5.9)%

 

 314,338

 

 326,717

 

 (3.8)%

    Total retail

 

 310,374

 

 313,649

 

 (1.0)%

 

 2,511,470

 

 2,523,627

 

 (0.5)%

Sales to the market

 

 2,239

 

 682

 

 228.3 %

 

 62,538

 

 22,052

 

 183.6 %

Adjustments to revenues

 

 (4,195)

 

 (4,155)

 

 (1.0)%

 

 -

 

 -

 

 -  %

    Total

$

 308,418

$

 310,176

 

 (0.6)%

 

 2,574,008

 

 2,545,679

 

 1.1 %

 

 

 

 

 

 

 

 

 

 

 

 

 

Cooling degree days (normal 659)

 

 

 

 

 

 

 

620

 

707

 

(12.3)%


Electric operating revenues decreased $1.8 million or 0.6% for the nine months ended September 30, 2014, compared to the same period in 2013, due to the following:


 

(In millions)

 

 

 

 

Volume

$

(1.5)

 

 

Other

 

(1.8)

 

 

Sales to the market

 

1.5

 

 

Total

$

(1.8)

 


In July 2013, the PSCW authorized MGE to freeze 2014 rates at 2013 levels for retail electric customers.


·

Volume. During the nine months ended September 30, 2014, there was a 0.5% decrease in total retail sales volumes compared to the same period in the prior year driven by cooler than normal weather.


·

Other. During the nine months ended September 30, 2014, other items affecting electric operating revenues decreased $1.8 million primarily attributable to a decrease in demand charges and lower monthly on-peak sales.


·

Sales to the market. Sales to the market represent wholesale sales made to third parties who are not ultimate users of the electricity. These sales may include spot market transactions on the markets operated by MISO and PJM. These sales may also include bilateral sales to other utilities or power marketers. Generating units are dispatched by MISO based on cost considerations as well as reliability of the system. Sales to the market typically occur when MGE has more generation and purchases online than are needed for its own system demand. The excess electricity is then sold to others in the market. For the nine months ended September 30, 2014, market volumes increased compared to the same period in the prior year, reflecting increased opportunities for sales. In addition, market settlement resulted in higher revenue per kWh for the nine months ended September 30, 2014, reflecting higher market prices.


Electric fuel and purchased power


Electric fuel and purchased power costs reflect a decrease in internal generation volumes offset by an increase in the volume of purchased power when compared to the prior period. Adjustments related to the regulatory recovery for fuel costs, known as fuel rules, moderated the effects of that increased volume. These items are explained below.




39




Fuel for electric generation

The expense for fuel for internal electric generation increased $1.3 million during the nine months ended September 30, 2014, compared to the same period in the prior year, due to the following:


 

(In millions)

 

 

 

 

Increase in per-unit cost

$

4.0

 

 

Decrease in volume

 

(2.7)

 

 

Total

$

1.3

 


This increase in expense reflects an 11.5% increase in per-unit cost of internal electric generation, partially offset by a 6.9% decrease in internal generated volume delivered to the system primarily as a result of reduced generation at Columbia to reduce coal use in order to maintain inventory levels.


Purchased power

Purchased power expense decreased $2.5 million during the nine months ended September 30, 2014, compared to the same period in the prior year, due to the following:


 

(In millions)

 

 

 

 

Increase in volume

$

8.0

 

 

Decrease in per-unit cost

 

(1.3)

 

 

Fuel Rules Adjustments

 

 

 

 

    Decrease in recorded fuel rule surplus credit

 

(4.4)

 

 

    Amortization of 2012 fuel rule surplus credits

 

(4.8)

 

 

Total

$

(2.5)

 


The decrease in expense reflects a 2.0% decrease in the per-unit cost of purchased power and a 14.0% increase in the volume of power purchased from third parties primarily as a result of the reduced generation at Columbia.


Under fuel rules, MGE is required to defer electric fuel-related costs that fall outside a 2% cost tolerance band around the amount used in the most recent rate proceeding. Any fuel rules adjustments are reflected in purchased power expense. Cost savings that may be returned to customers are recorded as an increase to purchased power expense, and higher costs that MGE is entitled to recover, after adjustment for excess revenues, are recorded as a reduction to purchased power expense. Any over/under recovery of the deferred costs is determined on an annual basis and adjusted in future billings to customers. During the nine months ended September 30, 2014, MGE amortized $4.8 million of the 2012 fuel rule surplus credits. No fuel-related cost savings were deferred during the current period, as compared to $4.4 million of cost savings (surplus credit) in the prior period.


