MGEE

Business Context and Reporting Period

This Form 10-Q is a combined quarterly report for MGE Energy, Inc. (MGE Energy) and its principal subsidiary, Madison Gas and Electric Company (MGE), for the period ended September 30, 2009. 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 customers and 141,000 gas customers. The report includes unaudited consolidated financial statements and management discussion.

Key Financial Metrics (Nine Months Ended Sept 30, 2009)

Note: Working capital is calculated as Current Assets ($137,764) less Current Liabilities ($157,623). MGE Energy maintains a working capital deficit, partly due to funding capital commitments for the Elm Road project with short-term debt.

Material Changes vs. Prior Period

• Revenue Decline: Total operating revenues decreased 9.7% year-over-year. Electric revenues fell 4.7% and gas revenues fell 18.5%.
  • Electric: Driven by a 4.6% decrease in retail sales volume due to colder-than-normal weather (31% fewer cooling degree days) and reduced economic activity. Rate changes also reduced revenue by $6.0 million due to a PSCW-authorized rate decrease and a fuel credit.
  • Gas: Driven by a 20.6% decrease in the average retail rate per therm due to significantly lower natural gas commodity costs, partially offset by a 2.2% increase in retail gas deliveries.
• Net Income Decline: Net income decreased 9.9% to $37.6 million. This was primarily due to lower revenues and the absence of a $2.8 million pretax gain on the sale of investments recognized in the prior year.
• Operating Cash Flow Increase: Cash provided by operating activities increased significantly by $45.7 million to $104.2 million. This was primarily attributable to favorable working capital changes, including decreased inventory (due to lower gas costs), lower accounts receivable, and reduced collateral postings in the derivative portfolio.
• Capital Expenditures: Capital expenditures decreased $30.9 million to $54.1 million, reflecting lower construction activity on the Elm Road project and the completion of the Top of Iowa III wind project in early 2008.

Guidance, Outlook, Risks, and Unusual Items

• 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 generating station, transmission enhancements, and gas infrastructure.
• Elm Road Construction Claim: The contractor, Bechtel, has filed a claim for approximately $32.5 million in cost relief and schedule relief for the Elm Road generating units. The matter is in binding arbitration, expected to conclude in 2010 or early 2011. MGE believes the claims are without merit.
• Environmental Risks:
  • Columbia Station: MGE's share of capital expenditures for an emissions reduction project is estimated at $140 million. A lawsuit by the Sierra Club alleges Clean Air Act violations, which could result in penalties and increased costs.
  • Regulatory Changes: Potential impacts from EPA reconsideration of ozone standards, proposed NO2 standards, and the development of Maximum Achievable Control Technology (MACT) standards remain uncertain but could increase capital and operating expenditures.
• Restructuring: MGE plans to discontinue coal use at the Blount Station by the end of 2011. Due to reliability requirements from MISO, the retirement of 90 MW of generation equipment has been delayed, though the transition to natural gas remains on schedule.
• Derivatives: As of September 30, 2009, MGE held a ten-year purchased power agreement with a fair value loss position of $12.6 million, which is deferred as a regulatory liability.

Investor Verification Checklist

• Elm Road Arbitration Outcome: Verify the final ruling on Bechtel's cost and schedule claims and the potential impact on construction costs and rate recovery.
• 2010 Rate Approval: Monitor the PSCW's decision on the requested 4.5% electric and 2.3% gas rate increases for 2010.
• Environmental Compliance Costs: Track the final costs and regulatory approval for the $140 million Columbia emissions reduction project and the outcome of the Sierra Club lawsuit.
• Weather Sensitivity: Assess the impact of weather variability on future sales volumes, particularly given the significant revenue decline in Q3 2009 due to cold weather.
• Working Capital Position: Monitor the company's ability to manage its working capital deficit and liquidity needs as the Elm Road project nears completion.