The following discussion should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and related Notes and our Annual Report on Form 10-K for the year ended December 31, 2007.

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 expects to invest $2.7 billion in the next ten years to ensure that the power grid will continue to meet the needs of its customers in Wisconsin and Michigan's Upper Peninsula.

· 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 $85 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 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 Managing Nonregulated Business Growth - Integrys Energy Group expects Integrys Energy Services to provide up to 30% of annual consolidated earnings, on average, in the future. As a result of the recent turmoil in the credit markets, Integrys Energy Services will concentrate on adding customers in existing markets, but has put plans to expand into new geographical regions on hold. 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 business platform.

· The on-going development of new businesses that will focus on renewable energy products and conservation such as landfill gas generation and transportation projects and solar energy projects.

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 instruments consistent with the company's risk management policy. The Corporate Risk Management Group, which reports through the Chief Financial Officer, provides corporate oversight.

                             RESULTS OF OPERATIONS

                            Three Months Ended                             Nine Months Ended
                               September 30                 %                 September 30                %
Integrys Energy
Group's Results
(Millions, except                                        Increase                                      Increase
share amounts)                2008            2007      (Decrease)            2008          2007      (Decrease)

Income (loss)
available for common
 shareholders           $    (59.1 )     $    43.2                - %   $    100.8     $   166.2            (39.4 )%
Basic earnings (loss)
per common share        $    (0.77 )     $    0.57                - %   $     1.32     $    2.37            (44.3 )%
Diluted earnings
(loss) per common
share                   $    (0.77 )     $    0.56                - %   $     1.31     $    2.37            (44.7 )%

Average shares of
common stock
   Basic                      76.7            76.2              0.7 %         76.5          70.0              9.3 %
   Diluted                    76.7            76.5              0.3 %         76.9          70.2              9.5 %

Earnings Summary - Third Quarter 2008 Compared with Third Quarter 2007

Financial results at Integrys Energy Group decreased $102.3 million, to a net loss of $59.1 million ($0.77 net loss per share) for the quarter ended September 30, 2008, from earnings of $43.2 million ($0.56 diluted earnings per share) for the same period in 2007. Significant factors impacting the change in earnings were as follows (and are discussed in more detail thereafter):

· Integrys Energy Services' financial results decreased $107.7 million, from earnings of $13.2 million for the quarter ended September 30, 2007, to a net loss of $94.5 million for the same quarter in 2008, primarily due to the following:
The large decline in energy prices in the third quarter of 2008 had a $79.6 million net negative non-cash impact on Integrys Energy Services' accounting results due primarily to accounting mismatches. As required by GAAP, when electric energy prices fell, Integrys Energy Services' portfolio of derivative electric contracts were adjusted to fair value, while the corresponding non-derivative sales contracts are not adjusted to fair value under GAAP. In addition, natural gas inventory that was injected at higher market prices earlier in 2008 was required to be written down to the lower of cost or fair market value as energy prices fell. However, derivative contracts utilized to economically hedge the natural gas in storage were also adjusted to fair market value, partially offsetting the impact of the lower of cost or market adjustment on the natural gas inventory. Integrys Energy Services will recover net after-tax non-cash accounting losses, which were driven primarily by derivative accounting treatment of the electric supply contracts, when electricity is physically delivered to customers and the related hedging instruments are settled.

Realized losses on certain wholesale natural gas storage transactions drove an $11.2 million after-tax decrease in Integrys Energy Services' financial results. Significant price decreases in the quarter provided management the opportunity to re-evaluate and optimize the natural gas storage portfolio by delaying planned injections/withdrawals and entering into new longer term purchase/sales contracts, which are expected to provide greater gains in the future. Delaying these withdrawals led to realized losses on the settlement of the original sales contracts in the current period.

The recognition of $8.2 million of after-tax earnings during the three months ended September 30, 2007, from an investment in a synthetic fuel production facility. There was no income or loss in 2008 related to these facilities, as operations were suspended when the federal tax credit expired at the end of 2007.

Operating and maintenance expenses at Integrys Energy Services increased $4.5 million after-tax for the quarter ended September 30, 2008, compared to the same quarter in 2007, driven by an increase in bad debt expense largely due to exposure to Lehman Brothers.