Electric operating and maintenance expenses


Electric operating and maintenance expenses decreased $5.0 million during the nine months ended September 30, 2014, compared to the same period in 2013. The following changes contributed to the net change:


 

(In millions)

 

 

 

 

Decreased administrative and general costs

$

(4.7)

 

 

Decreased customer service costs

 

(0.6)

 

 

Decreased distribution expenses

 

(0.5)

 

 

Decreased customer accounts costs

 

(0.2)

 

 

Increased production expenses

 

0.8

 

 

Increased transmission costs

 

0.2

 

 

Total

$

(5.0)

 


For the nine months ended September 30, 2014, decreased administrative and general costs are primarily due to decreased pension and other postretirement benefit costs. Increased production expenses are primarily due to increased costs at Columbia.




40




Gas Utility Operations - MGE Energy and MGE


Gas deliveries and revenues


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


 

 

Revenues

 

Therms Delivered

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

 

Nine Months Ended September 30,

 

Nine Months Ended September 30,

 

2014

 

2013

 

% Change

 

2014

 

2013

 

% Change

Residential

$

 84,275

$

 66,034

 

 27.6 %

 

 76,626

 

 67,181

 

 14.1 %

Commercial/Industrial

 

 76,460

 

 52,758

 

 44.9 %

 

 103,313

 

 89,836

 

 15.0 %

    Total retail

 

 160,735

 

 118,792

 

 35.3 %

 

 179,939

 

 157,017

 

 14.6 %

Gas transportation

 

 2,223

 

 2,181

 

 1.9 %

 

 27,651

 

 27,048

 

 2.2 %

Other revenues

 

 377

 

 400

 

 (5.8)%

 

 -

 

 -

 

 -  %

    Total

$

 163,335

$

 121,373

 

 34.6 %

 

 207,590

 

 184,065

 

 12.8 %

Heating degree days (normal 4,512)

 

 

 

 

 

 

 

5,240

 

 4,799

 

9.2 %

Average Rate Per Therm of

 

 

 

 

 

 

 

 

 

 

 

 

Retail Customer

$

0.893

$

0.757

 

18.0 %

 

 

 

 

 

 


Gas revenues increased $42.0 million or 34.6% for the nine months ended September 30, 2014, compared to the same period in 2013. These changes are related to the following factors:


 

(In millions)

 

 

 

 

Rate/PGA changes

$

24.6

 

 

Volume

 

17.4

 

 

Total

$

42.0

 


·

Rate/PGA changes. The average retail rate per therm for the nine months ended September 30, 2014, increased 18.0% compared to the same period in 2013, reflecting higher natural gas commodity costs. MGE recovers the cost of natural gas in its gas segment through the purchased gas adjustment clause (PGA). Under the PGA, MGE is able to pass through to its gas customers the cost of gas.


·

Volume. For the nine months ended September 30, 2014, retail gas deliveries increased 14.6% compared to the same period in 2013, as a result of colder weather during the winter months compared to milder weather in the prior year.


Cost of gas sold


For the nine months ended September 30, 2014, cost of gas sold increased by $37.4 million, compared to the same period in the prior year. The cost per therm of natural gas increased 33.5%, which resulted in $27.0 million of increased expense. In addition, the volume of purchased gas increased 14.8%, which resulted in $10.4 million of increased expense.


Gas operating and maintenance expenses


Gas operating and maintenance expenses decreased by $1.6 million for the nine months ended September 30, 2014, compared to the same period in 2013. The following changes contributed to the net change:


 

(In millions)

 

 

 

 

Decreased administrative and general costs

$

(2.2)

 

 

Decreased customer service costs

 

(0.3)

 

 

Increased distribution expenses

 

0.5

 

 

Increased customer account costs

 

0.4

 

 

Total

$

(1.6)

 


For the nine months ended September 30, 2014, decreased administrative and general costs are primarily due to decreased pension and other postretirement benefit costs.




41




Nonregulated Energy Operations - MGE Energy and MGE


For the nine months ended September 30, 2014 and 2013, net income at the nonregulated energy operations segment was $14.4 million and $15.5 million, respectively. The nonregulated energy operations are conducted through MGE Energy's subsidiaries: MGE Power Elm Road and MGE Power West Campus, which have been formed to construct, own and lease electric generating capacity to assist MGE.


Results reflect the recovery of force majeure costs associated with the construction of the Elm Road Units. In December 2012, as part of WEPCO's (the operator and primary owner of the Elm Road Units) 2013 Wisconsin rate case, the PSCW determined that 100% of the construction costs for the Elm Road Units were prudently incurred, and approved the recovery in rates of more than 99.5% of the force majeure costs. The recovery of the force majeure costs began in 2013, including a one-time cumulative adjustment pertaining to affected periods prior to the PSCW order. The portion pertaining to prior periods was fully reflected in 2013 results.


