United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended:

December 31, 20022003

[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from __________ to __________

Commission

File No.

Name of Registrant, State of Incorporation, Address

of Principal Executive Offices, and Telephone No.

IRS Employer

Identification No.

000-49965MGE Energy, Inc.

(a Wisconsin Corporation)
133 South Blair Street
Madison, Wisconsin 53703
(608) 252-7000

39-2040501
000-1125Madison Gas and Electric Company
(a Wisconsin Corporation)
133 South Blair Street
Madison, Wisconsin 53703
(608) 252-7000
39-0444025
www.mge.com and/or
www.mgeenergy.com

(Web Sitesites)

SECURITIES REGISTERED PURSUANT TO SECTION 12(B)12(b) OF THE ACT:

None
None.

SECURITIES REGISTERED PURSUANT TO SECTION 12(G)12(g) OF THE ACT:

Title of Class

MGE Energy, Inc.
Madison Gas and Electric Company
Common Stock, $1 Par Value Per Share
Cumulative Preferred Stock, $25 Par Value Per Share

Indicate by checkmark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports) and (2) have been subject to such filing requirements for the past 90 days. YesX No

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants' knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X

Indicate by checkmark whether the registrant is anregistrants are accelerated filerfilers (as defined in Rule 12b-2 of the Act).

MGE Energy, Inc. - Yes X
Madison Gas and Electric Company - No X

MGE Energy, Inc.
Madison Gas and Electric Company
Yes X No
Yes No X
State the

The aggregate market value of the voting and nonvoting common equity held by nonaffiliates of MGE Energy, Inc.each registrant as of June 30, 2002 (based upon the average of the bid and asked prices of common stock of Madison Gas and Electric Company, which2003, was MGE Energy's predecessor): $478,331,322as follows:

MGE Energy, Inc.$560,764,000
Madison Gas and Electric Company$0


The number of shares outstanding of each registrant's common stock as of March 1, 2003.2004, was as follows:

MGE Energy, Inc.
Madison Gas and Electric Company
18,441,740
17,347,889


MGE Energy, Inc. - 17,638,797
Madison Gas and Electric Company - 17,347,889

Documents Incorporated by Reference

Portions of MGE Energy, Inc.'s definitive Proxy Statementproxy statement to be filed prior to April 30, 2003,29, 2004, relating to its annual meeting of shareholders, are incorporated by reference into Part III of this annual report on Form 10-K.

Madison Gas and Electric Company meets the conditions set forth in General Instruction (I)(1)(a) and (b) of Form 10-K and is therefore omitting (i)(i.) the information otherwise required by Item 601 of Regulation S-K relating to a list of subsidiaries of the registrant as permitted by General Instruction (I)(2)(b), (ii) certain(ii.) the information otherwise required by Item 6 of Form 10-K relating to Selected Financial Data, (iii) certain(iii.) the information otherwise required by Item 10 of Form 10-K relating to Directors and Executive Officers as permitted by General Instruction (I)(2)(c), and (iv) certain(iv.) the information otherwise required by Item 11 of Form 10-K relating to executive compensation as permitted by General Instruction (I)(2)(c).

This combined Form 10-K is separately filed, (v.) the information otherwise required by MGE Energy, Inc. and Madison Gas and Electric Company. Information contained hereinItem 12 relating to any individual registrant is filedSecurity Ownership of Certain Beneficial Owners and Management, and (vi.) the information otherwise required by such registrant in its own behalf. Neither registrant makes any representation asItem 13 to information relating to the other registrant.Certain Relationships and Related Transactions.

Table of Contents

Filing Format

Forward-Looking Statements

Where to Find More Information

Definitions

PART I.

Item 1. Business.

Item 2. Properties.

Item 3. Legal Proceedings.

Item 4. Submission of Matters to a Vote of Security Holders.

PART II.

Item 5. Market for Registrant's Common Equity and Related ShareholderStockholder Matters.

Item 6. Selected Financial DataData.

Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

Item 8. Financial Statements and Supplementary Data.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

Item 9A. Controls and Procedures.

PART III.

Item 10. Directors and Executive Officers of the Registrants.

Item 11. Executive Compensation.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.Management.

Item 13. Certain Relationships and Related Transactions.

Item 14. ControlsPrincipal Accountant Fees and Procedures.Services.

PART IV.

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

Signatures - MGE Energy, Inc.

Signatures - Madison Gas and Electric Company

Certification Pursuant to Rule 13a-14 and 15d-14 of the Securities Exchange Act of 1934Filing Format

Item 1. Business.

This combined Form 10-K is being filed separately by MGE Energy, Inc. (MGE Energy), through its principal subsidiary and Madison Gas and Electric Company (MGE). MGE is a wholly owned subsidiary of MGE Energy and represents a substantial portion of its assets, liabilities, revenues, expenses, and operations. Thus, all information contained in this report relates to, and is filed by, MGE Energy. Information that is specifically identified in this report as relating solely to MGE Energy, such as its financial statements and information relating to its nonutility business, does not relate to, and is not filed by, MGE. MGE makes no representation as to that information.

Forward-Looking Statements

This report, and other documents filed by MGE Energy and MGE with the Securities and Exchange Commission (SEC) from time to time, contain forward-looking statements that reflect management's current assumptions and estimates regarding future performance and economic conditions--especially as they relate to future load growth, revenues, expenses, capital expenditures, financial resources, regulatory matters, and the scope and expense associated with future environmental regulation. These forward-looking statements are made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Both MGE Energy and MGE caution investors that these forward-looking statements are subject to known and unknown risks and uncertainties that may cause actual results to differ materially from those projected, expressed, or implied. Some of those risks and uncertainties include:

- Weather, which enters into the calculation of MGE's rates for service and which affects the demand for electricity and gas and the projected and actual need for electric generation capacity to serve customers.

- Economic and market conditions in MGE's service territory, which affect demand for electricity and gas and, consequently, our revenues and expenses as well as capital investment requirements to extend, improve, or reinforce the existing electricity and gas distribution systems.

- Magnitude and timing of capital expenditures, which affect capital needs, financing costs, and operating expenses.

- Regulatory environment in which we operate, which can affect the way in which we do business as well as the accounting treatment of expenses that we incur and our ability to continue carrying specified assets and liabilities on our books.

- Environmental regulation, which can affect the way in which we operate, our operating expenses, and our capital expenditures.

- Availability and cost of power supplies, which affect operating expenses and capital expenditure decisions with respect to sources of new generation.

- Completion of the West Campus Cogeneration Facility at the University of Wisconsin-Madison, which provides MGE Energy with an opportunity if construction is completed on or ahead of schedule, but exposes it to liquidated damages if construction is delayed or the facility fails to operate according to specifications.

Readers are cautioned not to place undue reliance on these forward-looking statements, which apply only as of the date of this report. MGE Energy and MGE undertake no obligation to publicly release any revision to these forward-looking statements to reflect events or circumstances after the date of this report.

Where to Find More Information

The public may read and copy any reports or other information that MGE Energy and MGE file with the SEC at the SEC's public reference room at 450 Fifth Street, NW, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. These documents are also available to the public from commercial document retrieval services, the Web site maintained by the SEC athttp://www.sec.gov, MGE Energy's Web site athttp://www.mgeenergy.com, and MGE's Web site athttp://www.mge.com. Copies may be obtained from our Web sites free of charge.

Definitions

Abbreviations, acronyms, and definitions used in the text and notes of this report are defined below.

AFUDCallowance for funds used during construction
AMRautomated meter reading
ANRANR Pipeline Company
APBAccounting Principles Board
ATCAmerican Transmission Company LLC
AlliantAlliant Energy Corporation
BlountBlount Station
CPCNCertificate of Public Convenience and Necessity
CO2carbon dioxide
ColumbiaColumbia Energy Center
cooling degree daysMeasure of the extent to which the average daily temperature is above 65 degrees Fahrenheit, increasing demand for cooling
DNRWisconsin Department of Natural Resources
DOAWisconsin Department of Administration
DOEU.S. Department of Energy
Dthdekatherms
EITFEmerging Issues Task Force
Electric Marginelectric revenues less fuel and purchased power
EPAU.S. Environmental Protection Agency
EPC AgreementEngineering, Procurement, and Construction Agreement
FASBFinancial Accounting Standards Board
FERCFederal Energy Regulatory Commission
FINFinancial Interpretation No.
FTRFinancial Transmission Rights
gas margingas revenues less gas purchased
GCIMgas cost incentive mechanism
interconnection agreementGeneration-Transmission Interconnection Agreement
heating degree daysMeasure of the extent to which the average daily temperature is below 65 degrees Fahrenheit, increasing demand for heating
KewauneeKewaunee Nuclear Power Plant
kVkilovolt
kWhkilowatt-hour
LMPLocational Marginal Pricing
MACTMaximum available control technology
MAINMid-America Interconnected Network, Inc.
MAPPMid-Continent Area Power Pool
MGE EnergyMGE Energy, Inc.
MGE ConstructMGE Construct LLC
MGE Power West CampusMGE Power West Campus, LLC
MGEMadison Gas and Electric Company
MGE PowerMGE Power LLC
Midwest ISOMidwest Independent System Operator
Moody'sMoody's Investors Service, Inc.
MWmegawatt
MWhmegawatt-hour
NasdaqThe Nasdaq National Stock Market
NNGNorthern Natural Gas Company
NOxnitrogen oxide
NOx SIP CallNitrogen oxide State Implementation Plan (federal rule 40 CFR Part 96, commonly known as the NOx SIP Call)
NRCNuclear Regulatory Commission
PGA clausePurchased Gas Adjustment clause
PSCWPublic Service Commission of Wisconsin
RTCRegional Transmission Committee
RTORegional Transmission Organization
S&PStandard & Poor's Ratings Group, a division of McGraw-Hill Companies, Inc.
SABStaff Accounting Bulletin
SECSecurities and Exchange Commission
SFASStatement of Financial Accounting Standards (issued by the FASB)
SO2sulfur dioxide
the StateState of Wisconsin
UWUniversity of Wisconsin at Madison
VIEVariable Interest Entity
VOCvolatile organic compounds
WCCFWest Campus Cogeneration Facility
Working capitalcurrent assets less current liabilities
WPSCWisconsin Public Service Corporation
YorkYork International Corporation

PART I.

Item 1. Business.

MGE Energy operates in twothree business segments:

- Electric utility operations--generating and distributing electricity.
electricity through MGE.

- Gas utility operations--purchasing and distributing natural gas.gas through MGE.

- Nonutility energy operations--constructing and owning new electric generating capacity through its wholly owned subsidiaries MGE Construct, MGE Power, and MGE Power West Campus.

MGE Energy became the holding company for MGE on August 12, 2002, when shareholders exchanged each sharetheir shares of MGE common stock for one shareshares of MGE Energy common stock. The share exchange had no accounting effect on MGE's recorded assets, liabilities, revenues, or expenses.

MGE's utility operations represent substantially alla substantial portion of the assets, liabilities, revenues, expenses, and expensesoperations of MGE Energy. MGE Energy's nonutility energy operations relating, principally,currently relate to the development of a cogeneration project on the Madison campus of the University of Wisconsin (UW), are not significant at this time. Consequently, the following discussion focuses on the results of operations and financial condition of MGE.UW-Madison campus.

MGE Energy was organized as a Wisconsin corporation in 2001. MGE was organized as a Wisconsin corporation in 1896. Their principal offices are located at 133 South Blair Street, Madison, Wisconsin 53703.

MGE Energy and MGE maintain a Web site at the address specified on the cover of this report where copies of its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments thereto may be obtained free of charge. This address is inactive textural and the content of this Web site is not part of this Form 10-K.

MGE

As a public utility, MGE is subject to regulation by the Public Service Commission of Wisconsin (PSCW)PSCW and the Federal Energy Regulatory Commission (FERC).FERC. The PSCW has authority to regulate most aspects of MGE's business including rates, accounts, issuance of securities, and plant and transmission line siting. FERC has jurisdiction, under the Federal Power Act, over certain accounting practices and certain other aspects of MGE's business.

MGE is also subject to regulation under local, state, and federal laws regarding air and water quality and solid waste disposal. See Environmental section"Environmental" below.

MGE's business is seasonalfluctuates based on fluctuationschanges in weather conditions.conditions, with gas revenues generally higher during the winter months due to heating needs and electricity revenues generally higher in the summer months due to cooling needs.

Electric OperationUtility Operations

MGE generates and distributes electricity in a service area covering the 250-square-mile area of Dane County, Wisconsin. Its service area includes the city of Madison, Wisconsin.

At December 31, 2002,2003, MGE supplied electric service to nearly 130,000132,000 customers, of whom 115,000117,000 were located in the cities of Fitchburg, Madison, Middleton, and Monona and 15,000 in adjacent areas. Of the total number of customers, approximately 113,000114,500 were residential and 17,00017,500 were commercial and industrial. Electric revenues for 2003 were comprised of residential (35%), commercial (49%), industrial (6%), sales to public authorities including the UW (8%), and sales to other utilities and other (2%). Electric revenues for 2002 were comprised of residential (36%), commercial (48%), industrial (6%), sales to public authorities including the UW (7%), and sales to other utilities and other (3%). Electric operations accounted for approximately 60%, 65%, and 61% of MGE's total 2003, 2002, revenues.and 2001 revenues, respectively.

See Item 2, Properties, for a description of MGE's electric utility plant.

MGE is a member of Mid-America Interconnected Network, Inc. (MAIN),MAIN, a regional reliability group. MAIN members work together to utilize better reserve generating capacity and coordinate long-range system planning and day-to-day operations. MAIN seeks to maintain adequate planning reserve margins for generation in the region.

MGE is part owner of the American Transmission Company LLC (ATC),ATC, a for-profit transmission company resulting from Reliability 2000 legislation (Part of 1999 Wisconsin Act 9).enacted in Wisconsin. Part of Reliability 2000 createdthat legislation mandated the creation of a statewide transmission company to own the investor-owned utilities' transmission assets. TheATC's purpose of ATC is to provide reliable, economic transmission service to all customers in a fair and equitable manner. ATC plans, constructs, operates, maintains, and expands transmission facilities that it owns to provide adequate and reliable transmission of power.

Effective January 1, 2001, MGE transferred all of its electric utility transmission assets to ATC in exchange for an ownership interest. ATC is owned and governed by the utilities that contributed facilities or capital in accordance with Wisconsin Act 9. At December 31, 2003, MGE has approximately a 5% ownership interest in ATC. ATC is regulated by FERC for all rate terms and conditions of service and is a transmission-owning member of the Midwest ISO. MGE is a nontransmission-owning member of the Midwest ISO.

On February 1, 2002, MGE started taking network transmission service from the Midwest Independent Transmission System Operator, Inc. (Midwest ISO).ISO. Midwest ISO is a nonprofit Regional Transmission OrganizationRTO approved by the FERC. The Midwest ISO is responsible for monitoring the electric transmission system that delivers power from generating plants to wholesale power transmitters. The Midwest ISO'sIts role is to ensure equal access to the transmission system and to maintain or improve electric system reliability in the Midwest.

In connection with its role as a FERC-approved RTO, the Midwest ISO is in the process of developing a bid-based energy market, which is currently proposed to be implemented on December 1, 2004. In connection with the development of this energy market, the Midwest ISO is developing a market-based platform for valuing transmission congestion premised upon the LMP system that has been implemented in certain states. It is expected that the LMP system will include the ability to mitigate or eliminate congestion costs through the use of FTRs. The Midwest ISO will initially allocate FTRs, and it is anticipated that the FTRs will be available through an auction-based system run by the Midwest ISO. It is unknown at this time the quantity of FTRs that will be allocated by the Midwest ISO or what the financial impact of the LMP congestion pricing system might have on MGE.

Fuel Supplysupply and Generationgeneration

MGE estimates itsMGE's net kilowatt-hourkWh requirements for 2003 will bewere provided from the following sources: 64%61% from fossil-fueled steam plants, 33%38% from power purchases, and 3%1% from a combination of wind turbines, diesel generators, and combustion turbines. Actual sourcesSources used will dependdepended on generating unit availability, weather, and customer demand.

MGE has a 22% ownership interest in two 512-megawatt (MW)512-MW coal-burning units at the Columbia Energy Center (Columbia).Columbia. The coal inventory supply for the units decreased from 49 days on December 31, 2001, to 46 days on December 31, 2002.2002, to 45 days on December 31, 2003. The co-owners' current goal is to maintain approximately a 40-day35-day inventory. The units burn low-sulfur coal obtained (pursuant to long-term contracts) from the Powder River Basin coal fields located in Wyoming and Montana.

For information about a request from the U.S. Environmental Protection Agency (EPA) that affects Columbia, refer to the section on Air Quality under Environmental below.

Gas Utility Operations

MGE transports and distributes natural gas in a service area covering 1,375 square miles in seven south-central Wisconsin counties. Its service area includes the city of Madison, Wisconsin.

On December 31, 2002,2003, MGE supplied natural gas service to more than 126,000129,000 customers in the cities of Elroy, Fitchburg, Lodi, Madison, Middleton, Monona, Prairie du Chien, Verona, and Viroqua; 24 villages; and all or parts of 4546 townships. Gas revenues for 2003 were comprised of residential (58%), commercial (37%), industrial (2%), and transportation service and other (3%). Gas revenues for 2002 were comprised of residential (58%), commercial (37%), industrial (1%), and transportation service and other (1%(4%). Transportation service accounted for almost 3% of the total 2002 gas revenues. Gas operations accounted for approximately 40%, 35%, and 39% of MGE's total revenues.2003, 2002, and 2001 revenues, respectively.

MGE can curtail gas deliveries to its interruptible customers. Approximately 4% of gas sold in 20022003 was to interruptible customers.

Gas Supplysupply

MGE has physical interconnections with ANR Pipeline Company (ANR) and Northern Natural Gas Company (NNG).NNG. MGE's primary service territory, which includes Madison and the surrounding area, receives deliveries at one NNG and four ANR gate stations. MGE also receives deliveries at NNG gate stations located in Elroy, Prairie du Chien, Viroqua, and Crawford County. Interconnections with two major pipelines provide competition in interstate pipeline service and a more reliable and economical gas supply mix, which includes gas from Canada and from the mid-continent and Gulf/offshore regions in the United States.

During the winter months, when customer demand is high, MGE is primarily concerned with meeting its obligation to firm customers. MGE meets customer demand by using firm supplies under contracts finalized before the heating season, supplies in storage (injected during the summer), and other firm supplies purchased during the winter period.

By contract, a total of 4,946,342 dekatherms4,946,852 Dth can be injected into ANR's storage fields from April 1 through October 31. These gas supplies are then available for withdrawal during the subsequent heating season, November 1 through March 31. ANR's storage fields are located in Michigan. Using storage allows MGE to buy gas supplies during the summer season, when prices are normally lower, and withdraw these supplies during the winter season, when prices are typically higher. Storage also gives MGE more flexibility in meeting daily load fluctuations. Storage quantities were close to planned levels on December 31, 2003.

During the winter months, when customer demand is high, MGE is primarily concerned with meeting its obligation to firm customers. MGE meets customer demand by using firm supplies under contracts finalized before the heating season, supplies in storage (injected during the summer), and other firm supplies purchased during the winter period.

The prior heating season (November 2001 through March 2002) was warmer than normal (16% fewer heating degree days). The current heating season (November 2002 through March 2003) has been 2% warmer than normal (based on actual heating degree days through January) and storage quantities are at a normal level. A heating degree day is the number of degrees that the mean daily temperature is below 65 degrees Fahrenheit.

MGE's contracts for firm transportation service include winter maximum daily quantities of:

- 141,650 dekatherms143,650 Dth (including 86,078 dekathermsDth of storage withdrawals) on ANR.
- 54,719 dekatherms56,151 Dth on NNG.
- 2,457 dekathermsDth into Viroqua's NNG gate station.
- 1,432 dekatherms into Crawford County's NNG gate station.

Winter maximum daily quantities under these contracts are scheduled to increase an additional 15,000 Dth by November 2005.

Nonutility Energy Operations

MGE Energy, through subsidiaries, is seeking to develop generation sources that will assist MGE in meeting the electricity needs of its customers. It is currently engaged in the construction of a cogeneration facility on the UW-Madison campus and, with MGE, is examining other potential sources of electricity including new coal-fired plants through an initiative known as Power the Future as well as renewable forms of energy.

Decisions on the type of energy source and its size, timing, ownership, and financing depend upon a number of factors including the growth of customer demand in MGE's service area and surrounding areas, the effectiveness of customer demand management efforts, the costs and availability of alternative power sources, the availability of transmission capacity, issues associated with siting power generation sources, available financing and ownership structures, regulatory treatment and recovery, construction lead times and risks, and other factors. The decisions tend to involve long time horizons due to the lead time involved in siting and constructing new generation sources and the associated transmission infrastructure.

Power the Future Generation

On February 23, 2001, MGE secured an option to own a portion of the advanced technology, coal-fired, base-load generation proposed in We Energies' Power the Future plan. The plan included three new 600-MW coal-fired plants, which would be located in Wisconsin. On November 11, 2003, a PSCW order approved issuing a CPCN for We Energies' proposal for two of the coal facilities. Pursuant to an amended agreement reached on January 31, 2003, MGE has the option to acquire an undivided 8.33% (16.66% under certain conditions) ownership interest in each of the proposed coal plants or up to approximately 50 MW per unit. If the options on Units 1 and 2 are fully exercised, MGE Energy's share of capital costs is estimated to be $175 million. Unit 1 is expected to begin operating in 2009, and Unit 2 is scheduled to begin operating in 2010. MGE has filed its own Certificate of Authority with the PSCW for the coal facilities and a proposed lease structure with an MGE Energy affiliate. MGE expects PSCW approval on this filing in the first half of 2004.

WCCF

MGE Energy has undertaken, through MGE Construct, the construction of a chilled-water, steam, and electric generation facility on the UW-Madison campus. When completed in the spring of 2005, the facility will have the capacity to produce 20,000 tons of chilled water, 500,000 pounds per hour of steam, and approximately 150 MW of electricity. It will be jointly owned by the State, the UW, and MGE Power West Campus. MGE Power West Campus' share will be leased and the entire facility will be operated by MGE. The State and the UW will own a controlling interest in the chilled-water and steam plants in accordance with the EPC Agreement, which will be used to meet the UW's growing need for air-conditioning and steam-heat capacity. MGE Power West Campus will own a controlling interest in the electric generation plant, which will provide electricity for MGE's customers.

MGE Energy, MGE Power West Campus, and MGE Construct have assumed certain risks related to some of the executed agreements. In the EPC Agreement, MGE Power West Campus is responsible for cost overruns and MGE Construct is responsible for the construction process of the entire facility, paying liquidated damages relating to failure to achieve the Mechanical Completion Date Guarantee and/or the Acceptance Test Capacity Guarantee. MGE Energy is the guarantor of MGE Construct's obligations under the EPC Agreement.

The cost to construct WCCF is expected to be approximately $180 million in total, of which MGE Power West Campus' portion will be $103 million. On November 20, 2003, the State paid $19.4 million to MGE Construct for its share of construction costs incurred since its last payment in November 2002. MGE Construct now bills the State monthly for its share of the cost of WCCF in accordance with the EPC Agreement. As of December 31, 2003, MGE Power West Campus had incurred $48.6 million of costs on the project, which is reflected in construction work in progress on MGE Energy's and MGE's consolidated balance sheets. These costs largely represent amounts paid under long lead-time equipment contracts in order to meet project schedules.

Environmental

MGE is subject to local, state, and federal regulations concerning air quality, water quality, and solid waste disposal. Those regulations affect the manner in which MGE conducts its operations, the costs of those operations, as well as some capital and operating expenditures. It can also affect the siting, timing, and cost of new projects or other significant actions affecting the environment. MGE believes that it has met the requirements of current environmental regulations. MGE is not able to predict the direction of future regulations or if compliance with future pollution controlany such regulations will involve additional expenditures for pollution control equipment, or plant modifications, operations curtailments, reductions inor curtailment of operations. Such actions could reduce capacity or efficiency at existing plants or delays indelay the construction and operation of future generating facilities.

The Wisconsin Department of Natural Resources (DNR) regulatesEPA and DNR regulate pollution and environmental control matters at MGE's electric generating plants. The DNR has primary jurisdiction over air and water quality as well as solid and hazardous waste standards.

The ongoing issue of global warming could result in significant costs to reduce carbon dioxide CO2emissions. MGE does not yet know the amounts of these expenditures or the period of time over which they may be required.

The National Environmental Policy Act and the Wisconsin Environmental Policy Act require MGE to conduct a complete environmental review and issue a detailed environmental impact statement before obtaining necessary authorizations or permits from regulatory agencies for certain projects. This applies to any new projects, such as generating plants, or other major actions that could significantly affect the environment.

Air Qualityquality

Proposed eight-hour ozone standard.In the summer of 1997, the EPA finalizedpromulgated a new stricter federaleight-hour ozone ambient air-quality standard. EPA has recommended that Dane County be designated as in attainment with that eight-hour ozone standard based upon a review of preliminary monitoring data for the county. The final nonattainment designations will not be made by the EPA until later in 2004 and will be based upon final monitoring data for 2001 through 2003. That data currently shows Dane County air quality standardsto be in attainment with the eight-hour ozone standard.

Dane County ozone levels have been increasing over time. MGE is working with the DNR and other Dane County sources to make voluntary reductions of ozone precursor emissions and prevent the county from being classified as a nonattainment area. If Dane County were classified as a nonattainment area, MGE facilities in Dane County may need to meet new limits for ozone precursor emissions.

Proposed utility MACT standards. Section 112 of the 1990 Clean Air Act Amendments requires the EPA to develop standards to control major sources of hazardous air pollutants to levels consistent with the lowest-emitting facilities in similar source categories. MGE operates several sources that may be subject to MACT standards including electric steam generating units; combustion turbines; reciprocating internal combustion engines; and fine particulate matter. Under the new standards, EPA anticipates designating new nonattainment areas by late 2003 or early 2004. Southeastern Wisconsin isindustrial, commercial, and institutional boilers. All sources, except Blount and Columbia coal-fired units, are expected to be classified as nonattainment. There is a possibility that Dane County, the location of the Blount Generating Station (Blount), will also be classified as nonattainment.

The DNR is required to develop a State Implementation Plan by 2007 to demonstrate how the state will attain and maintain compliance with the new ozone and fine particulate matter standards. The DNR is considering a plan that would require NOx and fine particulate limits for sources throughout the state rather than focusing reductions on just those sources located in the nonattainment areas. If this approach is taken, MGE may need to evaluate emission control options for its facilities in order to comply. The EPA has set 2010 as the deadline for states to meet the new standards. However, emission control requirements could be imposed in Wisconsin as early as the spring of 2006.

On October 27, 1998, the EPA issued final rules requiring more NOx emission reductionsexempt from sources in 22 states and the District of Columbia, including Wisconsin, to reduce the transport of ozone across state boundaries. However, a successful legal challenge resulted in excluding Wisconsin from part of this rule. After further modeling and research, theimplementing additional emission-control strategies. The EPA is expected to revise or amend these rules to impose additional NOx emission reduction requirements on Wisconsin sourcesfinalize standards for electric-steam generating units in order to help other states meet ambient ozone standards.

2004. It is expected that MGE is evaluating NOx compliance strategies, including fuel switching, emissions trading, purchased power agreements, new emission control devices, and/or installation of new fuel-burning and clean-coal technologies. Implementing any of these new measures would likely increase capital, operating, and maintenance expenditures.

Wisconsin's acid rain law imposes limitations on SO2 emissions. Blount and MGE's share of Columbia arewill be required to meet a combined SO2 emission rate of 1.20 pounds of SO2 per million Btu. MGE does not anticipate any capital expenditure in order to comply with this standard.

The DNR continues to develop rules to limitnew mercury emissions from coal-fired boilers. The proposed rules require sources emitting mercury to reduce emissions over 15 years. It also currently sets a ceilinglimits by the current proposal date of 10 pounds of mercury per year for smaller sources. Depending onDecember 2007. Complying with the outcome of these regulations, they may require MGE to evaluate emission control options for its facilities in order to comply. These controlsMACT standards would likely increase capital expenditures and operating and maintenance expenses.

On January 1, 2000, Phase II of the 1990 Federal Clean Air Act amendments took effect, setting new emission limits for sulfur dioxide (SO2) and nitrogen oxide (NOx). MGE's generating units meet those limits. The units were modified well in advance to meet year 2000 NOx requirements. Early modifications at Blount allow MGE to postpone meeting more stringent Phase II NOx requirements at this plant until 2007.

In December 2000, February 2001, June 2002, and January 2003, Columbia received Requests for Information from the EPA to evaluate compliance with the Clean Air Act. Alliant Energy Corp. (Alliant), the plant operator, has responded to all requests and has not yet received a response from the EPA. On a broader basis, the EPA is assessing the regulatory consequences of investments in utility generation, energy efficiency, maintenance, and environmental protection. EPA is also assessing proposed multi-pollutant legislation. The EPA will be recommending clarification and revisions to the process in the future. The plant operator has not informed MGE of any likely increase in capital expenditures or operating and maintenance expenses arising from the EPA's inquiry.

In December 2002, the EPA issued proposed rules that will impose maximum achievable control technology limits for hazardous air-pollutant emissions for industrial boilers, combustion turbines, and stationary diesel generators. The EPA plans to have the final regulations published by 2004, and compliance deadlines are expected in 2007. The proposed rule for industrial boilers sets limits for particulate matter, hydrogen chloride, and mercury. The proposed rule for combustion turbines and stationary diesel generators sets limits for formaldehyde and carbon monoxide. Based on an initial review of the proposed rules, it is likely that emission control options will need to be evaluated for Blount and Columbia coal-fired boilers, such as scrubbers and/or baghouses. Control requirements for other generation facilities is less likely. Since Because the rules are still in the process of being developed and in the public comment stage, it is not possible to determine exactly what impact this compliance would have for MGE's generation facilities.

NOx SIP Call. On October 27, 1998, the EPA issued the "NOx SIP Call" rule that imposed a NOx emission budget for emission sources in Wisconsin. The NOx SIP Call was premised upon two theories: the downwind contribution of Wisconsin air emissions to existing one-hour ozone nonattainment areas and the downwind contribution of Wisconsin air emissions to potential future eight-hour nonattainment areas.

On March 2, 2000, the Court of Appeals for the District of Columbia held that the EPA "acted unlawfully by including Wisconsin in the [NOx] SIP Call" for purposes of the State's alleged impacts to downwind one-hour ozone nonattainment areas. However, the Court and EPA stayed that portion of the challenge concerning Wisconsin's alleged impacts on downwind, eight-hour ozone nonattainment areas. If that stay is lifted and that portion of the NOx SIP Call concerning eight-hour ozone nonattainment areas is upheld, the resulting NOx emission budget for Wisconsin could potentially affect the level of permissible NOx emissions from Blount, Columbia, and WCCF. The new NOx limits could increase capital expenditures and operating and maintenance expenses at those facilities.

Interstate Air Quality Rule. This proposed rule was introduced in December 2003 and would reduce emissions of SO2 and NOx in 29 eastern states and the District of Columbia in two phases. SO2 emissions would be reduced by 3.6 million tons in 2010 (approximately 40% below current levels) and by another 2 million tons per year when the rules are fully implemented (approximately 70% below current levels). Emissions of NOx would be cut by 1.5 million tons in 2010 (approximately 55% below current levels) and 1.8 million tons annually in 2015 (approximately 65% below current levels). The EPA is expected to finalize the rule by the end of 2005. It is expected that MGE will be required to comply with NOx and particulate limits by 2010. Complying with the rule would likely increase capital expenditures and operating and maintenance expenses at Blount and Columbia.

Columbia. In December 2000, February 2001, June 2002, and January 2003, Alliant received Requests for Information from the EPA seeking information concerning Columbia's compliance with the Clean Air Act. The requests appear to be part of an EPA initiative to assess the regulatory consequences of past investments in utility generation, energy efficiency, maintenance, and environmental protection within the utility sector. Alliant, the plant operator, has responded to all requests, but MGE has not been informed of any response from the EPA. The plant operator has not informed MGE of any definitive increase in capital expenditures or operating and maintenance expenses arising from the EPA's inquiry.

Water Qualityquality

MGE is subject to water quality regulations issued by the DNR. These regulations include categorical-effluent discharge standards and general water quality standards. The regulations limit discharges from MGE's plants into Lake Monona and other Wisconsin waters.

The categorical-effluent discharge standards require each discharger to use effluent-treatment processes equivalent to categorical "best practicable" or "best available" technologies under compliance schedules established under the Federal Water Pollution Control Act. The DNR has published categorical regulations for chemical and thermal discharges from electric-steam generating plants.

In February 2003, Columbia received a Notice of Violation from the DNR for exceeding limits in its Wisconsin Pollutant Discharge Elimination System permit. That matter has been referred to the Wisconsin Department of Justice for prosecution. In addition, the plant operator has been named in a Clean Water Act citizen suit action alleging similar violations. The Columbia plant operator has been working with the DNR to resolve the issues set forthallegations raised in the notice. Resolution of thosethese proceedings. Resolving these issues may require additional capital expenditures to install and implement new treatment techniques. While it is possible that the DNRa court may also seek to impose a civil penalty in these proceedings, the operator believes it can resolve these issues to the DNR's satisfaction in a manner that will not have a material adverse effect on their companies'the operator's financial conditions or results of operations. See Item 3, Legal Proceedings, regarding an action filed by Wisconsin Environmental Law Advocates U.A.

On April 9, 2002, theFebruary 16, 2004, EPA issuedsigned a proposed rule under the National Pollution Discharge Elimination System (NPDES, 40 CFR Parts 9, 122, 123, 124, and 125) that establishes requirementsestablishing performance standards for aquatic life entrapment and impingement in existing cooling water intake structures (also referredat large power plants. The rule applies to as the 316(b) rule). If the proposedstructures that withdraw at least 50 million gallons per day of water and use 25% of that withdrawal for cooling. The rule is finalized as written, capital improvementswill have no impact on MGE's wholly owned power plants but may be required. The final version of the rule is not expected for several years.impact power plants in which MGE has a partial interest.

Solid Wastewaste

MGE is listed as a potentially responsible party for a site the EPA has placed on the national priorities Superfund list. The Lenz Oil site in Lemont, Illinois, was used for storing and processing waste oil for several years. This site requires clean up under the Comprehensive Environmental Response, Compensation and Liability Act. A group of companies, including MGE, is currently working on cleaning up the site.

Management believes that its share of the final cleanup costs will not result in any materially adverse effects on MGE's operations, cash flows, or financial position. Insurance may cover a portion of the cleanup costs. Management believes that the cleanup costs not covered by insurance will be recovered in current and future rates. MGE estimates its future expense to clean up this site could range from $0.1 million to $0.2 million. At December 31, 2002,2003, MGE accrued a $0.1 million liability for these matters.this matter.

As a result of the Blount 69-kV transmission substation expansion, coal tar-contaminated soil and debris within the excavation zone are being removed and disposed of in accordance with a DNR-approved "Removal Action Work Plan." MGE estimates cleanup costs for this site will be $1.0 million. MGE has recorded a $1.0 million liability for the cleanup of this site with an offsetting regulatory asset (deferred charge). We expect to recover cleanup costs in future rates. Carrying costs associated with the cleanup expenditures will not be recoverable.

MiscellaneousEnvironmental Cooperative Agreement

On September 26, 2002, MGE and the DNR signed an Environmental Cooperative Agreement under which MGE committed to work toward superior environmental performance at its Blount plant. Among other things, the five-year agreement requires MGE to evaluate combustion efficiency improvements, enhance new pollution control on Boiler 8, increase use of alternative fuels, attempt to increase beneficial reuse of fly ash and bottom ash, study cogeneration possibilities, and upgrade MGE's environmental management system to be consistent with ISO 14001 standards. Implementing these and other actions required by the agreement will increase capital expenditures and operating and maintenance expenses over the next five years.

As part of the agreement, MGE conducted a voluntary audit of Blount's compliance with various environmental laws. The auditors identified several conformance exceptions which were addressed and disclosed pursuant to a state statute that provides for qualified civil enforcement immunity. MGE believes that it has adequately responded to the audit's findings and does not anticipate any further action by the state regulators.

Employees

As of December 31, 2002,2003, MGE had 683691 full-time employees. Of these employees, 242251 are covered by a collective bargaining agreement with Local Union 2304 of the International Brotherhood of Electrical Workers and 112107 are covered by a collective bargaining agreement with Local Union No. 39 of the Office and Professional Employees International Union. Both collective bargaining agreements expire on May 1, 2003.2006.

Executive Officers of the Registrants



Executive


Title


Effective

Date

Service

Years as

an Officer

Gary J. Wolter*
Age: 49
Chairman of the Board, President and Chief Executive Officer
President and Chief Executive Officer
Senior Vice President - Administration and Secretary
02/01/2002
02/01/2000
05/01/1995
14
Lynn K. Hobbie**
Age: 45
Senior Vice President
Vice President - Marketing
02/01/2000
05/01/1996
9
Mark T. Maranger**
Age: 55
Senior Vice President, MGE
President and CEO, Wisconsin Fuel and Light Company
04/09/2001
1996-2001
2
James G. Bidlingmaier**
Age: 57
Vice President - Admin. and Chief Information Officer
Executive Director - Information Management Systems
02/01/2000
09/01/1994
4
Kristine A. Euclide**
Age: 51
Vice President and General Counsel, MGE
Partner in the law firm of Stafford Rosenbaum LLP

Executive Assistant to County Executive of Dane County,
Wisconsin, in which capacity she served as a senior policy
advisor to the chief-elected official in Dane County.
11/15/2001
1982-05/1997

06/99-11/2001
05/97-05/1999

2
Terry A. Hanson*
Age: 52
Vice President, Chief Financial Officer and Secretary
Vice President and Chief Financial Officer
Vice President - Finance
10/01/2001
05/01/2000
11/01/1997
12
Jeffrey C. Newman*
Age: 41
Vice President and Treasurer
Treasurer
01/01/2001
11/01/1997
6


Note: Ages, years of service, and positions as of February 1, 2004.
|*Executive officer of MGE Energy and MGE
**Executive officer of MGE

Item 2. Properties.

MGE's net generating capability in service at December 31, 2002,2003, was as follows:

PlantsCommercial Operation DateFuelNet Capability (MW)No. of Units
Steam plants:
Columbia1975 & 1978Low-sulfur coal
225(1,2,3)
2
Blount (Madison)1957 & 1961Coal/gas972
 1938 & 1943Gas392
 1949Coal/gas221
 1964-1968Gas/oil354
Combustion turbines1964-2000Gas/oil1746
Portable generators1998-2001Diesel5155
Wind turbines1999Wind217
Total645

1 Base load generation
2 MGE's 22% share of two 512-MW units located near Portage, Wisconsin. The other owners are Alliant, which operates Columbia, and Wisconsin Public Service Corporation.
3 See Item 3, Legal Proceedings.


Plants


Location


Commercial
Operation Date



Fuel
Net
Capability
(MW)



No. of
Units
Steam plants:
ColumbiaPortage, WI1975 & 1978Low-sulfur coal225(1,2,3)2
BlountMadison, WI1957 & 1961Coal/gas972
1938 & 1943Gas392
1949Coal/gas221
1964-1968Gas/oil354
Combustion turbinesMadison, WI

Marinette, WI

1964-2000Gas/oil1746
Portable generatorsMadison, WI1998-2001Diesel5155
Wind turbinesTownships of Lincoln and Red River, WI1999Wind217
Total645


(1) Base load generation.
(2) MGE's 22% share of two 512-MW units. The other owners are Alliant, which operates Columbia, and WPSC.
(3) See Item 3, Legal Proceedings.


MGE sold its 17.8% ownership interest in Kewaunee Nuclear Power Plant (Kewaunee) to WPSC in 2001. Footnote 1018 of the Notes to Consolidated Financial Statements in this report includes information regarding that sale along with a description of MGE's continuing obligations for Kewaunee beyond the closing date and MGE's decision to exercisedate. MGE exercised an option to buy electric capacity and energy from WPSC for two years starting in 2001.through September 23, 2003.

