10-K 1 f10k_2016.htm FORM 10-K Form 10-K


United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K


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


For the fiscal year ended:

December 31, 2016


[ ] 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


SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:


 


Title of Class

Name of Each Exchange on which Registered

MGE Energy, Inc.

Common Stock, $1 Par Value Per Share

The Nasdaq Stock Market



SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:


 

Title of Class

Madison Gas and Electric Company

Common Stock, $1 Par Value Per Share


Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.


MGE Energy, Inc.

Yes [X] No [   ]

Madison Gas and Electric Company

Yes [X] No [   ]


Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

MGE Energy, Inc.

Yes [  ] No [X]

Madison Gas and Electric Company

Yes [  ] No [X]




1




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 registrants were 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants' knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [  ]


Indicate by check mark if the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition 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 checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).


MGE Energy, Inc.

Yes [  ] No [X]

Madison Gas and Electric Company

Yes [  ] No [X]


The aggregate market value of the voting and nonvoting common equity held by nonaffiliates of each registrant as of June 30, 2016, was as follows:


MGE Energy, Inc.

$1,954,670,687

Madison Gas and Electric Company

$0


The number of shares outstanding of each registrant's common stock as of February 1, 2017, were as follows:


MGE Energy, Inc.

34,668,370

Madison Gas and Electric Company

17,347,894


DOCUMENTS INCORPORATED BY REFERENCE


Portions of MGE Energy, Inc.'s definitive proxy statement to be filed on or before March 27, 2017, relating to its annual meeting of shareholders, are incorporated by reference into Part III of this annual report on Form 10-K.


Madison Gas and Electric Company meets the conditions set forth in General Instruction (I)(1)(a) and (b) of Form 10-K and is therefore omitting (i.) the information otherwise required by Item 601 of Regulation S-K relating to a list of subsidiaries of the registrant as permitted by General Instruction (I)(2)(b), (ii.) the information otherwise required by Item 6 relating to Selected Financial Data as permitted by General Instruction (I)(2)(a), (iii.) the information otherwise required by Item 10 relating to Directors and Executive Officers as permitted by General Instruction (I)(2)(c), (iv.) the information otherwise required by Item 11 relating to executive compensation as permitted by General Instruction (I)(2)(c), (v.) the information otherwise required by Item 12 relating to Security Ownership of Certain Beneficial Owners and Management as permitted by General Instruction (I)(2)(c), and (vi.) the information otherwise required by Item 13 relating to Certain Relationships and Related Transactions as permitted by General Instruction (I)(2)(c).




2




Table of Contents



Filing Format

4

Forward-Looking Statements

4

Where to Find More Information

4

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

5

PART I.

7

Item 1. Business.

7

Item 1A. Risk Factors.

14

Item 1B. Unresolved Staff Comments.

19

Item 2. Properties.

20

Item 3. Legal Proceedings.

22

Item 4. Mine Safety Disclosures.

22

PART II.

23

Item 5. Market for Registrants' Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.  23

Item 6. Selected Financial Data.

26

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

27

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

49

Item 8. Financial Statements and Supplementary Data.

51

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

105

Item 9A. Controls and Procedures.

105

Item 9B. Other Information.

105

PART III.

106

Item 10. Directors, Executive Officers, and Corporate Governance.

106

Item 11. Executive Compensation.

106

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

106

Item 13. Certain Relationships and Related Transactions, and Director Independence.

106

Item 14. Principal Accounting Fees and Services.

106

PART IV.

108

Item 15. Exhibits and Financial Statement Schedules.

108

Item 16. Form 10-K Summary.

112

Signatures - MGE Energy, Inc.

117

Signatures - Madison Gas and Electric Company

118




3




Filing Format


This combined Form 10-K 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 Item 1A. Risk Factors, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, and Item 8. Financial Statements and Supplementary Data, Footnote 17. Commitments and Contingencies, and (b) other factors discussed herein and in other filings made by that registrant with the SEC.


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


Where to Find More Information


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




4




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


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


MGE Energy and Subsidiaries:

 

 

 

CWDC

Central Wisconsin Development Corporation

MAGAEL

MAGAEL, LLC

MGE

Madison Gas and Electric Company

MGE Energy

MGE Energy, Inc.

MGE Power

MGE Power, LLC

MGE Power Elm Road

MGE Power Elm Road, LLC

MGE Power West Campus

MGE Power West Campus, LLC

MGE Services

MGE Services, LLC

MGE State Energy Services

MGE State Energy Services, LLC

MGE Transco

MGE Transco Investment, LLC

MGEE Transco

MGEE Transco, LLC

NGV Fueling Services

NGV Fueling Services, LLC

 

 

Other Defined Terms:

 

 

 

AFUDC

Allowance for Funds Used During Construction

AICPA

American Institute of Certified Public Accountants

ANR

ANR Pipeline Company

ARO

Asset Retirement Obligation

ATC

American Transmission Company LLC

ATC Holdco

ATC Holdco, LLC

BART

Best Available Retrofit Technology

Blount

Blount Station

CAA

Clean Air Act

CAVR

Clean Air Visibility Rule

CCR

Coal Combustion Residual

CIAC

Contributions in Aid of Construction

CO2

Carbon Dioxide

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

COSO

Committee of Sponsoring Organizations

CPP

Clean Power Plan

CSAPR

Cross-State Air Pollution Rule

CWA

Clean Water Act

Dth

Dekatherms

EEI

Edison Electric Institute

EGUs

Electric Generating Units

ELG

Effluent Limitations Guidelines

Elm Road Units

Elm Road Generating Station

EPA

United States Environmental Protection Agency

FASB

Financial Accounting Standards Board

FERC

Federal Energy Regulatory Commission

FTR

Financial Transmission Rights

GAAP

Generally Accepted Accounting Principles

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

ICF

Insurance Continuance Fund

IRS

Internal Revenue Service

kVA

Kilovolt Ampere

kWh

Kilowatt-hour



5





MISO

Midcontinent Independent System Operator Inc. (a regional transmission organization)

MRO

Midwest Reliability Organization

MW

Megawatt

MWh

Megawatt-hour

NAAQS

National Ambient Air Quality Standards

Nasdaq

The Nasdaq Stock Market

NERC

North American Electric Reliability Corporation

NNG

Northern Natural Gas Company

NO2

Nitrogen Dioxide

NOV

Notice of Violation

NOx

Nitrogen Oxides

NYSE

New York Stock Exchange

PCBs

Polychlorinated Biphenyls

PGA

Purchased Gas Adjustment clause

PJM

PJM Interconnection, LLC (a regional transmission organization)

PM

Particulate Matter

PPA

Purchased power agreement

ppb

Parts Per Billion

PSCW

Public Service Commission of Wisconsin

REC

Renewable Energy Credit

Riverside

Riverside Energy Center in Beloit, Wisconsin

ROE

Return on Equity

RTO

Regional Transmission Organization

SCR

Selective Catalytic Reduction

SEC

Securities and Exchange Commission

SIP

State Implementation Plan

SO2

Sulfur Dioxide

the State

State of Wisconsin

Stock Plan

Direct Stock Purchase and Dividend Reinvestment Plan of MGE Energy

UW

University of Wisconsin at Madison

VIE

Variable Interest Entity

WCCF

West Campus Cogeneration Facility

WDNR

Wisconsin Department of Natural Resources

WEPCO

Wisconsin Electric Power Company

Working capital

Current assets less current liabilities

WPDES

Wisconsin Pollutant Discharge Elimination System

WPL

Wisconsin Power and Light Company

WPSC

Wisconsin Public Service Corporation

WRERA

Worker, Retiree and Employer Recovery Act of 2008

XBRL

eXtensible Business Reporting Language



6




PART I.


Item 1. Business.


MGE Energy operates in the following business segments:


·

Regulated electric utility operations – generating, purchasing, and distributing electricity through MGE.


·

Regulated gas utility operations – purchasing and distributing natural gas through MGE.


·

Nonregulated energy operations – owning and leasing electric generating capacity that assists MGE through MGE Energy's wholly owned subsidiaries MGE Power Elm Road and MGE Power West Campus.


·

Transmission investments – representing our investment in American Transmission Company LLC, a company engaged in the business of providing electric transmission services primarily in Wisconsin, and our investment in ATC Holdco, a company created to facilitate out-of-state electric transmission development and investments.


·

All other – investing in companies and property that relate to the regulated operations and financing the regulated operations, through its wholly owned subsidiaries CWDC, MAGAEL, MGE State Energy Services, NGV Fueling Services, and Corporate functions.


MGE's utility operations represent a majority of the assets, liabilities, revenues, expenses, and operations of MGE Energy. MGE Energy's nonregulated energy operations currently include an undivided interest in two coal-fired generating units located in Oak Creek, Wisconsin, which we refer to as the Elm Road Units, and an undivided interest in a cogeneration facility located on the Madison campus of the University of Wisconsin, which we refer to as the West Campus Cogeneration Facility or WCCF.


As a public utility, MGE is subject to regulation by the PSCW and the FERC. The PSCW has authority to regulate most aspects of MGE's business including rates, accounts, issuance of securities, and plant siting. The PSCW also has authority over certain aspects of MGE Energy as a holding company of a public utility. FERC has jurisdiction, under the Federal Power Act, over certain accounting practices and certain other aspects of MGE's business.


MGE Energy's subsidiaries are also subject to regulation under local, state, and federal laws regarding air and water quality and solid waste disposal. See "Environmental" below.


MGE Energy was organized as a Wisconsin corporation in 2001. MGE was organized as a Wisconsin corporation in 1896. Their principal offices are located at 133 South Blair Street, Madison, Wisconsin 53788, and their telephone number is (608) 252-7000.


Electric Utility Operations


MGE distributes electricity in a service area covering a 316 square-mile area of Dane County, Wisconsin. The service area includes the city of Madison, Wisconsin. It owns or leases ownership interests in electric generation facilities located in Wisconsin and Iowa.


At December 31, 2016, MGE supplied electric service to approximately 149,000 customers, with approximately 90% located in the cities of Fitchburg, Madison, Middleton, and Monona and 10% in adjacent areas. Of the total number of customers, approximately 87% were residential and 13% were commercial or industrial. Electric retail revenues for 2016, 2015, and 2014 were comprised of the following:


 

 

 

Year Ended December 31,

 

 

 

 

2016

 

2015

 

2014

 

 

Residential

 

33.9%

 

32.6%

 

33.3%

 

 

Commercial

 

52.9%

 

53.2%

 

52.8%

 

 

Industrial

 

4.4%

 

4.8%

 

4.8%

 

 

Public authorities (including the UW)

 

8.8%

 

9.4%

 

9.1%

 

 

Total

 

100.0%

 

100.0%

 

100.0%

 


Electric operations accounted for approximately 75.2%, 74.2%, and 64.0% of MGE's total 2016, 2015, and 2014 regulated revenues, respectively.



7




See Item 2. Properties, for a description of MGE's electric utility plant.


MGE is registered with North American Electric Reliability Corporation (NERC) and one regional entity, the Midwest Reliability Organization (MRO). The essential purposes of these entities are the development and implementation of regional and NERC reliability standards; and determining compliance with those standards, including enforcement mechanisms.


Transmission


American Transmission Company LLC (ATC) was formed by utilities who were required by Wisconsin law to contribute their transmission facilities to it in 2001, and is owned by those utilities and their affiliates. ATC's purpose is to provide reliable, economic transmission service to all customers in a fair and equitable manner. ATC plans, constructs, operates, maintains, and expands transmission facilities that it owns to provide adequate and reliable transmission of power. ATC is regulated by FERC for all rate terms and conditions of service, is regulated by the PSCW as to some aspects of its governance and is a transmission-owning member of the MISO.


Regional Transmission Organizations (RTO)


MISO

MGE is a nontransmission owning member of the MISO. MISO, a FERC approved RTO, is responsible for monitoring the electric transmission system that delivers power from generating plants to wholesale power transmitters. MISO's role is to ensure equal access to the transmission system and to maintain or improve electric system reliability in the Midwest.


MISO maintains a bid-based energy market. MGE offers substantially all of its generation on the MISO market and purchases much of its load requirement from the MISO market in accordance with the MISO Tariff. MGE participates in the ancillary services market operated by MISO. That market is an extension of the existing energy market in which MISO assumes the responsibility of maintaining sufficient generation reserves. In the ancillary services market, MISO provides the reserves for MGE's load, and MGE may offer to sell reserves from its generating units.


MGE participates in the voluntary capacity auction, which provides an optional monthly forum for buyers and sellers of aggregate planning resource credits to interact. Load serving entities, such as MGE, may participate in the voluntary capacity auction potentially to obtain the necessary aggregate planning resource credits needed to meet their planning reserve margin requirement established by the PSCW. Generator owners may participate to sell any excess aggregate planning resource credits that are not needed by them.


PJM

MGE is a member of PJM. PJM, an RTO, is a neutral and independent party that coordinates and directs the operation of the transmission grid within its area of coverage, administers a competitive wholesale electricity market, and plans regional transmission expansion improvements to maintain grid reliability and relieve congestion.


Fuel supply and generation


MGE satisfies its customers' electric demand with internal generation and purchased power. Sources used depend on market prices, generating unit availability, weather, and customer demand. During 2016, 2015, and 2014, MGE's electric energy delivery requirements were satisfied from the following fuel sources:

 

 

 

Year Ended December 31,

 

 

 

 

2016

 

2015

 

2014

 

 

Coal

 

48.2%

 

47.9%

 

47.8%

 

 

Natural gas(a)

 

18.6%

 

9.1%

 

3.2%

 

 

Fuel oil

 

0.1%

 

0.1%

 

0.1%

 

 

Renewable sources

 

2.8%

 

3.0%

 

3.1%

 

 

Purchased power

 

 

 

 

 

 

 

 

    Renewable

 

8.0%

 

8.2%

 

8.7%

 

 

    Other

 

22.3%

 

31.7%

 

37.1%

 

 

Total

 

100.0%

 

100.0%

 

100.0%

 


(a)

MGE's electric operations burn natural gas in several of its peaking power plants. The market price of natural gas decreased in 2016, which improved the economics of natural gas-fueled generation over other types of generation.



8




Generation Sources

MGE receives electric generation supply from coal-fired, gas-fired, and renewable energy sources. These sources include owned facilities as well as facilities leased from affiliates and accounted for under our nonregulated energy operations. See Item 2. Properties for more information regarding these generation sources, including location, capacity, ownership or lease arrangement, and fuel source. See "Nonregulated Energy Operations" below for more information regarding generating capacity leased to MGE by nonregulated subsidiaries.


Purchased power

MGE enters into short and long-term purchase power commitments with third parties to meet a portion of its anticipated electric energy supply needs. The following table identifies purchase power commitments at December 31, 2016, with unaffiliated parties for the next five years.


 

(Megawatts)

 

2017

 

2018

 

2019

 

2020

 

2021

 

 

Purchase power commitments

152.5

 

102.5

 

98.5

 

98.5

 

98.5

 


Gas Utility Operations


MGE transports and distributes natural gas in a service area covering 1,682 square miles in seven south-central Wisconsin counties. The service area includes the city of Madison, Wisconsin and surrounding areas.


At December 31, 2016, MGE supplied natural gas service to approximately 154,000 customers in the cities of Elroy, Fitchburg, Lodi, Madison, Middleton, Monona, Prairie du Chien, Verona, and Viroqua; 25 villages; and all or parts of 48 townships. Of the total number of customers, approximately 90% were residential and 10% were commercial or industrial. Gas revenues for 2016, 2015, and 2014 were comprised of the following:


 

 

Year Ended December 31,

 

 

 

2016

 

2015

 

2014

 

 

Residential

60.2%

 

59.4%

 

53.0%

 

 

Commercial

34.9%

 

35.7%

 

34.3%

 

 

Industrial(a)

1.1%

 

1.3%

 

11.0%

 

 

Transportation service and other(a)

3.8%

 

3.6%

 

1.7%

 

 

Total

100.0%

 

100.0%

 

100.0%

 

 

 

 

 

 

 

 

 

 

(a)   During 2015, a large interruptible industrial customer decided to purchase gas from a third party supplier and

 

       to use MGE's facilities for the transport of that gas, resulting in a shift in gas revenues between industrial

 

       and transportation services.


Gas operations accounted for approximately 24.8%, 25.8%, and 36.0% of MGE's total 2016, 2015, and 2014 regulated revenues, respectively.


MGE can curtail gas deliveries to its interruptible customers. Approximately 3% of retail gas deliveries in 2016 and 2015 were to interruptible customers.


Gas supply


MGE has physical interconnections with ANR Pipeline Company (ANR) and Northern Natural Gas Company (NNG). MGE's primary service territory, which includes Madison and the surrounding area, receives deliveries at one NNG and four ANR gate stations. MGE's outlying territory receives deliveries at NNG gate stations located in Elroy, Prairie du Chien, Viroqua, and Crawford County. Interconnections with two major pipelines provide competition in interstate pipeline service and a more reliable and economical gas supply mix, which includes gas from Canada and from the mid-continent and Gulf/offshore regions in the United States.


During the winter months, when customer demand is high, MGE is primarily concerned with meeting its obligation to firm customers. MGE meets customer demand by using firm supplies under contracts finalized before the heating season, supplies in storage (injected during the summer), and other firm supplies purchased during the winter period.


By contract, a total of 5,936,318 Dth of gas can be injected into ANR's storage fields in Michigan from April 1 through October 31. These gas supplies are then available for withdrawal during the subsequent heating season, November 1 through March 31. Using storage allows MGE to buy gas supplies during the summer season, when prices are normally lower, and withdraw these supplies during the winter season, when prices are typically higher. Storage also gives MGE more flexibility in meeting daily load fluctuations.



9




MGE's contracts for firm transportation service of gas include winter maximum daily quantities of:


·

162,150 Dth (including 106,078 Dth of storage withdrawals) on ANR.

·

65,828 Dth on NNG.


Nonregulated Energy Operations


MGE Energy, through its subsidiaries, has developed generation sources that assist MGE in meeting the electricity needs of its customers. These sources consist of the Elm Road Units and the WCCF, which are leased by MGE Power Elm Road and MGE Power West Campus, respectively, to MGE. See Item 2. Properties for a description of these facilities, their joint owners, and the related lease arrangements.


Transmission Investments


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 owned by MGE Energy. At December 31, 2016, MGE Transco held a 3.6% ownership interest in ATC.


In 2011, ATC and Duke Energy announced the creation of a joint venture, Duke-American Transmission Company, LLC, that seeks to build, own, and operate new electric transmission infrastructure in North America to address increasing demand for affordable, reliable transmission capacity.


In 2016, ATC Holdco was formed by several of the members of ATC, including MGE Energy, to facilitate electric transmission development and investments outside of Wisconsin. MGE Energy's ownership interest in ATC Holdco is held by MGEE Transco, a wholly-owned subsidiary. At December 31, 2016, MGEE Transco held a 4.0% ownership interest in ATC Holdco. In the near term, it is expected that ATC Holdco will be pursuing transmission development opportunities that typically have long development and investment lead times before becoming operational.


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. In addition to the regulations discussed below, MGE continues to track state and federal initiatives such as potential changes to regulations governing polychlorinated biphenyl (PCB), potential changes to air and water standards, and potential climate change legislation.


Water Quality


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

The ELG rule establishes federal limits on the amount of metals and other pollutants that can be discharged in wastewater from new and existing steam electric generation plants. The ELG rule mostly covers pollutants that are captured by certain air pollution control systems and via wet ash handling systems at coal-burning power plants with units greater than 50 MW generation capacity. The operators of our Columbia and Elm Road Units have indicated that equipment upgrades may be necessary to comply with the new discharge standards. The rule will be applied to Wisconsin-based power plants as they renew their WPDES permits, beginning in 2018 but no later than 2023. Management believes that any compliance costs will be recovered in future rates based on previous treatment of environmental compliance projects.


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

Section 316(b) of the Clean Water Act requires that the cooling water intake structures at electric power plants meet best available technology standards so that mortality from entrainment (drawing aquatic life into a plant's cooling system) and impingement (trapping aquatic life on screens) are reduced. The Wisconsin Department of Natural Resources is currently developing guidance and rules to implement the EPA 316(b) rule.




