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, 2008.

Integrys Energy Group is a diversified energy holding company with regulated electric and natural gas utility operations (serving approximately 2.2 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 core regulated businesses. The company has made a decision to divest of its nonregulated energy services business segment, Integrys Energy Services, or to reduce its scale, risk exposure, and liquidity and credit commitments.

Integrys Energy Group continues to focus on:

Maintaining and Growing a Strong Regulated Utility Base - A strong regulated utility base is essential to maintain a strong balance sheet, predictable cash flows, a desired risk profile, attractive dividends, and quality credit ratings. This is critical to our success as a strategically focused regulated business. Integrys Energy Group believes the following projects have helped, or will help, maintain and grow its regulated utility base and meet its customers' needs:

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

· Our ownership interest in ATC, a transmission company that has over $2.6 billion of transmission assets at March 31, 2009. Integrys Energy Group will continue to fund its share of the equity portion of future ATC growth. Integrys currently owns an approximate 34% interest in ATC. ATC plans to invest approximately $2.7 billion during the next ten years.

· Weston 4, a 537-megawatt coal-fired base-load power plant located near Wausau, Wisconsin, was completed and became operational June 30, 2008. WPS holds a 70% ownership interest in the Weston 4 power plant.

· A proposed accelerated annual investment in natural gas distribution facilities (replacement of cast iron mains) at PGL upon ICC approval of a cost recovery mechanism.

· The investment of approximately $80 million to connect WPS's natural gas distribution system to the Guardian II natural gas pipeline completed in February 2009.

· WPS's purchase of the 99-megawatt Crane Creek wind generation project currently under construction in Howard County, Iowa.

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

Divest or Significantly Reduce the Size and the Capital and Liquidity Commitments of the Nonregulated Energy Services Business Segment - Unprecedented energy price volatility, combined with significant growth in the forward contract portion of the business, has increased the collateral requirements of Integrys Energy Services at a time when global credit and financial market conditions are both constraining the availability and increasing the cost of capital. As a result, Integrys Energy Group has decided to pursue a divestiture of its nonregulated energy services business segment. In the event that a full divestiture of Integrys Energy Services does not occur and/or a portion of the nonregulated energy services business segment remains, it will be a smaller segment that requires significantly less capital, parental guarantees, and overall financial liquidity from Integrys Energy Group. Integrys Energy Group is committed to a full divestiture or a nonregulated energy services operation with credit and collateral support requirements that are insignificant by the end of 2010. Integrys Energy Group is seeking to deploy its capital to areas with more desirable risk-adjusted rates of return. Although Integrys Energy Group anticipates a reduction in future earnings capacity from this business segment going forward, an improvement in the liquidity position, capital deployed, and reduced business risk profile of Integrys Energy Group is expected.

Integrating Resources to Provide Operational Excellence - Integrys Energy Group is committed to integrating resources of all its businesses, while meeting all applicable legal and regulatory 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:

· IBS, a wholly owned service company of Integrys Energy Group, became operational on January 1, 2008. IBS 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.

· "Operational Excellence" initiatives were implemented to provide top performance in the areas of project management, process improvement, contract administration, and compliance in order to reduce costs and manage projects and activities within appropriate budgets, schedules, and regulations.

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 property, plant, and equipment 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 decision regarding the future of Integrys Energy Services illustrates our asset management strategy.

Our risk management strategy includes the management of market exposure, credit, and operational risks through the 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 the risk profile related to these instruments consistent with the company's risk management policy, which is approved by the Board of Directors. The Corporate Risk Management Group, which reports through the Chief Financial Officer, provides corporate oversight.

