WISCONSIN ELECTRIC POWER CO - Quarter Report: 2002 March (Form 10-Q)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

Indicate by check mark whether the Registrant (1) has 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 each Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes [X]    No [  ]

Indicate the number of shares outstanding of each of the Registrant's classes of common stock as of the latest practicable date (April 30, 2002):

Wisconsin Energy Corporation is the sole holder of Wisconsin Electric Power Company Common Stock.

Wisconsin Electric Power Company ("Wisconsin Electric" or "the Company"), a wholly-owned subsidiary of Wisconsin Energy Corporation ("Wisconsin Energy"), is an electric, gas and steam utility with operations in Wisconsin and the Upper Peninsula of Michigan.

In April 2002, Wisconsin Energy introduced a single, unified trade name, "We Energies" for the operations of Wisconsin Electric and its affiliate, Wisconsin Gas Company ("Wisconsin Gas"), a wholly-owned subsidiary of Wisconsin Energy. Through the We Energies trade name, Wisconsin Energy intends to create a strong, unified utility branding that will represent Wisconsin Energy's brand and products and reinforce the core attributes of the organization. Under the new name, the Company offers customers the ability to meet all of their energy needs with one call. In addition, some of the new services being introduced to customers include automated meter reading, a portfolio of power quality services, and faster, more complete information during storm outages.

The unaudited interim financial statements presented in this Form 10-Q have been prepared by Wisconsin Electric pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. Wisconsin Electric's financial statements should be read in conjunction with the financial statements and notes thereto included in Wisconsin Electric's 2001 Annual Report on Form 10-K.

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

Wisconsin Electric Power Company, a wholly-owned subsidiary of Wisconsin Energy Corporation, is an energy utility with electric, natural gas and steam utility operations.

Cautionary Factors:   A number of forward-looking statements are included in this document. When used, the terms "anticipate," "believe," "estimate," "expect," "forecast," "objective," "plan," "possible," "potential," "project" and similar expressions are intended to identify forward-looking statements. Forward-looking statements are subject to certain risks, uncertainties and assumptions which could cause actual results to differ materially from those that are described, including the factors that are noted throughout this document and below in "Factors Affecting Results, Liquidity and Capital Resources".

Earnings increased by $3.7 million or 5.9% in the first quarter of 2002 compared with the first quarter of 2001, primarily reflecting improved recovery of electric fuel and purchased power costs and reduced operating and interest costs, partially offset by reduced total gas margin and costs associated with the redemption of $103.4 million of long-term debt with a weighted average interest rate of 8.4%. The Company's total revenues decreased by $119.9 million or 17.0% in the first quarter of 2002 compared to first quarter 2001. The primary reason for this decline is a $106.3 million decrease in revenues from the gas utility segment, reflecting the decline in purchased gas costs that flow through to customers and do not impact margin.

During the first quarter of 2002, total electric utility operating revenues decreased by $12.7 million or 2.8% when compared with the first quarter of 2001, reflecting a decrease due to lower overall electric megawatt-hour sales during the first quarter of 2002 resulting from the effects of a soft economy and warmer winter weather partially offset by higher retail electric rates under Wisconsin's fuel cost adjustment procedure that became effective in February and May 2001.As measured by heating degree days, the first quarter of 2002 was 11.1% warmer than the first quarter of 2001 and 8.7% warmer than normal.

Electric gross margin increased 1.2% between the comparative periods primarily due to lower fuel and purchased power costs, which more than offset the decline in revenues. Between the comparative periods, total fuel and purchased power expenses decreased primarily due to significantly higher natural gas prices during 2001 and, to a lesser extent, due to higher demand charges associated with long-term power purchase contracts in effect during 2001.

The following table compares Wisconsin Electric's electric utility operating revenues and electric utility megawatt-hour sales by customer class during the first quarter of 2002 with similar information for the first quarter of 2001.

