MGEE

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 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 three segments: regulated electric utility operations, regulated gas utility operations, and nonregulated energy operations. The nonregulated segment is currently focused on the development of the West Campus Cogeneration Facility (WCCF) and does not yet generate revenue. MGE serves approximately 130,000 electric customers and 126,000 gas customers in Wisconsin.

Key Financial Metrics (Six Months Ended June 30, 2003)

Material Changes vs. Prior Period

• Revenue Growth: Consolidated revenues increased 22.6% year-over-year. Electric revenues rose 9.0% due to rate increases effective March 1, 2003, and higher sales for resale. Gas revenues surged 44.0% driven by a 41.9% increase in the average cost of natural gas and higher retail deliveries due to colder weather in Q1.
• Expense Increases: Natural gas purchased costs jumped 61.6% ($24.8 million) due to higher commodity prices. Other operations and maintenance expenses increased 21.0%, primarily due to higher transmission wheeling costs, employee health/pension expenses, and maintenance.
• Depreciation: Depreciation expense decreased 19.1% ($2.8 million) largely due to reduced decommissioning expenses following the sale of the Kewaunee Nuclear Power Plant interest.
• Capital Spending: Capital expenditures more than doubled to $56.4 million, with $29.7 million allocated to the WCCF project.
• Liquidity: Cash and cash equivalents improved significantly to $10.3 million from $0.7 million at the end of 2002, supported by strong operating cash flows.

Guidance, Outlook, and Risks

• Rate Matters: On May 30, 2003, MGE filed a request with the Public Service Commission of Wisconsin (PSCW) for a 7.7% electric rate increase and a 1.9% gas rate increase to cover rising fuel costs and system upgrades. An order is expected in early 2004.
• WCCF Project: The $180 million West Campus Cogeneration Facility is in the pre-construction stage. As of June 30, 2003, $48.5 million in costs have been incurred. The project faces regulatory approval risks; failure to obtain approvals could result in a write-off of these costs.
• Environmental Compliance: MGE faces potential capital and operating cost increases related to EPA ozone standards, utility MACT standards, and Wisconsin mercury emission reduction rules. Compliance deadlines range from 2007 to 2015.
• Fuel Credit: A subsequent event noted that MGE notified the PSCW on July 29, 2003, that fuel costs were below the 3% bandwidth, triggering a fuel credit to customers. The amount has not yet been set.
• Market Risks: The company is exposed to commodity price volatility (natural gas, electricity), weather sensitivity (cooling/heating degree days), and interest rate fluctuations on variable-rate debt.

Investor Verification Checklist

• WCCF Regulatory Approval: Verify the status of PSCW and State of Wisconsin approvals for the West Campus Cogeneration Facility, as delays could impact capital recovery and project viability.
• Rate Case Outcome: Monitor the PSCW decision on the May 2003 rate increase request, which is critical for offsetting rising fuel and transmission costs.
• Environmental Capital Requirements: Assess the potential financial impact of upcoming EPA and state environmental mandates (ozone, MACT, mercury) on future capital expenditures.
• Fuel Cost Volatility: Track natural gas price trends and the implementation of the subsequent fuel credit to customers, which could impact near-term margins.
• Debt Maturities and Ratings: Review MGE's credit ratings (currently AA/Aa2) and the company's ability to refinance debt, particularly given the increased short-term borrowing to fund WCCF.