MGEE

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2004, for MGE Energy, Inc. (MGE Energy) and its principal subsidiary, Madison Gas and Electric Company (MGE). MGE Energy is a holding company operating in three segments: electric utility operations, gas utility operations, and nonregulated energy operations. MGE serves approximately 132,000 electric and 129,000 gas customers in Wisconsin. The report highlights the ongoing construction of the West Campus Cogeneration Facility (WCCF), a 150-MW project on the University of Wisconsin-Madison campus.

Key Financial Metrics

Note: MGE Energy's effective income tax rate was 39.5% for Q1 2004.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 5.2% year-over-year. Electric revenues rose 6.8% due to a 3.2% increase in retail sales volume and rate adjustments, partially offset by a $3.1 million fuel credit refunded to customers. Gas revenues increased 3.2% driven by higher gas costs, despite a 5.1% decline in deliveries due to warmer weather (5.3% fewer heating degree days).
• Profitability: Net income increased 45.5% to $13.6 million. Operating income improved significantly due to lower purchased power costs ($2.4 million decrease) as MGE increased internal generation, and lower interest expenses.
• Cash Flow: Operating cash flow decreased 21.9% to $36.4 million, primarily due to a $24.2 million decrease in current assets (notably stored natural gas and prepaid taxes) and a $9.1 million decrease in current liabilities.
• Capital Spending: Capital expenditures decreased 38.6% to $18.3 million. This reduction is attributed to a decrease in WCCF-related spending compared to Q1 2003, where the State's portion was included, and a reduction in utility plant additions.

Guidance, Outlook, and Risks

• Capital Requirements: MGE Energy anticipates 2004 capital commitments for WCCF to be approximately $48.8 million. Total 2004 regulated capital expenditures for MGE are estimated at $45 million. The company plans to finance these through debt and equity, utilizing a $200 million shelf registration.
• Rate Matters: On May 5, 2004, MGE filed a request with the Public Service Commission of Wisconsin (PSCW) to increase electric rates by 8.5% and decrease gas rates by 1.0%. An order is expected in early 2005. A fuel credit of $4.4 million was refunded to customers through March 31, 2004.
• WCCF Project: Construction is ongoing with an estimated completion in spring 2005. Total project cost is estimated at $185 million. MGE Energy guarantees the construction obligations of MGE Construct, exposing it to liquidated damages if completion dates or capacity guarantees are not met.
• Regulatory and Environmental Risks:
  • Environmental Compliance: MGE faces potential costs related to EPA regulations on NOx, SO2, and mercury emissions. A citizen suit and state enforcement action regarding water quality violations at the Columbia plant (in which MGE holds a 22% interest) are ongoing, though management does not expect a material adverse effect.
  • Transmission: The Midwest ISO is developing a bid-based energy market with Locational Marginal Pricing (LMP), the financial impact of which is currently unknown.
• Weather Risk: Gas margins are sensitive to weather volatility. MGE utilizes weather derivatives to mitigate this risk.

Investor Verification Checklist

• WCCF Construction Status: Verify the project remains on schedule for spring 2005 completion and that cost overruns are within the $185 million estimate.
• Rate Case Outcome: Monitor the PSCW's decision on the May 2004 rate filing (8.5% electric increase, 1.0% gas decrease) expected in early 2005.
• Environmental Liabilities: Track the resolution of the Columbia plant water quality litigation and the potential financial impact of new EPA emission standards (NOx, SO2, Mercury).
• Capital Market Access: Confirm the company's ability to raise the necessary equity and debt capital for the $48.8 million WCCF commitment and $45 million regulated capex.
• Weather Sensitivity: Assess the impact of future weather deviations on gas delivery volumes and margins, given the 5.1% volume decline in Q1 2004.