Integrys Energy Group is a diversified energy holding company with regulated electric and natural gas utility operations (serving approximately 2 million customers in Illinois, Michigan, Minnesota, and Wisconsin), nonregulated energy operations, and an equity ownership interest in ATC (a federally regulated electric transmission company operating in Wisconsin, Michigan, Minnesota, and Illinois) of approximately 34%.

Strategic Overview

Integrys Energy Group's goal is to create long-term value for shareholders and customers through growth in its regulated and nonregulated operations (while placing an emphasis on regulated growth). In order to create value, Integrys Energy Group focuses on:

Maintaining and Growing a Strong Regulated Utility Base- A strong regulated utility base is necessary to maintain a strong balance sheet, predictable cash flows, a desired risk profile, attractive dividends, and quality credit ratings, which are critical to our success. Integrys Energy Group believes the following investments have helped, or will help, maintain and grow its regulated utility base:

· The February 2007 merger with PEC, which added the natural gas distribution operations of PGL and NSG to the regulated utility base of Integrys Energy Group.

· Our ownership interest in ATC, an electric transmission company which owned over $2 billion of assets at December 31, 2007. Integrys Energy Group will continue to fund its share of the equity portion of future ATC growth. ATC anticipates net investment in plant to grow by approximately $1.1 billion from 2008 through 2017.

· Weston 4, a 500-megawatt coal-fired base-load power plant located near Wausau, Wisconsin, was completed and operational in June 2008. WPSC holds a 70% ownership interest in the Weston 4 power plant, with Dairyland Power Cooperative owning the remaining 30% interest in the facility.

· A proposed accelerated annual investment in natural gas distribution facilities (replacement of cast iron mains) at PGL beginning in 2010.

· The investment of approximately $75 million to connect WPSC's natural gas distribution system to the Guardian II natural gas pipeline.

· WPSC's agreement to purchase a 99-megawatt wind generation facility to be constructed in Howard County, Iowa.

· WPSC's announced intent to acquire (along with High Country Energy, LLC) a 150-megawatt portion of the planned 300-megawatt High Country wind project located in Dodge and Olmsted counties in Minnesota.

· WPSC's continued investment in environmental projects to improve air quality and meet the requirements set by environmental regulators. Capital projects to construct and upgrade equipment to meet or exceed required environmental standards are planned each year.

· For more detailed information on Integrys Energy Group's capital expenditure program, see "Liquidity and Capital Resources, Capital Requirements."

Strategically Growing Nonregulated Business- Integrys Energy Services focuses on growth in the competitive energy services and supply business through growing its customer base. Integrys Energy Group expects Integrys Energy Services to provide between 20% and 30% of annual consolidated earnings, on average, in the future. Integrys Energy Group believes the following recent developments have helped, or will help, maintain and grow Integrys Energy Services:

· The merger with PEC combined the nonregulated energy marketing businesses of both companies. The combination provided Integrys Energy Services with a strong market position in the Illinois retail electric market and expanded its originated wholesale natural gas business, creating a stronger, more competitive, and better-balanced growth platform.

· Continued expansion of operations in the Western Systems Coordinating Council markets.

· The on-going development of renewable energy products, such as a 6.4-megawatt landfill gas project in Illinois, a landfill gas project in Texas that includes building a 33-mile pipeline, solar energy projects, and a new business unit that will focus on renewable energy and conservation.

Integrating Resources to Provide Operational Excellence- Integrys Energy Group is committed to integrating resources of all its regulated and nonregulated businesses, while meeting all applicable regulatory and legal requirements. This will provide the best value to customers and shareholders by leveraging the individual capabilities and expertise of each business and lowering costs. Integrys Energy Group believes the following recent developments have helped, or will help, integrate resources and provide operational excellence:

· The PEC merger provides the opportunity to align the best practices and expertise of both companies, which will continue to result in efficiencies by eliminating redundant and overlapping functions and systems.

· IBS, a wholly owned subsidiary of Integrys Energy Group, was formed to achieve a significant portion of the cost synergies anticipated from the PEC merger through the consolidation and efficient delivery of various support services and to provide more consistent and transparent allocation of costs throughout Integrys Energy Group and its subsidiaries.

· The implementation of "Competitive Excellence" and project management initiatives to improve processes, reduce costs, and manage projects within budget and timeline constraints.

