The primary reason for the lower income was a decrease in electric utility earnings. In addition, other operating expenses increased for all segments. An increased gas utility margin and improved performance at WPS Power Development contributed positively to overall earnings. Contributing to the higher consolidated operating revenues was a 332% increase in gas revenues at WPS Energy Services and a 113% increase in gas utility revenues as a result of higher natural gas prices and sales volume growth.

Overview of Utility Operations

Utility operations include the electric utility operations at Wisconsin Public Service and Upper Peninsula Power, and the gas utility operations at Wisconsin Public Service. Net income from electric utility operations was $14.6 million in the first quarter of 2001 compared with $20.2 million in the first quarter of 2000. Net income from gas utility operations was $8.8 million in the first quarter of 2001 compared with $8.5 million in the same period of 2000.

Electric Utility Operations

The consolidated electric utility margin represents electric revenue less cost of sales exclusive of intercompany transactions. Our consolidated electric utility margin decreased $1.0 million in spite of an increase in Wisconsin retail electric rates. The Public Service Commission of Wisconsin authorized a 5.4% rate increase for Wisconsin Public Service's Wisconsin retail electric customers effective January 1, 2001. The primary reasons for the lower margin were higher fuel and purchased power costs. Also affecting the margin was a change in the customer mix at Wisconsin Public Service. Sales to lower margin, non-firm customers increased more than sales to higher margin customers.

Our consolidated electric utility revenues increased in the first quarter of 2001 as the result of the electric rate increase and a 2% increase in overall sales volumes at Wisconsin Public Service. Sales volumes to Wisconsin Public Services' wholesale customers increased 15%, while sales to residential customers increased 4%.

Our consolidated fuel expense for all production plants increased $5.5 million, or 19%. Of this amount, $3.7 million is the result of increased fuel costs at Wisconsin Public Service's combustion turbine generation plants. Fuel costs at the combustion turbine generation plants increased 126% as the result of higher natural gas prices in the first quarter of 2001. Our consolidated purchased power expense increased $6.7 million, or 43%, largely as a result of a 26% increase in the average cost per kilowatt-hour of purchases coupled with a 12% increase in volumes purchased at Wisconsin Public Service in the first quarter of 2001.

The Public Service Commission of Wisconsin allows Wisconsin Public Service to adjust prospectively the amount billed to Wisconsin retail customers for fuel and purchased power if costs fall outside a specified range. Wisconsin Public Service is required to file an application to adjust rates either higher or lower when costs are plus or minus 2% from forecasted costs on an annualized basis. Forecasted annual 2001 fuel costs at March 31, 2001 are expected to be within this 2% window.

Gas Utility Operations

The consolidated gas utility margin represents gas revenues less purchases exclusive of intercompany transactions. The gas utility margin at Wisconsin Public Service increased $2.4 million, or 8%, for the first quarter of 2001 compared with the first quarter of 2000. This increase was due to a 1.5% increase in Wisconsin retail gas rates authorized by the Public Service Commission of Wisconsin and effective January 1, 2001. While overall gas throughput volumes decreased slightly, gas throughput volumes increased 6% to residential customers and 10% to small commercial and industrial customers.

Weather was normal in the first quarter of 2001, but 9% colder than in the first quarter of 2000. Gas throughput volumes were slightly lower in the first quarter of 2001 due to a 14% decrease in throughput volumes to gas transport customers.

Wisconsin Public Service's gas revenues increased $86.3 million, or 113%, as the result of a 155% increase in the average unit cost of natural gas coupled with the 1.5% increase in Wisconsin retail gas rates.

Wisconsin Public Service's gas purchase costs increased $84.0 million, or 176% due to a higher average cost of gas. Under current regulatory practice, the Public Service Commission of Wisconsin and the Michigan Public Service Commission allow Wisconsin Public Service to pass changes in the cost of gas on to customers through a purchased gas adjustment clause. Therefore, the higher natural gas prices experienced in the first quarter of 2001 were passed on to customers. The higher natural gas prices are reflected in both revenues and gas purchases, thus having little impact on margin.

Other Utility Expenses/Income

Utility operation and maintenance expenses increased $8.3 million largely due to increased payments to the Wisconsin Department of Administration for demand-side management (energy conservation) activities, increased benefit expenses, and higher transmission costs as the result of the establishment of American Transmission Company, LLC. A portion of the higher transmission costs has been deferred for future rate recovery.

