MGE ENERGY INC (MGEE) FY 2022 MD&A

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:

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Regulated electric utility operations, conducted through MGE,

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Regulated gas utility operations, conducted through MGE,

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

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

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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, purchases, and distributes electricity to approximately 161,000 customers in Dane County, Wisconsin, including the city of Madison, and purchases and distributes natural gas to approximately 173,000 customers in the Wisconsin counties of Columbia, Crawford, Dane, Iowa, Juneau, Monroe, and Vernon.

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

We have not included a discussion of results of operations and changes in financial position for the year ended

December 31, 2021, as compared to the year ended December 31, 2020. That discussion can be found in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our annual report on Form 10-K for the year ended December 31, 2021, which was filed with the SEC on February 23, 2022.

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 works on meeting this challenge by investing in more efficient generation projects, including renewable energy sources. As we work toward achieving 80% carbon reduction by 2030 (from 2005 levels), MGE continues to examine and pursue opportunities to reduce the proportion that coal generation represents in its generation mix, as evidenced by its most recent announcements of the retirement of Columbia (a coal generation plant), the planned change in the Elm Road Units fuel source from coal to natural gas, and its growing ownership of renewable generation sources. MGE will continue to focus on growing earnings while controlling operating and fuel costs. MGE's goal is to provide safe and efficient operations in addition to providing customer value. We believe it is critical to maintain a strong credit rating consistent with financial strength in MGE in order to accomplish these goals.

We principally earn 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:

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Weather, and its impact on customer sales,

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

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

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Energy commodity prices, including natural gas prices,

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Equity price risk pertaining to pension related assets,

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

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

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Other factors listed in Item 1A. Risk Factors of this Report.

During the year ended December 31, 2022, MGE Energy's earnings were $111.0 million or $3.07 per share compared to $105.8 million or $2.92 per share for the same period in the prior year. MGE's earnings for the year ended December 31, 2022, were $83.9 million compared to $78.4 million for the same period in the prior year.

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

Our net income during 2022 compared to 2021 primarily reflects the effects of the following factors:

Electric Utility

An increase in electric investments contributed to earnings for 2022. The new customer information system went live in September 2021 and Badger Hollow I was completed in November 2021.

Gas Utility

An increase in gas investments contributed to increased earnings for 2022. Higher gas retail sales resulting from colder weather in 2022 contributed to higher earnings for 2022. Heating degree days (a measure for determining the impact of weather during the heating season) increased by approximately 9% in 2022 compared to 2021.

During 2022, the following events occurred:

2022/2023 Rate Settlement Agreement: In December 2021, the PSCW approved a settlement agreement for MGE's 2022 rate case. The settlement agreement provides for an 8.81% increase to electric rates and a 2.15% increase to gas rates for 2022. As part of that settlement agreement, the PSCW approved a 0.96% increase in 2023 gas rates and a potential 2023 electric rate change to be addressed through a limited rate case reopener. See "Other Matters" below for additional information on the 2022/2023 rate case settlement.

Utility Solar: Large solar generation projects were recently completed or are under construction, as shown in the following table. Incurred costs are reflected in "Property, plant, and equipment, net" for projects placed in service, or "Construction work in progress" for projects under construction on the consolidated balance sheets.

(a)
Excluding AFUDC.

(b)
MGE received specific approval to recover 100% AFUDC on Badger Hollow II and Paris. After tax, MGE recognized $2.6 million and $0.8 million of AFUDC equity earnings through December 31, 2022, on Badger Hollow II and Paris, respectively, during construction. AFUDC has been excluded from the costs incurred in the table above.

(c)
Includes an allocation of common facilities at Badger Hollow placed in service in November 2021.

(d)
Battery storage timing to be determined.

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Deferred Fuel Costs: MGE under-recovered fuel costs in 2022. As of December 31, 2022, MGE had deferred $8.8 million of 2022 fuel costs. Coal transportation constraints resulted in reduced generation at Columbia, which required MGE to purchase power in the market at higher cost. We may continue to see increased fuel costs in the near term because of these coal transportation constraints. These costs will be subject to the PSCW's annual review of 2022 fuel costs, expected to be completed during 2023. See Footnote 9.b. of the Notes to Consolidated Financial Statements in this Report for further information regarding fuel proceedings.

During 2023, several items may affect us, including:

2021 Annual Fuel Proceeding: MGE under-recovered fuel costs in 2021. As of December 31, 2021, MGE had deferred $3.3 million of 2021 fuel costs. In August 2022, the PSCW issued a final decision in the 2021 fuel rules proceedings for MGE to include the recovery of these costs as part of the 2023 electric limited rate case reopener. There was no change to the costs to be recovered in the fuel rules proceedings from the amount MGE deferred in the previous year.

