We have prepared the consolidated financial statements of WPS Resources Corporation and Wisconsin Public Service Corporation under the rules and regulations of the Securities and Exchange Commission. These financial statements have not been audited. Management believes that these financial statements include all normal recurring adjustments which are necessary for a fair presentation of the financial results for each period shown. Certain items from the prior period have been reclassified to conform with the current year presentation. We have condensed or omitted certain financial information and footnote disclosures normally included in our Annual Report on Form 10-K. We believe that the disclosures made are adequate to make the information presented not misleading. These financial statements should be read along with the financial statements and notes included with our Annual Report on Form 10-K for the year ended December 31, 2002.

We consider short-term investments with an original maturity of three months or less to be cash equivalents.

 

(Millions)	Three Months Ended March 31
WPS Resources	2003	2002
Cash paid for interest	$11.2	$11.0
Cash paid for income taxes	4.8	12.4
Wisconsin Public Service
Cash paid for interest	$ 9.1	$ 9.1
Cash paid for income taxes	5.3	6.7

There were no noncash investing and financing activities during the first three months of 2003 and 2002 at WPS Resources or Wisconsin Public Service.

As part of our regular operations, WPS Resources enters into contracts, including options, swaps, futures, forwards, and other contractual commitments to manage market risks such as changes in commodity prices, interest rates, and foreign currency exchange rates.

WPS Resources evaluates its contracts in accordance with Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." Statement No. 133 establishes accounting and financial reporting standards for derivative instruments and requires, in part, that we recognize certain derivative instruments on the balance sheet as assets or liabilities at their fair value. Subsequent changes in fair value of the derivatives are recorded currently in earnings unless certain hedge accounting criteria are met or the derivatives qualify for regulatory deferral subject to the provisions of Statement No. 71, "Accounting for the Effects of Certain Types of Regulation."

Our regulated utility segments have entered into a limited number of natural gas purchase agreements and electric purchase and sale contracts to service customers that are accounted for as derivatives. Management believes any gains or losses resulting from the eventual settlement of these contracts will be collected from or refunded to customers. The Public Service Commission of Wisconsin approved the recording of derivative amounts as a result of these contracts to a regulatory asset or liability pursuant to Statement No. 71. As of March 31, 2003, we have recorded an Asset from risk management activities of $9.0 million and a Liability from risk management activities of $0.1 million on the Consolidated Balance Sheets related to these contracts. We recorded an Asset from risk management activities of $1.4 million and a Liability from risk management activities of $0.7 million related to these contracts at December 31, 2002.

Our nonregulated segments have also entered into contracts that are accounted for as derivatives under Statement No. 133. At March 31, 2003, those derivatives not designated as hedges are primarily commodity contracts entered into to manage price risk associated with wholesale and retail natural gas purchase and sale activities and electric energy contracts. Changes in the fair value of the nonregulated segments' non-hedge derivatives are recognized currently in earnings. At March 31, 2003, the fair value of these contracts is recorded as an Asset from risk management activities of $472.4 million and a Liability from risk management activities of $469.4 million on the Consolidated Balance Sheets. At December 31, 2002, we recorded an Asset from risk management activities of $25.5 million and a Liability from risk management activities of $23.2 million, for those commodity contracts entered into after October 25, 2002 that qualified as derivatives and were not designated as hedges. At December 31, 2002, WPS Energy Services' commodity contracts entered into before October 25, 2002 were accounted for as energy trading contracts under Emerging Issues Task Force Issue 98-10, "Accounting for Contracts Involved in Energy Trading and Risk Management Activities." All contracts that meet the definition of a derivative entered into subsequent to October 25, 2002, were accounted for in accordance with Statement No. 133.  At March 31, 2003 all commodity contracts that meet the definition of a derivative are accounted for in accordance with Statement No. 133. See the last paragraph of this note for further discussion of the transition from Issue 98-10 to Statement No. 133.

Our nonregulated segments also enter into derivative contracts that are designated as both fair value and cash flow hedges. At March 31, 2003 and December 31, 2002, those contracts designated as fair value hedges were not significant. Cash flow hedges at our nonregulated segments consist of commodity contracts associated with our energy marketing activities and an interest rate swap. At March 31, 2003, the fair value of commodity contracts designated as cash flow hedges is recorded as an Asset from risk management activities of $16.7 million and a Liability from risk management activities of $3.9 million on the Consolidated Balance Sheets. Cash flow hedges related to these commodity contracts extend through December 2005. The majority of the commodity contracts were determined to be perfectly effective; therefore, the changes in the values to these contracts are included in Other comprehensive income, net of deferred taxes. Amounts recorded in Other comprehensive income related to these cash flow hedges will be recognized in earnings as the related contracts are settled or if hedge accounting treatment is discontinued. The portion of these contracts that was determined to be ineffective was not significant and was recorded in Nonregulated cost of fuel, gas, and purchased power on the Consolidated Statements of Income. When testing for effectiveness, no portion of the derivative instrument's loss was excluded. At December 31, 2002, those commodity contracts designated as cash flow hedges were not significant.

