MGEE

Business Context and Reporting Period

This Form 10-K covers the fiscal year ended December 31, 2007, for MGE Energy, Inc. (MGE Energy) and its principal subsidiary, Madison Gas and Electric Company (MGE). MGE Energy is a holding company operating in five segments: electric utility, gas utility, nonregulated energy operations, transmission investments, and all other. MGE serves approximately 136,000 electric customers and 140,000 gas customers in south-central Wisconsin, primarily in Dane County. The company is regulated by the Public Service Commission of Wisconsin (PSCW) and the Federal Energy Regulatory Commission (FERC).

Key Financial Metrics (2007)

Note: MGE Energy's net income includes minority interest adjustments not present in the MGE subsidiary statement. MGE's net income is reported after minority interest.

Material Changes vs. Prior Period (2006)

• Revenue Growth: Total operating revenues increased 5.9% to $537.6 million. Electric revenues rose 4.9% driven by a 2.8% increase in sales volume and rate adjustments (including fuel surcharges). Gas revenues increased 6.9% due to an 8.4% increase in deliveries, partially offset by lower gas costs.
• Profitability: Net income for MGE Energy increased 15.1% to $48.8 million ($2.27 per share) from $42.4 million ($2.06 per share) in 2006. Operating income rose 5.9% to $83.7 million.
• Expense Trends: Fuel for electric generation increased 15.2% due to higher internal generation volumes and per-unit costs. Purchased power expense remained relatively flat (up 0.6%) as higher per-unit costs were offset by lower volumes. Gas purchased costs increased 8.9% due to higher volumes.
• Capital Investment: Capital expenditures surged 47.2% to $136.3 million, primarily driven by construction of the Elm Road coal-fired generating units ($23.3 million) and the Top of Iowa III wind project ($25.8 million).
• Working Capital: Cash provided by operating activities decreased 24.5% to $76.6 million, largely due to increases in accounts receivable and unbilled revenues.

Guidance, Outlook, Risks, and Unusual Items

Management Commentary and Outlook

Management expects to continue maintaining a strong credit standing to fund capital projects. The company anticipates recovering costs for new generation projects (Elm Road and Top of Iowa III) through rates. A PSCW order issued in December 2007 authorized a 4.8% increase in electric rates and a 2.8% increase in gas rates for 2008 to cover new wind energy projects, transmission improvements, and accelerated costs to discontinue coal use at the Blount Station.

Key Risks and Contingencies

• Environmental Compliance: Significant capital expenditures ($130 million to $200 million share) are estimated for compliance with Clean Air Interstate Rule (CAIR) and Clean Air Mercury Rule (CAMR) at the Columbia plant. Costs are expected to be recoverable in rates.
• Regulatory Risk: The company faces risk regarding the recovery of fuel and purchased power costs if they exceed base rates. The PSCW established a +/- 2% fuel rules bandwidth effective January 1, 2008.
• Construction Risk: The Elm Road project faces potential cost overruns and permitting delays, specifically regarding the Wisconsin Pollution Discharge Elimination System (WPDES) permit for water intake, which is under administrative review.
• Weather Sensitivity: Revenues are sensitive to cooling degree days (electric) and heating degree days (gas). 2007 saw higher cooling degree days (22.6% above normal) and heating degree days (6.4% above normal) compared to 2006.

Unusual Items

• Fuel Credits/Refunds: In 2006, MGE recorded a $19.1 million reduction to revenues due to a PSCW-ordered fuel credit and refund provision. In 2007, a $1.3 million refund was applied to customer accounts related to an interim fuel surcharge.
• Restructuring: MGE announced a plan to discontinue coal use at the Blount Station by 2011, resulting in severance costs and a reduction in capacity from 190 MW to 100 MW.

Investor Verification Checklist

• Capital Project Costs: Verify the final cost estimates and completion timelines for the Elm Road coal units and Top of Iowa III wind project, given the significant increase in capital expenditures.
• Environmental Compliance Costs: Monitor the actual capital expenditures required for CAIR and CAMR compliance at the Columbia plant against the $130M-$200M estimate.
• Regulatory Rate Recovery: Confirm the implementation of the 2008 rate increases authorized by the PSCW and the status of the fuel rules bandwidth.
• WPDES Permit Status: Track the resolution of the WPDES permit contest for the Oak Creek/Elm Road facility, as this could impact construction schedules and costs.
• Debt Maturities: Note the $30 million medium-term note maturing in 2008 and the company's plan to refinance it with long-term debt.