10




Both our Blount plant and our Columbia plant have WPDES permits that are up for renewal in 2017 and will need to comply with the 316(b) requirements, Blount has conducted historical studies that will show that it will likely be in compliance with this rule. The operator of our Columbia plant is conducting an intake study to demonstrate compliance and/or identify design criteria needed to meet the new rule requirements prior to Columbia's 2017 WPDES permit renewal. The exact requirements at Blount and Columbia, however, will not be known until the WDNR finalizes its rule, approves the plant operators' approach, and WPDES permits are modified to account for this rule. Nonetheless, MGE expects that the 316(b) rule will not have material effects on its existing plants.


Energy Efficiency and Renewables


The Wisconsin Energy Efficiency and Renewables Act requires that 10% of the state's electricity be generated from renewable sources. MGE is in compliance with the requirement. The costs to comply with the Act and its accompanying regulations are being recovered in rates.


Air Quality


Air quality regulations promulgated by the EPA and Wisconsin Department of Natural Resources (WDNR) in accordance with the Federal Clean Air Act and the Clean Air Act Amendments of 1990 impose restrictions on emission of particulates, sulfur dioxide (SO2), nitrogen oxides (NOx), hazardous air pollutants and other pollutants, and require permits for operation of emission sources. These permits must be renewed periodically. Various newly enacted and/or proposed federal and state initiatives may result in additional operating and capital expenditure costs for fossil-fueled electric generating units.


Ozone NAAQS

In October 2015, the EPA revised the primary and secondary ozone NAAQS, lowering it to 70 ppb. The final standard will likely cause Milwaukee County, where our Elm Road Units are located, to be designated as nonattainment for ozone. A nonattainment designation may have an effect on operations at our facilities, however, the NAAQS process involves many steps and any effect on our generation units will not be fully understood until the State of Wisconsin develops, receives approval for, and finalizes an implementation plan for any counties found to be in nonattainment.


The State of Wisconsin has joined a lawsuit filed by several states challenging the EPA's new ozone standard. Oral arguments in this case are scheduled to begin in April 2017. MGE will continue to monitor the EPA's progress on attainment designations and related litigation to assess potential impacts at our facilities, particularly our Elm Road Units.


Nitrogen Dioxide (NO2) NAAQS

The WDNR has revised its state rules to incorporate the EPA's one hour NO2 NAAQS rule that was finalized in 2010. The effective date of the state rule was August 1, 2016. The WDNR is currently seeking input from the public on ideas for implementing this one-hour standard. Wisconsin's NO2 NAAQS rule will affect our stationary fossil-fuel generation sources by requiring that we demonstrate consistency with the NAAQS when applying for certain air permits. Sources that cannot demonstrate compliance with the NAAQS may be required to install emission controls or restrict operations. MGE will continue to monitor developments while the WDNR implements guidance for compliance with the one-hour NAAQS.


EPA's Cross-State Air Pollution Rule: Proposed Ozone Season Update based on 2008 Ozone NAAQS

The EPA's Cross-State Air Pollution Rule (CSAPR) is an interstate air pollution transport rule designed to reduce ozone and fine particulate (PM2.5) air levels in areas that the EPA has determined are being affected by pollution from neighboring and upwind states. This is accomplished in the CSAPR through a reduction in SO2 and NOx from qualifying fossil-fuel fired power plants in upwind or "contributing" states. NOx and SO2 contribute to fine particulate pollution, and NOx contributes to ozone formation. Reductions are achieved through a cap and trade system. Individual plants can meet their caps through modifications and/or buying allowances on the market.


In October 2016, the EPA finalized rulemaking for an update to CSAPR that incorporated 2008 Ozone NAAQS levels into the rule (the original CSAPR is based on 1997 Ozone NAAQS levels). The update affects 22 states, including Wisconsin, by further limiting statewide NOx allowances in each of those states. The rule also includes revisions to CSAPR that are designed to address issues remaining from the D.C. Circuit remand of CSAPR, including Wisconsin's inclusion in the NOx ozone season portion of the rule. The State of Wisconsin filed a legal challenge to the CSAPR update rule asserting, among other things, that the rule over-controls NOx emissions in Wisconsin.




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The CSAPR Update rule will further reduce summertime (or Ozone Season) NOx emissions allocations from power plants starting in 2017. MGE intends to meet the rule requirements through a combination of allocations owned, received, or purchased. Depending on the number of allocations MGE receives for ozone season, the number of allocations that MGE must purchase, and the cost of allocations, this requirement could be material for MGE.


Clean Air Visibility Rule (CAVR)

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


In December 2016, the EPA introduced a final rule (posted online but not yet scheduled for publication in the Federal Register) extending state implementation plan deadlines by three years from 2018 to 2021 for the next implementation phase of the CAVR, which goes beyond BART and may affect utilities. This extension would allow for states to coordinate their CAVR compliance with other compliance efforts, which should lessen the burden to comply. It is too early to determine if the rule will affect MGE. MGE will continue to monitor developments.


Global Climate Change


MGE is a producer of GHG emissions, primarily from the fossil fuel generating facilities it uses to meet customers' energy needs, as well as from its natural gas pipeline system and fleet vehicles. Climate change and the regulatory response to it could significantly affect our operations in a number of ways, including increased operating costs and capital expenditures, restrictions on energy supply options, operational limits on our coal plants, permitting difficulties, and emission limits. MGE management would expect to seek and receive rate recovery of such compliance costs, if and when required. MGE continues to monitor proposed climate change legislation and regulation.


MGE has taken steps to address GHG emissions through voluntary actions. In 2005, MGE implemented its Energy 2015 Plan, which committed to ensuring a balanced, economic energy supply with reduced environmental emissions. The Plan emphasized increased renewable energy, energy efficiency, and new cleaner generation – three strategies that reduced GHG emissions. Under the Plan and other actions, our CO2 emissions declined from 2005 to 2015 by approximately 20% even though total system energy increased. In 2015, MGE announced its Energy 2030 framework that continues steps to reduce CO2 emissions. Subject to regulatory approvals and other conditions, MGE aims to increase renewable energy to 25% of retail electric sales by 2025 and to 30% by 2030. Under our Energy 2030 framework, we will also work to reduce CO2 emissions by 40% from 2005 levels by 2030.


Climate Change Legislation


It is not anticipated that U.S. Congress will enact broad GHG reduction legislation in 2017.


It is not expected that the Wisconsin Legislature will enact broad GHG regulation in 2017.


Greenhouse Gas Regulation


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

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


In October 2015, many states (including Wisconsin) and other litigants filed petitions with the U.S. Court of Appeals for the District of Columbia Circuit. On January 26, 2016, several parties filed a request for a stay of the CPP with the U.S. Supreme Court; and on February 9, 2016, the U.S. Supreme Court granted that request. The CPP may not be implemented until the courts ultimately resolve the underlying legality of the rule, which is expected in 2017.




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Given the pending legal proceedings the nature and timing of any final requirements is subject to uncertainty. If the rule remains substantially in its present form, it is expected to have a material impact on MGE.


Solid Waste


EPA's Coal Combustion Residuals Rule

In December 2014, the EPA finalized its Disposal of Coal Combustion Residuals from Electric Utilities (CCR) rule. The rule became effective in October 2015. It provides that coal ash will be regulated as a solid waste, and defines what ash use activities would be considered generally exempt beneficial reuse of coal ash. The rule also regulates landfills, ash ponds, and other surface impoundments for coal combustion residuals by regulating their design, location, monitoring, and operation. This portion of the rule is accomplished in phases to allow for sites with onsite storage and/or disposal to evaluate their compliance with the rule's design criteria. Landfills and impoundments that cannot meet design criteria will need to close formally within defined timeframes.


The Columbia and Elm Road Units co-owners and plant operators are working through the phased requirements to plan and implement changes necessary at those facilities to meet design criteria. Review of our Elm Road Units has indicated that the costs to comply with this rule are not expected to be significant. Columbia's operator has developed a preliminary implementation schedule for meeting the various deadlines spelled out in the rule. Costs at Columbia will be dependent on what is determined during the evaluation stage. Management believes compliance costs will be recovered in future rates based on previous treatment of environmental compliance projects.


Columbia


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


Columbia Clean Air Act Litigation

Columbia is a coal-fired generating station operated by WPL in which WPL, WPSC, and MGE have ownership interests. In December 2009, the EPA sent a Notice of Violation (NOV) to the co-owners, including MGE. 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 June 2013, the court approved and entered a consent decree entered by the EPA, Sierra Club, and the co-owners of Columbia. One of the requirements of the consent decree requires installation of an SCR system at Columbia Unit 2 by December 31, 2018. Installation of the SCR has been approved by the PSCW and is currently under construction. MGE's share of the projected cost for the SCR system is estimated to be $22-$24 million, with expected completion in 2018.


Employees


As of December 31, 2016, MGE had 704 employees. MGE employs 227 employees who are covered by a collective bargaining agreement with Local Union 2304 of the International Brotherhood of Electrical Workers and 84 employees who are covered by a collective bargaining agreement with Local Union No. 39 of the Office and Professional Employees International Union. Both of these collective bargaining agreements expire on April 30, 2018. There are also 5 employees covered by a collective bargaining agreement with Local Union No. 2006, Unit 6 of the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied Industrial, and Service Workers International Union. This collective bargaining agreement expires on October 31, 2018.


Financial Information About Segments


See Footnote 20 of the Notes to the Consolidated Financial Statements for financial information relating to MGE Energy's and MGE's business segments.




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Executive Officers of the Registrants


As of December 31, 2016, the executive officers of the registrants were as follows:


Executive

Title

Effective

Date

Service

Years as

an Officer

Gary J. Wolter(a)

Age: 62

Chairman of the Board, President and Chief Executive Officer

02/01/2002

27

Jeffrey M. Keebler(b)

Age: 45

Senior Vice President - Energy Supply and Planning

Assistant VP - Energy Supply and Customer Service

07/23/2015

01/01/2012

5

Craig A. Fenrick(b)

Age: 57

Senior Vice President - Energy Operations

Vice President - Energy Delivery

Vice President - Electric Transmission and Distribution

07/23/2015

02/10/2015

01/01/2012

10


Lynn K. Hobbie(b)

Age: 58

Senior Vice President - Marketing and Communications

02/01/2000

22

Jeffrey C. Newman(a)

Age: 54

Senior Vice President, Chief Financial Officer, Secretary and Treasurer

Vice President, Chief Financial Officer, Secretary and Treasurer

07/23/2015


01/01/2009

19


Cari Anne Renlund(b)

Age: 43

Vice President and General Counsel

Dewitt Ross & Stevens S.C. (law firm) - Partner

11/02/2015

06/11 – 10/15

1


Note: Ages, years of service, and positions as of December 31, 2016.

(a) Executive officer of MGE Energy and MGE.

(b) Executive officer of MGE.


Item 1A. Risk Factors.


MGE Energy and its subsidiaries, including MGE, operate in a market environment that involves significant risks, many of which are beyond their control. The following risk factors may adversely affect their results of operations, cash flows and market price for their publicly traded securities. While MGE Energy and MGE believe they have identified and discussed below the key risk factors affecting their business, there may be additional risks and uncertainties that are not presently known or that are not currently believed to be significant that may adversely affect their performance or financial condition in the future.


Regulatory Risk


We are subject to extensive government regulation in our business, which affects our costs and responsiveness to changing events and circumstances.


Our business is subject to regulation at the State and Federal levels. We are subject to regulation as a holding company by the PSCW. MGE is regulated by the PSCW as to its rates, terms and conditions of service; various business practices and transactions; financing; and transactions between it and its affiliates, including MGE Energy. MGE is also subject to regulation by the FERC, which regulates certain aspects of its business. The regulations adopted by the State and Federal agencies affect the manner in which we do business, our ability to undertake specified actions since pre-approval or authorization may be required, the costs of operations, and the level of rates charged to recover such costs. Our ability to attract capital is also dependent, in part, upon our ability to obtain a fair return from the PSCW.


We could be subject to higher costs and potential penalties resulting from mandatory reliability standards.


MGE must adhere to mandatory reliability standards for its electric distribution system established by NERC. These standards cover areas such as critical infrastructure protection, emergency preparedness, facility design, and transmission operations, among others. The critical infrastructure protection standards focus on physical and access security of cyber assets, as well as incident response and recovery planning. MGE could be subject to higher operating costs in order to maintain compliance with the mandatory reliability standards, and any noncompliance could result in sanctions including monetary penalties.




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We are subject to changing environmental laws and regulations that may affect our costs and business plans.


Our subsidiaries are subject to environmental laws and regulations that affect the manner in which they conduct business, including capital expenditures, operating costs and potential liabilities. Changes and developments in these laws and regulations may alter or limit our business plans, make them more costly, or expose us to liabilities for past or current operations.


Numerous environmental laws and regulations govern many aspects of our present and future operations, including air emissions, water quality, wastewater discharges, solid waste, threatened and endangered species, and hazardous waste. These evolving regulations can introduce uncertainty with respect to capital expenditures and operational planning, and can introduce costly delays if previous decisions need to be revisited as a result of judicial mandate or regulatory change. These regulations generally require us to obtain and comply with a wide variety of environmental permits and approvals, and can result in increased capital, operating, and other costs and operating restrictions, particularly with regard to enforcement efforts focused on obligations under existing regulations with respect to power plant emissions and compliance costs associated with regulatory requirements. These effects can be seen not only with respect to new construction but could also require the installation of additional control equipment or other compliance measures such as altered operating conditions at existing facilities.


In addition, we may be a responsible party for environmental clean-up at current or future sites identified as containing hazardous materials or to which waste was sent that is subsequently determined to be hazardous. It is difficult to predict the costs potentially associated with a site clean-up due to the potential joint and several liability for all potentially responsible parties, the nature of the clean-up required, and the availability of recovery from other potentially responsible parties.


The following are significant proposed regulations that are expected to impact our operations:


The EPA's Cross-State Air Pollution Rule (CSAPR) is an interstate air pollution transport rule designed to reduce ozone and fine particulate (PM2.5) air levels in areas that the EPA has determined are being affected by pollution from neighboring and upwind states. In October 2016, the EPA finalized rulemaking for an update to CSAPR that incorporated 2008 Ozone NAAQS levels into the rule (the original CSAPR is based on 1997 Ozone NAAQS levels). The update affects 22 states, including Wisconsin, by further limiting statewide NOx allowances in each of those states. Depending on the number of allocations MGE receives for ozone season, the number of allocations that MGE must purchase, and the cost of allocations, this requirement could be material for MGE.


In October 2015, the EPA finalized its Clean Power Plan (CPP) rule with an effective date of December 2015, setting guidelines and approval criteria for states to use in developing plans to control GHG emissions from existing fossil fuel-fired electric generating units (EGUs) and systems. Implementation of the rule is expected to have a direct impact on existing coal and natural gas fired generating units, including possible changes in dispatch and additional operating costs. Given the pending legal proceedings, the nature and timing of any final requirements is subject to uncertainty. If the rule remains substantially in its present form, it is expected to have a material impact on MGE.


We face risk for the recovery of fuel and purchased power costs.


MGE has price risk exposure with respect to the price of natural gas, electricity, coal, emission credits, and oil. MGE burns natural gas in several of its peak electric generation facilities, and in many cases, the cost of purchased power is tied to the cost of natural gas. Under the electric fuel rules, MGE is required to defer electric fuel-related costs that fall outside a symmetrical cost tolerance band that is currently plus or minus 2% around the amount approved in its most recent rate order. Any over/under recovery of the actual costs in a year is determined in the following year and is then reflected in future billings to electric retail customers. Under the electric fuel rules, MGE is required to defer the benefit of lower costs, if its actual fuel costs fall outside the lower end of the range, and is required to defer costs, less any excess revenues, if its actual 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. MGE assumes the risks and benefits of variances that are within the cost tolerance band.




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Operating Risk


We are affected by weather, which affects customer demand and can affect the operation of our facilities.


The demand for electricity and gas is affected by weather. Very warm and very cold temperatures, especially for prolonged periods, can dramatically increase the demand for electricity and gas for cooling and heating, respectively, as opposed to the softening effect of more moderate temperatures. Our electric revenues are sensitive to the summer cooling season and, to a lesser extent, the winter heating season. Similarly, very cold temperatures can dramatically increase the demand for gas for heating. A significant portion of our gas system demand is driven by heating. Extreme summer conditions or storms may stress electric transmission and distribution systems, resulting in increased maintenance costs and limiting the ability to meet peak customer demand.


We could be adversely affected by changes in the development, and utilization by our customers, of power generation, storage, and use technology.


Our revenues and the timing of the recovery of our costs could be adversely affected by improvements in power generation, storage, and use technology.


Advancements in power generation technology, including commercial and residential solar generation installations and commercial micro turbine installations, are improving the cost-effectiveness of customer self-supply of electricity. Improvements in energy storage technology, including batteries and fuel cells, could also better position customers to meet their around-the-clock electricity requirements. Improvements in the energy efficiency of lighting, appliances, and equipment will also affect energy consumption by customers. Such developments could reduce customer purchases of electricity, but may not necessarily reduce our investment and operating requirements due to our obligation to serve customers, including those self-supply customers whose equipment has failed for any reason to provide the power they need whether due to inadequate on-site resources, restricted operating hours, or equipment failure. In addition, since a portion of our costs are recovered through charges based upon the volume of power delivered, reductions in electricity deliveries will affect the timing of our recovery of those costs and may require changes to our rate structures.


Changes in power generation, storage, and use technology could have significant effects on customer behaviors and their energy consumption. Customers could engage in individual conservation efforts by voluntarily reducing their consumption of electricity through voluntary changes in energy use and through the use of more energy efficient lighting, appliances, and equipment. They could also change their consumption of electricity from us through the installation of alternative energy sources, such as roof top solar panels and micro turbines for self-supply. Customer energy conservation could adversely affect our results of operations by reducing our revenues without necessarily changing our operating costs due to our obligation to serve.


We are affected by economic activity within our service area.


Higher levels of development and business activity generally increase the numbers of customers and their use of electricity and gas. Likewise, periods of recessionary economic conditions generally adversely affect our results of operations.


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. Demand for coal has 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



16




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.


Our ability to manage our purchased power costs is influenced by a number of uncontrollable factors.


We are exposed to additional purchased power costs to the extent that our power needs cannot be fully covered by the supplies available from our existing facilities and contractual arrangements. Those needs, and our costs, could be affected by:


·

Increased demand due to, for example, abnormal weather, customer growth, or customer obligations,


·

The inability to transmit our contracted power from its generation source to our customers due to transmission line constraints, outages, or equipment failures,


·

Reductions in the availability of power from our owned or contracted generation sources due to equipment failures, shortages of fuel or environmental limitations on operations, and


·

Failure to perform on the part of any party from which we purchase capacity or energy, whether due to equipment failures or other causes.


An unexpected change in demand or the availability of generation or transmission facilities can expose us to increased costs of sourcing electricity in the short-term market where pricing may be more volatile.


The equipment and facilities in our operational system are subject to risks which may adversely affect our financial performance.


Weather conditions, accidents, and catastrophic events can result in damage or failures of equipment or facilities and disrupt or limit our ability to generate, transmit, transport, purchase, or distribute electricity and gas. Efforts to repair or replace equipment and facilities may take prolonged periods or may be unsuccessful, or we may be unable to make the necessary improvements to our operational system, causing service interruptions. The resulting interruption of services would result in lost revenues and additional costs. We are also exposed to the risk of accidents or other incidents that could result in damage to or destruction of our facilities or damage to persons or property. Such issues could adversely affect revenues or increase costs to repair and maintain our systems.


Our operations and confidential information are subject to the risk of cyber-attacks.


Our operations rely on sophisticated information technology systems and networks. Cyber-attacks targeting our electronic control systems used at our generating facilities and for electric and gas distribution systems, could result in a full or partial disruption of our operations. Any disruption of these operations could result in a loss of service to customers and loss of revenue, as well as significant expense to repair system damage and remedy security breaches.


Our business requires the collection and retention of personally identifiable information of our customers, shareholders, and employees, who expect that we will adequately protect such information. A significant theft, loss, or fraudulent use of personally identifiable information may cause our business reputation to be adversely impacted and could lead to potentially large costs to notify and protect the impacted persons. The occurrence of such an event may cause us to become subject to legal claims, fines, or penalties, any of which could adversely impact our results of operations.


The safeguards we have may not always be effective due to the evolving nature of cyber-attacks. We cannot guarantee that such protections will be completely successful in the event of a cyber-attack. If the technology systems were to fail or be breached by a cyber-attack, and not be recovered in a timely fashion, we may be unable to fulfill critical business functions and confidential data could be compromised, adversely impacting our financial condition and results of operations.




