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Earnings Conference Call - First Quarter 2007

by Larry L. Weyers
President and Chief Executive Officer

Joseph P. O'Leary
Senior Vice President and Chief Financial Officer

Phil Mikulsky
Executive Vice President and Chief Development Officer

and

Mark A. Radtke
President - Integrys Energy Services

and

Donna M. Sheedy
Manager - Investor Relations

Good afternoon. Welcome to Integrys Energy Group's 2007 first quarter earnings conference call. With me today are Larry Weyers, President and Chief Executive Officer; Joe O'Leary, our Senior Vice President and Chief Financial Officer; Phil Mikulsky, our Executive Vice President and Chief Development Officer; and Mark Radtke, President of our nonregulated subsidiary, Integrys Energy Services.

Today we will outline our expectations for 2007 and 2008, as well as discuss our first quarter results. Larry Weyers will start us off by reviewing our recent merger with Peoples Energy and the progress of our integration efforts. Then Joe O'Leary will review our first quarter financial results and discuss our 2007 and 2008 financial guidance. Mark Radtke will then give us an operational update on Integrys Energy Services. At the end of our prepared remarks you will have an opportunity to ask questions.

Before we begin, I need to point out that this presentation contains forward-looking statements within the definition of the Securities and Exchange Commission's Safe Harbor rules including projected results for 2007 and 2008 for Integrys Energy Group and its subsidiaries. Forward-looking statements are beyond the ability of Integrys Energy Group to control and, in many cases, Integrys Energy Group cannot predict what factors would cause actual results to differ materially from those indicated by forward-looking statements. I refer you to the forward-looking statement section of today's news release and to our filed Securities and Exchange Commission disclosure documents for further information.

I will now turn the call over to Larry Weyers.

Larry Weyers - President and Chief Executive Officer

Thank you, Donna. Good afternoon, everyone, and thanks for joining us on the call today. We accomplished much during the first quarter of 2007, including closing on the merger with Peoples Energy, filing rate cases in Illinois, completing the sale of the Niagara generation facility, and producing strong results. I'm proud of our team at Integrys Energy Group and all that has been accomplished thus far in 2007. But, we are not done. We have a long list of goals to accomplish by year end.

The first goal on our list is to ensure that the merger integration continues to move forward. We believe that the due diligence and planning we undertook before the merger closed allowed our integration teams to hit the ground running once they were given the green light. Now they are effectively executing some of those plans. Up to this point, our efforts have progressed as planned.

One of the initial steps we took after the merger closed was to file rate cases with the Illinois Commerce Commission, the first rate cases for Peoples Gas and North Shore Gas in 12 years. In Illinois, receipt of a written order is required within 11 months, which would be in the first quarter of 2008.

A major integration goal we plan to complete soon is the integration of our nonregulated operations. This should be achieved before the end of the third quarter of 2007 and will include a fully integrated risk control system. To our customers, Integrys Energy Services has already made a clean transition. Since the merger we are operating under one name and one brand.

As we look farther down the road toward the latter portion of 2007, we plan to establish a new services company to provide certain support services to our regulated and nonregulated businesses. The new services company, just like our other operations, will be focused on operational excellence and driving value, resulting in high levels of service at reasonable costs.

We also anticipate completing the divestiture of our energy production company by the end of this year, which will allow us to focus on our core businesses, reduce our external financing requirements, and lower our business risk profile.

In just a few moments, Joe O'Leary will update you on our projections for achieving 94 million dollars of steady state synergies within five years. We remain on track with this long-term goal. We would like to stress that throughout this integration we will be focusing on achieving operational excellence, which includes upgrading our systems. It may take a little longer than anticipated to gain the initial synergies, but in the long run we believe that the benefits will far outweigh the costs.

Now, let's turn to our capital projects.

First of all, our largest project, Weston 4, is on schedule and on budget. We still anticipate that it will begin operations during the first half of 2008. We are proud to announce that during the first quarter of this year we reached a significant construction milestone by achieving one million man hours without any injuries or accidents. To our construction team, I would like to say thank you and keep up the good work.

Many of you might not be familiar with our efforts to recycle construction materials. At Weston 4 alone we have generated over 5,400 tons of recycled material ranging from scrap metal to plastic to cardboard.