2023 Electric Limited Rate Case Reopener: In December 2022, the PSCW approved an 9.01% increase to electric rates for 2023. See "Other Matters" below for additional information on the 2023 electric limited rate case reopener.

ATC Return on Equity: As discussed in "Other Matters" below, ATC's authorized ROE, which is used in calculating its rates and revenues, is the subject of a challenge before FERC. A decrease in ATC's ROE could result in lower equity earnings and distributions from ATC in the future. We derived approximately 5.9% and 6.7% of our net income for the years ended December 31, 2022 and 2021, respectively, from our investment in ATC.

Environmental Initiatives: There are proposed legislative rules and initiatives involving matters related to air emissions, water effluent, hazardous materials, and greenhouse gases, all of which affect generation plant capital expenditures and operating costs as well as future operational planning. Legislation and rulemaking addressing climate change and related matters could significantly affect the costs of owning and operating fossil-fueled generating plants. 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 any legislation or rules, and the scope and time of the recovery of costs in rates, which may occur after those costs have been incurred and paid.

Future Generation - 80% carbon reduction target by 2030 (from 2005 levels): MGE has outlined initiatives to achieve our raised target.

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Transitioning away from coal. Columbia: MGE, along with the other plant co-owners, announced plans to retire Columbia Unit 1 and Unit 2 by June 2026. Final timing and retirement dates for Units 1 and 2 are subject to change depending on operational, regulatory, and other factors. MGE continues to evaluate additional investments to replace the generation from Columbia while maintaining electric service reliability. These investments include cost-effective, clean energy projects to help achieve MGE's carbon reduction goals.

Elm Road Units: MGE, along with the plant co-owner, announced plans to end the use of coal as a primary fuel at the Elm Road Units and transition the plant to natural gas. Transition plans and costs will be subject to PSCW approval. MGE's remaining use of coal is expected to be further reduced as the Elm Road Units transition to natural gas. By the end of 2030, coal is expected to be used only as a backup fuel at the Elm Road Units. This transition will help MGE meet its 2030 carbon reduction goals. By 2035, MGE expects that the Elm Road Units will be fully transitioned away from coal, which will eliminate coal as an internal generation source for MGE.

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Growing renewable generation. MGE is seeking to acquire a joint interest in several renewable generation projects. See our 2023-2027 capital expenditures forecast included under "Liquidity and Capital Resources" below for information on these projects.

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Natural gas as a fuel source. West Riverside: MGE received PSCW approval for its purchase of an ownership interest in West Riverside. See the 2023-2027 capital expenditures forecast included under "Liquidity and Capital Resources" below for additional information on West Riverside.

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Solar Procurement Disruptions – Import Regulations: In June 2021, the U.S. Customs and Border Protection (CBP) issued a Withhold Release Order (WRO) against silica-based products made by Hoshine Silicon Industry Co. Ltd., a company located in China's Xinjiang Uyghur Autonomous Region. As a result of this WRO, CBP is holding many solar panels imported into the United States until importers can prove that the panels do not contain materials originating from this region. The Uyghur Forced Labor Protection Act, a federal law that became effective on June 21, 2022, further established that all goods mined, produced, or manufactured wholly or in part in Xinjiang or by certain defined entities are prohibited from U.S. importation. MGE is currently assessing the potential impact of these disruptions on current and future solar projects which may result in an increase in costs or delays in construction timelines. In the event that such disruptions cause costs to exceed the levels approved for specific projects, we expect to file a notification with the PSCW and expect to request recovery of any increases in MGE's next rate proceeding.

Solar Procurement Disruptions – Solar Tariff Investigation: In March 2022, the U.S. Department of Commerce (USDOC) announced a solar tariff investigation on solar panels from four Southeast Asian countries. This investigation could result in additional tariffs on solar panels. In June 2022, the USDOC issued a 24-month exemption from tariffs for solar panel and module imports from these four countries. MGE is currently assessing the potential impact of these disruptions on current and future solar projects which may result in an increase in costs or delays in construction timelines. In the event that such disruptions cause costs to exceed the levels approved for specific projects, we expect to file a notification with the PSCW and expect to request recovery of any increases in MGE's next rate proceeding.

The following discussion is based on the business segments as discussed in Footnote 22 of the Notes to Consolidated Financial Statements in this Report.

