MGEE

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2010, for MGE Energy, Inc. (MGE Energy) and its principal subsidiary, Madison Gas and Electric Company (MGE). 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 138,000 electric and 142,000 gas customers. The report is unaudited but includes all normal recurring adjustments.

Key Financial Metrics

Margins: Operating margin for Q1 2010 was approximately 13.6% ($21.8M / $159.6M), compared to 13.4% in Q1 2009. The effective income tax rate increased to 36.9% in Q1 2010 from 34.8% in Q1 2009.

Material Changes vs. Prior Period

• Revenue Decline: Total operating revenues decreased 11.9% year-over-year. This was primarily driven by a 22.5% drop in gas revenues due to milder weather (7.9% fewer heating degree days) and lower natural gas commodity costs. Electric revenues increased slightly by 2.3% due to rate increases, offsetting a 2.1% decline in sales volume.
• Cost Reductions: Cost of gas sold decreased $17.6 million due to lower gas prices and reduced volume. Purchased power expenses decreased $3.6 million, aided by the commercial operation of Elm Road Unit 1 in February 2010.
• One-Time Gain: Net income included a one-time $2.6 million gain from the sale of property to American Transmission Company (ATC) in March 2010.
• Cash Flow: Operating cash flow decreased significantly ($19.8 million) compared to the prior year, largely due to changes in working capital accounts (specifically prepaid taxes and unbilled revenues) and higher pension contributions ($2.1 million increase).

Guidance, Outlook, and Risks

• Rate Filing: On April 22, 2010, MGE filed an application with the Public Service Commission of Wisconsin (PSCW) requesting a 9.4% increase in electric rates and a 2.0% increase in gas rates, effective January 1, 2011. This is intended to recover costs for the Elm Road Units, environmental equipment at Columbia, and transmission enhancements.
• Elm Road Project: Unit 1 is operational; Unit 2 is expected to enter commercial operation in August 2010. MGE Power Elm Road issued $50 million in senior secured notes in February 2010 to refinance construction debt.
• Environmental Risks: Significant uncertainty exists regarding EPA and state regulations on air quality (Ozone, NO2, MACT standards), water quality (thermal discharge, phosphorus, mercury), and greenhouse gases. Compliance could require substantial capital expenditures, particularly at the Columbia and Blount stations. MGE expects to recover these costs through rates but cannot estimate the final amounts.
• Legal Proceedings: MGE faces a Notice of Violation from the EPA and a Notice of Intent to sue from the Sierra Club regarding alleged Clean Air Act violations at the Columbia plant. MGE is defending these actions but acknowledges potential penalties or remediation costs if claims are proven.
• Blount Station: MGE switched Blount's primary fuel from coal to natural gas in March 2010. While coal use will discontinue by end of 2011, MISO reliability requirements may delay capacity reduction until 2013.

Investor Verification Checklist

• Rate Case Outcome: Verify the PSCW's decision on the April 2010 rate filing requesting 9.4% electric and 2.0% gas increases.
• Elm Road Unit 2 Timeline: Confirm the August 2010 commercial operation date for Unit 2 and associated cost recovery mechanisms.
• Environmental Compliance Costs: Monitor final EPA rules on Ozone, NO2, and MACT standards to assess potential capital expenditure impacts on Columbia and Blount stations.
• Columbia Legal Resolution: Track the status of the EPA Notice of Violation and Sierra Club lawsuit regarding Columbia plant permitting.
• Weather Sensitivity: Assess the impact of weather variability on gas sales volumes, given the 12.2% volume decline in Q1 2010.