Placing Strong Emphasis on Asset and Risk Management- Our asset management strategy calls for the continuous assessment of our existing assets, the acquisition of assets, and contractual commitments to obtain resources that complement our existing business and strategy. The goal is to provide the most efficient use of our resources while maximizing return and maintaining an acceptable risk profile. This strategy focuses on the disposition of assets, including plants and entire business units, which are no longer strategic to ongoing operations, are not performing as needed, or have an unacceptable risk profile. We maintain a portfolio approach to risk and earnings.

Our risk management strategy includes the management of market, credit, and operational risk through the normal course of business. Forward purchases and sales of electric capacity, energy, natural gas, and other commodities allow opportunities to secure prices in a volatile energy market. Each business unit monitors daily oversight of the risk profile related to these financial instruments consistent with the company's financial risk management policy. The Corporate Risk Management Group, which reports through the Chief Financial Officer, provides corporate oversight.

                             RESULTS OF OPERATIONS

                             Three Months                                Six Months
                                 Ended                                      Ended
                                June 30                 %                  June 30                 %
                             2008          2007      Increase           2008          2007      Increase

Income (loss)
available for
common shareholders     $    24.1     $   (16.4 )            - %   $   159.9     $   123.0           30.0 %
Basic earnings (loss)
per common share        $    0.31     $   (0.22 )            - %   $    2.09     $    1.84           13.6 %
Diluted earnings
(loss) per common
share                   $    0.31     $   (0.22 )            - %   $    2.08     $    1.83           13.7 %

Average shares of
common stock
   Basic                     76.6          76.0            0.8 %        76.6          66.8           14.7 %
   Diluted                   76.9          76.0            1.2 %        76.9          67.1           14.6 %

Earnings Summary - Second Quarter 2008 Compared with Second Quarter 2007

Integrys Energy Group recognized income available for common shareholders of $24.1 million ($0.31 diluted earnings per share) for the quarter ended June 30, 2008, compared with a net loss of $16.4 million ($0.22 net loss per share) for the quarter ended June 30, 2007. Significant factors impacting the change in earnings and earnings per share were as follows (and are discussed in more detail thereafter):

· The net loss from the regulated natural gas utility segment increased $5.3 million (132.5%), from a net loss of $4.0 million during the second quarter of 2007, to a net loss of $9.3 million during the second quarter of 2008. The change was driven by the following:

- A non-cash after-tax goodwill impairment loss in the amount of $6.5 million was recognized for NSG in the second quarter of 2008.

- The change in the effective tax rate from the second quarter of 2007 to the second quarter of 2008 had a negative quarter-over-quarter impact on natural gas segment operating results. Quarter-over-quarter changes in the effective tax rate can sometimes occur as a result of adjustments required by generally accepted accounting principles (GAAP) to ensure our year-to-date interim effective tax rate reflects our projected annual effective tax rate. An approximate $6 million adjustment to the benefit for income taxes at the natural gas segment was required in accordance with these GAAP requirements in the second quarter of 2007, driving a decrease in quarter-over-quarter earnings.

- Pre-tax operating and maintenance expenses at the natural gas utilities increased $8.6 million ($5.2 million after-tax), driven by higher quarter-over-quarter street restoration costs at PGL and amortization expense related to regulatory assets recorded at PGL and NSG for costs to achieve merger synergies and costs related to the 2007/2008 rate case.

- Partially offsetting the items discussed above, margins at the natural gas utilities increased $23.5 million ($14.1 million after-tax), from $144.6 million during the second quarter of 2007, to $168.1 million during the second quarter of 2008. A rate increase at PGL that was effective in the first quarter of 2008 had an approximate $18 million ($10.8 million after-tax) positive impact on the quarter-over-quarter margin. A 4.5% increase in natural gas throughput volumes, driven by colder weather conditions, had an estimated $3 million ($1.8 million after-tax) favorable quarter-over-quarter impact on margin.

· Regulated electric utility segment earnings increased $5.2 million (34.7%), from earnings of $15.0 million for the quarter ended June 30, 2007, to earnings of $20.2 million for the same quarter in 2008. The quarter-over-quarter increase in earnings at the regulated electric utility segment was driven by an $8.0 million ($4.8 million after-tax) increase in operating income at WPSC's electric utility, resulting primarily from the following:

- Fuel and purchased power costs at WPSC were approximately $7 million ($4.2 million after-tax) lower than what was recovered in rates during the quarter ended June 30, 2008, compared with fuel and purchased power costs that were approximately $2 million ($1.2 million after-tax) higher than what was recovered in rates during the same quarter in 2007, which drove a $5.4 million after-tax increase in operating income quarter-over-quarter. As a result of approximately $23 million of higher than anticipated energy costs in the first quarter of 2008, the PSCW approved an interim rate increase effective March 22, 2008, and subsequently approved a higher final rate increase effective July 4, 2008.

