MGEE

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2004, for MGE Energy, Inc. (MGE Energy) and its wholly-owned subsidiary, Madison Gas and Electric Company (MGE). MGE Energy is a holding company operating in three segments: electric utility, gas utility, and non-regulated energy operations. MGE serves approximately 132,000 electric and 129,000 gas customers in south-central Wisconsin. A significant portion of the company's current capital activity is focused on the construction of the West Campus Cogeneration Facility (WCCF) at the University of Wisconsin-Madison.

Key Financial Metrics (Nine Months Ended Sept 30, 2004)

Note: Figures represent MGE Energy consolidated results. MGE (the utility subsidiary) reported Net Income of $27,405 thousand for the nine-month period.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 2.8% year-over-year. Regulated utility revenues rose to $305.49 million, driven by rate increases approved by the Public Service Commission of Wisconsin (PSCW) to cover fuel costs and system demands, partially offset by volume declines due to milder weather.
• Profitability: Net income increased 13.5% to $28.7 million. The effective income tax rate decreased to 37.9% from 39.7%, attributed to the Medicare Part D federal subsidy and a favorable tax contingency resolution.
• Capital Structure: Shareholders' equity increased significantly by $67.9 million, primarily due to a $39.0 million common stock offering in September 2004 and proceeds from the Dividend Reinvestment Plan. This equity was used to repay short-term borrowings related to WCCF construction.
• Operating Expenses: Total operating expenses increased to $256.4 million. Natural gas purchased costs rose $1.4 million due to higher commodity prices, despite a decrease in volume. Electric fuel costs increased $2.0 million due to higher rates and increased internal generation.
• Cash Flow: Cash provided by operating activities decreased $12.9 million to $62.6 million, largely due to a decrease in unbilled and billed receivables reflecting lower retail sales volumes.

Guidance, Outlook, and Risks

• WCCF Project: The West Campus Cogeneration Facility is expected to be completed by spring 2005. Total estimated cost is $185 million, with $84.9 million incurred as of September 30, 2004. Remaining capital commitments are estimated at $20.1 million. The project exposes the company to liquidated damages if construction is delayed or fails to meet capacity guarantees.
• Rate Matters: MGE filed a request in May 2004 for an 8.5% electric rate increase and a 1.0% gas rate decrease. An order is expected in early 2005. Additionally, a fuel credit refund of approximately $1.3 million was recorded in Q3 2004 pending final PSCW determination.
• Regulatory and Environmental Risks:
  • Environmental Compliance: Potential costs associated with new EPA rules (Clean Air Interstate Rule, MACT standards) and state mercury emission reductions could increase capital and operating expenses at the Blount and Columbia plants.
  • Legal Proceedings: A settlement of $150,000 was reached regarding water quality violations at the Columbia plant (MGE's 22% share recorded as a liability).
  • Weather Sensitivity: Revenues are sensitive to weather conditions; milder summers reduced electric cooling demand, while warmer winters reduced gas heating demand.
• Power the Future: MGE holds an option to acquire an interest in new coal-fired generation units. A decision on exercising this option is anticipated by mid-2005. If exercised, capital costs could reach $183 million.

Investor Verification Checklist

• WCCF Construction Status: Verify the timeline and cost adherence for the West Campus Cogeneration Facility, given the risk of liquidated damages for delays.
• Rate Case Outcome: Monitor the PSCW order expected in early 2005 regarding the requested 8.5% electric rate increase.
• Fuel Credit Resolution: Confirm the final determination of the fuel credit refund amount currently estimated at $1.3 million.
• Environmental Liabilities: Assess the potential financial impact of pending EPA regulations (MACT, Clean Air Interstate Rule) on capital expenditures for the Blount and Columbia plants.
• Power the Future Decision: Track the mid-2005 decision regarding the option to invest in We Energies' coal-fired generation units.