As noted above, total electric megawatt-hour sales fell by 10.1% during the first quarter of 2002 reflecting a soft economy that is primarily affecting large commercial/industrial customers such as Wisconsin Electric's largest customers, two iron ore mines. Sales to these customers decreased by 320 thousand megawatt-hours or 51.8% between the comparative periods. Excluding these two mines, Wisconsin Electric's total electric energy sales decreased by 6.5% and sales volumes to the remaining large commercial/industrial customers fell by 4.3% between the comparative periods. Sales for resale to other utilities, the Resale-Utilities customer class, declined 59.6% between the periods due to a reduced demand for wholesale power purchases.

A comparison follows of Wisconsin Electric's gas utility operating revenues, gross margin and gas deliveries during the first quarter of 2002 with similar information for the first quarter of 2001. Gross margin is a better performance indicator than revenues because changes in the cost of gas sold flow through to revenue under gas cost recovery mechanisms that do not impact gross margin. Due primarily to a significant decline in the delivered cost of natural gas between the comparative periods, gas operating revenues declined by $106.3 million or 42.7% offset by a $103.2 million or 54.4% decrease in purchased gas costs.

For the three months ended March 31, 2002, gas margin declined by $3.1 million or 5.3% when compared to the three months ended March 31, 2001 due primarily to a weather-related decline in therm deliveries, especially to residential customers who are more weather sensitive and contribute higher margins per therm than other customer classes. As measured by heating degree days, the first quarter of 2002 was 11.1% warmer than the first quarter of 2001 and 8.7% warmer than normal. The negative impact of weather on total gas margin during 2002 was partially offset by a rate increase that became effective December 20, 2001.

The following table compares Wisconsin Electric's gas utility gross margin and natural gas therm deliveries by customer class during the first quarter of 2002 with similar information for the first quarter of 2001.

Other Operation and Maintenance Expenses:   Other operation and maintenance expenses decreased by $5.5 million or 3.1% during the first quarter of 2002 when compared with the first quarter of 2001. The decrease primary resulted from tight control of operating and maintenance costs and operational efficiencies gained from Wisconsin Energy's acquisition of WICOR on April 26, 2000. During the latter part of 2001, the Company and Wisconsin Gas finalized the consolidation of customer service functions including billing and call center operations. These reductions more than offset cost increases in other areas of the Company including employee benefits costs.

Other Income and Deductions:   Other Income and Deductions decreased by $6.4 million or 71.1% during the first quarter of 2002 due primarily to one-time costs of $5.3 million ($3.5 million net of tax) from the early extinguishment of $103.4 million of long-term debt with a weighted average interest rate of 8.4%.

Financing Costs:   Financing costs decreased by $4.8 million or 16.5% during the first quarter of 2002 due to lower outstanding short-term and long-term debt due in part to the receipt of $100 million related to the Giddings & Lewis, Inc./City of West Allis Lawsuit plus accrued interest, and due to lower interest rates.

The following summarizes Wisconsin Electric's cash flows during the first three months of 2002 and 2001:

Cash provided by operating activities increased to $309.8 million during the first three months of 2002 compared with $198.0 million during the same period in 2001. This increase was due partially to the return of $100 million deposit plus accrued interest income as a result of a favorable court ruling (See Note 7). The Company is expected to pay income taxes of approximately $47.1 million related to the return of the deposit. In addition, lower energy prices and warm winter weather during the first quarter of 2002 reduced working capital needs.

During the first three months of 2002, Wisconsin Electric invested a total of $81.2 million on investing activities including total capital expenditures of $67.5 million for utility plant. Due to timing of refueling outage schedules at Point Beach Nuclear Plant between the comparative periods, the Company spent $10.2 million more on the acquisition of nuclear fuel between the comparative periods.

During the three months ended March 31, 2002, Wisconsin Electric used $237.6 million of net cash for financing activities compared with $103.6 million during the first three months of 2001, including approximately $80.4 million to reduce short-term debt, $103.4 million for the early retirement of long-term debt and $44.9 million for the payment of dividends to Wisconsin Energy.

Cash requirements during the remaining nine months of 2002 are expected to be met through a combination of internal sources of funds from operations and through short-term borrowings supplemented, if necessary, through the sale of debt securities.