Continuing Emphasis on Safe, Reliable, Competitively Priced, and Environmentally Sound Energy and Energy Related Services - Integrys Energy Group's mission is to provide customers with the best value in energy and related services. By effectively operating a mixed portfolio of generation assets and investing in new generation and natural gas distribution assets, while maintaining or exceeding environmental standards, we are able to provide a safe, reliable, value-priced service to our customers. We concentrate our efforts on improving and operating efficiently in order to reduce costs and maintain a low risk profile. We actively evaluate opportunities for adding more renewable generation to provide

additional environmentally sound energy to our portfolio. Integrys Energy Group believes the following activities have helped, and will continue to help, integrate resources to provide safe, reliable, competitively priced, and environmentally sound energy services:

· Contract administration and the use of formal project management tools to better manage the costs of our construction programs. These cost reduction initiatives will provide competitively priced energy and energy related services.

· Managing operations to minimize the impact on the environment. Our Weston 4 facility, completed in 2008, is one of the most efficient pulverized coal-fired electric generation units in the country with state-of-the-art environmental controls which allow us to reduce the amount of emissions produced. We also expect to maintain or decrease the amount of greenhouse gases released over time and support research and development initiatives that will enable further progress toward decreasing our carbon footprint.

· Effectively operating a mixed portfolio of generation assets and investing in new generation and distribution assets, such as Weston 4, wind projects, and our natural gas connection to the Guardian II pipeline, ensures continued reliability for our customers.

                             RESULTS OF OPERATIONS

              First Quarter 2009 Compared with First Quarter 2008

                                                                                    % Increase
(Millions, except per share amounts)                    2009          2008          (Decrease)

Natural gas utility operations                        $  (173.1 )   $    75.6                N/A
Electric utility operations                                27.1           6.8              298.5 %
Nonregulated energy operations                            (29.1 )        51.6                N/A
Holding company and other operations                       (5.1 )         1.8                N/A

Net income (loss) attributed to common shareholders   $  (180.2 )   $   135.8                N/A

Basic earnings (loss) per share                       $   (2.35 )   $    1.77                N/A
Diluted earnings (loss) per share                     $   (2.35 )   $    1.77                N/A

Average shares of common stock
   Basic                                                   76.7          76.6                0.1 %
   Diluted                                                 76.7          76.9               (0.3 )%

Financial Results Summary

Financial results at Integrys Energy Group decreased $316.0 million, to a net loss attributed to common shareholders of $180.2 million ($2.35 net loss per share) for the quarter ended March 31, 2009, from net income attributed to common shareholders of $135.8 million ($1.77 diluted earnings per share) for the same quarter in 2008. Significant factors impacting the change in earnings were as follows (and are discussed in more detail thereafter):

· Financial results at the regulated natural gas utility segment decreased $248.7 million, from earnings of $75.6 million for the quarter ended March 31, 2008, to a net loss of $173.1 million for the same quarter in 2009. The net loss at the natural gas utility segment was driven by a non-cash goodwill impairment loss in the amount of $248.8 million after tax. Lower quarter-over-quarter volumes, driven by the general economic slowdown and warmer weather during the heating season, contributed to a decrease in financial results at the regulated natural gas utility segment and were primarily offset by higher quarter-over-quarter earnings from rate increases at MERC and MGU, the full year's benefit of PGL's 2008 rate increase, and a change in the rate design at WPS.

· Earnings at the regulated electric utility segment increased $20.3 million, from $6.8 million during the quarter ended March 31, 2008, to $27.1 million for the same quarter in 2009, driven by an $18.9 million increase in earnings at WPS. WPS's electric utility segment earnings increased largely due to fuel and purchased power costs that were lower than what was recovered in rates during the quarter ended March 31, 2009, compared with fuel and purchased power costs that were higher than what was recovered in rates for the same period in 2008. In the first quarter of 2009, electric utility earnings at WPS were also favorably impacted by a fuel surcharge increase effective July 4, 2008, a portion of which was incorporated into 2009 non-fuel base retail electric rates, and an increase in wholesale demand charges. The higher electric earnings were partially offset by an increase in depreciation expense related to Weston 4.