· Earnings decreased as a result of the sale of PEP in the third quarter of 2007. PEP provided earnings of $32.4 million as a component of discontinued operations in the third quarter of 2007.

· The net loss at the regulated natural gas utility segment decreased $12.8 million, from $30.6 million for the quarter ended September 30, 2007, to $17.8 million during for the same quarter in 2008. The decrease in the net loss was driven by a rate increase at PGL, a change in the rate design at PGL and NSG, and merger synergies, partially offset by an increase in bad debt expense and a decrease in natural gas throughput volumes related to customer conservation efforts. Due to the seasonal nature of natural gas utilities, higher earnings are generally derived during the heating season (first and fourth quarters).

· Earnings at the regulated electric utility segment increased $13.6 million, from $38.0 million for the quarter ended September 30, 2007, to $51.6 million for the same quarter in 2008. The increase in electric utility segment earnings was driven by a $15.0 million increase in electric earnings at WPSC. The increase in WPSC's electric utility earnings was largely related to actual fuel and purchased power costs that were lower than what was recovered in rates during the third quarter of 2008, as WPSC continued its recovery of higher than expected energy costs experienced during the first quarter of 2008. WPSC's rate increase, which was effective January 16, 2008, also contributed to higher earnings. Lower sales volumes due to unfavorable weather during the summer cooling season and customer conservation efforts, as well as higher transmission and depreciation expense, partially offset the increase in earnings.

· Financial results at the holding company and other segment increased $10.3 million, from a net loss of $8.7 million during the quarter ended September 30, 2007, to earnings of $1.6 million for the same quarter in 2008, largely due to lower interest expense, higher earnings from its investment in ATC, and decreased operating expenses related to consulting and other costs incurred in 2007 pertaining to the PEC merger.

Earnings Summary - Nine Months 2008 Compared with Nine Months 2007

Integrys Energy Group's earnings decreased $65.4 million, to $100.8 million ($1.31 diluted earnings per share) for the nine months ended September 30, 2008, from $166.2 million ($2.37 diluted earnings per share) for the same period in 2007. Significant factors impacting the change in earnings and earnings per share were as follows (and are discussed in more detail thereafter):

· Integrys Energy Services' financial results decreased $82.8 million, from earnings of $48.9 million for the nine months ended September 30, 2007, to a net loss of $33.9 million for the same period in 2008. The decrease was driven by the following:

Similar to the third quarter, lower earnings at Integrys Energy Services' for the nine months ended September 30, 2008, compared to the same period in 2007, were driven by a $63.4 million after-tax inventory write down, which was required to reflect natural gas inventory in storage at the lower of cost or fair market value. A $43.2 million after-tax increase in unrealized gains on derivative instruments utilized to mitigate the market price risk on certain physical natural gas storage transactions, natural gas transportation contracts, and natural gas sales contracts partially offset the inventory write-down.

Also similar to the third quarter, Integrys Energy Services recognized a $24.3 million after-tax period-over-period increase in non-cash unrealized losses related to the derivative accounting treatment of electric customer supply contracts used to economically hedge customer sales contracts.

Integrys Energy Services recognized $12.0 million of after-tax earnings during the nine months ended September 30, 2007, from an investment in a synthetic fuel production facility. There was no income or loss in 2008 related to these facilities, as operations were suspended when the federal tax credit expired at the end of 2007.

For the nine months ended September 30, 2008, compared to the same period in 2007, operating and maintenance expenses at Integrys Energy Services increased $7.8 million after-tax, driven by an increase in bad debt expense largely due to exposure to Lehman Brothers, as well as continued business expansion.

During 2007, WPS Niagara Generation, LLC recognized after-tax income of $14.7 million, primarily related to the $14.8 million gain on the sale of this facility recorded in discontinued operations in January 2007.

· A $62.1 million decrease in income available for common shareholders was related to Integrys Energy Group's sale of PEP in the third quarter of 2007. PEP provided earnings of $64.6 million as a component of discontinued operations during the nine months ended September 30, 2007.