The Company has access to outside capital markets and has been able to generate funds internally and externally to meet its capital requirements. Wisconsin Electric's ability to attract the necessary financial capital at reasonable terms is critical to the Company's overall strategic plan. Wisconsin Electric believes that it has adequate capacity to fund its operations for the foreseeable future through its borrowing arrangements and internally generated cash.

On March 31, 2002, Wisconsin Electric had $220.7 million of total available unused short-term borrowing capacity under their existing commercial paper program and other short-term borrowing arrangements. On that date, Wisconsin Electric had $250.0 million of available unused lines of bank credit to support its outstanding commercial paper program and other short-term borrowing arrangements.

The following table shows Wisconsin Electric's capitalization structure at March 31, 2002 and at December 31, 2001:

Access to capital markets at a reasonable cost is determined in large part by credit quality. The following table summarizes the current ratings of the debt securities of Wisconsin Electric by Standard & Poors Corporation ("S&P"), Moody's Investors Service ("Moody's") and Fitch.

S&P's, Moody's and Fitch's current outlook for Wisconsin Electric is stable.

Wisconsin Electric believes these ratings should provide a significant degree of flexibility in obtaining funds on competitive terms. However, these security ratings reflect the views of the rating agencies. An explanation of the significance of these ratings may be obtained from each rating agency. Such ratings are not a recommendation to buy, sell or hold securities, but rather an indication of creditworthiness. Any rating can be revised upward or downward or withdrawn at any time by a rating agency if it decides that the circumstances warrant the change. Each rating should be evaluated independently of any other rating.

Capital requirements during the remainder of 2002 are expected to be principally for capital expenditures, for long-term debt retirements, and for the purchase of nuclear fuel. Wisconsin Electric's annual capital expenditure budget for 2002 is approximately $370 million.

Wisconsin Electric is a party to various financial instruments with off-balance sheet risk as a part of its normal course of business, which may include, from time to time, financial guarantees and letters of credit which support construction projects, commodity contracts and other payment obligations. As of March 31, 2002, the Company's estimated maximum exposure under such agreements has not changed significantly compared to December 31, 2001. In addition, the Company believes the likelihood is remote that material payments will be required under these agreements.

Total contractual obligations and other commercial commitments for Wisconsin Electric as of March 31, 2002 declined compared with December 31, 2001 due to the early extinguishment of $103.4 million of long-term debt and normal periodic payments related to these types of obligations. There were no significant new contracts entered into in the first quarter of 2002. Obligations for utility operations by Wisconsin Electric have historically been included as part of the rate making process and were therefore generally recoverable from customers.

Power the Future Strategy:   Implementation of Wisconsin Energy's Power the Future strategy is subject to a number of regulatory approvals. On February 1, 2002, Wisconsin Energy filed for Certificates of Public Convenience and Necessity ("CPCN") with the Public Service Commission of Wisconsin ("PSCW") for a generating facility at the Port Washington Power Plant site and a generating facility at the Oak Creek Power Plant site, a certificate for a gas lateral to serve the Port Washington plant and related affiliated interest approvals. Supplemental information requested by the PSCW was filed in April 2002. On April 9, 2002 the PSCW authorized the bifurcation of its consideration of Wisconsin Energy's CPCN application along the lines of fuel source. On April 25, 2002, the PSCW determined that Wisconsin Energy's CPCN application with respect to the gas-based generation facilities to be constructed in the City of Port Washington, Wisconsin was complete. Wisconsin Energy anticipates filing additional material with the PSCW in May, 2002 related to the coal-based generating facilities proposed in their CPCN application at the Oak Creek Power Plant site. Wisconsin Energy expects that the PSCW will make a decision on the Port Washington generating station by the end of 2002. Wisconsin Energy does not anticipate the PSCW will complete its consideration of the proposal for the coal-based generation facilities until mid 2003. Wisconsin Energy continues to work with the PSCW and the Wisconsin Department of Natural Resources to obtain all required permits and project approvals.