Major electric distribution lines and substations in service at December 31, 2002,2003, are as follows:

MilesMiles
Distribution LinesOverheadUnderground
Distribution lines:OverheadUnderground
69 kV7171
13.8 kV and under967856960898
DistributionSubstationsInstalled Capacity (kVA)
Distribution:SubstationsInstalled Capacity (kVA)
69-13.8 kV22789,00023819,000
13.8-4 kV32276,00032291,000


On January 1, 2001,As required by Wisconsin law, MGE and other Wisconsin electric utilities transferred itstheir electric transmission assets to ATC. InATC on January 1, 2001. MGE received an approximate 5% ownership interest in ATC in exchange for its transmission plant and related deferred taxes and deferred investment tax credits,credits. MGE received approximately a 6% ownership interest in ATC. MGE expects to receivereceives a return on its investment in ATC that is approximately equal to the return it would have earned by retaining its transmission facilities. A small portion of the 69-kilovolt (kV)69-kV lines and substations has been classified as distribution assets.

Gas facilities include 2,1732,234 miles of distribution mains.

Item 3. Legal Proceedings.

MGE Energy

None.On November 6, 2003, Friends of Responsible Energy (FORE), an unincorporated citizen association, filed a petition with the Dane County, Wisconsin, Circuit Court seeking judicial review of various decisions made by the PSCW, the Wisconsin Department of Natural Resources, the UW, and the Wisconsin Department of Administration in connection with the WCCF. Those decisions include the grant of a CPCN by the PSCW and various environmental determinations made by the governmental parties. FORE alleges that those decisions were arbitrary, capricious, and contrary to law and seeks to have them set aside or remanded for further review.

MGE Energy, along with MGE and MGE Power West Campus, have intervened as a party to the proceeding. MGE Energy believes the suit is not likely to cause any material adverse change in the WCCF or its construction schedule.

MGE

In May 1999, MGE broughtBy letter dated October 23, 2003, the Wisconsin Environmental Law Advocates U.A. (WELA), an arbitration proceeding againstunincorporated, not-for-profit association, sent a Notice of Violation and Intent to File Suit under the Clean Water Act regarding alleged violations at Columbia to Alliant and to Wisconsin Power and Light Company (WPL), a subsidiary of Alliant, as well as to Columbia's joint owners and their parent companies. The notice is required by the Clean Water Act as a condition precedent to filing a lawsuit based on the alleged environmental law violations. The notice alleges numerous violations of the Clean Water Act and of Columbia's wastewater discharge permit. On December 16, 2003, WPL and Alliant responded to WELA that the parent companymajority of WPL. The arbitration was basedthe allegations are inaccurate and of those that are accurate, the Wisconsin DNR had already begun enforcement and many of the violations have been corrected and have ceased. This notwithstanding, on December 29, 2003, WELA filed a claim regarding WPL's merger into Alliant, the improper transfer of WPL's interest in Columbia to Alliant, and the manner in which it was running Columbia that triggered MGE's right to acquire WPL's interestcomplaint in the plant at book value.U.S. District Court, Western District of Wisconsin, against WPL and Alliant.

In March 2001, MGE received an arbitration decisiondoes not operate Columbia and was not named as a party in the dispute. Whilelitigation. WELA communicated to WPL and Alliant that it filed the arbitrators didaction in order to formally assert its claims in order to ensure WELA's participation in any enforcement resolution expected to be sought by the Wisconsin DNR. Although the complaint was filed, WELA indicated that it would not grantserve it on WPL and Alliant while good faith settlement negotiations were ongoing or unless otherwise directed by the specific relief MGE sought in the arbitration (the right to purchase WPL's interest in the plant), the arbitrators recognized onedistrict court.

Also see "Environmental" under Item 1, Business, for a description of MGE's primary arguments. MGE argued that WPL had transferred its interest in the Columbia plant to its parent company, Alliant, after the merger in 1998. The arbitrators required Alliant to fully assume the obligations of WPL as the operator and manager of the plant. The Dane County Circuit Court confirmed the arbitration award in late November 2001. In June 2002, an order enforcing the Circuit Court's judgment was entered and subsequently Alliant passed a resolution pursuant to the arbitration decision.several environmental proceedings involving MGE.

Item 4. Submission of Matters to a Vote of Security Holders.

MGE Energy and MGE

None.

PART II.

Item 5. Market for Registrant's Common Equity and Related ShareholderStockholder Matters.

MGE Energy

MGE Energy common stock is traded on The Nasdaq Stock Market (Nasdaq) under the symbol MGEE. On March 1, 2003,2004, there were approximately 18,52518,948 registered shareholders of record.

The following table shows high and low sale prices for the common stock on NASDAQNasdaq for each quarter over the past two years.

Common stock price rangeCommon stock price range
HighLowHighLow
2002 

2003

First quarter$29.35$25.00$29.95$25.00
Second quarter$28.64$25.77$33.65$26.40
Third quarter$30.14$24.58$35.84$28.65
Fourth quarter$29.75$25.32$33.00$30.26
2001 

2002*

First quarter$24.13$20.88$29.35$25.00
Second quarter$27.80$21.50$28.64$25.77
Third quarter$26.50$23.09$30.14$24.58
Fourth quarter$27.63$24.00$29.75$25.32


MGE

As of March 1, 2003, there was outstanding 17,347,889 shares of common stock, all of which was held by MGE Energy. There is no market for shares of common stock of MGE. *On August 12, 2002, MGE Energy became the holding company for MGE following a share exchange and began trading on NASDAQNasdaq under the symbol MGEE. Prior to the share exchange, MGE traded on NASDAQNasdaq under the symbol MDSN.

MGE

As of March 1, 2004, there were outstanding 17,347,889 shares of common stock, all of which were held by MGE Energy. There is no market for shares of common stock of MGE.

Dividends

The following table sets forth MGE Energy's quarterly cash dividends paid during 20022003 and 2001:2002:

2002200120032002
(Per share)1st Qtr.*2nd Qtr.*3rd Qtr.4th Qtr.1st Qtr.2nd Qtr.3rd Qtr.4th Qtr.1st Qtr.2nd Qtr.3rd Qtr.4th Qtr.1st Qtr.*2nd Qtr.*3rd Qtr.4th Qtr.
MGE Energy$0.333$0.336$0.331$0.333$0.336$0.338$0.333$0.336

*The dividends for the first two quarters of 2002 and during all of 2001 were paid by MGE. As a result of the corporate reorganization described in Part I, Item 1, the dividends for the third and fourth quarters were paid by MGE Energy.
*The dividends for the first two quarters of 2002 were paid by MGE. As a result of the share exchange described in Part I, Item 1, the dividends for the remainder of 2002 and all of 2003 were paid by MGE Energy.*The dividends for the first two quarters of 2002 were paid by MGE. As a result of the share exchange described in Part I, Item 1, the dividends for the remainder of 2002 and all of 2003 were paid by MGE Energy.

The following table sets forth MGE's quarterly cash dividends paid during 20022003 and 2001:2002:

2002200120032002
(In thousands)1st Qtr.2nd Qtr.3rd Qtr.4th Qtr.1st Qtr.2nd Qtr.3rd Qtr.4th Qtr.1st Qtr.2nd Qtr.3rd Qtr.4th Qtr.1st Qtr.2nd Qtr.3rd Qtr.4th Qtr.
MGE$5,707$5,749$5,860$ -$5,510$5,544$5,622$5,665$11,804$5,977$6,074$5,830$5,707$5,749$5,860$ -

See "Liquidity and Capital Resources - Capital Requirements and Investing Activities for MGE Energy relies primarily on dividends from its principal subsidiary, MGE, as the sourceand MGE" under Item 7, Management's Discussion and Analysis of fundsFinancial Condition and Results of Operations, for a description of restrictions applicable to pay its dividends to its shareholders. Under the PSCW order authorizing MGE Energy to become the parent holding company for MGE, MGE may not pay a dividend to MGE Energy in excess of a "normal dividend payment" when its common equity ratio is below 55%. As of December 31, 2002, MGE's common equity ratio was 53.8%.

payments by MGE.

Item 6. Selected Financial DataData.

MGE Energy
(In thousands, except per-share amounts)

For the years ended December 31,For the years ended December 31,
Summary of Operations
2002
2001
2000
1999
1998
20032002200120001999
Operating revenues: 
Electric$224,987$203,178$203,176$185,955$169,563$241,745$224,987$203,178$203,176$185,955
Gas122,109130,533120,93288,07980,189159,802122,109130,533120,93288,079
Total347,096333,711324,108274,034249,752401,547347,096333,711324,108274,034
Operating expenses278,105274,340258,411219,910199,954330,124278,105274,340258,411219,910
Other general taxes10,86110,86410,1809,3069,26311,59210,86110,86410,1809,306
Operating income58,13048,50755,51744,81840,53559,83158,13048,50755,51744,818
Other income2,3358,5851,8954,9985,7232,4862,3358,5851,8954,998
Interest expense(12,545)(13,789)(14,305)(12,194)(10,921)(11,776)(12,545)(13,789)(14,305)(12,194)
Income before taxes47,92043,30343,10737,62235,33750,54147,92043,30343,10737,622
Income tax provision(18,727)(15,941)(15,752)(13,876)(13,107)(19,901)(18,727)(15,941)(15,752)(13,876)
Income before cumulative effect of a change in accounting principle29,19327,36227,35523,74622,230
30,640

29,193

27,362

27,355

23,746
Cumulative effect of a change in accounting principle, net of tax benefit of $78*-(117)-


-

-

(117)

-

-
Net income$ 29,193$ 27,245$ 27,355$ 23,746$ 22,230$ 30,640$ 29,193$ 27,245$ 27,355$ 23,746
Average shares outstanding17,31116,81916,38216,08416,08017,89417,31116,81916,38216,084
Earnings per share before cumulative effect of a change in accounting principle$1.69$1.63$1.67$1.48$1.38


$1.71

$1.69

$1.63

$1.67

$1.48
Cumulative effect of a change in accounting principle-(.01)-
-

-

(.01)

-

-
Basic and diluted earnings per share$1.69$1.62$1.67$1.48$1.38$1.71$1.69$1.62$1.67$1.48
Dividends paid per share$1.338$1.328$1.318$1.308$1.298$1.348$1.338$1.328$1.318$1.308
Assets 
Electric$415,849$372,997$395,622$342,130$311,563$445,728$414,827$376,568$399,634$345,964
Gas139,608131,174123,486114,881111,762165,577151,548144,145135,844126,510
Assets not allocated52,79939,90352,49638,49942,94056,13652,79939,90352,49638,499
Nonregulated20,639-54,24620,639---
Total$628,895$544,074$571,604$495,510$466,265$721,687$639,813$560,616$587,974$510,973
Capitalization including Short-Term Debt 
Common shareholders' equity$227,370$216,292$200,312$185,686$182,275$263,070$227,370$216,292$200,312$185,686
Long-term debt**192,149177,600183,637159,799159,761222,204192,149177,600183,637159,799
Short-term debt34,2989,50044,00015,750-31,68034,2989,50044,00015,750
Total Capitalization$453,817$403,392$427,949$361,235$342,036$516,954$453,817$403,392$427,949$361,235

*The change in accounting principle in 2001 is due to MGE's adoption of SFAS No. 133.
**Includes current maturities.

Item 7. Management's Discussion and Analysis of Financial Condition and

Results of Operations.

General

MGE Energy Inc. (MGE Energy),is a holding company operating through itssubsidiaries in three business segments: electric utility operations, gas utility operations, and nonutility energy operations. Our principal subsidiary Madison Gasis MGE, which conducts our electric utility and Electric Company (MGE), operates in two business segments:

- Electric operations generategas utility operations. MGE generates and distributedistributes electricity to nearly 130,000132,000 customers in Dane County, Wisconsin, which includesincluding the Citycity of Madison. MGE contracts with American Transmission Company (ATC)Madison, and others for transmission service.

- Gas operations purchasepurchases and distributedistributes natural gas to more than 126,000129,000 customers in seventhe Wisconsin counties (Columbia,of Columbia, Crawford, Dane, Iowa, Juneau, Monroe, and Vernon). MGE also contracts with various pipelines for transporting natural gas.Vernon. Other subsidiaries, which constitute our nonutility energy operations, have been formed to own and construct new electric generating capacity. Those subsidiaries are currently undertaking the construction of a 150-MW, electricity, steam, and chilled-water cogeneration facility on the UW-Madison campus.

MGE EnergyWe became the holding company for MGE on August 12, 2002, when MGE shareholders exchanged each sharetheir shares of MGE common stock for one shareshares of MGE Energyour common stock. The share exchange had no accounting effect on MGE's recorded assets, liabilities, revenues, or expenses.

MGE's electric and gas utility operations represent substantially alla substantial part of theour assets, liabilities, revenues, and expenses of MGE Energy. MGE Energy'sexpenses. Our nonutility operations, relating, principally, to the development of a cogeneration project on the MadisonUW-Madison campus, of the University of Wisconsin (UW), are not significant at this time. Consequently, with the exception of the discussion under Nonutility Energy Outlook under Results of Operations, the following discussion focuses mainly on the results of operations and financial condition of MGE.

The following discussion provides informationExecutive Summary

In 2003, our utility operations experienced an increase in gas deliveries offset by a slight decline in electric sales due to cooler-than-normal summer weather. Operation and maintenance expenses increased due to higher employee benefit costs associated with pensions and health care, higher transmission costs, and higher distribution and maintenance costs. We also experienced lower interest costs as a result of debt refinancings that management believeswere completed in 2002 as well as the generally lower interest rates for our variable and short-term debt during 2003.

Our liquidity and capital position remained strong during 2003, although our overall debt increased as a result of a cogeneration facility that MGE Power West Campus is relevantconstructing on the UW-Madison campus. We anticipate relying on short- and long-term borrowings to support that construction and the associated capital expenditures. We also anticipate a need for additional equity capital during 2004 beyond the amounts we are able to raise through our Dividend Reinvestment and Direct Stock Purchase Plan.

Our primary focus today and for the foreseeable future is our core utility customers at MGE. MGE continues to face the challenge of providing its customers with reliable power at competitive prices. It plans to meet this challenge by building more efficient generation projects and continuing its efforts to control its operational costs. We believe it is critical to continue maintaining a strong credit standing and financial strength in MGE as well as the parent company in order to accomplish these goals.

Results of Operations

Earnings Overview - MGE Energy

In 2003, our earnings were $30.6 million, or $1.71 per share. MGE's increase in base rates to cover, in large part, rising fuel costs led to an assessmentincrease in utility revenues. Electric retail sales declined slightly, but retail gas deliveries increased 6.4%. Operations and understanding ofmaintenance costs increased due to higher costs for employee benefits (health care, pension, etc.), transmission wheeling charges, distribution costs, and maintenance. These costs were somewhat offset by a decrease in depreciation costs, as MGE was no longer required to contribute to the decommissioning fund for Kewaunee in 2003. Also, MGE Energy benefited from lower interest costs due to refinancing a large portion of its long-term debt in 2002 and MGE's consolidated results of operationsthe lower interest rates on its variable rate and financial condition. This discussion should be readshort-term debt in conjunction with the consolidated financial statements and notes.2003.

Forward-Looking Statements

This report, and certain other MGE Energy and MGE public documents, contain forward-looking statements that reflect management's current assumptions and estimates regarding future performance and economic conditions--especially as they relate to future revenues, expenses, financial resources, and regulatory matters. These forward-looking statements are made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. MGE Energy cautions investors that forward-looking statements are subject to known and unknown risks and uncertainties that may cause MGE Energy's actual results to differ materially from those projected, expressed, or implied. Some of those risks and uncertainties include:

- Weather
- Economic and market conditions in MGE's service territory.
- Magnitude and timing of capital expenditures.
- Regulatory environment (including restructuring the electric utility industry in Wisconsin).
- Availability and cost of power supplies.

MGE Energy and MGE undertake no obligation to publicly release any revision to these forward-looking statements to reflect events or circumstances after the date of this report.

Results of Operations

MGE Energy - Earnings Overview

In 2002, MGE Energy'sour earnings were $29.2 million, or $1.69 per share. MGE's 5.5% increase in electric retail sales, and higher average rate per customercoupled with an increase in base rates to cover rising fuel costs, contributed to a 10.7% increase in electric revenues. Purchased power costs increased substantially. 2002 was the first full year MGE purchased 90 megawatts (MW)MW of capacity and energy to replace its share of generation lost from Kewaunee. MGE sold its interest in Kewaunee to Wisconsin Public Service Corporation (WPSC)WPSC in September 2001. As a result, MGE's operations and maintenance costs were lower in 2002. MGE's gas margin (revenues less the cost of gas) increased $4.2 million due to growth in gas deliveries.

Earnings inIn 2001, MGE Energy's earnings were $27.2 million, or $1.62 per share. Electric revenues remained constant despite a third-quarter pretax adjustment of approximately $4.5 million, reducing electric unbilled revenues. Electric operating income was down due to increased fuel costs, transmission wheeling expenses paid to ATC, and higher distribution expenses. Gas operating income mainly decreased mainly because warm weather in the fourth quarter resulted in lower gas deliveries. Other income increased substantially due to MGE's equity in earnings inof ATC, gains on weather hedge instruments, and lower charitable contributions. Interest expense was down due to lower interest rates and less short-term debt.

Earnings in 2000 were $27.4 million or $1.67 per share. Electric Utility Operations

Electric sales and revenues

The following table compares MGE's electric retail revenues and electric kWh sales by customer class during each of the years ended December 31:

(In thousands)
RevenueskWh Sales
200320022001200320022001
Residential$ 85,164$ 81,258$ 71,401800,535839,005771,094
Commercial119,585108,84299,2141,651,5781,640,1901,543,866
Industrial14,55512,94913,845299,449296,220314,448
Other - retail/municipal17,97516,58515,271324,188323,380307,132
Total retail237,279219,634199,7313,075,7503,098,7952,936,540
Sales for resale5,1842,6591,659106,56959,61669,544
Other revenues(718)2,6941,788---
Total$241,745$224,987$203,1783,182,3193,158,4113,006,084
Cooling degree days
(normal 629)



NA


NA


NA


555


752


643

Electric operating income wasrevenues were up $5.9 million7.4% and 10.7% in 2003 and 2002 due to the following:

(In millions)
20032002
Rate changes$19.3$ 8.9
Sales for resale2.51.0
Volume(1.6)11.0
Other effects(3.4)0.9
Total$16.8$21.8

-Rates. The PSCW authorized increases in MGE's electric rates effective March 1, 2003, and January 1, 2002, to cover rising fuel costs, increased system demands, and the installation of an AMR system. Revenues in 2003 also reflect a surcharge of 2% on electric rates, effective October 24, 2002, and ending October 23, 2003, which the PSCW authorized to recover deferred costs associated with forming ATC and ongoing incremental transmission costs. See Footnote 15 of the Notes to Consolidated Financial Statements for additional information.

-Sales for resale. The change in 2003 reflects higher sales and new generating facilities that earnvolume as the result of a return for investors. An 8.8% increasecontract to sell 25 MW of electric capacity to Alliant from January through August 2003. The change in total gas deliveries added $1.7 million to gas operating income. Two other factors contributed significantly2002 was attributable to higher net income: gains on some performance-based natural gas incentives andprices, although the volume of sales was 14.3% lower pension costs due to strong performance in MGE's plan assets.

MGE - Electric Sales and Revenues

In 2002, electric retail sales rose 5.5% due to warmer-than-normal summer temperatures. Total cooling degree days were up 17.0% (see table). In 2001, total retail sales were down 1.8% because MGE changed its estimated unbilled sales calculation in the third quarter of that year.

Sales for resale were down 14.3% in 2002 due to lower off-peak sales during the first half of that year.

-Volume. Electric retail sales were slightly lower in 2003 due to cooler-than-normal summer temperatures, as reflected in the year.

Electric operating revenues26.2% reduction in cooling degree days. The opposite effect was felt in 2002 when warmer-than-normal temperatures caused electric retail sales to increase 5.5%. Total cooling degree days were up $21.8 million or 10.7%17% in 2002.

-Other effects. The higher revenues are attributed to:

- Customer growth and greater use per customer ($11.0 million).

- Another effects in 2003 reflect a fuel credit that was in effect from mid-August through year-end. In 2002, the increase in electric rates ($8.9 million, Footnote 7).

- An increase in other electric revenues due in large part towas associated with a vendor settlement and a true-up for thea spring 2000 outage at Kewaunee ($0.9 million).Kewaunee.

- A rise in sales for resale (despite a drop in sales volume) because electricity was sold at a higher rate per kilowatt-hour ($1.0 million).

Electric sales(MW-hours)20022001
% Change
Residential839,005771,0948.8
Commercial1,640,1901,543,8666.2
Industrial296,220314,448(5.8)
Other323,380307,1325.3
Total retail3,098,7952,936,5405.5
Resale - utilities59,61669,544(14.3)
Total sales3,158,4113,006,0845.1
 
Cooling degree days (normal 607)75264317.0


Cooling degree days measure the extent to which the average daily temperature rises above 65 degrees Fahrenheit, increasing demand for cooling.

In 2001, electric retail sales decreased 1.6% despite warmer-than-normal summer temperatures.

In 2001, total electric revenues remained the same, even though electric sales dropped slightly. Retail revenues were up $6.7 million or 3.5%. These increases offset an approximate $4.5 million reduction in the third quarter that resulted from a change in estimated unbilled revenues (described below). Significant items affecting retail revenues included:

- A 3.9% electric rate increase effective January 1, 2001, combined with customer growth and greater use per customer ($5.8 million, net of the unbilled adjustment).

- A $0.001 kilowatt-hour electric fuel surcharge effective May 9 through September 2, 2001 ($0.8 million; see Footnote 7).

The increase in retail revenues was offset by:

- A $1.4 million decrease in other electric revenues.

- A $5.3 million decrease in sales for resale because a contract expired with Wisconsin Public Power Inc. MGE sold 30 MWs of firm energy and capacity to Wisconsin Public Power from March 1999 through September 30, 2000.

As noted above, MGE adjusted unbilled revenues in the third quarter of 2001, reducing revenues by approximately $4.5 million. The adjustment was made after reviewing MGE's assumptions regarding electricity lost in the process of transmission and distribution, or line loss. Prior to the adjustment, MGE estimated line loss based on a computer-modeled study performed in 1985. At times, the study has been reviewed for reasonableness and adjustments made, as needed. An analysis of various operating and financial statistics in the third quarter of 2001 (including the unbilled-to-billed sales ratio) indicated the estimate for unbilled revenues needed adjusting. MGE's adjustment aligned the unbilled-to-billed ratio with the 40% to 50% range it would normally expect.

MGE changed its method for incorporating unbilled consumption from prior periods into the calculation ofcalculating amounts available for sale to customers during the current period.customers. The revised calculation determines unbilled quantities available for sale in the current month based on the current month and the trailing two months. MGE previously brought forward the unbilled quantity from prior months, which had the effect of cumulatingaccumulating any underestimated line loss amounts. The three months is based on an assumption (which MGE believes is reasonable) that all electricity consumed by all classes of customers is billed within three months. MGE also determined the ratio of unbilled-to-billed sales had a sufficient relationship to include that statistic in validating results of its estimation methodology. This is in addition to the ratio between unbilled sales and accounts receivable that was previously used. See Footnote 1.b.1.c. for more information regarding the unbilled revenue estimation methodology.

MGE - Gas SalesElectric fuel and Revenuespurchased power

In 2002, retail gas deliveries2003, fuel used for electric generation increased 10.2%$3.3 million, or 8.8%, primarily due to:

- Colder weather during most of the 2002 heating season. Total heating degree days were up 3.7% (see table).

- A larger customer base in southwestern Wisconsin. On December 28, 2001, MGE purchased the Prairie du Chien-area natural gas system from We Energies for $3.9 million. MGE gained approximately 3,600 residential and commercial customersto a rise in the Prairie du Chien area.

Transport deliveries increased 17.0% in 2002 as alternative fuel customers used more natural gas during the first half of the year. In 2001, transport sales declined as customers turned to other fuels when the pricecost of natural gas hit record-high levels.

Despite growthused at certain MGE generating plants. MGE's internal generation increased 2.5% in gas deliveries, retail gas revenues were down $8.42003. Purchased power expense increased $4.9 million, or 6.5%11.0%, primarily due to an increase in the cost of natural gas ($6.4 million). The average price for purchased power was $39.309 per MWh in 2003 compared to $34.210 in 2002, due to lower gas costs.an increase of 14.9%. The average rate for residential customersincrease in purchased power expense was $0.78 per thermpartially offset by a 3.4% decrease in 2002 compared to $0.91 per thermvolume ($1.5 million) resulting from the expiration of a 90-MW purchased power agreement with WPSC in 2001.September 2003.

The following table shows total gas deliveries by customer class.

Therms delivered(In thousands)20022001
% Change
Residential91,47082,63710.7
Commercial and industrial78,01071,1699.6
Total retail system169,480153,80610.2
Transport55,61447,52417.0
Total gas deliveries225,094201,33011.8
 
Heating degree days (normal 7,247)6,9576,7063.7


Heating degree days measure the extent to which the average daily temperature is below 65 degrees Fahrenheit, increasing demand for heating.

During 2001, retail gas deliveries were down 8.8%. Warmer weather in November and December resulted in lower gas use per customer. The average temperature for November and December 2001 was 38.5 degrees Fahrenheit, 65% warmer than the same period in 2000. Transport deliveries were up 5.2% primarily because customers who have the ability to switch fuels bought more gas to generate electricity or produce steam.

In 2001, gas revenues increased $9.6 million or 7.9%. Revenues were up due to significantly higher gas costs during the first half of the year and a 2.7% rate increase effective January 1, 2001 (see Footnote 7).

MGE - Electric Fuel and Purchased Power

In 2002, fuel used for electric generation decreased $2.1 million, or 5.2%., due to the following:

- Fuel costs for MGE's electric generating units--excluding Columbia and Kewaunee--were downunits (excluding Columbia) decreased $1.5 million, or 7.3%. MGE relied less on certain generating units because higher fuel costs made it generally cheaper to buy electricity than operate those units.

- Nuclear fuel expense decreased $2.3 million, or 89.5%, since MGE sold its ownership interest in Kewaunee in 2001.

- Fuel costs for the Columbia units increased $1.7 million, or 9.5%, due to higher coal costs.

- Nuclear fuel expense decreased $2.3 million or 89.5% since MGE sold its ownership interest in Kewaunee in 2001.

In 2002, purchased power expense increased $26.3 million, or 143.6%. MGE purchased electric capacity and energy to replace the energy generation lost from selling its ownership interest in Kewaunee and to meet expected load growth. In June 2001, MGE exercised an option to buy 90 MWsMW of electric capacity and energy at a fixed price from WPSC from September 24, 2001, through September 23, 2003.

Increased purchased power costs in 2002 reduced MGE's electric margin (revenues less fuel and purchased power) by $2.4Electric operating expenses

Electric operating expense increased $13.3 million, or 1.7%.

In 2001, fuel for electric generation increased $4.035.4%, in 2003 and decreased $0.8 million, or 10.9%1.4%, in 2002. The following changes contributed to the net change in electric operating expenses for the indicated year:

(In millions)
20032002
Increased transmission costs due to growing reliance on purchased power$ 3.5$ 0.6
Amortization of deferred costs related to ATC's formation and incremental
operating costs

2.8

-
Increased health and pension expenses due to rising health care costs and
lower investment returns on plan assets

3.7

2.6
Increased outside service expenses associated with holding company
formation and participation in Power the Future proposal

-

1.2
Decreased operating expenses as a result of sale of interest in Kewaunee-(5.3)
Increased miscellaneous distribution expenses0.7-
Increased regulatory expenses due to filing a CPCN for authority to build
WCCF


0.6

-
Increased/(decreased) miscellaneous steam power expenses*0.5(0.4)
Increased miscellaneous electric operating expenses1.50.5
Total electric operating expenses$13.3$(0.8)

*Amount for 2002 reflects a decrease of $1.1 million, or 41.9%, as a result of MGE's recovery through rates of some carrying costs for actions taken at Columbia to reduce NOx emissions, partially offset by increased expenses for Columbia of $0.7 million, or 27.8%, as a result of increased administrative and general overheads ($0.4 million) and employee pensions and benefits ($0.3 million).

Maintenance expense

In 2003, electric maintenance expense increased $3.6 million, or 30.8%. Fuel costs for MGE's electric generating units were up primarilyThis is due to the following factors:

- Increase in maintenance of distribution assets ($2.1 million), including substation work, transformers, and overhead and underground lines. Maintenance and system upgrades help to improve the reliability of MGE's electric distribution system.

- Increase in other maintenance sources, including electric generating assets and Columbia ($1.5 million).

In 2002, electric maintenance expense was down $2.5 million, or 20.2%. This decrease is the net result of the following two factors:

- Maintenance expenses declined ($3.1 million) since MGE sold its 17.8% ownership interest in Kewaunee to WPSC.

- Maintenance expenses at Columbia increased use($0.6 million) as a result of base-load power plants at a marginally higher fuelscheduled seven-week outage during April and May 2002.

Depreciation

Electric depreciation expense decreased $6.6 million and $6.7 million in 2003 and 2002, respectively. The decrease in 2003 reflects lower decommissioning expense ($8.2 million) as a result of the sale of Kewaunee, offset in part by $1.6 million of increased depreciation associated with an increase in electric plant assets. The decrease in 2002 reflects reduced decommissioning expense ($4.0 million), reduced depreciation due to the sale of Kewaunee ($3.4 million, see Footnote 18), and is partially offset by increased depreciation expense for the addition of electric assets ($0.7 million).

Gas Utility Operations

Gas deliveries and revenues

The following table compares MGE's gas retail revenues and gas delivered by customer class during each of the years ended December 31:

(In thousands)
RevenuesTherms delivered
200320022001200320022001
Residential$ 92,472$ 71,341$ 75,47897,76791,47082,637
Commercial/industrial62,02546,24850,82882,58078,01071,169
Total retail154,497117,589126,306180,347169,480153,806
Gas transportation3,3943,2382,93450,01255,61447,524
Other revenues1,9111,2821,293---
Total$159,802$122,109$130,533230,359225,094201,330
Heating degree days
(normal 7,209)

NA

NA

NA

7,366

6,957

6,706

Gas revenues were up 30.9% in 2003 and decreased 6.5% in 2002 due to the following:

(In millions)
20032002
Gas costs/rates$29.4$(21.5)
Gas deliveries7.512.9
Gas transportation0.10.3
Other effects0.7(0.1)
Total$37.7$ (8.4)
Average rate per therm of residential customers$0.95$ 0.78


-Gas costs/rates. The PSCW authorized increases in MGE's gas rates effective March 1, 2003, and January 1, 2002, to cover increased system demands. Gas costs increased significantly in 2003 from 2002. The average rate per therm in 2003 increased 23% compared to the prior year. The reverse was true for 2002. Despite a 10.2% increase in retail gas deliveries, revenues decreased due to the decrease -in the cost (especiallyof gas. See Footnote 15 of the Notes to Consolidated Financial Statements for additional information on gas base rates.

-Retail gas deliveries. The 6.4% increase in 2003 was due to colder-than-normal temperatures, as reflected in the second quarter)5.9% increase in heating degree days. The same effect was felt in 2002 when colder-than-normal temperatures caused gas deliveries to increase 10.2%. Total heating degree days were up 3.7% in 2002. The 2002 increase also reflects a full year of ownership of the Prairie du Chien-area natural gas system that was purchased on December 28, 2001, from We Energies for $3.9 million. MGE gained approximately 3,600 residential and commercial customers in southwestern Wisconsin as a result of the purchase.

-Gas transportation. The 10.1% decrease in deliveries in 2003 reflects fuel switching by customers with other fuel options, who switched due to the higher costprice of naturalgas. The reverse effect was observed in 2002 as alternative fuel customers used more gas used to generate electricity during the first half of 2002, causing a 17% increase in deliveries.

-Other effects. The other effects in 2003 reflect an increase of $0.6 million in the year. MGE customers set a record for peak demand (714 MWs) on August 7, 2001.GCIM and other miscellaneous increases totaling $0.1 million.

During 2001,Natural gas purchased power decreased $0.7 million or 3.4%. This decrease is attributed to the following:

- In the first three quarters of 2001, MGE did not need to buy additional capacity from outside sources because its base-load units operated at full capacity. In the second quarter of 2000, MGE purchased more expensive open-market replacement power during a six-week scheduled refueling and maintenance outage at Kewaunee.

- MGE purchased only 15 MWs from Commonwealth Edison in 2001 compared to 30 MWs in 2000.

The purchased power decreases described above were partially offset by the following:

- MGE executed its option to purchase 90 MWs of electric capacity and energy at a fixed price from WPSC from September 24, 2001, through September 23, 2003. This option was part of the Kewaunee sale agreement between WPSC and MGE (see Footnote 10).

Electric margin (revenues less fuel and purchased power) decreased $3.3 million or 2.2%, in 2001 reflecting constant revenues and the higher fuel costs as previously described.

MGE - Natural Gas Purchased

In 2002,2003, natural gas purchased was down $12.6increased $30.7 million, or 14.7%41.8%, primarily due to lowerhigher wellhead prices, on average. Natural gas prices (cost per therm) decreasedincreased more than 22.0%33% in 2002.2003. A purchased gas adjustmentPGA clause (PGA) allows MGE to pass along to customers the cost of gas, subject to certain limited incentives. The PGA is authorized by the PSCW.

MGE gas margin (revenues less gas purchased) increased $4.2 million or 9.4% in 2002. Customer growth increased deliveries and a 0.6% rate increase effective January 1,In 2002, contributed to the rise in gas margins (see Footnote 7).

In 2001, natural gas purchased increased $8.6decreased $12.6 million, or 11.0%14.7%, despite retail deliveries declining 8.8%. Even though customer use was down due to the warmer-than-normal winter weather, the average cost per therm of natural gas was up 21.8% over 2000. Gas margins increased $1.0 million or 2.4% primarily due to a 2.7% rate increase effective January 1, 2001.lower wellhead prices.

MGE - Other Operations and MaintenanceGas operating expenses

Electric

In 2002, electricGas operating expense decreased $0.8increased $2.3 million, or 1.4%.21.4%, in 2003 and increased $1.8 million, or 8.3%, in 2002. The following changes contributed to lower electric operating expenses for the year.

- MGE sold its 17.8% ownership interestnet change in Kewaunee to WPSC. As a result, operating expenses declined $5.3 million.

- Miscellaneous steam power expense decreased $1.1 million or 41.9%. MGE recovered through rates some carrying costs for actions taken at Columbia to reduce NOx emissions.

- Employee health and pension expenses increased $2.6 million or 61.8%, due to dramatically rising health care costs and lower investment returns on plan assets.

- Outside service expenses increased $1.2 million primarily due to forming the holding company and participating in Power the Future.

- Miscellaneous steam power expenses for Columbia increased $0.7 million or 27.8% as a result of increased administrative and general overheads ($0.4 million) and employee pensions and benefits ($0.3 million).

- Transmission wheeling costs rose $0.6 million or 5.7% due to relying on more purchased power.

- Miscellaneous electric operating expenses increased $0.5 million.

In 2001, electric operating expense increased $6.1 million or 11.7%. The following changes contributed to higher electricgas operating expense for the year.indicated year:

(In millions)
20032002
Increased health and pension expenses due to rising health care costs and
lower investment returns on plan assets



$1.7


$1.4
Increased administrative and general costs-1.4
Decreased uncollected revenues-(1.3)
Increased miscellaneous gas operating expenses0.60.3
Total gas operating expenses$2.3$1.8

- Increased transmission costs ($6.6 million). MGE started paying ATC a wheeling charge on January 1, 2001. The wheeling charge is offset by equity earnings for MGE's ownership interest in ATC. These equity earnings were recorded in other income.

- NOx accrual ($0.9 million). The PSCW authorized utilities to defer all project costs for complying with the federal US Environmental Protection Agency's (EPA) new requirements on NOx emissions. In its rate case (Docket 3270-UR-110), the PSCW allowed MGE to establish an escrow mechanism for these costs due to uncertainties regarding the amount and timing of NOx emissions remediation expenditures. The annual recovery allowed in rates is $1.6 million, of which $0.7 million is recorded in depreciation expense and $0.9 million in operating expense.

- Increased miscellaneous distribution expenses ($1.0 million).

Increases in electric operating expenses were offset somewhat by:

- Lower Kewaunee operating expenses ($2.2 million) due to three fewer months of expense after MGE sold its ownership interest in the plant (see Footnote 10) and lower overhead for administrative and general.

- The PSCW decreasing MGE's energy conservation escrow amount ($0.8 million).

Gas

In 2002, gas operating expense increased $1.8 million or 8.3%. The following changes contributed to higher gas operating expenses for the year.

- Employee health and pension expenses increased $1.4 million or 64.0% due to dramatically rising health care costs and lower investment returns on plan assets.

- Other expenses increased $1.4 million due to increased administrative and general expenses ($0.4 million), increased injuries and damages ($0.3 million), and other miscellaneous expenses ($0.7 million).

- Outside service expenses increased $0.3 million or 44.4% primarily due to forming the holding company.

- Uncollectible account expenses were down $1.3 million or 75.8%. More customers paid their bills in 2002 as warmer-than-normal weather and lower-priced natural gas in the first quarter significantly reduced utility bills.

In 2001, gas operating expense increased $1.7 million or 8.2%. Uncollectible customer account balances were up due to significantly higher natural gas costs during the first half of the year ($1.0 million) and increased administrative and billing expenses ($0.7 million).

Maintenance Expense

In 2002, electric maintenance expense was down $2.5 million or 20.2%. It is the net result of the following two factors:

- Maintenance expenses declined ($3.1 million) since MGE sold its 17.8% ownership interest in Kewaunee to WPSC.

- Maintenance expenses at Columbia increased as a result of a scheduled seven-week outage during April and May 2002 ($0.6 million).

In 2001, electric maintenance expense was down $4.5 million or 26.5% primarily due to:

- Three fewer months of expense at Kewaunee after MGE sold its ownership interest in the plant (see Footnote 10) combined with lower maintenance expense compared to 2000 ($1.8. million).

- Lower maintenance expense at Columbia ($1.2 million).

Depreciation

In 2002, depreciation expense decreased $6.3 million or 17.7%.

- Electric depreciation decreased $6.7 million. The decrease is attributed to reduced decommissioning expense ($4.0 million), the sale of Kewaunee assets ($3.4 million, see Footnote 10), and offset by increased depreciation expense for the addition of electric assets ($0.7 million).

- Gas depreciation expense increased because MGE added plant assets ($0.4 million).

In 2001, depreciation expense increased $0.6 million or 1.6%.

- Electric depreciation expense increased $0.7 million. The change in depreciation expense is attributed to increased earnings on the decommissioning trust fund ($0.6 million), a NOx accrual ($0.7 million), the addition of electric assets ($1.4 million), and somewhat offset by reduced transmission depreciation ($1.8 million, see Footnote 9) and the transfer of assets related to the Kewaunee sale ($0.5 million).

- There were no significant changes to gas depreciation in 2001.

Other General Taxes

Other general taxes, consisting mainly of the Wisconsin license fee tax and payroll taxes, were consistent between 2002 and 2001.

Income Taxes

The 2002 effective income tax rate increased to 39.1% from 36.8% for 2001 and 36.5% for 2000 due to a combination of reasons.

The increase in tax rate is partly attributable to lower amounts of amortized tax benefits from excess deferred income taxes and deferred investment tax credit. These lower amortized tax benefits are the result of MGE's investment in ATC and the sale of its interest in Kewaunee, both 2001 transactions. In 2002 compared to 2001, amortized excess deferred income taxes and amortized investment tax credits have decreased by a total of $0.4 million.

In 2002, MGE recorded a net deferred tax expense of $0.4 million to fully accrue its deferred tax liability for utility property. MGE is evaluating its ability to recover these taxes in rates.

On August 12, 2002, MGE Energy became the holding company for MGE and other subsidiaries. Certain one-time intercompany transactions for state tax purposes and costs of capital associated with forming MGE Energy have resulted in permanent differences between financial and income tax reporting and have increased the state tax component of the effective income tax rate.

Other Nonoperating Items

In 2002, other income decreased $6.3 million or 72.8%. The decrease in other income is attributed to the following:

- MGE transferred its Qualified Decommissioning Fund ($65.0 million, fair market value) and Nonqualified Decommissioning Fund ($28.1 million, fair market value) to WPSC with the sale of its 17.8% ownership interest in Kewaunee (Footnote 10). There was no impact on earnings. The lower decommissioning earnings on trust assets were offset by an equal decrease in accumulated depreciation expense. The related decrease in other income was $4.0 million.