· Financial results at Integrys Energy Services decreased $80.7 million, from earnings of $51.6 million for the quarter ended March 31, 2008, to a net loss of $29.1 million for the same quarter in 2009, driven by:

- A $91.2 million after-tax decrease in Integrys Energy Services' margin quarter-over-quarter related to non-cash activity, due to a $94.9 million decrease related to non-cash activity associated with electric operations, partially offset by a $3.7 million increase related to non-cash activity associated with natural gas operations. An overview of this non-cash activity is provided below.

Non-cash electric operations:

The approximate 18% decline in electric commodity prices during the first quarter of 2009 drove a $35.5 million net after-tax non-cash loss, compared with a $59.4 million net after-tax non-cash gain recognized in the first quarter of 2008 related to a 23% increase in electric commodity prices during the first quarter of 2008. The non-cash unrealized gains and losses recognized resulted from the application of derivative accounting rules to Integrys Energy Services' portfolio of derivative electric customer supply contracts, requiring that these derivative instruments be adjusted to fair market value. The derivative instruments are utilized to economically hedge the price, volume, and ancillary risks associated with related electric customer sales contracts. The associated electric customer sales contracts are not adjusted to fair value, as they do not meet the definition of derivative instruments under GAAP, creating an accounting mismatch. As such, the non-cash unrealized gains and losses related to the electric customer supply contracts will vary each period, with non-cash unrealized gains being recognized in periods of increasing energy prices and non-cash unrealized losses being recognized in periods of declining energy prices, and will ultimately reverse when the related customer sales contracts settle.

Non-cash natural gas operations:

The market price of natural gas continued its decline in the first quarter of 2009, decreasing approximately 24% from December 31, 2008 to March 31, 2009, driving additional after-tax non-cash lower-of-cost-or-market inventory adjustments of $21.4 million for the quarter ended March 31, 2009. These lower-of-cost-or-market adjustments were required to reflect natural gas still in storage at March 31, 2009 at its net realizable value, as required by GAAP. As a result of the current volatility and uncertainty in the global financial markets and in order to improve its liquidity position, Integrys Energy Services placed more emphasis on storage withdrawals in the first quarter of 2009, compared with the first quarter of 2008. Quarter-over-quarter, the natural gas withdrawn from storage and sold to customers had a $29.1 million lower after-tax cost basis as a result of lower-of-cost-or-market adjustments recorded in prior periods. Quarter-over-quarter, the natural gas storage withdrawals (net of the lower-of-cost-or-market adjustments) drove a $7.7 million after-tax quarter-over-quarter increase in the non-cash natural gas margin.

Integrys Energy Services' non-cash natural gas margin was negatively impacted by a $4.0 million after-tax quarter-over-quarter increase in non-cash unrealized losses, driven by the settlement of derivative instruments utilized to mitigate the price risk on natural gas inventory withdrawn from storage. Similar to the electric operations discussed above, non-cash gains and losses related to derivative natural gas sales and customer supply contracts will vary each period, and will ultimately reverse when the physical contracts settle, or when natural gas is withdrawn from inventory.

- A $9.4 million ($5.6 million after-tax) increase in operating and maintenance expense, primarily due to an increase in payroll and benefits expense, an increase in bad debt expense, and increased broker commissions driven by higher transacted volumes.

- Partially offsetting the above items, realized natural gas margins increased $17.7 million after-tax, from $22.0 million after-tax in the first quarter of 2008, to $39.7 million after-tax in the first quarter of 2009. As discussed above, as a result of the current volatility and uncertainty in the financial markets and in order to improve its liquidity position, Integrys Energy Services increased its storage withdrawals and related delivery of the stored natural gas to customers quarter-over-quarter. Also, per-unit retail natural gas margins were higher quarter-over-quarter as Integrys Energy Services restructured many of its retail natural gas sales contracts in 2008, in order to reflect increased business risk and financing costs. Together, these two items drove the increase in realized natural gas margins.