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We rely on the performance of our information technology systems, the failure of which could have an adverse effect on our business and performance.


We operate in a highly engineered industry that requires the continued operation of sophisticated information technology systems and network infrastructure to manage our finances, to operate our control facilities, to provide electric and gas service to our customers, and to enable compliance with applicable regulatory requirements. Our computer-based systems are vulnerable to interruption or failure due to the age of certain systems, the introduction of viruses, malware, security breaches, fire, power loss, system malfunction, network outages and other events, which may be beyond our control. System interruptions or failures, whether isolated or more widespread, could impact our ability to provide service to our customers, which could have a material adverse effect on our operations and financial performance.


Acts of terrorism could materially and adversely impact our operations and financial condition.


Facilities for electric generation, transmission, and gas distribution are subject to the risk of being potential targets of terrorist threats and activities. A terrorist act at our facilities could result in a disruption of our ability to generate, transmit, transport, purchase, or distribute electricity or natural gas. A possible attack would have additional adverse effects, including environmental ramifications, increased security and insurance costs, as well as general economic volatility or uncertainty within our service territories. The inability to maintain operational continuity and any additional costs incurred for repairing our facilities could materially and adversely affect our financial condition and results of operations.


Failure to attract and retain an appropriately qualified workforce could affect our operations.


Events such as an aging workforce and retirement of key employees without appropriate replacements may lead to operating challenges and increased costs. Some of the challenges include lack of resources, loss of knowledge, and length of time period associated with skill development. Failure to identify qualified replacement employees could result in decreased productivity and increased safety costs. If we are unable to attract and retain an appropriately qualified workforce, our operations could be negatively affected.


Financial Risk


We are exposed to commodity price risk relating to our purchases of natural gas, electricity, coal and oil.


We face commodity price risk exposure with respect to our purchases of natural gas, electricity, coal, oil, and environmental allowances and risk through our use of derivatives, such as futures, forwards and swaps, to manage that commodity price risk. We could experience increased costs as a result of volatility in the market values of those commodities. We could also experience losses on our derivative contracts as a result of that market value volatility or if a counterparty fails to perform under a contract. In the absence of actively quoted market prices and pricing information from external sources, the valuation of these derivative contracts involves our exercise of judgment and use of estimates. As a result, changes in the underlying assumptions or use of alternative valuation methods could affect the reported fair value of these contracts.


Interest rate movements and market performance affects our employee benefit plan costs.


Prevailing interest rates affect our assessment and determination of discount rates that are a key assumption in the determination of the costs and funding of our defined benefit pension plans and may impact the amount of expense and timing of contributions to those plans. The performance of the capital markets affects the values of the assets that are held in trust to satisfy the future obligations under our pension and postretirement benefit plans. We have significant obligations in these areas and hold significant assets in these trusts. A decline in the market value of those assets may increase our current and longer-term funding requirements for these obligations. Changes in the value of trust fund assets may affect the level of required contributions to these trusts to meet benefit obligations. Reduced benefit plan assets could result in increased benefit costs in future years and may increase the amount and accelerate the timing of required future funding contributions.


We are exposed to interest rate risk.


We are exposed to interest rate risk on our variable rate financing. Borrowing levels under commercial paper arrangements vary from period to period depending upon capital investments and other factors. Such interest rate risk means that we are exposed to increased financing costs and associated cash payments as a result of changes in the short-term interest rates.



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We are exposed to credit risk primarily through our regulated energy business.


Credit risk is the loss that may result from counterparty nonperformance. We face credit risk primarily through MGE's regulated energy business. Failure of contractual counterparties to perform their obligations under purchase power agreements, commodity supply arrangements or other agreements may result in increased expenses for MGE as a result of being forced to cover the shortfall in the spot or short-term market, where prices may be more volatile.


As a holding company, we are dependent on upstream cash flows from our subsidiaries for the payment of dividends on our common stock.


As a holding company, we have no operations of our own, and our ability to pay dividends on our common stock is dependent on the earnings and cash flows of our operating subsidiaries and their ability to pay upstream dividends or to repay funds to us. Prior to funding us, our subsidiaries have financial obligations that must be satisfied, including among others, debt service and obligations to trade creditors, and are subject to contractual and regulatory restrictions on the payment of dividends.


Disruptions in the financial markets or changes to our credit ratings may affect our ability to finance at a reasonable cost and in accordance with our planned schedule.


The credit markets have experienced disruption and uncertainty in recent years. To the extent that such issues affect the ability or willingness of credit providers or investors to participate in the credit markets or particular types of investments, or affect their perception of the risk associated with particular types of investments, our cost of borrowing could be affected. We also rely on our strong credit ratings to access the credit markets. If our credit ratings are downgraded for any reason, borrowing costs could increase, potential investors could decrease, or we could be required to provide additional credit assurance, including cash collateral, to contract counterparties.


General economic conditions may affect our operating revenues and our counterparty risks.


Operational

MGE Energy's and MGE's operations are affected by local, national and worldwide economic conditions. The consequences of a prolonged period of reduced economic activity may include lower demand for energy, uncertainty regarding energy prices and the capital and commodity markets, and increased credit risk. A decline in energy consumption may adversely affect our revenues and future growth. Increased credit risk reflects the risk that our retail customers will not pay their bills in a timely manner or at all, which may lead to a reduction in liquidity and an eventual increase in bad debt expense.


Counterparty creditworthiness

Credit risk also includes the risk that trading counterparties that owe us money or product will breach their obligations. MGE's risk management policy is to limit transactions to a group of high quality counterparties. Should the counterparties to these arrangements fail to perform, we may be forced to enter into alternative arrangements. In that event, our financial results could be adversely affected and we could incur losses.


Item 1B. Unresolved Staff Comments.


MGE Energy and MGE


None.




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Item 2. Properties.


Electric Generation


Net summer rated capacity in service at December 31, 2016, was as follows:


Plants

 

Location

 

Commercial Operation Date

 

Fuel

 

Net Summer Rated Capacity (MW)(a)

 

No. of Units

Steam plants:

 

 

 

 

 

 

 

 

 

 

   Columbia

 

Portage, WI

 

1975 & 1978

 

Low-sulfur coal

 

225(b,c)

 

2

   Blount

 

Madison, WI

 

1957 & 1961

 

Gas

 

103(g)

 

2

   WCCF

 

Madison, WI

 

2005

 

Gas/oil

 

120(d)

 

2

   Elm Road Units

 

Oak Creek, WI

 

2010 & 2011

 

Coal

 

106(b,e)

 

2

Combustion turbines

 

Madison, WI

 

1964-2000

 

Gas/oil

 

151(f)

 

6

 

 

Marinette, WI

 

 

 

 

 

 

 

 

Portable generators

 

Madison, WI

 

1998-2001

 

Diesel

 

49(g)

 

54

Wind turbines

 

Townships of Lincoln

 

 

 

 

 

 

 

 

 

 

and Red River, WI

 

1999

 

Wind

 

1(g,h)

 

17

 

 

Township of

 

 

 

 

 

 

 

 

 

  

Brookfield, IA

 

2008

 

Wind

 

4(g,i)

 

18

                 Total

 

 

 

 

  

 

 

759

 

 


(a)

Net summer rated capacity is determined by annual testing and may vary from year to year due to, among other things, the operating and physical conditions of the units.


(b)

Baseload generation.


(c)

MGE's share. See "Columbia" below.


(d)

Facility is jointly owned. Based on the terms of the joint plant agreement between MGE and the UW, the UW has the ability to reduce net capability of these units by approximately 17 MW in the summer. The net summer rated capacity shown reflects this decrease. See "WCCF" below.


(e)

MGE's share. See "Elm Road" below.


(f)

Three facilities are owned by MGE, and three facilities are leased.


(g)

These facilities are owned by MGE.


(h)

Nameplate capacity rating is 11 MW.


(i)

Nameplate capacity rating is 30 MW.


Columbia


MGE and two other utilities jointly own Columbia, a coal-fired generating facility consisting of two 512 MW units, which, at December 31, 2016, accounts for 30% of MGE's net summer rated capacity. Power from this facility is shared in proportion to each owner's ownership interest. At December 31, 2016, MGE had a 22% ownership interest in Columbia. The other owners are WPL, which operates Columbia, and WPSC. The Columbia units burn low-sulfur coal obtained from the Powder River Basin coal fields located in Wyoming. The coal inventory supply for the Columbia units decreased from approximately 88 days on December 31, 2015, to approximately 65 days on December 31, 2016. See "Executive Overview" under Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, for a discussion of the reduction in MGE's ownership share in Columbia commencing January 2017 and continuing through June 2020.




20




Elm Road Units


MGE Power Elm Road and two other owners own undivided interests in the Elm Road Units, consisting of two 615 MW units, which, at December 31, 2016, account for 14% of MGE's net summer rated capacity. Power from these units is shared in proportion to each owner's ownership interest. MGE Power Elm Road owns an 8.33% ownership interest in the Elm Road Units, and its interest in the Elm Road Units is leased to MGE. The other owners are Wisconsin Energy Corporation, which operates the Units, and WPPI Energy, Inc. The Elm Road Units burn bituminous coal obtained from northern West Virginia and southwestern Pennsylvania, and Powder River Basin coal from Wyoming. MGE's share of the coal inventory supply for the Elm Road Units increased from approximately 50 days on December 31, 2015, to approximately 51 days on December 31, 2016.


MGE leases MGE Power Elm Road's ownership interest in the Elm Road Units pursuant to two separate facility leases. The financial terms of each facility lease include a capital structure of 55% equity and 45% long-term debt, return on equity of 12.7%, and a lease term of 30 years. At the end of the respective lease terms, MGE may, at its option, renew the facility lease for an additional term, purchase the leased ownership interest at fair market value, or allow the lease to end. The Unit 1 and Unit 2 leases commenced with the commercial operation of each respective unit.


WCCF


MGE Power West Campus and the UW jointly own undivided interests in a natural gas-fired cogeneration facility on the UW campus. The facility has the capacity to produce 20,000 tons of chilled water, 500,000 pounds per hour of steam, and approximately 150 MW of electricity. The UW owns 45% of the facility, which represents its interest in the chilled-water and steam assets. These assets are used to meet a part of the UW's need for air-conditioning and steam-heat capacity. MGE Power West Campus owns 55% of the facility, which represents its interest in the electric generating assets. These assets are used to provide electricity to MGE's customers. The UW's share of the plant and portion of the earnings from the WCCF are not reflected in the consolidated financial statements of MGE Energy or MGE. MGE Power West Campus' share of the plant is reflected in property, plant, and equipment on MGE Energy's and MGE's consolidated balance sheets.


MGE leases the electric generating assets owned by MGE Power West Campus and is responsible for operating the entire facility. The financial terms of the facility lease include a capital structure of 53% equity and 47% long-term debt, return on equity of 12.1%, and a lease term of 30 years. At the end of the lease term in 2035, MGE may, at its option, renew the facility lease for an additional term, purchase the generating facility at fair market value, or allow the lease contract to end.


Electric and Gas Distribution Facilities


At December 31, 2016, MGE owned 872 miles of overhead electric distribution line and 1,236 miles of underground electric distribution cable, all of which are located in Wisconsin. These electric distribution facilities are connected by approximately 52 substations, installed with a capacity of 1,190,500 kVA. MGE's gas facilities include 2,765 miles of distribution mains, which are all owned by MGE.


A significant portion of MGE's electric and gas distribution facilities are located above or underneath highways, streets, other public places or property that others own. MGE believes that it has satisfactory rights to use those places or property in the form of permits, grants, easements, and licenses; however, it has not necessarily undertaken to examine the underlying title to the land upon which the rights rest.


Encumbrances


The principal plants and properties of MGE are subject to the lien of its Indenture of Mortgage and Deed of Trust dated as of January 1, 1946, as amended and supplemented, under which MGE's first mortgage bonds are issued. As of December 31, 2016, there were $1.2 million of first mortgage bonds outstanding. See Footnote 9 of the Notes to Consolidated Financial Statements for additional information regarding MGE's first mortgage bonds.


MGE Power Elm Road has collaterally assigned its right to lease payments from MGE for the Elm Road Units in order to secure the repayment of $62.6 million of senior secured notes issued by MGE Power Elm Road. See Footnote 9 of the Notes to Consolidated Financial Statements for additional information regarding these senior notes.




21




MGE Power West Campus has collaterally assigned its right to lease payments from MGE for the WCCF in order to secure the repayment of $45.1 million of senior secured notes issued by MGE Power West Campus. See Footnote 9 of the Notes to Consolidated Financial Statements for additional information regarding these senior notes.


Item 3. 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 "Environmental" under Item 1. Business and Footnote 17.c. of the Notes to Consolidated Financial Statements for a description of several environmental proceedings involving MGE. See Footnote 17.d. of the Notes to Consolidated Financial Statements for a description of other legal matters.


Item 4. Mine Safety Disclosures.


MGE Energy and MGE


Not applicable.




22





PART II.


Item 5. Market for Registrants' Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities.


Market for Common Equity


MGE Energy


MGE Energy common stock is traded on Nasdaq under the symbol MGEE. On February 1, 2017, there were approximately 38,688 shareholders of record. The following table shows high and low sale prices for the common stock on Nasdaq for each quarter over the past two years.


 

 

 

Common Stock Price Range

 

 

 

 

2016

 

 

2015

 

 

 

 

High

 

Low

 

 

High

 

Low

 

 

Fourth quarter

$

66.85

$

53.48

 

$

47.23

$

39.18

 

 

Third quarter

$

59.49

$

53.78

 

$

41.97

$

36.75

 

 

Second quarter

$

56.54

$

47.90

 

$

45.33

$

36.46

 

 

First quarter

$

53.48

$

44.83

 

$

47.97

$

40.66

 


MGE


As of February 1, 2017, there were 17,347,894 outstanding shares of common stock, all of which were held by MGE Energy. There is no market for shares of common stock of MGE.


Dividends


MGE Energy


The following table sets forth MGE Energy's quarterly cash dividends per share declared during 2016 and 2015:


 

(Per share)

 

2016

 

2015

 

 

Fourth quarter

$

0.308

$

0.295

 

 

Third quarter

$

0.308

$

0.295

 

 

Second quarter

$

0.295

$

0.283

 

 

First quarter

$

0.295

$

0.283

 


MGE


The following table sets forth MGE's quarterly cash dividends declared during 2016 and 2015:


 

(In thousands)

 

2016

 

2015

 

 

Fourth quarter

$

10,000

$

10,000

 

 

Third quarter

$

15,000

$

10,000

 

 

Second quarter

$

15,000

$

10,000

 

 

First quarter

$

10,000

$

-

 


See discussion below as well as "Liquidity and Capital Resources - Financing Activities" under Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, for a description of restrictions applicable to dividend payments by MGE.


Dividend Restrictions


Dividend payments by MGE to MGE Energy are subject to restrictions arising under a PSCW rate order and, to a lesser degree, MGE's first mortgage bonds. The PSCW order restricts any dividends, above the PSCW authorized amount of $43 million, that MGE may pay MGE Energy if its common equity ratio, calculated in the manner used in the rate proceeding, is less than 55%. MGE's thirteen month rolling average common equity ratio at December 31, 2016, is 60.2%, as determined under the calculation used in the rate proceeding. This restriction did not impact



23




MGE's payment of dividends in 2016. Cash dividends of $50.0 million and $30.0 million were paid by MGE to MGE Energy in 2016 and 2015, respectively. In 2016, MGE also transferred its ownership interest in MGE Transco to MGE Energy in the form of a dividend in kind of $15.8 million. The rate proceeding calculation includes as indebtedness imputed amounts for MGE's outstanding purchase power capacity payments and other PSCW adjustments, but does not include the indebtedness associated with MGE Power Elm Road and MGE Power West Campus, which are consolidated into MGE's financial statements but are not direct obligations of MGE.


MGE has covenanted with the holders of its first mortgage bonds not to declare or pay any dividend or make any other distribution on or purchase any shares of its common stock unless, after giving effect thereto, the aggregate amount of all such dividends and distributions and all amounts applied to such purchases, after December 31, 1945, shall not exceed the earned surplus (retained earnings) accumulated subsequent to December 31, 1945. As of December 31, 2016, approximately $338.5 million was available for the payment of dividends under this covenant.


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. Shareholders received cash in lieu of any fractional shares of common stock they otherwise would have received in connection with the dividend. All share and per share data provided in this report give effect to this stock split.


Issuer Purchases of Equity Securities


MGE Energy


 

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*

 

 

October 1-31, 2016

 

21,025

$

55.21

 

-

 

-

 

 

November 1-30, 2016

 

15,905

 

60.17

 

-

 

-

 

 

December 1-31, 2016

 

55,400

 

64.86

 

-

 

-

 

 

Total

 

92,330

$

61.85

 

-

 

-

 


*

Under the MGE Energy, Inc. Direct Stock Purchase and Dividend Reinvestment Plan (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. MGE Energy uses 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 by MGE Energy pursuant to a registration statement that was filed with the SEC and is currently effective.


MGE


None.




24




Stock Performance Graph


The performance graph below illustrates a five-year comparison of cumulative total returns based on an initial investment of $1,000 in MGE Energy common stock, as compared with the Russell 2000 and the EEI Index for the period 2011 through 2016. The EEI Index reflects the consolidated performance of Edison Electric Institute investor-owned electric utilities.


Cumulative Five-Year Total Return Comparison

[f10k_2016002.gif](assumes $1,000 invested on 12/31/2011 with dividends reinvested)


Value of Investment at December 31,


 

 

 

2011

 

2012

 

2013

 

2014

 

2015

 

2016

 

 

MGEE

$

1,000

$

1,126

$

1,315

$

1,602

$

1,677

$

2,414

 

 

Russell 2000

 

1,000

 

1,163

 

1,615

 

1,694

 

1,619

 

1,965

 

 

EEI Index

 

1,000

 

1,021

 

1,154

 

1,487

 

1,429

 

1,678

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 




25




Item 6. Selected Financial Data.


MGE Energy, Inc.

(In thousands, except per share amounts)


 

 

For the Years Ended December 31,

 

 

2016

 

2015

 

2014

 

2013

 

2012

Summary of Operations

 

 

 

 

 

 

 

 

 

 

Operating revenues:

 

 

 

 

 

 

 

 

 

 

    Electric

$

410,202

$

420,291

$

398,132

$

409,425

$

401,596

    Gas

 

134,543

 

143,737

 

221,720

 

181,462

 

139,727

        Total operating revenues

 

544,745

 

564,028

 

619,852

 

590,887

 

541,323

Operating expenses

 

396,455

 

419,894

 

462,102

 

444,293

 

410,200

Other general taxes

 

20,062

 

19,879

 

19,652

 

18,607

 

18,360

Operating income

 

128,228

 

124,255

 

138,098

 

127,987

 

112,763

Other income, net

 

9,711

 

8,613

 

10,079

 

10,701

 

10,069

Interest expense, net

 

(19,866)

 

(20,162)

 

(19,673)

 

(18,924)

 

(19,467)

    Income before taxes

 

118,073

 

112,706

 

128,504

 

119,764

 

103,365

Income tax provision

 

(42,513)

 

(41,363)

 

(48,185)

 

(44,859)

 

(38,919)

    Net income

$

75,560

$

71,343

$

80,319

$

74,905

$

64,446

Average shares outstanding

 

34,668

 

34,668

 

34,668

 

34,668

 

34,668

    Basic and diluted earnings per share

$

2.18

$

2.06

$

2.32

$

2.16

$

1.86

    Dividends declared per share

$

1.21

$

1.16

$

1.11

$

1.07

$

1.04

 

 

 

 

 

 

 

 

 

 

 

Assets(a)

 

 

 

 

 

 

 

 

 

 

Electric

$

1,021,905

$

974,235

$

945,790

$

896,864

$

889,889

Gas

 

318,603

 

298,435

 

306,106

 

264,099

 

282,815

Assets not allocated

 

27,338

 

49,753

 

41,124

 

19,853

 

18,549

Nonregulated energy operations

 

271,277

 

277,858

 

280,542

 

287,042

 

290,889

Transmission investments

 

74,535

 

69,470

 

67,697

 

64,504

 

61,064

All others

 

465,202

 

434,868

 

438,898

 

431,436

 

412,840

Eliminations

 

(377,800)

 

(378,216)

 

(390,636)

 

(389,800)

 

(397,372)

    Total assets

$

1,801,060

$

1,726,403

$

1,689,521

$

1,573,998

$

1,558,674

 

 

 

 

 

 

 

 

 

 

 

Capitalization including Short-Term Debt

 

 

 

 

 

 

 

 

 

 

Common shareholders' equity

$

724,088

$

690,458

$

659,401

$

617,510

$

579,429

Long-term debt(a,b)

 

387,124

 

391,010

 

394,775

 

398,454

 

356,737

Short-term debt

 

-

 

-

 

7,000

 

-

 

-

    Total capitalization and short-term debt

$

1,111,212

$

1,081,468

$

1,061,176

$

1,015,964

$

936,166

 

 

 

 

 

 

 

 

 

 

 

(a) Reflects retrospective application of new accounting pronouncement related to debt issuance costs. See Footnote 19 of the

      Notes to the Consolidated Financial Statements for additional information.