- An increase in charitable contributions reduced other income by $1.6 million.

- During 2002, MGE did not benefit from a gain on a weather hedge. In 2001, MGE received a $0.8 million pretax gain from weather hedge instruments. The net effect was a $0.8 million decrease in other income in 2002.

In 2001, other income increased $6.7 million primarily due to:

- $3.3 million equity earnings in ATC (see Footnote 9).
- A $0.8 million gain from weather hedge instruments.
- A $0.6 million increase in earnings on the decommissioning funds.
- A $1.6 million reduction in charitable contributions.

In 2000, other income decreased $3.1 million. MGE donated $1.3 million to the MGE Innovation Center and the MGE Foundation. These donations provide substantial benefits to the community and MGE's service territory. Other income was also down because there was a gain from MGE's gas marketing subsidiaries in 1999 and not in 2000. Earnings on the decommissioning fund were up $0.4 million in 2000.

Interest Expense

In2003 and 2002, interest expense decreased $1.2 million or 9.0%. Lower rates on MGE's $20.0 million variable rate debt (which matured on May 3, 2002) reduced interest expense by $0.7 million. Lower short-term debt levels in the first quarter, coupled with significantly lower interest rates, reduced other interest expense by $0.5 million.

In 2001, total interest decreased $0.5 million or 3.6%. Lower short-term debt, due to proceeds received from ATC and the sale of Kewaunee, caused the decline in other interest expense of $0.6 million. In addition, MGE redeemed $6.1 million of its 6-1/2%, 2006 Series, Pollution Control Revenue Bonds, at par on November 1, 2001.

In 2000, total interest increased $2.1 million or 17.3%. Compared to 1999, MGE had higher levels of short-term debt and interest on $35.0 million in new long-term debt ($20.0 million issued on May 4, 2000, and $15.0 million issued on September 20, 2000).

MGE - Electric and Gas Operations Outlook

MGE anticipates electric and gas sales will grow at a compounded rate of 1.0% to 2.0% through 2007. Peak demand will grow an estimated 3.0% each year through 2007.

MGE expects to maintain a competitive advantage because of its:

- Service territory, which has one of the strongest economies in the nation. It is distinguished by consistent growth; high employment and wages; and a diversified base of business, industry, government, and education.

- Competitive distribution costs, low percentage of industrial customers, and lower risk of stranded investments.

- Size and agility, which allow employees to respond quickly and offer more flexibility as customers' needs change.

MGE sold its ownership interest in Kewaunee in the fall of 2001. This will help eliminate the risk of future stranded investment. The capacity lost from Kewaunee will be replaced with purchased power contracts.

The PSCW has focused on improving the infrastructure needed in Wisconsin to ensure reliable service for consumers. MGE invests in new facilities to meet its customers' needs. It also advocates statewide solutions that will keep pace with the growing demand for energy.

Nonutility Energy Outlook

MGE Energy's primary focus is its core utility customers. The holding company structure will facilitate competitive new electric generation projects. It will also allow financial returns from these projects to be retained for the benefit of MGE's system and MGE Energy's shareholders.

MGE Energy's nonutility energy operations will be conducted through its subsidiaries, MGE Construct, LLC, and MGE Power, LLC. Both were formed in 2002 to construct and own new generating capacity. It is expected that, subject to PSCW approval in each instance, MGE Power will lease-back new generating facilities to MGE under regulated, long-term lease agreements.

Power the Future Generation

On February 23, 2001, MGE secured an option to own a portion of the advanced technology, coal-fired, base-load generation proposed in We Energies' Power the Future plan. The plan includes three new 600-MW coal-fired plants, which would be located in Wisconsin. The plan is subject to pending regulatory proceedings. We Energies filed its Certificate of Public Convenience and Necessity (CPCN) proposal with the PSCW in early 2002. A PSCW decision is expected on the plan in 2003.

Pursuant to an amended agreement reached on January 31, 2003, MGE has the option to acquire an undivided 8.33% (16.66% under certain conditions) ownership interest in each of the proposed coal plants, up to a total of 150 MWs for all three plants. If these options are fully exercised, that exercise would require an estimated $150 million to $175 million investment over ten years.

West Campus Cogeneration Facility (WCCF)

MGE Energy, through MGE Power and MGE Construct, has assumed responsibility from MGE for the construction and ownership of a proposed natural gas-fired cogeneration facility to be built on the Madison campus of the UW. As planned, the facility would have 20,000 tons of chilled water capacity, 500,000 pounds per hour of steam capacity, and approximately 150 MWs of electricity capacity. The facility would be jointly-owned by the State of Wisconsin, the UW, and MGE Power and would be leased and operated by MGE. The State and the UW would own a controlling interest in the chilled water and steam plants, which would be used to meet the growing UW need for air-conditioning and steam heat capacity. MGE Power would own a controlling interest in the electric generation plant, which would be used to provide electricity to MGE's customers. MGE Construct would be responsible for the construction of the facility.

The ownership, construction, and operation of the facility requires various state approvals as well as the completion of definitive agreements, including a construction agreement. As part of this process, the State is reviewing its alternatives before entering final agreements. Depending on the approval process, construction could start in 2003, with the facility coming on-line in 2005. MGE also requires PSCW approval in order to lease and operate the facility. On October 21, 2002, the PSCW deemed MGE's CPCN application complete. A PSCW decision is expected on MGE's participation in the facility during 2003.

The facility is expected to cost approximately $180 million. On November 29, 2002, the State paid $11.9 million to MGE for its share of those costs under a September 2002 Pre-Certification Cost Sharing Agreement between MGE and the State. On December 31, 2002, MGE Power reimbursed MGE for the remainder of those costsrespectively, as a partresult of MGE Power's assumption of the project. As of December 31, 2002, MGE Power had incurred $18.9 million of costs on the project, which is reflected as construction work in progress on MGE Energy's consolidated balance sheets. These costs largely represent amounts paid under long-lead time equipment contracts in order to meet project schedules, although, as noted, several approvals remain outstanding. A failure to obtain these approvals could terminate the project and could result in the write-off of these costs to the extent that the associated equipment and efforts cannot be put to alternative uses.additional gas plant assets.

Liquidity And Capital ResourcesGas cost incentives

Cash Flows

The following summarizes MGE Energy's cash flows during 2002, 2001, and 2000:

Thousands of dollars200220012000
Cash provided by/(Used for):
Operating activities$56,729$74,684$47,774
Investing activities(86,377)(24,533)(84,841)
Financing activities30,225(52,037)39,426


Cash Provided by Operating Activities for MGE Energy

In 2002, cash provided by operating activities decreased $18.0 million or 24.0%. Working capital (current assets less current liabilities) decreased $0.8 million primarily due to an increase in customer payables. MGE deposited $5.0 million in an escrow account and granted ATC a security interest in the collateral. ATC will provide system upgrades for MGE in conjunction with the WCCF proposed on the UW-Madison campus. The collateral account complies with the Interconnection Agreement between ATC and MGE dated November 22, 2002.

Depreciation and other amortization expenses decreased $8.3 million, mainly because MGE sold its ownership interest in Kewaunee. Deferred income taxes for 2002 decreased $8.0 million compared to 2001. The significantly larger deferred tax expense in 2001 was attributable to the sale of Kewaunee, which resulted in reversal of temporary differences associated with the plant and decommissioning funds.

In 2001, cash provided by operating activities increased $26.9 million or 56.3%. Decreases in customer receivables ($13.1 million) and unbilled revenues ($11.4 million) were offset by higher stored gas inventories of $6.8 million and a $4.4 million reduction in accounts payable. Deferred income taxes increased in 2001 due to the sale of Kewaunee.

Capital Requirements and Investing Activities for MGE Energy

In 2002, cash used for investing activities increased $61.8 million. Utility plant additions were up $17.5 million due to installing an automated meter reading (AMR) system, installing NOx emissions equipment at Columbia, and upgrading MGE substations to improve reliability. Capital expenditures related to the WCCF totaled $18.9 million. In 2001, MGE received a $15.0 million capital distribution from ATC and $15.4 million for selling its interest in Kewaunee.

In 2001, MGE's cash used for investing activities was down $60.3 million or 71.1% mainly because of a significant decrease in plant additions. In 2000, MGE paid $31.6 million for an 83-MW gas-fired combustion turbine. MGE also received a capital distribution of $15.0 million from ATC for debt repayment and a cash payment of $15.4 million from the sale of Kewaunee (see Footnote 10).

MGE Energy's and MGE's liquidity are primarily affected by their construction requirements. Capital expenditures in 2002 totaled $78.3 million, which included $18.9 million of capital commitments for the WCCF. MGE's capital requirements were higher in 2002 due to installing an AMR system ($17.6 million), upgrading MGE substations to improve reliability ($4.7 million), and installing NOx emissions equipment at Columbia ($2.4 million). MGE anticipates 2003 capital expenditures will be $51.6 million and include substation improvements ($5.1 million), AMR project costs ($3.4 million), and upgrading its Energy Management System ($1.8 million).

Capital expenditures for 2003 through 2007 will average an estimated $46 million per year (excluding the WCCF and MGE's option to purchase a portion of Power the Future coal plants). The following table shows MGE's estimated expenditures for 2003, actual for 2002, and the three-year average for 1999 to 2001.

Capital expenditures (including nuclear fuel)
(In thousands)
For the years ended December 31
2003
(Estimated)
 2002
(Actual)
 Three-Year Average
(1999 to 2001)
Electric: 
Production$ 8,36816.2% $10,64217.9% $28,51151.4%
Transmission-- -- 2,2124.0%
Distribution and general25,10648.7% 21,76636.6% 13,97125.2%
Nuclear fuel-- -- 2,0903.8%
Total electric33,47464.9% 32,40854.5% 46,78484.4%
Gas8,42516.3% 7,33412.4% 7,10112.8%
Common9,70118.8% 19,68833.1% 1,6362.8%
Total$51,600100.0% $59,430100.0% $55,521100.0%

In 2002, MGE used internally generated funds and short-term debt to satisfy most of its capital requirements. For the larger capital investments, MGE issues additional long-term debt and common stock. MGE Energy used existing lines of credit to satisfy capital commitments related to the WCCF.

Financing Activities and Capitalization Matters for MGE Energy

In 2002, cash provided by financing activities was $30.2 million. Short-term debt increased $24.8 million. Two long-term debt issues occurred in the fourth quarter of 2002. A $20.0 million issue replaced the $20.0 million in debt that matured in May, which was rolled into short-term debt at that time. Another $15.0 million issue financed capital expenditures for the AMR project, which had been financed with short-term debt.

MGE Energy's capitalization ratios were as follows:

Capital structure ratios
2002
2001
Common shareholders' equity*51.1%53.7%
Long-term debt*41.5%43.9%
Short-term debt7.4%2.4%
*Does not include accumulated other comprehensive loss; includes current maturities.


In 2001, cash used for financing activities was $52.0 million as MGE reduced its short-term debt by $34.5 million. MGE reduced short-term debt and redeemed $6.1 million in long-term debt by using the cash distribution from ATC and cash received from the sale of its interest in Kewaunee. MGE raised $10.9 million by issuing common stock for its Dividend Reinvestment and Direct Stock Purchase Plan (the Plan). MGE issues new shares of common stock for the Plan to improve cash flow and capitalization ratios.

MGE's First Mortgage Bonds are currently rated Aa2 by Moody's Investors Service, Inc. (Moody's) and AA by Standard & Poor's Corp. (S&P). MGE's medium-term notes are rated Aa3 by Moody's and AA- by S&P. MGE's dealer-issued commercial paper carries the highest ratings assigned by Moody's and S&P. MGE Energy is not yet rated because it has not issued any debt securities.

MGE's access to the capital markets, including the commercial paper market, and its financing costs in those markets are dependent on its securities' ratings. None of MGE's borrowing is subject to default or prepayment due to downgrading of securities' ratings.

Contractual Obligations and Commercial Commitments for MGE Energy and MGE

MGE Energy and MGE's contractual obligations as of December 31, 2002, representing cash obligations that are considered to be firm commitments, are as follows:

In thousandsPayment due within:Due after
 
Total
1 Year
2-3 Years
4-5 Years
5 Years
Long-term debt$193,500 $ -$20,000$15,000 $158,500
Short-term debt34,298 34,298-- -
Operating leases9,516 1,5921,6781,054 5,192
Purchase obligations203,925 33,90046,90040,600 82,525
Other long-term obligations1,140 285570285 -
Total contractual obligations$442,379 $70,075$69,148$56,939 $246,217

For additional information about:

- Long-term debt consisting of secured First Mortgage Bonds and unsecured medium-term notes, see Footnote 6.c. of the Notes to Consolidated Financial Statements.

- Short-term debt consisting of commercial paper issued by MGE, which is supported by unused lines of credit from banks and bank loans to MGE Energy, see Footnote 6.d. of the Notes to Consolidated Financial Statements.

- Operating leases, see Footnote 8 of the Notes to Consolidated Financial Statements.

- Purchase obligations consisting of obligations to purchase electricity and to purchase and transport natural gas, see Footnote 8 of the Notes to Consolidated Financial Statements.

- Other long-term obligations, see Footnotes 1.c. and 10 of the Notes to Consolidated Financial Statements.

MGE Energy and MGE's commercial commitments as of December 31, 2002, representing commitments triggered by future events and including financing arrangements to secure obligations of MGE Energy and MGE, and guarantees by MGE, are as follows:

In thousandsExpiration within:Due after
 
Total
1 Year
2-3 Years
4-5 Years
5 Years
MGE - Available lines of credit (a)$40,000 $40,000 $ - $ - $ -
MGE - Bank letter of credit (b)5,000 5,000 - - -
MGE Energy - Available lines of credit (c)45,000 45,000 - - -
MGE - Guarantees (d)6,775 1,138 1,738 1,512 2,387

(a) Lines of credit consisting of a 364-day credit facility to support commercial paper issuances. At December 31, 2002, there were no borrowings against the credit facility. Additionally, at December 31, 2002, there was $13.5 million of commercial paper outstanding.

(b) MGE has a letter of credit with a commercial bank established as collateral for equipment purchases that ATC will make to provide necessary system upgrades for the WCCF.

(c) MGE Energy has established two temporary lines of credit, one for temporary financing of the capital commitments for the WCCF ($40.0 million) and one for general corporate purposes ($5.0 million). Both lines expire in the first half of 2003. Additionally, at December 31, 2002, MGE Energy had $20.8 million in bank loans outstanding.

(d) MGE has guaranteed repayment of certain receivables it has sold to a financial institution under a Chattel Paper Agreement (see Footnote 8 of the Notes to Consolidated Financial Statements).

Other Factors

Due to the performance of the United States debt and equity markets, the value of assets held in trusts to satisfy the obligations of pension and postretirement benefit plans has decreased. These factors may also result in additional future funding requirements of the pension and postretirement benefit plans.

Business And Regulatory Environment

Electric Transmission - ATC

On January 1, 2001, MGE transferred substantially all of its electric transmission facilities to ATC in exchange for approximately a 6.0% interest in this joint venture. ATC is comprised of Wisconsin investor-owned utilities and some Wisconsin municipal utilities, cooperatives, and power supply agencies.

Effective October 24, 2002, the PSCW authorized an electric rate surcharge of $4.5 million or 2.0% for MGE to recover deferred costs associated with ATC's formation and ongoing incremental transmission costs during 2001 and 2002. The surcharge will be in effect for a 12-month period ending October 23, 2003.

On November 21, 2002, MGE and ATC entered into a Generation-Transmission Interconnection Agreement related to transmission system upgrades due to the WCCF. MGE issued to ATC a "Notice to Proceed for the Procurement of the Equipment" for the system upgrades. In accordance with the agreement, MGE had to provide ATC with a form of security, such as a Letter of Credit or a collateral account, in the amount of $5.0 million. MGE set up a collateral (escrow) account to satisfy the security interest to ATC until MGE was able to secure a Letter of Credit from a commercial bank, which it received on December 30, 2002. The collateral account was terminated on January 2, 2003. MGE will make an estimated $10 million capital payment for transmission equipment and work done by ATC throughout 2003 related to the WCCF. MGE expects to be reimbursed by ATC for its capital outlay once the project is completed.

Kewaunee

Effective September 23, 2001, MGE sold to WPSC its 17.8% ownership interest in Kewaunee. In exchange for a cash payment of $15.4 million, MGE transferred its net book value of utility plant ($8.2 million), net nuclear fuel ($7.9 million), inventories ($1.5 million), and other assets ($0.1 million). These assets were offset by $2.3 million owed to WPSC. On the closing date, MGE also transferred its Qualified Decommissioning Fund ($65.0 million fair market value) and Nonqualified Decommissioning Fund ($28.1 million fair market value), which decreased accumulated depreciation by an equal amount. This transaction occurred in accordance with an agreement between MGE and WPSC dated September 29, 1998. That agreement required certain continuing obligations of MGE and WPSC after the closing date, as described below.

MGE made monthly contributions to the MGE Nonqualified Decommissioning Fund from September 23, 2001, in the amount of approximately $0.7 million (the level authorized by the PSCW) through December 31, 2002. These costs were recovered from customers in rates. MGE's decommissioning liability is limited to the fund balances at the closing date plus all decommissioning collections through 2002. MGE's Nonqualified Decommissioning Fund is shown on the balance sheet in the Utility Plant section. As of December 31, 2002, this fund totaled $8.8 million (pretax fair market value) and was offset by an equal amount recorded in accumulated provision for depreciation. The securities and uninvested cash balances in the fund, net of trust investment expenses and taxes on investment income, were transferred to the WPSC Nonqualified Decommissioning Fund on January 3, 2003.

The federal government is responsible for the disposition and storage of spent nuclear fuel. Federal legislation is being considered to establish an interim storage facility. Spent nuclear fuel is currently stored at Kewaunee. Minor plant modifications to the spent fuel pools in 2001 should ensure Kewaunee has sufficient fuel storage capacity until the end of its licensed life in 2013. MGE retains its spent fuel obligations for all fuel burned at Kewaunee for MGE's generation from the opening of the plant to the closing date. WPSC took title to such fuel at the closing date.

A surcharge imposed by the National Energy Policy Act of 1992 requires nuclear power companies to fund the decontamination and decommissioning of US Department of Energy facilities that process nuclear fuel. As a result, the Kewaunee co-owners are required to pay a surcharge on uranium enrichment services purchased from the federal government prior to October 23, 1992. On an inflation-adjusted basis, MGE's portion of the obligation related to Kewaunee is approximately $1.1 million at December 31, 2002. MGE is required to continue paying its portion of this annual assessment.

In accordance with the sale agreement, MGE exercised its option in June 2001 to buy electric capacity and energy at a fixed price from WPSC. MGE purchased 90 MWs of electric capacity and energy from September 24, 2001, through December 31, 2002, and will continue to do so through September 23, 2003, to help meet customers' electric needs.

Formation of Holding Company

On August 12, 2002, MGE Energy became the holding company for MGE following a share exchange. Each share of MGE common stock was exchanged for one share of MGE Energy common stock. MGE Energy's consolidated financial statements reflect this transaction for all periods presented. MGE Energy's operations are based primarily on the operations of MGE. Consequently, MGE constitutes a majority of the assets, liabilities, and results of operations of MGE Energy and is expected to continue to do so for the foreseeable future.

Industry Restructuring in Wisconsin

Wisconsin has focused on building the infrastructure needed to provide reliable electric service to customers. State regulators realize a competitive market cannot exist when supply is short. The PSCW will decide when it is appropriate for retail competition to proceed in the electric industry. MGE cannot predict what impact future PSCW actions may have on its future financial condition, cash flows, and results of operations. However, MGE believes it is well-positioned to compete.

Restructuring the electric industry could affect MGE's ability to continue establishing certain regulatory asset and liability amounts allowed under Statement of Financial Accounting Standards (SFAS) No. 71,Accounting for the Effects of Certain Types of Regulation. MGE is unable to predict whether any adjustments to regulatory assets and liabilities will occur in the future. However, the PSCW has recognized the need to allow recovery for commitments made under prior regulation.

Gas Cost Incentives

Under MGE's gas cost incentives,GCIM, if actual gas commodity costs are above or below a benchmark set by the PSCW, then MGE's gas sales service customers and shareholders share equally in any increased costs or savings up to $1.5 million. Any costs or savings that exceed $1.5 million will be passed on to gas sales service customers. The PSCW allows MGE to resell gas pipeline capacity reserved to meet peak demands but not needed every day to serve customers. Revenues from capacity release that exceed or fall short of PSCW-targeted levels are shared equally. In 2002,2003, MGE shareholders benefited $0.5$0.9 million (after tax) from capacity release revenues and commodity savings under the GCIM.

The PSCW recently lowered the formula used in establishing the benchmark for gas commodity costs. Beginning February 1, 2004, the benchmark will be 99.5% of what it would have been under the prior formula. This change is intended to better reflect market conditions.

Other General Taxes

The 6.7% increase ($0.7 million) in other general taxes from 2002 to 2003 is due to an increase in MGE's license fee tax, which for any year is based on adjusted operating revenues of the prior year. The Wisconsin license fee tax is in lieu of all property taxes on utility property.

Income Taxes

The 2003 effective income tax rate increased slightly from 2002 from 39.1% to 39.4% due to constant amounts of tax credits (amortized investment tax credits and credit for electricity from wind energy) in relation to pretax income (see Footnote 9).

The increase in effective income tax rates from 2001 to 2002 (36.8% to 39.1%) is partly attributable to lower amounts of amortized tax benefits from excess deferred income taxes and deferred investment tax credit. These lower amortized tax benefits are the result of the MGE's investment in ATC and the sale of its interest in Kewaunee, both 2001 transactions. In 2002 compared to 2001, amortized excess deferred income taxes and amortized investment tax credits decreased by a total of $0.4 million.

Additionally, the state tax component of the effective income tax rate was greater in 2002 than in 2001 due to permanent differences for certain one-time intercompany transactions for state tax purposes and for costs of capital incurred in forming MGE Energy on August 12, 2002.

Other Nonoperating Items

In 2003, MGE Construct received a service fee from the State in relation to WCCF of $1.0 million. This was offset by an increase in charitable contributions of $1.2 million. Dividend and interest income increased in 2003 by $0.4 million.

In 2002, other income decreased $6.3 million, or 72.8%. The decrease in other income is attributed to the following:

- MGE transferred its qualified decommissioning fund ($65.0 million, fair market value) and nonqualified decommissioning fund ($28.1 million, fair market value) to WPSC with the sale of its 17.8% ownership interest in Kewaunee (Footnote 18). There was no impact on earnings. The lower decommissioning earnings on trust assets were offset by an equal decrease in accumulated depreciation expense. The related decrease in other income was $4.0 million.

- An increase in charitable contributions reduced other income by $1.6 million.

- In 2001, MGE received a $0.8 million pretax gain from weather hedge instruments. During 2002, MGE did not receive a similar benefit. The net effect was a $0.8 million decrease in other income in 2002.

Interest Expense

In 2003, interest expense decreased by $0.8 million, or 6.1%, due to the following factors:

- MGE refinanced a large portion of its long-term debt in 2002, helping to decrease interest expense by $0.5 million.

- Lower short-term interest rates coupled with reduced borrowing levels helped to decrease other interest expense by $0.3 million.

In 2002, interest expense decreased $1.2 million, or 9.0%, due to the following factors:

- Lower rates on MGE's $20.0 million variable rate debt (which matured on May 3, 2002) reduced interest expense by $0.7 million.

- Lower short-term debt levels in the first quarter, coupled with significantly lower interest rates, reduced other interest expense by $0.5 million.

Liquidity and Capital Resources

Cash Flows

The following summarizes cash flows for MGE Energy and MGE during 2003, 2002, and 2001:

MGE EnergyMGE
(Thousands of dollars)
200320022001200320022001
Cash provided by/(Used for):
Operating activities$ 68,602$ 56,246$ 73,987$ 73,162$ 53,500$ 73,502
Investing activities(93,474)(86,709)(24,853)(54,259)(67,857)(24,853)
Financing activities26,20730,709(51,340)(18,921)14,136(50,855)

Cash Provided by Operating Activities for MGE Energy

In 2003, cash provided by operating activities increased $12.4 million, or 22.0%. Working capital increased $6.6 million primarily due to increases in unbilled revenues ($3.1 million), stored natural gas ($5.6 million), prepayments ($3.4 million), and accounts receivable ($1.4 million). These increases in current assets were offset by higher accounts payable of $3.0 million and other current liabilities totaling $3.7 million.

Deferred income taxes increased $13.1 million in 2003 due to the impact of 50% additional bonus depreciation, which went into effect in May 2003. An increase in other noncurrent items net, of $5.2 million, also contributed to the increase in cash provided by operating activities.

In 2002, cash provided by operating activities decreased $17.7 million, or 24.0%. Working capital decreased $0.3 million primarily due to an increase in customer payables. Depreciation and other amortization expenses decreased $6.3 million, mainly because MGE sold its ownership interest in Kewaunee. Deferred income taxes for 2002 decreased $8.0 million compared to 2001. The significantly larger deferred tax expense in 2001 was due to selling Kewaunee, which resulted in reversal of temporary differences associated with the plant and decommissioning funds.

Cash Provided by Operating Activities for MGE

In 2003, cash provided by operating activities increased $19.7 million, or 36.8%. Working capital increased $3.2 million in 2003 due to a decrease in accounts receivable of $1.8 million and increases in accounts payable of $3.7 million. Other current assets, such as unbilled revenues, inventories, and prepayments, increased in total $12.1 million. Other current liabilities increased $3.6 million. Deferred income taxes increased $13.2 million in 2003, while depreciation decreased $6.0 million, due to lower decommissioning expenses. Other noncurrent items, net, increased $6.6 million, which contributed to the increase in cash provided by operating activities.

In 2002, cash provided by operating activities decreased $20.0 million. Working capital increased $2.5 million in 2002 due to an increase in accounts receivable of $11.2 million and increases in unbilled revenues and prepayments of $2.0 million each. The increases in current assets were offset by an increase in accounts payable of $6.5 million, an increase in other current liabilities of $3.9 million, and a decrease in inventories of $2.4 million. Decreases in depreciation of $6.3 million and deferred taxes of $8.0 million attributed to the decrease in operating activities. The decreases in these items was attributable to the sale of Kewaunee as discussed earlier.

Capital Requirements and Investing Activities for MGE Energy and MGE

In 2003, MGE Energy's cash used for investing activities increased $6.8 million. Capital expenditures increased $6.0 million in 2003. Utility plant additions decreased $3.4 million, while capital expenditures related to the WCCF increased $9.4 million over last year. MGE's advance to ATC in connection with the installation of equipment and system upgrades for WCCF increased $7.9 million in 2003. In 2002, MGE was still contributing to the decommissioning fund for Kewaunee.

In 2002, cash used for investing activities increased $61.8 million. Utility plant additions were up $16.2 million due to installing an AMR system, installing NOx emissions equipment at Columbia, and upgrading MGE substations to improve reliability. Capital expenditures related to WCCF totaled $18.9 million. The increase in 2002 also reflects an unfavorable comparison to 2001, in which MGE received a $15.0 million capital distribution from ATC and $15.4 million for selling its interest in Kewaunee.

The following table shows MGE Energy's and MGE's estimated capital expenditures for 2004, actual for 2003, and the three-year average for 2000 to 2002:

(In thousands)

For the years ended December 31

2004
(Estimated)
2003
(Actual)
Three-Year Average (2000 to 2002)
Electric:
Production$10,73910.9%$7,5419.1%$23,23836.3%
Transmission----9361.5%
Distribution and general20,44920.8%27,18232.8%17,34627.0%
Nuclear fuel----1,7282.7%
Total electric31,18831.8%34,72341.9%43,24867.5%
Gas8,6568.8%9,26911.2%7,59011.8%
Common5,4565.5%10,71612.9%7,49711.7%
Utility plant total45,30046.1%54,70865.9%58,33591.0%
Nonutility (WCCF)52,92053.9%28,26234.1%5,7609.0%
MGE Energy total$98,220100.0%$82,970100.0%$64,095100.0%

MGE Energy's and MGE's liquidity are primarily affected by their construction requirements. MGE's major 2003 capital projects included substation improvements ($3.5 million), AMR project costs ($7.0 million), upgrading its energy management system ($1.6 million).

MGE Energy used funds received as dividend payments from MGE as well as short- and long-term external financing to meet its 2003 capital requirements and cash obligations, including dividend payments. External financing included short-term financing under existing lines of credit and longer-term financing through the issuance of $30 million of 5.68% senior secured notes due September 25, 2033, and the issuance of 165,000 shares of its common stock pursuant to a Distribution Agreement with Banc One Capital Markets, Inc. While dividends from MGE will remain a significant source for the cash needs of MGE Energy, MGE Energy expects that revenues from the WCCF will supplement those dividends starting in 2005 when the WCCF becomes operational. In the interim, MGE Energy expects to continue to use existing lines of credit and to issue additional long-term debt and shares of common stock, in addition to cash dividends from MGE, to meet its capital requirements and other cash obligations, including dividends.

Dividend payments by MGE to MGE Energy are subject to restrictions arising under a January 12, 2004, PSCW rate order and, to a lesser degree, MGE's First Mortgage Bonds. The PSCW order limits the amount of dividends that MGE may pay MGE Energy when its common equity ratio, calculated in the manner used in the rate proceeding, is less than 55%. Under those circumstances, MGE may not pay dividends in excess of $25.1 million plus dividends on shares issued in excess of the shares issued in the rate proceeding forecast if the proceeds are invested in MGE. MGE's common equity ratio at December 31, 2003, as determined under the calculation used in the rate proceeding, is estimated to be 55.4%. The rate proceeding calculation includes as indebtedness imputed amounts for MGE's outstanding purchase power capacity payments and other PSCW adjustments and excludes the indebtedness associated with MGE Power West Campus, which is consolidated in accordance with FIN No. 46-R into MGE's financial statements.

In addition, MGE has covenanted with the holders of its First Mortgage Bonds not to declare or pay any dividend or make any other distribution on or purchase any shares of its common stock unless, after giving effect thereto, the aggregate amount of all such dividends and distributions and all amounts applied to such purchases, after December 31, 1945, shall not exceed the earned surplus (retained earnings) accumulated subsequent to December 31, 1945. As of December 31, 2003, approximately $145 million was available for the payment of dividends under this covenant.

MGE used internally generated funds, short-term debt, and proceeds from common stock issued through MGE Energy's Dividend Reinvestment and Direct Stock Purchase Plan to satisfy most of its 2003 capital requirements and expects to do the same in 2004. For the larger capital investments, MGE would expect to finance these with additional long-term debt and capital contributions from MGE Energy.

Financing Activities and Capitalization Matters for MGE Energy and MGE

In 2003, cash provided by MGE Energy's financing activities was $26.2 million. On September 30, 2003, MGE Energy's subsidiary, MGE Power West Campus, issued $30 million in private-placement debt, increasing long-term debt and using the proceeds from this issue to pay off short-term debt. MGE Energy was temporarily financing the capital expenditures for WCCF with short-term debt. MGE refinanced $20.0 million of its 7.70%, 2028 Series, First Mortgage Bonds with lower cost incentives.debt.

Proceeds from the issuance of common stock increased $9.6 million when compared to last year. In addition to its Dividend Reinvestment and Direct Stock Purchase Plan, MGE Energy also has been selling additional shares of stock through Banc One Capital Markets, Inc., under a Distribution Agreement.

Short-term debt decreased $2.6 million in 2003. MGE Energy, through its affiliate MGE Construct, received a reimbursement of $19.4 million in November from the State for its share of the capital expenditures related to WCCF. This reimbursement was used to pay down MGE Energy's bank loan.

In 2002, MGE Energy's cash provided by financing activities was $30.7 million. Short-term debt increased $24.8 million. Two long-term debt issues occurred in the fourth quarter of 2002. A $20.0 million issue replaced the $20.0 million in debt that matured in May, which was rolled into short-term debt at that time. Another $15.0 million issue financed capital expenditures for the AMR project, which had been financed with short-term debt.

In 2003, MGE's cash used for financing activities was $18.9 million. In conformity with FIN No. 46-R, MGE includes the consolidation of MGE Power West Campus (see Footnote 2). MGE Power West Campus had $10.5 million of affiliate loans for the financing of WCCF. MGE benefited from $19.6 million in equity contributions from its parent, which was offset by $29.7 million in cash dividends paid to parent. MGE's short-term debt increased $2.0 million.

In 2002, MGE's cash provided by financing activities was $14.1 million. MGE refinanced $20.0 million of debt in 2002 and issued an additional $15.0 million in November of 2002 to help finance the AMR project.

MGE Energy's and MGE's capitalization ratios were as follows:

MGE EnergyMGE
2003200220032002
Common shareholders' equity50.9%50.1%52.0%52.9%
Long-term debt*43.0%42.3%44.9%44.1%
Short-term debt6.1%7.6%3.1%3.0%
*Includes current maturities and $30 million in debt for MGE Power West Campus, which is being consolidated into MGE in accordance with FIN No. 46-R.

Below is a table of MGE's current credit ratings. MGE Energy is not rated because it has not issued any debt securities.

Standard & Poor'sMoody's
First Mortgage BondsAAAa2
Unsecured Medium Term NotesAA-Aa3
Commercial paperA1+P1

MGE's access to the capital markets, including the commercial paper market, and its financing costs in those markets are dependent on its securities' ratings. None of MGE's borrowing is subject to default or prepayment due to downgrading of securities' ratings.

Contractual Obligations and Commercial Commitments for MGE Energy and MGE

MGE Energy's and MGE's contractual obligations as of December 31, 2003, representing cash obligations that are considered to be firm commitments, are as follows:

(In thousands)
Payment due within:Due after
Total1 Year2-3 Years4-5 Years5 Years
MGE:
Long-term debt$193,500$20,000$ -$45,000$128,500
Short-term debt15,50015,500---
Operating leases8,9401,3791,7741,1194,668
Purchase obligations208,55931,64757,48549,09370,334
ATC - capital call3,5603,560---
ATC - WCCF849849---
Other long-term obligations1,216655561--
Total MGE contractual obligations$432,124$73,590$59,820$95,212$203,502
MGE Energy:
Long-term debt$30,000$ -$ -$ -$30,000
Short-term debt16,18016,180---
Purchase obligations-WCCF24,93424,934---
Total Non-MGE contractual obligations71,11441,114--30,000
Total MGE Energy contractual obligations$503,238$114,704$59,820$95,212$233,502

For additional information about:

- Long-term debt consisting of secured First Mortgage Bonds and unsecured medium-term notes, see Footnotes 13.c. The long-term debt under MGE Energy is the obligation of MGE Power West Campus. This debt is being consolidated into MGE's financials in accordance with FIN No. 46-R, see Footnote 13.d.

- Short-term debt consisting of commercial paper issued by MGE, which is supported by unused lines of credit from banks and bank loans to MGE Energy, see Footnote 14.

- Operating leases, see Footnote 16.

- Purchase obligations for MGE consist of the purchase of electricity and the purchase and transport of natural gas, see Footnote 16.

- MGE has made a commitment to ATC for an additional capital contribution.

- Commitment to advance funds to ATC for the construction of transmission equipment related to WCCF, see Footnote 17.

- Purchase obligations for MGE Energy related to contracts for equipment and services related to the construction of WCCF, see Footnote 16.f.

- Other long-term obligations are related to a special assessment for decontaminating and decommissioning of nuclear facilities, see Footnotes 3 and 18, and investment in a limited partnership.

MGE Energy's and MGE's commercial commitments as of December 31, 2003, representing commitments triggered by future events and including financing arrangements to secure obligations of MGE Energy and MGE, and guarantees by MGE, are as follows:

(In thousands)
Expiration within:Due after
Total1 Year2-3 Years4-5 Years5 Years
MGE:
Available lines of credit (a)$40,000$40,000$ -$ -$ -
Bank letter of credit (b)$ 5,000$ 5,000---
MGE Energy:
Available lines of credit (c)$60,000$60,000---
Guarantees (d)$ 6,130$ 904$1,695$1,598$1,933

(a) Lines of credit consisting of a 364-day credit facility to support commercial paper issuances. At December 31, 2003, there were no borrowings against the credit facility. Additionally, at December 31, 2003, there was $15.5 million of commercial paper outstanding.

(b) MGE has a letter of credit with a commercial bank established as collateral for equipment purchases that ATC will make to provide necessary system upgrades for WCCF.

(c) MGE Energy has established a $60.0 million line of credit for temporary financing of the capital commitments for WCCF and for general corporate purposes. Additionally, at December 31, 2003, MGE Energy had $16.2 million in bank loans outstanding.

(d) MGE has guaranteed repayment of certain receivables it sold to a financial institution under a Chattel Paper Agreement (see Footnote 16 of the Notes to Consolidated Financial Statements).

Other Factors

Due to the performance of the United States debt and equity markets, the value of assets held in trusts to satisfy the obligations of pension and postretirement benefit plans has decreased. These factors may also result in additional future funding requirements of the pension and postretirement benefit plans.

Business and Regulatory Environment

Electric Transmission - ATC

On January 1, 2001, MGE transferred substantially all of its electric transmission facilities to ATC in exchange for approximately a 5.0% interest in this joint venture. ATC is comprised of Wisconsin investor-owned utilities and some Wisconsin municipal utilities, cooperatives, and power supply agencies.

The PSCW authorized an electric rate surcharge of $4.5 million, or 2.0%, over a twelve-month period ended October 23, 2003, for MGE to recover deferred costs associated with ATC's formation and ongoing incremental transmission costs during 2001 and 2002.

On November 21, 2002, MGE and ATC entered into an interconnection agreement related to transmission system upgrades for WCCF. MGE issued to ATC a "Notice to Proceed for the Procurement of the Equipment" for the system upgrades. MGE has advanced funds for construction of transmission equipment and work done by ATC related to WCCF in the amounts of $9.2 million and $1.3 million in 2003 and 2002, respectively. MGE expects to advance an additional $0.8 million in 2004. MGE will be reimbursed by ATC upon completion of the project.

Kewaunee Sale

MGE sold to WPSC its 17.8% ownership interest in Kewaunee in September 2001. In exchange for a cash payment of $15.4 million, MGE transferred its net book value of utility plant ($8.2 million), net nuclear fuel ($7.9 million), inventories ($1.5 million), and other assets ($0.1 million). These assets were offset by $2.3 million owed to WPSC. On the closing date, MGE also transferred its qualified decommissioning fund ($65.0 million, fair market value) and nonqualified decommissioning fund ($28.1 million, fair market value), which decreased accumulated depreciation by an equal amount.

Under the Kewaunee sale agreement, MGE was obligated to continue collecting decommissioning costs from its customers during 2002 and to remit those amounts, net of trust investment expenses and taxes on investment income, to the WPSC nonqualified decommissioning fund, which it did on January 3, 2003. MGE has no further obligation with respect to the decommissioning of Kewaunee except as described in the next paragraph with respect to spent nuclear fuel.

The federal government is responsible for the disposition and storage of spent nuclear fuel. Federal legislation is being considered to establish an interim storage facility. Spent nuclear fuel is currently stored at Kewaunee. Minor plant modifications to the spent fuel pools completed in 2001 should ensure Kewaunee has sufficient fuel storage capacity until the end of its licensed life in 2013. MGE retained its spent fuel obligations for all fuel burned at Kewaunee for MGE's share of the generation from the opening of the plant to the closing date. WPSC took title to such fuel at the closing date.

A surcharge imposed by the National Energy Policy Act of 1992 requires nuclear power companies to fund the decontamination and decommissioning of U.S. Department of Energy facilities that process nuclear fuel. As a result, the Kewaunee co-owners are required to pay a surcharge on uranium enrichment services purchased from the federal government prior to October 23, 1992. On an inflation-adjusted basis, MGE's portion of the obligation related to Kewaunee is approximately $0.8 million at December 31, 2003. MGE is required to continue paying its portion of this annual assessment.

As allowed under the Kewaunee sale agreement, MGE exercised an option to purchase 90 MW of electric capacity and energy at a fixed price from September 24, 2001, through September 23, 2003, to help meet customers' electric needs.