Results of Operations

Year Ended December 31, 2022, Versus the Year Ended December 31, 2021

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:

Electric revenue increased $44.9 million during 2022 compared to 2021, due to the following:

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Rate changes. In December 2021, the PSCW authorized MGE to increase 2022 rates for retail electric customers by approximately 8.81%. Rates charged to retail customers during 2022 were $38.0 million higher than those charged during 2021. See Footnote 9 of the Notes to Consolidated Financial Statements in this Report for further information on rate increase. Any increase in rates associated with fuel or purchase power costs are generally offset in fuel and purchased power costs and do not have a significant impact on net income.

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Sales to the market. Sales to the market typically occur when MGE has more generation and purchases in the MISO market than are needed for its customer demand. The excess electricity is then sold to other utilities or power marketers in the MISO market. During 2022, sales were made at higher market prices and partially offset by decreased market volume compared to 2021, reflecting a decrease in sales. The revenue generated from these sales is included in fuel rules monitored costs. See fuel rules discussion in Footnote 9 of the Notes to Consolidated Financial Statements.

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Customer fixed and demand charges. During 2022, fixed and demand charges increased $1.2 million primarily attributable to the increase in demand charges for commercial customers.

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Revenue subject to refund. For cost recovery mechanisms, any over-collection of revenues resulting from costs authorized to be collected from customers in rates exceeding actual costs is recorded as a reduction of revenue in the period incurred, as the over-collection is expected to be refunded to customers in a subsequent period. In the year the over-collection is refunded, rates are reduced and offset as revenue subject to refund. There is no net income impact in the year the costs are refunded.

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Residential volume. During 2022, residential sales decreased by approximately 1% compared to 2021. This decrease was driven by a shift in usage patterns reflecting a reduction in remote work associated with the COVID-19 pandemic.

Electric fuel and purchased power

The $6.7 million increase in fuel for electric generation was due to an approximately 25% increase in the average cost offset by an approximately 10% decrease in internal generation. Coal transportation constraints resulted in reduced generation at Columbia, which required MGE to purchase power in the market at higher cost.

The $7.4 million increase in purchased power was due to an approximately 26% increase in market purchases as a result of lower internal generation. Also, fuel costs deferred as a regulatory asset increased $5.5 million contributing to the change in purchased power.

Fuel and purchased power costs are generally offset by electric revenue and do not have a significant impact on net income. MGE expects to seek and receive recovery of fuel and purchased power costs outside the fuel rules bandwidth in customer rates. See Footnote 9 of the Notes to Consolidated Financial Statements in this Report for further information on the fuel rules bandwidth.

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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:

Gas revenue increased $63.1 million during 2022 compared to 2021, due to the following:

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Rate changes. In December 2021, the PSCW authorized MGE to increase 2022 rates for retail gas customers by 2.15%.

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 change net income in view of the pass-through treatment of the costs. Payments for natural gas increased driving higher rates during 2022. The average retail rate per therm for 2022, increased approximately 18% compared to 2021, reflecting an increase in natural gas commodity costs (recovered through the PGA).

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Volume. For 2022 retail gas deliveries increased approximately 15% compared to 2021 primarily related to favorable weather conditions in the current year.

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Other. Other revenues increased primarily related to increase in gas customers in 2022 increasing revenue recorded for fixed customer charge compared to 2021.

Cost of gas sold

A $52.9 million increase in cost of gas sold driven by higher cost per therm of gas. Average cost per therm increased approximately 35%. An increase in volume of approximately 13% also contributed to the increase in cost. MGE recovers the cost of natural gas in its gas segment through the PGA as described under gas deliveries and revenue above.

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Consolidated operations and maintenance expenses

For 2022, operations and maintenance expenses increased $10.5 million, compared to 2021. The following contributed to the net change:

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Increased administrative and general costs are primarily related to an increase in pension and OPEB service costs.

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Increased customer accounts are primarily related to increased costs associated with the new customer information system, which went live in September 2021.

Consolidated depreciation expense

Electric depreciation expense increased $6.2 million and gas depreciation expense increased $2.4 million for 2022, compared to 2021. MGE placed Badger Hollow I in service in November 2021. The timing of the in-service date contributed to the increase in electric depreciation expense. The new customer information system went live in September 2021, which increased depreciation expense for both electric and gas in 2022.

Electric and gas other income

Electric other income increased $2.9 million and gas other income increased $5.6 million during 2022, compared to 2021, primarily related to the collection in 2021 of the deferred pension and other postretirement other than service costs from 2019.

Nonregulated Energy Operations - MGE Energy and MGE

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. For 2022 and 2021, net income at the nonregulated energy operations segment was $22.1 million and $21.4 million, respectively.