The interest rate swap designated as a cash flow hedge is used to fix the interest rate for the full term of a variable rate loan that is due in March 2018. At March 31, 2003 and December 31, 2002, we recorded a Liability from risk management activities of $12.7 million on the Consolidated Balance Sheet related to this swap. Because the swap was determined to be perfectly effective, the changes in the value of this contract are included in Other comprehensive income, net of deferred taxes. We did not exclude any components of the derivative instrument's loss from the assessment of hedge effectiveness.

WPS Energy Services began applying Issue 98-10 in the first quarter of 2000 due to changes in strategic focus that resulted in a shift in customer mix. Issue 98-10 required all contracts to be recorded at fair value on the balance sheet, with changes in fair value included in earnings. In October 2002, the Emerging Issues Task Force issued Issue 02-03, "Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities," that rescinded Issue 98-10. The rescission of Issue 98-10 was effective immediately for all energy contracts entered into after October 25, 2002. The rescission of Issue 98-10 was effective January 1, 2003 for contracts entered into on or prior to October 25, 2002. All contracts have been evaluated using Statement No. 133 and those that meet the definition of a derivative are included in the above discussion of our nonregulated segments. The impact of the rescission of Issue 98-10 on contracts has been recorded as a cumulative effect of change in accounting principle of $3.3 million (after taxes), which was reflected as an increase to income in the first quarter of 2003. The cumulative effect of adopting Statement No. 133 was partially offset in net income by associated changes in WPS Energy Services' margins, for a positive net after-tax impact of approximately $1 million in the first quarter of 2003. This cumulative effect represents the reversal of the risk management assets and liabilities for those contracts that are not derivatives or that are designated as normal pursuant to Statement No. 133 that were recorded on WPS Energy Services' financial statements at December 31, 2002 pursuant to Issue 98-10. Implementation of Issue 02-03 has not changed the economics or cash flows of the underlying transactions.

Upon adoption, Issue 02-03 also required revenues related to derivative instruments classified as trading to be reported net of related cost of sales for all periods presented. Prior to January 1, 2003, WPS Energy Services classified all its activities as trading in accordance with the accounting standards in effect at that time (Issue 98-10). Consistent with the new accounting standards under Issue 02-03, effective January 1, 2003, WPS Energy Services classifies as trading activities only those transactions that at inception are intended to be settled in the near term. As a result of the change in the definition of trading, a larger portion of WPS Energy Services' business activities were classified as trading in 2002 than in 2003. Previously reported trading revenues related to derivatives for 2002 have been reclassified using net reporting while the majority of 2003 revenues continue to be reported on a gross basis. Thus, the revenues and cost of sales for more activities are reported on a gross basis, rather than a net basis, in 2003 than in 2002, as reclassified. The retroactive reclassification to net revenues and cost of sales for 2002 trading activities resulted in a $274.2 million decrease to WPS Resources' previously reported first quarter 2002 consolidated nonregulated revenues and a corresponding $274.2 million decrease to previously reported first quarter 2002 nonregulated cost of fuel, gas, and purchased power. Neither margins nor net income for 2002 were impacted by the reclassification of revenue upon adoption of Issue 02-03.

Wisconsin Public Service recorded $36.1 million of goodwill in its natural gas segment related to its merger with Wisconsin Fuel and Light in April 2001. On January 1, 2002, WPS Resources adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," and amortization of the goodwill was discontinued. There was no impairment of goodwill upon adoption of Statement No. 142. Wisconsin Public Service has elected to perform its annual impairment test during the second quarter of each year. There was no impairment in the second quarter of 2002.

Wisconsin Public Service transferred from a regulatory acquisition premium previously classified as Property, plant and equipment $0.9 million to goodwill, as a result of a rate order received in March 2003 from the Public Service Commission of Wisconsin. The increase in goodwill reflects an adjustment to the amount of recoverable goodwill recorded from the Wisconsin Fuel and Light merger allowed by the Public Service Commission of Wisconsin.

Goodwill and purchased intangible assets are included in Other Assets on the Consolidated Balance Sheets. Information in the tables below relates to total purchased intangible assets for the periods indicated.

Aggregate Amortization Expense:
For quarter ended March 31, 2003 $1.1 million

Effective January 1, 2003, WPS Resources adopted Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations." Under the new accounting standard, WPS Resources recognizes, at fair value, legal obligations associated with the retirement of tangible long-lived assets that result from the acquisition, construction or development and/or normal operation of the asset. The associated retirement costs are capitalized as part of the related long-lived asset and depreciated over the useful life of the asset. For the regulated segment of WPS Resources, we believe it is probable that any differences between expenses under Statement No. 143 and expenses currently recovered through customer rates will be recoverable in future customer rates. Accordingly, the adoption of this statement had no impact on the regulated segment income as the effects were offset by the establishment of regulatory assets or liabilities pursuant to Statement No. 71.

