MGEE

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2009, for MGE Energy, Inc. (MGE Energy) and its principal subsidiary, Madison Gas and Electric Company (MGE). MGE Energy is an investor-owned public utility holding company operating in Wisconsin through five segments: electric utility, gas utility, nonregulated energy, transmission investments, and all other. MGE serves approximately 137,000 electric and 141,000 gas customers.

Key Financial Metrics

Margins: Operating margin was approximately 13.4% in Q1 2009 compared to 12.8% in Q1 2008. The effective income tax rate for MGE Energy was 34.8% in Q1 2009, down from 35.5% in Q1 2008, primarily due to increased federal tax credits for wind energy production.

Material Changes vs. Prior Period

• Revenue Decline: Total operating revenues decreased 4.7% to $181.1 million. Electric revenues fell 2.8% due to lower demand and decreased sales for resale. Gas revenues decreased 6.3% driven by lower retail deliveries and reduced gas costs.
• Profit Growth: Despite lower revenues, Net Income increased 8.1% to $15.0 million. This was driven by a significant 39.0% decrease in fuel for electric generation expenses ($6.3 million reduction) and a 9.8% decrease in the cost of gas sold ($7.6 million reduction).
• Capital Expenditures: Capital expenditures decreased 34.7% to $18.6 million, primarily due to reduced construction activity on the Elm Road generating units and the completion of the Top of Iowa III wind project in the prior year.
• Debt Reduction: Short-term debt decreased by $25.5 million during the quarter, reflecting a net repayment of commercial paper.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Rate Filings: In April 2009, MGE filed an application with the Public Service Commission of Wisconsin (PSCW) requesting a 4.5% increase in electric rates and a 2.3% increase in gas rates for 2010 to cover costs for the Elm Road station, transmission enhancements, and gas infrastructure.
• Fuel Credit: MGE filed for a proposed fuel credit of $0.00204 per kWh in April 2009 due to lower-than-expected fuel costs, which could reduce 2009 electric revenues by an estimated $4.6 million if approved.
• Elm Road Project: Construction continues on the Elm Road generating units. The contractor, Bechtel, has filed claims for cost and schedule relief totaling approximately $485 million (MGE's share estimated at $40.4 million). MGE disputes these claims, and the matter is expected to proceed to mediation and potentially binding arbitration in 2010.

Risks and Contingencies

• Environmental Regulations: Significant uncertainty exists regarding future costs related to the Clean Air Mercury Rule (CAMR) vacatur and potential Maximum Achievable Control Technology (MACT) standards. MGE estimates its share of capital expenditures for an emissions reduction project at the Columbia facility to be approximately $140 million.
• Weather Sensitivity: Revenues are sensitive to weather conditions. Q1 2009 heating degree days were 5.0% lower than the prior year, impacting gas sales.
• Working Capital: MGE Energy reported a working capital deficit as of March 31, 2009, largely due to funding the Elm Road project with short-term debt.

Investor Verification Checklist

• Elm Road Claims: Verify the status of the dispute with Bechtel regarding the $40.4 million potential cost claim and the likelihood of cost recovery through rates.
• Regulatory Approvals: Monitor the PSCW's decision on the proposed 2010 rate increase and the 2009 fuel credit application.
• Environmental Compliance Costs: Assess the final impact of EPA MACT standards and the $140 million Columbia emissions project on future capital requirements.
• Debt Structure: Review the company's strategy for converting short-term debt used for Elm Road construction into long-term financing to address the working capital deficit.
• Wind Tax Credits: Confirm the sustainability of the wind energy tax credits that contributed to the lower effective tax rate in Q1 2009.