(b) Includes long-term debt due within one year, debt issuance costs, and unamortized discount.




26





Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.


General


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


·

Regulated electric utility operations, conducted through MGE,

·

Regulated gas utility operations, conducted through MGE,

·

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

·

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

·

All other, which includes corporate operations and services.


Our principal subsidiary is MGE, which generates and distributes electric energy, distributes natural gas, and represents a majority portion of our assets, liabilities, revenues, and expenses. MGE generates and distributes electricity to approximately 149,000 customers in Dane County, Wisconsin, including the city of Madison, and purchases and distributes natural gas to approximately 154,000 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,

·

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

·

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

·

Energy commodity prices, including natural gas prices,

·

Equity price risk pertaining to pension related assets,

·

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

·

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

·

Other factors listed in Item 1A. Risk Factors.


For the year ended December 31, 2016, MGE Energy's earnings were $75.6 million or $2.18 per share compared to $71.3 million or $2.06 per share for the same period in the prior year. MGE's earnings for the year ended December 31, 2016, were $51.2 million compared to $45.4 million for the same period in the prior year.




27




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


 

(In millions)

 

Year Ended December 31,

 

 

Business Segment:

 

2016

 

2015

 

2014

 

 

    Electric Utility

$

40.6

$

36.4

$

41.4

 

 

    Gas Utility

 

10.6

 

10.4

 

15.8

 

 

    Nonregulated Energy

 

19.1

 

20.1

 

19.3

 

 

    Transmission Investments

 

5.6

 

4.6

 

5.5

 

 

    All Others

 

(0.3)

 

(0.2)

 

(1.7)

 

 

    Net Income

$

75.6

$

71.3

$

80.3

 


Our net income during 2016 compared to 2015 primarily reflects the effects of the following factors:


·

Electric net income increased due to a 5.4% increase in residential electric retail sales as the result of more favorable weather conditions in 2016 compared to 2015. Electric utility operations experienced an increase in operating and maintenance costs partially offsetting the increase in net income compared to the same period in the prior year.


·

Carrying costs incurred during construction of the Elm Road Units and WCCF were recognized by MGE Power Elm Road and MGE Power West Campus over the period allowed for recovery in rates. The recovery period ended in 2015, contributing to a reduction in nonregulated earnings in 2016. The reduction in earnings was partially offset by an increase in lease revenue.


·

Transmission investment income reflects our share of ATC's earnings. ATC's earnings for 2015 reflected a charge representing its estimate of its refund liability covering 2015, 2014, and a portion of 2013 associated with the return on equity complaint filed with FERC. See "Other Matters" below for additional information concerning ATC.


Our net income during 2015 compared to 2014 primarily reflects the effects of the following factors:


·

Electric net income decreased due to lower AFUDC and higher depreciation expense primarily related to the Columbia environmental project being placed in service in April (Unit 2) and July 2014 (Unit 1). In addition, there was a 0.3% decrease in electric retail sales in 2015 compared to 2014.


·

Gas net income decreased due to a 27.0% decrease in gas retail sales reflecting lower customer demand compared to the demand resulting from the extremely cold weather experienced in 2014. Heating degree days (a measure for determining the impact of weather during the heating season) decreased by 18.9% compared to 2014. The average temperature in January 2015 was 20.1 degrees compared to 11.5 degrees in 2014.


·

ATC's earnings for 2015 reflected a charge representing its estimate of its refund liability covering 2015, 2014, and a portion of 2013 associated with the return on equity complaint filed with FERC. See "Other Matters" below for additional information concerning ATC.


·

The increase in all other income primarily results from a decrease in voluntary contributions.


During 2016, the following events occurred:


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


2016 Annual Fuel Proceeding: In August 2015, the PSCW approved a $0.00256/kWh fuel credit that began on September 1, 2015, and continued throughout 2016. The fuel credit established a mechanism to return $10.9 million of fuel savings to electric customers as a bill credit. MGE returned $8.3 million of electric fuel-related savings to customers through bill credits during the year ended December 31, 2016.


In January 2016, the PSCW lowered MGE's 2016 fuel rules monitored costs by $14.8 million as a result of continued lower projected fuel costs in 2016. Also, in March 2016, MGE filed its 2015 fuel plan reconciliation application showing an overcollection of 2015 fuel rules monitored costs. In July 2016, the PSCW issued a final



28




order stating that MGE shall refund the additional fuel savings incurred during 2015 and 2016 for a total of $15.7 million to its retail electric customers over a one-month period. In September 2016, MGE returned $15.5 million to customers through bill credits.


As of December 31, 2016, MGE has deferred $5.6 million of 2016 fuel savings that were in excess of the fuel savings included within the fuel credits referenced above. These costs will be subject to the PSCW's annual review of 2016 fuel costs, expected to be completed in 2017.


Loss of Industrial Customer: In November 2015, a large industrial customer announced its intention to relocate its operations out of state and to close its manufacturing facilities within our service territory. That closure is expected to occur in early 2017. For the years ended December 31, 2016 and 2015, this customer contributed approximately $3.4 million and $3.8 million, respectively, of pre-tax earnings. Our rate case filing for 2017 addressed the effects of the closure.


ATC Return on Equity: Several parties have filed complaints with the FERC seeking to reduce the base return on equity (ROE) used by MISO transmission owners, including ATC. In June 2016, an administrative law judge issued an initial decision regarding a second filed complaint for the period February 2015 through May 2015 that would reduce the transmission owners' base ROE to 9.7%. ATC recorded an estimated refund liability with respect to the administrative law judge's order, which was reflected within our share of ATC earnings. On September 28, 2016, FERC issued an order on the first complaint, for the period November 2013 through February 2015, reducing the base ROE to 10.32%. This base ROE also became effective September 28, 2016, and will apply to future periods until FERC rules in the second complaint, at which time the base ROE ordered by FERC in the second complaint will prospectively become the authorized base ROE. See "Other Matters" below for additional information concerning ATC.


During 2017, several items may affect us, including:


2017 Rate Case Filing: On December 15, 2016, the PSCW authorized MGE to decrease 2017 rates for retail electric customers by 0.8% or $3.3 million and to increase rates for retail gas customers by 1.9% or $3.1 million. The decrease in retail electric rates reflects declining fuel and purchased power costs. The increase in retail gas rates covers costs associated with MGE's natural gas system infrastructure improvements. The authorized return on common stock equity for 2017 is 9.8% on 57.2% common equity. The PSCW also approved MGE's request to extend the current accounting treatment for transmission related costs through 2018.


ATC Return on Equity: Several parties have filed complaints with the FERC seeking to reduce the ROE used by MISO transmission owners, including ATC. Any change to ATC's ROE could result in lower equity earnings and distributions from ATC in the future. We derived approximately 6.8% and 6.4% of our net income for the years ended December 31, 2016 and 2015, respectively, from our investment in ATC. See "Other Matters" below for additional information concerning ATC.


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. At present, it is unclear how the changes in the Presidential and EPA administration may affect pending or new legislative or rulemaking proposals or regulatory initiatives. Such legislation and rulemaking could significantly affect the costs of owning and operating fossil-fueled generating plants, such as Columbia and the Elm Road Units, from which we derive approximately 43% of our electric generating capacity as of December 31, 2016. We would expect to seek and receive recovery of any such costs in rates; however, it is difficult to estimate the amount of such costs due to the uncertainty as to the timing and form of the legislation and rules, and the scope and time of the recovery of costs in rates, which may lag the incurrence of those costs.


EPA's Clean Power Plan: In October 2015, the EPA finalized its Clean Power Plan (CPP) rule with an effective date of December 2015, setting guidelines and approval criteria for states to use in developing plans to control GHG emissions from existing fossil fuel-fired electric generating units (EGUs) and systems. Implementation of the rule is expected to have a direct impact on existing coal and natural gas fired generating units, including possible changes in dispatch and additional operating costs. Given the pending legal proceedings, the nature and timing of any final requirements is subject to uncertainty. If the rule remains substantially in its present form, it is expected to have a material impact on MGE.




29




Future Generation: During the first quarter of 2016, MGE entered into an agreement with WPL under which MGE may acquire up to 50 MW of capacity in a gas-fired generating plant to be constructed by WPL at its Riverside Energy Center in Beloit, Wisconsin, during the five-year period following the in-service date of the plant. The plant is expected to be completed by early 2020. MGE and WPL have negotiated an amendment to the existing Columbia joint operating agreement, effective January 1, 2017, under which MGE will reduce its obligation to pay certain capital expenditures (other than SCR-related expenditures) at Columbia prior to the expected in-service date of the Riverside gas-fired generating plant in exchange for a proportional reduction in MGE's ownership in Columbia. On January 1 of each year, beginning in 2017 and ending June 1, 2020, the ownership percentage will be adjusted, through a partial sale, based on the amount of capital expenditures foregone. During 2016, MGE accrued $14.8 million of 2016 capital expenditures that MGE has forgone as part of the ownership transfer agreement with WPL. As of December 31, 2016, MGE classified $14.8 million of Columbia assets as held-for-sale on the consolidated balance sheets. In January 2017, MGE reduced its ownership interest in Columbia from 22.0% to 20.4% through the partial sale of plant assets to WPL. By June 2020, MGE's ownership in Columbia is forecasted to be approximately 19%.


Saratoga Wind Farm: On February 21, 2017, MGE filed with the PSCW a letter notifying the commission of MGE's intent to seek approval to construct, own and operate a 66MW wind farm, consisting of 33 turbines, located near Saratoga, Iowa. MGE anticipates filing its formal application with the PSCW in March. If approved, construction of the project is expected to begin in early 2018, with an estimated capital cost of $107 million.


Financing Plans: In January 2017, MGE issued $40 million of new long-term unsecured debt carrying an interest rate of 3.76% per annum over its 35-year term. The proceeds of this debt financing were used to refinance the maturing $30 million medium-term notes and, assist with the financing of additional capital expenditures. The covenants of this debt are substantially consistent with MGE's existing unsecured long-term debt. In accordance with applicable accounting guidance, MGE has classified the $30 million of maturing medium-term notes as long-term debt on the consolidated balance sheets for 2016. MGE also plans to issue an additional $30 million of new long-term debt during 2017 to cover capital expenditures and other corporate obligations.


The following discussion is based on the business segments as discussed in Footnote 20 of the Notes to Consolidated Financial Statements.


Results of Operations


Year Ended December 31, 2016, Versus the Year Ended December 31, 2015


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 years indicated:


 

 

 

Revenues

 

Sales (kWh)

 

 

(In thousands, except cooling degree days)

 

2016

 

2015

 

% Change

 

2016

 

2015

 

% Change

 

 

Residential

$

136,792

$

135,201

 

1.2 %

 

828,887

 

786,741

 

5.4 %

 

 

Commercial

 

213,101

 

220,745

 

(3.5)%

 

1,866,035

 

1,831,251

 

1.9 %

 

 

Industrial

 

17,589

 

20,283

 

(13.3)%

 

232,854

 

248,443

 

(6.3)%

 

 

Other-retail/municipal

 

35,559

 

38,824

 

(8.4)%

 

395,662

 

422,188

 

(6.3)%

 

 

    Total retail

 

403,041

 

415,053

 

(2.9)%

 

3,323,438

 

3,288,623

 

1.1 %

 

 

Sales to the market

 

6,135

 

2,154

 

N/A%

 

183,195

 

68,886

 

N/A%

 

 

Return of fuel savings

 

(423)

 

-

 

-%

 

-

 

-

 

-%

 

 

Adjustments to revenues

 

253

 

(4,679)

 

(105.4)%

 

-

 

-

 

-%

 

 

    Total

$

409,006

$

412,528

 

(0.9)%

 

3,506,633

 

3,357,509

 

4.4 %

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cooling degree days (normal 647)

 

 

 

 

 

 

 

780

 

666

 

17.1 %

 




30




Electric operating revenues decreased $3.5 million or 0.9% during 2016, due to the following:


 

(In millions)

 

 

 

 

Deferral of fuel savings/fuel credit

$

(21.5)

 

 

Volume

 

6.7

 

 

Adjustments to revenues

 

4.9

 

 

Sales to the market

 

4.0

 

 

Other

 

2.4

 

 

Total

$

(3.5)

 


In July 2015, the PSCW authorized MGE to freeze 2016 rates at 2015 levels for retail electric customers.


·

Deferral of fuel savings/fuel credit. During 2016, customers received a fuel credit on their bill related to the fuel savings of $21.1 million, which decreased electric revenues when compared to 2015. This amount was partially offset by the 2016 deferred fuel rules monitored costs. In January 2016, the PSCW lowered MGE's 2016 fuel rules monitored costs as a result of continued lower projected fuel costs in 2016.


·

Volume. During 2016, there was a 5.4% increase in total residential sales volumes compared to the same period in the prior year driven by increased customer demand due, at least in part, to more favorable weather conditions, as evidenced by the higher number of cooling degree days.


·

Adjustments to Revenue. The adjustments to revenues amount includes the elimination of carrying costs for the Elm Road Units and the WCCF that were collected in electric rates ending in 2015, which were recognized as operating revenues in our Nonregulated Energy Operations segment.


MGE leases electric generating capacity from MGE Power Elm Road. MGE collects in rates the lease payments associated with the electric generating capacity as authorized by the PSCW. Any differential between estimated lease payments collected in rates and actual lease payments paid to MGE Power Elm Road are included in adjustments to revenues.


·

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. 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 2016, market volumes increased compared to the same period in the prior year, reflecting increased opportunities for sales, and those sales were made at higher market prices. The revenue generated from these sales is included in fuel rules monitored costs. See fuel rules discussion in Footnote 16.b. of the Notes to Consolidated Financial Statements.


·

Other. During 2016, other items affecting electric operating revenues increased $2.4 million. MGE experienced an increase in residential and small commercial customers contributing to the increase in other electric revenue. Higher monthly on-peak sales also attributed to the increase.


Electric fuel and purchased power


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


Fuel for electric generation

The expense for fuel for internal electric generation increased $6.9 million during 2016 compared to 2015 due to the following:


 

(In millions)

 

 

 

 

Increase in volume

$

10.5

 

 

Decrease in per-unit cost

 

(3.6)

 

 

Total

$

6.9

 




31




This increase in expense reflects a 21.0% increase in internal generation volume delivered to the system primarily as a result of increased generation at WCCF based on market prices, partially offset by a 6.8% decrease in per-unit cost of internal electric generation, reflective of lower natural gas prices.


Purchased power

Purchased power expense decreased $24.9 million during 2016 compared to 2015 due to the following:


 

(In millions)

 

 

 

 

Decrease in volume

$

(15.2)

 

 

Increase in per-unit cost

 

3.0

 

 

Change in fuel rule adjustments, net of recoveries

 

(12.7)

 

 

Total

$

(24.9)

 


The decrease in expense (before fuel rules adjustments) reflects a 21.1% decrease in the volume of power purchased from third parties primarily as a result of the increased internal generation, partially offset by a 5.2% increase in the per-unit cost of purchased power.


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.


Electric operating and maintenance expenses


Electric operating and maintenance expenses increased $2.5 million during 2016 compared to 2015. The following changes contributed to the net change:


 

(In millions)

 

 

 

 

Increased customer accounts costs

$

0.9

 

 

Increased production costs

 

0.7

 

 

Increased distribution costs

 

0.5

 

 

Increased other costs

 

0.4

 

 

Total

$

2.5

 


For 2016, increased customer accounts costs are primarily related to higher customer billing expenses.


Electric depreciation expense


Electric depreciation expense decreased $0.8 million for 2016, compared to the prior year. A new depreciation study approved by the PSCW, effective January 1, 2016, resulted in a decrease in expense.


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 years indicated:


 

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

 

Revenues

 

Therms Delivered

 

 

 

2016

 

2015

 

% Change

 

2016

 

2015

 

% Change

 

 

Residential

$

81,014

$

85,438

 

(5.2)%

 

91,791

 

92,970

 

(1.3)%

 

 

Commercial/Industrial

 

48,497

 

53,161

 

(8.8)%

 

86,641

 

88,489

 

(2.1)%

 

 

    Total retail

 

129,511

 

138,599

 

(6.6)%

 

178,432

 

181,459

 

(1.7)%

 

 

Gas transportation

 

4,635

 

4,652

 

(0.4)%

 

72,922

 

75,572

 

(3.5)%

 

 

Other revenues

 

397

 

486

 

(18.3)%

 

-

 

-

 

-%

 

 

    Total

$

134,543

$

143,737

 

(6.4)%

 

251,354

 

257,031

 

(2.2)%

 

 

Heating degree days (normal 7,083)

 

 

 

 

 

 

 

6,417

 

6,395

 

0.3 %

 

 

Average rate per therm of retail customer

$

0.726

$

0.764

 

(5.0)%

 

 

 

 

 

 

 




32




Gas revenues decreased $9.2 million or 6.4% during 2016. These changes are related to the following factors:


 

(In millions)

 

 

 

 

Rate/PGA changes

$

(5.6)

 

 

Volume

 

(3.5)

 

 

Transportation and other effects

 

(0.1)

 

 

Total

$

(9.2)

 


·

Rate/PGA changes. 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. Changes in PGA recoveries affect revenues but do not impact net income.


The average retail rate per therm for 2016, decreased 5.0% compared to 2015, reflecting a $6.3 million decrease in natural gas commodity costs (recovered through the PGA), partially offset by an increase in fixed rate charges.


Volume. For 2016, retail gas deliveries decreased 1.7% compared to the prior year.


Cost of gas sold


For 2016, cost of gas sold decreased by $9.3 million, compared to the prior year. The cost per therm of natural gas decreased 10.3%, which resulted in $7.6 million of decreased expense. The volume of gas purchased decreased 2.2%, which resulted in $1.7 million of decreased expense.


Gas operating and maintenance expenses


Gas operating and maintenance expenses increased $1.0 million for 2016 compared to 2015. The following changes contributed to the net change.


 

(In millions)

 

 

 

 

Increased customer accounts costs

$

0.8

 

 

Increased administrative and general costs

 

0.5

 

 

Decreased distribution costs

 

(0.3)

 

 

Total

$

1.0

 


For 2016, increased customer accounts costs are due to higher customer billing expenses.


Gas depreciation expense


Gas depreciation expense increased $1.4 million for 2016, compared to the prior year. This increase is primarily driven by an increase in gas utility plant in-service in 2016 and a new depreciation study approved by the PSCW, effective January 1, 2016.


Nonregulated Energy Operations - MGE Energy and MGE


For 2016 and 2015, net income at the nonregulated energy operations segment was $19.1 million and $20.1 million, respectively. The nonregulated energy operations are conducted through MGE Energy's subsidiaries: MGE Power Elm Road (the Elm Road Units) and MGE Power West Campus (WCCF), which have been formed to own and lease electric generating capacity to assist MGE. Carrying costs incurred during construction of the Elm Road Units and WCCF were recognized by MGE Power Elm Road and MGE Power West Campus over the period allowed for recovery in rates. The recovery period ended in 2015, contributing to a reduction in nonregulated earnings in 2016. The reduction in earnings was partially offset by an increase in lease revenue.


Transmission Investment Operations - MGE Energy and MGE


Transmission investment other income


For 2016 and 2015, other income at the transmission investment segment was $8.4 million and $7.7 million, respectively. The transmission investment segment holds our interest in ATC and ATC Holdco, and its income reflects our equity in the earnings of ATC. ATC Holdco was formed in 2016. In the near term, it is expected that ATC Holdco will be pursuing transmission development opportunities that typically have long development and



33




investment lead times before becoming operational. See Footnote 4.b. of the Notes to Consolidated Financial Statements and "Other Matters" below for additional information concerning the transmission investments and summarized financial information regarding ATC.