- Also contributing to the increase in WPSC's regulated electric operating income, electric maintenance expenses decreased $5.8 million ($3.5 million after-tax).

- Partially offsetting the items discussed above, cooler quarter-over-quarter weather conditions contributed an approximate $1 million after-tax quarter-over-quarter decrease in operating income. Weather normalized volumes were also down as customers are conserving energy as a result of high prices and a general slowdown in the economy. It is estimated that the decrease in weather normalized sales volumes resulted in an approximate $2 million after-tax decrease in operating income quarter-over-quarter.

· Financial results at Integrys Energy Services increased $53.0 million, from a net loss of $44.0 million for the quarter ended June 30, 2007, to earnings of $9.0 million for the same quarter in 2008, driven by the following:

- Integrys Energy Services recognized a combined $121.1 million ($72.7 million after-tax) increase in retail and wholesale electric margins, driven by derivative accounting treatment of customer supply contracts used to mitigate the price risk of related customer sales contracts. Integrys Energy Services recognized $70.5 million ($42.3 million after-tax) of unrealized gains on derivative contracts in the second quarter of 2008, compared with $50.2 million ($30.1 million after-tax) of unrealized losses during the same period in 2007. These non-cash unrealized gains and losses result from the application of derivative accounting rules to customer supply contracts, requiring that these derivative instruments be valued at current market prices. No gain or loss is recognized on the corresponding customer sales contracts, which are not considered derivative instruments. These non-cash gains and losses will vary each period, and ultimately reverse as the related customer sales contracts settle. As a result, Integrys Energy Services generally expects to experience non-cash losses on supply contracts in periods of declining market prices and non-cash gains in periods of increasing market prices. Electric prices experienced an increase from April 1, 2008 to June 30, 2008, compared with a decrease over the same period in 2007.

- Integrys Energy Services also recognized a $15.2 million net loss from its investment in a synthetic fuel production facility during the three months ended June 30, 2007. Section 29/45K of the Internal Revenue Code, which provided for Section 29/45K federal tax credits from the production and sale of synthetic fuel, expired effective December 31, 2007, at which time Integrys Energy Services ended synthetic fuel operations. This drove a $15.2 million after-tax increase in Integrys Energy Services' earnings during the three months ended June 30, 2008, compared with the same period in 2007.

- Partially offsetting the increases noted above, Integrys Energy Services' natural gas margins decreased $62.9 million ($37.7 million after-tax), driven by an $84.8 million ($50.9 million after-tax) decrease in quarter-over-quarter margins related to derivative accounting required fair value

adjustments, partially offset by a $21.9 million ($13.2 million after-tax) increase in quarter-over-quarter realized natural gas margins.

- Unrealized losses related to fair value adjustments were $84.2 million ($50.5 million after-tax) in the second quarter of 2008, compared with unrealized gains of $0.6 million ($0.4 million after-tax) in the second quarter of 2007. Period-by-period variability in the margin contributed by Integrys Energy Services' retail and wholesale natural gas operations was primarily related to changes in the fair market value of basis swaps utilized to mitigate market price risk associated with natural gas transportation contracts and certain natural gas sales contracts, as well as contracts utilized to mitigate market price risk related to certain natural gas storage contracts. These non-cash unrealized gains and losses result from the application of derivative accounting rules to the basis and other swaps (requiring that these derivative instruments be valued at current market prices), without a corresponding market value offset related to the physical natural gas transportation contracts, the natural gas sales contracts, or the natural gas storage contracts (as these contracts are not considered derivative instruments). Therefore, no gain or loss is recognized on the transportation contracts, customer sales contracts, or natural gas storage contracts until physical settlement of these contracts occurs.

- Realized natural gas margins increased $21.9 million ($13.2 million after-tax), from $18.0 million ($10.8 million after-tax) in the second quarter of 2007, to $39.9 million ($24.0 million after-tax) in the second quarter of 2008. This increase was driven by realized wholesale natural gas margins that were $15.8 million ($9.5 million after-tax) higher quarter-over-quarter. Also, the margin from retail natural gas operations in Illinois increased $4.6 million ($2.8 million after-tax) quarter-over-quarter.

