MGEE

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2003, for MGE Energy, Inc. (MGE Energy) and its principal subsidiary, Madison Gas and Electric Company (MGE). MGE Energy operates as a holding company with no significant operations beyond MGE. MGE provides regulated electric service to nearly 130,000 customers in Dane County, Wisconsin, and natural gas service to over 126,000 customers across seven Wisconsin counties. The company is currently developing the West Campus Cogeneration Facility (WCCF) on the University of Wisconsin-Madison campus.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 30.7% to $128.5 million. Electric revenues rose 10.4% due to rate increases, customer growth, and higher sales for resale. Gas revenues surged 52.6% primarily due to a 42.7% increase in the average cost of natural gas passed through to customers and a 20.1% increase in retail gas deliveries driven by colder-than-normal weather.
• Profitability Decline: Despite revenue growth, Net Income decreased 15.0% to $9.4 million. Operating Income fell 13.9% to $17.5 million. The decline was driven by a significant increase in fuel and purchased power costs (natural gas prices) and higher operating and maintenance expenses ($5.3 million increase), which outpaced revenue gains in the electric segment.
• Capital Expenditures: Investing cash outflows increased significantly to $29.8 million (from $10.3 million), largely due to $16.1 million in expenditures for the West Campus Cogeneration Facility (WCCF) and $5.1 million for utility plant additions including an automated meter reading (AMR) system.
• Liquidity: Cash and cash equivalents increased to $18.0 million from $3.0 million, supported by strong operating cash flows of $46.6 million.

Guidance, Outlook, and Risks

• Rate Matters: Effective March 1, 2003, the Public Service Commission of Wisconsin (PSCW) authorized a 9.1% increase in electric rates and a 5.4% increase in gas rates to cover rising fuel costs and system upgrades. A 12.3% return on common stockholder equity was authorized.
• Capital Requirements: MGE Energy estimates 2003 capital commitments for the WCCF at $74.1 million. Total 2003 capital expenditures for MGE are anticipated to be $51.6 million. The company filed a $200 million shelf registration statement to finance future capital needs.
• Regulatory and Environmental Risks:
  • WCCF Approvals: The WCCF project requires state and PSCW approvals. Failure to obtain these could result in the write-off of $35.0 million in costs incurred to date.
  • Environmental Compliance: Potential costs associated with new EPA ozone standards, utility MACT standards (mercury, particulate limits), and Wisconsin mercury emission reduction rules may increase future capital and operating expenses.
  • Weather: Gas margins are sensitive to weather volatility; warmer-than-normal weather could reduce gas margins.
• Accounting Changes: The company adopted SFAS No. 143 (Asset Retirement Obligations) effective January 1, 2003, recording a liability of approximately $1.3 million.

Investor Verification Checklist

• WCCF Project Status: Verify the timeline and likelihood of obtaining necessary PSCW and State approvals for the West Campus Cogeneration Facility to avoid potential write-offs of $35 million in capitalized costs.
• Commodity Price Exposure: Monitor natural gas price trends, as the company's electric fuel costs and purchased power expenses are heavily correlated with gas prices, impacting margins despite pass-through mechanisms.
• Environmental Compliance Costs: Assess the potential financial impact of upcoming EPA and Wisconsin DNR regulations regarding mercury emissions and ozone standards on future capital expenditures.
• Rate Case Outcomes: Confirm the implementation of the March 2003 rate increases and monitor for any future regulatory actions regarding cost recovery for the WCCF and environmental upgrades.
• Debt Financing: Track the utilization of the $200 million shelf registration and the company's ability to maintain its current credit ratings (S&P AA/A1+, Moody's Aa2/P1) given the increased capital spending.