Consolidated Income Taxes - MGE Energy and MGE


MGE Energy's effective income tax rate for 2016 and 2015 was 36.0% and 36.7%, respectively. MGE's effective income tax rate for 2016 and 2015 was 35.9% and 36.7%, respectively. The decrease in the effective tax rate is due in part to a combination of individually insignificant fluctuations. See Footnote 12 of the Notes to Consolidated Financial Statements for details of effective income tax rates for continuing operations.


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 with respect to MGE 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 statements of income:


 

 

 

Year Ended December 31,

 

 

(In millions)

 

2016

 

2015

 

 

MGE Power Elm Road

$

14.8

$

16.6

 

 

MGE Power West Campus

$

7.2

$

7.3

 

 

MGE Transco(a)

$

1.4

$

2.2

 


(a)

MGE Transco holds an ownership interest in ATC. In July 2016, MGE's ownership interest in MGE Transco declined below a majority, resulting in MGE Energy's investment in MGE Transco being deconsolidated from MGE's consolidated financial statements. See Footnote 8 of the Notes to Consolidated Financial Statements for further discussion of noncontrolling interest. In December 2016, MGE's ownership interest in MGE Transco was transferred to MGE Energy, see Footnote 4 of the Notes to Consolidated Financial Statements for additional information.


Results of Operations


Year Ended December 31, 2015, Versus the Year Ended December 31, 2014


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 years indicated:


 

 

 

Revenues

 

Sales (kWh)

 

 

(In thousands, except cooling degree days)

 

2015

 

2014

 

% Change

 

2015

 

2014

 

% Change

 

 

Residential

$

135,201

$

132,359

 

2.1 %

 

786,741

 

807,265

 

(2.5)%

 

 

Commercial

 

220,745

 

210,141

 

5.0 %

 

1,831,251

 

1,834,473

 

(0.2)%

 

 

Industrial

 

20,283

 

19,163

 

5.8 %

 

248,443

 

246,267

 

0.9 %

 

 

Other-retail/municipal

 

38,824

 

36,281

 

7.0 %

 

422,188

 

409,737

 

3.0 %

 

 

    Total retail

 

415,053

 

397,944

 

4.3 %

 

3,288,623

 

3,297,742

 

(0.3)%

 

 

Sales to the market

 

2,154

 

2,547

 

(15.4)%

 

68,886

 

68,727

 

0.2 %

 

 

Other revenues

 

1,705

 

1,489

 

14.5 %

 

-

 

-

 

-%

 

 

Adjustments to revenues

 

(6,384)

 

(7,131)

 

10.5 %

 

-

 

-

 

-%

 

 

    Total

$

412,528

$

394,849

 

4.5 %

 

3,357,509

 

3,366,469

 

(0.3)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cooling degree days (normal 665)

 

 

 

 

 

 

 

666

 

620

 

7.4 %

 




34




Electric operating revenues increased $17.7 million or 4.5% during 2015 compared to 2014 due to the following:


 

(In millions)

 

 

 

 

Rate changes

$

14.4

 

 

Fuel credit

 

3.9

 

 

Adjustments to revenues

 

0.8

 

 

Other revenues

 

0.4

 

 

Volume

 

(1.4)

 

 

Sales to the market

 

(0.4)

 

 

Total

$

17.7

 


·

Rate changes. Rates charged to retail customers for 2015 were $14.4 million or 3.6% higher than those charged during 2014.


In December 2014, the PSCW authorized MGE to increase 2015 rates for retail electric customers by $15.4 million or 3.8%.


·

Fuel Credit. During 2015 and 2014, customers received a fuel credit on their bill related to the fuel savings of $2.6 million and $6.5 million, respectively, which increased electric revenues when compared to 2014.


·

Adjustments to Revenue. The adjustments to revenues amount includes the elimination of carrying costs for the Elm Road Units and the WCCF that were collected in electric rates, which are recognized as nonregulated energy operating revenues in our Nonregulated Energy Operations segment.


·

Volume. During 2015, there was a 0.3% decrease in total retail sales volumes compared to 2014 primarily driven by lower use per residential customer.


·

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. 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 2015, market volumes increased compared to 2014, reflecting increased opportunities for sales. In addition, market settlement resulted in lower revenue per kWh for 2015, reflecting lower market prices. The revenue generated from these sales is included in fuel rules monitored costs. See fuel rules discussion in Footnote 16.b. of the Notes to Consolidated Financial Statements.


Electric fuel and purchased power


Electric fuel and purchased power costs reflect an increase in internal generation volumes during 2015 partially offset by a decrease in the volume of purchased power when compared to 2014. Adjustments related to the regulatory recovery for fuel costs, known as fuel rules, increased purchased power expense. These items are explained below.


Fuel for electric generation

The expense for fuel for internal electric generation increased $11.0 million during 2015 compared to 2014 due to the following:


 

(In millions)

 

 

 

 

Increase in per-unit cost

$

5.8

 

 

Increase in volume

 

5.2

 

 

Total

$

11.0

 


This increase in expense reflects a 13.6% increase in per-unit cost of internal electric generation primarily at Columbia and a 10.7% increase in internal generated volume delivered to the system.




35




Purchased power

Purchased power expense increased $8.0 million during 2015 compared to 2014 due to the following:


 

(In millions)

 

 

 

 

Decrease in volume

$

(11.0)

 

 

Decrease in per-unit cost

 

(2.8)

 

 

Change in fuel rule adjustments, net of recoveries

 

21.8

 

 

Total

$

8.0

 


The decrease in expense (before fuel rules adjustments) reflects a 3.8% decrease in the per-unit cost of purchased power and a 12.8% decrease in the volume of power purchased from third parties primarily as a result of increased internal generation.


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.


Electric operating and maintenance expenses


Electric operating and maintenance expenses increased $4.0 million during 2015 compared to 2014. The following changes contributed to the net change:


 

(In millions)

 

 

 

 

Increased transmission costs

$

3.3

 

 

Increased administrative and general costs

 

1.6

 

 

Increased customer service costs

 

0.5

 

 

Increased production costs

 

0.1

 

 

Decreased customer accounts costs

 

(1.5)

 

 

Total

$

4.0

 


For 2015, increased transmission costs are primarily related to an increase in transmission reliability enhancements. In addition, increased administrative and general costs are primarily due to increased pension and other postretirement benefits costs predominantly driven by a reduction in the discount rate, which has the effect of increasing the related costs. Decreased customer account costs are primarily related to lower uncollectible accounts receivable.


Electric depreciation expense


Electric depreciation expense increased $3.0 million for 2015 compared to 2014. This increase is primarily related to the completion of the Columbia environmental project. The systems and equipment for Unit 2 and Unit 1 were placed into service in April 2014 and July 2014, respectively.


Other Electric Income


Other electric income decreased $2.4 million, primarily due to AFUDC equity related to the completion of the Columbia environmental project. Unit 2 and Unit 1 were placed into service in April and July 2014, respectively.




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 years indicated:


 

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

 

Revenues

 

Therms Delivered

 

 

 

2015

 

2014

 

% Change

 

2015

 

2014

 

% Change

 

 

Residential

$

85,438

$

117,523

 

(27.3)%

 

92,970

 

110,422

 

(15.8)%

 

 

Commercial/Industrial

 

53,161

 

100,338

 

(47.0)%

 

88,489

 

138,151

 

(35.9)%

 

 

    Total retail

 

138,599

 

217,861

 

(36.4)%

 

181,459

 

248,573

 

(27.0)%

 

 

Gas transportation

 

4,652

 

3,373

 

37.9 %

 

75,572

 

46,905

 

61.1 %

 

 

Other revenues

 

486

 

486

 

-%

 

-

 

-

 

-%

 

 

    Total

$

143,737

$

221,720

 

(35.2)%

 

257,031

 

295,478

 

(13.0)%

 

 

Heating degree days (normal 7,080)

 

 

 

 

 

 

 

6,395

 

7,887

 

(18.9)%

 

 

Average rate per therm of retail customer

$

0.764

$

0.876

 

(12.8)%

 

 

 

 

 

 

 


Gas revenues decreased $78.0 million or 35.2% for 2015 compared to 2014. These changes are related to the following factors:


 

(In millions)

 

 

 

 

Volume

$

(58.8)

 

 

Rate/PGA changes

 

(20.5)

 

 

Transportation and other effects

 

1.3

 

 

Total

$

(78.0)

 


Volume. For 2015, retail gas deliveries decreased 27.0% compared to 2014, as a result of extremely cold weather experienced in the first quarter of 2014. The decrease was also attributable to a large commercial customer's decision to purchase gas from a third party supplier and to use MGE's facilities for the transport of that gas. While the shift affects revenues, the impact to gas income of this shift is not material as we do not earn margin on the natural gas commodity cost billed to customers.


·

Rate/PGA changes. In December 2014, the PSCW approved changes to customer rates and rate design for gas service. Rates were reduced by 2.0%, effective January 1, 2015. Gas rate design consists of a fixed monthly customer charge and a variable charge tied to actual usage, in addition to the separate charge for natural gas commodity costs that is recovered through the PGA. The change shifted more of the rate recovery to the monthly charge, reflecting the related fixed costs of providing gas services, and reduced the variable usage-based charge. Thus, gas net income was more evenly distributed during the year and less sensitive to weather.


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. Changes in PGA recoveries affect revenues but do not impact net income.


The average retail rate per therm for 2015 decreased 12.8% compared to 2014, reflecting a $28.7 million decrease in natural gas commodity costs (PGA) offset by an $8.2 million increase (comprised of a decrease in variable rate costs offset by an increase in fixed rate charges) related to rate design changes. As noted previously, as a result of the rate design changes, revenues in the first and fourth quarters, when usage is higher, were lower than in past years; and revenues in the second and third quarters, when usage is lower, were higher than in past years.


·

Transportation and other effects. During 2015, transportation and other effects increased $1.3 million primarily attributable to a large commercial customer's decision to purchase gas from a third party supplier and to use MGE's facilities for the transport of that gas. The impact to gas income of this shift is not material.




37




Cost of gas sold


For 2015, cost of gas sold decreased by $67.5 million compared to 2014. The volume of gas purchased decreased 26.8%, which resulted in $38.5 million of decreased expense. The cost per therm of natural gas decreased 27.6%, which resulted in $29.0 million of decreased expense.


Gas operating and maintenance expenses


Gas operating and maintenance expenses decreased $1.2 million for 2015 compared to 2014. The following changes contributed to the net change.


 

(In millions)

 

 

 

 

Decreased customer service costs

$

(1.0)

 

 

Decreased customer accounts costs

 

(0.9)

 

 

Increased administrative and general costs

 

0.7

 

 

Total

$

(1.2)

 


For 2015, decreased customer service costs are due to lower Focus on Energy payments, Wisconsin's statewide energy efficiency and renewable resource program to promote energy efficiency on customer's premises. Decreased customer accounts costs are due to lower uncollectible accounts receivable. Increased administrative and general costs are primarily due to increased pension and other postretirement benefit costs predominantly driven by a reduction in the discount rate.


Nonregulated Energy Operations - MGE Energy and MGE


For 2015 and 2014, net income at the nonregulated energy operations segment was $20.1 million and $19.3 million, respectively. The nonregulated energy operations are conducted through MGE Energy's subsidiaries: MGE Power Elm Road (the Elm Road Units) and MGE Power West Campus (WCCF), which have been formed to own and lease electric generating capacity to assist MGE.


Transmission Investment Operations - MGE Energy and MGE


Transmission investment other income


For 2015 and 2014, other income at the transmission investment segment was $7.7 million and $9.2 million, respectively. The transmission investment segment holds our interest in ATC, and its income reflects our equity in the earnings of ATC. See Footnote 4.b. of the Notes to Consolidated Financial Statements and "Other Matters" below for additional information concerning ATC and summarized financial information regarding ATC.


All Other Operations - MGE Energy and MGE


Other income


The increase in all other income primarily results from a decrease in voluntary contributions.


Consolidated Income Taxes - MGE Energy and MGE


Both MGE Energy's and MGE's effective income tax rate for 2015 and 2014, was 36.7% and 37.5%, respectively. The decrease in the effective tax rate is due in part to a higher estimated domestic manufacturing deduction, offset by lower AFUDC equity earnings in 2015. See Footnote 12 of the Notes to Consolidated Financial Statements for details of effective income tax rates for continuing operations.


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 with respect to MGE 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



38




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 statements of income:


 

 

 

Year Ended December 31,

 

 

(In millions)

 

2015

 

2014

 

 

MGE Power Elm Road

$

16.6

$

16.2

 

 

MGE Power West Campus

$

7.3

$

7.7

 

 

MGE Transco

$

2.2

$

2.4

 


Liquidity and Capital Resources


MGE Energy and MGE have adequate liquidity to fund operations and capital expenditures over the next twelve months. Available resources include cash and cash equivalents, operating cash flows, liquid assets, borrowing capacity under revolving credit facilities, and access to equity and debt capital markets.


Cash Flows


The following summarizes cash flows for MGE Energy and MGE during 2016, 2015, and 2014:


 

 

 

MGE Energy

 

MGE

 

 

(In thousands)

 

2016

 

2015

 

2014

 

 

2016

 

2015

 

2014

 

 

Cash provided by/(used for):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Operating activities

$

147,513

$

141,185

$

128,762

 

$

146,501

$

148,460

$

128,538

 

 

    Investing activities

 

(86,826)

 

(73,313)

 

(96,158)

 

 

(85,648)

 

(72,920)

 

(95,597)

 

 

    Financing activities

 

(46,112)

 

(52,243)

 

(35,662)

 

 

(76,845)

 

(53,342)

 

(43,187)

 


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.


2016 vs. 2015


Cash provided by operating activities for 2016 was $147.5 million, an increase of $6.3 million when compared to the prior year.


MGE Energy's net income increased $4.2 million for 2016 when compared to the prior year.


In both 2016 and 2015, MGE received a $10.0 million refund from the IRS for the 2015 and 2014 tax years, respectively. Excluding the 2016 and 2015 refund, MGE Energy's federal and state taxes paid decreased $1.8 million during 2016, when compared to the prior year.


Working capital accounts (excluding prepaid and accrued taxes) resulted in $5.2 million in cash provided by operating activities for 2016, primarily due to increased accounts payable, decreased inventories, and decreased receivable margin, partially offset by increased unbilled revenues, increased receivables, and decreased current liabilities. The decrease in current liabilities includes a fuel credit, approved in August 2015, of $8.3 million that customers received on their bill throughout 2016 and a one-time fuel credit, approved in July 2016, of $15.5 million that customers received on their bill in September 2016.


Working capital accounts (excluding prepaid and accrued taxes) resulted in $5.0 million in cash provided by operating activities for 2015, primarily due to decreased receivables and decreased unbilled revenues, partially offset by increased inventories, decreased accounts payable, and decreased current liabilities. The decrease in current liabilities includes a fuel credit of $2.6 million that customers received on their bill in the period September through December 2015 related to the 2015 fuel savings and $11.4 million of deferred fuel related cost savings to be returned to customers.




39




2015 vs. 2014


Cash provided by operating activities for 2015 was $141.2 million, an increase of $12.4 million when compared to 2014.


MGE Energy's net income decreased $9.0 million for 2015 when compared to 2014.


In 2015, MGE received a $10.0 million refund from the IRS for the 2014 tax year. Excluding the 2015 refund, MGE Energy's federal and state taxes paid increased $4.7 million during 2015 when compared to 2014. In December 2014, bonus depreciation was extended for 2014. Tax payments were made earlier in 2014 before the additional depreciation deduction was known.


Working capital accounts (excluding prepaid and accrued taxes) resulted in $5.0 million in cash provided by operating activities for 2015, primarily due to decreased receivables and decreased unbilled revenues, partially offset by increased inventories, decreased accounts payable, and decreased current liabilities. The decrease in current liabilities includes a fuel credit of $2.6 million that customers received on their bill in the period September through December 2015 related to the 2015 fuel savings and $11.4 million of deferred fuel related cost savings to be returned to customers.


Working capital accounts (excluding prepaid and accrued taxes) resulted in $14.8 million in cash used for operating activities for 2014, primarily due to increased gas inventories, increased other current assets, and decreased current liabilities, partially offset by increased accounts payable. The decrease in current liabilities includes a fuel credit of $6.5 million that customers received on their bill in October 2014 related to the 2013 fuel savings.


An increase in pension contribution resulted in an additional $10.4 million in cash used for operating activities for 2015 when compared to 2014. Pension contributions reflect amounts required by law and discretionary amounts. See Footnote 13 of the Notes to Consolidated Financial Statements for further discussion of MGE Energy's pension and other postretirement benefits.


MGE


2016 vs. 2015


Cash provided by operating activities for 2016 was $146.5 million, a decrease of $2.0 million when compared to the prior year.


Net income increased $3.1 million for 2016, when compared to the prior year.


In both 2016 and 2015, MGE received a $10.0 million refund from the IRS for the 2015 and 2014 tax years, respectively. Excluding the 2016 and 2015 refund, MGE's federal and state taxes paid to MGE Energy increased $4.2 million during 2016, when compared to the prior year.


Working capital accounts (excluding prepaid and accrued taxes) resulted in $7.4 million in cash provided by operating activities for 2016, primarily due to increased accounts payable, decreased inventories, and decreased receivable margin, partially offset by increased receivables, increased unbilled revenues, and decreased current liabilities. The decrease in current liabilities includes a fuel credit, that was approved in August 2015, of $8.3 million that customers received on their bill throughout 2016 and $15.5 million of deferred fuel related cost savings to be returned to customers.


Working capital accounts (excluding prepaid and accrued taxes) resulted in $14.0 million in cash provided by operating activities for 2015, primarily due to decreased receivables and decreased unbilled revenues, partially offset by increased gas inventories, decreased accounts payable, and decreased other current liabilities. The decrease in current liabilities includes a fuel credit of $2.6 million that customers received on their bill in the period September through December 2015 related to the 2015 fuel savings and $11.4 million of deferred fuel related cost savings to be returned to customers.


2015 vs. 2014


Cash provided by operating activities for 2015 was $148.5 million, an increase of $19.9 million when compared to 2014.




40




Net income decreased $10.5 million for 2015 when compared to 2014.


In 2015, MGE received a $10.0 million refund from the IRS for the 2014 tax year. Excluding the 2015 refund, MGE's federal and state taxes paid to MGE Energy decreased $3.3 million during 2015, when compared to the prior year. In December 2014, bonus depreciation was extended for 2014. Tax payments were made earlier in 2014 before the additional depreciation deduction was known.


Working capital accounts (excluding prepaid and accrued taxes) resulted in $14.0 million in cash provided by operating activities for 2015, primarily due to decreased receivables and decreased unbilled revenues, partially offset by increased gas inventories, decreased accounts payable, and decreased other current liabilities. The decrease in current liabilities includes a fuel credit of $2.6 million that customers received on their bill in the period September through December 2015 related to the 2015 fuel savings and $11.4 million of deferred fuel related cost savings to be returned to customers.


Working capital accounts (excluding prepaid and accrued taxes) resulted in $20.9 million in cash used for operating activities for 2014, primarily due to increased gas inventories, increased receivables, and decreased current liabilities, partially offset by increased accounts payable. The decrease in current liabilities includes a fuel credit of $6.5 million that customers received on their bill in October 2014 related to the 2013 fuel savings.


An increase in pension contribution resulted in an additional $10.4 million in cash used for operating activities for 2015 when compared to 2014. These contributions reflect amounts required by law and discretionary amounts. See Footnote 13 of the Notes to Consolidated Financial Statements for further discussion of MGE's pension and other postretirement benefits.


Capital Requirements and Investing Activities


MGE Energy


2016 vs. 2015


MGE Energy's cash used for investing activities increased $13.5 million for 2016 when compared to the prior year.


Capital expenditures for 2016 were $83.7 million. This amount represents an increase of $11.6 million from the expenditures made in the prior year. This increase primarily reflects increased expenditures on electric and gas distribution assets.


There was a $1.9 million increase in the capital contributions to investments for 2016 when compared to the prior year.


2015 vs. 2014


MGE Energy's cash used for investing activities decreased $22.8 million for 2015 when compared to 2014.