· Financial results at the Holding Company and Other segment improved $10.4 million, from a net loss of $6.2 million during the quarter ended June 30, 2007, to earnings of $4.2 million for the quarter ended June 30, 2008. This improvement was driven by an $8.6 million ($5.2 million after-tax) increase in operating income (see "Holding Company and Other Segment Operations," for more information), a $7.1 million ($4.3 million after-tax) decrease in interest expense and a $3.9 million ($2.3 million after-tax) increase in earnings from Integrys Energy Group's approximate 34% ownership interest in ATC (see "Miscellaneous Income," for more information).

· In connection with the PEC merger on February 21, 2007, Integrys Energy Group announced its intent to divest of PEP, which was sold in the third quarter of 2007. During the quarter ended June 30, 2007, PEP recognized earnings of $24.0 million as a component of discontinued operations.

· For the quarter ended June 30, 2008, diluted earnings per share were impacted by a 0.9 million share (1.2%) increase in the weighted average number of outstanding shares of Integrys Energy Group common stock, compared with the same quarter in 2007. In the first six months of 2008, Integrys Energy Group purchased shares of its common stock in the open market to meet the requirements of its Stock Investment Plan and certain stock-based employee benefit and compensation plans. During 2007, however, Integrys Energy Group issued new shares of common stock to meet these requirements.

Earnings Summary - Six Months 2008 Compared to Six Months 2007

Integrys Energy Group recognized income available for common shareholders of $159.9 million ($2.08 diluted earnings per share) for the six months ended June 30, 2008, compared with income available for common shareholders of $123.0 million ($1.83 diluted earnings per share) for the six months ended June 30, 2007. Significant factors impacting the change in earnings and earnings per share were as follows (and are discussed in more detail thereafter):

· Earnings from the regulated natural gas utility segment increased $35.1 million (112.5%), from $31.2 million during the six months ended June 30, 2007, to $66.3 million during the six months ended June 30, 2008, due primarily to the following:

- Combined natural gas utility earnings at PGL and NSG increased approximately $28 million, from earnings of approximately $8 million for the six months ended June 30, 2007, to earnings of approximately $36 million for the same period in 2008. The increase in earnings at both of these natural gas utilities was due to the fact that they were not acquired until February 21, 2007. PGL was also positively impacted by an annual rate increase of $71.2 million, which was effective February 14, 2008, and both PGL and NSG benefited from colder than normal weather conditions in the first quarter of 2008 before the Volume Balancing Adjustment rider went into effect. These increases were partially offset by a $6.5 million non-cash after-tax goodwill impairment loss recognized for NSG in the second quarter of 2008.

- An increase in natural gas throughput volumes at WPSC, MERC, and MGUC, primarily related to colder period-over-period weather conditions at these natural gas utilities, contributed an approximate $5 million after-tax increase to earnings.

· Regulated electric utility segment earnings decreased $4.5 million (14.3%), from earnings of $31.5 million for the six months ended June 30, 2007, to earnings of $27.0 million for the same period in 2008. The period-over-period change in earnings at the regulated electric segment was driven by a $7.0 million ($4.2 million after-tax) decrease in operating income at WPSC's electric utility, resulting primarily from the following:

- Fuel and purchased power costs at WPSC that were approximately $16 million ($9.6 million after-tax) higher than what was recovered in rates during the six months ended June 30, 2008, compared with fuel and purchased power costs that were approximately $1 million ($0.6 million after-tax) less than what was recovered in rates during the same period in 2007. This drove an approximate $17 million ($10.2 million after-tax) decrease in operating income period-over-period.

- Also contributing to the decrease in operating income at WPSC was a 2.7% decrease in residential sales volumes, which resulted in an approximate $4 million ($2.4 million after-tax) decrease in operating income and was driven by customer conservation efforts related to high energy costs and a general slowdown in the economy.

- Partially offsetting the decreases to WPSC's regulated electric operating income discussed above, electric maintenance expenses decreased $10.1 million ($6.1 million after-tax).

- WPSC also experienced a decrease in pension, post-retirement pension, and medical benefit costs (merger synergy savings) attributable to headcount reductions and certain changes made to its retirement plans.

· Earnings at Integrys Energy Services increased $24.9 million, from earnings of $35.7 million for the six months ended June 30, 2007, to earnings of $60.6 million for the same period in 2008, due to the following:

- Integrys Energy Services recognized a combined $177.3 million ($106.4 million after-tax) increase in retail and wholesale electric margins, driven by the following:

- Integrys Energy Services recognized $169.5 million ($101.7 million after-tax) of unrealized gains on derivative contracts during the six months ended June 30, 2008, compared with $7.0 million ($4.2 million after-tax) of unrealized gains during the same period in 2007. See the "Earnings Summary - Second Quarter 2008 Compared with Second Quarter 2007," above for more information on this change.