Transmission Investment Operations - MGE Energy and MGE


Transmission investment other income


For the nine months ended September 30, 2014 and 2013, other income at the transmission investment segment was $7.3 million and $7.0 million, respectively. The transmission investment segment holds our interest in ATC, and its income reflects our equity in the earnings of ATC. See Footnote 3 of Notes to Consolidated Financial Statements for additional information concerning ATC and summarized financial information regarding ATC.


Consolidated Income Taxes - MGE Energy and MGE


MGE Energy's and MGE's effective income tax rate for the nine months ended September 30, 2014 and 2013, was 37.8%.


Noncontrolling Interest, Net of Tax - MGE


The noncontrolling interest, net of tax, reflects the accounting required for MGE Energy's interest in MGE Power Elm Road (the Elm Road Units) and MGE Power West Campus (WCCF). MGE Energy owns 100% of MGE Power Elm Road and MGE Power West Campus; however, due to the contractual agreements for these projects with MGE, the entities are considered VIEs and their results are consolidated with those of MGE, the primary beneficiary of the VIEs. Also included in noncontrolling interest, net of tax, is MGE Energy's interest in MGE Transco, which holds our investment in ATC. The following table shows MGE Energy's noncontrolling interest, net of tax, reflected on MGE's consolidated statement of income:


 

 

 

Nine Months Ended

 

 

 

 

September 30,

 

 

(In millions)

 

2014

 

2013

 

 

MGE Power Elm Road

$

12.1

$

13.0

 

 

MGE Power West Campus

 

5.7

 

5.7

 

 

MGE Transco

 

2.0

 

1.8

 


Contractual Obligations and Commercial Commitments - MGE Energy and MGE


There were no material changes, other than from the normal course of business, to MGE Energy's and MGE's contractual obligations (representing cash obligations that are considered to be firm commitments) and commercial commitments (representing commitments triggered by future events) during the nine months ended September 30, 2014, except as noted below. Further discussion of the contractual obligations and commercial commitments is included in Footnote 8 of Notes to Consolidated Financial Statements in this Report, and Footnote 18 of Notes to Consolidated Financial Statements, and "Contractual Obligations and Commercial Commitments for MGE Energy and MGE" under "Management's Discussion and Analysis of Financial Condition and Results of Operations" in MGE Energy's and MGE's 2013 Annual Report on Form 10-K.


Purchase Contracts - MGE Energy and MGE


See Footnote 8.d. of Notes to Consolidated Financial Statements for a description of commitments at September 30, 2014 that MGE Energy and MGE have entered with respect to various commodity supply, transportation, and storage contracts to meet their obligations to deliver electricity and natural gas to customers.



42




Liquidity and Capital Resources


Cash Flows


The following summarizes cash flows for MGE Energy and MGE during the nine months ended September 30, 2014 and 2013:


 

 

 

MGE Energy

 

MGE

 

 

(In thousands)

 

2014

 

2013

 

 

2014

 

2013

 

 

Cash provided by/(used for):

 

 

 

 

 

 

 

 

 

 

 

    Operating activities

$

 120,972

$

 108,600

 

$

 122,747

$

 107,826

 

 

    Investing activities

 

 (69,233)

 

 (94,177)

 

 

 (68,645)

 

 (93,835)

 

 

    Financing activities

 

 (31,833)

 

 14,550

 

 

 (45,927)

 

 22,249

 


Cash Provided by Operating Activities


MGE Energy


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


Cash provided by operating activities for the nine months ended September 30, 2014, was $121.0 million, an increase of $12.4 million when compared to the same period in the prior year. The increase is primarily related to no pension contributions being made in 2014.


MGE Energy's net income increased $4.3 million for the nine months ended September 30, 2014, when compared to the same period in the prior year.


MGE Energy's federal and state taxes paid increased $12.3 million during the nine months ended September 30, 2014, when compared to the same period in the prior year, primarily due to federal tax payments made in 2014. No federal tax payments were made during the nine months ended September 30, 2013, due to the NOL as a result of bonus depreciation, which was fully utilized in 2013.


Working capital accounts (excluding prepaid and accrued taxes) resulted in $2.3 million in cash provided by operating activities for the nine months ended September 30, 2014, primarily due to decreased unbilled revenues and decreased accounts receivable, partially offset by increased inventories and decreased other current liabilities. Working capital accounts (excluding prepaid and accrued taxes) resulted in $2.6 million in cash provided by operating activities for the nine months ended September 30, 2013, primarily due to decreased accounts receivable and decreased unbilled revenues, partially offset by decreased accounts payable and increased gas inventories.