Transmission Investment Operations - MGE Energy

The transmission investment segment holds our interest in ATC and ATC Holdco, and its income reflects our equity in the earnings of those investments. ATC Holdco was formed in December 2016 to pursue transmission development opportunities that typically have long development and investment lead times before becoming operational. ATC Holdco's transmission development activities have been suspended for the near term. During 2022 and 2021, other income at the transmission investment segment primarily reflects ATC's operations and was $9.1 million and $9.3 million, respectively. In August 2022, the U.S. Court of Appeals for the D.C. Circuit vacated the underlying FERC orders regarding methodology for setting authorized return on equity resulting in an additional estimated possible loss. See Footnote 7 of the Notes to Consolidated Financial Statements in this Report and "Other Matters" below for additional information concerning ATC and summarized financial information regarding ATC.

Consolidated Income Taxes - MGE Energy and MGE

In 2022, the effective electric tax rate increased as a result of the return of electric excess deferred taxes related to the 2017 Tax Act not governed by IRS normalization rules in 2021. These costs were recorded as a regulatory

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liability in the year of remeasurement. See Footnote 10 of the Notes to Consolidated Financial Statements in this Report for the effective tax rate reconciliation.

Noncontrolling Interest, Net of Tax - MGE

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. The following table shows MGE Energy's noncontrolling interest, net of tax, reflected on MGE's consolidated statement of income:

Liquidity and Capital Resources

MGE Energy and MGE expect to have adequate liquidity to support future operations and capital expenditures over the next twelve months. Available resources include cash and cash equivalents, operating cash flows, liquid assets, borrowing working capacity under revolving credit facilities, and access to equity and debt capital markets. MGE Energy expects to generate funds from operations and both long-term and short-term debt financing. See "Credit Facilities" below for information regarding MGE Energy's and MGE's credit facilities.

Cash Flows

The following summarizes cash flows for MGE Energy and MGE during 2022 and 2021:

Cash Provided by Operating Activities

Cash flows from operating activities for MGE Energy and MGE principally reflect the receipt of customer payments for electric and gas service and outflows related to fuel for electric generation, purchased power, gas, and operation and maintenance expenditures.

MGE Energy

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

Cash provided by operating activities during 2022 was $153.7 million, an increase of $16.2 million when compared to 2021.

MGE Energy's net income increased $5.2 million for 2022 when compared to 2021.

MGE Energy's net federal and state taxes paid decreased $0.8 million during 2022, when compared to 2021.

Working capital accounts (excluding prepaid and accrued taxes) resulted in $40.5 million in cash used for operating activities for 2022, primarily due to increased gas inventory driven by the increase cost of gas, increased unbilled

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revenues, and customer receivables. These increases in cash used for operations were partially offset by an increase in accounts payable.

Working capital accounts (excluding prepaid and accrued taxes) resulted in $36.5 million in cash used for operating activities for 2021, primarily due to increased accounts receivable, increased other receivables, increased unbilled revenues, increase in gas inventory, and decrease in other current liabilities. Natural gas costs increased significantly throughout the central part of the country in February 2021 related to extreme weather conditions. In addition to those increased natural gas costs, we incurred higher natural gas costs throughout 2021, as a result of an increase in the price of natural gas. The decrease in other current liabilities is attributable to a $3.2 million one-time fuel credit returned to retail customers in 2021. These increases in cash used for operations were partially offset by an increase in accounts payable.

Hosted software asset expenditures during 2022 were $0.5 million. This amount represents a decrease of $2.9 million in cash used when compared to 2021.

MGE

Cash provided by operating activities for 2022 was $151.1 million, an increase of $20.8 million when compared to 2021.

Net income increased $4.7 million for 2022 when compared to 2021.

MGE's net federal and state taxes paid decreased $2.4 million during 2022, when compared to 2021.

Working capital accounts (excluding prepaid and accrued taxes) resulted in $40.0 million in cash used for operating activities for 2022, primarily due to increased gas inventory driven by the increase cost of gas, increased unbilled revenues, and customer receivables. These increases in cash used for operations were partially offset by an increase in accounts payable.

Working capital accounts (excluding prepaid and accrued taxes) resulted in $39.0 million in cash used for operating activities for 2021, primarily due to increased accounts receivable, increased other receivables, increased unbilled revenues, increase in gas inventory, and decreased other current liabilities. Natural gas costs increased significantly throughout the central part of the country in February 2021 related to extreme weather conditions. In addition to those increased natural gas costs, we incurred higher natural gas costs throughout 2021, as a result of an increase in the price of natural gas. The decrease in other current liabilities is attributable to a $3.2 million one-time fuel credit returned to retail customers in 2021. These increases in cash used for operations were partially offset by an increase in accounts payable.