Point Beach Nuclear Plant:   In August 2001, the United States Nuclear Regulatory Commission ("NRC") issued Bulletin 2001-01, Circumferential Cracking of Reactor Pressure Vessel Head Penetration Nozzles, requesting that pressurized water reactor licensees provide information on the structural integrity of the subject nozzles. Nuclear Management Company, LLC ("NMC"), which operates the two unit Point Beach Nuclear Plant owned by Wisconsin Electric, responded that tests and inspections conducted at Point Beach over the last several years had not identified any evidence of such cracking. NMC also responded to the March 2002 NRC Bulletin 2002-01, Reactor Pressure Vessel Head Degradation And Reactor Coolant Pressure Boundary Integrity, providing information on the structural integrity of the reactor vessel head and a basis for concluding that the vessel head will continue to perform its function as a coolant pressure boundary.

During the Spring 2002 Point Beach Unit 2 refueling outage, NMC conducted a more thorough inspection of the reactor pressure vessel head which showed no evidence of leakage. NMC will conduct a more thorough inspection of the reactor pressure vessel head on Point Beach Unit 1 during the Fall 2002 refueling outage.

On April 8, 2002, the NRC issued a preliminary red finding for Point Beach related to the plant's auxiliary feedwater system. In November 2001, as part of comprehensive risk assessment, plant employees had discovered the potential for a common mode failure in the plant's auxiliary feed pumps. The matter was immediately reported to the NRC and prompt interim corrective actions were implemented. Point Beach has updated its procedures to ensure operators have explicit guidance that matches training and to ensure plant personnel take appropriate actions when necessary. In addition, backup air supplies for the valves have been installed. As part of the normal regulatory review process, NMC attended a NRC regulatory conference on April 29, 2002 and offered information to support NMC's request for closure of this issue without further NRC action. The Company expects a decision from the NRC within one month.

This report and other documents or oral presentations contain or may contain forward-looking statements made by or on behalf of Wisconsin Electric. Such statements are based upon management's current expectations and are subject to risks and uncertainties that could cause Wisconsin Electric's actual results to differ materially from those contemplated in the statements. Readers are cautioned not to place undue reliance on the forward-looking statements. When used in written documents or oral presentations, the terms "anticipate," "believe," "estimate," "expect," "forecast," "objective," "plan," "possible," "potential," "project" and similar expressions are intended to identify forward-looking statements. In addition to the assumptions and other factors referred to specifically in connection with such statements, factors that could cause Wisconsin Electric's actual results to differ materially from those contemplated in any forward-looking statements include, among others, the following:

• Factors affecting utility operations such as unusual weather conditions; catastrophic weather-related or terrorism-related damage; availability of electric generating facilities; unscheduled generation outages, or unplanned maintenance or repairs; unanticipated changes in fossil fuel, nuclear fuel, purchased power, gas supply or water supply costs or availability due to higher demand, shortages, transportation problems or other developments; nonperformance by electric energy or natural gas suppliers under existing power purchase or gas supply contracts; nuclear or environmental incidents; resolution of used nuclear fuel storage and disposal issues; electric transmission or gas pipeline system constraints; unanticipated organizational structure or key personnel changes; collective bargaining agreements with union employees or work stoppages; inflation rates; or demographic and economic factors affecting utility service territories or operating environment.

• Regulatory factors such as unanticipated changes in rate-setting policies or procedures; unanticipated changes in regulatory accounting policies and practices; industry restructuring initiatives; transmission system operation and/or administration initiatives; recovery of costs of previous investments made under traditional regulation; required changes in facilities or operations to reduce the risks or impacts of potential terrorist activities; required approvals for new construction; changes in the United States Nuclear Regulatory Commission's regulations related to Point Beach Nuclear Plant; changes in the United States Environmental Protection Agency's regulations as well as regulations from the Wisconsin or Michigan Departments of Natural Resources related to emissions from fossil-fueled power plants such as carbon dioxide, sulfur dioxide, nitrogen oxide, small particulates or mercury; or the siting approval process for new generation and transmission facilities.