A decrease in pension contribution resulted in an additional $31.5 million in cash provided by operating activities for the nine months ended September 30, 2014, when compared to the same period in the prior year. Pension contributions reflect amounts required by law and discretionary amounts. There have been no required contributions and no discretionary contributions for 2014.


A decrease in employee benefit plan expenses resulted in $9.9 million lower net cash provided by operations for the nine months ended September 30, 2014, when compared to the same period in the prior year


During the nine months ended September 30, 2013, MGE paid a make-whole premium equal to $6.8 million related to the redemption of $40 million of long-term debt.


MGE


Cash provided by operating activities for the nine months ended September 30, 2014, was $122.7 million, an increase of $14.9 million when compared to the same period in the prior year. The increase is primarily related to no pension contributions being made in 2014.


Net income increased $4.4 million for the nine months ended September 30, 2014, when compared to the same period in the prior year.




43




MGE's federal and state taxes paid to MGE Energy increased $11.9 million during the nine months ended September 30, 2014, when compared to the same period in the prior year, primarily due to federal tax payments made in 2014. No federal tax payments were made during the nine months ended September 30, 2013, due to the NOL as a result of the bonus depreciation, which was fully utilized in 2013.


Working capital accounts (excluding prepaid and accrued taxes) resulted in $4.9 million in cash provided by operating activities for the nine months ended September 30, 2014, primarily due to decreased unbilled revenues and decreased accounts receivable, partially offset by increased inventories and decreased accounts payable. Working capital accounts (excluding prepaid taxes and accrued taxes) resulted in $3.0 million in cash provided by operating activities for the nine months ended September 30, 2013, primarily due to decreased accounts receivable, decreased unbilled revenues, and increased current liabilities, partially offset by decreased accounts payable and increased gas inventories.


A decrease in pension contribution resulted in an additional $31.5 million in cash provided by operating activities for the nine months ended September 30, 2014, when compared to the same period in the prior year. Pension contributions reflect amounts required by law and discretionary amounts. There have been no required contributions and no discretionary contributions for 2014.


A decrease in employee benefit plan expenses resulted in $9.9 million lower net cash provided by operations for the nine months ended September 30, 2014, when compared to the same period in the prior year


During the nine months ended September 30, 2013, MGE paid a make-whole premium equal to $6.8 million related to the redemption of $40 million of long-term debt.


Cash Used for Investing Activities


MGE Energy


MGE Energy's cash used for investing activities decreased $24.9 million for the nine months ended September 30, 2014, when compared to the same period in the prior year.


Capital expenditures for the nine months ended September 30, 2014, were $66.1 million. This amount represents a decrease of $26.0 million from the expenditures made in the same period in the prior year. This decrease primarily reflects $39.7 million of lower expenditures on the Columbia environmental project in 2014 versus 2013.


MGE


MGE's cash used for investing activities decreased $25.2 million for the nine months ended September 30, 2014, when compared to the same period in the prior year.


Capital expenditures for the nine months ended September 30, 2014, were $66.1 million. This amount represents a decrease of $26.0 million from the expenditures made in the same period in the prior year. This decrease primarily reflects $39.7 million of lower expenditures on the Columbia environmental project in 2014 versus 2013.


Cash Provided by (Used for) Financing Activities


MGE Energy


Cash used for MGE Energy's financing activities was $31.8 million for the nine months ended September 30, 2014, compared to $14.6 million of cash provided by MGE Energy's financing activities in the nine months ended September 30, 2013.


For the nine months ended September 30, 2014, dividends paid were $28.6 million compared to $27.7 million in the prior year. This increase was a result of a higher dividend per share ($0.826 vs. $0.799).


During the nine months ended September 30, 2013, MGE issued $85 million of long-term debt, which was used to retire $40 million of long-term debt and to assist with the funding for the Columbia environmental project.


MGE


During the nine months ended September 30, 2014, cash used for MGE's financing activities was $45.9 million compared to $22.2 million of cash provided by MGE's financing activities in the prior year.



44




Dividends paid from MGE to MGE Energy were $26.5 million during the nine months ended September 30, 2014. There were no dividends paid from MGE to MGE Energy in 2013.


During the nine months ended September 30, 2013, MGE issued $85 million of long-term debt, which was used to retire $40 million of long-term debt and to assist with the funding for the Columbia environmental project.


Distributions to parent from noncontrolling interest, which represent distributions from MGE Power Elm Road and MGE Power West Campus, were $17.8 million for the nine months ended September 30, 2014, compared to $21.1 million in the prior year.