The American Transmission Company, of which we own a 31% interest, is also on schedule with the construction of the Wausau, Wisconsin to Duluth, Minnesota transmission line, which should be completely energized by early 2008. 145 miles of the 220-mile project are complete and energized. An additional 27 miles of the project were constructed over the winter. There remains only 48 more miles to construct before the projected 2008 in-service date for the remainder of this line. We have resumed 100 percent of the equity capital calls associated with this transmission line, which should take our ownership position in ATC to 34 percent by year-end 2007 and 35 percent by the end of 2008.

Now, I am pleased to report that for the first quarter of 2007, we reported income available for common shareholders of 139.4 million dollars and earnings per diluted share of 2 dollars and 41 cents. We look forward to generating diluted earnings per share in the range of 3 dollars and 35 cents to 3 dollars and 55 cents in 2007 and 3 dollars and 67 cents to 3 dollars and 94 cents in 2008. This guidance includes the negative impacts of expenses incurred to achieve merger synergies and also includes the impact of purchase accounting adjustments related to the merger. Our 2008 guidance for diluted earnings per share from continuing operations - adjusted, which excludes the negative 26 cents impact of costs to achieve merger synergies and merger purchase accounting adjustments, is between $3.93 and $4.20.

Joe O'Leary will now discuss in more detail our financial results and our future guidance. Joe…

Joe O'Leary - Senior Vice President and Chief Financial Officer

Thanks, Larry.

Before I begin, let me refer everyone to our news release issued this morning and our Form 10-Q that was filed earlier today with the Securities and Exchange Commission for details of our first quarter financial results. I will review the major financial and segment highlights for the quarter. Please keep in mind that it is challenging to make year-over-year comparisons this year given the increase in our portfolio of assets. In particular, our first quarter 2007 results include the operations of Peoples Energy starting on February 22, 2007. In addition, last year's quarterly results do not include our natural gas distribution operations in Michigan and Minnesota, which we acquired on April 1, 2006 and July 1, 2006, respectively. On that note:

As Larry mentioned, during the first quarter, we produced earnings of 139.4 million dollars. Our income from continuing operations was 117.2 million dollars or 2 dollars and 1 cent per diluted share. In our news release, we have included non-GAAP financial information related to adjusted diluted earnings per share from continuing operations. We believe that adjusted diluted EPS from continuing operations is a useful measure for providing investors with additional insight into our operating performance and the effects of certain items that are not comparable from one period to the next. The items in the first quarter of 2007 that are not comparable with 2006's first quarter results include:

Taking into consideration the items I mentioned, our adjusted diluted earnings per share from continuing operations were 1 dollar and 74 cents for the first quarter of 2007 compared to 1 dollar and 29 cents in the comparable quarter last year.

Turning to our segment results, our regulated electric utility margins increased 13.9 percent in the first quarter of 2007 to 148.9 million dollars, driven by rate increases at Wisconsin Public Service and Upper Peninsula Power, as well as a 2.8 percent increase in sales volumes, including a 5.7 percent increase in residential and a 4.6 percent increase in wholesale electric sales volumes. The volume increases were due to a 6.9 percent quarter-over-quarter increase in heating degree days and a slight increase in weather-normalized usage per customer. The colder weather conditions contributed approximately an additional 800 thousand dollars, or one cent in diluted earnings per share to electric utility earnings.

Earnings at our electric utility operations grew 6.5 percent to 16.5 million dollars for the first quarter of 2007, compared to 15.5 million dollars in 2006. Included in the 2007 results were pre-tax costs to achieve synergy savings associated with the Peoples Energy merger of approximately 4.8 million dollars. In March 2007, all external costs to achieve, including costs incurred in 2006 and in the first quarter of 2007, were allocated from the holding company and Peoples Energy to the appropriate business segments. These segments are being allocated these costs because they will ultimately be the beneficiaries of the synergy savings resulting from the costs to achieve.

At our regulated natural gas utility operations, volumes were up substantially due to the additional natural gas distribution operations, which we have added since last year. The acquired natural gas distribution operations in Michigan and Minnesota added approximately 409 million therms and the Peoples Energy natural gas distribution operations added approximately 314 million therms. Please keep in mind that Integrys Energy Group's results only reflect a contribution from Peoples Energy beginning on February 22, 2007, representing only 38 days of the quarter and excluding a large portion of their heating season.

On a comparable basis, volumes at Wisconsin Public Service's natural gas operations rose 9.3 percent to approximately 292 million therms in 2007 from 267 million therms in the first quarter of 2006.

Margins rose to 171.9 million dollars in our natural gas utility operations, from 44.8 million dollars in the first quarter of 2006. Peoples Gas and North Shore Gas contributed approximately 40 percent of the total margin, or approximately 69 million dollars; Wisconsin Public Service contributed 32 percent of the total margin, or approximately 55 million dollars; and our Minnesota and Michigan operations contributed approximately 48 million dollars, or 28 percent of the total margin. On a comparable basis, Wisconsin Public Service's margin was up 22.8 percent, or 10.2 million dollars, driven by the retail natural gas rate increase, favorable quarter-over-quarter weather conditions, and an increase in weather normalized usage per customer.

Pre-tax external costs to achieve merger synergy savings attributed to the natural gas utility operations were 2.5 million dollars in the first quarter, with 2.0 million dollars associated with the integration of Peoples Gas and North Shore Gas.

Overall, our natural gas utility operations produced net income of 35.2 million dollars in the first quarter of 2007 compared with 6.7 million dollars for the same period in 2006. Of that total, our natural gas distribution operations in Minnesota and Michigan contributed 11.9 million dollars in net income and natural gas operations in Illinois added 7.4 million dollars. Net income at Wisconsin Public Service increased 5.2 million dollars due primarily to an increase in volumes related to the colder quarter-over-quarter weather conditions and increases in weather-normalized usage per customer discussed earlier. The colder weather conditions contributed approximately an additional 1.4 million dollars, or 2 cents in diluted earnings per share, to Wisconsin Public Service's natural gas earnings.

Turning to our nonregulated operations, Integrys Energy Services posted net income of 79.7 million dollars, a 42.6 million dollar increase versus 2006's first quarter results. 2007's results include a 14.8 million dollar after-tax gain related to the sale of the Niagara generation facility. Pre-tax margins increased by 29.3 million dollars during the first quarter of 2007 compared to 2006's first quarter. Excluding the positive impact of mark-to-market gains, Integrys Energy Services' gross margins increased 6.9 million dollars on a pre-tax basis. Total pre-tax net mark-to-market gains included in margin were 56.2 million dollars in the first quarter of 2007 as compared to net mark-to-market gains of 31.8 million dollars in 2006's first quarter. The 24.4 million dollar change was driven largely by the timing of gain and loss recognition on derivative retail supply transactions that do not qualify for hedge accounting treatment. These retail supply contracts protect the economic value of customer sales contracts. The ultimate margin related to the retail supply and customer sales contracts will be recognized when the energy is delivered.

During the first quarter of 2007, the results at our nonregulated operations included after-tax income of 19.0 million dollars from synthetic fuel activity compared to 9.7 million dollars during the comparable quarter last year. Included in the 2007 first quarter results were 20.6 million dollars of Section 29 federal tax credits and an after-tax operating loss of 2.8 million dollars at the synthetic fuel facility. The higher tax credits resulted primarily from the impact of accounting rules associated with the accounting for income taxes in interim financial statements. Since Integrys Energy Group, as a whole, realized more than half of its expected income for 2007 in the first quarter of 2007, we were required to use our estimated annual effective tax rate and, therefore, we recognized more than half of our expected Section 29 tax credits in the first quarter of 2007.

Finally, in our Holding Company and Other operations, we broke even for the first quarter of 2007 compared with net income of 800 thousand dollars in 2006. One of primary drivers for the decrease in income was higher interest expense due to increased borrowing levels associated with the acquisition of our natural gas distribution operations in Michigan and Minnesota. Offsetting, in part, the increase in interest expenses was the positive impact of the allocation of costs to achieve merger synergies to the business segments of 7.8 million dollars, which were incurred between July 2006 and March 2007. In March 2007 these costs were allocated to the applicable segments, which will ultimately be the beneficiaries of the synergy savings resulting from the costs to achieve.

Also, included in our Holding Company and other operations for the first quarter were after-tax equity earnings at ATC of 7.1 million dollars, a 34 percent increase from 5.3 million dollars in 2006.

Now we would like to review our potential financings in 2007 and 2008. In 2007, Wisconsin Public Service expects to issue up to 125 million dollars of long-term debt, Peoples Gas intends to issue about 50 million dollars of long-term debt, and the North Shore Gas Company will most likely issue 10 million dollars of long-term debt. As far as issuing long-term debt in 2008, Integrys Energy Group expects to issue 100 million dollars and Peoples Gas will most likely issue 35 million dollars.

We anticipate issuing only about 40 million dollars of equity in 2007 and about 45 million dollars in 2008 through our existing stock investment plans, dividend reinvestment program, and compensation plans.

If you go to our web site, you will find a table which provides information relating to synergy savings and related costs to achieve the savings, by year, through 2011. We still expect to achieve our target of 94 million dollars in steady state annual pre-tax merger synergy savings in 2011.

I am also pleased to tell you that our latest estimates for pre-tax costs-to-achieve merger synergies are 179 million dollars, a decrease of 4 percent from our previous estimate of 186 million dollars. About 65 million dollars of this will be deferred pending future recovery or capitalized. As part of the agreement relating to the approval of the merger by the Illinois Commerce Commission, Peoples Gas and North Shore Gas were allowed to seek recovery of up to 45 million dollars of certain deferred costs to achieve synergy savings in future rates, subject to the terms of the agreement.

Now we will move on to our 2007 and 2008 financial guidance.

We expect our 2007 total diluted earnings per share to be between 3 dollars and 35 cents and 3 dollars and 55 cents for Integrys Energy Group. Our guidance assumes normal weather for 2007, the continued availability of generating units, merger synergy savings and related costs to achieve them, merger purchase accounting adjustments, results from discontinued operations, and completion of asset management sales. Our diluted earnings per share guidance does not include the impact of mark-to-market activity except for certain mark-to-market activity related to business originating prior to 2007, which will be completed in 2007. This guidance is outlined in the news release we issued this morning. Our guidance for diluted earnings per share from continuing operations will be between 2 dollars and 50 cents and 2 dollars and 69 cents as compared with three dollars and 50 cents in 2006.

Also included in the news release is the projected guidance range for 2007 diluted earnings per share from continuing operations - adjusted, which is anticipated to be between 2 dollars and 66 cents and 2 dollars and 85 cents compared with 3 dollars and 20 cents actual diluted earnings per share from continuing operations - adjusted in 2006. The diluted earnings per share from continuing operations - adjusted guidance indicates the financial results we anticipate will come from the rest of our continuing operations after excluding the impacts of certain items that are not comparable from one period to the next. This includes the negative impacts of the Peoples Energy merger relating to transition costs to achieve merger synergy savings, negative impacts of merger purchase accounting adjustments, and positive impacts of synfuel operations. See our news release for further details relating to these items.

We expect our 2008 diluted earnings per share to be between 3 dollars and 67 cents and 3 dollars and 94 cents for Integrys Energy Group. Our guidance assumes normal weather for 2008, the continued availability of generating units, the impacts of the Peoples Energy merger synergy savings and related transition costs to achieve them, merger purchase accounting adjustments, and asset management sales. Our guidance also considers that Peoples Gas and North Shore Gas receive the full rate increase requested effective in early February of 2008. Our diluted earnings per share guidance does not include the impact of mark-to-market activity except for certain mark-to-market activity related to business originating prior to 2008, which will be completed in 2008. This guidance is outlined in the news release we issued this morning.

Also included in the news release is the projected guidance range for 2008 diluted earnings per share from continuing operations - adjusted, which is anticipated to be between 3 dollars and 93 cents and 4 dollars and 20 cents. The diluted earnings per share from continuing operations - adjusted guidance indicates the financial results we anticipate will come from our continuing operations after excluding the negative impacts of the Peoples Energy merger transition costs to achieve merger synergy savings and merger purchase accounting adjustments. See our news release for further details relating to the special items.

Now I'll turn the call back to Larry Weyers.

The President and Chief Executive Officer speaks.

Thanks, Joe.

Now I would like to ask Mark Radtke, President of Integrys Energy Services to discuss our nonregulated operations. Mark…

Mark Radtke, the President of Integrys Energy Services speaks.

Thanks, Larry.

Integrys Energy Services reported strong results for the first quarter of 2007. As Joe noted, we experienced significant earnings volatility over the past two quarters due to the difference in the accounting recognition of changes in value between derivatives, supply contracts, and non-derivative customer sales contracts. The magnitude of this non-cash difference is a function of market price movement and customer supply volume. While we cannot predict the future mark-to-market volatility we will experience from quarter to quarter on this growing business, we do know how much margin will ultimately be realized since our portfolio is substantially hedged. Even though we experienced fairly significant unrealized gains here in the first quarter, we still have approximately 25 million dollars of gross margin to recognize for the remainder of 2007 and over 35 million dollars in future years as a result of existing contracts. This is in addition to new business that we would expect to execute and recognize in 2007 and beyond. Looked at another way, at the end of the quarter we recognized approximately 70 percent of our total forward book value to income, a fairly significant increase from the 40 percent at year end 2006.

Excluding the growth that came with Peoples, our retail electric forward book sales volumes, or backlog, is up 26 percent since December 31, 2006, and up 465 percent since March 31, 2006. When you include the merger, we are up 99 percent since year-end 2006 and 795 percent since the end of the first quarter 2006. While Illinois and Texas are two of the larger contributors to that growth, we are showing increases in each of the markets in which we operate.

Although our merger integration activity has necessitated delaying our Mid-Atlantic expansion work by a couple of months, we began signing customers late in the quarter, and look to that region to come on strong during the second half of the year.

As we reported last quarter, the Illinois electric market was very active in front of the January 1, 2007, expiration of their market transition period. Our team has had good success adding business despite some anxiety in that market. We have forward contract commitments for 11 million megawatt-hours of retail supply, and 725 thousand megawatt-hours of wholesale supply to Commonwealth Edison via the auction. We are obviously watching developments in Illinois closely, and will not speculate on what changes may occur in that market, or the impact it could have on that supply portfolio.

Wholesale electric origination has been another bright spot. New customer business in the Northeast and Midwest added 6.5 million megawatt-hours to our forward book volume. Expansion of our wholesale electric group west of the Mississippi into Denver will help us expand our customer base into the mid-continent and further our trading and supply capabilities in the Midwest. We expect to complete the build-out of our technology infrastructure for this office in the second quarter, at which time we will begin to scale up our business activity.

Our wholesale natural gas business continues to produce solid results. Market conditions created opportunities to withdraw natural gas from storage, allowing us to realize some of the value associated with customer business originated and hedged in over the past year. We continue to expand our producer services and originated structured products customer base and the addition of the Peoples' wholesale origination team will further strengthen our capabilities.

While the business has performed well in the current period and forward sales terms, we have also dedicated significant effort to merging the nonregulated business of Integrys Energy Group and Peoples. Beginning February 22, we faced the marketplace as a unified company, operating as Integrys Energy Services. I am pleased with our success in delivering a focused and seamless transition for our customers. From an internal perspective, there are three principle areas; integration of the team, process integration, and the conversion and integration of the support systems. The organizational level decisions have been made for integrating the team, and our process and infrastructure integration is well underway using a risk mitigation prioritization approach. We have made good progress integrating the business for purposes of daily risk management, and found no surprises when evaluating the combined business risk. We have taken this opportunity to assess our information infrastructure and customer service capabilities. Some of our highest priority information is already coming together. Much of our integrated data and infrastructure will go into production beginning in the third quarter.

Our synthetic fuel project contributed 19.0 million dollars to earnings during the quarter in accordance with required estimated annual tax treatment. Having 75 percent of our production volume hedged, we have some exposure to oil prices rising above approximately 62 dollars per barrel. Nevertheless, with a full year of production and associated costs, we expect the project to contribute 18.4 million dollars, a 600 thousand dollar decrease through the balance of the year.

Now, I'll turn the call back to Larry.

The Chairman, President, and Chief Executive Officer speaks.

Thanks, Mark.

As we have discussed on this call, we have accomplished a significant amount during the first quarter of 2007, but we still have more to do. Our near-term goals include:

To recap our results:

We are now available to answer your questions about our financial picture and plans for the future.

Thank you for being a part of our first quarter earnings conference call. A replay of this conference call will be available through May 23, 2007, by dialing toll free 866-448-4799.

The text for today's presentation is available on our Web site at www.integrysgroup.com. Just select Investors and then Presentations.

If you have additional questions, you may contact Joe O'Leary, at 312-228-5411 or Donna Sheedy at 920-433-1857.