Capital expenditures for 2015 were $72.0 million. This amount represents a decrease of $20.6 million from the expenditures made in 2014. The decrease primarily reflects $16.2 million of lower expenditures on the Columbia environmental project in 2015 versus 2014 and decreased expenditures in electric and gas distribution assets.


MGE


2016 vs. 2015


MGE's cash used for investing activities increased $12.7 million for 2016 when compared to the prior year.


Capital expenditures for 2016 were $83.7 million. This amount represents an increase of $11.6 million from the expenditures made in the prior year. This increase primarily reflects increased expenditures on electric and gas distribution assets.


There was a $0.9 million increase in the capital contributions to investments for 2016 when compared to the prior year.




41




2015 vs. 2014


MGE's cash used for investing activities decreased $22.7 million for 2015 when compared to 2014.


Capital expenditures for 2015 were $72.0 million. This amount represents a decrease of $20.6 million from the expenditures made in 2014. The decrease primarily reflects $16.2 million of lower expenditures on the Columbia environmental project in 2015 versus 2014 and decreased expenditures in electric and gas distribution assets.


Capital expenditures


The following table shows MGE Energy's actual capital expenditures for both 2016 and 2015, forecasted capital expenditures for 2017, and annual average forecasted capital expenditures for the years 2018 through 2020:


 

 

 

Actual

 

Forecasted

 

 

(In thousands)

 

 

 

 

 

 

 

(Annual Average)

 

 

For the years ended December 31,

2015

 

2016

2017

2018-2020

 

 

Electric

$

49,370

$

50,699

$

72,603

$

78,768

 

 

Gas

 

18,787

 

29,136

 

34,197

 

35,475

 

 

    Utility plant total

 

68,157

 

79,835

 

106,800

 

114,243

 

 

Nonregulated

 

3,873

 

3,824

 

7,362

 

4,959

 

 

    MGE Energy total

$

72,030

$

83,659

$

114,162

$

119,202

 


The forecasted capital expenditures are based upon management's assumptions with respect to future events, including the timing and amount of expenditures associated with compliance with environmental compliance initiatives, load growth, and the timing and adequacy of rate recovery. Actual events may differ materially from those assumptions and result in material changes to those forecasted amounts.


MGE Energy used funds received as dividend payments from MGE Power West Campus and MGE Power Elm Road, internally generated cash, and short-term external financing to meet its 2016 capital requirements and cash obligations, including dividend payments. External financing included short-term financing under existing lines of credit.


Financing Activities


MGE Energy


2016 vs. 2015


Cash used for MGE Energy's financing activities was $46.1 million for 2016, compared to $52.2 million of cash used for 2015.


For 2016, cash dividends paid were $41.8 million compared to $40.0 million in the prior year. This increase was a result of a higher dividend per share ($1.21 vs. $1.16).


For 2015, net short-term debt repayments were $7.0 million. There were no short-term debt repayments for 2016.


2015 vs. 2014


Cash used for MGE Energy's financing activities was $52.2 million for 2015, compared to $35.7 million of cash used for 2014.


For 2015, cash dividends paid were $40.0 million compared to $38.4 million in 2014. This increase was a result of a higher dividend per share ($1.16 vs. $1.11).


For 2015, net short-term debt repayments were $7.0 million. There were no short-term debt repayments for 2014.




42




MGE


2016 vs. 2015


During 2016, cash used for MGE's financing activities was $76.8 million, compared to $53.3 million of cash used for MGE's financing activities in the prior year.


Cash dividends paid from MGE to MGE Energy were $50.0 million for 2016, compared to $30.0 million in the prior year.


Distributions to parent from noncontrolling interest, which represent distributions from MGE Power Elm Road and MGE Power West Campus, were $24.1 million for 2016, compared to $14.7 million in the prior year.


For 2015, net short-term debt repayments were $7.0 million. There were no short-term debt repayments for 2016.


2015 vs. 2014


During 2015, cash used for MGE's financing activities was $53.3 million, compared to $43.2 million of cash used for MGE's financing activities in 2014.


Cash dividends paid from MGE to MGE Energy were $30.0 million for 2015, compared to $26.5 million in 2014.


Distributions to parent from noncontrolling interest, which represent distributions from MGE Power Elm Road and MGE Power West Campus, were $14.7 million for 2015, compared to $21.4 million in 2014.


For 2015, net short-term debt repayments were $7.0 million. There were no short-term debt repayments for 2014.


Dividend Restrictions


Dividend payments by MGE to MGE Energy are subject to restrictions arising under a PSCW rate order and, to a lesser degree, MGE's first mortgage bonds. The PSCW order restricts any dividends, above the PSCW authorized amount of $43 million, that MGE may pay MGE Energy if its common equity ratio, calculated in the manner used in the rate proceeding, is less than 55%. MGE's thirteen month rolling average common equity ratio at December 31, 2016, is 60.2%, as determined under the calculation used in the rate proceeding. This restriction did not impact MGE's payment of dividends in 2016. Cash dividends of $50.0 million and $30.0 million were paid by MGE to MGE Energy in 2016 and 2015, respectively. In 2016, MGE also transferred its ownership interest in MGE Transco to MGE Energy in the form of a dividend in kind of $15.8 million. The rate proceeding calculation includes as indebtedness imputed amounts for MGE's outstanding purchase power capacity payments and other PSCW adjustments, but does not include the indebtedness associated with MGE Power Elm Road and MGE Power West Campus, which are consolidated into MGE's financial statements but are not direct obligations of MGE.


MGE has covenanted with the holders of its first mortgage bonds not to declare or pay any dividend or make any other distribution on or purchase any shares of its common stock unless, after giving effect thereto, the aggregate amount of all such dividends and distributions and all amounts applied to such purchases, after December 31, 1945, shall not exceed the earned surplus (retained earnings) accumulated subsequent to December 31, 1945. As of December 31, 2016, approximately $338.5 million was available for the payment of dividends under this covenant.


Credit Facilities


At December 31, 2016, MGE Energy and MGE had the following aggregate bank commitments and available capacity under their credit agreements:


Borrower

 

Aggregate Bank Commitments

 

Outstanding Commercial Paper

 

Outstanding Borrowings

 

Available Capacity

 

Expiration Date

 

 

(Dollars in millions)

 

 

MGE Energy

$

50.0

$

-

$

-

$

50.0

 

June 1, 2020

 

 

 

 

 

 

 

 

 

 

 

MGE

$

100.0

$

-

$

-

$

100.0

 

June 1, 2020




43




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


The agreements require the borrower to maintain a ratio of consolidated debt to consolidated total capitalization not to exceed a maximum of 65%. The ratio calculation excludes assets, liabilities, revenues, and expenses included in MGE's financial statements as a result of the consolidation of VIEs, such as MGE Power Elm Road and MGE Power West Campus. At December 31, 2016, the ratio of consolidated debt to consolidated total capitalization for each of MGE Energy and MGE, as calculated under the credit agreements' covenant, were 34.8% and 36.5%, respectively. See Footnote 10 of the Notes to Consolidated Financial Statements for additional information regarding the credit facilities.


Capitalization Ratios


MGE Energy's capitalization ratios were as follows:


 

 

MGE Energy

 

 

 

2016

 

2015

 

 

Common shareholders' equity

65.2 %

 

63.8 %

 

 

Long-term debt*

34.8 %

 

36.2 %

 

 

*Includes the current portion of long-term debt.

 


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.


Contractual Obligations and Commercial Commitments for MGE Energy and MGE


MGE Energy's and MGE's contractual obligations as of December 31, 2016, representing cash obligations that are considered to be firm commitments, are as follows:


 

 

 

 

Payment Due Within:

 

Due After

(In thousands)

 

Total

 

1 Year

 

2-3 Years

 

4-5 Years

 

5 Years

MGE Energy

 

 

 

 

 

 

 

 

 

 

Long-term debt(a)

$

391,242

$

4,358

$

29,005

$

24,430

$

333,449

Repurchase-to-maturity transactions - loans(b)

 

3,895

 

559

 

1,215

 

1,000

 

1,121

Interest expense(c)

 

258,164

 

17,659

 

33,052

 

30,803

 

176,650

Operating leases(d)

 

11,339

 

1,331

 

1,400

 

588

 

8,020

Purchase obligations(e)

 

444,792

 

122,846

 

142,872

 

89,512

 

89,562

Other obligations(f)

 

30,445

 

20,569

 

2,835

 

1,395

 

5,646

Total MGE Energy contractual obligations

$

1,139,877

$

167,322

$

210,379

$

147,728

$

614,448

 

 

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

 

 

Long-term debt(a)

$

391,242

$

4,358

$

29,005

$

24,430

$

333,449

Repurchase-to-maturity transactions - loans(b)

 

3,895

 

559

 

1,215

 

1,000

 

1,121

Interest expense(c)

 

258,164

 

17,659

 

33,052

 

30,803

 

176,650

Operating leases(d)

 

11,339

 

1,331

 

1,400

 

588

 

8,020

Purchase obligations(e)

 

444,792

 

122,846

 

142,872

 

89,512

 

89,562

Other obligations(f)

 

18,613

 

8,737

 

2,835

 

1,395

 

5,646

Total MGE contractual obligations

$

1,128,045

$

155,490

$

210,379

$

147,728

$

614,448




44




(a)

Long-term debt consisting of secured first mortgage bonds, unsecured medium-term notes, and Industrial Development Revenue Bonds issued by MGE, and private placement debt issued by MGE, MGE Power Elm Road, and MGE Power West Campus.


(b)

Chattel paper agreements. See Footnote 1.g. of the Notes to Consolidated Financial Statements.


(c)

Amount represents interest expense on long-term debt. See Footnote 9 of the Notes to Consolidated Financial Statements for further discussion of the long-term debt outstanding at December 31, 2016.


(d)

Operating leases. See Footnote 17.b. of the Notes to Consolidated Financial Statements.


(e)

Purchase obligations for MGE Energy and MGE consist primarily of the purchase of electricity and natural gas, electric transmission, natural gas storage capacity, natural gas pipeline transportation, and the purchase and transport of coal. See Footnote 17.a. of the Notes to Consolidated Financial Statements.


(f)

Other obligations are primarily related to investment commitments, easements, environmental projects, fuel credit, and uncertain tax positions.


The above amounts do not include any contributions for MGE's pension and postretirement plans. Voluntary contributions to the qualified plans for 2017 were $6.0 million, which were paid in January 2017. MGE does not expect to make contributions to the plans for 2018. The contributions for years after 2018 are not yet currently estimated. Due to uncertainties in the future economic performance of plan assets, discount rates, and other key assumptions, estimated contributions are subject to change. MGE may also elect to make additional discretionary contributions to the plans.


The above amounts do not include future capital calls by ATC and ATC Holdco. On January 31, 2017, MGE Transco made a $1.4 million capital contribution to ATC, and on January 10, 2017, MGEE Transco made a $0.2 million capital contribution to ATC Holdco. The amount and timing of future capital calls is uncertain and primarily dependent on the operations and expansion of ATC and ATC Holdco.


MGE Energy's and MGE's commercial commitments as of December 31, 2016, representing commitments triggered by future events and including financing arrangements to secure obligations of MGE Energy and MGE, are as follows:


 

 

 

 

 

Expiration Within:

 

Due After

 

 

(In thousands)

 

Total

 

1 Year

 

2-3 Years

 

4-5 Years

 

5 Years

 

 

MGE Energy

 

 

 

 

 

 

 

 

 

 

 

 

Available lines of credit(a)

$

150,000

$

-

$

-

$

150,000

$

-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

MGE

 

 

 

 

 

 

 

 

 

 

 

 

Available lines of credit(b)

$

100,000

$

-

$

-

$

100,000

$

-

 


(a)

Amount includes the facility discussed in (b) plus an additional line of credit. MGE Energy has available at any time a $50 million committed revolving credit agreement, expiring in June 2020. At December 31, 2016, MGE Energy had no borrowings outstanding under this credit facility.


(b)

Amount includes two committed revolving credit agreements totaling $100 million expiring in June 2020. These credit facilities are used to support commercial paper issuances. At December 31, 2016, MGE had no borrowings outstanding under these facilities, and MGE had no commercial paper outstanding.


Other Matters


ATC


In 2013, several parties filed the first complaint with the FERC seeking to reduce the base return on equity (ROE) used by MISO transmission owners, including ATC, "due to changes in the capital markets." The complaint alleged 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. At the time, MISO's base ROE was 12.38% and ATC's base ROE was 12.2%. In February 2015, a second complaint was filed for the period February 2015 through May 2015 with the FERC requesting a reduction in the base ROE used by MISO



45




transmission owners, including ATC, to 8.67%, with a refund effective date retroactive to the filing date of the complaint. In June 2016, an administrative law judge issued an initial decision for the second complaint that would reduce the transmission owner's base ROE to 9.7%. The initial decision will be reviewed by FERC. It is anticipated FERC will issue an order on this issue by mid-2017. On September 28, 2016, FERC issued an order on the first complaint, for the period November 2013 through February 2015, reducing the base ROE to 10.32%. This base ROE also became effective September 28, 2016, and will apply to future periods until FERC rules in the second complaint, at which time the base ROE ordered by FERC in the second complaint will prospectively become the authorized base ROE.


In January 2015, FERC accepted the transmission owner's request for a 50 basis-point incentive ROE adder for participating in MISO. The adder became effective January 6, 2015, subject to refund, and FERC accepted the transmission owner's request to defer collection of the adder pending the outcome of the first ROE complaint proceeding.


Any change to ATC's ROE could result in lower equity earnings and distributions from ATC in the future. Our share of ATC's earnings reflects a pre-tax charge of $1.9 million and $2.3 million for 2016 and 2015, respectively, recorded by ATC for this matter representing its estimate of its refund liability. We derived approximately 6.8% and 6.4% of our net income for 2016 and 2015, respectively, from our investment in ATC.


Critical Accounting Estimates - MGE Energy and MGE


The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to unbilled revenues, allowance for doubtful accounts, pension obligations, income taxes, derivatives, and regulatory assets and liabilities. We base our estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Those values may differ from these estimates under different assumptions or conditions. We believe the following critical accounting estimates affect our more significant judgments used in the preparation of our consolidated financial statements.


Unbilled Revenues


Revenues from the sale of electricity and gas to customers are recorded when electricity/gas is delivered to those customers. The quantity of those sales is measured by customers' meters. Due to the large volume of those meters, it is impractical to read all of them at month end. Meters are read on a systematic basis throughout the month based on established meter-reading schedules. Consequently, at the end of any month, there exists a quantity of electricity and gas that has been delivered to customers but has not been captured by the meter readings. As a result, management must estimate revenue related to electricity and gas delivered to customers between their meter-read dates and the end of the period. These estimates include:


·

The amount of electricity expected to be lost in the process of its transmission and distribution to customers (line loss) and the amount of electricity actually delivered to customers.


·

The amount of gas expected to be lost in the process of its distribution to customers and the amount of gas actually delivered to customers.


·

The mix of sales between customer rate classes, which is based upon historical utilization assumptions.


MGE monitors the reasonableness of the unbilled revenue estimate through the review of ratios such as unbilled electric consumption compared to billed electric sales. In the case of unbilled gas, the estimated unbilled consumption is compared to various other statistics, including percent of gas available for sale, change in unbilled month to month and change in unbilled compared to the prior year in order to confirm its reasonableness.


Allowance for Doubtful Accounts


MGE maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. It determines the allowance based on historical write-off experience, regional economic data, and review of the accounts receivable aging. MGE reviews its allowance for doubtful accounts monthly.



46




Although management believes that the allowance for doubtful accounts is MGE's best estimate of the amount of probable credit losses, if the financial condition of MGE's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.


Pension and Other Postretirement Benefit Plans


MGE provides employees with certain retirement (pension) and postretirement (health care and life insurance) benefits. In order to measure the expense and obligations associated with these benefits, management must make a variety of estimates, including discount rates used to value certain liabilities, the expected return on plan assets set aside to fund these costs, the rate of compensation increase, employee turnover rates, retirement rates, health care trends, mortality rates, and other factors. These accounting estimates bear the risk of change due to the uncertainty attached to the estimate as well as the fact that these estimates are difficult to measure. Different estimates used by us could result in recognizing different amounts of expense over different periods of time and recovery in rates is expected.


We use third-party specialists to assist us in evaluating our assumptions as well as appropriately measure the costs and obligations associated with these retirement benefits. The discount rate and expected return on plan assets are based primarily on available investment yields and the historical performance of our plan assets. They are critical accounting estimates because they are subject to management's judgment and can materially affect net income.


·

Assumed return on assets. This assumption represents the rate of return on plan assets reflecting the average rate of earnings expected on the funds invested (or to be invested) to provide for the benefits included in the projected benefit obligation. For 2016, MGE used an assumed return on assets of 7.65% for pension and 6.96% for other postretirement benefits. In 2017, the pension asset assumption will decrease from 7.65% to 7.40%. MGE will decrease the postretirement benefit assumption from 6.96% to 6.78% in 2017. The annual expected rate of return is based on projected long-term equity and bond returns, maturities and asset allocations. Holding other assumptions constant, for every 1% reduction in the expected rate of return on plan assets, annual pension and other postretirement cost would increase by approximately $3.3 million, before taxes.


·

Discount rate. The discount rate represents the rate at which pension obligations could effectively be settled on a present-value basis. MGE uses high-grade bond yields as a benchmark for determining the appropriate discount rate. At December 31, 2015, MGE refined its methodology for using discount rates to measure the components of net periodic benefit cost. The refined methodology uses individual spot rates, instead of a weighted average of the yield curve spot rates, for measuring the service cost and interest cost components. Holding other assumptions constant, a 0.5% reduction in the discount rate on the obligation balance at December 31, 2016, would increase annual pension and other postretirement cost by approximately $2.8 million, before taxes.


·

Medical trend assumptions. The health care cost trend rate is the assumed rate of increase in per-capita health care charges.


·

Mortality rate assumption. Expected mortality rates are used in the valuation to determine the expected duration of future benefit payments to the plan participants. In 2016, the Society of Actuaries released new mortality tables and projection scales. At December 31, 2016, the Company adopted a modified version of these tables that were developed by a third party actuary.


See Footnote 13 of the Notes to Consolidated Financial Statements for additional discussion of these plans.


Income Tax Provision


MGE Energy's and MGE's income tax provisions, including both current and deferred components, are based on estimates, assumptions, calculations, and interpretation of tax statutes for the current and future years. Determination of current-year federal and state income tax will not be settled for years.


Management regularly makes assessments of tax return outcomes relative to financial statement tax provisions and adjusts the tax provisions in the period when facts become final.


Additionally, in determining our current income tax provision, we assess temporary differences resulting from differing treatments of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are recorded in our balance sheets. When we maintain deferred tax assets, we assess the likelihood that these assets will be recovered through adjustments to future taxable income. To the extent we believe recovery



47




is not more likely than not, we establish a valuation allowance. We record an allowance reducing the asset to a value we believe will be recoverable based on our expectation of future taxable income. We believe the accounting estimate related to the valuation allowance is a critical accounting estimate because it is highly susceptible to change from period to period as it requires management to make assumptions about our future income over the lives of the deferred tax assets, and the impact of increasing or decreasing the valuation allowance is potentially material to our results of operations.


Accounting for uncertainty in income taxes applies to all tax positions and requires a recognition threshold and measurement standard for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in an income tax return. The threshold is defined for recognizing tax return positions in the financial statements as "more likely than not" that the position is sustainable, based on its merits. Subsequent recognition, derecognition, and measurement is based on management's best judgment given the facts, circumstances and information available at the reporting date.


Accounting for Derivative Instruments


MGE accounts for derivative financial instruments, except those qualifying for the normal purchase normal sale exception, at their fair value on the balance sheet. Fair value is determined using current quoted market prices, except for the PPA, which is valued utilizing an internally-developed pricing model. This model includes observable and unobservable inputs.


MGE received approval from the PSCW to establish a regulatory asset or liability for the deferral of the effects of mark-to-market accounting on contracts related to commodity hedging in MGE's regulated operations.


Regulatory Assets/Liabilities


Regulatory assets represent costs that have been deferred to future periods when it is probable that the regulator will allow future recovery of those costs through rates. MGE bases its assessment of recovery on precedents established by the regulatory body. Regulatory liabilities represent previous collections from customers that are expected to be refunded to customers in future periods. Regulatory assets and regulatory liabilities typically include deferral of energy costs, the normalization of income taxes, the deferral of certain operating expenses, and non-ARO removal costs. The accounting for these regulatory assets and liabilities is in accordance with regulatory accounting standards.