Capitalization Ratios


MGE Energy's capitalization ratios were as follows:


 

 

MGE Energy

 

 

 

September 30, 2014

 

December 31, 2013

 

 

Common shareholders' equity

62.0 %

 

60.5 %

 

 

Long-term debt*

38.0 %

 

39.5 %

 

 

*Includes the current portion of long-term debt.

 


MGE Energy's and MGE's Capital Requirements


MGE Energy's and MGE's liquidity are primarily affected by their capital requirements. During the nine months ended September 30, 2014, capital expenditures for MGE Energy and MGE totaled $66.1 million, which included $64.6 million of capital expenditures for utility operations.


In early 2011, the PSCW authorized the construction of air emission reduction systems and associated equipment on Columbia Units 1 and 2. For the nine months ended September 30, 2014, MGE had incurred $11.0 million (excluding carrying costs) in construction expenditures at Columbia related to the project and had accrued $5.0 million in incurred, but unpaid capital expenditures. MGE has recognized $3.0 million (after tax) in AFUDC equity related to this project for the nine months ended September 30, 2014.


Credit Ratings


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


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


Environmental Matters


The following discussion is limited to updates or developments in environmental matters that occurred during the nine months ended September 30, 2014. Further discussion of environmental matters is included in MGE Energy's and MGE's 2013 Annual Report on Form 10-K and Footnote 8.a. of Notes to Consolidated Financial Statements in this Report.


EPA's Final 316(b) Rule Governing Water Intake Systems at Electric Generating Facilities

In August 2014, the EPA published its Phase II and III Rules pursuant to Section 316(b) of the Clean Water Act, which governs cooling water intake structures located at large existing power plant and industrial facilities. The 316(b) Rule requires these facilities to implement methods for reducing fish impingement by their water intakes using one of seven options, including closed cycle cooling (CCC) systems.


Our WCCF facility already employs a CCC system as defined under the Rule. The Columbia plant may need to address multiple intake structures. Our Blount plant has conducted studies regarding compliance with this rule. The exact requirements at Blount and Columbia, however, will not be known until those sites' permits are modified to account for this rule. Nonetheless, MGE expects that this 316(b) Rule will not have material effects on its existing plants.




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EPA's Cross-State Air Pollution Rule (CSAPR) Upheld by the Supreme Court

On April 29, 2014, the US Supreme Court issued a decision upholding CSAPR, thereby reversing the D.C. Circuit Court's decision on CSAPR, and remanding the matter back to the D.C. Circuit for further proceedings. At that time CSAPR remained subject to an order of the D.C. Circuit that stayed its implementation. On October 23, 2014, the D.C. Circuit lifted its stay of CSAPR and set a briefing schedule for ongoing litigation with oral arguments scheduled for March 2015. The State of Wisconsin has filed a motion with the D.C. Circuit Court reiterating its contention that Wisconsin be removed from CSAPR and may be part of the court's briefing and oral arguments schedule. With several issues undecided and court proceedings extending into 2015, there is remaining uncertainty as to whether MGE's facilities will be required to meet the CSAPR mandates and, if so, the deadline for achieving compliance. The Clean Air Interstate Rule (CAIR) remains in effect for the time being. See MGE Energy's and MGE's 2013 Annual Report on Form 10K for additional information on the legal proceedings associated with these environmental matters.


With CSAPR now reinstated, it will require (once implemented) that qualifying power plants meet SO2 and NOx allocations or purchase them on the market. MGE has been monitoring our overall compliance options, particularly at our Columbia power plant as we awaited installation and testing of SO2 controls. With the 2014 installation of SO2 pollution controls at Columbia, we will likely meet or exceed the allocations for Columbia based on the CSAPR allocations in the current rule (see Footnote 4 for information regarding the Columbia environmental construction project and Footnote 8.a. for information regarding our consent decree). MGE expects that the costs pertaining to meeting CSAPR requirements will be fully recoverable through rates. We will continue to monitor and evaluate the D.C. Circuit Court remand proceedings and the implementation of the rule by the EPA and WDNR.


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

On June 2, 2014, the EPA released proposed guidelines for states to use in developing plans to control GHG emissions from existing fossil fuel fired electric generating units (EGUs). The proposed rule was published in the Federal Register on June 17, 2014.


The EPA's proposal seeks to reduce GHG emissions from EGUs by a national average of 30% by 2030 as measured from a 2005 baseline. Each state is given its own emission reduction targets to meet this goal. These targets are expressed as a "rate-based" emission average to be achieved by the combined fleet of EGUs within the state. States would be expected to make "meaningful progress" towards these reductions by 2020 and to meet their respective targets by 2030.


