MGEE

Business Context and Reporting Period

This Form 10-K covers the fiscal year ended December 31, 2004, for MGE Energy, Inc. (MGE Energy) and its wholly-owned subsidiary, Madison Gas and Electric Company (MGE). MGE Energy operates as a holding company with three segments: regulated electric utility operations, regulated gas utility operations, and nonregulated energy operations. The utility operations serve approximately 134,000 electric and 133,000 gas customers in south-central Wisconsin. The nonregulated segment focuses on the construction of the West Campus Cogeneration Facility (WCCF) at the University of Wisconsin-Madison.

Key Financial Metrics (2004)

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenues increased 5.5% to $424.9 million from $402.6 million in 2003. Electric revenues rose 3.6% due to rate increases covering fuel costs and a 1.6% increase in retail sales volume. Gas revenues increased 7.5% driven by rate hikes, despite a 4.2% decline in retail deliveries due to warmer weather.
• Profitability: Net income increased 10.4% to $33.8 million ($1.77 per share) from $30.6 million ($1.71 per share) in 2003. This was aided by lower pension expenses, lower transmission costs, and reduced interest expense due to lower debt levels in the latter half of the year.
• Capital Expenditures: Total capital expenditures were $95.7 million, a significant increase from $83.0 million in 2003. This was primarily driven by $47.0 million in spending on the WCCF project.
• Financing: MGE Energy completed an equity offering in September 2004, selling 1.265 million shares for net proceeds of approximately $39.0 million, which were used to repay short-term borrowings.

Guidance, Outlook, and Risks

• WCCF Project: The West Campus Cogeneration Facility is expected to be completed in the second quarter of 2005. Total construction costs are estimated at $185 million. MGE Power West Campus has incurred $95.7 million as of year-end. The project carries risks regarding cost overruns and liquidated damages if construction milestones are missed.
• Power the Future: MGE holds an option to acquire an 8.33% interest in two new coal-fired units. A decision to exercise this option is expected in Q2 2005, pending a final ruling by the Wisconsin Supreme Court regarding the project's authorization, which was vacated by a lower court in late 2004.
• Regulatory Environment: The Midwest ISO is implementing a bid-based energy market and Locational Marginal Pricing (LMP) system in April 2005. The financial impact of this transition on MGE is currently unknown.
• Environmental Compliance: MGE faces potential capital and operating cost increases due to EPA regulations on SO2, NOx, and mercury emissions. The company is also subject to cleanup costs at the Lenz Oil Site (estimated $0.1M - $0.3M) and coal tar remediation at the Blount substation.
• Weather Risk: Gas margins are sensitive to heating degree days. MGE utilizes weather derivatives (HDD Collar) to hedge against volatility, with a maximum exposure of $1.0 million.

Investor Verification Checklist

• WCCF Completion Status: Verify the project remains on schedule for Q2 2005 completion and monitor for any cost overruns or liquidated damages.
• Power the Future Litigation: Track the Wisconsin Supreme Court ruling expected in Q2 2005 regarding the coal plant authorization, which dictates MGE's potential $183 million capital commitment.
• Midwest ISO Implementation: Assess the financial impact of the new LMP congestion pricing system implemented in April 2005.
• Dividend Restrictions: Confirm MGE's common equity ratio remains above the 55% threshold required by the PSCW to maintain unrestricted dividend payments to the parent company.
• Environmental Liabilities: Monitor final EPA rules on mercury emissions and the status of the Lenz Oil Site cleanup to ensure cost estimates remain accurate.