Industry Restructuring in Wisconsin

Wisconsin has focused on building the infrastructure needed within the state to provide reliable electric service to customers. Wisconsin has been building new generating capacity, improving existing and adding new electric transmission lines, and continues to develop an independent electric transmission system operator. State regulators realize a competitive market cannot exist when supply is short. The PSCW will decide if or when it is appropriate for retail competition to proceed in the electric industry. MGE cannot predict what impact future PSCW actions may have on its future financial condition, cash flows, and results of operations.

Restructuring the electric industry could affect MGE's ability to continue establishing certain regulatory asset and liability amounts allowed under SFAS No. 71,Accounting for the Effects of Certain Types of Regulation. MGE is unable to predict whether any adjustments to regulatory assets and liabilities will occur in the future. However, the PSCW has recognized the need to allow recovery for commitments made under prior regulation.

Nonutility Energy Outlook

Power the Future Generation

On February 23, 2001, MGE secured an option to own a portion of the advanced technology, coal-fired, base-load generation proposed in We Energies' Power the Future plan. The plan included three new 600-MW coal-fired plants, which would be located in Wisconsin. On November 11, 2003, a PSCW order approved issuing a CPCN for We Energies' proposal for two of the coal facilities. Pursuant to an amended agreement reached on January 31, 2003, MGE has the option to acquire an undivided 8.33% (16.66% under certain conditions) ownership interest in each of the proposed coal plants or up to approximately 50 MW per unit. If the options on Units 1 and 2 are fully exercised, MGE Energy's share of capital costs is estimated to be $175 million. Unit 1 is expected to begin operating in 2009 and Unit 2 is scheduled to begin operating in 2010. MGE has filed its own Certificate of Authority with the PSCW for the coal facilities and a proposed lease structure with an MGE Energy affiliate. MGE expects PSCW approval on this filing in the first half of 2004.

WCCF

The cost to construct WCCF is expected to be approximately $180 million in total, of which MGE Power West Campus' portion will be $103 million. On November 20, 2003, the State paid $19.4 million to MGE Construct for its share of construction costs incurred since its last payment in November 2002. MGE Construct now bills the State monthly for its share of the cost of WCCF in accordance with the EPC Agreement. As of December 31, 2003, MGE Power West Campus had incurred $48.6 million of costs on the project, which is reflected in construction work in progress on MGE Energy's and MGE's consolidated balance sheets. These costs largely represent amounts paid under long lead-time equipment contracts in order to meet project schedules. In 2003, MGE Construct received a service fee of $1.0 million (pretax) from the State in relation to its role as EPC contractor for WCCF. The total fee of $5.0 million will be recognized as services are rendered and will be collected over a 22-month period.

MGE Energy, MGE Power West Campus, and MGE Construct have assumed certain risks related to some of the executed agreements. In the EPC Agreement, MGE Power West Campus is responsible for cost overruns and MGE Construct is responsible for the construction process of the entire facility, paying liquidated damages relating to failure to achieve the Mechanical Completion Date Guarantee and/or the Acceptance Test Capacity Guarantee. MGE Energy is the guarantor of MGE Construct's obligations under the EPC Agreement.

Critical Accounting Policies -MGE Energy and MGE

The preparation of financial statements in conformity with generally accepted accounting principles requires management to apply policies and make estimates and assumptions that affect results of operations and the reported amounts of assets and liabilities in the financial statements. Because of the inherent uncertainty in the nature of the matters where estimates are used, actual amounts could differ from estimated amounts. The following accounting policies represent those that management believes are particularly important to the financial statements and require the use of judgment in estimating matters that are inherently uncertain.

Unbilled Revenues

Revenues from the sale of electricity and gas to customers are generally recorded when electricity/gas is delivered to those customers. The quantity of those sales is measured by customers' meters. Due to the large volume of those meters, it is impractical to read all of them at month end and, thus, those metersend. Meters are read on a systematic basis throughout the month based on established meter-reading schedules. Consequently, at the end of any month, there exists a quantity of electricity and gas that has been delivered to customers but has not been captured by the meter readings. As a result, management must estimate revenue related to electricity and gas delivered to customers between their meter read dates and the end of the period. These estimates include:

- The amount of electricity expected to be lost in the process of its transmission and distribution to customers (line loss) and therefore, the amount of electricity actually delivered to customers.

- The mix of sales between customer rate classes, which is based upon historical utilization assumptions.

During 2003, many of MGE's largest customers were shifted to a calendar month bill. As a result of this shift, the majority of these customers' electricity usage is now accounted for in the unbilled calculation. The unbilled amounts are based on actual usage billed the following month and are therefore very reliable. Due to this billing shift, MGE believes thathas seen the ratio of unbilled-to-billed electric sales should typically fall inclimb. The ratio has settled into a 40%range of 45% to 50% range on a monthly basis. A ratio outside that range would indicate a need for further review65%, and analysis. It should be noted that a small change in line loss could have a significant impact on estimated electric unbilled revenues.MGE will continue to monitor and track this range.

Pension Plans

MGE maintains qualified and nonqualified pension plans. MGE also provides health care and life insurance benefits for its retired employees. MGE's pensions are funded through an outside trust. The recent declines in the stock market have resulted in equally consistent declines in the investments in the trusts. The years 2000 through 2002 have been the worst three-year period of pension plan financing ever, which produced the lowest returns since 1929 through 1932. Due to the loss in asset value, MGE is required to record an additional minimum pension liability and corresponding charge to equity at the end of the year.

In addition to the market returns, various other assumptions also affect the investment returns and pension costs.

-Assumed Returnreturn on Assetsassets.. An This assumption as tois the rate of return on plan assets reflecting the average rate of earnings expected on the funds invested or(or to be investedinvested) to provide for the benefits included in the projected benefit obligation. For the year 2002,2003, MGE used a 9.5%9.0% assumed return on assets. This rate was set at the end of 2001.2002. One of the approaches MGE used in determining its assumed return on assets is based on historical returns. As of December 31, 2001,2003, the ten-year historical return was 11.9%11.3%. For 2003, MGE has reduced the assumed return on assets to 9.0%.

-Discount Raterate.. The discount rate for SFAS No. 87 pension cost purposes is a rate at which pension obligations could be effectively settled. MGE bases its rate on high-grade bond yields with a 25 basis point adder. This adder is based on the relatively long duration of pension plan liabilities, benefit payments that are in the form of an annuity, and the rate used has historically been at the top of the range. Moody's Aa Corporate Bond Yield was 6.52%6.01% on December 31, 2002.2003. This approach generated a 6.75%6.25% discount rate (i.e., 6.52%6.01% + 0.25%), rounded).

-Medical Trend Assumptionstrend assumptions.. The health care cost trend rate is the assumed rate of increase in per capitaper-capita health care charges. For 2002, the health trend was reset to 10% with the ultimate trend of 5% reached in 2007. In 2003, the health trend was again reset to 14% with the ultimate trend of 5% reached in 2012.

Tax Provision

MGE Energy's and MGE's tax provisions, including both current and deferred components, are based on estimates, assumptions, calculations, and interpretation of tax statutes for the current and future years. Determination of current year federal and state income tax will not be settled for years.

Management regularly makes assessments of tax return outcomes relative to financial statement tax provisions and adjusts the tax provisions in the period when facts become final.

Accounting for Derivative Instruments

MGE accounts for derivative financial instruments under SFAS No. 133,Accounting for Derivatives and Hedging Activities, and SFAS No. 149,Amendment of SFAS No. 133 on Derivative Instruments and Hedging Activities. Under the provisions of SFAS No. 133, all derivatives except those qualifying for the normal purchase normal sale exception are recognized on the balance sheet at their fair value. Fair value is determined using current quoted market prices. If a contract is designated as a cash flow hedge, the change in its market value is generally deferred as a component of other comprehensive income until the transaction it is hedging is completed. Conversely, the change in the market value of a derivative not designated as a cash flow hedge is recorded in current period earnings. A cash flow hedge is a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability. To qualify as a cash flow hedge, the fair value changes in the derivative must be expected to offset 80% to 120% of the changes in fair value or cash flows of the hedged item.

In the third quarter of 2002, MGE received approval from the PSCW to establish a regulatory asset or liability for the deferral of the effects of mark-to-market accounting as required by SFAS No. 133 on contracts related to MGE's regulated operations.

Regulatory Assets/Liabilities

Regulatory assets represent costs that have been deferred to future periods when it is probable or certain that the regulator will allow future recovery of those costs through rates. MGE bases its assessment of recovery by precedents established by the regulatory body. Regulatory liabilities represent previous collections from customers to fund future expected costs or amounts received in rates that are expected to be refunded to customers in future periods. These costs typically include the recovery of stranded costs due to deregulation, deferral of energy costs, the normalization of income taxes, and the deferral of losses incurred on debt retirements. The accounting for these regulatory assets and liabilities is in accordance with the provisions of SFAS No. 71.

MGE continually assesses whether the regulatory assets continue to meet the criteria for probability of future recovery. This assessment considers factors such as changes in the regulatory environment, recent rate orders to other regulated entities under the same jurisdiction, and the status of any pending or potential deregulation legislation. If future recovery of costs becomes no longer probable, the assets and liabilities would be recognized as current periodcurrent-period revenue or expense.

Amortization of regulatory assets is provided over the recovery period as allowed in the related regulatory agreement. It is also included in depreciation and amortization expense. The most significant regulatory assets recorded by MGE include demand-side management programs, decommissioning and decontaminating enrichment facilities, environmental costs, deferred charges related to the setup of ATC, deferred charges on the interest expense of its 2027A Series First Mortgage Bonds, deferred charges related to the effects of mark-to-market accounting as required by SFAS No. 133, and deferred charges related to tax recovery on AFUDC equity (seeequity. See Footnote 1.f.).6 for a listing of these assets and liabilities.

New Accounting Pronouncements

SFAS Nos. 141The most significant regulatory liabilities recorded by MGE include decommissioning and 142

In June 2001,decontaminating enrichment facilities, deferred credits related to the Financial Accounting Standards Board (FASB) issuedaccounting of deferred taxes as required by SFAS No. 141,Business Combinations, and109, amounts recorded for certain gas supply contracts that are considered derivatives under SFAS No. 142,Goodwill133 but are part of the PGA clause authorized by the PSCW, and Other Intangible Assets, that supersedea customer fuel credit.

Adoption of Accounting Principles Board (APB) Opinion No. 16,Business Combinations, and APB Opinion No. 17,Intangible Assets. The two statements modify the method of accounting for business combinationsRecently Issued Accounting Pronouncements - MGE Energy and address the accounting and reporting for goodwill and intangible assets. SFAS No. 141 is effective for all business combinations initiated after June 30, 2001 and, with acquisitions completed after June 30, 2001, for all business combinations accounted for by the purchase method for which the date of acquisition is completed after June 30, 2001. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 141 and 142 had no impact on the consolidated financial statements.MGE

SFAS No. 143

In June 2001, the FASB issued SFAS No. 143,Accounting for Asset Retirement Obligations. SFAS No. 143 provides accounting requirements for retirement obligations associated with tangible long-lived assets. MGE Energy and MGE were required to adopt SFAS No. 143 as of January 1, 2003. Retirement obligations associated with long-lived assets included within the scope of SFAS No. 143 are those for which there is effectivea legal obligation under existing or enacted law, statute, written or oral contract, or by legal construction under the doctrine of promissory estoppel.

Effective January 1, 2003, requires entities to recordMGE recorded an obligation for the fair value of aits legal liability for an asset retirement obligation inobligations associated with removing an electric substation, a combustion turbine generating unit, wind generating facilities, and the period inphotovoltaic generating facilities, all of which it is incurred. When a neware located on property not owned by MGE and would be removed upon the ultimate end of the lease. At December 31, 2003, this liability is recorded beginningestimated at $1.4 million and is included in 2003,other deferred liabilities.

At the entity will capitalizepoint the costliability for asset retirement is incurred, SFAS No. 143 requires capitalization of the liability by increasingcosts to the carrying amountrelated asset, property, plant, and equipment, net. For asset retirement obligations existing at the time of adoption, the statement requires capitalization of costs at the level that existed at the point of incurring the liability. These capitalized costs are depreciated over the same period as the related property. At the date of adoption, the depreciation expense for past periods was recorded as a regulatory asset in accordance with SFAS No. 71 because MGE believes the PSCW will allow it to recover these costs in future rates. Current depreciation of the related long-lived asset. asset retirement cost is also being deferred as a regulatory asset under SFAS No. 71.

The initial liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity settles the obligation forperiod. MGE defers this accretion as a regulatory asset based on its recorded amount or incurs a gain or loss upon settlement.

determination that these costs can be collected from customers. MGE adopted SFAS No. 143 on January 1, 2003. MGE completed an assessment of the specific applicability and implications of SFAS No. 143. MGE found that SFAS No. 143 has specific applicabilityalso may have asset retirement obligations relating to various electricassets, such as combustion turbine generating units, small distributed generating units, aboveground and substationunderground storage tanks, facilities located on leased property, as well as variousat Columbia (co-owned with Alliant and WPSC), and certain electric and gas distribution facilities. These facilities installedare generally located on easementsproperty owned by third parties, on which MGE is permitted to operate by lease, permit, easement, license, or permits. The asset retirement obligation associated with electric generating and substationservice agreement, but also include some facilities is approximately $1 million.located on property owned by MGE. The asset retirement obligations associated with the electric and gas distributionthese facilities cannot be reasonably estimateddetermined due to anthe indeterminate life of the associatedrelated assets.

The pro forma asset retirement obligation MGE believeswould have recognized as of January 1, 2002, had MGE implemented SFAS No. 143 as of that date, was approximately $1.2 million based on the information, assumptions, and interest rates as of January 1, 2003, used to determine the $1.4 million liability recognized upon initial adoption of SFAS No. 143. Because MGE's regulators are allowing these costs to be recovered in future rates, adoption of SFAS No. 143 results primarily in timing differences in the recognitionfirst quarter of the legal asset retirement obligations2002 would have had no impact on net income and earnings per share of common stock. Accordingly, pro forma impacts are not presented.

The following table shows costs as of January 1, 2003, and changes to the asset retirement obligation and accumulated depreciation during the twelve months ended December 31, 2003.



(In thousands)
(a)

Original Asset
Retirement
Obligation

 (b)

Accumulated
Accretion

 (c)

(a + b)
Asset
Retirement
Obligation

 (d)

Accumulated
Depreciation-
Related Asset

Balance, Jan. 1, 2003 (date of adoption)$685 $596 $1,281 $148
Changes through Dec. 31, 20031 79 80 27
Balance, Dec. 31, 2003$686 $675 $1,361 $175

As of December 31, 2003, MGE's regulatory asset, included in deferred charges, is the total accumulated accretion ($675,000) and accumulated depreciation ($175,000) or $850,000.

MGE made a significant reclassification related to the reporting of accumulated costs which MGE is currently recovering in rates and will be deferring such differences under SFAS No. 71. Early in 2003, MGE received assurance from the PSCWof removal that the adoption of SFASare non-SFAS No. 143 would not result in a change toobligations. The reclass removed the current ratemaking process at this time.costs from accumulated depreciation and recorded them as regulatory liability.

SFAS No. 144

In August 2001, the FASB issued SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets, which supersedes SFAS No. 121,Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of, and the accounting and reporting provisions of APB No. 30,Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and is effective for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. This statement had no material impact on the consolidated financial statements.

SFAS No. 145

In May 2002, the FASB issued SFAS No. 145,Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections as of April 2002. SFAS No. 145 rescinds both FASB Statement No. 4 (SFAS 4),Reporting Gains and Losses from Extinguishment of Debt, and the amendment to SFAS 4, FASB Statement No. 64 (SFAS 64),Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. SFAS No. 145 is effective for transactions occurring after May 15, 2002. This statement does not have a material impact on the consolidated financial statements.

SFAS No. 146

In June 2002, the FASB issued SFAS No. 146,Accounting for Costs Associated with Exit or Disposal Activities. This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No.EITF 94-3,Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 is effective for transactions initiated after December 31, 2002. ThisAdoption of this statement doesdid not have a material impact on the consolidated financial statements.

SFAS No. 148

In December 2002, the FASB issued SFAS No. 148,Accounting for Stock-Based Compensation- TransitionCompensation-Transition and Disclosure. This statement amends FASB Statement No. 123,Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based employee compensation. In addition, the statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. MGE Energy has no stock options as of December 31, 2002,2003, and therefore SFAS No. 148 willdid not have no impact.

EITF Issue 02-3

EITF Issue 02-3,Accounting for Contracts Involved in Energy Trading and Risk Management Activities (EITF 02-3), issued by the FASB EITF in June 2002, requires revenues and energy costs related to energy trading contracts to be presented on a net basis in the income statement. This EITF has no currentmaterial impact on the consolidated financial statements.

SFAS No. 149

On April 30, 2003, the FASB issued SFAS No. 149,Amendment of SFAS No. 133 on Derivative Instruments and Hedging Activities. This statement amends and clarifies accounting for derivative instruments including certain derivative instruments embedded in other contracts for hedging activities. SFAS No. 149 amends certain other existing pronouncements. The amendments will result in a more consistent reporting of contracts that are derivatives in their entirety or that contain embedded derivatives that warrant separate accounting. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. Adoption of this statement did not have a material impact on the consolidated financial statements.

SFAS No. 150

In May 2003, the FASB issued SFAS No. 150,Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within the scope of SFAS No. 150 as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS No. 150 is effective for interim periods beginning after June 15, 2003, for financial instruments entered into or modified after May 31, 2003, except for mandatorily redeemable financial instruments of nonpublic entities which will be effective for interim periods beginning after December 15, 2003. Adoption of this statement did not have a material impact on the consolidated financial statements.

SFAS No. 132

In December 2003, the FASB issued an amended SFAS No. 132,Employers' Disclosures about Pensions and Other Postretirement Benefits. This revised statement requires additional disclosures to those in the original SFAS No. 132 about the plan assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans.

FIN No. 45

In November 2002, the FASB issued Financial InterpretationFIN No. (FIN) 45,Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. This interpretation provides the disclosures to be made by a guarantor in interim and annual financial statements about obligations under certain guarantees. The interpretation also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation. The initial recognition

MGE makes available to qualifying customers a financing program for the purchase and measurement requirements are effective prospectively for guarantees issuedinstallation of energy-related equipment that will provide more efficient use of utility service at the customer's property. MGE is party to a chattel paper purchase agreement with a financial institution under which it can sell or modified after December 31, 2002. However, the disclosure requirementsfinance an undivided interest with recourse, in up to $7.5 million of the interpretationfinancing program receivables, until February 28, 2004. Loans totaling $1.1 million have been sold to the financial institution during 2003. The liability for the fair value of the obligation associated with these loans is not material.

MGE would be required to perform under the guarantee if the customer defaulted on its loan. The energy-related equipment installed at the customer sites is used to secure the customer loans. The length of the MGE guarantee to the financial institution varies from one to ten years depending on the term of the customer loan. Principal payments for the next five years on the loans are effective for this Form 10-K$0.9 million in 2004 and included2005 and $0.8 million in Footnote 8.2006, 2007, and 2008.

FIN No. 46

In January 2003, the FASB issued FIN No. 46,Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51." In December 2003, the FASB issued the updated and final interpretation FIN No. 46-R. FIN No. 46-R requires that an equity investor in a VIE have significant equity at risk (generally a minimum of 10%, that addresses conditions whenwhich is an entity should be consolidated based upon variable interests rather than voting interests. Variable interests are ownership interests or contractual relationships that enableincrease from 3% required under the holder to share in the financial risksprevious guidance) and rewards resulting from the activities ofhold a Variable Interest Entity (VIE). A VIE is a corporation, partnership, trust, or any other legal structure used for business purposes that either does not have equity investors withcontrolling interest, evidenced by voting rights, or has equity investors that do not provide sufficient financial resources for the entity to support its activities.

In order to apply FIN 46, MGE must evaluate every entity with which it is involved through variable interests to determine whether the entity isand absorb a VIE and, if it is, whether or not MGE is the primary beneficiary of the entity. The primary beneficiary of a VIE is the entity that receives the majority of the entity's expected losses, receive a majority of the entity's expected returns, or both. If the equity investor is unable to evidence these characteristics, the entity that retains these ownership characteristics will be required to consolidate the VIE as the primary beneficiary. FIN No. 46 was applicable immediately to VIEs created or obtained after January 31, 2003. FIN No. 46-R was effective on December 31, 2003, for interests in entities that were previously considered special purpose entities under then existing authoritative guidance.

MGE Power West Campus is a VIE pursuant to FIN No. 46-R, as the equity investment at December 31, 2003, was not sufficient to permit the entity to finance its activities without additional support. MGE concluded a VIE relationship exists due to the long-term lease arrangement between MGE and MGE Power West Campus. MGE Power West Campus will lease all of its assets, a power plant, to MGE, pursuant to this leasing arrangement and MGE will absorb a majority of the expected losses, residual returns, or both. As a result, FIN 46 could result in consolidationThe VIE was consolidated into MGE as of an entityDecember 31, 2003.

EITF 03-11

In July 2003, FASB issued EITF 03-11,Reporting Realized Gains and Losses on Derivative Instruments that MGE is associated with other than by (and evenare subject to SFAS No. 133 (Accounting for Derivative Instruments and Hedging Activities), and Not Held for Trading Purposes. This issue addresses whether realized gains and losses should be shown gross or net in the absence of) a voting ownership interest. FIN 46 isincome statement, for contracts that are not believed toheld for trading purposes. This issue will not have a material impact on the consolidated financialfinancials statements.

FSP 106-1

In January 2004, the FASB issued FASB Staff Position No. FAS 106-1 (FSP 106-1),Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act). FSP 106-1 permits employers that sponsor postretirement benefit plans (plan sponsors) that provide prescription drug benefits to retirees to make a one-time election to defer accounting for any effects of the Act. The FSP 106-1 requires all plan sponsors to provide certain disclosures, regardless of whether they choose to account or defer accounting. FSP 106-1 is effective for annual fiscal periods ending after December 7, 2003. If deferral is elected, the deferral must remain in effect until the earlier of (1) the issuance of guidance by the FASB on how to account for the federal subsidy to be provided to plan sponsors under the Act or (2) the remeasurement of plan assets and obligations subsequent to January 31, 2004. MGE has elected to defer recognition of the Act.

SEC SAB No. 104

In December 2003, the SEC issued SAB No. 104 regarding revenue recognition. SAB No. 104 revises or rescinds portions of the interpretive guidance included in Topic 13 of the codification of Staff Accounting Bulletins to make the guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. MGE Energy and MGE will comply with the revised guidance.

Inflation

The current financial statements report operating results in terms of historical cost, but they do not evaluate the impact of inflation. Because utilities can depreciate only the historical cost of utility plant, there may not be adequate cash flows from existing plant to replace this investment. Under PSCW rate treatment, projected operating costs, including the impacts of inflation, are recovered in revenues.

Item 7A. Quantitative and Qualitative Disclosures aboutAbout Market Risk.Risk - MGE Energy and MGE.

Market Risks

MGE isEnergy and MGE are potentially exposed to market risk associated with interest rates, commodity prices, weather, and equity returns. MGE currently has no exposure to foreign currency risk. MGE manages some risk exposure through risk management policies and uses derivative instruments. MGE's market risk has not changed between 2003 and 2002. MGE does not enter into speculative trading transactions.

Interest Rate Risk

MGE issues commercial paper at varying interest rates for its short-term borrowings (see Footnote 6.d.)14). MGE also has $15.0 million in variable rate long-term debt outstanding as of December 31, 2002.2003. Borrowing levels under commercial paper arrangements vary from period to period depending upon capital investments and other factors. Future short-term interest expense and payments will reflect both future short-term interest rates and borrowing levels. MGE has a swap agreement with a commercial bank at a notional amount of $5.0 million, backed by MGE's commercial paper. MGE pays a fixed rate of 6.91% on the swap, which was used to replace a portion of MGE's 7.70%, 2028 Series, First Mortgage Bonds. MGE manages its interest rate risk by limiting its variable rate exposure and continually monitoring the effects of market changes on interest rates. MGE is not exposed to changes in interest rates on a substantial portion of its long-term debt until that debt matures and is refinanced at market rates. MGE records the changes in the fair market value of its commercial paper swap agreement currently in the income statement as required by SFAS No. 133 each period, which is then offset by a corresponding regulatory asset or liability in accordance with authorization received from the PSCW.

Commodity Price Risk

MGE has commodity price risk exposure with respect to the price of natural gas, electricity, coal, and oil. MGE employs established policies and procedures to reduce the market risks associated with changing commodity prices, including the use of commodity and financial instruments (see Footnote 5)12). MGE's commodity risks are somewhat mitigated by the current ratemaking process in place for recovering electric fuel, purchased energy, and the cost of natural gas purchased for resale. MGE's electric fuel costs are subject to fuel rules established by the PSCW, which further mitigate commodity risk. Under the fuel rules, if electric fuel costs exceed or fall below a 3.0% bandwidth set by the PSCW, MGE can apply for a fuel surcharge or may have a fuel credit to its customers. Under the PGA authorized by the PSCW, MGE passes through to customers the cost of gas, subject to certain limited incentives.

Under the fuel rules, MGE may include the costs and benefits of fuel price risk management tools implemented under a risk management plan approved by the PSCW. In 2003, the PSCW approved MGE's Electric Procurement Risk Management Program, with conditions, through December 31, 2004. No transactions have occurred under this program through December 31, 2003.

MGE has a limited number of financial gas commodity contracts. These contracts are primarily comprised of exchange-traded option contracts to manage the cost of gas and over-the-counter financial floating-to-fixed price swaps and calls for the Winter"Winter Set-Price Firm Gas Sales ServiceService" pilot program. The derivative amounts recorded as a result of these gas contracts are offset with a corresponding regulatory asset or liability because these transactions are part of the PGA and not subject to incentive participation.

Weather Risk

MGE's sales forecasts, used to establish rates, are set by the PSCW based upon estimated temperatures, which approximate 20-year averages. MGE's electric revenues are sensitive to the summer cooling season and, to some extent, to the winter heating season. A significant portion of MGE's gas system demand is driven by heating. MGE's gas margin (revenues less gas purchased) areis collected under a combination of fixed and volumetric rates set by the PSCW based on "normal weather." As a result of weather-sensitive demand and volumetric rates, a portion of MGE's gas margin is at risk for warmer-than-normal weather. MGE usesmay use weather derivatives, pursuant to its risk management program, to reduce the impact of weather volatility on its gas margins.margin.

In August 2003, MGE purchased a nonexchange-traded Heating Degree Day (HDD) Put Option with a strike of 5,500 HDD and sold a nonexchange-traded HDD Call Option with a strike of 5,800 HDD. The options have a net premium cost of $0.1 million; notional amounts of $2,500 per HDD; a maximum HDD-related receipt or payment of $1.0 million; terms covering November 1, 2003, through March 31, 2004; and financial settlements against Madison weather. If the total actual HDD, as calculated under the contract, is greater than 5,800, MGE will pay. If the total actual HDD is less than 5,500, MGE receives payment. For the contract period, MGE's average gas margin per HDD at risk is estimated to exceed $2,500. MGE is accounting for the HDD options using the intrinsic value method pursuant to EITF 99-2,Accounting for Weather Derivatives. Through December 31, 2003, actual HDD were 1,984 and contract allocated HDD strikes were 2,087 and 2,201, resulting in a $0.3 million gain for MGE.

A summary of actual weather information in the utility segment's service territory during 2003, 2002, 2001, and 2000,2001, as measured by degree days, may be found above in Results of Operations.

Regulatory Recovery Risk

TheMGE's electric operations of MGE burn natural gas in several of its peak power plants or as a supplemental fuel at several coal-fired plants--and in many cases, the cost of purchased power is tied to the cost of natural gas. MGE bears significant regulatory risk for the recovery of such fuel and purchased power costs when they are higher than the base rate established in its current rate structure.

As noted above in Commodity Price Risk, the electric operations of MGE operate under a "fuel rules" adjustment clause for fuel and purchased power costs associated with the generation and delivery of electricity. This clause establishes a base rate for fuel and purchased power. MGE assumes the risks and benefits of variances that are within a 3.0% bandwidth. For 20022003 and 2001,2002, fuel and purchased power costs included in MGE's base fuel rates were $85.1$81.0 million and $60.1$85.1 million, respectively. In 2003 and 2002, the base fuel rates included a fuel credit in the amount of $4.0 million and $1.2 million.million, respectively.

Equity Price RisksRisk

MGE currently funds its liabilities related to employee benefits through trust funds. These funds, which include investments in debt and equity securities, are managed by various investment managers. Changes in market value of these investments can have an impact on the future expenses related to these liabilities. MGE's risk of expense and annuity payments, as a result of changes in the market value of the trust funds, is mitigated in part through future rate actions by the PSCW.

Credit RisksRisk

Credit risk is the loss that may result from counterparty nonperformance. MGE is exposed to credit risk primarily through its merchant energy business. MGE uses credit policies to manage its credit risk, which includes utilizing an established credit approval process, monitoring counterparty limits, employing credit mitigation measures such as collateral or prepayment arrangements, and using netting agreements.

Due to the possibility of extreme volatility in the prices of energy commodities and derivatives, the market value of contractual positions with individual counterparties could exceed established credit limits or collateral provided by those counterparties. If such a counterparty were then to fail to perform its obligations under its contract (for example, fail to deliver the electricity MGE originally contracted for), MGE could sustain a loss that could have a material impact on its financial results.

Additionally, if a counterparty were to default and MGE were to liquidate all contracts with that entity, MGE's credit loss would include the loss in value of mark-to-market contracts, the amount owed for settled transactions, and additional payments, if any, to settle unrealized losses on accrual contracts.

MGE is obligated to provide service to all electric and gas customers within its respective franchised territories. As a result, MGE has a broad customer base. For the year ended December 31, 2002,2003, MGE's ten largest electric customers represented approximately 18.3%17.3% of its retail electric revenues. MGE's ten largest gas customers represented approximately 5.4% of its gas revenues. Credit risk for electric and gas is managed by MGE's credit and collection policies, which are consistent with state regulatory requirements.

Item 8. Financial Statements and Supplementary Data.

ReportsReport of Independent AccountantsAuditors

To the Board of Directors and
Shareholders of MGE Energy, Inc.
:

In our opinion, the consolidated financial statements listed in the accompanying index appearing under Item 15(a)15 (a)(1) present fairly, in all material respects, the financial position of MGE Energy, Inc. and its subsidiaries at December 31, 20022003 and December 31, 2001,2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 20022003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index appearing under Item 15(a)15 (a)(2) presentspresent fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the company'sCompany's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 1 to the consolidated financial statements, effective August 12, 2002, MGE Energy, Inc. became the holding company for Madison Gas and Electric Company (MGE). As a result of the formation of the holding company, an exchange of shares of MGE Energy, Inc. common stock for shares of MGE common stock occurred. The MGE Energy, Inc.Inc financial statements reflect this transaction for all periods presented.

/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
February 6, 200327, 2004

Report of Independent Auditors

To the Board of Directors and
Shareholder of Madison Gas and Electric CompanyCompany:

In our opinion, the consolidated financial statements listed in the accompanying index appearing under Item 15(a)15 (a)(1) present fairly, in all material respects, the financial position of Madison Gas and Electric Company and its subsidiaries at December 31, 20022003 and December 31, 2001,2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 20022003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index appearing under Item 15(a)15 (a)(2) presentspresent fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the company'sCompany's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 2 to the consolidated financial statements, the Company adopted certain provisions of Financial Accounting Standards Board Interpretation No. 46, "Consolidation of Variable Interest Entities - an interpretation of ARB 51 (revised December 2003)," as of December 31, 2003.

/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
February 6, 200327, 2004

MGE Energy, Inc.
Consolidated Statements of Income

(In thousands, except per-share amounts)

For the years ended December 31,For the years ended December 31,
2002
2001
2000
2003 2002 2001
Operating Revenues:
Regulated utility operations$347,096$333,711$324,108
Operating Revenues$401,547$347,096$333,711
Operating Expenses:
Fuel for electric generation38,21040,29936,33841,55738,21040,299
Purchased power44,60718,31018,96349,52144,60718,310
Natural gas purchased73,41286,03577,482104,06673,41286,035
Other operations and maintenance92,51494,03790,547111,63692,51494,037
Depreciation and amortization29,36235,65935,08123,34429,36235,659
Other general taxes10,86110,86410,18011,59210,86110,864
Total Operating Expenses288,966285,204268,591341,716288,966285,204
Operating Income58,13048,50755,51759,83158,13048,507
Other income2,3358,5851,8952,4862,3358,585
Interest expense(12,545)(13,789)(14,305)(11,776)(12,545)(13,789)
Income before income taxes47,92043,30343,10750,54147,92043,303
Income Tax Provision(18,727)(15,941)(15,752)
Income tax provision(19,901)(18,727)(15,941)
Income before cumulative effect of a change in accounting principle29,19327,36227,35530,64029,19327,362
Cumulative effect of a change in accounting principle, net of tax benefit of $78-(117)-
-

-

(117)
Net Income$ 29,193$ 27,245$ 27,355$ 30,640$ 29,193$ 27,245
Earnings Per Share of Common Stock (basic and diluted):
Income before cumulative effect of a change in accounting principle$1.69$1.63$1.67$1.71$1.69$1.63
Cumulative effect of a change in accounting principle-(.01)---(.01)
Net Income$1.69$1.62$1.67$1.71$1.69$1.62
Dividends paid per share of common stock$1.34$1.33$1.32$1.35$1.34$1.33
Average Shares Outstanding (basic and diluted)17,31116,81916,38217,89417,31116,819

The accompanying notes are an integral part of the above consolidated financial statements.

MGE Energy, IncInc.
Consolidated Statements of Cash Flows

(In thousands)

For the years ended December 31,For the years ended December 31,
2002
2001
2000
2003 2002 2001
Operating Activities:
Net income$29,193$27,245$27,355$30,640$29,193$27,245
Items not affecting cash:
Depreciation and amortization29,36235,65935,08123,34429,36235,659
Deferred income taxes3,62911,601(1,074)13,0753,62911,601
Amortization of nuclear fuel-1,6492,194--1,649
Amortization of investment tax credits(520)(849)(727)(516)(520)(849)
Equity in earnings in ATC(3,316)(3,345)-(3,687)(3,316)(3,345)
Cumulative effect of change in accounting principle, net of tax benefit of $78
-

117

-

-

-

117
Other items(380)(385)(1,168)(514)(380)(385)
Dividend income from ATC2,7141,630-2,6402,7141,630
Collateral to ATC(5,000)--
Prepayments to ATC5,000(5,000)-
Changes in working capital items:
Receivables, net(11,214)13,100(10,248)(1,438)(11,214)13,100
Inventories2,375(8,809)(1,143)(5,195)2,375(8,809)
Unbilled revenues(2,053)11,414(14,733)(3,105)(2,053)11,414
Prepayments(2,278)(1,813)(895)(3,368)(2,278)(1,813)
Accounts payable9,883(4,364)9,2393,0449,399(5,061)
Accrued taxes and interest51(2,602)2,051
Other4,036(1,520)1,621
Accrued interest(193)51(2,602)
Other current liabilities3,6554,036(1,520)
Other noncurrent items, net247(4,044)2215,220248(4,044)
Cash Provided by Operating Activities56,72974,68447,77468,60256,24673,987
Investing Activities:
Capital expenditures(78,282)(41,966)(73,606)(82,970)(77,001)(41,966)
Advance to ATC related to WCCF(9,223)(1,281)-
Increase in nuclear decommissioning fund(7,804)(8,931)(11,059)-(7,804)(8,931)
Capital distribution from ATC-15,000---15,000
Sale of interest in nuclear plant-15,381---15,381
Purchase of gas service territory(78)(3,800)--(78)(3,800)
Other(213)(217)(176)(1,281)(545)(537)
Cash Used for Investing Activities(86,377)(24,533)(84,841)(93,474)(86,709)(24,853)
Financing Activities:
Issuance of common stock13,59710,8798,96423,16213,59710,879
Cash dividends on common stock(23,170)(22,341)(21,588)
Long-term debt maturity(20,000)(6,075)(11,200)
Cash dividends paid on common stock(24,137)(23,170)(22,341)
Long-term debt maturities/redemptions(20,000)(20,000)(6,075)
Issuance of long-term debt35,000-35,00050,00035,000-
Increase/(decrease) in short-term debt24,798(34,500)28,250(2,618)24,798(34,500)
Other(200)484697
Cash Provided by/(Used for) Financing Activities30,225(52,037)39,42626,20730,709(51,340)
Change in Cash and Cash Equivalents577(1,886)2,359
Change in Cash and Cash Equivalents:1,335246(2,206)
Cash and cash equivalents at beginning of period2,4214,3071,9486854392,645
Cash and cash equivalents at end of period$ 2,998$ 2,421$ 4,307$ 2,020$ 685$ 439

The accompanying notes are an integral part of the above consolidated financial statements.

MGE Energy, Inc.
Consolidated Balance Sheets

(In thousands)

At December 31,
2002
2001
At December 31,
ASSETS2003 2002
Utility plant in service (at original cost, in service)$769,250 $714,678
Less accumulated provision for depreciation(365,243) (340,660)
Net plant in service404,007 374,018
Construction work in progress47,539 27,372
Nuclear decommissioning fund8,782 1,855
Total Utility Plant460,328 403,245
Other property and investments35,493 29,847
Current Assets: 
Cash and cash equivalents2,998 2,421$ 2,020 $ 685
Accounts receivable, less reserves of $2,659 and $3,764, respectively36,275 25,061
Restricted cash3,364 2,313
Accounts receivable, less reserves of $2,735 and $2,659, respectively37,713 36,275
Unbilled revenues18,539 16,48621,644 18,539
Materials and supplies, at lower of average cost or market8,147 7,8107,851 8,147
Fossil fuel, at lower of average cost or market5,213 4,2665,054 5,213
Stored natural gas, at lower of average cost or market12,948 16,60718,598 12,948
Prepaid taxes10,827 8,84614,063 10,827
Other prepayments2,024 1,7272,156 2,024
Total Current Assets96,971 83,224112,463 96,971
Deferred Charges36,103 27,75840,420 29,653
Property, Plant, and Equipment, Net449,022 421,375
Construction work in progress88,489 47,539
Nuclear decommissioning fund- 8,782
Total Property, Plant, and Equipment537,511 477,696
Other property and investments31,293 35,493
Total Assets$628,895 $544,074$721,687 $639,813
CAPITALIZATION AND LIABILITIES
Common shareholders' equity$227,370 $216,292
Long-term debt192,149 157,600
Total Capitalization419,519 373,892
LIABILITIES AND CAPITALIZATION 
Current Liabilities: 
Long-term debt due within one year- 20,000$ 20,000 $ -
Short-term debt - commercial paper34,298 9,50031,680 34,298
Accounts payable32,039 22,15635,043 31,999
Accrued interest3,161 3,1102,968 3,161
Other current liabilities11,049 7,01315,874 11,089
Total Current Liabilities80,547 61,779105,565 80,547
Other Credits: 
Deferred income taxes62,450 58,82175,525 62,450
Investment tax credit - deferred5,407 5,9274,891 5,407
Regulatory liabilities34,469 33,561
Other deferred liabilities60,972 43,65535,963 38,329
Total Other Credits128,829 108,403150,848 139,747
Commitments and Contingencies (Note 9)- -
Total Capitalization and Liabilities$628,895 $544,074
Capitalization: 
Common shareholders' equity263,070 227,370
Long-term debt202,204 192,149
Total Capitalization465,274 419,519
Commitments and contingencies- -
Total Liabilities and Capitalization$721,687 $639,813

The accompanying notes are an integral part of the above consolidated financial statements.