· Earnings at the regulated natural gas utility segment increased $47.9 million, from earnings of $0.6 million during the nine months ended September 30, 2007, to earnings of $48.5 million for the same period in 2008. Natural gas utility segment earnings increased due to PGL and NSG being acquired on February 21, 2007 (compared to being included for the full nine months ended September 30, 2008), a rate increase for PGL, changes in the rate design for PGL and NSG, higher sales volumes due to colder weather during the heating season, and merger synergies. The increase in earnings was partially offset by an increase in bad debt expense, as well as a goodwill impairment loss related to NSG.

· Financial results at the holding company and other segment increased $22.5 million, from a net loss of $14.9 million during the nine months ended September 30, 2007, to earnings of $7.6 million for the same period in 2008, largely due to lower interest expense, higher earnings from its investment in ATC, and lower operating expenses as a result of consulting and other costs incurred in connection with the PEC merger in 2007.

· Regulated electric utility segment earnings increased $9.1 million, from earnings of $69.5 million during the nine months ended September 30, 2007, to earnings of $78.6 million for the same period in 2008, driven by a $12.4 million increase in earnings at WPSC. WPSC's electric utility segment earnings increased largely due to a rate increase, which was effective January 16, 2008. Lower maintenance expenses and merger synergies also contributed to increased earnings. The increased earnings were partially offset by lower sales volumes due to unfavorable weather during the summer cooling season and customer conservation efforts, higher transmission expense, and an increase in depreciation expense.

· For the nine months ended September 30, 2008, diluted earnings per share were impacted by a 6.7 million share (9.5%) increase in the weighted average number of outstanding shares of Integrys Energy Group common stock, compared with the same period 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 nine months ended September 30, 2008, but were only considered outstanding for that portion of the same period in 2007 subsequent to the PEC merger. Additional shares were also issued during the nine months ended September 30, 2007, under Integrys Energy Group's Stock Investment Plan and certain stock-based employee benefit and compensation plans.

Utility Operations

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

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

Regulated Natural Gas Utility Segment Operations

                              Three Months                                  Nine Months
                                  Ended                   %                    Ended                   %
                              September 30            Increase             September 30             Increase
 (Millions)                   2008          2007     (Decrease)            2008          2007      (Decrease)

Revenues                 $   315.2     $   236.0            33.6 %    $ 2,091.5     $ 1,335.6             56.6 %
Purchased natural gas
costs                        182.0         128.5            41.6 %      1,468.5         911.6             61.1 %
Margins                      133.2         107.5            23.9 %        623.0         424.0             46.9 %

Operating and
maintenance expense          112.1         104.2             7.6 %        391.2         295.0             32.6 %
Goodwill impairment
loss (1)                         -             -               - %          6.5             -                - %
Depreciation and
amortization expense          28.1          27.4             2.6 %         80.6          70.9             13.7 %
Taxes other than
income                         7.8           7.5             4.0 %         24.3          22.7              7.0 %

Operating income
(loss)                       (14.8 )       (31.6 )         (53.2 )%       120.4          35.4            240.1 %

Miscellaneous income           1.0           1.5           (33.3 )%         4.8           4.3             11.6 %
Interest expense             (14.7 )       (14.8 )          (0.7 )%       (41.4 )       (37.4 )           10.7 %
Other expense                (13.7 )       (13.3 )           3.0 %        (36.6 )       (33.1 )           10.6 %

Income (loss) before
taxes                    $   (28.5 )   $   (44.9 )         (36.5 )%   $    83.8     $     2.3          3,543.5 %

Throughput in therms
 Residential                  91.5          98.0            (6.6 )%     1,152.0         748.8             53.8 %
 Commercial and
industrial                    38.5          40.7            (5.4 )%       378.8         283.8             33.5 %
 Interruptible                 6.0           8.7           (31.0 )%        41.7          40.6              2.7 %
 Interdepartmental             5.8          17.4           (66.7 )%        24.2          32.1            (24.6 )%
 Transport                   296.2         310.8            (4.7 )%     1,320.1       1,022.1             29.2 %
 Total sales in therms       438.0         475.6            (7.9 )%     2,916.8       2,127.4             37.1 %

(1) See Note 7, "Goodwill and Other Intangible Assets," for more information.