• Unexpected difficulties or unanticipated effects of the qualified five-year electric and gas rate freeze ordered by the Public Service Commission of Wisconsin as a condition of its approval in 2000 of the merger of Wisconsin Energy Corporation and WICOR, Inc.

• The rapidly changing and increasingly competitive electric and gas utility environment as market-based forces replace strict industry regulation and other competitors enter the electric and gas markets resulting in increased wholesale and retail competition.

• Consolidation of the industry as a result of the combination and acquisition of utilities in the Midwest, nationally and globally.

• Changes in social attitudes regarding the utility and power industries.

• Customer business conditions including demand for their products or services and supply of labor and material used in creating their products and services.

• The cost and other effects of legal and administrative proceedings, settlements, investigations and claims, and changes in those matters, including the final outcome of the Giddings & Lewis, Inc./City of West Allis lawsuit against Wisconsin Electric.

• Factors affecting the availability or cost of capital such as: changes in interest rates; the Company's capitalization structure; market perceptions of the utility industry or the Company; or security ratings.

• Federal, state or local legislative factors such as changes in tax laws or rates; changes in trade, monetary and fiscal policies, laws and regulations; electric and gas industry restructuring initiatives; or changes in environmental laws and regulations.

• Authoritative generally accepted accounting principle or policy changes, such as adoption of SFAS 143, Accounting for Asset Retirement Obligations, from such standard setting bodies as the Financial Accounting Standards Board and the Securities and Exchange Commission.

• Unanticipated technological developments that result in competitive disadvantages and create the potential for impairment of existing assets.

• Factors which impede execution of Wisconsin Energy's Power the Future strategy announced in September 2000 and revised in February 2001, including receipt of necessary state and federal regulatory approvals local opposition to siting of new generating facilities and obtaining the investment capital from outside sources necessary to implement the strategy.

• Other business or investment considerations that may be disclosed from time to time in Wisconsin Electric's Securities and Exchange Commission filings or in other publicly disseminated written documents.

Wisconsin Electric undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

*****

For certain other information which may impact Wisconsin Electric's future financial condition or results of operations, see Item 1, Financial Statements -- "Notes to Condensed Financial Statements," in Part I of this report as well as Item 1, Legal Proceedings, in Part II of this report.

For information concerning market risk exposures, see Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations -- "Factors Affecting Results, Liquidity and Capital Resources -- Market Risks and Other Significant Risks," in Part II of Wisconsin Electric's 2001 Annual Report on
Form 10-K.

The following should be read in conjunction with Item 3, Legal Proceedings, in Part I of Wisconsin Electric's 2001 Annual Report on Form 10-K.

Giddings & Lewis, Inc./City of West Allis Lawsuit:   See Note 7 in Item 1, Financial Statements -- "Notes to Condensed Financial Statements" in Part I of this report for information concerning recent developments related to the Giddings & Lewis, Inc./City of West Allis lawsuit which information is incorporated herein by reference.

Power the Future:   See Item 2, Management's Discussion & Analysis of Finance Condition and Results of Operations-" Factors Affecting Results, Liquidity and Capital Resources" in Part I of this report for information concerning recent PSCW actions related to Wisconsin Energy's Power the Future strategy.

At Wisconsin Electric's 2002 Annual Meeting of Stockholders held on April 26, 2002 for which Wisconsin Electric did not solicit proxies, nine incumbent directors, as listed in Wisconsin Electric's Information Statement dated March 20, 2002, were elected for one year terms. Each director received 33,289,327 votes (100% of votes cast). Directors are elected by a plurality of the votes cast by the shares entitled to vote. Any shares not voted, whether by withheld authority, broker non-votes or otherwise, have no effect in the election of directors. There was no solicitation in opposition to the nominees proposed in the Information Statement.

Further information concerning these matters is contained in Wisconsin Electric's Information Statement.

The following Exhibits are filed with or incorporated by reference in this Form 10-Q report:

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.