Legal retirement obligations identified for the regulated segments of WPS Resources relate primarily to the final decommissioning of our Kewaunee nuclear plant. WPS Resources has a legal obligation to decommission the radiated portions of the Kewaunee nuclear plant in accordance with the Nuclear Regulatory Commission's minimum decommissioning requirements. We have also identified other legal retirement obligations related to utility plant assets that are not currently significant to the financial statements. Upon implementation of Statement No. 143, we reclassified previously recorded liabilities of $290.5 million from Accumulated Depreciation and capitalized a net asset retirement cost of $90.8 million, resulting in an increase in net Property, plant and equipment of $381.3 million. The difference of $56.5 million between previously recorded liabilities and the liability recorded as a result of adopting Statement No. 143 was deferred as a regulatory liability.

The nonregulated segments of WPS Resources have identified a legal retirement obligation related to the closure of an ash basin located at the Sunbury generating facility. Upon implementation of Statement No. 143, the nonregulated segments of WPS Resources recorded an increase in net Property, plant, and equipment of $1.4 million, a liability of $2.0 million, and a cumulative effect of adoption after tax which reduced net income by $0.3 million in the first quarter of 2003. The following table describes all changes to the asset retirement obligation liabilities of WPS Resources.

 

(Millions)	Regulated	Nonregulated	Total
Asset retirement obligations at beginning of year	$       -	$   -	$       -
Liability recognized in transition	324.8	2.0	326.8
Accretion expense	4.7	-	4.7
Asset retirement obligation at March 31, 2003	$329.5	$2.0	$331.5

The following pro forma liabilities reflect amounts as if Statement No. 143 had been applied during all periods presented:

Pro forma net income and earnings per share have not been presented for the periods ended March 31, 2003 and 2002 because the pro forma application of Statement No. 143 to prior periods would result in pro forma net income and earnings per share not materially different from the actual amounts reported for those periods in the Consolidated Statements of Income.

The regulated segments of WPS Resources recognize removal costs for utility assets as a component of depreciation expense in accordance with regulatory treatment. These costs do not have associated legal retirement obligations and, therefore, are outside the scope of Statement No. 143. At March 31, 2003, there was approximately $175 million of removal costs included in Accumulated Depreciation.

Shareholders approved the WPS Resources Corporation 2001 Omnibus Incentive Compensation Plan and the WPS Resources Corporation 1999 Stock Option Plan for certain management personnel. The Board of Directors approved the WPS Resources Corporation 1999 Non-Employee Directors Stock Option Plan. WPS Resources accounts for these plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (Opinion 25), and related Interpretations. No stock option-based compensation cost is reflected in net income, as all options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if WPS Resources had applied the fair value recognition provisions of Statement of Financial Accounting Standards Statement No. 123, "Accounting for Stock Based Compensation," to stock option-based employee compensation:

 

	Three Months Ended March 31
(Millions, except per share amounts)	2003	2002
Income available for common shareholders	$33.0	$28.1
Deduct: Total stock option-based employee compensation expense determined under fair value based method for all awards, net of related tax effects	(0.1)	(0.1)
Pro forma income	$32.9	$28.0
Basic earnings per common share
As reported	$ 1.03	$ 0.89
Pro forma	1.02	0.89
Diluted earnings per common share
As reported	$ 1.02	$ 0.89
Pro forma	1.02	0.89

NOTE 8--COMPREHENSIVE INCOME

Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income," requires the reporting of other comprehensive income in addition to income available for common shareholders. Total comprehensive income includes all changes in equity during a period except those resulting from investments by shareholders and distributions to shareholders. Total comprehensive income includes income available for common shareholders, unrealized gains and losses on securities classified as available-for-sale, changes in the fair value of interest rate swaps, and foreign currency translation adjustments. WPS Resources' total comprehensive income is:

The following table shows the changes to Other Comprehensive Income from December 31, 2002 to March 31, 2003.

We have reviewed the status of our commitments and have discussed material changes from the disclosures made in our Annual Report on Form 10-K for the year ended December 31, 2002 below. See WPS Resources' Notes to Consolidated Financial Statements Note 15--Commitments and Contingencies in our Annual Report on Form 10-K for the year ended December 31, 2002 for specific details.

In accordance with Nuclear Regulatory Commission industry requirements, during the completed spring 2003 refueling outage, a visual inspection of the Kewaunee plant reactor vessel head was conducted. There were no problems with the vessel head during the most recently completed operating cycle.

After evaluating the cost of continued required inspections of the existing reactor vessel head and the cost to replace the reactor vessel head, the Kewaunee plant owners submitted a construction authorization request to the Public Service Commission of Wisconsin for replacement of the reactor vessel head. Approval of the request was received in 2003. The replacement is scheduled to occur during the fall 2004 refueling outage at a cost of approximately $12 million to Wisconsin Public Service.

Earnings per share is computed by dividing net income available for common shareholders for the period by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income available for common shareholders for the period by the weighted average number of shares of common stock outstanding during the period adjusted for the exercise and/or conversion of all potentially dilutive securities. Such dilutive items include in-the-money stock options. Diluted earnings per share for the periods shown are calculated excluding some stock option plan shares that had an anti-dilutive effect. The number of anti-dilutive shares is immaterial at March 31, 2003 and 2002. The following table reconciles the computation of basic and diluted earnings per share: