The following discussion should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and related Notes and the 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. Integrys Energy Group is in the process of executing its previously announced strategy to divest of its nonregulated energy services operations or reduce the size of these operations to one with credit and collateral support requirements that are insignificant by the end of 2010.

The essential components of Integrys Energy Group's business strategy are:

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 Integrys Energy Group's 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.

· Integrys Energy Group's 34% ownership interest in ATC, a transmission company that has over $2.6 billion of transmission assets at June 30, 2009. Integrys Energy Group will continue to fund its share of the equity portion of future ATC growth. 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, which is expected to be completed in the fourth quarter of 2009.

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. Through the restructuring process, Integrys Energy Group is committed to reducing credit and collateral support requirements by the end of 2010 to an insignificant level. 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 - Integrys Energy Group's asset management strategy calls for the continuous assessment of existing assets, the acquisition of assets, and contractual commitments to obtain resources that complement its existing business and strategy. The goal is to provide the most efficient use of 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. Integrys Energy Group maintains a portfolio approach to risk and earnings. Integrys Energy Group's decision regarding the future of Integrys Energy Services illustrates its asset management strategy.

Integrys Energy Group's risk management strategy includes the management of market exposure, credit, and operational risks through the normal course of business. Forward purchases and sales of electric capacity, energy, natural gas, and other commodities allow for opportunities to secure prices in a volatile energy market. Each business unit manages daily the risk profile related to these instruments consistent with Integrys Energy Group's risk management policies, which are 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 energy 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, Integrys Energy Group is able to provide a safe, reliable,

value-priced service to its customers. Integrys Energy Group concentrates its efforts on improving and operating efficiently in order to reduce costs and maintain a low risk profile. Integrys Energy Group actively evaluates opportunities for adding more renewable generation to provide additional environmentally sound energy to its 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 and energy related services:

· Managing operations to minimize the impact on the environment. WPS's 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 allows reductions in the amount of emissions produced. Integrys Energy Group also expects to maintain or decrease the amount of greenhouse gases released over time and supports research and development initiatives that will enable further progress toward decreasing its 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 its natural gas connection to the Guardian II pipeline, ensures continued reliability for Integrys Energy Group's customers.

                             RESULTS OF OPERATIONS

                            Three Months Ended               %               Six Months Ended              %
                                  June 30                Increase                June 30               Increase
(Millions, except per
share amounts)             2009             2008        (Decrease)          2009          2008        (Decrease)

Natural gas utility
operations              $     (4.1 )     $     (9.3 )         (55.9 )%   $   (177.2 )   $    66.3             N/A
Electric utility
operations                    22.9             20.2            13.4 %          50.0          27.0            85.2 %
Nonregulated energy
operations                    11.4              9.0            26.7 %         (17.7 )        60.6             N/A
Holding company and
other operations               4.5              4.2             7.1 %          (0.6 )         6.0             N/A

Net income (loss)
attributed to common
shareholders            $     34.7       $     24.1            44.0 %    $   (145.5 )   $   159.9             N/A

Basic earnings (loss)
per share               $     0.45       $     0.31            45.2 %    $    (1.90 )   $    2.09             N/A
Diluted earnings
(loss) per share        $     0.45       $     0.31            45.2 %    $    (1.90 )   $    2.08             N/A

Average shares of
common stock
   Basic                      76.8             76.6             0.3 %          76.7          76.6             0.1 %
   Diluted                    76.8             76.9            (0.1 )%         76.7          76.9            (0.3 )%

Financial Results - Second Quarter 2009 Compared with Second Quarter 2008

Earnings at Integrys Energy Group increased $10.6 million, to net income attributed to common shareholders of $34.7 million ($0.45 diluted earnings per share) for the quarter ended June 30, 2009, compared with net income of $24.1 million ($0.31 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):

· The net loss at the regulated natural gas utility segment decreased $5.2 million, from $9.3 million for the quarter ended June 30, 2008, to $4.1 million for the same quarter in 2009. The decrease in net loss was driven by a goodwill impairment loss related to NSG recorded in the second quarter of 2008.

· Earnings at the regulated electric utility segment increased $2.7 million, from $20.2 million during the quarter ended June 30, 2008, to $22.9 million for the same quarter in 2009. The increase in earnings was driven by an increase in wholesale demand charges, higher margins from residential and commercial and industrial customers, and the favorable impact from a fuel surcharge increase that was effective July 4, 2008, a portion of which was incorporated into WPS's 2009 non-fuel base retail electric rates. The higher electric earnings were partially offset by increases in maintenance expense, pension and other postretirement benefit costs, and interest expense.

