MGEE

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2005, for MGE Energy, Inc. (MGE Energy) and its principal subsidiary, Madison Gas and Electric Company (MGE). MGE Energy is a holding company operating through three segments: electric utility operations, gas utility operations, and nonregulated energy operations. MGE serves approximately 134,000 electric customers and 133,000 gas customers in Wisconsin. The report highlights the commercial operation of the West Campus Cogeneration Facility (WCCF) beginning April 26, 2005, and the subsequent acquisition of an 8.33% interest in the Elm Road Generating Station.

Key Financial Metrics (Nine Months Ended Sept 30, 2005)

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 15.0% year-over-year. Electric revenues rose 36.4% in the third quarter and 21.8% for the nine months, driven by rate increases approved in 2005 and warmer weather (increased cooling degree days).
• Profitability Decline: Net income decreased 18.0% for the nine months ended September 30, 2005. This was primarily due to a substantial increase in fuel and purchased power costs caused by natural disasters in the Gulf of Mexico, which impacted natural gas prices.
• Expense Increases: Fuel for electric generation increased 42.1% and purchased power expenses increased 60.6% for the nine-month period. Operating expenses rose due to higher transmission and production costs.
• Capital Expenditures: Capital spending decreased significantly to $45.3 million from $69.7 million in the prior year, largely due to the completion of major construction phases for the WCCF and reduced advances to American Transmission Company (ATC).

Guidance, Outlook, and Risks

• Fuel Cost Outlook: Management expects higher fuel and purchased power costs to continue into the fourth quarter of 2005. Costs exceeded the regulatory "fuel rules" bandwidth by approximately $4.6 million in September. MGE has filed for a fuel surcharge to recover these costs, estimating an additional $5.9 million in excess costs for Q4 absent a surcharge.
• Capital Requirements: Total 2005 capital expenditures are anticipated to be approximately $87.5 million. Remaining commitments for the WCCF are estimated at $2.5 million.
• Elm Road Acquisition: MGE Power Elm Road exercised an option to acquire an 8.33% interest in two new coal-fired generating units. The estimated capital cost share is approximately $190 million, with significant costs expected in 2006 and 2007.
• Key Risks:
  • Weather: Warmer-than-normal weather reduces gas demand and margins.
  • Regulatory: Reliance on PSCW approval for rate increases and fuel surcharges to recover rising commodity costs.
  • Commodity Prices: Exposure to volatile natural gas and coal prices, partially mitigated by fuel rules and risk management derivatives.

Investor Verification Checklist

• Fuel Surcharge Approval: Verify the status and amount of the fuel surcharge application filed with the PSCW to offset Q4 fuel cost overruns.
• Elm Road Financing: Confirm the financing structure and capital contribution schedule for the $190 million Elm Road Generating Station investment.
• WCCF Revenue Recognition: Review the timing of revenue recognition for the West Campus Cogeneration Facility lease payments and carrying costs.
• ATC Investment: Monitor the status of voluntary capital contributions to American Transmission Company (ATC) and the impact on equity earnings.
• Weather Derivatives: Assess the effectiveness of weather derivative contracts entered in October 2005 to hedge against heating degree day volatility.