· Financial results at the holding company and other segment decreased $6.9 million, from earnings of $1.8 million during the quarter ended March 31, 2008, to a net loss of $5.1 million for the same quarter in 2009, largely due to an increase in the effective tax rate. The effective tax rate of this segment includes the effect of certain state income taxes at the consolidated level that are not allocated to other segments. One specific item affecting income tax expense for this segment during the quarter was the impact of a February 2009 tax law change in Wisconsin. Increases in interest expense at the holding company and other segment were partially offset by higher earnings from Integrys Energy Group's investment in ATC and gains from land sales.

Utility Operations

For the quarters ended March 31, 2009, and 2008, utility operations included the regulated natural gas utility segment, consisting of the natural gas operations of PGL, WPS, MERC, MGU, and NSG, and the regulated electric segment, consisting of the regulated electric operations of WPS and UPPCO.

Regulated Natural Gas Utility Segment Operations

                                                Three Months Ended             %
                                                     March 31              Increase
     (Millions, except heating degree days)        2009          2008     (Decrease)

    Revenues                                  $ 1,096.8     $ 1,260.5           (13.0 )%
    Purchased natural gas costs                   776.3         938.8           (17.3 )%
    Margins                                       320.5         321.7            (0.4 )%

    Operating and maintenance expense             151.1         155.6            (2.9 )%
    Goodwill impairment loss *                    291.1             -             N/A
    Depreciation and amortization expense          25.8          25.4             1.6 %
    Taxes other than income taxes                   9.0           8.9             1.1 %

    Operating income (loss)                      (156.5 )       131.8             N/A

    Miscellaneous income                            1.2           1.6           (25.0 )%
    Interest expense                              (13.6 )       (14.3 )          (4.9 )%
    Other expense                                 (12.4 )       (12.7 )          (2.4 )%

    Income (loss) before taxes                $  (168.9 )   $   119.1             N/A

    Throughput in therms
     Residential                                  795.9         842.8            (5.6 )%
     Commercial and industrial                    253.3         268.5            (5.7 )%
     Interruptible                                 18.0          23.2           (22.4 )%
     Interdepartmental                              2.1           9.4           (77.7 )%
     Transport                                    613.4         669.3            (8.4 )%
     Total sales in therms                      1,682.7       1,813.2            (7.2 )%

    Weather
     Average heating degree days                  3,587         3,664            (2.1 )%

* See Note 6, "Goodwill and Other Intangible Assets," for more information.

First Quarter 2009 Compared with First Quarter 2008

Revenue

Regulated natural gas utility segment revenue decreased $163.7 million, driven by:

· An approximate $113 million decrease in revenue as a result of an approximate 9% decrease in the per-unit cost of natural gas over all of the regulated natural gas utilities in the first quarter of 2009, compared with the same quarter in 2008. 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 approximate $41 million decrease in revenue as a result of lower quarter-over-quarter natural gas throughput volumes, excluding the impact of weather, driven by:

- An approximate $35 million decrease related to lower volumes sold to residential customers resulting from energy conservation efforts and a decrease in volumes sold to commercial and industrial and transportation customers resulting from lower demand, all of which we believe are related to the general economic slowdown.

- An approximate $6 million decrease related to lower volumes sold to the electric utility segment as a result of a decrease in the need for the electric utility to run its peaking generation units because of lower usage by residential and commercial and industrial customers, the availability of lower cost power from MISO, and the availability of Weston 4, WPS's coal-fired generating facility that became commercially operational in June 2008.

· An approximate $23 million decrease in revenue from warmer weather during the heating season for the quarter ended March 31, 2009, compared with the same quarter in 2008, evidenced by the 2.1% decrease in heating degree days.

· A $5.5 million decrease in revenue from a quarter-over-quarter decrease in the recovery of cleanup expenditures at PGL and NSG related to former manufactured gas plant sites. This decrease in revenue was offset by a decrease in operating expense due to the amortization of the related regulatory asset and, therefore, had no impact on earnings.