Hosted software asset expenditures during 2022 were $0.5 million. This amount represents a decrease of $2.9 million in cash used when compared to 2021.

Capital Requirements and Investing Activities

Cash outflows for MGE Energy and MGE principally reflect capital expenditures. See "Capital Expenditures" below for more information.

MGE Energy

MGE Energy's cash used for investing activities increased $23.2 million for 2022 when compared to 2021.

Capital expenditures for 2022 were $175.0 million. This amount represents an increase of $21.9 million from the expenditures made in 2021. This increase primarily reflects the increase of expenditures for Badger Hollow II and Paris.

Capital contributions in ATC and other investments increased $1.2 million for 2022 when compared to 2021.

Proceeds from the sale of investments decreased $0.8 million during 2022, when compared to 2021.

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MGE

MGE's cash used for investing activities increased $21.2 million for 2022 when compared to 2021.

Capital expenditures for 2022 were $175.0 million. This amount represents an increase of $21.9 million from the expenditures made in 2021. This increase primarily reflects the increase of expenditures for Badger Hollow II and Paris.

Capital Expenditures

The following table shows MGE Energy's actual capital expenditures for both 2021 and 2022, and forecasted capital expenditures for 2023 through 2027:

Forecasted capital expenditures are based upon management's assumptions with respect to future events, including the timing and amount of expenditures associated with environmental compliance initiatives, legislative and regulatory action, supply chain and market disruptions, customer demand and support for electrification and renewable energy resources, energy conservation programs, load growth, the timing of any required regulatory approvals, and the adequacy of rate recovery. Actual events may differ materially from these assumptions and result in material changes to those forecasted amounts.

MGE is targeting at least 80% carbon reduction from electric generation by 2030 (from 2005 levels) and net-zero carbon electricity by 2050. Solar, wind, and battery storage projects are a major step toward deep decarbonization and greater use of clean energy sources in pursuit of our goal. MGE continues to evaluate solar, wind, and battery storage projects that align with its goals as legacy fossil fuel-fired facilities are retired. The target early retirement date for Columbia is June 2026. MGE has included forecasted capital expenditures for the years 2023 through 2026 for projects to replace Columbia's generation.

The following table provides further detail of MGE Energy's forecasted capital expenditures, separating spending into capital project categories for 2023 through 2027:

(a)
Includes solar and wind generation and battery storage.

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Our forecasted capital expenditures reflect the following significant renewable projects that are proposed or currently under construction:

(a)
Approved by the PSCW.

(b)
Pending approval by the PSCW. There is no certainty that this project will be approved by the PSCW.

(c)
Excluding AFUDC.

(d)
Requested, in the case of projects pending PSCW approval, or received, in the case of Badger Hollow II, Paris, and Darien, approval to recover 100% AFUDC.

(e)
See Footnote 6 of Notes to Consolidated Financial Statements in the Report for information on costs incurred.

(f)
Battery storage timing to be determined.

In 2022, MGE notified the PSCW of increases in projected costs at Badger Hollow II and Paris. The main drivers were increases in the costs of key commodities, labor, and solar modules resulting from supply chain and market disruptions. See Footnote 6 of Notes to Consolidated Financial Statements in this Report for more information on these projects. Furthermore, solar procurement disruptions have also shifted construction timelines for Darien and Koshkonong. Projected completion dates of these projects are one year later than originally anticipated. MGE continues to assess the potential impact of these disruptions on current and future solar projects that may result in an increase in costs or delays in construction timelines. See further information on procurement disruptions discussed earlier under "Executive Overview."

West Riverside: In December 2022, the PSCW approved MGE's request for its purchase of an ownership interest in the West Riverside Energy Center, a highly efficient, state-of-the-art natural gas-fired plant in Beloit, Wisconsin. MGE's share of West Riverside will be 25 MW at a purchase price of approximately $25 million. The acquisition of that ownership interest is expected to occur in March 2023. MGE also has an option to purchase an additional 25 MW of capacity from West Riverside until May 2025. MGE currently expects to file in the first half of 2023 with the PSCW a request for a purchase of the additional 25 MW.

Electric and Gas Distribution: In 2023 through 2027, electric and gas capital expenditures include investment in enhanced metering solutions to provide customers with more timely and detailed energy use information. Investments in advanced metering infrastructure will provide additional benefits including outage and demand response and automated meter reading capabilities. Forecasted capital expenditures in those years is approximately $36 million.