Third Quarter 2008 Compared with Third Quarter 2007

Revenue

Regulated natural gas utility segment revenue increased $79.2 million, driven by:

· An approximate 60% increase in the average per-unit cost of natural gas over all of the regulated natural gas utilities in the third quarter of 2008, compared with the same quarter in 2007. For all of Integrys Energy Group's regulated natural gas utilities, natural gas commodity costs are directly passed through to customers in current rates.

· An annualized rate increase for PGL of $71.2 million, which was effective February 14, 2008. The new rate structure provides the company the opportunity to recover the fixed costs of operating its natural gas delivery system while also better aligning the energy efficiency interests of the company with those of consumers, regulators, and elected officials.

· A combined 7.9% decrease in throughput volumes partially offset the increase in natural gas utility revenue. The decrease was driven by energy conservation efforts by natural gas utility customers and a larger number of customer disconnections quarter-over-quarter, which resulted from high energy prices and a general slowdown in the economy. The impact of the VBA decoupling mechanism for PGL and NSG partially offset the effect of the decrease in overall natural gas utility throughput volumes on revenue.

Margin

The regulated natural gas utility segment margin increased $25.7 million, driven by:

· The 2008 rate increase at PGL, which had an estimated $19 million positive quarter-over-quarter impact on margin.

· An approximate $3 million quarter-over-quarter increase in margin at MGUC related to certain favorable adjustments to the reconciliation of revenues from the natural gas charge and related natural gas costs as required by the MPSC.

· An approximate $2 million quarter-over-quarter increase in margin from the new 2008 rate design for NSG, effective February 14, 2008, which incorporated higher fixed customer charges and lower volumetric rates.

· An approximate $2 million quarter-over-quarter increase in margin related to the Enhanced Efficiency Program enacted by PGL and NSG in 2008 as approved by the ICC. The increase in the margin related to higher revenues received to support this program was offset by a corresponding increase in operating and maintenance expenses related to costs associated with enacting the program.

· A 6.2% decrease in throughput volumes to residential and commercial and industrial natural gas customers partially offset the increase in margin. This decrease in throughput volumes had an approximate $3 million negative quarter-over-quarter impact on margin, but was partially offset by an approximate $2 million positive impact of decoupling on the margins of PGL and NSG, resulting in an approximate $1 million negative quarter-over-quarter impact at the natural gas utility segment related to lower volumes. Under decoupling, utilities are allowed to adjust rates to recover or refund the difference between the actual and authorized delivery charge components of revenue.

Operating Income (Loss)

The operating loss at the regulated natural gas utility segment decreased $16.8 million, driven by the $25.7 million increase in natural gas margin, partially offset by a $7.9 million increase in operating and maintenance expenses.

The increase in operating and maintenance expenses primarily related to:

· A $7.6 million increase in bad debt expense, driven by the impact of high energy prices on overall accounts receivable balances, as well as an increase in the number of past due accounts related to worsening economic conditions.

· A $2.0 million increase in the amortization of both costs to achieve synergy savings and costs related to the 2007/2008 rate cases for PGL and NSG, which were initially deferred as regulatory assets. The increase in operating expenses related to these costs was offset in margin, through an increase in revenues. As a result, there was no significant impact on earnings related to the amortization of these regulatory assets.

· An approximate $2 million quarter-over-quarter increase related to the Enhanced Efficiency Program discussed above. The increase in operating and maintenance expenses related to this program was offset in margin through an increase in revenues. As a result, there was no significant impact on earnings.

· These increases in operating expenses were offset by decreases in pension, postretirement, and other benefit costs resulting from plan design changes and merger synergies.

Nine Months 2008 Compared with Nine Months 2007

Revenue

Regulated natural gas utility segment revenue increased $755.9 million, driven by:

· A combined increase in PGL and NSG natural gas utility revenue of $640.6 million, from $658.9 million during the nine months ended September 30, 2007, to $1,299.5 million during the same period in 2008. The increase in revenue at both of these natural gas utilities was driven primarily by the fact that they were not acquired until February 21, 2007. Other factors for the increase include:

- PGL's rate increase of $71.2 million, effective February 14, 2008.

- Higher period-over-period natural gas prices.

- Colder than prior year weather during the heating season for both utilities in 2008.

· An increase in natural gas revenue of $115.3 million at the . . .