- Realized retail electric margins increased $20.3 million ($12.2 million after-tax), from $4.4 million ($2.6 million after-tax) during the six months ended June 30, 2007, to $24.7 million ($14.8 million after-tax) during the same period in 2008, driven by the addition of new customers in Illinois as a result of the PEC merger, expansion into the Mid-Atlantic region, and the resolution of certain regulatory issues in Northern Maine.

- Partially offsetting the increase in retail and wholesale electric margins, Integrys Energy Services' natural gas margins decreased $96.0 million ($57.6 million after-tax), driven by a $121.9 million ($73.1 million after-tax) decrease in period-over-period margins related to SFAS No. 133 fair value adjustments, partially offset by a $25.9 million ($15.5 million after-tax) increase in period-over-period realized margins.

- Unrealized losses were $123.2 million ($73.9 million after-tax) during the six months ended June 30, 2008, compared with unrealized losses of $1.3 million ($0.8 million after-tax) for the six months ended June 30, 2007. See the "Earnings Summary - Second Quarter 2008 Compared with Second Quarter 2007," above for more information on this change.

- Realized natural gas margins increased $25.9 million ($15.5 million after-tax), from $56.7 million ($34.0 million after-tax) during the six months ended June 30, 2007, to $82.6 million ($49.5 million after-tax) during the six months ended June 30, 2008. The increased natural gas margin was driven by realized wholesale natural gas margins that were $18.6 million higher period-over-period. Also, the margin from retail natural gas operations in Illinois increased $7.2 million period-over-period.

- Integrys Energy Services recognized a $14.8 million after-tax gain on the sale of WPS Niagara Generation, LLC as a component of discontinued operations in 2007.

- Integrys Energy Services also recognized $3.8 million of after-tax earnings from its investment in a synthetic fuel production facility during the six months ended June 30, 2007. Section 29/45K of the Internal Revenue Code, which provided for Section 29/45K federal tax credits from the production and sale of synthetic fuel, expired effective December 31, 2007, at which time Integrys Energy Services ended synthetic fuel operations.

· Financial results at the Holding Company and Other segment improved $12.2 million, from a net loss of $6.2 million during the six months ended June 30, 2007, to earnings of $6.0 million for the same period in 2008. This improvement was driven by a $5.5 million ($3.3 million after-tax) increase in operating income (see "Holding Company and Other Segment Operations," for more information), a $10.7 million ($6.4 million after-tax) decrease in interest expense, and a $6.8 million ($4.0 million after-tax) increase in earnings from Integrys Energy Group's approximate 34% ownership interest in ATC (see "Miscellaneous Income," for more information).

· In connection with the PEC merger on February 21, 2007, Integrys Energy Group announced its intent to divest of PEP, which was sold in the third quarter of 2007. During the six months ended June 30, 2007, PEP recognized earnings of $32.2 million as a component of discontinued operations.

· For the six months ended June 30, 2008, diluted earnings per share were impacted by a 9.8 million share (14.6%) increase in the weighted average number of outstanding shares of Integrys Energy Group common stock, compared with the same quarter in 2007. Integrys Energy Group issued 31.9 million shares of common stock on February 21, 2007, in conjunction with the PEC merger. Accordingly, these shares were considered outstanding for purposes of computing diluted earnings per share for the six months ended June 30, 2008, but were only considered outstanding for that portion of the six-month period ended June 30, 2007 subsequent to the PEC merger. Additional shares were also issued during the six months ended June 30, 2007 under the Integrys Energy Group Stock Investment Plan and certain stock-based employee benefit and compensation plans.

Utility Operations

For the three and six months ended June 30, 2008, utility operations included the regulated electric segment, consisting of the regulated electric operations of WPSC and UPPCO, and the regulated natural gas utility segment, consisting of the natural gas operations of PGL, WPSC, MERC, MGUC, and NSG.

The regulated electric operations of WPSC and UPPCO as well as the natural gas operations of WPSC, MERC, and MGUC were included for the three and six months ended June 30, 2007, while the natural gas operations of PGL and NSG were included in results of operations beginning February 22, 2007 through June 30, 2007.

Regulated Natural Gas Utility Segment Operations

                             Three Months                                  Six Months
. . .