The EPA's proposal establishes guidelines for states and encourages the use of four "building blocks" for achieving these reductions. These "building blocks" are: (1) increasing the efficiency of EGUs; (2) re-dispatching of gas-fired generation at the expense of coal; (3) expanding the use of low and no carbon power sources, such as wind, nuclear and solar; and (4) improving demand side energy efficiency to reduce electric use.


The EPA is taking comments on the proposed rule through December 1, 2014. The rule is expected to be finalized by June 2015. States will then have up to two years to prepare compliance plans. This rule could have significant impacts on EGUs. MGE is reviewing the proposal at this time.


Coal Combustion Residual Rule

The EPA's proposed Coal Combustion Residual (CCR) is anticipated to be finalized in December 2014. The final CCR Rule will regulate disposal and management of ash and other coal combustion byproducts as a waste under the EPA's solid waste rules.


Columbia


Columbia is a coal-fired generating station operated by WPL in which WPL, WPSC, and MGE have ownership interests. In December 2009, the EPA sent a Notice of Violation (NOV) to MGE as one of the co-owners of Columbia. The NOV alleged that WPL and the Columbia co-owners failed to comply with appropriate pre-construction review and permitting requirements and, as a result, violated the Prevention of Significant Deterioration program requirements, Title V Operating Permit requirements of the CAA, and the Wisconsin SIP. In April 2013, the EPA filed a lawsuit against the co-owners of Columbia asserting similar allegations. In September 2010 and April 2013, the Sierra Club filed civil lawsuits against WPL alleging violations of the CAA at Columbia and other Wisconsin facilities operated by WPL. In June 2013, the court approved and entered a consent decree entered by the EPA, Sierra Club, and the co-owners of Columbia to resolve these claims, while admitting no liability. One of the requirements of the consent decree requires installation of a SCR system at Columbia Unit 2 by December 31, 2018. In July 2014, a CA was filed with the PSCW for the installation of the SCR system. MGE's share of the projected cost for the SCR system is approximately $30-40 million. See Footnote 8.a. of the Notes to Consolidated Financial Statements for additional information regarding this matter.



46




Other Matters


Elm Road


The warranty periods for both of the Elm Road Units have expired. During 2013, WEPCO and Bechtel (the construction contractor for the Elm Road Units) were working through the outstanding warranty claims. The warranty claim for the costs incurred to repair steam turbine corrosion damage identified on both units was resolved through a binding arbitration in June 2013. Final acceptance of the Elm Road Units occurred in June 2013 after all requirements stated in the contract with Bechtel were satisfied. In April 2014, an additional warranty claim was resolved that did not have a material impact on our financial statements. The parties continue to work through one potential remaining warranty claim.


ATC


On November 12, 2013, MISO and numerous other MISO transmission owners, including ATC, were named as respondents in a complaint filed at FERC. The complainants argue that the respondents' transmission rates are no longer just and reasonable "due to changes in the capital markets," and that the MISO base return on equity (ROE) should not exceed 9.15%, equity components of hypothetical capital structures should be restricted to 50%, and that relevant incentive ROE adders should be discontinued. MISO's base ROE is 12.38% and ATC's base ROE is 12.2%. MISO and the other MISO transmission owners filed a motion to dismiss the complaint. MGE Energy and MGE are currently unable to determine what, if any, impact the complaint may have on MISO's and ATC's current authorized return on equity.


Joint Venture


MGE Energy has entered into a joint venture with Wisconsin Energy Corporation to evaluate the advisability and feasibility of potentially bidding on generating assets owned by the State of Wisconsin, which might include the University of Wisconsin's interest in the WCCF, which the Company co-owns and operates.


Should the State determine that the assets be sold, the joint venture would decide on a case-by-case basis whether to submit a bid. If the bid is successful, the joint venture would finance the acquisition and would own and manage the acquired assets. If those acquired assets include the State's interest in the WCCF, MGE would continue to operate the WCCF as it does currently.


New Accounting Principles


See Footnote 12 of Notes to Consolidated Financial Statements for discussion of new accounting pronouncements.




47




Item 3. Quantitative and Qualitative Disclosures About Market Risk.


MGE Energy and MGE are potentially exposed to market risk associated with interest rates, commodity prices, and equity returns. MGE currently has no exposure to foreign currency risk. MGE manages some risk exposure through risk management policies and the use of derivative instruments. MGE's risk management policy prohibits speculative trading transactions.


Commodity Price Risk


MGE has commodity price risk exposure with respect to the price of natural gas, electricity, coal, emission credits, and oil. MGE's electric operations burn natural gas in several of its peaking power plants and, in many cases, the cost of purchased power is tied to the cost of natural gas. MGE employs established policies and procedures to reduce the market risks associated with changing commodity prices. MGE's commodity risks are somewhat mitigated by the current ratemaking process in place for recovering electric fuel cost, purchased energy costs, and the cost of natural gas.