Financing Activities

The principal sources and uses of cash are related to short-term and long-term borrowings and repayments and the payment of cash dividends.

MGE Energy

Cash provided by MGE Energy's financing activities was $25.5 million for 2022, compared to $8.8 million of cash used for financing activities in 2021.

For 2022, cash dividends paid were $57.5 million compared to $54.8 million in 2021. The increase reflected a higher dividend rate per share ($1.59 vs. $1.52).

During 2022, MGE borrowed $25.0 million of senior unsecured notes whose proceeds were used to assist with the payment of additional capital expenditures and other corporate obligations compared to $100.0 million of borrowings in 2021.

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For 2022, net short-term debt borrowings were $65.0 million, compared to $47.0 million of repayments in 2021.

MGE

During 2022, cash provided by MGE's financing activities was $27.7 million, compared to $26.0 million of cash provided by financing activities in 2021.

Cash dividends to parent (MGE Energy) were $33.5 million in 2022, compared to $5.0 million in 2021.

Distributions to parent (MGE Energy) from noncontrolling interest, which represent distributions from MGE Power Elm Road and MGE Power West Campus, were $22.0 million for 2022, compared to $15.0 million in 2021. The noncontrolling interest arises from the accounting required for the entities, which are not owned by MGE but are consolidated as VIEs.

During 2022, MGE issued $25.0 million of senior unsecured notes whose proceeds were used to assist with the payment of additional capital expenditures and other corporate obligations compared to $100.0 million of borrowings in 2021.

For 2022, net short-term debt borrowings were $65.0 million compared to $47.0 million of repayments in 2021.

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 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 as of December 31, 2022, is 60.5%, as determined under the calculation used in the rate proceeding. This restriction did not restrict MGE's payment of dividends in 2022. Cash dividends of $33.5 million and $5.0 million, respectively, were paid by MGE to MGE Energy in 2022 and 2021. The rate proceeding calculation includes 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, 2022, approximately $650.1 million was available for the payment of dividends under this covenant.

MGE Power West Campus has covenanted with the holders of its outstanding senior secured notes not to declare or make distributions to us in the event that, both before and after giving effect to such distribution, its total debt to total capitalization would exceed 0.65 to 1.00 or its projected debt service coverage ratio for the following four fiscal quarters would be less than 1.25 to 1.00. Projected debt service coverage considers the projected revenues available for debt service, after deducting expenses other than debt service, in relation to projected debt service on indebtedness.

MGE Power Elm Road has covenanted with the holders of its outstanding senior secured notes not to declare or make distributions to us in the event that, both before and after giving effect to such distribution, its projected debt service coverage ratio for the following four fiscal quarters would be less than 1.25 to 1.00. Projected debt service coverage considers the projected revenues available for debt service, after deducting expenses other than debt service, in relation to projected debt service on indebtedness.

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Credit Facilities

As of December 31, 2022, MGE Energy and MGE had the following aggregate bank commitments and available capacity under their credit agreements:

In January 2023, MGE amended one of its credit agreements to increase the available credit by an additional $30 million, increasing MGE's aggregate bank commitments to $130 million.

Borrowings under the Credit Agreements may bear interest at a rate based upon either a "floating rate" or an "Adjusted Term SOFR Rate," 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 and several adjusted interest rate indices (as set forth in the Credit Agreements), subject to a floor of one percent per annum or zero, depending on the credit agreement. The "floating rate" adder ranges from zero to 0.125%. The "Adjusted Term SOFR Rate" is calculated as provided in the Credit Agreements. The "Adjusted Term SOFR Rate" adder ranges from 0.625% to 1.125%.

The credit agreements require the borrower to maintain a ratio of consolidated debt to consolidated total capitalization not to exceed a maximum of 65%. In the case of MGE, 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. As of December 31, 2022, the ratio of consolidated debt to consolidated total capitalization for each of MGE Energy and MGE, as calculated under the credit agreements' covenant, were 39.6% and 42.4%, respectively. See Footnote 13 of the Notes to Consolidated Financial Statements in this Report for additional information regarding the credit facilities.

Capitalization Ratios

MGE Energy's capitalization ratios were as follows:

(a)
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 would increase fees and interest charges under both MGE Energy's and MGE's credit agreements.