MGE Energy, Inc.
Consolidated Statements of Capitalization

(In thousands)

At December 31,
 2003 2002
Common Shareholders' Equity: 
Common stock - par value $1 per share: 
Authorized 50,000,000 shares 
Outstanding 18,343,913 and 17,574,796 shares, respectively$ 18,344 $ 17,575
Additional paid-in capital168,574 146,181
Retained earnings79,542 73,039
Accumulated other comprehensive loss(3,390) (9,425)
Total Common Shareholders' Equity263,070 227,370
 
First Mortgage Bonds: 
7.70%, 2028 Series1,200 21,200
 
Other Long-Term Debt: 
Variable rate, due 2004- 15,000
6.91%, due 2004- 5,000
7.49%, due 200715,000 15,000
6.02%, due 200830,000 30,000
4.875% 2012 Series, Industrial Development Revenue Bonds19,300 19,300
5.875% 2034 Series, Industrial Development Revenue Bonds28,000 28,000
6.58%, due 201215,000 15,000
5.26%, due 201720,000 20,000
7.12%, due 203225,000 25,000
6.12%, due 202820,000 -
5.68%, due 203330,000 -
Total Other Long-Term Debt202,300 172,300
 
Unamortized discount and premium on bonds, net(1,296) (1,351)
Total Long-Term Debt202,204 192,149
 
Total Capitalization$465,274 $419,519

At December 31,
 
2002
2001
Common Shareholders' Equity: 
Common stock - par value $1 per share: 
Authorized 50,000,000 shared 
Outstanding 17,574,796 and 17,071,554 shares, respectively$ 17,575 $ 17,072
Additional paid-in capital146,181 133,087
Retained earnings73,039 67,016
Accumulated other comprehensive loss(9,425) (883)
Total Common Shareholders' Equity227,370 216,292
 
Redeemable Preferred Stock,

cumulative, $25 par value, 1,175,000 authorized, but unissued



-
 

-
 
First Mortgage Bonds: 
8.50%, 2022 Series-40,000
6.75%, 2027A Series, Industrial Development Revenue Bonds-28,000
6.70%, 2027B Series, Industrial Development Revenue Bonds-19,300
7.70%, 2028 Series21,20021,200
Total First Mortgage Bonds21,200108,500
Other Long-Term Debt:
Variable rate, due 200415,000-
6.91%, due 20045,0005,000
7.49%, due 200715,00015,000
6.02%, due 200830,00030,000
4.875% 2012 Series, Industrial Development Revenue Bonds19,300-
5.875% 2034 Series, Industrial Development Revenue Bonds28,000-
6.58%, due 201215,000 -
5.26%, due 201720,000 -
7.12%, due 203225,000 -
Other Long-term Debt172,30050,000
Unamortized discount and premium on bonds, net(1,351)(900)
Total Long-term Debt192,149157,600
Total Capitalization$419,519$373,892

The accompanying notes are an integral part of the above consolidated financial statements.

MGE Energy, Inc.
Consolidated Statements of Common Equity and Comprehensive Income

(In thousands, except per-share amounts)

Common Stock

 

Additional
Paid-in
Capital
Retained
Earnings

Accumulated Other
Comprehensive (Loss)/Income

Comprehensive
Income


Common Stock

Shares Value

 



Additional

Paid-in

Capital

 



Retained

Earnings

 Accumulated Other Comprehensive (Loss)/Income 



Comprehensive

Income

2000SharesValue
Beginning balance - December 31, 199916,161$16,161$114,155$56,345$ (975)



2001
 
Beginning balance - December 31, 200016,619 $16,619 $122,661 $62,112 $(1,080) 
Net income 27,355$27,355 27,245 $27,245
Other comprehensive income/(loss):  
Minimum pension liability adjustment, net of $70 tax benefit









(105)


(105)
Minimum pension liability adjustment, net of $132 tax expense











197
 

197
Total comprehensive income $27,250 $27,442
Common stock dividends ($1.32 per share) (21,588)
Common stock issued4584588,506
Ending balance - December 31, 200016,619$16,619$122,661$ 62,112$(1,080)
2001 
Net income 27,245$27,245
Other comprehensive income/(loss): 
Minimum pension liability adjustment, net of $132 tax provision









197


197
Total comprehensive income $27,442
Common stock dividends ($1.33 per share) (22,341)
Common stock dividends declared ($1.33 per share) (22,341) 
Common stock issued45345310,426453 453 10,426 
Ending balance - December 31, 200117,072$17,072$133,087$ 67,016$(883)17,072 $17,072 $133,087 $ 67,016 $ (883) 
2002  
Net income 29,193$29,193 29,193 $29,193
Other comprehensive income/(loss):  
Minimum pension liability adjustment, net of $5,727 tax benefit 



(8,542)


(8,542)
 



(8,542)
 

(8,542)
Total comprehensive income $20,651 $20,651
Common stock dividends ($1.34 per share) (23,170)
Common stock dividends declared ($1.34 per share) (23,170) 
Common stock issued50350313,094503 503 13,094 
Ending balance - December 31, 200217,575$17,575$146,181$73,039$(9,425)17,575 $17,575 $146,181 $73,039 $(9,425) 



2003 
Net income 30,640 $30,640
Other comprehensive income/(loss): 
Minimum pension liability adjustment, net of $4,046 tax expense 



6,035
 

6,035
Total comprehensive income $36,675
Common stock dividends declared ($1.35 per share) (24,137) 
Common stock issued769 769 22,393 
Ending balance - December 31, 200318,344 $18,344 $168,574 $79,542 $(3,390) 

The accompanying notes are an integral part of the above consolidated financial statements.

Madison Gas and Electric Company
Consolidated Statements of Income

(In thousands)

For years ended December 31,For years ended December 31,
2002
2001
2000
2003 2002 2001
Operating Revenues: 
Regulated electric revenues$224,987$203,178$203,176$241,745 $224,987 $203,178
Regulated gas revenues122,109130,533120,932159,802 122,109 130,533
Total Operating Revenues347,096333,711324,108401,547 347,096 333,711
Operating Expenses: 
Fuel for electric generation38,21040,29936,33841,557 38,210 40,299
Purchased power44,60718,31018,96349,521 44,607 18,310
Natural gas purchased73,41286,03577,482104,066 73,412 86,035
Other operations80,77579,75872,015
Maintenance11,72414,27918,532
Other operations and maintenance111,254 92,499 94,037
Depreciation and amortization29,36235,65935,08123,344 29,362 35,659
Other general taxes10,86110,86410,18011,589 10,861 10,864
Income tax provision17,57313,83615,41619,094 17,573 13,836
Total Operating Expenses306,524299,040284,007360,425 306,524 299,040
Net Operating Income40,57234,67140,10141,122 40,572 34,671
Other Income and Deductions: 
AFUDC - equity funds380385343514 380 385
Equity in earnings in ATC3,3163,345-3,687 3,316 3,345
Income tax provision(889)(2,105)(336)(463) (889) (2,105)
Other(1,421)4,6381,376
Total Other Income1,3866,2631,383
Other deductions(3,002) (1,421) 4,638
Total Other Income and Deductions736 1,386 6,263
Income before interest expense and cumulative effect of a change in accounting principle
41,958

40,934

41,484

41,858
 
41,958
 
40,934
Interest Expense: 
Interest on long-term debt12,03212,78112,62211,558 12,032 12,781
Other interest5081,0081,683201 508 1,008
AFUDC - borrowed funds(213)(217)(176)(230) (213) (217)
Net Interest Expense12,32713,57214,12911,529 12,327 13,572
Net income before cumulative effect of a change in accounting

principle



29,631


27,362


27,355

30,329
 
29,631
 
27,362
Cumulative effect of a change in accounting principle, net of tax benefit of $78

-


(117)


-

-
 
-
 
(117)
Net Income$ 29,631$ 27,245$ 27,355$ 30,329 $ 29,631 $ 27,245

The accompanying notes are an integral part of the above financial statements.

Madison Gas and Electric Company
Consolidated Statements of Cash Flows

(In thousands)

For the years ended December 31,For the years ended December 31,
Operating Activities:
2002
2001
2000
2003 2002 2001
Net income$29,631$27,245$27,355$30,329 $29,631 $27,245
Items not affecting cash: 
Depreciation and amortization29,36235,65935,08123,344 29,362 35,659
Deferred income taxes3,62911, 601(1,074)13,156 3,629 11, 601
Amortization of nuclear fuel-1,6492,194- - 1,649
Amortization of investment tax credits(520)(849)(727)(516) (520) (849)
AFUDC - equity funds(380)(385)(343)(514) (380) (385)
Equity in earnings in ATC(3,316)(3,345)-(3,687) (3,316) (3,345)
Cumulative effect of change in accounting principle, net of tax benefit of $78
-

117

-

-
 
-
 
117
Other items--(825)
Dividend income from ATC2,7141,630-2,640 2,714 1,630
Collateral account - ATC(5,000)--
Prepayments to ATC5,000 (5,000) -
Changes in working capital items: 
Receivables, net(11,230)13,100(10,248)1,838 (11,230) 13,100
Inventories2,375(8,809)(1,143)(5,195) 2,375 (8,809)
Unbilled revenues(2,053)11,414(14,733)(3,105) (2,053) 11,414
Prepayments(2,047)(1,813)(895)(3,813) (2,047) (1,813)
Accounts payable6,995(4,364)9,2393,675 6,511 (5,546)
Accrued taxes and interest47(2,602)2,051
Other3,923(1,520)1,621
Accrued interest(166) 47 (2,602)
Other current liabilities3,592 3,923 (1,520)
Other noncurrent items, net(147)(4,044)2216,584 (146) (4,044)
Cash Provided by Operating Activities53,98374,68447,77473,162 53,500 73,502
Investing Activities: 
Additions to utility plant and nuclear fuel(59,430)(41,966)(73,606)
Capital expenditures(43,755) (58,149) (41,966)
Advance to ATC related to WCCF(9,223) (1,281) -
AFUDC - borrowed funds(213)(217)(176)(230) (213) (217)
Increase in nuclear decommissioning fund(7,804)(8,931)(11,059)- (7,804) (8,931)
Purchase of gas service territory(78)(3,800)-- (78) (3,800)
Capital distribution from ATC-15,000-- - 15,000
Sale of interest in nuclear plant-15,381-- - 15,381
Other(1,051) (332) (320)
Cash Used for Investing Activities(67,525)(24,533)(84,841)(54,259) (67,857) (24,853)
Financing Activities: 
Equity contributions from parent4,497--19,606 4,497 -
Issuance of common stock7,47110,8798,964- 7,471 10,879
Cash dividends on common stock-(22,341)(21,588)
Cash dividends to parent(17,316)--
Cash dividends paid on common stock- - (22,341)
Cash dividends paid to parent(29,685) (17,316) -
Affiliate financing of WCCF(10,542) - -
Long-term debt maturities/redemptions(20,000)(6,075)(11,200)(20,000) (20,000) (6,075)
Issuance of long-term debt35,000-35,00020,000 35,000 -
Increase/(decrease) in short-term debt4,000(34,500)28,2502,000 4,000 (34,500)
Cash Used for Financing Activities13,652(52,037)39,426
Other(300) 484 1,182
Cash Provided by/(Used for) Financing Activities(18,921) 14,136 (50,855)
Change in Cash and Cash Equivalents110(1,886)2,359(18) (221) (2,206)
Cash and cash equivalents at beginning of period2,4214,3071,948468 439 2,645
Cash and cash equivalents at end of period$ 2,531$ 2,421$ 4,307$ 450 $ 218 $ 439

The accompanying notes are an integral part of the above financial statements.

Madison Gas and Electric Company
Consolidated Balance Sheets

(In thousands)

At December 31,At December 31,
ASSETS
2002
2001
2003 2002
Utility Plant (at original cost, in service):
Utility Plant (At Original Cost, In Service): 
Electric$547,139 $506,810$573,326 $547,139
Gas222,111 207,868232,401 222,111
Gross plant in service769,250 714,678805,727 769,250
Less accumulated provision for depreciation(365,243) (340,660)(356,705) (347,875)
Net plant in service404,007 374,018449,022 421,375
Construction work in progress28,686 27,37288,489 28,686
Nuclear decommissioning fund8,782 1,855- 8,782
Total Utility Plant441,475 403,245537,511 458,843
Other property and investments7,550 3,6102,679 7,550
Investment in ATC26,839 26,23727,886 26,839
Total other property and investments34,389 29,847
Total Other Property and Investments30,565 34,389
Current Assets: 
Cash and cash equivalents2,531 2,421450 218
Accounts receivable, less reserves of $2,659 and $3,764, respectively36,291 25,061
Restricted cash3,364 2,313
Accounts receivable, less reserves of $2,735 and $2,659, respectively34,453 36,291
Unbilled revenues18,539 16,48621,644 18,539
Materials and supplies, at lower of average cost or market8,147 7,8107,851 8,147
Fossil fuel, at lower of average cost or market5,213 4,2665,054 5,213
Stored natural gas, at lower of average cost or market12,948 16,60718,598 12,948
Prepaid taxes10,619 8,84614,305 10,619
Other prepayments2,001 1,7272,128 2,001
Total Current Assets96,289 83,224107,847 96,289
Special billing projects14,574 4,426
Regulatory assets8,241 10,308
Other deferred charges36,103 27,75817,334 14,919
Total Assets$608,256 $544,074$716,072 $619,174
CAPITALIZATION AND LIABILITIES 
Common shareholders' equity$230,534 $216,292
Common stockholder equity$256,819 $230,534
Long-term debt192,149 157,600202,204 192,149
Total Capitalization422,683 373,892459,023 422,683
Current Liabilities: 
Long-term debt due within one year- 20,000
Long-term debt - due within one year20,000 -
Short-term debt - commercial paper13,500 9,50015,500 13,500
Accounts payable29,151 22,15632,826 29,151
Affiliate payables18,918 -
Accrued interest3,157 3,1102,967 3,157
Accrued payroll - related items5,811 5,1866,786 5,811
Other current liabilities5,125 1,8278,872 5,125
Total Current Liabilities56,744 61,779105,869 56,744
Other Credits: 
Deferred income taxes62,450 58,82175,606 62,450
Investment tax credit - deferred5,407 5,9274,891 5,407
Regulatory liability (SFAS No. 109)10,931 16,235
Other regulatory liabilities5,262 6,201
Regulatory liabilities34,469 33,561
Pension liability29,947 32,866
Other deferred liabilities44,779 21,2196,267 5,463
Total Other Credits128,829 108,403151,180 139,747
Commitments and Contingencies (Note 9)
Commitments and Contingencies- -
Total Capitalization and Liabilities$608,256 $544,074$716,072 $619,174

The accompanying notes are an integral part of the above financial statements.

Madison Gas and Electric Company
Consolidated Capitalization Statement

(In thousands)

At December 31,
 2003 2002
Common Shareholders' Equity 
Common stock - par value $1 per share: 
Authorized 50,000,000 shares 
Outstanding 17,347,889 shares, respectively$ 17,348 $ 17,348
Additional paid-in capital164,385 144,779
Retained earnings78,476 77,832
Accumulated other comprehensive loss(3,390) (9,425)
Total Common Shareholders' Equity256,819 230,534
 
Redeemable Preferred Stock,
Cumulative, $25 par value, 1,175,000 authorized, but unissued

-
 
-
 
First Mortgage Bonds 
7.70%, 2028 Series1,200 21,200
 
Other Long-Term Debt 
Variable rate, due 2004- 15,000
6.91%, due 2004- 5,000
7.49%, due 200715,000 15,000
6.02%, due 200830,000 30,000
4.875% 2012 Series, Industrial Development Revenue Bonds19,300 19,300
5.875% 2034 Series, Industrial Development Revenue Bonds28,000 28,000
6.58%, due 201215,000 15,000
5.26%, due 201720,000 20,000
7.12%, due 203225,000 25,000
6.12%, due 202820,000 -
5.68%, due 203330,000 -
Other Long-Term Debt202,300 172,300
 
Unamortized discount and premium on bonds, net(1,296) (1,351)
Total Long-Term Debt202,204 192,149
 
Total Capitalization$459,023 $422,683

The accompanying notes are an integral part of the above financial statements.

Madison Gas and Electric Company
Consolidated Statements of Common Equity and Comprehensive Income

(In thousands, except per-share amounts)


Common Stock

Shares Value


Additional
Paid-in
Capital


Retained
Earnings
Accumulated Other Comprehensive (Loss)/Income
Comprehensive
Income
2001 
Beginning balance - December 31, 200016,619 $16,619 $122,661 $ 62,112 $(1,080) 
Net income 27,245 $27,245
Other comprehensive income/(loss): 
Minimum pension liability adjustment, net of $70 tax expense











197
 

197
Total comprehensive income $27,442
Common stock dividends declared (22,341) 
Common stock issued453 453 10,426 
Ending balance - December 31, 200117,072 $17,072 $133,087 $ 67,016 $ (883) 


2002 
Net income 29,631 $29,631
Other comprehensive income/(loss): 
Minimum pension liability adjustment, net of $5,727 tax benefit 



(8,542)
 

(8,542)
Total comprehensive income $21,089
Common stock dividends declared (17,316) 
Transfer of subsidiary equity to parent (1,499) 
Common stock issued276 276 11,692 
Ending balance - December 31, 200217,348 $17,348 $144,779 $77,832 $(9,425) 


2003 
Net income 30,329 $30,329
Other comprehensive income/(loss): 
Minimum pension liability adjustment, net of $4,046 tax expense 



6,035
 

6,035
Total comprehensive income $36,364
Common stock dividends declared (29,685) 
Capital distribution from parent 19,606 
Ending balance - December 31, 200317,348 $17,348 $164,385 $78,476 $(3,390) 

The accompanying notes are an integral part of the above financial statements.

Madison Gas and Electric Company
Capitalization Statement
(In thousands)

At December 31,
2002
2001
Common Shareholders' Equity
Common stock - par value $1 per share:
Authorized 50,000,000 shared
Outstanding 17,347,889 and 17,071,554 shares, respectively$ 17,348$ 17,072
Additional paid-in capital144,779133,087
Retained earnings77,83267,016
Accumulated other comprehensive loss(9,425)(883)
Total Common Shareholders' Equity230,534216,292
Redeemable Preferred Stock,

cumulative, $25 par value, 1,175,000 authorized, but unissued



-


-
First Mortgage Bonds
8.50%, 2022 Series-40,000
6.75%, 2027A Series, Industrial Development Revenue Bonds-28,000
6.70%, 2027B Series, Industrial Development Revenue Bonds-19,300
7.70%, 2028 Series21,20021,200
Total First Mortgage Bonds21,200108,500
Other Long-term Debt
Variable rate, due 200415,000-
6.91%, due 20045,0005,000
7.49%, due 200715,00015,000
6.02%, due 200830,00030,000
4.875% 2012 Series, Industrial Development Revenue Bonds19,300-
5.875% 2034 Series, Industrial Development Revenue Bonds28,000-
6.58%, due 201215,000-
5.26%, due 201720,000-
7.12%, due 203225,000-
Other Long-term Debt172,30050,000
Unamortized discount and premium on bonds, net(1,351)(900)
Total Long-term Debt192,149157,600
Total Capitalization$422,683$373,892

The accompanying notes are an integral part of the above financial statements.

Madison Gas and Electric Company
Statements of Common Equity and Comprehensive Income
(In thousands, except per-share amounts)



Common Stock


Additional
Paid-in
Capital



Retained
Earnings
Accumulated Other Comprehensive (Loss)/Income



Comprehensive
Income
2000SharesValue
Beginning balance - December 31, 199916,161$16,161$114,155$56,345$(975)
Net income 27,355$27,355
Other comprehensive income/(loss): 
Minimum pension liability adjustment, net of $70 tax benefit











(105)


(105)
Total comprehensive income $27,250
Common stock dividends ($1.32 per share) (21,588)
Common stock issued4584588,506
Ending balance - December 31, 200016,619$16,619$122,661$ 62,112$(1,080)
2001 
Net income 27,245$27,245
Other comprehensive income/(loss): 
Minimum pension liability adjustment, net of $132 tax provision











197


197
Total comprehensive income $27,442
Common stock dividends ($1.33 per share) (22,341)
Common stock issued45345310,426
Ending balance - December 31, 200117,072$17,072$133,087$ 67,016$(883)
2002 
Net income 29,631$29,631
Other comprehensive income/(loss): 
Minimum pension liability adjustment, net of $5,727 tax benefit 



(8,542)


(8,542)
Total comprehensive income $21,089
Common stock dividends ($1.34 per share) (17,316)
Transfer of subsidiary equity to parent (1,499)
Common stock issued27627611,692
Ending balance - December 31, 200217,348$17,348$144,779$77,832$(9,425)

The accompanying notes are an integral part of the above financial statements.

Notes to Consolidated Financial Statements

December 31, 2003, 2002, 2001, and 20002001

This report is a combined report of MGE Energy Inc. and Madison Gas and Electric Company. References in this reportMGE. The notes to "MGE Energy" are tothe consolidated financial statements that follow include consolidated MGE Energy Inc.Footnotes and its subsidiaries. References in this reportcertain Footnotes related to "MGE" are to Madison Gas and Electric Company. The footnotes are applicable to MGE Energy in its entirety.MGE.

1. Summary of Significant Accounting PoliciesPolicies.

a. General -MGE Energy.

On August 12, 2002, MGE Energy became the holding company for MGE as the result of the completion of an exchange of shares of MGE Energy common stock for shares of MGE common stock. The MGE Energy financial statements reflect this transaction for all periods presented. Consequently, MGE constitutes a substantial portion of all of the assets, liabilities, and results of operations of MGE Energy and is expected to continue to do so for the foreseeable future.

MGE Energy is an investor-owned publica holding company. MGE, a wholly owned subsidiary of MGE Energy, is a regulated electric and gas utility headquartered in Madison, Wisconsin. MGE generates and distributes electricity to nearly 130,000132,000 customers in a 250-square-mile area of Dane County. MGE also purchases and distributes natural gas to more than 126,000129,000 customers in 1,375 square miles of service territory in seven south-central Wisconsin counties. Other wholly owned subsidiaries of MGE Energy include MGE Power, which owns 100% of MGE Power West Campus, and MGE Construct. These subsidiaries are part of our nonutility energy operations, which have been formed to construct and own new electric generation projects.

The consolidated financial statements reflect the application of certain accounting policies described in this note. All significant intercompany accounts and transactions have been eliminated in consolidation.

Accounting policies for regulated operations are in accordance with those prescribed by the regulatory authorities having jurisdiction, principally the PSCW, FERC, and SEC under the Public Utility Holding Company Act of 1935.

b. Use of Estimates - MGE Energy and MGE.

In order to prepare consolidated financial statements in conformity with generally accepted accounting principles, management must make estimates and assumptions thatassumptions. These estimates could affect reported amounts of assets, liabilities, the disclosure of contingent assets and liabilities at the datesdate of the financial statements, as well as the reported amounts of revenues and expenses during the reported periods, and disclosure of contingencies.reporting periods. Actual results could differ from management's estimates.

Accounting policies for regulated operations are in accordance with those prescribed by the regulatory authorities having jurisdiction, principally the Public Service Commission of Wisconsin (PSCW), the Federal Energy Regulatory Commission (FERC), and the Securities and Exchange Commission under the Public Utility Holding Company Act of 1935.c. Revenues - MGE.

b. MGE - Revenues

Revenues from the sale of electricity and gas to customers are generally recorded when electricity/gas is delivered to those customers. The quantity of those sales is measured by customers' meters. Due to the large volume of those meters, it is impractical to read all of them at month end and, thus, those metersmonth-end. Meters are read on a systematic basis throughout the month based on established meter-reading schedules. Consequently, at the end of any month, there exists a quantity of electricity and gas service that has been delivered to customersrendered but has not been captured by the meter readings.billed. As a result, management must estimate revenue related to electricity and gas delivered to customers between their meter readmeter-read date and the end of the period.

In order to estimate unbilled revenues as of the end of a particular period, MGE performs a series of calculations based upon actual and estimated numbers and assumptions. MGE begins by calculating the amount of electricity and gas available for sale within its system during that period based upon known inputs i.e.(i.e., electricity and gas purchases from third parties, gas from storage, and MGE-generated electricity.electricity). These amounts are then adjusted to deduct the amounts actually included withinin customers' bills for that period.

In the case of electricity, the amount is further reduced by an estimate ofestimating the quantity of electricity lost in the process of transmitting and distributing it to customers. The resulting available-for-sale quantities are then allocated to various customer classes based upon historical utilization patterns for those customers, andcustomers. MGE applies published tariffs to determine the associated revenues. Utilization patterns are based upon assumptions regarding weather, economic conditions, and consistency of use over the period in question andquestion. Actual use can be affected by variations in those items. The resulting estimate is then compared to other available statistics, including accounts receivable and billed sales for the particular period, in order to confirm its reasonableness.

During 2003, many of MGE's largest customers were shifted to a calendar month bill. As a result of this shift, the majority of these customers' electricity usage is now accounted for in the unbilled calculation. The unbilled amounts are based on actual usage billed the following month and are therefore very reliable. Due to this billing shift, MGE believes thathas seen the ratio of unbilled-to-billed electric sales should typically fall inclimb. The ratio has settled into a 40%range of 45% to 50% range on a monthly basis. A ratio outside that range would indicate a need for further review65%, and analysis.MGE will continue to monitor and track this range.

Gas revenues are subject to an adjustment clause related to periodic changes in the cost of gas. MGE has been operating under a gas cost incentive mechanism since 1999.

d. Income Taxes and Excise Taxes - MGE.

Under this mechanism, if actual gas commodity coststhe liability method prescribed by SFAS 109, income taxes are above or below a benchmark setdeferred for all temporary differences between pretax financial and taxable income and between the book and tax basis of assets and liabilities using the tax rates scheduled by state regulators, MGE's gas sales service customers and shareholders share equallylaw to be in effect when the higher costs or savings up to $1.5 million. Any costs or savings that exceed $1.5 million will be passed ontemporary differences reverse. Future tax benefits are recognized to the gas salesextent that realization of such benefits is more likely than not. A valuation allowance is recorded for those benefits that do not meet this criterion.

Regulation and SFAS No. 109 have resulted in a regulatory liability related to income taxes. Excess deferred income taxes result from past taxes provided at rates higher than current rates. The SFAS No. 109 regulatory liability and deferred investment tax credit reflects the revenue requirement associated with the return of these tax benefits to customers.

Investment tax credits from regulated operations are amortized over related property service customers.lives.

c. MGE - Nuclear Fuel

The 1992 National Energy Policy Act requires all utilities that have used federal enrichment facilities to pay a special assessmentTax credits for decontaminating and decommissioning these facilities. This special assessment isthe generation of electricity from wind are based on past enrichment. MGE has accrued in other regulatory liabilitieskWh produced and deferred in deferred charges an estimated $1.1 million for its portion ofsold during the special assessment. MGE believes any additional costs will be recovered in future rates.

Effective September 23, 2001, MGE sold its 17.8% ownership interest in Kewaunee to Wisconsin Public Service Corporation (WPSC) (see Footnote 10).

d. MGE - Property, Plant, and Equipment

MGE's utility plant is statedyear at the original cost of construction, which includes indirect costs consisting of payroll taxes, pensions, postretirement benefits, other fringe benefits, administrative and general costs, and an allowance for funds used during construction (AFUDC).

AFUDC represents the approximate cost of debt and equity capital devoted to plant under construction. MGE presently capitalizes AFUDC at acurrent statutory tax credit rate of 10.58% on 50.0% of average construction work in progress. The AFUDC rate approximates MGE's cost of capital. The portion of the allowance that applies to borrowed funds is presented in the Consolidated Statements of Income as a reduction of interest expense, and equity funds is presented as other income. Although the allowance does not represent current cash income, it is recovered under the ratemaking process over the service lives of the related properties.1.8 cents per kWh.

MGE's accounting policy for planned major maintenance projects is to expense the costs for such projects in the periods for which they are incurred.

MGE Energy's nonregulated businesses capitalize interest costs under Statement of Financial Accounting Standards (SFAS) No. 34,Capitalizing Interest Costs, for costs incurred to finance its power plant construction projects and real estate developed for internal use.

MGE Power calculates capitalized interest in accordance with SFAS No. 34, on construction projects for periods where financing is provided by MGE Energy, through interim debt. The interest rate capitalizedits utility operations, pays a state license fee tax in lieu of property taxes on property used in utility operations. License fee tax is based upon the monthly short-term borrowing rate MGE Energy incurs for such funds.

e. MGE - Depreciation

Provisions at composite straight-line depreciation rates, excluding decommissioning costs, approximate the following percentages for the costcalculated as a percent of depreciable property:

200220012000
Electric2.8% 3.4% 3.2%
Gas3.3% 3.3% 3.4%


Depreciation rates are approved by the PSCW and are generally based on the estimated economic lives of property.

Included in accumulated provision for depreciation is a regulatory liability in the amount of $17.4 million representing future removal costs collected through depreciation.

Effective September 23, 2001, MGE transferred the assets of its external decommissioning trusts to external trusts of WPSC. This transfer was partadjusted operating revenues of the Kewaunee sale agreement between WPSCprior year. The electric tax rate is 3.19%, and MGE (see Footnote 10)the gas tax rate is 0.97%. The agreement required MGE to continue funding its external decommissioning trust through the endEstimated tax is prepaid (prepaid taxes) one year in advance of 2002 at the PSCW authorized level of approximately $0.7expense recognition. License fee tax expense, included in other general taxes, was $8.4 million, per month. These costs were recovered from customers in rates. At the beginning of 2003, the remaining assets of the MGE external trust were transferred to the external trust of WPSC. The trusts are shown on the balance sheet in the Utility Plant section.

As required by SFAS No. 115,Accounting for Certain Investments in Debt and Equity Securities, MGE's debt and equity security investments in the trusts are classified as available for sale. Gains and losses on the trusts were determined based on specific identification. Net unrealized holding gains and losses on the trusts were recorded as part of accumulated provision for depreciation.

As of December 31, 2002, the decommissioning trust totaled $8.8 million, its pretax fair market value. Realized earnings on the trusts were $0.1 million, $4.1$7.8 million, and $3.5$7.7 million for the years ended December 31, 2003, 2002, and 2001, respectively.

Operating income taxes, including tax credits, and 2000, respectively. Unrealized earnings (loss)license fee tax are included in rates.

e. Inventories - MGE.

Inventories consist of the trusts totaled $(1.2 million), $0 million,natural gas in storage, fossil fuels, and $28.0 million at December 31, 2002, 2001,materials and 2000, respectively.supplies. MGE values all natural gas in storage, fossil fuels, and materials and supplies using average cost.

f. MGERegulatory Matters - Regulatory MattersMGE.

Pursuant to SFAS No. 71,Accounting for the Effects of Certain Types of Regulation, MGE capitalizes (as deferred charges)as regulatory assets incurred costs that are expected to be recovered in future electric and natural gas rates. MGE also records (as other credits)as regulatory liabilities obligations to customers to refund previously collected revenue or to spend revenue collected from customers on future costs.

Electric industry restructuring could affect MGE's ability to continue establishing certain regulatory asset and liability amounts now allowed under SFAS No. 71. MGE is unable to predict whether any adjustments to regulatory assets and liabilities will occur in the future. However, the PSCW has recognized the need to allow recovery for commitments made under prior regulation.

MGE's regulatoryg. Debt Issuance Costs - MGE Energy and deferred assetsMGE.

Premiums, discounts, and liabilities consistedexpenses incurred with the issuance of the following as of December 31:

20022001
(In thousands)AssetsLiabilitiesAssetsLiabilities
Demand-side management$ -$ -$ 1,955$ 653
Decommissioning and decontamination1,1401,1401,3561,356
Environmental costs492-584-
Regulatory liability - SFAS No. 109-10,931-16,235
Gas supply derivatives-483634-
Deferred charges related to ATC3,652-1,247-
Deferred charges related to interest - 2027A Series844-878-
Nitrogen oxide escrow-996-1,608
Deferred charges - SFAS No. 133546---
Deferred charges - tax recovery related to AFUDC equity2,640-2,623-
Other9942,6431,2322,584
Subtotal - regulatory assets/liabilities10,30816,19310,50922,436
Pension and deferred compensation assets/liabilities6,45039,3166,10116,860
Unamortized debt expense*7,464-4,684-
Customer advances for construction-2,114-2,672
Other deferred items11,8813,3496,4641,687
Subtotal - deferred assets/liabilities25,79544,77917,24921,219
Total$36,103$60,972$27,758$43,655

*Unamortized debt expense includes costs associated with the issuance of long-term debt. These costs are amortized over the respective lives of the associated debt instruments. MGE recovers these costs in rates as a cost of long-term debt.

Demand-side management expenditures are for programs to promote energy efficiency. The demand-side management asset balance is for conservation expenditures that were previously capitalized. MGE recovers a carrying cost on this asset. MGE has not incurred any expenditures for capitalized conservation since 1997. The capitalized conservation balance as of December 31, 1999, has been recovered in rates over a four-year amortization period, which ended December 2002.

The demand-side management liability balance is for MGE's conservation escrow expenditures. Costs for demand-side management programs are estimated in MGE's rates. To the extent the costs are over or under spent compared to the estimate included in rates, MGE will be required in its next rate case to seek recovery on any amounts overspent and return to ratepayers any amounts underspent.

Costs related to decommissioning and decontamination will be recovered in rates through September 2007 (see Footnote 1.c.)

Environmental costs MGE has received regulatory treatment on include clean up of two landfill sites and costs of certain nitrogen oxide (NOx) related expenditures. The regulators have allowed MGE to recover carrying costs on certain NOx-related expenditures. These costsoutstanding long-term debt are amortized over varying time periods between four years for cleanup of sites and ten years for NOx-related expenditures.

MGE has a limited number of physical and financial gas commodity contracts that are defined as derivatives under SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities. The derivative amounts recorded as a result of these gas contracts is offset with a corresponding regulatory asset or liability because these transactions are part of the Purchased Gas Adjustment Clause (PGA) authorized by the PSCW and not subject to the gas cost incentive sharing mechanism. This regulatory liability will be returned in the first quarter of 2003.

Deferred charges in connection with the start-up of the American Transmission Company (ATC) are being deferred under SFAS No. 71, as MGE believes it is probable that MGE will obtain recovery of these costs in future rates based on the PSCW's order in Docket O5-EI-121. MGE is earning a current return on the deferred charges related to this regulatory asset, which will be recovered over the next biennial rate case, which is 2003-2004.

Deferred charges on the interest expense of the 2027A Series relates to the incremental difference in the interest that MGE earned on its construction bond fund and the actual interest that MGE paid out. That incremental difference between interest earned and interest expensed is currently being amortized over the remaining life of the bonds as part of the rate recovery allowed by the PSCW.

The PSCW has authorized utilities to defer all project costsdebt issue. Any call premiums or unamortized expenses associated with the compliancerefinancing higher-cost debt obligations used to finance utility-regulated assets and operations are amortized consistent with regulatory treatment of the federal US Environmental Protection Agency's (EPA) new requirements on NOx emissions. In MGE's rate case (Docket 3270-UR-110), due to the uncertainty regarding the level and timing of NOx emissions remediation expenditures, the PSCW allowed MGE to establish an escrow mechanism for these costs. The annual recovery allowed in rates is $1.6 million, of which $0.7 million is recorded in depreciation expense and $0.9 million in operating expense. Charges to the NOx escrow for 2002 totaled $1.1 million for carrying costs of the capitalized expenditures, $0.9 million for depreciation expense of the related asset, and $0.2 million for deferred NOx costs associated with the Blount Generating Station (Blount). MGE earns a return on the unrecovered portion, which will be amortized over a ten-year period.those items.

In the third quarter of 2002, MGE received approval from the PSCW to establish a regulatory asset or liability for the deferral of the effects of mark-to-market accounting as required by SFAS No. 133 on contracts related to MGE's regulated operations. Management believes that it is the PSCW's intent to allow a utility to recover its actual costs imbedded in the contract, if the costs are deemed reasonable and prudent. MGE believes its interpretation of the PSCW's letter required MGE to record a gain or loss from the application of SFAS No. 133, as either a regulatory asset or liability. MGE has recorded a regulatory asset of $0.5 million for the cumulative mark-to-market value of its derivative contracts, the commercial paper swap agreement, and the Columbia coal contract as of December 31, 2002.

AFUDC equity represents the after-tax equity cost associated with utility plant construction, and results in a temporary difference between the book and tax basis of such plant. Deferred income taxes are provided on this temporary difference in accordance with SFAS No. 109,Accounting for Income Taxes. It is probable under PSCW regulation that MGE will recover in future rates the future increase in taxes payable represented by the deferred income tax liability. Deferred charges--tax recovery related to AFUDC equity represents the revenue requirement related to recovery of these future taxes payable, calculated at current statutory tax rates.

g. MGE Energy - Statement of Cash Flows

MGE considers cash equivalents to be those investments that are highly liquid with original maturity dates of less than three months.

Supplementary noncash investing items and cash paid/(received) for interest and income taxes and other noncash investing items for the years ended December 31 were as follows:

(In thousands)200220012000
Interest paid, net of amount capitalized$12,408$13,551$13,822
Income taxes paid17,22310,34716,078
Income taxes received(759)(570)-
Noncash financing item1,499--


On August 16, 2002, the Board of Directors for MGE approved a resolution to dividend the ownership of two small nonregulated subsidiaries previously owned by MGE to MGE Energy. The net assets transferred approximated $1.5 million. This represented a noncash transaction.

The amortization of debt issuance costs for the years ended 2002, 2001, and 2000 are included in the line item "Other noncurrent items, net" in the cash flow statement from operating activities and is not separated in a separate line as it is immaterial.

h. MGEComprehensive Income - Comprehensive IncomeMGE.

Comprehensive income includes all changes in equity during a period except those resulting from investments by and distributions to shareholders. Comprehensive income is reflected in the Consolidated Statements of Common Equity and Comprehensive Income.

i. MGEHedge Accounting - Hedge AccountingMGE.

Hedge accounting is applied only if the derivative reduces the risk of the underlying hedged item and is designated at inception as a hedge, with respect to the hedged item. If a derivative instrument ceased to meet the criteria for deferral, any gains or losses were recognized in income.

j. MGE - Accounting for Financial Derivatives - MGE.

MGE manages its risk exposure related to interest rates, commodity prices, and gas margin through its risk management policies and the use of various derivative instruments. MGE manages its interest rate risk by limiting its variable rate exposure through interest rate swap agreements. MGE uses various derivative contracts to manage the cost of gas for its "Winter Set-Price Firm Gas Sales Service" pilot program. MGE willmay use weather derivatives to reduce the impact of weather volatility on its gas margins.margin.

MGE has a swap agreement with a commercial bank for a notional amount of $5.0 million, backed by MGE's commercial paper. MGE pays a fixed rate of 6.91% on the swap, which was used to replace a portion of MGE's 7.70%, 2028 Series, First Mortgage Bonds. This swap agreement did not meet the criteria for hedge accounting due to the term of the swap being four years while the item being hedged has a 30-day maturity. Therefore, MGE's commercial paper swap agreement has been classified as a derivative and the changes in fair market value are recorded each quarter in the income statement.

MGE has a 22.0% ownership interest in the coal-fired Columbia Energy Center (Columbia), which is operated by Alliant Energy Corp. (Alliant). Alliant has entered into a long-term coal supply agreement with Dynegy Marketing and Trade. The contract contains certain put options and consequently, in accordance with the terms of SFAS No. 133, the contract is recorded at fair value on the balance sheet. Gains and losses are recorded in other income.

In the third quarter of 2002, MGE received approval from the PSCW to establish a regulatory asset or liability for the deferral of the effects of mark-to-market accounting as required by SFAS No. 133 on contracts related to MGE's regulated operations. Management believes that it is the PSCW's intent to allow a utility to recover its actual costs imbedded in the contract, if the costs are deemed reasonable and prudent. MGE believes its interpretation of the PSCW's letter required MGE to record a gain or loss from the application of SFAS No. 133, as either a regulatory asset or liability. MGE has recorded a regulatory asset of $0.5 million for the cumulative mark-to-market value of its derivative contracts, the commercial paper swap agreement, and the Columbia coal contract (described earlier) as of December 31, 2002.

MGE has a limited number of physical and financial gas commodity contracts that are defined as derivatives under SFAS No. 133. These gas instruments are primarily comprised of exchange-traded option contracts to manage the cost of gas and over-the-counter financial floating-to-fixed price swaps and calls for the Winter Set-Price Firm Gas Sales Service pilot program. The derivative amounts recorded as a result of these gas contracts is offset with a corresponding regulatory asset or liability because these transactions are part of the PGA clause and not subject to the gas cost incentive sharing mechanism. As of December 31, 2002, MGE has recorded an asset from gas supply derivatives and a corresponding regulatory liability of $0.5 million related to these contracts.

k. MGE - New Accounting Pronouncements

SFAS Nos. 141 and 142

In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141,Business Combinations, and SFAS No. 142,Goodwill and Other Intangible Assets, that supersede Accounting Principles Board (APB) Opinion No. 16,Business Combinations, and APB Opinion No. 17,Intangible Assets. The two statements modify the method of accounting for business combinations and address the accounting and reporting for goodwill and intangible assets. SFAS No. 141 is effective for all business combinations initiated after June 30, 2001 and, with acquisitions completed after June 30, 2001, for all business combinations accounted for by the purchase method for which the date of acquisition is completed after June 30, 2001. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 141 and 142 had no impact on the consolidated financial statements.