MGE's electric fuel costs are subject to fuel rules established by the PSCW. The fuel rules require the PSCW and Wisconsin utilities to defer electric fuel-related costs that fall outside a symmetrical cost tolerance band. Any over/under recovery of the actual costs is determined on an annual basis and is adjusted in future billings to electric retail customers. Under the electric fuel rules, MGE is required to defer the benefit of lower costs if the actual electric fuel costs fall outside the lower end of the range and is required to defer costs, less any excess revenues, if the actual electric fuel costs exceed the upper end of the range. 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. The range is defined by the PSCW and has been modified throughout the years based on market conditions and other relevant factors. Currently, MGE is subject to a plus or minus 2% range. MGE assumes the risks and benefits of variances that are within the cost tolerance band. For 2014, fuel and purchased power costs included in MGE's base fuel rates are $106.1 million. See Footnote 10.b. of the Notes to Consolidated Financial Statements for additional information.


MGE recovers the cost of natural gas in its gas segment through the purchased gas adjustment clause (PGA). Under the PGA, MGE is able to pass through to its gas customers the cost of gas.


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


MGE has financial gas and electric commodity contracts to hedge commodity price risk in the gas and electric segments. These contracts are primarily comprised of exchange-traded option and future contracts. MGE also holds FTRs, which are used to hedge the risk of increased transmission congestion charges. At September 30, 2014, the fair value of these instruments exceeded their cost basis by $2.3 million. Under the PGA clause and electric fuel rules, MGE may include in the costs of fuel (natural gas or power) the costs and benefits of the aforementioned fuel price risk management tools. Because these costs/benefits are recoverable, the related unrealized loss/gain has been deferred on the consolidated balance sheet as a regulatory asset/liability.


MGE has also entered into a ten-year purchased power agreement that provides MGE with firm capacity and energy that began on June 1, 2012, and ends on May 31, 2022 (the "base term"). The agreement also allows MGE an option to extend the contract after the base term. The agreement is considered a derivative contract and is recognized at its fair value on the consolidated balance sheet. However, the derivative qualifies for regulatory deferral and is recognized with a corresponding regulatory asset or liability depending on whether the fair value is in a loss or gain position. The fair value of the contract at September 30, 2014, reflects a loss position of $54.9 million.


Interest Rate Risk


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




48




Equity Price Risk - Pension-Related Assets


MGE currently funds its liabilities related to employee benefits through trust funds. These funds, which include investments in debt and equity securities, are managed by various investment managers. Changes in market value of these investments can have an impact on the future expenses related to these liabilities.


Credit Risk - Counterparty


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


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


Additionally, if a counterparty were to default and MGE were to liquidate all contracts with that entity, MGE's credit loss would include the loss in value of mark-to-market contracts; the amount owed for settled transactions; and additional payments, if any, to settle unrealized losses on accrual contracts. As of September 30, 2014, no counterparties have defaulted.


MGE is obligated to provide service to all electric and gas customers within its respective franchised territories. MGE's franchised electric territory includes a 316 square-mile area in Dane County, Wisconsin, and MGE's franchised gas territory includes a service area covering 1,649 square miles in Wisconsin. Based on results for the year ended December 31, 2013, no one customer constituted more than 10% of total operating revenues for MGE Energy and MGE. Credit risk for electric and gas is managed by MGE's credit and collection policies, which are consistent with state regulatory requirements.


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




49




Item 4. Controls and Procedures.


During the third quarter of 2014, each registrant's management, including the principal executive officer and principal financial officer, evaluated its disclosure controls and procedures related to the recording, processing, summarization, and reporting of information in its periodic reports that it files with the SEC. These disclosure controls and procedures have been designed to ensure that material information relating to that registrant, including its subsidiaries, is accumulated and made known to that registrant's management, including these officers, by other employees of that registrant and its subsidiaries as appropriate to allow timely decisions regarding required disclosure, and that this information is recorded, processed, summarized, evaluated, and reported, as applicable, within the time periods specified in the SEC's rules and forms. Due to the inherent limitations of control systems, not all misstatements may be detected. These inherent limitations include the realities that judgments in decision making can be faulty and breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. Also, the registrants do not control or manage certain of their unconsolidated entities and thus, their access and ability to apply their procedures to those entities is more limited than is the case for their consolidated subsidiaries.


As of September 30, 2014, each registrant's principal executive officer and principal financial officer concluded that its disclosure controls and procedures were effective. Each registrant intends to strive continually to improve its disclosure controls and procedures to enhance the quality of its financial reporting.