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Contractual Obligations and Commercial Commitments for MGE Energy and MGE

MGE Energy's and MGE's contractual obligations as of December 31, 2022, representing cash obligations that are considered to be firm commitments, are as follows:

(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. In November 2022, MGE entered into a private placement Note Purchase Agreement in which it committed to issue $25 million of new long-term debt (Series A), $15 million of new long-term debt (Series B), carrying an interest rate of 5.43% per annum over its 10-year life, and $35 million of new long-term debt (Series C), carrying an interest rate of 5.53% per annum over its 12-year life. Funding occurred on December 1, 2022, for Series A and will occur on February 28, 2023, for Series B and Series C. The proceeds of the debt financing will be used to assist with capital expenditures and other corporate obligations.

(b)
Short-term debt consisting of commercial paper for MGE. See Footnote 13 of the Notes to Consolidated Financial Statements in this Report.

(c)
Amount represents interest expense on long-term debt. See Footnote 14 of the Notes to Consolidated Financial Statements in this Report for further discussion of the long-term debt outstanding as of December 31, 2022.

(d)
Leases. See Footnote 5 of the Notes to Consolidated Financial Statements in this Report.

(e)
Purchase obligations 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 16.c. of the Notes to Consolidated Financial Statements in this Report.

(f)
Construction obligations consist primarily of Badger Hollow II, Paris, and other renewable projects. In January 2023, MGE entered into an asset purchase agreement for approximately $10 million for a solar generating facility. The project is expected to be in service in 2023. This amount is excluded from the table above.

(g)
Other obligations are primarily related to investment commitments, environmental projects, and uncertain tax positions.

The above amounts do not include any contributions for MGE's pension and postretirement plans. MGE does not expect to need to make any required contributions to the qualified plans for 2023. The contributions for years after 2023 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. In January 2023, MGE Transco made a $0.4 million contribution to ATC. The amount and timing of future capital calls to these entities is uncertain and primarily dependent on the operations and expansion of ATC and the resumption of development activities by ATC Holdco.

MGE Energy's and MGE's commercial commitments as of December 31, 2022, representing commitments triggered by future events and including financing arrangements to secure obligations of MGE Energy and MGE, are as follows:

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(a)
Amount includes the facilities 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 November 2027. As of December 31, 2022, MGE Energy had no borrowings outstanding under this credit facility.

(b)
Amount includes two committed revolving credit agreements totaling $100 million expiring in November 2027. These credit facilities are used to support commercial paper issuances. As of December 31, 2022, MGE had $70.5 million of commercial paper outstanding backed by the facilities but no borrowings outstanding. As of December 31, 2022, MGE had $0.7 million of letters of credit issued inside credit facilities.

(c)
In January 2023, MGE amended its credit agreement to increase the line of credit available an additional $30 million. This amount has been excluded from the table above.

Other Matters

Rate Matters

In December 2021, the PSCW approved a settlement agreement for MGE's 2022 rate case. The settlement agreement provides for an 8.81% increase for electric rates and a 2.15% increase to gas rates for 2022. As part of the settlement agreement, the PSCW approved a 0.96% increase in 2023 gas rates and a potential 2023 electric rate change to be addressed through a limited rate case reopener.

In December 2022, the PSCW approved the electric rate case reopener. The reopener provides for a 9.01% increase to electric rates for 2023.

Details related to MGE's 2022/2023 approved settlement agreement and 2023 electric limited reopener are shown in the table below:

(a)
Average rate base amounts reflect MGE's allocated share of rate base and do not include construction work in progress (CWIP) or a cash working capital allowance and were calculated using a forecasted 13-month average for the test periods. The PSCW provides a return on selected CWIP and a cash working capital allowance by adjusting the percentage return on rate base.

(b)
50% of the forecasted 13-month average CWIP for the test periods which earns an AFUDC return. Projects eligible to earn 100% AFUDC are excluded from this balance and discussed further in the Management Discussion and Analysis of Financial Condition and Results of Operations - Executive Overview section.

(c)
Authorized returns on common equity may not be indicative of actual returns earned or projections of future returns, as actual returns will be affected by the volume of electricity or gas sold.

See Footnote 9.a. of the Notes to Consolidated Financial Statements in this Report for further discussion of rate proceedings.

ATC

MISO transmission owners, including ATC, are involved in two complaints filed at FERC by several parties challenging that the base ROE in effect for MISO transmission owners, including ATC, was no longer just and reasonable. Each complaint provided for a 15-month statutory refund period: November 12, 2013 through February 11, 2015 (the "First Complaint Period") and February 12, 2015 through May 11, 2016 (the "Second Complaint Period").