· The decrease in revenue was partially offset by the positive impact of natural gas distribution rate cases and the change in rate design at the regulated natural gas utilities:

- Effective January 14, 2009, MGU received a final rate order from the MPSC for a natural gas distribution rate increase. Effective October 1, 2008, MERC received an interim natural gas distribution rate increase. Together, these rate increases had an approximate $8 million positive impact on revenue quarter-over-quarter. See Note 19, "Regulatory Environment," for more information on the rate increases at MGU and MERC.

- In 2009, PGL and NSG received the full impact of the 2008 natural gas distribution rate cases, effective February 14, 2008, which increased revenue quarter-over-quarter by approximately $5 million, net. NSG's new rate design incorporated both higher fixed customer charges and, the driving factor for the quarter, lower volumetric rates. See Note 19, "Regulatory Environment," for more information on PGL's and NSG's rates.

- Effective January 1, 2009, the PSCW required WPS to decrease retail natural gas distribution rates through a new rate design which incorporates higher volumetric rates and lower fixed customer charges. For the quarter ended March 31, 2009, revenue increased approximately $3 million related to this rate design change. See Note 19, "Regulatory Environment," for more information on WPS's rates.

Margin

The regulated natural gas utility segment margin decreased $1.2 million, driven by:

· A 7.2% decrease in natural gas throughput volumes related to the negative impact of the general economic slowdown and warmer quarter-over-quarter weather, which resulted in an approximate $15 million quarter-over-quarter decrease in natural gas utility segment margin. This quarter-over-quarter decrease in margin included the impact of decoupling mechanisms that were first effective for PGL and NSG on March 1, 2008, and for WPS on January 1, 2009. Under decoupling, these utilities are allowed to adjust rates to recover or refund the difference between the actual and authorized delivery charge components of margin from certain customers.

· A $5.5 million decrease in revenue from lower quarter-over-quarter recovery of cleanup expenditures at PGL and NSG related to former manufactured gas plant sites.

· The decreases in margin were substantially offset by the $16 million net positive impact quarter-over-quarter of rate cases and changes in rate design at the regulated natural gas utilities.

Operating Income (Loss)

Operating income at the regulated natural gas utility segment decreased $288.3 million, driven by a $287.1 million increase in operating expenses and the $1.2 million decrease in natural gas margin.

The increase in operating expenses primarily related to a non-cash pre-tax goodwill impairment charge of $291.1 million recognized in the first quarter of 2009 related to PGL, NSG, MERC, and MGU. See Note 6, "Goodwill and Other Intangible Assets," for more information. The increase in operating expenses was partially offset by a $5.5 million decrease in amortization of the regulatory asset related to cleanup costs of manufactured gas plant sites. These costs were recovered from customers in revenues.

Regulated Electric Segment Operations

                                               Three Months Ended             %
                                                    March 31              Increase
    (Millions, except heating degree days)        2009     2008          (Decrease)

    Revenues                                 $   329.7     $   329.2             0.2 %
    Fuel and purchased power costs               147.4         185.4           (20.5 )%
    Margins                                      182.3         143.8            26.8 %

    Operating and maintenance expense             96.3          97.1            (0.8 )%
    Depreciation and amortization expense         22.4          18.8            19.1 %
    Taxes other than income taxes                 12.0          11.1             8.1 %

    Operating income                              51.6          16.8           207.1 %

    Miscellaneous income                           0.9           2.2           (59.1 )%
    Interest expense                             (10.5 )        (8.8 )          19.3 %
    Other expense                                 (9.6 )        (6.6 )          45.5 %

    Income before taxes                      $    42.0     $    10.2           311.8 %

    Sales in kilowatt-hours
     Residential                                 843.1         850.1            (0.8 )%
     Commercial and industrial                 1,998.9       2,178.8            (8.3 )%
. . .