SFAS No. 143

In June 2001, the FASB issued SFAS No. 143,Accounting for Asset Retirement Obligations. SFAS No. 143, which is effective January 1, 2003, requires entities to record the fair value of a legal liability for an asset retirement obligation in the period in which it is incurred. When a new liability is recorded beginning in 2003, the entity will capitalize the cost of the liability by increasing the carrying amount of the related long-lived asset. The liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity settles the obligation for its recorded amount or incurs a gain or loss upon settlement.

MGE adopted SFAS No. 143 on January 1, 2003. MGE completed an assessment of the specific applicability and implications of SFAS No. 143. MGE found that SFAS No. 143 has specific applicability to various electric generating and substation facilities located on leased property, as well as various electric and gas distribution facilities installed on easements or permits. The asset retirement obligation associated with electric generating and substation facilities is approximately $1 million. The asset retirement obligations associated with the electric and gas distribution facilities cannot be reasonably estimated due to an indeterminate life of the associated assets.

MGE believes that the adoption of SFAS No. 143 results primarily in timing differences in the recognition of the legal asset retirement obligations and the asset retirement costs which MGE is currently recovering in rates and will be deferring such differences under SFAS No. 71. Early in 2003, MGE received assurance from the PSCW that the adoption of SFAS No. 143 would not result in a change to the current ratemaking process at this time.

SFAS No. 144

In August 2001, the FASB issued SFAS No. 144,Accounting for the Impairment or Disposal of Long-lived Assets, which supersedes SFAS No. 121,Accounting for the Impairment of Long-livedLong-Lived Assets and for Long-lived Assets to be Disposed of, and the accounting and reporting provisions of APB No. 30,Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and is effective for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. This statement had no material impact on the consolidated financial statements.- MGE.

SFAS No. 145

In May 2002, the FASB issued SFAS No. 145,Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections as of April 2002. SFAS No. 145 rescinds both FASB Statement No. 4 (SFAS 4),Reporting Gains and Losses from Extinguishment of Debt, and the amendment to SFAS 4, FASB Statement No. 64 (SFAS 64),Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. SFAS No. 145 is effective for transactions occurring after May 15, 2002. This statement does not have a material impact on the consolidated financial statements.

SFAS No. 146

In June 2002, the FASB issued SFAS No. 146,Accounting for Costs Associated with Exit or Disposal Activities. This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3,Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 is effective for transactions initiated after December 31, 2002. This statement does not have a material impact on the consolidated financial statements.

SFAS No. 148

In December 2002, the FASB issued SFAS No. 148,Accounting for Stock-Based Compensation- Transition and Disclosure. This statement amends FASB Statement No. 123,Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based employee compensation. In addition, the statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. MGE Energy has no stock options as of December 31, 2002, and therefore SFAS No. 148 will have no impact.

EITF Issue 02-3

EITF Issue 02-3,Accounting for Contracts Involved in Energy Trading and Risk Management Activities (EITF 02-3), issued by the FASB EITF in June 2002, requires revenues and energy costs related to energy trading contracts to be presented on a net basis in the income statement. This EITF has no current impact on the consolidated financial statements.

FIN 45

In November 2002, the FASB issued Financial Interpretation No. (FIN) 45,Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. This interpretation provides the disclosures to be made by a guarantor in interim and annual financial statements about obligations under certain guarantees. The interpretation also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation. The initial recognition and measurement requirements are effective prospectively for guarantees issued or modified after December 31, 2002. However, the disclosure requirements of the interpretation are effective for this Form 10-K and included in Footnote 8.

FIN 46

In January 2003, the FASB issued FIN 46,Consolidation of Variable Interest Entities, that addresses conditions when an entity should be consolidated based upon variable interests rather than voting interests. Variable interests are ownership interests or contractual relationships that enable the holder to share in the financial risks and rewards resulting from the activities of a Variable Interest Entity (VIE). A VIE is a corporation, partnership, trust, or any other legal structure used for business purposes that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities.

In order to apply FIN 46, MGE must evaluate every entity with which it is involved through variable interests to determine whether the entity is a VIE and, if it is, whether or not MGE is the primary beneficiary of the entity. The primary beneficiary of a VIE is the entity that receives the majority of the entity's expected losses, residual returns, or both. As a result, FIN 46 could result in consolidation of an entity that MGE is associated with other than by (and even in the absence of) a voting ownership interest. FIN 46 is not believed to have a material impact on the consolidated financial statements.

l. MGE - Impairment of Long-lived Assets

MGE continually reviews plant and equipment and other intangible assets and property and goodwill, if any, for impairment wheneverwhen events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. MGE's policy for determining when long-lived assets are impaired is to recognize an impairment loss if the sum of the expected future cash flows (undiscounted and without interest charges) from an asset is less than the carrying amount of that asset. If an impairment loss is recognized, the amount that will be recorded will be measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. MGE believes there is no impairment of long-lived assets in accordance towith SFAS No. 144 at December 31, 2002.2003.

m. l. Restricted Cash - MGE

MGE - Income and Excise Taxes

Under the liability method prescribed by SFAS 109, income taxeshas some cash accounts that are deferred for all temporary differences between pretax financial and taxable income and between the book and tax basis of assets and liabilities using the tax rates scheduled by lawrestricted to be in effect when the temporary differences reverse. Future tax benefits are recognized to the extent that realization of such benefits is more likely than not. A valuation allowance is recorded for those benefits which do not meet this criterion.

Regulation and SFAS No. 109 have resulted in a regulatory liability related to income taxes. Excess deferred income taxes result from past taxes provided at rates higheruses other than current rates. The SFAS No. 109 regulatory liabilityoperations, and deferred investment tax credit reflect the revenue requirement associateddesignated for a specific purpose. MGE's restricted cash accounts relate to cash deposited for operations and capital expenditures at its joint operating plant and cash held by trustee for certain employee benefits.

m. Unbilled Receivables and Retainage Receivable Associated with the returnWCCF.

Unbilled receivables for MGE Construct represent actual costs incurred on behalf of these tax benefits to customers.

Investment tax credits from regulated operations are amortized over related property service lives.

Tax creditsthe State for the generationconstruction of electricity from windWCCF. The costs are based on kilowatt-hours produced and sold during the year at the current statutory tax credit rate, 1.8 cents per kilowatt-hour.

MGE Energy, through its utility operations, pays a license fee taxbilled to the State of Wisconsinon a monthly basis pursuant to the EPC Agreement. The unbilled receivable at December 31, 2003, totaled $2.0 million and was billed to the State in lieu of property taxes on property used in utility operations. License fee tax is calculated asJanuary 2004.

At December 31, 2003, MGE Construct has a $1.2 million retainage receivable from the State associated with WCCF. Ten percent of adjusted operating revenuesall nonmajor equipment and service costs (up to $5 million) billed to the State will be retained until commercial operation of the prior year. The electric tax rate is 3.19% andfacility pursuant to the gas tax rate is 0.97%. Estimated tax is prepaid (Prepaid taxes) one year in advance of expense recognition. License fee tax expense, included in Other general taxes, was $7.8 million, $7.7 million, and $6.9 million for the years ended December 31, 2002, 2001, and 2000, respectively.EPC Agreement.

Operating income taxes, including tax credits, and license fee tax are included in rates.

n. ReclassificationReclassification.

Certain prior-year amounts have been reclassified for comparative purposes. The financial statements include the accounts of MGE Energy and its subsidiaries. These reclassifications did not affect consolidated net income for the years presented.

MGE made a significant reclassification related to the reporting of accumulated costs of removal, which are nonlegal retirement obligations. Previously, these costs were included as components of accumulated depreciation.

2. Basis of Consolidation - MGE.

MGE Power West Campus was created for the purpose of owning new generating assets including WCCF. These new generating assets are for the primary benefit of MGE's customers. The long-term lease arrangement between MGE and MGE Power West Campus creates a VIE relationship under FIN No. 46-R (see Footnote 20). MGE is considered the primary beneficiary to this VIE because it will absorb a majority of the entity's expected losses, residual returns, or both. Therefore, MGE Power West Campus has been consolidated into MGE in accordance with FIN No. 46-R as of December 31, 2003.

The consolidation of MGE Power West Campus resulted in an increase to construction work in progress of $48.6 million, an increase in long-term debt of $30.0 million, and affiliate payables of $18.9 million at December 31, 2003. As MGE Power West Campus had no significant operations, the consolidation of this entity by MGE did not have a material impact on the Consolidated Statements of Income for the year ended December 31, 2003.

3. Nuclear Fuel - MGE.

The 1992 National Energy Policy Act requires all utilities that have used federal enrichment facilities to pay a special assessment for decontaminating and decommissioning these facilities. This special assessment is based on past enrichment. MGE has accrued in other regulatory liabilities and deferred in deferred charges an estimated $0.8 million for its portion of the special assessment. MGE believes any additional costs will be recovered in future rates.

MGE sold its 17.8% ownership interest in Kewaunee to WPSC in September 2001 (see Footnote 18). However, it retained financial responsibility for spent nuclear fuel associated with its share of generation from Kewaunee for the period from the opening of the plant to the closing date of the sale.

4. Property, Plant, and Equipment - MGE Energy and MGE.

MGE's utility plant is stated at the original cost of construction, which includes indirect costs consisting of payroll taxes, pensions, postretirement benefits, other fringe benefits, administrative and general costs, and AFUDC.

AFUDC represents the approximate cost of debt and equity capital devoted to plant under construction. MGE presently capitalizes AFUDC at a rate of 9.97% on 50.0% of average construction work in progress. The AFUDC rate approximates MGE's cost of capital. The portion of the allowance that applies to borrowed funds is presented in the Consolidated Statements of Income as a reduction of interest expense, and equity funds is presented as other income. Although the allowance does not represent current cash income, it is recovered under the ratemaking process over the service lives of the related properties.

MGE's accounting policy for planned major maintenance projects is to expense the costs for these projects in the periods for which they are incurred.

MGE Energy's nonregulated businesses capitalize interest costs under SFAS No. 34,Capitalizing Interest Costs, for costs incurred to finance their power plant construction projects.

MGE Power West Campus calculates capitalized interest in accordance with SFAS No. 34 on construction projects for periods where financing is provided by MGE Energy through interim debt. The interest rate capitalized is based upon the monthly short-term borrowing rate MGE Energy incurs for such funds and the interest rate related to MGE Power West Campus's long-term debt.

Total capitalized interest as of December 31, 2003, related to WCCF was $1.2 million.

5. Depreciation - MGE.

Provisions at composite straight-line depreciation rates, excluding decommissioning costs, approximate the following percentages for the cost of depreciable property:

2003 2002 2001
Electric3.0% 2.8% 3.4%
Gas3.3% 3.3% 3.3%

Depreciation rates are approved by the PSCW and are generally based on the estimated economic lives of property.

MGE transferred the assets of its external decommissioning trusts to external trusts of WPSC in September 2001 as part of the Kewaunee sale agreement (see Footnote 18). The agreement required MGE to continue funding its external decommissioning trust through the end of 2002 at the PSCW-authorized level of approximately $0.7 million per month. These costs were recovered from customers in rates. At the beginning of 2003, the remaining assets of the MGE external trust were transferred to the external trust of WPSC. The trusts are shown on the balance sheet in the Utility Plant section.

As required by SFAS No. 115,Accounting for Certain Investments in Debt and Equity Securities, MGE's debt and equity security investments in the trusts were classified as available for sale. Gains and losses on the trusts were determined based on specific identification. Net unrealized holding gains and losses on the trusts were recorded as part of accumulated provision for depreciation.

As of December 31, 2003, the decommissioning trust had been transferred to WPSC. Realized earnings on the trusts were $0.0 million, $0.1 million, and $4.1 million for the years ended December 31, 2003, 2002, and 2001, respectively. Unrealized earnings (loss) of the trusts totaled $0 million, ($1.2 million), and $0 million at December 31, 2003, 2002, and 2001, respectively.

6. Regulatory Assets and Liabilities - MGE.

MGE's regulatory and deferred assets and liabilities consisted of the following as of December 31:

2003 2002
(In thousands)
Assets Liabilities Assets Liabilities
Decommissioning and decontamination$ 846 $ 846 $ 1,140 $ 1,140
Environmental costs1,825 - 767 -
Regulatory liability - SFAS No. 109- 9,877 - 10,931
Gas supply derivatives- 732 - 483
Non-SFAS No. 143 removal cost- 18,247 - 17,368
Deferred charges related to ATC340 - 3,652 -
Deferred charges related to interest -
2027A Series

810
 
-
 
844
 
-
Nitrogen oxide escrow- - - 996
Deferred charges - SFAS No. 133277 - 546 -
Deferred charges - tax recovery related
to AFUDC equity

2,740
 
-
 
2,640
 
-
Regulatory liability - customer fuel credit- 2,762 - -
Asset retirement obligation - SFAS No. 143850 - - -
Other553 2,005 719 2,643
Total - regulatory assets/liabilities$8,241 $34,469 $10,308 $33,561

MGE is recovering carrying costs on all regulatory assets, except for amounts expended for environmental costs.

Costs related to decommissioning and decontamination will be recovered in rates through September 2007 (see Footnotes 3 and 18).

MGE has received regulatory treatment on environmental costs including clean up of two landfill sites and a substation site. The regulators have not allowed MGE to recover carrying costs on these environmental expenditures. As of December 31, 2003, MGE has recorded $1.8 million in regulatory assets for environmental costs, including $1.1 million for accrual for estimated future site remediation and $0.7 million of deferrals for actual remediation costs incurred. MGE is currently recovering in rates some of the actual costs incurred through the first quarter of 2003 and expects to recover any additional costs in our next rate case. The actual costs are amortized over four years in our rate case.

MGE has a limited number of physical and financial gas commodity contracts that are defined as derivatives under SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities. The derivative amounts recorded as a result of these gas contracts is offset with a corresponding regulatory asset or liability because these transactions are part of the PGA clause authorized by the PSCW and not subject to the gas cost incentive sharing mechanism. This regulatory liability will be returned in the first quarter of 2004.

In connection with the adoption of SFAS No. 143, companies are required to reclassify non-ARO removal costs as a regulatory liability, with an offsetting entry to accumulated depreciation. Under the current rate structure, these removal costs are being recovered as a component of depreciation expense.

Deferred charges in connection with the start-up of ATC and ongoing incremental transmission costs during 2001 and 2002 associated with ATC were deferred under SFAS No. 71. MGE recovered these costs from October 2002 through October 23, 2003. The PSCW has also allowed MGE to use escrow accounting for the incremental transmission costs for 2003. The escrow accounting allows the utility to true-up its actual costs incurred and reflect the amount of the true-up in its next rate case filing and amortized over that rate case period. A carrying cost component is calculated on the escrow balance.

Deferred charges on the interest expense of the 2027A Series relates to the incremental difference in the interest that MGE earned on its construction bond fund and the actual interest that MGE paid out. That incremental difference between interest earned and interest expensed is currently being amortized over the remaining life of the bonds as part of the rate recovery allowed by the PSCW.

In the third quarter of 2002, MGE received approval from the PSCW to establish a regulatory asset or liability for the deferral of the effects of mark-to-market accounting as required by SFAS No. 133 on contracts related to MGE's regulated operations. Management believes that it is the PSCW's intent to allow a utility to recover its actual costs embedded in the contract if the costs are deemed reasonable and prudent. MGE interpreted the PSCW's letter as requiring MGE to record a gain or loss from the application of SFAS No. 133 as either a regulatory asset or liability. As of December 31, 2003, MGE has recorded a regulatory asset of $0.3 million for the cumulative mark-to-market value of its derivative contracts, the commercial paper swap agreement, and the Columbia coal contract.

AFUDC equity represents the after-tax equity cost associated with utility plant construction and results in a temporary difference between the book and tax basis of such plant. Deferred income taxes are provided on this temporary difference in accordance with SFAS No. 109,Accounting for Income Taxes. It is probable under PSCW regulation that MGE will recover in future rates the future increase in taxes payable represented by the deferred income tax liability. The amounts will be recovered in rates over 28 years. Deferred charges (tax recovery related to AFUDC equity) represents the revenue requirement related to recovery of these future taxes payable, calculated at current statutory tax rates.

7. Joint Plant Ownership - MGE.

MGE and two other utilities jointly own Columbia, a coal-fired generating facility, which accounts for 34.9%35.0% (225 megawatts)MW) of MGE's net generating capability. Power from this facility is shared in proportion to each company's ownership interest. MGE has a 22.0% ownership interest in Columbia. The other owners are Alliant, which operates Columbia, and WPSC. MGE's share of fuel, operating, and maintenance expenses for Columbia was $27.4 million, $26.2 million, and $23.5 million for the years ended December 31, 2003, 2002, and 2001, respectively.

Information regarding MGE's sale in 2001 of its 17.8% ownership interest in Kewaunee to WPSC, MGE's obligations relative to Kewaunee continuing beyond the closing date, and MGE's exercise in 2001 of an option to buy electric capacity and energy for a two-year period from WPSC is included in Footnote 10.

Each owner provides its own financing and reflects its respective portion of facilities and operating costs in its financial statements. MGE's interest in this facility,Columbia, included in its gross utility plant in service, and the related accumulated depreciation reserves at December 31 were as follows:

Columbia
(In thousands)20022001
Utility plant$ 94,169$ 88,148
Accumulated depreciation(58,147)(55,016)
Net plant$ 36,022$ 33,132
(In thousands)
2003 2002
Utility plant$ 95,594 $ 94,169
Accumulated depreciation(60,723) (58,147)
Net plant$ 34,871 $ 36,022

Information regarding MGE's 2001 sale of its 17.8% ownership interest in Kewaunee to WPSC, MGE's obligations relative to Kewaunee continuing beyond the closing date, and MGE's 2001 exercise of an option to buy electric capacity and energy for a two-year period from WPSC is included in Footnote 18.


3.8. Statement of Cash Flows - MGE Energy and MGE.

MGE Energy and MGE considers cash equivalents to be those investments that are highly liquid with original maturity dates of less than three months.

Supplementary noncash investing items and cash paid/(received) for interest and income taxes and other noncash investing and financing items for the years ended December 31 were as follows:

(In thousands)
2003 2002 2001
Interest paid, net of amount capitalized$12,439 $12,408 $13,551
Income taxes paid18,279 17,223 10,347
Income taxes received(3,159) (759) (570)
Noncash financing item- 1,499 -
Noncash financing item (MGE Energy)46,618 - -
Noncash investing item (MGE Energy)(46,618) - -

On August 16, 2002, the Board of Directors for MGE approved a resolution to dividend the ownership of two small nonregulated subsidiaries previously owned by MGE to MGE Energy. The net assets transferred approximated $1.5 million. This transfer represented a noncash transaction.

In June 2003, MGE Power assigned its assets and liabilities to MGE Power West Campus. The assets transferred represented $46.6 million of construction work in progress related to WCCF. The liabilities represented intercompany loans to finance WCCF in the amount of $46.6 million. This transfer of assets and liabilities represented a noncash transaction.

The amortization of debt issuance costs for the years ended 2003, 2002, and 2001 are included in the line item "Other noncurrent items, net" in the cash flow statement from operating activities and is not presented in a separate line as it is immaterial.

9. Income TaxesTaxes.

a. MGE Energy Income TaxesTaxes.

MGE Energy files a consolidated federal income tax return that includes the operations of all subsidiary companies. The consolidated income tax provision before cumulative effect of a change in accounting principle (2001 only) consists of the following provision (benefit) components for the years ended December 31:

(In thousands)200220012000
Current payable: 
Federal$10,677 $ 6,634 $14,280
State4,384 1,100 3,273
Net-deferred: 
Federal4,073 6,487 (878)
State113 2,569 (196)
Amortized investment tax credits(520) (849) (727)
Total income taxes$18,727 $15,941 $15,752
(In thousands)
2003 2002 2001
Current payable: 
Federal$ 8,976 $10,677 $ 6,634
State3,366 4,384 1,100
Net-deferred: 
Federal6,874 4,073 6,487
State1,201 113 2,569
Amortized investment tax credits(516) (520) (849)
Total income taxes$19,901 $18,727 $15,941


MGE Energy's consolidated provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to income before tax provision and cumulative effect of a change in accounting principle (2001 only), as follows:

200220012000
Statutory federal income tax rate35.0%35.0%35.0%
Amortized investment tax credits(1.1)%(2.0)%(1.7)%
State income taxes, net of federal benefit5.5%5.0%5.0%
Credit for electricity from wind energy(0.9)%(0.9)%(0.9)%
Valuation allowance--(1.1)%
Other, individually insignificant0.6%(0.3)%0.2%
Effective income tax rate39.1%36.8%36.5%
2003 2002 2001
Statutory federal income tax rate35.0% 35.0% 35.0%
Amortized investment tax credits(1.0)% (1.1)% (2.0)%
State income taxes, net of federal benefit5.4% 5.5% 5.0%
Credit for electricity from wind energy(0.8)% (0.9)% (0.9)%
Other, individually insignificant0.8% 0.6% (0.3)%
Effective income tax rate39.4% 39.1% 36.8%


The significant components of deferred tax liabilities (assets) that appear on MGE Energy's Consolidated Balance Sheets and also on MGE's Balance Sheets as of December 31 are as follows:

(In thousands)20022001
Property-related$66,959 $56,988
Investment in ATC11,530 10,134
Nuclear plant decommissioning liability- 3,598
Bond transactions2,637 1,651
Energy conservation- 523
Pension expense2,798 2,703
Other2,390 2,351
Gross deferred income tax liabilities86,314 77,948
Accrued expenses(7,061) (6,478)
Retirement benefits, other than pension(2,928) (2,429)
Deferred tax regulatory account(6,557) (8,895)
Minimum pension liability adjustment(6,319) (592)
Other(1,367) (1,104)
Gross deferred income tax assets(24,232) (19,498)
Less valuation allowance368 371
Net deferred income tax assets(23,864) (19,127)
Deferred income taxes$62,450 $58,821
(In thousands)
2003 2002
Property-related$ 73,395 $ 66,959
Investment in ATC10,862 11,530
Bond transactions2,841 2,637
Pension expense1,742 2,798
Tax deductible prepayments4,275 -
Other3,276 2,390
Gross deferred income tax liabilities96,391 86,314
Accrued expenses(7,502) (7,061)
Retirement benefits, other than pension(3,909) (2,928)
Deferred tax regulatory account(5,927) (6,557)
Minimum pension liability adjustment(2,273) (6,319)
Other(1,623) (1,367)
Gross deferred income tax assets(21,234) (24,232)
Less valuation allowance368 368
Net deferred income tax assets(20,866) (23,864)
Deferred income taxes$ 75,525 $ 62,450


The valuation allowance reduces MGE Energy's deferred tax assets for state carryforward losses to estimated realizable value due to the uncertainty of future income estimates in various state tax jurisdictions.

For tax purposes, as of December 31, 2002,2003, MGE Energy had approximately $7.6 million of state tax net operating loss deductions that expire variously in 2013,2011 through 2019 if unused.

b. MGE Income TaxesTaxes.

On a separate company basis, the components of MGE's tax provision isare as follows for the years ended December 31:

(In thousands)200220012000
Current payable:
Federal$10,877$ 6,634$14,280
State3,9191,1003,273
Net-deferred:
Federal4,0736,487(878)
State1132,569(196)
Amortized investment tax credits(520) (849) (727)
Total income taxes$18,462 $15,941 $15,752
(In thousands)
2003 2002 2001
Current payable: 
Federal$ 8,747 $10,877 $ 6,634
State3,191 3,919 1,100
Net-deferred: 
Federal6,922 4,073 6,487
State1,213 113 2,569
Amortized investment tax credits(516) (520) (849)
Total income taxes$19,557 $18,462 $15,941


MGE's provision for income taxes on a separate company basis differs from the amount computed by applying the statutory federal income tax rate to income before tax provision as follows:

2002
Statutory federal income tax rate35.0%
Amortized investment tax credits(1.1)%
State income taxes, net of federal benefit4.9%
Credit for electricity from wind energy(0.9)%
Valuation allowance-
Other, individually insignificant0.5%
Effective income tax rate38.4%
2003 2002 2001
Statutory federal income tax rate35.0% 35.0% 35.0%
Amortized investment tax credits(1.0)% (1.1)% (2.0)%
State income taxes, net of federal benefit5.2% 4.9% 5.0%
Credit for electricity from wind energy(0.8)% (0.9)% (0.9)%
Other, individually insignificant0.8% 0.5% (0.3)%
Effective income tax rate39.2% 38.4% 36.8%

The significant components of deferred tax liabilities (assets) that appear on MGE's Consolidated Balance Sheets as of December 31 are as follows:

(In thousands)
2003 2002
Property-related$73,395 $66,959
Investment in ATC10,862 11,530
Bond transactions2,841 2,637
Pension expense1,742 2,798
Tax deductible prepayments4,275 -
Other3,276 2,390
Gross deferred income tax liabilities96,391 86,314
Accrued expenses(7,502) (7,061)
Retirement benefits, other than pension(3,909) (2,928)
Deferred tax regulatory account(5,927) (6,557)
Minimum pension liability adjustment(2,273) (6,319)
Other(1,542) (1,367)
Gross deferred income tax assets(21,153) (24,232)
Less valuation allowance368 368
Net deferred income tax assets(20,785) (23,864)
Deferred income taxes$75,606 $62,450


4. MGE10. Pension Plans - Pension PlansMGE
.

MGE maintains qualified and nonqualified pension plans. MGE also provides health care and life insurance benefits for its retired employees. The "Change in Benefit Obligation" table below providesMGE uses a reconciliationmeasurement date of benefit obligations, plan assets, and funded status of the plans.

The projected benefit obligation, accumulated benefit obligation, and fair value of assetsDecember 31 for pension plans and welfare plans with accumulated benefit obligations in excess of the fair value of assets are as follows:


(In thousands)

Pension Benefits
Postretirement
Benefits
As of December 31,
2002
2001
2002
2001
Projected benefit obligation$117,410$7,753NANA
Accumulated benefit obligation100,4047,198$45,639$27,504
Fair value of assets79,821-7,2927,387

During 2001, MGE's nonqualified pension plan had an accumulated benefit obligation greater than the fair value of assets and, according to SFAS 132, required additional disclosure of that plan's projected benefit obligation, accumulated benefit obligation, and fair value of assets. MGE's qualified pension plans had assets in excess of accumulated benefit obligation and therefore did not require the additional disclosure during 2001.

In 2002, MGE's nonqualified and qualified pension plans both had an accumulated benefit obligation greater than the fair value of assets and, according to SFAS 132, required additional disclosure of the projected benefit obligation, accumulated benefit obligation, and fair value of assets.

MGE has elected to recognize the costall of its transition obligation (the accumulatedpension and postretirement benefit obligation as of January 1, 1993) by amortizing it on a straight-line basis over 20 years.plans.

MGE maintains two defined contribution 401(k) benefit plans for its employees. MGE's costs of the 401(k) plans were $0.7 million in 2003, $0.6 million in 2002, $0.6 million in 2001, and $0.6 million in 2000.2001.

Sensitivitya. Benefit Obligations.

(In thousands)


Pension Benefits
 Postretirement

Benefits

Change in benefit obligation:2003 2002 2003 2002
Net benefit obligation at beginning of year$117,410 $101,593 $ 45,639 $ 27,504
Service cost3,418 2,603 1,806 1,062
Interest cost8,023 7,514 3,248 2,190
Plan participants' contributions- - 304 264
Plan amendments557 - - -
Actuarial loss7,743 9,277 5,051 15,422
Special termination benefits280 - - -
Gross benefits paid(3,970) (3,577) (1,235) (803)
Net benefit obligation at end of year$133,461 $117,410 $ 54,813 $ 45,639

The accumulated benefit obligation for the defined benefit pension plan at the end of retiree welfare results. 2003 and 2002 was $113.8 million and $100.4 million, respectively.



Pension Benefits
 Postretirement
Benefits
Weighted-average assumptions used to
determine end of year benefit obligations:


2003
 
2002
 
2003
 
2002
Discount rate6.25% 6.75% 6.25% 6.75%
Expected return on plan assets9.00% 9.00% 9.00% 9.00%
Rate of compensation increase4.50% 4.50% NA NA

Assumed health care cost trend rates at December 31:

2003 2002
Health care cost trend rate assumed for next year13% 14%
Rate to which the cost trend rate is assumed to decline
(the ultimate trend rate)

5%
 
5%
Year that the rate reaches the ultimate trend rate2012 2012

The assumed health care cost percentage was 10.0% for 2002. Assumed health care trend rates have a significant effect on the amounts reported for the health care plans. The 1% sensitivity for the "total service and interest cost components" is based on the 10% medical trend rate schedule (since the service and interest cost components disclosed correspond to the 2002 year). The health care cost trend was reset to 14% for 2003. The rate is assumed to decrease to 5% for 2012 and remain at that level thereafter. The 1% sensitivity for the "postretirement benefit obligation" is based on the 14% medical trend rate schedule since the liability disclosed is calculated as of December 31, 2002.

The following table shows how an assumed 1% increase or 1% decrease in health care cost trends could impact postretirement benefits in 2003 dollars:

(In thousands)
1% Increase 1% Decrease
Effect on postretirement benefit obligation$8,815 $(7,579)

On December 8, 2003, the "Medicare Prescription Drug, Improvement and Modernization Act of 2003" (the Act) was signed into law. The Act introduced a prescription drug benefit program under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D.

In general, accounting rules require that changes in relevant laws and government benefit programs be considered in measuring postretirement benefit costs and the Accumulated Projected Benefit Obligation (APBO). However, certain accounting issues raised by the Act--in particular, how to account for the federal subsidy--are not explicitly addressed by FASB Statement 106. In addition, significant uncertainties exist for a plan sponsor both as to the direct effects of the Act and its ancillary effects on plan participants' behavior and health care costs.

The FASB issued FASB Staff Position No. FAS 106-1,Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (FSP 106-1), that allows sponsors to elect to defer recognition of the effects of the Act.

In accordance with FSP 106-1, MGE has elected to defer recognition of the effects of the Act. Accordingly, any measurers of the APBO or net periodic postretirement benefit cost in the financial statements or the accompanying footnotes do not reflect the effects of the Act on the plan.

b. Plan Assets.

(In thousands)


Pension Benefits
 Postretirement

Benefits

Change in plan assets:2003 2002 2003 2002
Fair value of plan assets at beginning of year$ 79,821 $ 91,739 $ 7,292 $7,387
Actual return on plan assets20,883 (10,225) 1,429 (526)
Employer contributions3,494 1,884 2,152 970
Plan participants' contributions- - 304 264
Gross benefits paid(3,970) (3,577) (1,236) (803)
Fair value of plan assets at end of year$100,228 $ 79,821 $ 9,941 $7,292

The asset allocation for the MGE's pension plans at the end of 2003 and 2002, dollars.and the target allocation for 2004, by asset category, follows. The fair value of plan assets for these plans is $100.2 million and $79.8 million at the end of 2003 and 2002, respectively. The expected long-term rate of return on these plan assets was 9.0% in 2003 and 9.5% in 2002.

(In thousands)1% Increase1% Decrease
Effect on total service and interest cost components$ 607$ (497)
Effect on postretirement benefit obligation$7,573$(6,243)


c. Explanation of Long-Term Rate of Return.

MGE employs a building-block approach in determining the expected long-term rate of return for asset classes. Historical markets are studied and long-term historical relationships among asset classes are analyzed, consistent with the widely accepted capital market principle that assets with higher volatility generate a greater return over the long run. Current market factors such as interest rates and dividend yields are evaluated before long-term capital market assumptions are determined.

The expected long-term nominal rate of return for plan assets is primarily a function of expected long-term real rates of return for component asset classes and the plan's target asset allocation in conjunction with an inflation assumption. Consideration is also given to diversification, rebalancing, and active portfolio management. Peer data and historical returns are reviewed to check for reasonability and appropriateness.

Target

Allocation

 Percentage of Plan Assets at Year End
 2003 2002
Equity securities75.0% 75.8% 71.9%
Debt securities20.0% 19.4% 21.2%
Real estate5.0% 4.8% 6.9%
Other0.0% 0.0% 0.0%
Total100.0% 100.0% 100.0%

d. Investment Strategy.

MGE employs a total return investment approach whereby a mix of equities, fixed income, and real estate investments are used to maximize the expected long return of plan assets for a prudent level of risk. Risk tolerance is established through careful consideration of plan liabilities, plan-funded status, and corporate financial condition. The investment portfolio contains a diversified blend of equity, fixed income, and real estate investments. Target asset allocations are as follows: 55% United States equity, 20% non-United States equity, 20% fixed income, and 5% real estate. Investment risk is measured and monitored on an ongoing basis through periodic investment portfolio reviews and liability measurements.

e. Postretirement Benefits.

The fair value of plan assets for these postretirement benefit plans is $9.9 million and $7.3 million at the end of 2003 and 2002, respectively. The expected long-term rate of return on these plan assets was 9.0% in 2003 and 9.5% in 2002.

Of the above amounts, $7.3 million and $6.6 million, at the end of 2003 and 2002, respectively, was held in the master pension trust and is allocable to postretirement health expenses. The target asset allocation and investment strategy for the portion of assets held in the master pension trust is the same as that explained for MGE's pension plans.

The remainder of postretirement benefit assets are held either in an insurance continuance fund for the payment of retiree life benefits or a health benefit trust for payment of retiree health claims. There is no formal target asset allocation for these assets, but the intent is to seek interest income and maintain stability of principal.

f. Funded Status.

The funded status of the plans, reconciled to the amount reported on the statement of financial position, follows:



(In thousands)


Pension Benefits
 Postretirement

Benefits

 2003 2002 2003 2002
Fair value of plan assets at end of year$100,228 $ 79,821 $ 9,941 $ 7,292
Benefit obligations133,461 117,410 54,813 45,639
Funded status at end of year(33,233) (37,589) (44,872) (38,347)
Unrecognized net actuarial (gain)/loss25,364 32,925 24,904 21,809
Unrecognized prior service cost4,170 4,094 971 1,161
Unrecognized net transition obligation1,167 1,271 3,908 4,342
Net amount recognized at end of year$ (2,532) $ 701 $(15,089) $(11,035)
 
Amounts recognized in the balance sheet consist of: 
Prepaid benefit cost$ - $ - $ 67 $ 79
Accrued benefit liability(13,551) (20,583) (15,156) (11,114)
Intangible asset5,357 5,540 - -
Accumulated other comprehensive income5,662 15,744 - -
Net amount recognized at end of year$ (2,532) $ 701 $(15,089) $(11,035)

MGE reports comprehensive income in accordance with SFAS No. 130,Reporting Comprehensive Income. Comprehensive income includes the minimum pension liability adjustment, net of tax, for the pension plans and is reflected in the Consolidated Statements of Common Equity and Comprehensive Income.

(In thousands)
Pension Benefits
Postretirement
Benefits
 
2002
2001
2002
2001
Change in Benefit Obligation 
Net benefit obligation at beginning of year$101,593 $ 91,685 $ 27,504 $ 18,951
Service cost2,603 2,502 1,062 750
Interest cost7,514 7,073 2,190 1,569
Plan participants' contributions- - 264 193
Plan amendments- (125) - -
Actuarial loss9,277 3,896 15,422 7,141
Gross benefits paid(3,577) (3,438) (803) (1,100)
Net benefit obligation at end of year$117,410 $101,593 $ 45,639 $ 27,504
 
Change in Plan Assets 
Fair value of plan assets at beginning of year$ 91,739 $98,506 $ 7,387 $ 7,599
Actual return on plan assets(10,225) (4,712) (526) 147
Employer contributions1,884 1,383 970 548
Plan participants' contributions- - 264 193
Gross benefits paid(3,577) (3,438) (803) (1,100)
Fair value of plan assets at end of year$ 79,821 $91,739 $ 7,292 $ 7,387
 
Funded status at end of year$(37,589) $ (9,854) $(38,347) $(20,117)
Unrecognized net actuarial (gain)/loss32,925 5,014 21,809 5,459
Unrecognized prior service cost4,094 4,551 1,161 1,351
Unrecognized net transition obligation1,271 1,375 4,342 4,776
Net amount recognized at end of year$ 701 $ 1,086 $(11,035) $ (8,531)
 
Amounts recognized in the balance sheet consist of: 
Prepaid benefit cost$ 6,450 $ 6,100 $ 79 $ 81
Accrued benefit liability(5,749) (5,014) (11,114) (8,612)
Additional minimum liability(21,284) (2,184) - -
Intangible asset5,540 708 - -
Accumulated other comprehensive income15,744 1,476 - -
Net amount recognized at end of year$ 701 $ 1,086 $(11,035) $(8,531)


(In thousands)Pension BenefitsPostretirement Benefits
 2002 2001 2000 2002 2001 2000
Components of Net Periodic Benefit Cost 
Service cost$2,603 $2,502 $2,350 $1,062 $ 750 $ 612
Interest cost7,514 7,073 6,424 2,190 1,569 1,317
Expected return on assets(8,556) (9,217) (9,355) (687) (691) (655)
Amortization of: 
Transition obligation104 104 104 434 434 434
Prior service cost457 466 442 190 190 190
Actuarial gain/(loss)147 (166) (883) 285 4 (114)
Regulatory effect based on phase-in- - 112 - - -
Net periodic benefit cost$2,269 $ 762 $ (806) $3,474 $2,256 $1,784
 
Weighted-average Assumptions as of December 31 
Discount rate6.75% 7.25% 7.50% 6.75% 7.25% 7.50%
Expected return on plan assets9.50% 9.50% 9.50% 9.50% 9.50% 9.50%
Rate of compensation increase4.50% 4.50% 5.00% NA NA NA

The expected return onprojected benefit obligation, accumulated benefit obligation, and fair value of assets for pension plans with a projected benefit obligation in excess of plan assets was resetand pension plans and postretirement plans with an accumulated benefit obligation in excess of the fair value of assets are as follows:

(In thousands)


Pension Benefits
 Postretirement

Benefits

As of December 31,
2003 2002 2003 2002
Projected benefit obligation exceeds plan assets: 
Projected benefit obligation$133,461 $117,410 NA NA
Accumulated benefit obligation113,779 100,404 NA NA
Fair value of assets100,228 79,821 NA NA
 
Accumulated benefit obligation exceeds plan assets: 
Projected benefit obligation133,461 117,410 NA NA
Accumulated benefit obligation113,779 100,404 $54,813 $45,639
Fair value of assets100,228 79,821 9,941 7,292

g. Expected Cash Flows.

There are no required contributions, but MGE may elect discretionary deductible contributions depending upon its valuation results and cash flow from operations.

h. Net Periodic Cost.

MGE has elected to 9.0%recognize the cost of its transition obligation (the accumulated postretirement benefit obligation as of January 1, 1993) by amortizing it on a straight-line basis over 20 years.

