MGEE

Business Context and Reporting Period

This Form 10-K covers the fiscal year ended December 31, 2003, 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: electric utility operations, gas utility operations, and nonutility energy operations. The utility subsidiary, MGE, serves approximately 132,000 electric customers and 129,000 gas customers in south-central Wisconsin, primarily Dane County. The nonutility segment focuses on the construction of the West Campus Cogeneration Facility (WCCF) at the University of Wisconsin-Madison.

Key Financial Metrics

Capitalization Ratios (2003): Common shareholders' equity represented 50.9% of total capitalization, while long-term debt represented 43.0%.

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenues increased 15.7% to $401.5 million. This was driven by a 30.9% increase in gas revenues (due to higher gas costs passed through to customers and colder weather) and a 7.4% increase in electric revenues (due to rate increases). Electric retail sales volume declined slightly due to cooler-than-normal summer weather.
• Expense Increases: Operating expenses rose significantly, primarily due to higher fuel costs for electric generation ($3.3 million increase) and purchased power ($4.9 million increase). Operations and maintenance expenses increased due to higher employee benefit costs (pensions and health care) and transmission costs.
• Capital Expenditures: Total capital expenditures were $83.0 million in 2003, an increase from $77.0 million in 2002. A significant portion ($28.3 million) was allocated to the nonutility WCCF project, compared to $18.9 million in 2002.
• Debt Structure: Long-term debt increased by approximately $10 million, largely due to the consolidation of MGE Power West Campus debt ($30 million) related to the WCCF project, partially offset by refinancing activities that lowered interest costs.

Guidance, Outlook, and Risks

Outlook and Projects:

• WCCF Project: Construction of the 150-MW cogeneration facility is underway, with completion expected in spring 2005. Total project cost is estimated at $180 million. MGE Power West Campus has incurred $48.6 million in costs as of year-end 2003.
• Power the Future: MGE holds an option to acquire an interest in new coal-fired plants. If fully exercised, MGE Energy's share of capital costs is estimated at $175 million, with operations expected to begin in 2009 and 2010.
• Capital Needs: Management anticipates a need for additional equity capital in 2004 beyond amounts raised through the Dividend Reinvestment Plan, alongside short- and long-term borrowings to support WCCF construction.

• Regulatory and Environmental: MGE faces potential increased capital and operating expenses due to EPA regulations, including the NOx SIP Call, proposed utility MACT standards (mercury limits), and the Interstate Air Quality Rule. Compliance with these rules could impact the Blount and Columbia plants.
• Legal Proceedings: A citizen group (WELA) filed a Clean Water Act suit regarding alleged violations at the Columbia plant (operated by Alliant). MGE is not a named party but is a joint owner. Additionally, a citizen group (FORE) filed a petition challenging approvals for the WCCF project; management believes this is unlikely to cause material adverse changes.
• Weather Sensitivity: Revenues are sensitive to weather conditions. Gas margins are at risk during warmer-than-normal winters, while electric revenues are sensitive to summer cooling demand.
• Construction Risk: MGE Energy guarantees MGE Construct's obligations for the WCCF project, including potential liquidated damages for delays or failure to meet capacity guarantees.

Investor Verification Checklist

• WCCF Construction Progress: Verify the timeline and cost status of the West Campus Cogeneration Facility, as delays could trigger liquidated damages and impact cash flow.
• Environmental Compliance Costs: Monitor the finalization of EPA rules (MACT, NOx SIP Call) to assess potential capital expenditure requirements for the Blount and Columbia plants.
• Rate Case Outcomes: Track PSCW rate orders, specifically the recovery of fuel costs and the impact of the fuel credit mechanism on future margins.
• Debt Covenants: Review MGE's dividend restrictions tied to its common equity ratio (must remain above 55% to avoid dividend caps) and First Mortgage Bond covenants.
• Legal Status: Monitor the status of the WELA lawsuit regarding Columbia plant violations and the FORE challenge to WCCF approvals.