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In May 2020, FERC issued an order further refining the methodology for setting authorized ROE. This refined methodology increased the authorized ROE from 9.88% to 10.02%. This base ROE is effective for the First Complaint Period and for all periods following September 2016. This order also dismissed the second complaint. Accordingly, no refunds were ordered for the Second Complaint Period.

As a result of the May 2020 FERC order, our share of ATC's earnings reflected a $0.6 million reduction of our reserve. Additionally, our share of ATC's earnings reflected the derecognition of a possible refund related to the Second Complaint Period as ATC considered such a refund to be no longer probable. However, due to pending requests for rehearing, a loss related to the 2015 complaint remains possible. Our share of the estimated refund for the Second Complaint Period is approximately $2.3 million. MGE has not recorded a possible loss for the Second Complaint Period.

Several petitions for review of FERC’s prior orders were filed with the U.S. Court of Appeals for the D.C. Circuit (the "Court") and an oral argument was held in November 2021. In August 2022, the Court ruled that four of the five arguments made by the complaining parties were unpersuasive. However, the Court agreed that FERC’s decision to reintroduce a risk-premium model into its ROE methodology was arbitrary and capricious. The Court vacated the underlying orders for the First Complaint Period and remanded to FERC for further proceedings. In 2022, our share of ATC's earnings reflected an estimated possible loss of approximately $0.9 million, inclusive of interest and net of tax, for a possible additional refund for the First Complaint Period and for the period following the Second Complaint Period. Although the Court agreed that FERC was correct to use the base ROE established in the first complaint to adjudicate the second, and that FERC was right to dismiss the second complaint, the second complaint was also remanded for FERC to reopen proceedings. Any reduction in ATC's ROE could result in lower equity earnings and distributions from ATC in the future.

We derived approximately 5.9%, 6.7%, and 8.0%, respectively, of our net income for 2022, 2021, and 2020 from our investment in ATC.

Inflation Reduction Act

In August 2022, the Inflation Reduction Act (IRA) was signed into law. Among other provisions, the IRA: extends current PTC and ITC for renewable technologies (e.g., wind and solar); restores full value of the PTC and ITC for qualifying facilities placed into service after 2021 that satisfy prevailing wage and apprenticeship requirements; creates a PTC for solar, clean hydrogen and nuclear; establishes an ITC for energy storage, microgrids, and interconnection facilities; and allows companies to monetize or sell credits to unrelated parties. In addition, the IRA created a new corporate alternative minimum tax (AMT). MGE Energy does not expect to be subject to the AMT in the near term. Implementation of IRA provisions is subject to the issuance of additional guidance by the U.S. Treasury Department. While the final impact cannot be determined at this time, the IRA did not have a material impact on MGE Energy and MGE for the year ending December 31, 2022.

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 regulatory assets and liabilities, unbilled revenues, pension obligations, and income taxes. 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.

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

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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, pension and other postretirement costs, 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.

Unbilled Revenues

Revenues from the sale of electricity and gas are recorded when they are delivered to customers. Sales quantity 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 meter-read dates and the end of the reporting period. These estimates include:

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

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

•
The mix of sales between customer rate classes having different rates, 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. To confirm the reasonableness 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.

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 may change due to the uncertainty attached to the estimate as well as the fact that these estimates are difficult to measure. Different estimates used could result in recognizing different amounts of expense over different periods of time. Recovery in rates is expected.

MGE uses third-party specialists to assist with evaluating its assumptions and measurement of 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 plan assets. They are critical accounting estimates because they are subject to management's judgment and can materially affect financial performance.

•
Assumed return on assets. This assumption represents the rate of return on plan assets reflecting the average

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rate of earnings expected on the funds invested (or to be invested) to provide for the benefits included in the projected benefit obligation. For 2022, MGE used an assumed return on assets of 6.75% for pension and 6.40% for other postretirement benefits. In 2023, the pension asset assumption will increase to 7.00% and the postretirement benefit assumption will increase to 6.59%. 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 $5.2 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. MGE uses individual spot rates rather than a weighted average of the yield curve spot rates to measure the service cost and interest cost components for net periodic benefit cost. Holding other assumptions constant, a 0.5% decrease in the discount rate on the obligation balance as of December 31, 2022, would increase annual pension and other postretirement cost by approximately $1.9 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. MGE utilizes mortality tables and projection scales developed by the society of actuaries. These tables and scales were last updated in 2021.

See Footnote 11 of the Notes to Consolidated Financial Statements in this Report 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. Future tax benefits are recognized to the extent that realization of such benefits is more likely than not. A valuation allowance is recorded for those benefits that do not meet this criterion. 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.

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