(In thousands)
Pension Benefits Postretirement Benefits
Components of net periodic benefit cost:2003 2002 2001 2003 2002 2001
Service cost$3,418 $2,603 $2,502 $1,806 $1,062 $ 750
Interest cost8,023 7,514 7,073 3,248 2,190 1,569
Expected return on assets(7,023) (8,556) (9,217) (627) (687) (691)
Amortization of: 
Transition obligation104 104 104 434 434 434
Prior service cost480 457 466 190 190 190
Actuarial gain/(loss)1,444 147 (166) 1,155 285 4
Net periodic benefit cost$6,446 $2,269 $ 762 $6,206 $3,474 $2,256
 
Weighted-average assumptions used to
determine net periodic cost:
 
Discount rate6.75% 7.25% 7.50% 6.75% 7.25% 7.50%
Expected return on plan assets9.00% 9.50% 9.50% 9.00% 9.50% 9.50%
Rate of compensation increase4.50% 4.50% 5.00% NA NA NA

Assumed health care cost trend rates have a significant effect on the amounts reported for 2003.the health care plans. A 1% change in the assumed health care cost trend rates would have had the following effect:

(In thousands)
1% Increase 1% Decrease
Effect on total service and interest cost components$ 910 $ (785)

5. MGE -11. Fair Value of Financial Instruments - MGE Energy and MGE.

At December 31, 20022003 and 2001,2002, the carrying amount of cash, cash equivalents, and outstanding commercial paper approximates fair market value due to the short maturity of those investments and obligations. MGE's nuclear decommissioning trust is recorded at fair market value. The estimated fair market value of MGE's long-term debt and interest rate swap agreements are based on quoted market prices at December 31. The estimated fair market value of MGE's financial instruments are as follows:

200220012003 2002
(In thousands)Carrying
Amount
Fair ValueCarrying AmountFair
Value
Carrying

Amount

 Fair

Value

 Carrying

Amount

 Fair

Value

Assets: 
Cash and cash equivalents (MGE Energy)$ 2,998$ 2,998$ 2,421$ 2,421$ 2,020 $ 2,020 $ 685 $ 685
Restricted cash (MGE)3,364 3,364 2,313 2,313
Decommissioning fund (MGE)8,7828,7821,8501,855- - 8,782 8,782
Liabilities: 
Short-term debt (MGE Energy)34,29834,2989,5009,500
Long-term debt (MGE)188,500205,319173,500179,377
Short-term debt - bank loans (MGE Energy)16,180 16,180 20,798 20,798
Short-term debt - commercial paper (MGE)15,500 15,500 13,500 13,500
Long-term debt (MGE Energy)218,500 231,712 188,500 205,319
Other long-term debt swap agreements (MGE)-(411)-(404)(148) (148) (411) (411)

12. Risk Management Activities - MGE Energy and MGE.

Cash, cash equivalents, and customer accounts receivable are the financial instruments that potentially subject MGE Energy and MGE to concentrations of credit risk. MGE Energy and MGE place itstheir cash and cash equivalents with high credit-quality financial institutions. MGE has limited concentrations of credit risk from customer accounts receivable because of the large number of customers and strong economy in its service territory.

MGE has an interest rate swap agreement with a commercial bank totaling $5.0 million for 20022003 and 2001,2002 with effective interest rates of 1.7%1.1% and 4.0%1.7%, respectively. This agreement has a fixed rate and is backed by MGE's commercial paper. MGE believes the counterparties to the agreement will meet their obligations based on their high credit ratings. This swap agreement does not meet the criteria for hedge accounting due to the term of the swap being four years while the item being hedged has a 30-day maturity. Therefore, MGE records the changes in the fair market value currently in the income statement as required by SFAS No. 133 each quarter, which is offset by a corresponding regulatory asset or liability (Footnote 1j).liability.

MGE purchased and sold exchange-traded option contracts to manage the cost of gas and purchased over-the-counter financial floating-to-fixed price swaps and calls to fix the price of gas for the Winter"Winter Set-Price Firm Gas Sales ServiceService" pilot program. These contracts have terms of January, February, and March 2003.2004. Under MGE's natural gas risk management program, approved by the PSCW, the cost of the financial option and swap contracts (as well as the gains or losses realized) will be recovered under the PGA and will not affect net income. The fair value of these financial contracts was an asset of $0.5$0.7 million on the balance sheet at December 31, 2002.2003.

Nonperformance of counterparties to the nonexchange-traded derivatives could expose MGE to credit loss. However, MGE enters into transactions only with companies that meet or exceed strict credit guidelines.

MGE considers it has minimal risk for counter-party default.a 22.0% ownership interest in Columbia, which is operated by Alliant. Alliant has entered into a long-term coal supply agreement with Dynegy Marketing and Trade. The contract contains certain put options, and consequently, in accordance with the terms of SFAS No. 133, the contract is recorded at fair value on the balance sheet. Gains and losses are recorded in other income with an offsetting entry to a corresponding regulatory asset or liability.

6.13. Capitalization MattersMatters.

a. Common Stock -MGE Energy.

On August 15, 2003, MGE Energy - Common Stock

Effective in August 2002,entered into a Distribution Agreement (Agreement) with Banc One Capital Markets, Inc. Under the terms of this Agreement, MGE Energy assumedmay offer and sell up to 1,600,000 shares of its common stock from time to time through Banc One as its sales agent or to Banc One as principal. The sales will be made pursuant to a shelf registration statement MGE Energy filed with the responsibilitySEC in March 2003 and which has been declared effective.

Under the Agreement, MGE Energy sold 165,000 shares of its common stock as of December 31, 2003, for net proceeds of $5.1 million. The proceeds from the issuance of common stock were used to pay for capital expenditures related to WCCF and for other general corporate purposes.

MGE Energy also issues new shares of its common stock through its Dividend Reinvestment and Direct Stock Purchase Plan (the Plan). Through December 31, 2003, MGE Energy issues new shares for the Plan. Issuing new shares rather than buying shares on the open market helps improve cash flow and strengthens MGE Energy's capital structure.

In 2002, a total of 503,000issued 604,000 new shares of common stock were issued under the Plan.Plan for net proceeds of $18.7 million. The $13.6 million in proceeds were allocated to common stock and amounts received in excess of par value (see Consolidated Statements of Common Equity and Comprehensive Income).

In 2001, a total of 453,000 new sharesfrom the issuance of common stock for the Plan were issued under the Plan. The $10.9 million proceeds were allocatedcontributed to common stockMGE for its capital expenditures and amounts received in excess of par value (see Consolidated Statements of Common Equity and Comprehensive Income).to strengthen its capital structure.

At December 31, 2002, MGE Energy had $73.0 million of retained earnings available for dividends. However, MGE is restricted by the PSCW to paying normal common stock dividends when its common equity falls below 55%.

b. MGEPreferred Stock - Preferred StockMGE.

MGE has 1,175,000 shares of $25 par value redeemable preferred stock cumulative,(cumulative) that is authorized but unissued at December 31, 2002.2003.

c. MGE - First Mortgage Bonds and Other Long-termLong-Term Debt - MGE.

MGE's utility plant is subject to the lien of its First Mortgage Bonds.

MGE has the following call provisions for the First Mortgage Bonds:

Bond SeriesFirst Call DateCall Price
7.70%, 2028 SeriesFebruary 15, 2003104.26%


MGE's outstanding First Mortgage Bonds contain certain debt covenant restrictions with respect to dividends. The covenant restricts the payment of dividends or any other distribution or purchase of shares to the existing earned surplus (retained earnings) on MGE common stock. As of December 31, 2002,2003, MGE's earned surplus exceeded all such payments for all years covered under this report.

On April 4, 2002, MGE issued two unsecured taxable debt issues: a $15 million, 6.58% Medium Term Note maturing on April 1, 2012, and a $25 million, 7.12% Medium Term Note maturing on April 1, 2032. Interest on these notes will be paid semiannually on April 1 and October 1. The proceeds from these issues were used to redeem the $40 million, 8.50%, 2022 Series, First Mortgage Bonds on April 15, 2002. The call premium on this bond was $1.7 million and is recoverable through rates.

On April 25, 2002, MGE issued two unsecured tax-exempt debt issues. The $28 million, 5.875%, Industrial Development Revenue Bonds (IRB) mature on October 1, 2034, and the $19.3 million, 4.875%, IRBs mature on October 1, 2027. The $19.3 million issue has a ten-year mandatory call on October 1, 2012. Interest on these notes will be paid semiannually on April 1 and October 1. The proceeds from these two issues were used to redeem the $28 million, 6.75%, 2027A Series, IRBs and the $19.3 million, 6.70%, 2027B Series, IRBs on May 28, 2002. The IRBs were issued by the City of Madison for the benefit of MGE. The call premiums associated with these bonds was $0.9 million and is recoverable through rates.

On October 1, 2002, MGE issued $20.0 million in unsecured Medium Term Notes at 5.26%, maturing on September 29, 2017. Interest on the notes will be paid semiannually on April 1 and October 1. The proceeds from this issuance were used to repay outstanding commercial paper. MGE used the proceeds from the commercial paper issuances to repay a portion of its $20.0 million variable rate debt, which matured on May 3, 2002.

On November 27, 2002, MGE issued $15.0 million in unsecured variable rate Medium Term Notes, maturing on November 26, 2004. Interest on the notes will be paid quarterly on the third Wednesday of March, June, September, and December. The variable rate, based on the three-month London Interbank Offering Rate (LIBOR) plus 12.5 basis point, was 1.535%1.295% as of December 31, 2002.2003.

On September 9, 2003, MGE issued $20 million in unsecured 6.12% Medium Term Notes maturing on September 1, 2028. Interest on these notes will be paid semiannually on March 1 and September 1 of each year. The proceeds from this issuanceissue were used to repay outstanding commercial paper.redeem $20 million, 7.70%, 2028 Series, First Mortgage Bonds, on September 30, 2003. The call premium for the redeemed bonds was $0.9 million and is recoverable through rates.

The indenture under which the Medium Term Notes were issued provides that they will be entitled to be equally and ratably secured in the event that MGE used the proceeds from the commercial paper issuances to finance capital expenditures including the installation of an automated meter reading system.issues any additional First Mortgage Bonds.

Below is MGE's aggregate maturities for all long-term debt for years following the December 31, 2002,2003, balance sheet.

In thousands
YearAmount
2003$ -
(In thousands)(In thousands)
Amount
200420,000$ 20,000
2005--
2006--
200715,00015,000
200830,000
Future years158,500158,500
Total$193,500
Total*$223,500

*Includes $30 million maturity for MGE Power West Campus, which is consolidated with MGE's debt in accordance with FIN No. 46-R (see Footnote 2).


d. Long-Term Debt.

On September 30, 2003, MGE Energy, through MGE Power West Campus, issued $30.0 million of 5.68% senior secured notes maturing September 25, 2033, in a private placement offering. Interest only will be paid monthly for the first ten years and then principal and interest payments will be paid monthly for the remaining life of the debt. The proceeds from these notes were used to pay off a portion of MGE -Energy's bank loans, which provided temporary financing of capital expenditures for the WCCF.

The debt is subject to a collateral assignment of lease payments that MGE will be making to MGE Power West Campus for use of the cogeneration facility. Until the facility is operational, MGE Energy will guarantee the debt.

14. Notes Payable to Banks, Commercial Paper and Lines of Credit - MGE Energy and MGE.

For short-term borrowings, MGE generally issues commercial paper (issued at the prevailing discount rate at the time of issuance), which is supported by unused bank lines of credit. Through negotiations with three banks, MGE has $40$40.0 million in bank lines of credit.

MGE Energy has established two temporary linesa $60.0 million bank line of credit onewith a commercial bank. The line of credit will be used for temporary financing of the capital commitments for the West Campus Cogeneration Facility (WCCF) ($40 million)WCCF and one for general corporate purposes ($5 million).purposes.

Information concerning short-term borrowings for the past three years is shown below:

(In thousands)
2002
2001
2000
MGE 
As of December 31: 
Available lines of credit$40,000$40,000$55,000
Commercial paper outstanding$13,500$9,500$44,000
Weighted-average interest rate1.40%2.11%6.73%
During the year: 
Maximum short-term borrowings$33,500$44,000$44,000
Average short-term borrowings$14,359$12,803$17,117
Weighted-average interest rate1.82%5.27%6.58%
 
MGE Energy 
As of December 31: 
Available lines of credit$45,000--
Short-term debt outstanding$34,298--
Weighted-average interest rate2.09%--
During the year: 
Maximum short-term borrowings$34,298--
Average short-term borrowings$14,613--
Weighted-average interest rate1.83%--
(In thousands)
2003 2002 2001
MGE 
As of December 31: 
Available lines of credit$40,000 $40,000 $40,000
Commercial paper outstanding$15,500 $13,500 $9,500
Weighted-average interest rate1.21% 1.40% 2.11%
During the year: 
Maximum short-term borrowings$15,500 $33,500 $44,000
Average short-term borrowings$2,162 $14,359 $12,803
Weighted-average interest rate1.29% 1.82% 5.27%
 
MGE Energy 
As of December 31: 
Available lines of credit$60,000 $45,000 -
Short-term debt outstanding$31,680 $34,298 -
Weighted-average interest rate1.73% 2.09% -
During the year: 
Maximum short-term borrowings$54,605 $34,298 -
Average short-term borrowings$36,681 $14,613 -
Weighted-average interest rate1.99% 1.83% -


7.15. Rate Matters - MGE.

Under the fuel rules, if electric fuel costs are outside a 3.0% annual threshold set by the PSCW, MGE - Rate Matterscan apply for a fuel surcharge or may be required to return a fuel credit to its customers. MGE is allowed to retain fuel savings within 3% under and must bear fuel costs within 3% over the level set in its most recent order. On July 28, 2003, MGE submitted an application to the PSCW for decreasing electric rates as required under the fuel rules monitoring mechanism. The PSCW on August 14, 2003, reopened MGE's rate case docket to examine fuel costs and how to appropriately credit ratepayers. The PSCW approved an interim fuel cost credit of $.00099 per kWh. The PSCW also required a full review of the actual and forecasted costs for 2003 with MGE's fuel rates subject to refund. The fuel credit through December 31, 2003, totaled $4.0 million, of which $1.2 million represents the interim fuel credit and $2.8 million is the estimate for the additional fuel credit to be refunded to customers.

On January 14, 2004, the PSCW authorized MGE to increase revenues by $12.8 million. The increase covers rising fuel costs for electric generation and addresses increased system demands for both gas and electric.

Effective March 1, 2003, the PSCW authorized MGE to increase revenues by $27.1 million (a 9.1% increase in electric rates and a 5.4% increase in gas rates).million. The increase in electric rates coverscovered rising fuel costs and addressesaddressed increased system demands. Both the electricdemands and natural gas rate increases include costs to complete a new automated meter reading project, costs of system upgrades, and increased operating expenses. The PSCW authorized MGE a 12.3% return on its common shareholders equity.AMR project.

Effective October 24, 2002, the PSCW authorized an electric rate surcharge of $4.5 million or 2% to recover deferred costs that had been deferred, associated with the formation offorming ATC and ongoing incremental transmission costs during 2001 and 2002 associated with ATC.2002. The surcharge will bewas in effect for a twelve-month period ending October 23, 2003 (see Footnote 917 for additional information on ATC).

In July 2002, MGE notified the PSCW that MGE'sits electric fuel costs were below the 3% range established in its most recent order, thus triggering a fuel credit to its customers. The fuel credit was $1.2 million through December 31, 2002. The fuel credit continued through February 28, 2003.

Effective January 1, 2002, the PSCW authorized MGE to increase revenues by $12 million (a 5.7% increase in electric rates and a 0.6% increase in natural gas rates).million. The increase was associated with a limited reopener to address specific issues affecting 2002. These issues included the full-year impact of selling its ownership interest in Kewaunee, Nuclear Power Plant (Kewaunee), rising fuel costs, and installing an automated meter readingAMR system.

The PSCW approved MGE's request for a temporary electric fuel surcharge of 2.7% effective May 9 through September 2, 2001. The temporary rate increase covered the higher cost of natural gas used to generate electricity. Revenues collected from this surcharge were subject to refund, pending the PSCW's review of any excess revenues collected by MGE while the surcharge was in effect. The increase to revenue as a result of the surcharge, net of refunds to customers, was $1.0 million.16. Commitments.

In January 2001, the PSCW authorized an electric rate increase of $7.5 million or 3.9% to cover rising fuel costs and increased system demands; a natural gas rate increase of $3.4 million or 2.7% for improving the gas delivery system; and a return on common stock equity of 12.9%.

8. MGE Energy and MGE - Commitments

a. Coal Contracts - MGE.

MGE has no coal contracts that contain demand obligations for its Blount plant. Fuel procurement for MGE's jointly owned Columbia plant is handled by Alliant, the operating company. If any demand obligations must be paid under these contracts, management believes these obligations would be considered costs of service and recoverable in rates.

b. Purchased Power Contracts - MGE.

MGE has several purchased power contracts to help meet future electric supply requirements. As of December 31, 2002,2003, MGE's total commitments for energy and purchased power contracts for capacity are estimated to be $18.4 million in 2003, $12.1$14.8 million in 2004, $10.9$13.4 million in 2005, $10.0$13.5 million in 2006, and $9.5$10.5 million in 2007.2007, and $9.0 million in 2008. Management expects to recover these costs in future customer rates.

Related to the purchased power contracts, MGE has negotiated firm transmission contracts with Commonwealth Edison and Dairyland Power Cooperative, which are estimated to be $1.8 million for 2004, $1.1 million for the years 2003 throughin 2005 and 2006, and $0.8 million in 2007.2007, and $0.6 million in 2008. Management also expects to recover these costs in future customer rates.

c. Natural Gas Transportation and Storage Contracts - MGE.

MGE hasMGE's natural gas supply, transportation, and storage contracts that providerequire fixed monthly payments for the availability of firm supply pipeline transportation and storage capacity under which it must make fixed monthly payments.capacity. The pricing componentcomponents of the fixed monthly paymentpayments for thesethe transportation and storage contracts isare established by FERC but may be subject to change by the FERC.change. These payments are estimated to be $14.4 million in 2003, $12.1$15.0 million in 2004, $9.6$14.0 million in 2005, $14.3 million in 2006, $14.2 million in 2007, and 2007.$14.0 million in 2008. Management expects to recover these costs in future customer rates.

In December 2002, MGE entered into an agreement with ANR Pipeline Company to contract for additional firm pipeline transportation capacity related to ANR's proposed WestLeg Expansion. This agreement hasd. Environmental - MGE.

As a number of conditions including, but not limited to, receipt and acceptance by both parties of all regulatory approvals and constructionresult of the pipeline.Blount 69-kV transmission substation expansion, coal tar-contaminated soil and debris within the excavation zone are being removed and disposed of in accordance with a DNR approved "Removal Action Work Plan." MGE also has the right to delay or cancelrecorded a portion of the additional transportation capacity if the PSCW has not issued a Certificate of Public Convenience and Necessity (CPCN)$1 million liability for the WCCF by July 1, 2003, that is acceptable to it.

On January 16, 2003, MGE entered intocleanup of this site with an agreement with Northern Natural Gas Company to amend and extend two existing firm pipeline transportation capacity contracts through October 31, 2011, subject to approval by the PSCW. If these two contracts are amended and extended, estimated fixed monthly payments for natural gas transportation and storage contracts are expected to be $0.3 million higher in 2003, $1.8 million higher in 2004, and $3.7 million higher in 2005, 2006, and 2007. Management expects it would be ableoffsetting regulatory asset (deferred charge). We expect to recover thesecleanup costs in future customer rates.

Environmental

On January 1, 2000, Phase II of the 1990 Federal Clean Air Act amendments took effect, setting new emission limits for sulfur dioxide (SO2) and NOx. MGE's generating units meet those limits. The units were modified well in advance to meet year 2000 NOx requirements. Early modifications at Blount allow MGE to postpone meeting more stringent Phase II NOx requirements at this plant until 2007.

On October 27, 1998, the EPA issued final rules requiring more NOx emission reductions from sources in 22 states and the District of Columbia, including Wisconsin, to reduce the transport of ozone across state boundaries. However, a successful legal challenge resulted in excluding Wisconsin from part of this rule. After further modeling and research, the EPA is expected to revise or amend these rules to impose additional NOx emission reduction requirements on Wisconsin sources in order to help other states meet ambient standards.

MGE is evaluating NOx compliance strategies, including fuel switching, emissions trading, purchased power agreements, new emission control devices, and/or installation of new fuel-burning and clean-coal technologies. Implementing any of these new measures would likely increase capital, operating, and maintenance expenditures.

Wisconsin's acid rain law imposes limitations on SO2 emissions. Blount and MGE's share of Columbia are required to meet a combined SO2 emission rate of 1.20 pounds of SO2 per million Btu. MGE does not anticipate any capital expenditure in order to comply with this standard.

In December 2000, the EPA announced it would create rules to limit the amount of mercury emitted by coal- and oil-fired electric-steam generating facilities. EPA plans to have the proposed rules published no later than December 15, 2003, and final regulations published no later than December 15, 2004. The Wisconsin Department of Natural Resources is also developing rules to limit mercury emissions from coal-fired boilers. The proposed rules require sources emitting mercury to reduce emissions over 15 years. Depending on the outcomes of these regulations, they may require MGE to evaluate emission control options for its facilities in order to comply. These controls would likely increase capital expenditures and operating and maintenance expenses.

In December 2000, February 2001, June 2002, and January 2003, Columbia received Requests for Information from the EPA to evaluate compliance Carrying costs associated with the Clean Air Act. Alliant, the plant operator, has responded to these requests and hascleanup expenditures will not yet received a response from the EPA. On a broader basis, the EPA is assessing the regulatory consequences of past investments in utility generation, energy efficiency, maintenance, and environmental protection. EPA is also assessing proposed multi-pollutant legislation. The EPA will be recommending clarifications and revisions to these regulatory programs in the future. The plant operator has not informed MGE of any likely increase in capital expenditures or operating and maintenance expenses arising from the EPA's inquiry.recoverable.

MGE is listed as a potentially responsible party for a site the EPA has placed on the national priorities Superfund list. The Lenz Oil site in Lemont, Illinois, was used for storing and processing waste oil for several years. This site requires clean up under the Comprehensive Environmental Response, Compensation and Liability Act. A group of companies, including MGE, is currently working on cleaning up the site.

Management believes that its share of the Lenz Oil site final cleanup costs will not result in any materially adverse effects on MGE's operations, cash flows, or financial position. Insurance may cover a portion of the cleanup costs. Management believes that the cleanup costs not covered by insurance will be recovered in current and future rates. MGE estimates its future expense to clean up this site could range from $0.1 million to $0.2 million. At December 31, 2002,2003, MGE accrued a $0.1 million liability for these matters.this matter.

e. Chattel Paper Agreement - MGE.

MGE makes available to qualifying customers a financing program for the purchase and installation of energy-related equipment that will provide more efficient use of utility service at the customer's property. MGE is party to a chattel paper purchase agreement with a financial institution under which it can sell or finance an undivided interest with recourse, in up to $7.5 million of the financing program receivables, until February 28, 2005. At December 31, 2003 and 2002, respectively, MGE had sold a $6.1 million and $6.8 million interest in these receivables, which MGE accounted for as a sale under SFAS No. 140,Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities - a Replacement of FASB Statement No. 125. MGE retains the servicing responsibility for these receivables.

MGE maintains responsibility for collecting and remitting loan payments from customers to the financial institution and does not retain any interest in the assets sold to the financial institution. As of December 31, 2003 and 2002, MGE has recorded a servicing asset of $0.3 million and $0.2 million, respectively. In 2003 and 2002, gains of $0.1 million and $0.2 million, respectively, were recognized in connection with the sale of loan assets. In 2001, no gain or loss was recognized. The servicing asset recognized and the amount amortized in 2003 totaled $0.1 million. The loan assets are sold to the financial institution at cost, which approximates fair value in view of their market rates of interest. During 2003 and 2002, MGE received approximately $1.3 million and $3.3 million, respectively, from the financial institution for the sale of loan assets. During those same years, payments of $1.6 million and $2.4 million, respectively, were made by MGE to the financial institution.

MGE would be required to perform under the guarantee if the customer defaulted on their loan. The energy-related equipment installed at the customer sites is used to secure the customer loans. The length of the MGE guarantee to the financial institution varies from one to ten years depending on the term of the customer loan. Principal payments for the next five years on the loans are $0.9 million in 2004 and 2005 and $0.8 million in 2006, 2007, and 2008.

f. WCCF Purchase Commitments - MGE Energy.

MGE has entered into various contracts for the purchase of gas and steam turbines and miscellaneous equipment for the WCCF. Most of these contracts have been assigned or are in the process of being assigned to MGE Construct. MGE Construct has entered into a contract for the purchase of chiller equipment. All of these contracts are summarized in the following table.

(In thousands)


Contract Total
 Payments through

December 31, 2003

 Remaining

Contract Amounts

Gas turbines$30,190 $29,797 $ 393
Steam turbine7,805 7,805 -
Heat-recovery steam generators11,993 11,993 -
Chiller equipment6,689 1,876 4,813
Project management8,400 4,083 4,317
Miscellaneous equipment23,901 8,490 15,411
Total$88,978 $64,044 $24,934

g. Leases - MGE.

Future minimum rental payments at December 31, 2003, under agreements classified as operating leases with noncancellable terms in excess of one year are as follows:

(In thousands) 
2004$1,379
20051,023
2006751
2007595
2008524
Thereafter4,668
Total minimum future lease payments$8,940

Rental expense under operating leases totaled $1.5 million for 2003 and $1.6 million for 2002 and 2001.

17. ATC - MGE.

On January 1, 2001, MGE transferred substantially all of its electric transmission facilities to ATC in exchange for approximately a 5% interest in this joint venture. ATC is comprised of Wisconsin investor-owned utilities and some Wisconsin municipal utilities, cooperatives, and power-supply agencies.

MGE has a seat on the Board of Directors of ATC and has a 20% ownership interest in ATC Management, Inc. Due to MGE's ability to exercise significant control over management activities, MGE has accounted for this investment under the equity method of accounting. MGE records as equity in earnings of the investee its share of ATC's earnings, amortization of the SFAS No. 109 regulatory liability, and deferred investment tax credits related to the transmission assets transferred to ATC. MGE recorded equity earnings from its investment in ATC of $3.7 million (pretax) in 2003 and $3.3 million (pretax) both in 2002 and 2001. MGE recorded transmission expenses from ATC of $13.5 million in 2003, $7.5 million in 2002, and $7.3 million in 2001.

The PSCW authorized an electric rate surcharge of $4.5 million, or 2%, over a twelve-month period ended October 23, 2003, for MGE to recover deferred costs associated with the ATC formation and ongoing incremental transmission costs during 2001 and 2002.

On November 21, 2002, MGE and ATC entered into an interconnection agreement related to transmission system upgrades for WCCF. MGE issued to the ATC a "Notice to Proceed for the Procurement of the Equipment" for the system upgrades. MGE has advanced funds for construction to ATC for transmission equipment related to WCCF in the amounts of $9.2 million and $1.3 million in 2003 and 2002, respectively. MGE expects to advance an additional $0.8 million in 2004. MGE will be reimbursed by ATC upon completion of the project.

18. Kewaunee Sale - MGE.

MGE sold to WPSC its 17.8% ownership interest in Kewaunee in September 2001. In exchange for a cash payment of $15.4 million, MGE transferred its net book value of utility plant ($8.2 million), net nuclear fuel ($7.9 million), inventories ($1.5 million), and other assets ($0.1 million). These assets were offset by $2.3 million owed to WPSC. On the closing date, MGE also transferred its qualified decommissioning fund ($65.0 million, fair market value) and nonqualified decommissioning fund ($28.1 million, fair market value), which decreased accumulated depreciation by an equal amount.

MGE made monthly contributions of approximately $0.7 million (the level authorized by the PSCW) to the MGE nonqualified decommissioning fund from September 23, 2001, through December 31, 2002. These costs were recovered from customers in rates. MGE's decommissioning liability is limited to the fund balances at the closing date plus all decommissioning collections through 2002. MGE's nonqualified decommissioning fund is shown on the balance sheet in the Utility Plant section. Under the Kewaunee sale agreement, MGE was obligated to continue collecting decommissioning costs from its customers during 2002 and to remit those amounts, net of trust investment expenses and taxes on investment income, to the WPSC nonqualified decommissioning fund, which it did on January 3, 2003. MGE has no further obligation with respect to the decommissioning of Kewaunee except as described in the next paragraph with respect to spent nuclear fuel.

The federal government is responsible for the disposition and storage of spent nuclear fuel. Federal legislation is being considered to establish an interim storage facility. Spent nuclear fuel is currently stored at Kewaunee. Minor plant modifications to the spent fuel pools in 2001 should ensure Kewaunee has sufficient fuel storage capacity until the end of its licensed life in 2013. MGE retained its spent fuel obligations for all fuel burned at Kewaunee for MGE's share of the generation from the opening of the plant to the closing date. WPSC took title to such fuel at the closing date.

A surcharge imposed by the National Energy Policy Act of 1992 requires nuclear power companies to fund the decontamination and decommissioning of U.S. Department of Energy facilities that process nuclear fuel. As a result, the Kewaunee co-owners are required to pay a surcharge on uranium enrichment services purchased from the federal government prior to October 23, 1992. On an inflation-adjusted basis, MGE's portion of the obligation related to Kewaunee is approximately $0.8 million at December 31, 2003. MGE is required to continue paying its portion of this annual assessment.

As allowed under the Kewaunee sale agreement, MGE exercised an option to purchase 90 MW of electric capacity and energy at a fixed price from September 24, 2001, through September 23, 2003, to help meet customers' electric needs.

9. WCCF.

MGE Energy, through MGE Power, MGE Power West Campus, and MGE Construct, is building a natural gas-fired cogeneration facility on the UW-Madison campus. As planned, the facility will have capacity to produce 20,000 tons of chilled water, 500,000 pounds per hour of steam, and approximately 150 MW of electricity. The facility will be jointly owned by the UW and MGE Power West Campus. The UW will own a controlling interest in the chilled-water and steam plants, which will be used to meet the growing needs for air-conditioning and steam-heat capacity for the UW-Madison campus. MGE Power West Campus will own a controlling interest in the electric generation plant, which will be used to provide electricity to MGE's customers. MGE will lease the assets owned by MGE Power West Campus and will operate the entire facility. MGE Construct will be responsible for the construction of the facility. A PSCW order approving the issuance of a CPCN for the WCCF was received on October 9, 2003. The ownership, construction, and operation of the facility has received various other state approvals, and the parties have entered into definitive agreements including a construction agreement. Construction on the project commenced in October of 2003, and it is estimated that the project will be completed by the spring of 2005. In 2003, MGE Construct received a service fee of $1.0 million (pretax) from the State in relation to its role as EPC contractor for WCCF. The total fee of $5.0 million will be recognized as services are rendered and will be collected over a 22-month period.

MGE Energy, MGE Power West Campus, and MGE Construct have assumed certain risks related to some of the executed agreements. In the EPC Agreement, MGE Power West Campus is responsible for cost overruns and MGE Construct is responsible for the construction process of the entire facility, including paying liquidated damages relating to failure to achieve the Mechanical Completion Date Guarantee and/or the Acceptance Test Capacity Guarantee. MGE Energy is the guarantor of MGE Construct's obligations under the EPC Agreement.

The expected cost to construct WCCF is approximately $180 million in total, of which $103 million is MGE Power West Campus' estimated portion. On November 20, 2003, the State paid $19.4 million to MGE Construct for its share of the costs incurred since its last payment in November of 2002. MGE Construct is now billing the State monthly for its share of the cost of WCCF in accordance with the EPC Agreement. As of December 31, 2003, MGE Power West Campus had incurred $48.6 million of costs on the project, which is reflected in construction work in progress on MGE Energy's consolidated balance sheets. These costs largely represent amounts paid under long lead-time equipment contracts in order to meet project schedules.

20. Adoption of Accounting Principles and Recently Issued Accounting Pronouncements -MGE Energy and MGE.

a. SFAS No. 143.

In 2001, FASB issued SFAS No. 143,Accounting for Asset Retirement Obligations. SFAS No. 143 provides accounting requirements for retirement obligations associated with tangible long-lived assets. MGE Energy and MGE were required to adopt SFAS No. 143 as of January 1, 2003. Retirement obligations associated with long-lived assets included within the scope of SFAS No. 143 are those for which there is a legal obligation under existing or enacted law, statute, written or oral contract, or by legal construction under the doctrine of promissory estoppel.

Effective January 1, 2003, MGE recorded an obligation for the fair value of its legal liability for asset retirement obligations associated with removing an electric substation, a combustion turbine generating unit, wind generating facilities, and the photovoltaic generating facilities, all of which are located on property not owned by MGE and would be removed upon the ultimate end of the lease. At December 31, 2003, this liability is estimated at $1.4 million and is included in other deferred liabilities.

At the point the liability for asset retirement is incurred, SFAS No. 143 requires capitalization of the costs to the related asset, property, plant, and equipment, net. For asset retirement obligations existing at the time of adoption, the statement requires capitalization of costs at the level that existed at the point of incurring the liability. These capitalized costs are depreciated over the same period as the related property. At the date of adoption, the depreciation expense for past periods was recorded as a regulatory asset in accordance with SFAS No. 71 because MGE believes the PSCW will allow it to recover these costs in future rates. Current depreciation of the asset retirement cost is also being deferred as a regulatory asset under SFAS No. 71.

The initial liability is accreted to its present value each period. MGE defers this accretion as a regulatory asset based on its determination that these costs can be collected from customers. MGE also may have asset retirement obligations relating to various assets, such as combustion turbine generating units, small distributed generating units, aboveground and underground storage tanks, facilities located at Columbia (co-owned with Alliant and WPSC), and certain electric and gas distribution facilities. These facilities are generally located on property owned by third parties, on which MGE is permitted to operate by lease, permit, easement, license, or service agreement, but also include some facilities located on property owned by MGE. The asset retirement obligations associated with these facilities cannot be reasonably determined due to the indeterminate life of the related assets.

The pro forma asset retirement obligation MGE would have recognized as of January 1, 2002, had MGE implemented SFAS No. 143 as of that date, was approximately $1.2 million based on the information, assumptions, and interest rates as of January 1, 2003, used to determine the $1.4 million liability recognized upon initial adoption of SFAS No. 143. Because MGE's regulators are allowing these costs to be recovered in future rates, adoption of SFAS No. 143 in the first quarter of 2002 would have had no impact on net income and earnings per share of common stock. Accordingly, pro forma impacts are not presented.

The following table shows costs as of January 1, 2003, and changes to the asset retirement obligation and accumulated depreciation during the twelve months ended December 31, 2003.



(In thousands)
(a)

Original Asset
Retirement
Obligation

 (b)

Accumulated
Accretion

 (c)
(a + b)
Asset
Retirement
Obligation
 (d)

Accumulated
Depreciation-
Related Asset

Balance, Jan. 1, 2003 (date of adoption)$685 $596 $1,281 $148
Changes through Dec. 31, 20031 79 80 27
Balance, Dec. 31, 2003$686 $675 $1,361 $175

As of December 31, 2003, MGE's regulatory asset, included in deferred charges, is the total accumulated accretion ($675,000) and accumulated depreciation ($175,000) or $850,000.

MGE made a significant reclassification related to the reporting of accumulated costs of removal that are non-SFAS No. 143 obligations. The reclass removed the costs from accumulated depreciation and recorded them as regulatory liability.

b. SFAS No. 146.

In June 2002, the FASB issued SFAS No. 146,Accounting for Costs Associated with Exit or Disposal Activities. This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF 94-3,Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 is effective for transactions initiated after December 31, 2002. Adoption of this statement did not have a material impact on the consolidated financial statements.

c. SFAS No. 148.

In December 2002, the FASB issued SFAS No. 148,Accounting for Stock-Based Compensation-Transition and Disclosure. This statement amends FASB Statement No. 123,Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based employee compensation. In addition, the statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. MGE Energy has no stock options as of December 31, 2003, and therefore SFAS No. 148 did not have a material impact on the consolidated financial statements.

d. SFAS No. 149.

On April 30, 2003, the FASB issued SFAS No. 149,Amendment of SFAS No. 133 on Derivative Instruments and Hedging Activities. This statement amends and clarifies accounting for derivative instruments including certain derivative instruments embedded in other contracts for hedging activities. SFAS No. 149 amends certain other existing pronouncements. The amendments will result in a more consistent reporting of contracts that are derivatives in their entirety or that contain embedded derivatives that warrant separate accounting. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. Adoption of this statement did not have a material impact on the consolidated financial statements.

e. SFAS No. 150.

In May 2003, the FASB issued SFAS No. 150,Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within the scope of SFAS No. 150 as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS No. 150 is effective for interim periods beginning after June 15, 2003, for financial instruments entered into or modified after May 31, 2003, except for mandatorily redeemable financial instruments of nonpublic entities which will be effective for interim periods beginning after December 15, 2003. Adoption of this statement did not have a material impact on the consolidated financial statements.

f. SFAS No. 132.

In December 2003, the FASB issued an amended SFAS No. 132,Employers' Disclosures about Pensions and Other Postretirement Benefits. This revised statement requires additional disclosures to those in the original SFAS No. 132 about the plan assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans.

g. FIN No. 45.

In November 2002, the FASB issued FIN No. 45,Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. This interpretation provides the disclosures to be made by a guarantor in interim and annual financial statements about obligations under certain guarantees. The interpretation also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation.

MGE makes available to qualifying customers a financing program for the purchase and installation of energy-related equipment that will provide more efficient use of utility service at the customer's property. MGE is party to a chattel paper purchase agreement with a financial institution under which it can sell or finance an undivided interest with recourse, in up to $7.5 million of the financing program receivables, until February 28, 2004. At December 31, 2002 and 2001, respectively, MGE had sold a $6.8Loans totaling $1.1 million and $5.6 million interest in these receivables, which MGE accounted for as a sale under SFAS No. 140,Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities - a Replacement of FASB Statement No. 125.

MGE maintains responsibility for collecting and remitting loan payments from customers to the financial institution and does not retain any interest in the assets sold to the financial institution. As of December 31, 2002, MGE has recorded a servicing asset of $0.2 million. In 2002, a gain of $0.2 million was recognized in connection with sale of loan assets. In 2001, no gain or loss was recognized. The loan assets arehave been sold to the financial institution at cost, which approximatesduring 2003. The liability for the fair value in view of their market rates of interest. During 2002 and 2001, MGE received approximately $3.3 million and $2.2 million, respectively, of cash from the financial institution for the sale of loan assets. During those same years, payments of $2.4 million and $2.0 million, respectively, were made by MGE to the financial institution.obligation associated with these loans is not material.

MGE would be required to perform under the guarantee if the customer defaulted on theirits loan. The energy-related equipment installed at the customer sites is used to secure the customer loans. The length of the MGE guarantee to the financial institution varies from 1one to 10ten years depending on the term of the customer loan. Principal payments for the next five years on the loans are as follows: $1.1 million in 2003, $0.9 million in 2004 and 2005 and $0.8 million in 20052006, 2007, and 2006,2008.

h. FIN No. 46.

In January 2003, the FASB issued FIN No. 46,Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51." In December 2003, the FASB issued the updated and $0.7 millionfinal interpretation FIN No. 46-R. FIN No. 46-R requires that an equity investor in 2007.a VIE have significant equity at risk (generally a minimum of 10%, which is an increase from 3% required under the previous guidance) and hold a controlling interest, evidenced by voting rights, and absorb a majority of the entity's expected losses, receive a majority of the entity's expected returns, or both. If the equity investor is unable to evidence these characteristics, the entity that retains these ownership characteristics will be required to consolidate the VIE as the primary beneficiary. FIN No. 46 was applicable immediately to VIEs created or obtained after January 31, 2003. FIN No. 46-R was effective on December 31, 2003, for interests in entities that were previously considered special purpose entities under then existing authoritative guidance.

New Generation

On February 23, 2001, MGE announced that it had secured an option agreementPower West Campus is a VIE pursuant to ownFIN No. 46-R, as the equity investment at December 31, 2003, was not sufficient to permit the entity to finance its activities without additional support. MGE concluded a VIE relationship exists due to the long-term lease arrangement between MGE and MGE Power West Campus. MGE Power West Campus will lease a major portion of its assets, a power plant, to MGE, pursuant to this leasing arrangement and MGE will absorb a majority of the advanced technology, coal-fired, base-load generationexpected losses, residual, or both. The VIE was consolidated into MGE as of December 31, 2003.

i. EITF 03-11.

In July 2003, FASB issued EITF 03-11,Reporting Realized Gains and Losses on Derivative Instruments that are subject to SFAS No. 133 (Accounting for Derivative Instruments and Hedging Activities), and Not Held for Trading Purposes. This issue addresses whether realized gains and losses should be shown gross or net in the income statement, for contracts that are not held for trading purposes. This issue will not have a material impact on the consolidated financials statements.

j. FSP 106-1.