During the quarter ended September 30, 2014, there were no changes in either registrant's internal controls over financial reporting that materially affected, or are reasonably likely to affect materially, that registrant's internal control over financial reporting.




50




PART II. OTHER INFORMATION.


Item 1. Legal Proceedings.


MGE Energy and MGE


MGE Energy and its subsidiaries, including MGE, from time to time are involved in various legal proceedings that are handled and defended in the ordinary course of business.


See Footnote 8.a. and 8.c. of Notes to Consolidated Financial Statements for more information.


Item 1A. Risk Factors.


There have been no material changes in the risk factors affecting MGE Energy and MGE from those factors discussed in in their 2013 Annual Report on Form 10-K, except as follows:


Our ability to obtain an adequate supply of coal could limit our ability to operate our coal-fired facilities.


The availability of coal and the means to transport coal could:


·

affect our operating costs due to increased costs associated with lower levels of generation or the need for alternate supply or alternate transportation,

·

limit our ability to generate electricity if we are unable to arrange adequate deliveries of coal, and

·

result in potentially higher costs for replacement purchased power as well as potential lost market sales opportunities.


A significant portion of our electric generating capacity is dependent on coal. Increased oil exploration and production in the United States has increased the amount of oil being transported by railroad, which has affected the availability and scheduling of trains to transport coal. Demand for coal has also been impacted by prevailing prices for natural gas and may affect mine performance. Consequently, we are exposed to the risk that counterparties to these contracts will not be able to fulfill their obligations. Disruption in the delivery of fuel, including disruptions as a result of transportation delays, weather, labor relations, force majeure events, or environmental regulations affecting any of these fuel suppliers, could limit our ability to generate electricity at our facilities at the desired level. Should counterparties fail to perform, or other unplanned disruptions occur, we may be forced to replace the underlying commitment at higher prices, or we may be forced to reduce generation at our coal units and replace this lost generation through additional power purchases from third parties. These factors may also affect the terms under which any of our existing coal supply or transportation agreements are renewed or replaced upon the expiration of their current terms.


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


Issuer Purchases of Equity Securities

Period

 

Total Number of Shares Purchased

 

Average Price Paid per Share

 

Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs*

 

Maximum number (or Approximate Dollar Value) of Shares That May Yet Be Purchased Under the Plans or Programs*

July 1-31, 2014

 

33,010

$

39.34

 

-

 

-

August 1-31, 2014

 

27,821

 

39.19

 

-

 

-

September 1-30, 2014

 

78,425

 

39.61

 

-

 

-

Total

 

139,256

$

39.46

 

-

 

-


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



51





Item 4. Mine Safety Disclosures.


Not applicable to MGE Energy and MGE.


Item 6. Exhibits.


12

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


Certifications Pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities and Exchange Act of 1934 as to the Quarterly Report on Form 10-Q for the quarter ended September 30, 2014, filed by the following officers for the following companies:


31.1

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

31.2

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

31.3

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

31.4

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


Certifications Pursuant to Section 1350 of Chapter 63 of Title 18 United States Code (Sarbanes-Oxley Act of 2002) as to the Quarterly Report on Form 10-Q for the quarter ended September 30, 2014, filed by the following officers for the following companies:


32.1

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

32.2

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

32.3

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

32.4

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


101

Interactive Data Files:

101.INS

XBRL Instance

101.SCH

XBRL Taxonomy Extension Schema

101.CAL

XBRL Taxonomy Extension Calculation

101.DEF

XBRL Taxonomy Extension Definition

101.LAB

XBRL Taxonomy Extension Labels

101.PRE

XBRL Taxonomy Extension Presentation




52




Signatures - MGE Energy, Inc.


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



 

MGE ENERGY, INC.

 

 

 

 

 

 

Date: November 6, 2014

/s/ Gary J. Wolter

 

Gary J. Wolter

Chairman, President and Chief Executive Officer

(Duly Authorized Officer)

 

 

 

 

 

 

Date: November 6, 2014

/s/ Jeffrey C. Newman

 

Jeffrey C. Newman

Vice President, Chief Financial Officer, Secretary and Treasurer

(Chief Financial and Accounting Officer)

 



53




Signatures - Madison Gas and Electric Company


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



 

MADISON GAS AND ELECTRIC COMPANY

 

 

 

 

 

 

Date: November 6, 2014

/s/ Gary J. Wolter

 

Gary J. Wolter

Chairman, President and Chief Executive Officer

(Duly Authorized Officer)

 

 

 

 

 

 

Date: November 6, 2014

/s/ Jeffrey C. Newman

 

Jeffrey C. Newman

Vice President, Chief Financial Officer, Secretary and Treasurer

(Chief Financial and Accounting Officer)




54