MGE continually assesses whether the regulatory assets and liabilities meet the criteria for probability of future recovery or deferral. This assessment considers factors such as changes in the regulatory environment, recent rate orders to other regulated entities under the same jurisdiction, and the status of any pending or potential deregulation legislation. If future recovery of costs becomes no longer probable, the assets and liabilities would be recognized as current-period revenues or expenses.


Amortization of regulatory assets and liabilities is provided over the recovery or deferral period as allowed in the related regulatory agreement.


Adoption of Accounting Principles and Recently Issued Accounting Pronouncements - MGE Energy and MGE


See Footnote 19 of the Notes to Consolidated Financial Statements for discussion of new accounting pronouncements.




48




Item 7A. 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 in a year is determined in the following year and is then reflected 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 2017, fuel and purchased power costs included in MGE's base fuel rates are $101.9 million. See Footnote 16 of the Notes to Consolidated Financial Statements for additional information.


MGE recovers the cost of natural gas in its gas utility 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 utility 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 December 31, 2016, the fair value of these instruments exceeded their cost basis by $1.3 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 sheets as a regulatory asset/liability.


MGE has also entered into a 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 December 31, 2016, reflects a loss position of $50.6 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.




49




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. Holding other assumptions constant, for every 1% reduction in the expected rate of return on plan assets, annual pension and other postretirement cost would increase by approximately $3.3 million, before taxes. MGE's risk of expense and annuity payments, as a result of changes in the market value of the trust funds, is mitigated in part through future rate actions by the PSCW. The value of employee benefit plans trusts' assets have increased in value by approximately 8.36% and 1.39% during the years ended December 31, 2016, and 2015, respectively.


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 December 31, 2016, 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 1,682 square miles in Wisconsin. Based on results for December 31, 2016, 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.




50





Item 8. Financial Statements and Supplementary Data.


MGE Energy


Management's Report on Internal Control Over Financial Reporting


Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an assessment of the effectiveness of our internal control over financial reporting based on the framework in the Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment under the framework in the Internal Control - Integrated Framework (2013), our management concluded that our internal control over financial reporting was effective as of December 31, 2016.


Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.


The effectiveness of MGE Energy's internal control over financial reporting as of December 31, 2016, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.


February 24, 2017


MGE


Management's Report on Internal Control Over Financial Reporting


Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an assessment of the effectiveness of our internal control over financial reporting based on the framework in the Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment under the framework in the Internal Control - Integrated Framework (2013), our management concluded that our internal control over financial reporting was effective as of December 31, 2016.


Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.


February 24, 2017




51





Report of Independent Registered Public Accounting Firm


To the Board of Directors and Shareholders of MGE Energy, Inc.:


In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of MGE Energy, Inc. and its subsidiaries at December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(a)(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.


A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.


Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.


/s/ PricewaterhouseCoopers LLP

Chicago, Illinois

February 24, 2017




52





Report of Independent Registered Public Accounting Firm


To the Board of Directors and Shareholder of Madison Gas and Electric Company:


In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Madison Gas and Electric Company and its subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.


/s/ PricewaterhouseCoopers LLP

Chicago, Illinois

February 24, 2017




53





MGE Energy, Inc.

 

Consolidated Statements of Income

 

(In thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

For the Years Ended December 31,

 

 

 

2016

 

2015

 

2014

 

Operating Revenues:

 

 

 

 

 

 

 

    Electric revenues

$

410,202

$

420,291

$

398,132

 

    Gas revenues

 

134,543

 

143,737

 

221,720

 

        Total Operating Revenues

 

544,745

 

564,028

 

619,852

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

    Fuel for electric generation

 

60,736

 

53,858

 

42,828

 

    Purchased power

 

56,313

 

81,224

 

73,232

 

    Cost of gas sold

 

66,771

 

76,109

 

143,644

 

    Other operations and maintenance

 

167,989

 

164,478

 

161,703

 

    Depreciation and amortization

 

44,646

 

44,225

 

40,695

 

    Other general taxes

 

20,062

 

19,879

 

19,652

 

        Total Operating Expenses

 

416,517

 

439,773

 

481,754

 

Operating Income

 

128,228

 

124,255

 

138,098

 

 

 

 

 

 

 

 

 

Other income, net

 

9,711

 

8,613

 

10,079

 

Interest expense, net

 

(19,866)

 

(20,162)

 

(19,673)

 

    Income before income taxes

 

118,073

 

112,706

 

128,504

 

Income tax provision

 

(42,513)

 

(41,363)

 

(48,185)

 

Net Income

$

75,560

$

71,343

$

80,319

 

 

 

 

 

 

 

 

 

Earnings Per Share of Common Stock

 

 

 

 

 

 

 

(basic and diluted)

$

2.18

$

2.06

$

2.32

 

 

 

 

 

 

 

 

 

Dividends per share of common stock

$

1.21

$

1.16

$

1.11

 

 

 

 

 

 

 

 

 

Weighted Average Shares Outstanding

 

 

 

 

 

 

 

 (basic and diluted)

 

34,668

 

34,668

 

34,668

 

 

 

 

 

 

 

 

 

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

 


MGE Energy, Inc.

Consolidated Statements of Comprehensive Income

(In thousands)

 

 

 

 

 

 

 

 

 

 

For the Years Ended December 31,

 

 

 

2016

 

2015

 

2014

 

Net Income

$

75,560

$

71,343

$

80,319

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

    Unrealized (loss) gain on available-for-sale securities, net of

 

 

 

 

 

 

 

    tax ($104, $67, and ($54))

 

(155)

 

(101)

 

81

 

Comprehensive Income

$

75,405

$

71,242

$

80,400

 

 

 

 

 

 

 

 

 

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

 




54





MGE Energy, Inc.

Consolidated Statements of Cash Flows

(In thousands)

 

 

For the Years Ended December 31,

 

 

2016

 

2015

 

2014

Operating Activities:

 

 

 

 

 

 

    Net income

$

75,560

$

71,343

$

80,319

    Items not affecting cash:

 

 

 

 

 

 

        Depreciation and amortization

 

44,646

 

44,225

 

40,695

        Deferred income taxes

 

22,421

 

21,927

 

49,884

        Provision for doubtful receivables

 

1,196

 

596

 

1,898

        Employee benefit plan expenses

 

295

 

3,333

 

(1,080)

        Equity earnings in ATC

 

(8,428)

 

(7,728)

 

(9,150)

        Other items

 

1,426

 

721

 

729

    Changes in working capital items:

 

 

 

 

 

 

        Trade and other receivables

 

(5,666)

 

4,508

 

2,115

        Inventories

 

7,273

 

(2,646)

 

(10,399)

        Unbilled revenues

 

(4,838)

 

6,254

 

720

        Prepaid taxes

 

8,616

 

3,658

 

(19,804)

        Other current assets

 

700

 

978

 

(5,693)

        Accounts payable

 

9,881

 

(3,499)

 

2,756

        Other current liabilities

 

(1,738)

 

(597)

 

(4,195)

    Dividend income from ATC

 

7,926

 

6,645

 

7,740

    Cash contributions to pension and other postretirement plans

 

(14,452)

 

(13,676)

 

(3,321)

    Other noncurrent items, net

 

2,695

 

5,143

 

(4,452)

            Cash Provided by Operating Activities

 

147,513

 

141,185

 

128,762

Investing Activities:

 

 

 

 

 

 

    Capital expenditures

 

(83,659)

 

(72,030)

 

(92,676)

    Capital contributions to investments

 

(2,958)

 

(1,053)

 

(2,185)

    Other

 

(209)

 

(230)

 

(1,297)

            Cash Used for Investing Activities

 

(86,826)

 

(73,313)

 

(96,158)

Financing Activities:

 

 

 

 

 

 

    Cash dividends paid on common stock

 

(41,775)

 

(40,043)

 

(38,429)

    Repayment of long-term debt

 

(4,267)

 

(4,182)

 

(4,103)

    (Decrease) increase in short-term debt

 

-

 

(7,000)

 

7,000

    Other

 

(70)

 

(1,018)

 

(130)

            Cash Used for Financing Activities

 

(46,112)

 

(52,243)

 

(35,662)

    Change in cash and cash equivalents:

 

14,575

 

15,629

 

(3,058)

    Cash and cash equivalents at beginning of period

 

81,384

 

65,755

 

68,813

    Cash and cash equivalents at end of period

$

95,959

$

81,384

$

65,755


 

 

 

 

 

 

Supplemental Disclosures of Cash Flow Information:

 

 

 

 

 

 

    Interest paid

$

19,415

$

19,636

$

20,478

    Income taxes paid

$

21,831

$

23,800

$

19,579

    Income taxes received

$

(10,000)

$

(10,130)

$

(644)

    Significant noncash investing activities:

 

 

 

 

 

 

        Accrued capital expenditures

$

16,376

$

3,963

$

1,569

 

 

 

 

 

 

 

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




55





MGE Energy, Inc.

Consolidated Balance Sheets

(In thousands)

 

 

At December 31,

ASSETS

 

2016

 

2015

Current Assets:

 

 

 

 

    Cash and cash equivalents

$

95,959

$

81,384

    Accounts receivable, less reserves of $3,017 and $3,052, respectively

 

39,887

 

37,112

    Other accounts receivable, less reserves of $426 and $642, respectively

 

8,530

 

7,477

    Unbilled revenues

 

29,846

 

25,008

    Materials and supplies, at average cost

 

18,561

 

19,155

    Fossil fuel, at average cost

 

9,757

 

13,110

    Stored natural gas, at average cost

 

12,819

 

16,145

    Prepaid taxes

 

26,636

 

35,252

    Regulatory assets - current

 

6,414

 

9,538

    Assets held for sale

 

14,813

 

-

    Other current assets

 

12,293

 

10,570

        Total Current Assets

 

275,515

 

254,751

Other long-term receivables

 

5,603

 

5,045

Regulatory assets

 

158,485

 

148,199

Pension and other postretirement benefit asset

 

2,020

 

-

Other deferred assets and other

 

1,088

 

1,332

Property, Plant, and Equipment:

 

 

 

 

    Property, plant, and equipment, net

 

1,245,269

 

1,217,094

    Construction work in progress

 

36,790

 

26,351

        Total Property, Plant, and Equipment

 

1,282,059

 

1,243,445

Investments

 

76,290

 

73,631

        Total Assets

$

1,801,060

$

1,726,403

 

 

 

 

 

LIABILITIES AND CAPITALIZATION

 

 

 

 

Current Liabilities:

 

 

 

 

    Long-term debt due within one year

$

4,333

$

4,266

    Accounts payable

 

47,799

 

40,830

    Accrued interest and taxes

 

5,495

 

5,067

    Accrued payroll related items

 

11,892

 

11,215

    Regulatory liabilities - current

 

6,910

 

9,515

    Derivative liabilities

 

7,620

 

8,343

    Other current liabilities

 

19,456

 

4,910

        Total Current Liabilities

 

103,505

 

84,146

Other Credits:

 

 

 

 

    Deferred income taxes

 

383,813

 

360,785

    Investment tax credit - deferred

 

947

 

1,050

    Regulatory liabilities

 

22,173

 

20,785

    Accrued pension and other postretirement benefits

 

74,347

 

75,680

    Derivative liabilities

 

42,970

 

44,935

    Other deferred liabilities and other

 

66,426

 

61,820

        Total Other Credits

 

590,676

 

565,055

Capitalization:

 

 

 

 

    Common shareholders' equity:

 

 

 

 

        Common Stock - $1 par value - 75,000 shares authorized;

 

 

 

 

        34,668 shares issued and outstanding

 

34,668

 

34,668

        Additional paid-in capital

 

316,268

 

316,268

        Retained earnings

 

372,950

 

339,165

        Accumulated other comprehensive income, net of tax

 

202

 

357

        Total Common Shareholders' Equity

 

724,088

 

690,458

    Long-term debt

 

382,791

 

386,744

        Total Capitalization

 

1,106,879

 

1,077,202

Commitments and contingencies (see Footnote 17)

 

-

 

-

        Total Liabilities and Capitalization

$

1,801,060

$

1,726,403

 

 

 

 

 

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




56





 

MGE Energy, Inc.

 

 

Consolidated Statements of Common Equity

 

 

(In thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

 

 

 

 

Common Stock

 

Paid-in

 

Retained

 

Comprehensive

 

 

 

 

 

Shares

 

Value

 

Capital

 

Earnings

 

Income/(Loss)

 

Total

 

 

2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - December 31, 2013

34,668

$

34,668

$

316,268

$

266,197

$

377

$

617,510

 

 

Net income

 

 

 

 

 

 

80,319

 

 

 

80,319

 

 

Other comprehensive income

 

 

 

 

 

 

 

 

81

 

81

 

 

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

($1.11 per share)

 

 

 

 

 

 

(38,429)

 

 

 

(38,429)

 

 

Cash in lieu of fractional shares related to stock split

 

 

 

 

 

 

(80)

 

 

 

(80)

 

 

Ending balance - December 31, 2014

34,668

$

34,668

$

316,268

$

308,007

$

458

$

659,401

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2015

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - January 1, 2015

34,668

$

34,668

$

316,268

$

308,007

$

458

$

659,401

 

 

Cumulative effect of new accounting principle

 

 

 

 

 

 

(142)

 

 

 

(142)

 

 

Beginning balance - Adjusted

 

 

 

 

 

 

307,865

 

 

 

659,259

 

 

Net income

 

 

 

 

 

 

71,343

 

 

 

71,343

 

 

Other comprehensive loss

 

 

 

 

 

 

 

 

(101)

 

(101)

 

 

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

($1.16 per share)

 

 

 

 

 

 

(40,043)

 

 

 

(40,043)

 

 

Ending balance - December 31, 2015

34,668

$

34,668

$

316,268

$

339,165

$

357

$

690,458

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2016

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

75,560

 

 

 

75,560

 

 

Other comprehensive loss

 

 

 

 

 

 

 

 

(155)

 

(155)

 

 

Common stock dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

($1.21 per share)

 

 

 

 

 

 

(41,775)

 

 

 

(41,775)

 

 

Ending balance - December 31, 2016

34,668

$

34,668

$

316,268

$

372,950

$

202

$

724,088

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 




57





Madison Gas and Electric Company

 

Consolidated Statements of Income

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

For the Years Ended December 31,

 

 

 

2016

 

2015

 

2014

 

Operating Revenues:

 

 

 

 

 

 

 

    Electric revenues

$

410,226

$

420,313

$

398,154

 

    Gas revenues

 

134,572

 

143,752

 

221,741

 

        Total Operating Revenues

 

544,798

 

564,065

 

619,895

 

 

 

 

 

 

 

 

 

Operating Expenses:

 

 

 

 

 

 

 

    Fuel for electric generation

 

60,745

 

53,866

 

42,836

 

    Purchased power

 

56,327

 

81,237

 

73,245

 

    Cost of gas sold

 

66,800

 

76,124

 

143,665

 

    Other operations and maintenance

 

167,077

 

163,622

 

160,831

 

    Depreciation and amortization

 

44,622

 

44,178

 

40,648

 

    Other general taxes

 

20,062

 

19,879

 

19,652

 

    Income tax provision

 

39,616

 

38,159

 

45,090

 

        Total Operating Expenses

 

455,249

 

477,065

 

525,967

 

Operating Income

 

89,549

 

87,000

 

93,928

 

 

 

 

 

 

 

 

 

Other Income and Deductions:

 

 

 

 

 

 

 

    AFUDC - equity funds

 

1,207

 

712

 

3,466

 

    Equity earnings in MGE Transco

 

6,366

 

7,728

 

9,150

 

    Income tax provision

 

(2,175)

 

(3,247)

 

(4,055)

 

    Other deductions, net

 

(217)

 

(345)

 

(704)

 

        Total Other Income and Deductions

 

5,181

 

4,848

 

7,857

 

    Income before interest expense

 

94,730

 

91,848

 

101,785

 

 

 

 

 

 

 

 

 

Interest Expense:

 

 

 

 

 

 

 

    Interest on long-term debt

 

20,351

 

20,520

 

20,927

 

    Other interest, net

 

182

 

94

 

62

 

    AFUDC - borrowed funds

 

(395)

 

(231)

 

(1,142)

 

        Net Interest Expense

 

20,138

 

20,383

 

19,847

 

Net Income

$

74,592

$

71,465

$

81,938

 

Less Net Income Attributable to Noncontrolling Interest, net of tax

 

(23,358)

 

(26,097)

 

(26,310)

 

Net Income Attributable to MGE

$

51,234

$

45,368

$

55,628

 

 

 

 

 

 

 

 

 

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

 


Madison Gas and Electric Company

Consolidated Statements of Comprehensive Income

(In thousands)

 

 

 

 

 

 

 

 

 

 

For the Years Ended December 31,

 

 

 

2016

 

2015

 

2014

 

Net Income

$

74,592

$

71,465

$

81,938

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

    Unrealized loss on available-for-sale securities, net of

 

 

 

 

 

 

 

    tax ($2, $81, and $33)

 

(4)

 

(121)

 

(48)

 

Comprehensive Income

$

74,588

$

71,344

$

81,890

 

    Less: Comprehensive Income Attributable to Noncontrolling

 

 

 

 

 

 

 

    Interest, net of tax

 

(23,358)

 

(26,097)

 

(26,310)

 

Comprehensive Income Attributable to MGE

$

51,230

$

45,247

$

55,580

 

 

 

 

 

 

 

 

 

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

 




58





Madison Gas and Electric Company

Consolidated Statements of Cash Flows

(In thousands)

 

 

For the Years Ended December 31,

 

 

2016

 

2015

 

2014

Operating Activities:

 

 

 

 

 

 

    Net income

$

74,592

$

71,465

$

81,938

    Items not affecting cash:

 

 

 

 

 

 

        Depreciation and amortization

 

44,622

 

44,178

 

40,648

        Deferred income taxes

 

20,876

 

18,843

 

49,603

        Provision for doubtful receivables

 

1,196

 

596

 

1,898

        Employee benefit plan expenses

 

295

 

3,333

 

(1,080)

        Equity earnings in MGE Transco

 

(6,366)

 

(7,728)

 

(9,150)

        Other items

 

1,954

 

1,223

 

1,280

    Changes in working capital items:

 

 

 

 

 

 

        Trade and other receivables

 

(3,583)

 

11,079

 

(4,455)

        Inventories

 

7,273

 

(2,647)

 

(10,398)

        Unbilled revenues

 

(4,838)

 

6,254

 

720

        Prepaid taxes

 

8,481

 

4,824

 

(15,169)

        Other current assets

 

699

 

976

 

(5,693)

        Accounts payable

 

9,941

 

(3,587)

 

2,741

        Accrued interest and taxes

 

419

 

(18)

 

(1,001)

        Other current liabilities

 

(2,137)

 

1,885

 

(3,144)

    Dividend income from MGE Transco

 

5,032

 

6,645

 

7,740

    Cash contributions to pension and other postretirement plans

 

(14,452)

 

(13,677)

 

(3,321)

    Other noncurrent items, net

 

2,497

 

4,816

 

(4,619)

            Cash Provided by Operating Activities

 

146,501

 

148,460

 

128,538

Investing Activities:

 

 

 

 

 

 

    Capital expenditures

 

(83,659)

 

(72,030)

 

(92,676)

    Capital contributions to MGE Transco

 

(1,598)

 

(710)

 

(1,775)

    Other

 

(391)

 

(180)

 

(1,146)

            Cash Used for Investing Activities

 

(85,648)

 

(72,920)

 

(95,597)

Financing Activities:

 

 

 

 

 

 

    Cash dividends paid to parent by MGE

 

(50,000)

 

(30,000)

 

(26,500)

    Distributions to parent from noncontrolling interest

 

(24,113)

 

(14,708)

 

(21,359)

    Equity contribution received by noncontrolling interest

 

1,598

 

3,230

 

1,775

    Repayment of long-term debt

 

(4,267)

 

(4,182)

 

(4,103)

    (Decrease) increase in short-term debt

 

-

 

(7,000)

 

7,000

    Other

 

(63)

 

(682)

 

-

            Cash Used for Financing Activities

 

(76,845)

 

(53,342)

 

(43,187)

    Change in cash and cash equivalents:

 

(15,992)