In January 2004, the FASB issued FASB Staff Position No. FAS 106-1 (FSP 106-1),Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act). FSP 106-1 permits employers that sponsor postretirement benefit plans (plan sponsors) that provide prescription drug benefits to retirees to make a one-time election to defer accounting for any effects of the Act. The FSP 106-1 requires all plan sponsors to provide certain disclosures, regardless of whether they choose to account or defer accounting. FSP 106-1 is effective for annual fiscal periods ending after December 7, 2003. If deferral is elected, the deferral must remain in effect until the earlier of (1) the issuance of guidance by the FASB on how to account for the federal subsidy to be provided to plan sponsors under the Act or (2) the remeasurement of plan assets and obligations subsequent to January 31, 2004. MGE has elected to defer recognition of the Act.

k. SEC SAB No. 104.

In December 2003, the SEC issued SAB No. 104 regarding revenue recognition. SAB No. 104 revises or rescinds portions of the interpretive guidance included in We Energies' Power the Future proposal. The proposal includes three, 600-megawatt (MW) coal-fired units of new generation. Pursuant to an amended agreement reached on January 31, 2003, MGE's option is to acquire an undivided 8.33% (16.66% under certain conditions) ownership interest in eachTopic 13 of the proposed coal plants, for upcodification of Staff Accounting Bulletins to a maximum of 150 MWs total. This will require an estimated investment over a ten-year period of $150 million to $175 million. We Energies filed its CPCNmake the guidance consistent with the PSCW in early 2002. A decision from the PSCW on the coal facilities is expected in 2003. MGE may exercise its option up to 110 days after PSCW approval is issued.

WCCF

current authoritative accounting and auditing guidance and SEC rules and regulations. MGE Energy and MGE will comply with the University of Wisconsin-Madison (UW) have proposed buildingrevised guidance.

21. Segment Information - MGE Energy and MGE.

Prior to 2003, MGE Energy operated in two business segments: electric utility operations and gas utility operations. In 2003, MGE Energy added a natural gas-fired cogeneration plant to help meet the future needs of the university and MGE customers. This facility is designed to produce steam heat and chilled water air-conditioningthird segment for the university and up to 150 MWs of electricity to help meet the growing customer demand in the Madison area.nonutility energy operations as discussed below. The electric generation assets will be controlled by MGE Power and the steam and chilled water assets will be controlled by the State of Wisconsin. A PSCW decision is expected on the plant during 2003.

In July 2001, MGE entered into a contract with GE Packaged Power Inc. for the purchase of two gas turbines for the cogeneration plant. In June 2002, MGE entered into a contract with General Electric Company for the purchase of a steam turbine. The cost for the turbines is $37.3 million, of which $20.4 million has already been paid. Remaining payments include $16.9 million in 2003. Other miscellaneous equipment contracts total $6.5 million, of which $0.3 million has been paid.

Leases

Future minimum rental payments at December 31, 2002, under agreements classified as operating leases with noncancellable terms in excess of one year are as follows:

In thousands
2003$1,592
20041,013
2005665
2006530
2007524
Thereafter5,192
Total minimum future lease payments$9,516


Rental expense under operating leases totaled $1.6 million for each of the years 2002, 2001, and 2000.

9. MGE - ATC

On January 1, 2001, MGE transferred substantially all of its electric transmission facilities to ATC in exchange for approximately a 6% interest in this joint venture. ATC is comprised of Wisconsin investor-owned utilities and some Wisconsin municipal utilities, cooperatives, and power supply agencies.

MGE accounts for this investment on the equity method of accounting. MGE records as equity in earnings of the investee its share of ATC's earnings, amortization of the SFAS No. 109 regulatory liability and deferred investment tax credits related to the transmission assets transferred to ATC. MGE recorded $3.3 million (pretax) of equity earnings from its investment in ATC in 2002.

Effective October 24, 2002, the PSCW authorized an electric rate surcharge of $4.5 million or 2% for MGE to recover deferred costs associated with the ATC formation and ongoing incremental transmission costs during 2001 and 2002. The surcharge will be in effect for a twelve-month period ending October 23, 2003.

On November 21, 2002, MGE and ATC entered into a Generation-Transmission Interconnection agreement related to transmission system upgrades due to the WCCF. MGE issued to the ATC a "Notice to Proceed for the Procurement of the Equipment" for the system upgrades. In accordance with the agreement, MGE had to provide ATC with a form of security, such as a Letter of Credit or a collateral account, in the amount of $5.0 million. MGE set up a collateral (escrow) account to satisfy the security interest to ATC until MGE was able to secure a Letter of Credit from a commercial bank, which it received on December 30, 2002. The collateral account was terminated on January 2, 2003. MGE will make an estimated $10 million capital payment for transmission equipment and work done by ATC throughout 2003 related to the WCCF. MGE expects to be reimbursed by ATC for its capital outlay once the project is completed.

10. MGE - Kewaunee

Effective September 23, 2001, MGE sold to WPSC its 17.8% ownership interest in Kewaunee. In exchange for a cash payment of $15.4 million, MGE transferred its net book value of utility plant ($8.2 million), net nuclear fuel ($7.9 million), inventories ($1.5 million), and other assets ($0.1 million). These assets were offset by $2.3 million owed to WPSC. On the closing date, MGE also transferred its Qualified Decommissioning Fund ($65.0 million fair market value) and Nonqualified Decommissioning Fund ($28.1 million fair market value), which decreased accumulated depreciation by an equal amount. This transaction occurred in accordance with an agreement between MGE and WPSC dated September 29, 1998. That agreement required certain continuing obligations of MGE and WPSC after the closing date, as described below.

MGE made monthly contributions to the MGE Nonqualified Decommissioning Fund from September 23, 2001, in the amount of approximately $0.7 million (the level authorized by the PSCW) through December 31, 2002. These costs are currently recovered from customers in rates. MGE's decommissioning liability is limited to the fund balances at the closing date plus all decommissioning collections through 2002. MGE's Nonqualified Decommissioning Fund is shown on the balance sheet in the Utility Plant section. As of December 31, 2002, this fund totaled $8.8 million (pretax fair market value) and is offset by an equal amount recorded in accumulated provision for depreciation. The securities and uninvested cash balances in the fund, net of trust investment expenses and taxes on investment income, were transferred to WPSC Nonqualified Decommissioning Fund on January 3, 2003.

The federal government is responsible for the disposition and storage of spent nuclear fuel. Federal legislation is being considered to establish an interim storage facility. Spent nuclear fuel is currently stored at Kewaunee. Minor plant modifications to the spent fuel pools in 2001 should ensure Kewaunee has sufficient fuel storage capacity until the end of its licensed life in 2013. MGE retains its spent fuel obligations for all fuel burned at Kewaunee for MGE's generation from the opening of the plant to the closing date. WPSC took title to such fuel at the closing date.

A surcharge imposed by the National Energy Policy Act of 1992 requires nuclear power companies to fund the decontamination and decommissioning of US Department of Energy facilities that process nuclear fuel. As a result, the Kewaunee CO-owners are required to pay a surcharge on uranium enrichment services purchased from the federal government prior to October 23, 1992. On an inflation-adjusted basis, MGE's portion of the obligation related to Kewaunee is approximately $1.1 million at December 31, 2002. MGE is required to continue paying its portion of this annual assessment.

In accordance with the agreement, MGE exercised its option in June 2001 to buy electric capacity and energy at a fixed price from WPSC. MGE purchased 90 MWs of electric capacity and energy from September 24, 2001, through December 31, 2002, and will continue to do so through September 23, 2003, to help meet customers' electric needs.

11. WCCF

MGE Energy, through MGE Power and MGE Construct, has assumed responsibility from MGE for the construction and ownership of a proposed natural gas-fired cogeneration facility to be built on the Madison campus of the UW. As planned, the facility would have 20,000 tons of chilled water capacity, 500,000 pounds per hour of steam capacity, and approximately 150 MWs of electricity capacity. The facility would be jointly-owned by the State of Wisconsin, the UW, and MGE Power and would be leased and operated by MGE. The State and the UW would own a controlling interest in the chilled water and steam plants, which would be used to meet the growing UW need for air-conditioning and steam heat capacity. MGE Power would own a controlling interest in the electric generation plant, which would be used to provide electricity to MGE's customers. MGE Construct would be responsible for the construction of the facility.

The ownership, construction, and operation of the facility requires various state approvals as well as the completion of definitive agreements, including a construction agreement. As part of this process, the State is reviewing its alternatives before entering final agreements. Depending on the approval process, construction could start in 2003, with the facility coming on-line in 2005. MGE also requires PSCW approval in order to lease and operate the facility. On October 21, 2002, the PSCW deemed MGE's CPCN application complete. A PSCW decision is expected on MGE's participation in the facility during 2003.

The facility is expected to cost approximately $180 million. On November 29, 2002, the State paid $11.9 million to MGE for its share of those costs under a September 2002 Pre-Certification Cost Sharing Agreement between MGE and the State. On December 31, 2002, MGE Power reimbursed MGE for the remainder of those costs as a part of MGE Power's assumption of the project. As of December 31, 2002, MGE Power had incurred $18.9 million of costs on the project, which is reflected as construction work in progress on MGE Energy's consolidated balance sheets. These costs largely represent amounts paid under long-lead time equipment contracts in order to meet project schedules, although, as noted, several approvals remain outstanding. A failure to obtain these approvals could terminate the project and could result in the write-off of these costs to the extent that the associated equipment and efforts cannot be put to alternative uses.

12. MGE - Purchased Power Agreements

MGE has several purchased power agreements with various counterparties. Some of the counterparties have experienced severe liquidity issues. MGE management and external counsel have been reviewing the situation and at this time cannot determine what the impacts, if any, there would be.

13. MGE - Segments of Business

MGE has two main business segments, electric and gas, which are both regulated. The electric business generates and distributes electricity and contracts for transmission service. The gas utility business purchases and distributes natural gas and contracts for the transportation of natural gas. Both the electric and gas segments operate through MGE Energy's principal subsidiary MGE.

The nonutility energy operations are conducted through MGE Energy's other subsidiaries: MGE Power, MGE Power West Campus, and MGE Construct. These subsidiaries have been formed to own and construct new electric generating capacity and are currently undertaking the construction of WCCF, a 150-MW cogeneration plant on the UW-Madison campus. Construction on this facility started in the fall of 2003. The table below shows key information about MGE's electric and gas operations,all three of these segments, including the distribution of net assets, for the years ended December 31.

General corporate expenses include the cost of executive management, corporate accounting and finance, information technology, risk management, human resources and legal functions, and employee benefits that are allocated to electric and gas based on formulas prescribed by the PSCW. Identifiable assets are those used in MGE's operations in each segment. Corporate assets consist primarily of cash and cash equivalents and deferred taxes.

(In thousands)
2002
2001
2000
Electric Operations 
Gross operating revenues$225,453$203,570$203,553
Interdepartmental revenues eliminated(466)(392)(377)
Total revenues224,987203,178203,176
Operation and maintenance expenses149,914129,009124,101
Depreciation and amortization23,07229,79129,137
Other general taxes8,5148,6348,296
Pretax operating income43,487$ 35,744$ 41,642
Income tax provision12,44210,35311,534
Net operating income$ 31,045$ 25,391$ 30,108
 
Electric Construction and Nuclear Fuel Expenditures$ 43,873$ 33,722$ 65,312
 
Gas Operations 
Gross operating revenues$126,639$136,638$127,038
Interdepartmental revenues eliminated(4,530)(6,105)(6,106)
Total revenues122,109130,533120,932
Operation and maintenance expenses98,814109,67299,229
Depreciation and amortization6,2905,8685,944
Other general taxes2,3472,2301,884
Pretax operating income14,658$ 12,763$ 13,875
Income tax provision5,1313,4833,882
Net operating income$ 9,527$ 9,280$ 9,993
 
Gas Construction Expenditures$ 15,033$ 8,244$ 8,294
 
Assets (December 31) 
Electric$415,849$372,997$395,622
Gas139,608131,174123,486
Assets not allocated52,79939,90352,496
Total$608,256$544,074$571,604

The following table shows segment information for MGE Energy's and MGE's operations:

(In thousands)
Utility 
Year ended December 31, 2003Electric Gas Nonutility Consolidated
Gross operating revenues$ 242,264 $ 167,550 $ - $ 409,814
Interdepartmental revenues(519) (7,748) - (8,267)
Depreciation and amortization(16,437) (6,907) - (23,344)
Other operating expenses(196,286) (140,795) (729) (337,810)
Operating income$ 29,022 $ 12,100 $(729) $ 40,393
 
Year ended December 31, 2002 
Gross operating revenues$ 225,453 $ 126,639 $ - $ 352,092
Interdepartmental revenues(466) (4,530) - (4,996)
Depreciation and amortization(23,072) (6,290) - (29,362)
Other operating expenses(170,870) (106,292) (280) (277,442)
Operating income$ 31,045 $ 9,527 $(280) $ 40,292
 
Year ended December 31, 2001 
Gross operating revenues$ 203,570 $ 136,638 $ - $ 340,208
Interdepartmental revenues(392) (6,105) - (6,497)
Depreciation and amortization(29,791) (5,868) - (35,659)
Other operating expenses(147,997) (115,384) - (263,381)
Operating income$ 25,390 $ 9,281 $ - $ 34,671

MGE's regulated electric and gas utility operations are the only revenue-generating segments for MGE Energy. MGE Energy's nonutility segment does not currently generate any revenues.

(In thousands)
 
MGE Energy2003 2002 2001*
Electric operating income$29,022 $31,045 -
Gas operating income12,100 9,527 -
Nonregulated operating loss(729) (280) -
Consolidated40,393 40,292 -
Other income2,486 2,335 -
Interest expense(11,776) (12,545) -
Other general taxes(463) (889) -
Net income$30,640 $29,193 -
MGE 
Electric operating income$29,022 $31,045 $25,390
Gas operating income12,100 9,527 9,281
Net operating income41,122 40,572 34,671
Equity in earnings in ATC3,687 3,316 3,345
Other income and deductions(2,951) (1,930) 2,918
Interest expense, net(11,529) (12,327) (13,572)
Net income before cumulative effect of a
change in accounting principle

30,329
 
29,631
 
27,362
Cumulative effect of a change in accounting principle,
net of tax benefit of $78

-
 
-
 
(117)
Net income$30,329 $29,631 $27,245
*MGE Energy was formed in 2002.


(In thousands)

Utility Consolidated

MGE Energy and MGE



Electric
 

Gas
 Assets not Allocated 

Nonutility
 

Total
Assets 
December 31, 2003$445,728 $165,577 $56,136 $54,246 $721,687
December 31, 2002414,827 151,548 52,799 20,639 639,813
December 31, 2001*376,568 144,145 39,903 - 560,616
 
Capital Expenditures 
Year ended December 31, 2003$40,833 $13,875 - $28,262 $82,970
Year ended December 31, 200242,940 15,209 - 18,852 77,001
Year ended December 31, 2001*33,722 8,244 - - 41,966
*MGE Energy was formed in 2002.

14.22. Quarterly Summary of Operations (Unaudited)(unaudited).

(In thousands, except per-share amounts)Quarters EndedQuarters Ended
March 31June 30Sept. 30Dec. 31

2003

March 31 June 30 Sept. 30 Dec. 31
Operating revenues: 
Regulated electric revenues$56,099 $58,607 $72,811 $54,228
Regulated gas revenues72,395 24,041 15,120 48,246
Total128,494 82,648 87,931 102,474
Operating expenses111,043 71,015 68,238 91,420
Operating income17,451 11,633 19,693 11,054
Interest and other income(2,035) (1,991) (2,797) (2,467)
Income tax provision(6,041) (3,809) (6,788) (3,263)
Earnings on common stock$9,375 $5,833 $10,108 $5,324
Earnings per common share$0.53 $0.33 $0.56 $0.29
Dividends per share$0.336 $0.336 $0.338 $0.338
2002  
Operating revenues:  
Regulated electric revenues$50,820$54,464$67,953$51,750$50,820 $54,464 $67,953 $51,750
Regulated gas revenues47,45219,54011,47743,64047,452 19,540 11,477 43,640
Total98,27274,00479,43095,39098,272 74,004 79,430 95,390
Operating expenses78,00164,81659,96286,18778,001 64,816 59,962 86,187
Operating income20,2719,18819,4689,20320,271 9,188 19,468 9,203
Interest and other income(2,220)(2,457)(1,769)(3,764)(2,220) (2,457) (1,769) (3,764)
Income tax provision(7,029)(2,312)(7,209)(2,177)(7,029) (2,312) (7,209) (2,177)
Earnings on common stock$11,022$4,419$10,490$3,262$11,022 $4,419 $10,490 $3,262
Earnings per common share$0.64$0.26$0.60$0.19$0.64 $0.26 $0.60 $0.19
Dividends per share$0.333$0.336$0.333 $0.333 $0.336 $0.336
2001 
Operating revenues: 
Regulated electric revenues$49,438$50,686$56,432$46,622
Regulated gas revenues72,59219,5769,49928,866
Total122,03070,26265,93175,488
Operating expenses104,64759,76656,24464,547
Operating income17,38310,4969,68710,941
Interest and other income(1,809)(1,600)(280)(1,515)
Income tax provision(5,960)(3,490)(3,410)(3,081)
Earnings on common stock before cumulative

effect of a change in accounting principle



9,614


5,406


5,997


6,345
Cumulative effect of a change in accounting principle, net of tax benefit of $78
(117)

-
Earnings on common stock$ 9,497$ 5,406$ 5,997$ 6,345
Income before cumulative effective of a change in accounting principle$0.58$0.32$0.36$0.37
Cumulative effect of a change in accounting principle(0.01)-
Earnings per common share$0.57$0.32$0.36$0.37
Dividends per share$0.331$0.333
Notes:

- The quarterly results of operations within a year are not comparable because of seasonal and other factors.

- The sum of earnings per share of common stock for any four quarters may vary slightly from the earnings per share of common stock for the equivalent 12-month period due to rounding.

Notes:

- The quarterly results of operations within a year are not comparable because of seasonal and other factors.

- The sum of earnings per share of common stock for any four quarters may vary slightly from the earnings per share of common stock for the equivalent twelve-month period due to rounding.

MGE Energy's operations are based primarily on its utility subsidiary MGE.

Fourth Quarter 2002 vs. 2001

MGE's fourth quarter earnings reflected an increase in electric and gas revenues, attributed to colder weather during the fourth quarter of 2002. Increased operating expenses lowered operating income during this same time period. Higher fuel and purchased power costs during the fourth quarter resulted from the increased cost of gas used for electric generation and a higher volume of purchased power. Operations and maintenance expenses were higher due to rising health care, pension and other employee benefits, increased transmission wheeling costs, injuries and damages, and outside services. The decrease in other income in 2002 is attributed to a 2001 weather hedge benefit, due to abnormally warm weather in November and December 2001.

Third Quarter 2002 vs. 2001

MGE's utility revenues increased during the third quarter 2002 due in large part to in increase in electric retail sales. In the third quarter 2001, electric revenues were decreased by approximately $4.5 million (pretax), reflecting a revised estimate of electric unbilled revenues. Purchased power increased primarily due to MGE purchasing 90 MWs of electric capacity from WPSC to replace MGE's share of Kewaunee that it sold in 2001. The increased purchased power costs were somewhat offset by decreases in operations, maintenance and depreciation expense related to the Kewaunee plant. Other income decreased in the third quarter of 2002 primarily due to decreased decommissioning earnings. The lower decommissioning earnings are also reflected in the decrease in depreciation expense.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

MGE Energy and MGE

None.

PART III.

Item 10. Directors and Executive Officers of the Registrants.

MGE Energy

Directors

Information concerning the Directors of MGE Energy is contained in the definitive proxy statement under the section "Election of Directors" filed prior to April 30, 2003, with the Securities and Exchange Commission, which is incorporated herein by reference.

Executive Officers (elected annually by Directors)


Executive

Title

Effective
Date
Service Years as an
Officer
Gary J. Wolter* Age: 48Chairman of the Board, President and Chief Executive Officer President and Chief Executive Officer02/01/02
02/01/00
13
Lynn K. Hobbie** Age: 44Senior Vice President
Vice President - Marketing
02/01/00 05/01/968
Mark T. Maranger**
Age: 54
Senior Vice President, MGE
President and CEO, Wisconsin Fuel and Light Company
04/09/01
1996-2001
1
James G. Bidlingmaier** Age: 56Vice President - Admin. and Chief Information Officer
Executive Director - Information Management Systems
02/01/00
09/01/94
3
Kristine A. Euclide**
Age: 50
Vice President and General Counsel, MGE
Partner, in the law firm of Stafford Rosenbaum LLP

Executive Assistant to County Executive of Dane County, WI in which capacity she served as a senior policy advisor to the chief-elected official in Dane County.

11/15/01
1982-05/97

06/99-11/01
05/97-05/99

1
Terry A. Hanson*
Age: 51
Vice President, Chief Financial Officer and Secretary
Vice President and Chief Financial Officer
Vice President - Finance
10/01/01 05/01/00
11/01/97
11
Jeffrey C. Newman*
Age: 40
Vice President and Treasurer
Treasurer
01/01/01 11/01/975

Note: Ages, years of service and positions as of February 1, 2003.

*Executive officer of MGE Energy and MGE
**Executive officer of MGE

Item 11. Executive Compensation. (See Item 12.)

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

MGE Energy

The required information for Items 11 and 12 is included in MGE Energy's definitive proxy statement under the section "Executive Compensation," not including "Report on Executive Compensation" and "Company Performance," and under the section "Beneficial Ownership of Common Stock by Directors and Executive Officers" filed with the Securities and Exchange Commission prior to April 30, 2003, which is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions.

MGE Energy and MGE

None.

Item 14.9A. Controls and Procedures.

MGE Energy

WithinDuring the 90 days prior to the filingfourth quarter of this report,2003, MGE Energy's management, including the principal executive officer and principal financial officer, evaluated its disclosure controls and procedures related to the recording, processing, summarization, and reporting of information in its periodic reports that it files with the Securities and Exchange Commission (SEC).SEC. These disclosure controls and procedures have been designed to ensure that material information relating to MGE Energy, including its subsidiaries, is made known to MGE Energy's management, including these officers, by other employees of MGE Energy and its subsidiaries, and that this information is recorded, processed, summarized, evaluated, and reported, as applicable, within the time periods specified in the SEC's rules and forms. Due to the inherent limitations of control systems, not all misstatements may be detected. These inherent limitations include the realities that judgments in decision-makingdecision making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. MGE Energy's controls and procedures can only provide reasonable, not absolute, assurance that the above objectives have been met. Also, MGE Energy does not control or manage certain of its unconsolidated entities and as such,thus, its access and ability to apply its procedures to entities that it does not control or manage are more limited than is the case for the entities that it controls and manages.

As of December 31, 2003, these officers (principal executive officer and principal financial officer) concluded that MGE Energy's disclosure controls and procedures with respectwere effective to such entities are more limited than those it maintains with respect to its consolidated subsidiaries.

As of February 5, 2003, these officers concluded that, subject to the limitations noted above, the design of the disclosure controls and procedures provides reasonable assurance that they can accomplish their objectives.objectives (as defined in the SEC Act of 1934 Rules 13a-15(e) and 15d-15(e)). MGE Energy intends to continually strivestrives to improve its disclosure controls and procedures to enhance the quality of its financial reporting.

There have beenwere no significant changes in MGEMGE's Energy's internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the quarter ended December 31, 2003, that have materially affected, or in other factors that could significantlyreasonably likely to materially affect these controls subsequent to the date of their evaluation.internal control over financial reporting.

MGE

WithinDuring the 90 days prior to the filingfourth quarter of this report,2003, MGE's management, including the principal executive officer and principal financial officer, evaluated its disclosure controls and procedures related to the recording, processing, summarization, and reporting of information in its periodic reports that it files with the SEC. These disclosure controls and procedures have been designed to ensure that material information relating to MGE including its subsidiaries, is made known to MGE's management, including these officers, by other employees of MGE, and that this information is recorded, processed, summarized, evaluated, and reported, as applicable, within the time periods specified in the SEC's rules and forms. Due to the inherent limitations of control systems, not all misstatements may be detected. These inherent limitations include the realities that judgments in decision-makingdecision making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. MGE's controls and procedures can only provide reasonable, not absolute, assurance that the above objectives have been met. Also, MGE does not control or manage certain of its unconsolidated entities and as such,thus, its access and ability to apply its procedures to the entities that it does not control or manage are more limited than is the case for the entities that it controls and manages.

As of December 31, 2003, these officers (principal executive officer and principal financial officer) concluded that MGE's disclosure controls and procedures with respectwere effective to such entities are more limited than those it maintains with respect to its consolidated subsidiaries.

As of February 5, 2003, these officers concluded that, subject to the limitations noted above, the design of the disclosure controls and procedures provides reasonable assurance that they can accomplish their objectives.objectives (as defined in the SEC Act of 1934 Rules 13a-15(e) and 15d-15(e)). MGE intends to continually strive to improve its disclosure controls and procedures to enhance the quality of its financial reporting.

There have beenwere no significant changes in MGE's Energy's internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the quarter ended December 31, 2003, that have materially affected, or in other factors that could significantlyreasonably likely to materially affect these controls subsequentthe internal control over financial reporting.

PART III.

Item 10. Directors and Executive Officers of the Registrants.

MGE Energy

The information required by Item 10 relating to directors and nominees for election as directors at MGE Energy's annual meeting of shareholders is incorporated herein by reference to the dateinformation under the heading "ELECTION OF DIRECTORS" (not including the information under the subheading "Audit Committee Report," which is not incorporated herein) in MGE Energy's definitive proxy statement (2004 Proxy Statement) to be filed with the SEC prior to April 29, 2004.

The information required by Item 10 relating to executive officers is set forth above in Item 1. Business - Executive Officers of their evaluation.the Registrants.

Code of Ethics

MGE Energy has adopted a Code of Ethics applicable to its directors and all of its employees, including its chief executive officer, chief financial officer, and principal accounting officer. The Code of Ethics is available on MGE Energy's Web site at www.mgeenergy.com.

Item 11. Executive Compensation.

See Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management.

MGE Energy

The required information for Items 11 and 12 is included in MGE Energy's 2004 Proxy Statement under the section "Executive Compensation," not including "Report on Executive Compensation" and "Company Performance," and under the section "Beneficial Ownership of Common Stock," which is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions.

MGE Energy

None.

Item 14. Principal Accountant Fees and Services.

MGE Energy

The information required by Item 14 is incorporated herein by reference to the information under the heading "OTHER INFORMATION - Independent Accountants" in MGE Energy's 2004 Proxy Statement.

MGE

The following table presents fees for professional audit services rendered by PricewaterhouseCoopers LLP for the audit of MGE's financial statements for the years ended December 31, 2002 and 2003, and fees billed for other services rendered by PricewaterhouseCoopers LLP during those periods.

2003 2002
Audit Fees: 
Audit of financial statements$182,000 $174,800
Review of SEC filings and comfort letters8,700 56,000
Total Audit Fees$190,700 $230,800
 
Audit-Related Fees: 
Financial accounting and reporting standards consultation$14,000 $4,500
Total Audit-Related Fees$14,000 $4,500
 
Tax Fees: 
Tax advice on financial accounting issues$6,400 $21,500
Review of federal and state income tax returns13,400 12,700
Total Tax Fees$19,800 $34,200
 
All Other Fees: 
Financial analysis for WCCF project$198,400 $386,900
Business resumption and computer security analysis- 203,600
Total All Other Fees$198,400 $590,500

MGE is a wholly owned subsidiary of MGE Energy and does not have a separate audit committee. Instead, that function is fulfilled for MGE by the MGE Energy Audit Committee. That committee approves each engagement of the independent accountants to render any audit or nonaudit services before the accountants are engaged to render those services. The chair of that committee or other designated committee member may represent the entire committee for purposes of this approval. Any services approved by the chair or other designated committee member are reported to the full committee at the next scheduled MGE Energy Audit Committee meeting. No de minimis exceptions to this approval process are allowed under the MGE Energy Audit Committee Charter, and thus, none of the services described in the preceding table were approved pursuant to Rule 2-01(c)(7)(i)(C) of Regulation S-X.

PART IV.

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

(a) 1. Financial Statements.
MGE Energy
Report of Independent Auditors43
Consolidated Statements of Income
for the years ended December 31, 2003, 2002, and 2001


45
Consolidated Statements of Cash Flows
for the years ended December 31, 2003, 2002, and 2001

46
Consolidated Balance Sheets as of December 31, 2003 and 200247
Consolidated Statements of Capitalization as of December 31, 2003 and 200248
Consolidated Statements of Common Equity and Comprehensive Income
as of December 31, 2003, 2002, and 2001

49
Notes to Consolidated Financial Statements55
MGE
Report of Independent Auditors44
Consolidated Statements of Income
for the years ended December 31, 2003, 2002, and 2001


50
Consolidated Statements of Cash Flows
for the years ended December 31, 2003, 2002, and 2001

51
Consolidated Balance Sheets as of December 31, 2003 and 200252
Consolidated Capitalization Statement as of December 31, 2003 and 200253
Consolidated Statements of Common Equity and Comprehensive Income
as of December 31, 2003, 2002, and 2001
54
Notes to Consolidated Financial Statements55

(a) 1. Financial Statements

MGE Energy, Inc.
Report of Independent Accountants
Consolidated Statements of Income for the years ended December 31, 2002, 2001, and 2000
Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001, and 2000
Consolidated Balance Sheets as of December 31, 2002 and 2001
Consolidated Statements of Capitalization as of December 31, 2002 and 2001
Consolidated Statements of Common Equity and Comprehensive Income as of December 31, 2002, 2001, and 2000
Notes to Consolidated Financial Statements

Madison Gas and Electric Company
Report of Independent Accountants
Statements of Income for the years ended December 31, 2002, 2001, and 2000
Statements of Cash Flows for the years ended December 31, 2002, 2001, and 2000
Balance Sheets as of December 31, 2002 and 2001
Statements of Capitalization as of December 31, 2002 and 2001
Statements of Common Equity and Comprehensive Income as of December 31, 2002, 2001, and 2000
Notes to Consolidated Financial Statements

2. Financial Statement Schedules.Schedule.

Schedule II - Valuation and Qualifying Accounts for MGE Energy, Inc. and Madison Gas and Electric Company.

All other schedules have been omitted because they are not applicable or not required, or because the required information is shown in the consolidated financial statements or notes thereto.

3. All Exhibits Including Those Incorporated by Reference.

Exhibits. Certain of the following exhibits are incorporated herein by reference under Rule 12b-32 of the Securities and Exchange Act of 1934, as amended, as indicated by the parenthetical reference. Certain other instruments which would otherwise be required to be listed below have not been so listed because such instruments do not authorize securities in an amount which exceeds 10% of the total assets of the applicable registrant and its subsidiaries on a consolidated basis and the relevant registrant agrees to furnish a copy of any such instrument to the Commission upon request. An asterisk (*) indicates a management contract or compensatory plan or arrangement.

3.1 Amended and Restated Articles of Incorporation of the Registrant are incorporated herein by reference to ExhibitMGE Energy. (Exhibit 3.1 to the Registrant'sMGE Energy's Registration Statement on Form S-4, (RegistrationRegistration No. 333-72694.)

3.2 Amended and Restated By-LawsBylaws of the Registrant are incorporated herein by reference to ExhibitMGE Energy. (Exhibit 3.2 to the Registrant'sMGE Energy's Registration Statement on Form S-4, (RegistrationRegistration No. 333-72694.)

3.3 Articles of Incorporation of MGE as in effect at May 6, 1996. (Incorporated by reference to Exhibit(Exhibit 3.(i) with 1996to Form 10-K infor year ended December 31, 1996, File No. 0-1125.)

3.4 Amended Bylaws of MGE as in effect at August 16, 2002. (Exhibit 3.4 to Form 10-K for year ended December 31, 2002, File No. 0-1125.)

4.1 Indenture of Mortgage and Deed of Trust between MGE and Firstar Trust Company, as Trustee, dated as of January 1, 1946, and filed as Exhibit1946. (Exhibit 7-D to SEC File No. 0-11250-1125.)

4.2 Supplemental Indenture to aforementioned Mortgage and the following indentures supplemental thereto are incorporated herein by reference:Deed of Trust.

Supplemental Indenture
Dated as ofExhibit No.SEC File No.

Seventeenth

02/01/19934FFebruary 1, 19934FForm 10-K for year ended
December 31, 1992,
File No. 0-1125 (1992 10-K)

4.2

4.3 Indenture between MGE and Bank One, N.A., as Trustee, dated as of September 1, 1998. (Incorporated by reference(Exhibit 4B to Exhibit 4B with 1999 Form 10-K infor year ended December 31, 1999, File No. 0-1125.)

10.1 Copy of Joint Power Supply Agreement with Wisconsin Power and Light Company and Wisconsin Public Service Corporation dated February 2, 1967. (Incorporated by reference(Exhibit 4.09 to Exhibit 4.09 in FileRegistration Statement, Registration No. 2-27308.)

10.2 Copy of Joint Power Supply Agreement (Exclusive of Exhibits) with Wisconsin Power and Light Company and Wisconsin Public Service Corporation dated July 26, 1973, amending Exhibit 5.04. (Incorporated by reference(Exhibit 5.04A to Exhibit 5.04A in FileRegistration Statement, Registration No. 2-48781.)

10.3 Copy of revised Agreement for Construction and Operation of Columbia Generating Plant with Wisconsin Power and Light Company and Wisconsin Public Service Corporation dated July 26, 1973. (Incorporated by reference(Exhibit 5.07 to Exhibit 5.07 in FileRegistration Statement, Registration No. 2-48781.)

10.4* Form of Severance Agreement. (Incorporated by reference(Exhibit 10F to Exhibit 10F with 1994 Form 10-K infor the year ended December 31, 1994, File No. 0-1125.)

12 StatementStatements regarding computation of ratio of earnings to fixed charges.charges:

12.1 MGE Energy, Inc.

12.2 Madison Gas and Electric Company

2121.1 Subsidiaries of MGE Energy, Inc.

2323.1 Consent of Independent Accountants.

23.1Accountants - MGE Energy, Inc.

23.2Certifications Pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities and Exchange Act of 1934 as to the Annual Report on Form 10-K for the year ended December 31, 2003 filed by the following officers for the following companies:

31.1 Filed by Gary J. Wolter for MGE Energy, Inc.

31.2 Filed by Terry A. Hanson for MGE Energy, Inc.

31.3 Filed by Gary J. Wolter for Madison Gas and Electric Company

31.4 Filed by Terry A. Hanson for Madison Gas and Electric Company

Certifications Pursuant to Section 1350 of Chapter 63 of Title 18 United States Code (Sarbanes-Oxley Act of 2002) as to the Annual Report on Form 10-K for the year ended December 31, 2002, filed by the following officers for the following companies:

Exhibit 99-1 -32.1 Filed by Gary J. Wolter for MGE Energy, Inc.
Exhibit 99-2 -

32.2 Filed by Terry A. Hanson for MGE Energy, Inc.
Exhibit 99-3 -

32.3 Filed by Gary J. Wolter for Madison Gas and Electric Company
Exhibit 99-4 -

32.4 Filed by Terry A. Hanson for Madison Gas and Electric Company

(b)4. Reports on Form 8-K.

No current report on Form 8-K was filed for the quarter ended December 31, 2002.

Schedule II
On October 30, 2003, MGE Energy, Inc. and Madison Gas and Electric Company
furnished a Current Report on Form 8-K dated October 30, 2003, reporting the issuance of a press release announcing MGE Energy, Inc.'s earnings for the third quarter of 2003.

Schedule II

MGE Energy, Inc. and Madison Gas and Electric Company

Valuation and Qualifying Accounts

Additions


Balance at beginning of period
(1)

Charged to costs and expenses

(2)

Charged to other accounts



Net Accounts
written off



Balance at end of period
Fiscal Year 2000:
Accumulated provision for uncollectibles



(1,391,057)


(2,032,909)


-


1,352,862


(2,071,104)
Fiscal Year 2001:
Accumulated provision for uncollectibles



(2,071,104)


(2,887,124)


-


1,193,901


(3,764,327)
Fiscal Year 2002:
Accumulated provision for uncollectibles



(3,764,327)


(1,149,000)


-


2,254,073


(2,659,254)
Additions 

Balance at
beginning of
period
 (1)
Charged to
costs and
expenses
 (2)
Charged
to other
accounts
 


Net
Accounts
written off
 


Balance at
end of period
Fiscal Year 2001:
Accumulated provision
for uncollectibles



(2,071,104)
 

(2,887,124)
 

-
 

1,193,901
 

(3,764,327)
Fiscal Year 2002:
Accumulated provision
for uncollectibles



(3,764,327)
 

(1,149,000)
 

-
 

2,254,073
 

(2,659,254)
Fiscal Year 2003:
Accumulated provision
for uncollectibles



(2,659,254)
 

(1,340,863)
 

-
 

1,264,669
 

(2,735,448)

Signatures - MGE Energy, Inc.

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.

MGE ENERGY, INC.Energy, Inc.
(Registrant)
 
Date: March 26, 2003February 27, 2004/s/ Gary J. Wolter
 Chairman, President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 26, 2003.February 27, 2004.




/s/ Gary J. Wolter
Gary J. Wolter
Chairman, President and Chief Executive Officer and Director (Principal Executive Officer)



/s/ Terry A. Hanson
Terry A. Hanson
Vice President, Chief Financial Officer and Secretary (Principal
(Principal Financial Officer and Principal Accounting Officer)
/s/ David C. MebaneDavid C. Mebane, Vice Chairman of the Board and Director
/s/ Richard E. BlaneyRichard E. Blaney, Director
/s/ F. Curtis HastingsF. Curtis Hastings, Director
/s/ Regina M. MillnerRegina M. Millner, Director
/s/ Frederic E. MohsFrederic E. Mohs, Director
/s/ John R. NevinJohn R. Nevin, Director
/s/ Donna K. SollenbergerDonna K. Sollenberger, Director
/s/ H. Lee SwansonH. Lee Swanson, Director

Signatures - Madison Gas and Electric Company

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.

MADISON GAS AND ELECTRIC COMPANYMadison Gas and Electric Company
(Registrant)
 
Date: March 26, 2003February 27, 2004/s/ Gary J. Wolter
 Chairman, President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 26, 2003.February 27, 2004.



/s/ Gary J. Wolter
Gary J. Wolter
Chairman, President and Chief Executive Officer and Director (Principal Executive Officer)



/s/ Terry A. Hanson
Terry A. Hanson
Vice President, Chief Financial Officer and Secretary (Principal
(Principal Financial Officer and Principal Accounting Officer)
/s/ David C. MebaneDavid C. Mebane, Vice Chairman of the Board and Director
/s/ Richard E. BlaneyRichard E. Blaney, Director
/s/ F. Curtis HastingsF. Curtis Hastings, Director
/s/ Regina M. MillnerRegina M. Millner, Director
/s/ Frederic E. MohsFrederic E. Mohs, Director
/s/ John R. NevinJohn R. Nevin, Director
/s/ Donna K. SollenbergerDonna K. Sollenberger, Director
/s/ H. Lee SwansonH. Lee Swanson, Director

Certification Pursuant to Rule 13a-14 and 15d-14 of the Securities Exchange Act of 1934

I, Gary J. Wolter, certify that:

1. I have reviewed this annual report on Form 10-K of MGE Energy, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a. Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b. Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

c. Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a. All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize, and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

/s/ Gary J. Wolter
Chairman, President and Chief Executive Officer
March 26, 2003

Certification Pursuant to Rule 13a-14 and 15d-14 of the Securities Exchange Act of 1934

I, Terry A. Hanson, certify that:

1. I have reviewed this annual report on Form 10-K of MGE Energy, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a. Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b. Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

c. Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a. All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize, and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

/s/ Terry A. Hanson
Vice President, Chief Financial Officer and Secretary
March 26, 2003

Certification Pursuant to Rule 13a-14 and 15d-14 of the Securities Exchange Act of 1934

I, Gary J. Wolter, certify that:

1. I have reviewed this annual report on Form 10-K of Madison Gas and Electric Company.

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a. Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b. Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

c. Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a. All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize, and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

/s/ Gary J. Wolter
Chairman, President and Chief Executive Officer
March 26, 2003

Certification Pursuant to Rule 13a-14 and 15d-14 of the Securities Exchange Act of 1934

I, Terry A. Hanson, certify that:

1. I have reviewed this annual report on Form 10-K of Madison Gas and Electric Company.

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a. Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b. Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

c. Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a. All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize, and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

/s/ Terry A. Hanson
Vice President, Chief Financial Officer and Secretary
March 26, 2003