Overview of Nonregulated Operations

Nonregulated operations consist of the gas, electric, and other sales at WPS Energy Services, a diversified energy supply and services company and the operations of WPS Power Development, an electric generation asset development company.

WPS Energy Services' net income was $0.2 million in the first quarter of 2001 compared with $0.5 million in the same period of 2000. WPS Power Development's net income was $1.7 million in the first quarter of 2001 compared with $1.0 million in the first quarter of 2000.

Overview of WPS Energy Services

WPS Energy Services' principal business involves nonregulated gas sales. Revenues at WPS Energy Services grew to $634.2 million in the first quarter of 2001 compared with $146.0 million in the first quarter of 2000, an increase of 334%.

WPS Energy Services' Margins

The consolidated nonregulated gas margin represents nonregulated gas revenues less nonregulated gas cost of sales exclusive of intercompany transactions. The nonregulated gas margin at WPS Energy Services decreased $0.7 million due to some favorable wholesale transactions in the first quarter of 2000 which did not reoccur in the first quarter of 2001.

Gas revenues increased as the result of higher natural gas prices in the first quarter of 2001 and additional growth in both retail and wholesale activity.

Nonregulated electric sales at WPS Energy Services increased $15.3 million, and the nonregulated electric margin increased $0.9 million. Higher electric sales volumes in Maine contributed to these increases.

WPS Energy Services' Other Expenses

Operating expenses at WPS Energy Services increased $0.8 million in the first quarter of 2001 compared with the first quarter of 2000 due to greater payroll and other operational costs associated with business expansion.

WPS Energy Services' Price Risk Management Activities

WPS Energy Services began to mark to market its energy contracts in the first quarter of 2000. At March 31, 2001, WPS Energy Services had "Assets from Risk Management Activities" of $218.9 million which represents receivables based on the fair value of energy contracts and had "Liabilities from Risk Management Activities" of $214.1 million which represents payables based on the fair value of energy contracts. Net changes in the fair market value of energy contracts are reported in nonregulated energy cost of sales.

Overview of WPS Power Development

WPS Power Development's net income increased to $1.7 million in the first quarter of 2001 compared with $1.0 million in the first quarter of 2000. The increase in income was primarily due to additional tax credits of approximately $3.5 million from its ECO #12 synthetic fuel operation. Additional tax credits have significantly reduced the tax rate in the first quarter of 2001. Partially offsetting the additional tax credits were a lower margin on operating activities and higher operating expenses.

WPS Power Development experienced a decrease of $2.0 million in its margin on operating activities in the first quarter of 2001. This decrease was due to costs associated with higher fuel and purchased power at its Sunbury generation plant. Other operating expenses at WPS Power Development increased $3.3 million due to accelerated maintenance activities at the Sunbury plant.

Overview of Holding Company and Other Operations

Holding Company and Other operations include the operations of WPS Resources and WPS Resources Capital as holding companies and the activities at Wisconsin Public Service and Upper Peninsula Power that are nonutility. Holding Company and Other operations experienced a loss of $1.7 million in the first quarter of 2001 compared with a loss of $1.0 million in the first quarter of 2000. The increased loss was primarily due to additional interest expense at WPS Resources due to increased short-term financing to provide capital for working capital needs.

Wisconsin Public Service recognized a one-time before-tax gain of $0.8 million on the sale of property in the first quarter of 2001.

FINANCIAL CONDITION - WPS RESOURCES

Investments and Financing

Payments for return of capital of $10.0 million were paid by Wisconsin Public Service to WPS Resources in the first three months of 2001. Equity infusions of $15.0 million were made by WPS Resources to Wisconsin Public Service in the first three months of 2001. These payments and equity infusions allowed Wisconsin Public Service's average equity capitalization and its capitalization ratio for ratemaking to remain near target levels as established by the Public Service Commission of Wisconsin in its most recent rate order.

Cash requirements exceeded internally generated funds by $8.3 million in the first three months of 2001. Short-term borrowings through commercial paper increased $3.3 million. Our pretax interest coverage, including nonrecourse debt, was 2.03 times for the 12 months ended March 31, 2001. See the table below for WPS Resources' credit ratings.