 

22,198

 

(10,246)

    Cash and cash equivalents at beginning of period

 

26,760

 

4,562

 

14,808

    Cash and cash equivalents at end of period

$

10,768

$

26,760

$

4,562


 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

    Interest paid

$

19,415

$

19,636

$

20,478

    Income taxes paid

$

29

$

29

$

67

    Income taxes received

$

-

$

-

$

(644)

    Significant noncash investing activities:

 

 

 

 

 

 

        Accrued capital expenditures

$

16,376

$

3,963

$

1,569

        Dividend in kind to parent

$

15,822

$

-

$

-

 

 

 

 

 

 

 

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




59





Madison Gas and Electric Company

Consolidated Balance Sheets

(In thousands)

 

 

At December 31,

ASSETS

 

2016

 

2015

Current Assets:

 

 

 

 

    Cash and cash equivalents

$

10,768

$

26,760

    Accounts receivable, less reserves of $3,017 and $3,052, respectively

 

39,887

 

37,112

    Affiliate receivables

 

539

 

542

    Other accounts receivable, less reserves of $426 and $642, respectively

 

6,363

 

7,390

    Unbilled revenues

 

29,846

 

25,008

    Materials and supplies, at average cost

 

18,561

 

19,155

    Fossil fuel, at average cost

 

9,757

 

13,110

    Stored natural gas, at average cost

 

12,819

 

16,145

    Prepaid taxes

 

25,798

 

34,279

    Regulatory assets - current

 

6,414

 

9,538

    Assets held for sale

 

14,813

 

-

    Other current assets

 

12,268

 

10,544

        Total Current Assets

 

187,833

 

199,583

Affiliate receivable long-term

 

4,236

 

4,766

Regulatory assets

 

158,485

 

148,199

Pension and other postretirement benefit asset

 

2,020

 

-

Other deferred assets and other

 

4,353

 

4,216

Property, Plant, and Equipment:

 

 

 

 

    Property, plant, and equipment, net

 

1,244,648

 

1,216,415

    Construction work in progress

 

36,790

 

26,351

        Total Property, Plant, and Equipment

 

1,281,438

 

1,242,766

Investments

 

487

 

69,984

        Total Assets

$

1,638,852

$

1,669,514

 

 

 

 

 

LIABILITIES AND CAPITALIZATION

 

 

 

 

Current Liabilities:

 

 

 

 

    Long-term debt due within one year

$

4,333

$

4,266

    Accounts payable

 

47,790

 

40,742

    Accrued interest and taxes

 

5,440

 

5,021

    Accrued payroll related items

 

11,892

 

11,215

    Regulatory liabilities - current

 

6,910

 

9,515

    Derivative liabilities

 

7,620

 

8,343

    Other current liabilities

 

19,347

 

4,791

        Total Current Liabilities

 

103,332

 

83,893

Other Credits:

 

 

 

 

    Deferred income taxes

 

343,117

 

352,626

    Investment tax credit - deferred

 

947

 

1,050

    Regulatory liabilities

 

22,173

 

20,785

    Accrued pension and other postretirement benefits

 

74,347

 

75,680

    Derivative liabilities

 

42,970

 

44,935

    Other deferred liabilities and other

 

66,426

 

61,817

        Total Other Credits

 

549,980

 

556,893

Capitalization:

 

 

 

 

    Common shareholder's equity:

 

 

 

 

        Common Stock - $1 par value - 50,000 shares authorized; 17,348 shares outstanding

 

17,348

 

17,348

        Additional paid-in capital

 

192,417

 

192,417

        Retained earnings

 

277,300

 

291,888

        Accumulated other comprehensive income, net of tax

 

19

 

23

         Total Common Shareholder's Equity

 

487,084

 

501,676

    Noncontrolling interest

 

115,665

 

140,308

        Total Equity

 

602,749

 

641,984

    Long-term debt

 

382,791

 

386,744

        Total Capitalization

 

985,540

 

1,028,728

Commitments and contingencies (see Footnote 17)

 

-

 

-

        Total Liabilities and Capitalization

$

1,638,852

$

1,669,514

 

 

 

 

 

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




60





 

Madison Gas and Electric Company

 

 

Consolidated Statements of Common Equity

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

Other

 

Non-

 

 

 

 

 

Common Stock

 

Paid-in

 

Retained

Comprehensive

Controlling

 

 

 

 

 

Shares

 

Value

 

Capital

 

Earnings

Income/(Loss)

Interest

 

Total

 

 

2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - December 31, 2013

17,348

$

17,348

$

192,417

$

247,534

$

192

$

118,963

$

576,454

 

 

Net income

 

 

 

 

 

 

55,628

 

 

 

26,310

 

81,938

 

 

Other comprehensive loss

 

 

 

 

 

 

 

 

(48)

 

 

 

(48)

 

 

Cash dividends paid to parent by MGE

 

 

 

 

 

 

(26,500)

 

 

 

 

 

(26,500)

 

 

Equity contribution received by

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

1,775

 

1,775

 

 

Distributions to parent from

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

(21,359)

 

(21,359)

 

 

Ending balance - December 31, 2014

17,348

$

17,348

$

192,417

$

276,662

$

144

$

125,689

$

612,260

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Beginning balance - January 1, 2015

17,348

$

17,348

$

192,417

$

276,662

$

144

$

125,689

$

612,260

 

 

Cumulative effect of new accounting principle

 

 

 

 

 

 

(142)

 

 

 

 

 

(142)

 

 

Beginning balance - Adjusted

 

 

 

 

 

 

276,520

 

 

 

 

 

612,118

 

 

Net income

 

 

 

 

 

 

45,368

 

 

 

26,097

 

71,465

 

 

Other comprehensive loss

 

 

 

 

 

 

 

 

(121)

 

 

 

(121)

 

 

Cash dividends paid to parent by MGE

 

 

 

 

 

 

(30,000)

 

 

 

 

 

(30,000)

 

 

Equity contribution received by

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

3,230

 

3,230

 

 

Distributions to parent from

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

(14,708)

 

(14,708)

 

 

Ending balance - December 31, 2015

17,348

$

17,348

$

192,417

$

291,888

$

23

$

140,308

$

641,984

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

51,234

 

 

 

23,358

 

74,592

 

 

Other comprehensive loss

 

 

 

 

 

 

 

 

(4)

 

 

 

(4)

 

 

Cash dividends paid to parent by MGE

 

 

 

 

 

 

(50,000)

 

 

 

 

 

(50,000)

 

 

Dividend in kind to parent

 

 

 

 

 

 

(15,822)

 

 

 

 

 

(15,822)

 

 

Equity contribution received by

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

1,598

 

1,598

 

 

Distributions to parent from

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

noncontrolling interest

 

 

 

 

 

 

 

 

 

 

(24,113)

 

(24,113)

 

 

Deconsolidation of noncontrolling interest

 

 

 

 

 

 

 

 

 

 

(25,486)

 

(25,486)

 

 

Ending balance - December 31, 2016

17,348

$

17,348

$

192,417

$

277,300

$

19

$

115,665

$

602,749

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 




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Notes to Consolidated Financial Statements

December 31, 2016, 2015, and 2014


This report is a combined report of MGE Energy and MGE. The notes to the consolidated financial statements that follow include consolidated MGE Energy footnotes and certain footnotes related to MGE as signified below.


1.

Summary of Significant Accounting Policies.


a.

Basis of Presentation - MGE Energy and MGE.


The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America (GAAP), which give recognition to the rate making accounting policies for regulated operations prescribed by the regulatory authorities having jurisdiction, principally the PSCW and FERC. MGE's accounting records conform to the FERC uniform system of accounts.


b.

Principles of Consolidation - MGE Energy and MGE.


MGE, a wholly owned subsidiary of MGE Energy, is a regulated electric and gas utility headquartered in Madison, Wisconsin. MGE Energy and MGE consolidate all majority owned subsidiaries in which it has controlling influence.


Additional wholly owned subsidiaries of MGE Energy include CWDC, MAGAEL, MGE Power, MGE State Energy Services, MGE Services, MGE Transco, MGEE Transco, and NGV Fueling Services. MGE Power owns 100% of MGE Power Elm Road and MGE Power West Campus. MGE Power and its subsidiaries are part of MGE Energy's nonregulated energy operations, which were formed to own and lease electric generation projects to assist MGE. MGE Transco and MGEE Transco are nonregulated entities formed to manage the investments in ATC and ATC Holdco, respectively. On December 1, 2016, MGE's ownership interest in MGE Transco was transferred to MGE Energy. See Footnote 4 for further discussion of the transfer of MGE's investment in MGE Transco.


MGE Energy and MGE consolidate variable interest entities (VIEs) for which it is the primary beneficiary. Variable interest entities are legal entities that possess any of the following characteristics: equity investors who have an insufficient amount of equity at risk to finance their activities, equity owners who do not have the power to direct the significant activities of the entity (or have voting rights that are disproportionate to their ownership interest), or equity holders who do not receive expected losses or returns significant to the VIE. If MGE Energy or MGE is not the primary beneficiary and an ownership interest is held, the VIE is accounted for under the equity method of accounting. When assessing the determination of the primary beneficiary, all relevant facts and circumstances are considered, including: the power, through voting or similar rights, to direct the activities of the VIE that most significantly impact the VIE's economic performance and the obligation to absorb the expected losses and/or the right to receive the expected returns of the VIE. Ongoing reassessments of all VIEs are performed to determine if the primary beneficiary status has changed. MGE has consolidated MGE Power Elm Road and MGE Power West Campus. Both entities are VIEs. MGE is considered the primary beneficiary of these entities as a result of contractual agreements. See Footnote 2 for more discussion of these entities.


Prior to December 1, 2016, MGE Transco was jointly owned by MGE Energy and MGE. MGE's ownership interest in MGE Transco declined below a majority in July 2016. As a result of the change in majority ownership, MGE deconsolidated MGE Energy's proportionate share of the equity in MGE Transco. See Footnote 8 for further discussion regarding the deconsolidation of noncontrolling interest.


The consolidated financial statements reflect the application of certain accounting policies described in this note. All significant intercompany accounts and transactions have been eliminated in consolidation.


c.

Use of Estimates - MGE Energy and MGE.


In order to prepare consolidated financial statements in conformity with GAAP, management must make estimates and assumptions. These estimates could affect reported amounts of assets, liabilities, and disclosures at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from management's estimates.



62





d.

Cash Equivalents and Restricted Cash - MGE Energy and MGE.


Cash Equivalents

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


Restricted Cash

MGE has certain cash accounts that are restricted to uses other than current operations and designated for a specific purpose. MGE's restricted cash accounts include cash held by trustees for certain employee benefits and cash deposits held by third parties. As of December 31, 2016 and 2015, there was $3.7 million and $2.9 million, respectively, of cash deposits held by third parties. These are included in "Other current assets" on the consolidated balance sheets.


Receivable – Margin Account

Cash amounts held by counterparties as margin for certain financial transactions are recorded as receivable – margin account in "Other current assets" on the consolidated balance sheets. As of December 31, 2016 and 2015, the receivable – margin account balance of $1.3 million and $2.3 million, respectively, is shown net of any collateral posted against derivative positions. As of December 31, 2016, no cash collateral was posted against derivative positions. As of December 31, 2015, there was $1.0 million of collateral posted against derivative positions. Changes in this cash account are considered cash flows from operating activities to match with the costs being hedged. The costs being hedged are fuel for electric generation, purchased power, and cost of gas sold.


e.

Trade Receivables, Allowance for Doubtful Accounts, and Concentration Risk - MGE Energy and MGE.


Trade accounts receivable are recorded at the invoiced amount and do not bear interest. However, a 1% late payment charge is recorded on all receivables unpaid after the due date. The allowance for doubtful accounts associated with these receivables represents our best estimate of the amount of probable credit losses in our existing accounts receivable. We determine our allowance for doubtful accounts based on historical write-off experience, regional economic data, and review of the accounts receivable aging. MGE manages this concentration and the related credit risk through its credit and collection policies, which are consistent with state regulatory requirements.


f.

Inventories - MGE Energy and MGE.


Inventories consist of natural gas in storage, fossil fuels, materials and supplies, and renewable energy credits (RECs). MGE values natural gas in storage, fossil fuels, and materials and supplies using average cost.


REC allowances are included in "Materials and supplies" on the consolidated balance sheets and are recorded based on specific identification. These allowances are charged to purchase power expense as they are used in operations. MGE's REC allowance balance as of December 31, 2016 and 2015, was $0.3 million.


g.

Chattel Paper Agreements - MGE Energy and MGE.


MGE makes available to qualifying customers a financing program for the purchase and installation of energy-related equipment that will provide more efficient use of utility service at the customer's property. The energy-related equipment installed at the customer sites is used to secure the customer loans. MGE is a party to a chattel paper purchase agreement with a financial institution under which it can sell or finance an undivided interest with recourse, in up to $10.0 million of the financing program receivables, until July 31, 2017. The length of the MGE guarantee to the financial institution varies from one to ten years depending on the term of the underlying customer loan. The loan balances outstanding at December 31, 2016, approximate the fair value of the energy-related equipment acting as collateral. MGE accounts for these agreements as secured borrowings.




63




As of December 31, 2016, the remaining contractual maturities of the chattel paper agreements were as follows:


 

(In thousands)

 

2017

 

2018

 

2019

 

2020

 

2021

 

Thereafter

 

 

Repurchase-to-Maturity Transactions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Loans

$

559

$

620

$

595

$

568

$

432

$

1,121

 


h.

Regulatory Assets and Liabilities - MGE Energy and MGE.


Regulatory assets and regulatory liabilities are recorded consistent with regulatory treatment. Regulatory assets represent costs which are deferred due to the probable future recovery from customers through regulated rates. Regulatory liabilities represent the excess recovery of costs or accrued credits which were deferred because MGE believes it is probable such amounts will be returned to customers through future regulated rates. Regulatory assets and liabilities are amortized in the consolidated statements of income consistent with the recovery or refund included in customer rates. MGE believes that it is probable that its recorded regulatory assets and liabilities will be recovered and refunded, respectively, in future rates. See Footnote 6 for further information.


i.

Debt Issuance Costs - MGE Energy and MGE.


Premiums, discounts, and expenses incurred with the issuance of outstanding long-term debt are amortized over the life of the debt issue. Any call premiums or unamortized expenses associated with refinancing higher-cost debt obligations used to finance utility-regulated assets and operations are amortized consistent with regulatory treatment of those items. These costs are included as a direct deduction to the related debt liability on the consolidated balance sheets.


j.

Property, Plant, and Equipment - MGE Energy and MGE.


Property, plant, and equipment is recorded at original cost. Cost includes indirect costs consisting of payroll taxes, pensions, postretirement benefits, other fringe benefits, and administrative and general costs. Also, included in the cost is AFUDC for utility property and capitalized interest for nonregulated property. Additions for significant replacements of property are charged to property, plant, and equipment at cost; and minor items are charged to maintenance expense. Depreciation rates on utility property are approved by the PSCW, based on the estimated economic lives of property, and include estimates for salvage value and removal costs. Removal costs of utility property, less any salvage value, are adjusted through regulatory liabilities. Depreciation rates on nonregulated property are based on the estimated economic lives of the property. See Footnote 3 for further information.


Provisions at composite straight-line depreciation rates approximate the following percentages for the cost of depreciable property:


 

 

2016

 

2015

 

2014

 

 

 

Electric(a)

2.5 %

 

2.6 %

 

2.6 %

 

 

 

Gas(a)

2.1 %

 

1.7 %

 

1.7 %

 

 

 

Nonregulated

2.3 %

 

2.4 %

 

2.4 %

 

 


(a)

In December 2015, the PSCW approved new depreciation rates, which were implemented and became effective as of January 1, 2016.


k.

Asset Retirement Obligations - MGE Energy and MGE.


MGE Energy and MGE are required to record a liability for the fair value of an ARO to be recognized in the period in which it is incurred if it can be reasonably estimated. The offsetting associated asset retirement costs are capitalized as a long-lived asset and depreciated over the asset's useful life. The expected present value technique used to calculate the fair value of ARO liabilities includes assumptions about costs, probabilities, settlement dates, interest accretion, and inflation. Revisions to the assumptions, including the timing or amount of expected asset retirement costs, could result in increases or decreases to the AROs. All asset retirement obligations are recorded as "Other long-term liabilities" on the consolidated balance sheets. MGE has regulatory treatment and recognizes regulatory assets or liabilities for the timing differences between when we recover legal AROs in rates and when we would recognize these costs. See Footnote 18 for further information.



64





l.

Repairs and Maintenance Expense - MGE Energy and MGE.


MGE utilizes the direct expensing method for planned major maintenance projects. Under this method, MGE expenses all costs associated with major planned maintenance activities as incurred.


m.

Purchased Gas Adjustment Clause - MGE Energy and MGE.


MGE's natural gas rates are subject to a fuel adjustment clause designed to recover or refund the difference between the actual cost of purchased gas and the amount included in rates. Differences between the amounts billed to customers and the actual costs recoverable are deferred and recovered or refunded in future periods by means of prospective monthly adjustments to rates. At December 31, 2016 and 2015, MGE had over collected $0.9 million and $0.8 million, respectively. These amounts are included in "Regulatory liabilities - current" on the consolidated balance sheets.


n.

Revenue Recognition - MGE Energy and MGE.


Operating revenues are recorded as service is rendered or energy is delivered to customers. Meters are read on a systematic basis throughout the month based on established meter-reading schedules. At the end of the month, MGE accrues an estimate for the unbilled amount of energy delivered to customers. The unbilled revenue estimate is based on daily system demand volumes, weather factors, estimated line losses, estimated customer usage by class, and applicable customer rates.


o.

Utility Cost Recovery - MGE Energy and MGE.


MGE's rates include a provision for fuel costs. The PSCW allows Wisconsin utilities to defer electric fuel-related costs, less excess revenues, that fall outside a symmetrical cost tolerance band. Any over/under recovery of the actual costs in a year is determined in the following year and is then reflected in future billings to electric retail customers. Such deferred amounts will be recognized in "Purchased power" expense in MGE Energy's and MGE's consolidated income statements each period. The cumulative effects of these deferred amounts will be recorded in "Regulatory assets" or "Regulatory liabilities" on MGE Energy's and MGE's consolidated balance sheets until they are reflected in future billings to customers. See Footnote 16.b. for further information regarding the regulatory rules applicable to the recovery of electric fuel costs.


p.

Regional Transmission Organizations - MGE Energy and MGE.


MGE reports on a net basis transactions on the MISO markets in which it buys and sells power within the same hour to meet electric energy delivery requirements. This treatment resulted in a $77.2 million, a $68.6 million, and a $91.1 million reduction to sales to the market and purchase power expense for MISO markets for the years ended December 31, 2016, 2015, and 2014, respectively.


q.

Allowance for Funds Used During Construction - MGE Energy and MGE.


Allowance for funds used during construction is included in utility plant accounts and represents the cost of borrowed funds used during plant construction and a return on shareholder's capital used for construction purposes. In the consolidated income statements, the cost of borrowed funds (AFUDC-debt) is presented as an offset to "Interest expense" and the return on shareholder's capital (AFUDC-equity funds) is shown as an item within "Other income." For both 2016 and 2015, as approved by the PSCW, MGE capitalized AFUDC-debt and equity on 50% of applicable average construction work in progress at 7.93%. For 2014, MGE capitalized AFUDC-debt and equity on 50% of applicable average construction work in progress at 8.21%. For 2016, 2015, and 2014, MGE received specific approval to recover 100% AFUDC on certain environmental costs for Columbia. These amounts are recovered under the ratemaking process over the service lives of the related properties.


r.

Investments - MGE Energy and MGE.


Investments in limited liability companies that have specific ownership accounts in which MGE Energy or MGE's ownership interest is more than minor and are considered to have significant influence are accounted for using the equity method. All other investments are carried at fair value or at cost, as appropriate. See Footnote 4 for further information.



65





s.

Capitalized Software Costs - MGE Energy and MGE.


Property, plant, and equipment includes the net book value of capitalized costs of internal use software totaling $12.3 million and $12.0 million at December 31, 2016 and 2015, respectively. During 2016, 2015, and 2014, MGE recorded $3.0 million, $2.2 million, and $1.6 million, respectively, of amortization expense related to these costs. These costs are amortized on a straight-line basis over the estimated useful lives of the assets. For internal use software, the useful lives range from five to ten years.