Business Context and Reporting Period
This Form 10-Q is a combined quarterly report for MGE Energy, Inc. (the holding company) and its principal subsidiary, Madison Gas and Electric Company (MGE), for the period ended September 30, 2008. MGE operates regulated electric and gas utilities in Wisconsin, serving approximately 136,000 electric and 140,000 gas customers. The company also maintains nonregulated energy operations, including the construction of the Elm Road generating facility, and holds a significant investment in American Transmission Company (ATC).
Key Financial Metrics (Nine Months Ended Sept 30, 2008)
| Metric | 2008 (in thousands) | 2007 (in thousands) |
|---|---|---|
| Total Operating Revenues | $440,540 | $394,754 |
| Net Income (MGE Energy) | $41,704 | $37,804 |
| Net Income (MGE Subsidiary) | $29,937 | $28,702 |
| Earnings Per Share (Basic/Diluted) | $1.89 | $1.77 |
| Operating Cash Flow | $58,516 | $68,557 |
| Capital Expenditures | ($84,949) | ($102,576) |
| Total Assets | $1,158,706 | $1,111,587 |
| Long-Term Debt | $272,393 | $232,346 |
| Short-Term Debt | $130,500 | $103,500 |
| Shareholders' Equity | $456,390 | $427,726 |
Effective Tax Rate: MGE Energy's effective tax rate for the nine months was 35.8%, down from 36.5% in 2007, primarily due to increased federal tax credits from the Top of Iowa III wind project.
Material Changes vs. Prior Period
- Revenue Growth: Total operating revenues increased 11.6% year-over-year. Electric revenues rose 3.7% due to a 4.8% rate increase approved in late 2007 and an interim fuel surcharge. Gas revenues surged 25.6% driven by a 13.8% increase in retail deliveries (colder weather) and higher commodity costs passed through to customers.
- Profitability: Net income for MGE Energy increased 10.3% to $41.7 million. The electric utility segment contributed $22.5 million, while the gas utility segment contributed $5.8 million, a 41.9% increase over the prior year.
- Cost Structure: Natural gas purchased expenses increased $25.8 million due to higher volumes and a 13.1% increase in cost per therm. Conversely, fuel for electric generation decreased slightly ($0.9 million) due to lower fuel costs and increased internal generation.
- Cash Flow: Operating cash flow decreased $10.0 million to $58.5 million, primarily due to changes in working capital, including higher restricted cash balances for margin calls and increased stored natural gas inventory.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary and Outlook
Management expects to maintain strong credit standing and financial strength. Capital requirements remain high, with $84.9 million in capital expenditures for the nine months, largely driven by the Elm Road project ($42.4 million). The company does not anticipate a need for further long-term financing until the third quarter of 2009.
Key Risks and Contingencies
- Elm Road Construction Delays: The contractor notified MGE in July 2008 that Unit 1 would be delayed by three months (to late 2009) due to severe weather and labor conditions. The contractor expects to submit claims for schedule extensions and cost relief. MGE has invoked the contractual dispute resolution process; the financial impact is currently undeterminable.
- Environmental Compliance: Significant capital expenditures ($130 million to $200 million share) are estimated for the Columbia plant to comply with environmental initiatives (mercury, NOx, SO2). Regulatory uncertainty remains regarding the Clean Air Interstate Rule (CAIR) and state mercury rules (NR 446).
- Market Conditions: Recent uncertainty in capital and credit markets poses risks regarding liquidity, counterparty creditworthiness, and the value of pension plan assets (which declined ~16% in the first nine months of 2008).
- Weather Derivatives: MGE incurred a $1.5 million expense in Q1 2008 related to a heating degree day collar due to colder-than-expected weather.
Investor Verification Checklist
- Elm Road Project Status: Verify the outcome of the dispute resolution process regarding construction delays and potential cost claims from the contractor.
- Environmental Capital Expenditures: Monitor the finalization of state mercury rules (NR 446) and the status of the Clean Air Interstate Rule (CAIR) to assess the accuracy of the $130M-$200M capital estimate for the Columbia plant.
- Fuel Surcharge Refunds: Confirm the year-end reconciliation of the interim fuel surcharge, as MGE has accrued a $3.2 million refund liability to customers if actual costs fall short of collected amounts.
- Pension Plan Funding: Assess the impact of the 16% decline in pension trust asset values on future required contributions and benefit costs.
- Working Capital Deficit: Review the company's strategy for managing the working capital deficit, which is currently funded largely by short-term debt for the Elm Road project.