MGE ENERGY INC quarterly report, Q2 FY2011

Business context and reporting period

MGE Energy, Inc. filed this unaudited combined Form 10-Q with its wholly owned utility subsidiary, Madison Gas and Electric Company (MGE), for the quarter and six months ended June 30, 2011. MGE is the group’s principal electric and gas utility; other operations include nonregulated generation and an investment in American Transmission Company (ATC). Unless specified, financial amounts below are for consolidated MGE Energy and are in millions of dollars.

Financial performance and position

For the six months, cash from operations was $67.4 million, investing cash use was $31.2 million, and financing cash use was $11.3 million. Capital expenditures were $28.6 million; cash dividends paid were $17.3 million. Cash and equivalents at June 30 were $32.1 million, versus $7.1 million at year-end 2010. Current assets were $157.8 million and current liabilities $52.3 million. Long-term debt was $362.2 million, plus $2.7 million due within one year; short-term debt was zero, down from $22.5 million at year-end. Equity was $538.3 million, and long-term debt represented 40.4% of capitalization, versus 38.0% at year-end.

Material changes and management commentary

• Six-month electric retail sales volumes rose 1.1%; gas deliveries rose 15.5%, primarily reflecting colder weather. April heating degree days were 50% higher year over year.
• Elm Road Unit 2 entered commercial operation in January 2011, supporting higher nonregulated energy revenue, alongside higher generation-related depreciation and interest costs.
• Gas utility revenue rose 5.8% for the six-month period as higher deliveries more than offset lower average gas rates. Electric revenue increased 4.4%, reflecting rate changes and sales growth.
• Management attributed stronger operating cash flow partly to higher earnings and lower taxes paid following tax accounting changes and bonus depreciation. Pension and postretirement contributions used $19.9 million, $9.4 million more than in the prior-year period.
• The 2010 comparison included a one-time $2.6 million pretax gain on a property sale to ATC. A $0.5 million second-quarter compensation charge followed an amendment to the performance-unit plan.

Outlook, risks and contingencies

• MGE requested PSCW approval for 2012 rate changes that would increase electric rates 4.9% and gas rates 1.2%, effective January 1, 2012. These increases were requested, not approved. MGE had already received authorization for 2011 retail rate increases of 2.3% for electric and 1.0% for gas.
• The PSCW authorized Columbia air-emissions control work; MGE estimates its share of capital expenditures at approximately $140 million over 2011–2014. Management expects recovery through rates, but this is subject to regulatory treatment.
• Management expects CSAPR-related capital investment or modifications to be significant and anticipates higher power-plant emissions control costs in 2012. Other developing air and water rules could also increase operating costs or capital needs.
• MGE faces Clean Air Act claims concerning Columbia. Potential remedies could include penalties, pollution controls, operating restrictions, or other costs; MGE said it could not predict the outcome and an adverse result could have a significant effect.
• A ten-year purchased power agreement beginning in 2012 had a $23.6 million fair-value loss, deferred through regulatory accounting. If MGE’s credit rating falls below investment grade after purchases begin, the agreement could require $20–$40 million of collateral.
• Other exposures include proposed coal-ash rules, cooling-water and mercury limits, and uncertainty over phosphorus requirements. The filing says the potential costs of several proposed requirements cannot yet be estimated clearly.
• MGE reported $2.7 million of electric fuel-related costs deferred under the PSCW’s 2011 fuel rules. The gas purchased-cost adjustment had an overcollection of $1.6 million at June 30.
• On August 1, 2011, revolving credit agreements were amended to extend their termination date to July 31, 2015, and reduce certain fees and rate adders. The facilities are $40 million for MGE Energy and $75 million for MGE.

Most important facts for investors to verify

• Whether the PSCW approves the requested 2012 rate increases and how fuel-cost deferrals will be resolved through customer rates.
• Final Columbia project costs, timing, rate recovery, and the outcome or potential remedies of the Columbia permitting litigation.
• Actual costs and operating impacts of CSAPR and other environmental rules, including the expected 2012 increase in emissions-control costs.
• Whether operating cash generation can support planned capital investment, pension contributions, dividends, and the Columbia project without materially increasing debt.
• How the $23.6 million PPA fair-value loss, potential collateral requirements, and regulatory deferral evolve as the agreement approaches its 2012 start.