· Financial results at Integrys Energy Services increased $2.4 million, from earnings of $9.0 million for the quarter ended June 30, 2008, to $11.4 million for the same period in 2009, driven by:

- A $35.4 million after-tax non-cash increase in Integrys Energy Services' margin quarter-over-quarter, due to a $63.7 million after-tax increase related to non-cash activity associated with natural gas operations, partially offset by a $28.3 million after-tax decrease related to non-cash activity associated with electric operations,

- Combined, realized retail and wholesale electric margin increased $14.4 million after-tax:

Realized retail electric margins increased $9.2 million after-tax. Higher quarter-over-quarter realized retail per unit electric margins were experienced in Illinois, New England, and New York, as Integrys Energy Services begins to see the effects of including higher capital costs in its pricing. Margins were also higher in the Mid-Atlantic region, as Integrys Energy Services continued to realize volume growth in this newer market and also realized higher average per unit margins in 2009.

The realized wholesale electric margin increased $5.2 million after-tax. In general, realized margins are impacted by transaction activity in prior periods. Wholesale transactions increased at the end of 2007 and the beginning of 2008, but were scaled back in conjunction with the global credit crisis in the latter half of 2008 and continue to be scaled back with the announced Integrys Energy Services strategy change. The scaled back transaction activity will negatively impact realized margin in subsequent periods.

Partially offsetting the above increases;

- Realized natural gas margins decreased $21.0 million after-tax, driven by a reduction in wholesale transactions as a result of the strategy change announced earlier in the year.

- After-tax restructuring expenses recorded at Integrys Energy Services of $11.9 million, which included anticipated employee related costs, the write-off of capitalized development costs related to software that will not be utilized because of the restructuring, and consulting and legal costs.

- Operating and maintenance expense increased $10.6 million after-tax, primarily related to a $5.4 million after-tax novation fee paid to a counterparty to consolidate certain wholesale financial and physical transactions. The remaining increase in operating and maintenance expense related to higher bad debt expense and a loss recorded on the sale and leaseback of a solar equipment project in the second quarter of 2009. Integrys Energy Services realized offsetting gains on the sale and leaseback of other solar equipment projects that in accordance with GAAP were deferred and will be recognized in income over the 10-year life of the related leases.

- A small decrease in other income and an increase in interest expense also negatively impacted Integrys Energy Services' earnings by an after-tax combined $2.6 million quarter-over-quarter.

Financial Results - Six Months 2009 Compared with Six Months 2008

Financial results at Integrys Energy Group decreased $305.4 million, to a net loss attributed to common shareholders of $145.5 million ($1.90 net loss per share) for the six months ended June 30, 2009, from net income attributed to common shareholders of $159.9 million ($2.08 diluted earnings per share) for the same period 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 $243.5 million, from earnings of $66.3 million for the six months ended June 30, 2008, to a net loss of $177.2 million for the same period in 2009. The net loss at the natural gas utility segment was driven by a $242.3 million increase in after-tax non-cash goodwill impairment losses period-over-period. Lower period-over-period volumes, attributed to the general economic slowdown, warmer weather during the heating season, an increase in pension and other postretirement costs, and higher injuries and damages expense, including workers compensation, also contributed to the decrease in financial results at the regulated natural gas utility segment. The decrease in financial results was partially offset by higher period-over-period earnings from rate increases at MERC and MGU, the full year's benefit of PGL's 2008 rate increase, changes in rate design, and a decrease in bad debt expense.

· Earnings at the regulated electric utility segment increased $23.0 million, from $27.0 million during the six months ended June 30, 2008, to $50.0 million for the same period in 2009, driven by a $21.8 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 six months ended June 30, 2009, compared with the same period in 2008. Electric utility earnings were also favorably impacted by an increase in demand charges from wholesale customers, a fuel surcharge increase effective July 4, 2008, a portion of which was incorporated into WPS's 2009 non-fuel base retail electric rates, and higher margins from residential and commercial and industrial customers. The higher electric earnings were partially offset by increases in pension and other postretirement benefit costs, maintenance expenses, depreciation expense related to Weston 4, and interest expense.

· Financial results at Integrys Energy Services decreased $78.3 million, from earnings of $60.6 million for the six months ended June 30, 2008, to a net loss of $17.7 million for the same period in 2009, driven by:

- A $55.8 million after-tax decrease in Integrys Energy Services' margin period-over-period related to non-cash activity, due to a $123.2 million after-tax decrease related to non-cash activity associated with electric operations as market prices were lower in 2009 than in 2008, partially offset by a $67.4 million after-tax increase related to non-cash activity associated with natural gas operations.

- Operating and maintenance expense increased $16.3 million after-tax, primarily related to a $5.4 million after-tax novation fee paid to a counterparty in order to consolidate certain wholesale financial and physical transactions. The remaining increase in operating and maintenance expense related to higher employee benefit costs, higher bad debt expense, and a loss recorded on the sale and leaseback of a solar equipment project in the second quarter of 2009. Integrys Energy Services realized offsetting gains on the sale and leaseback of other solar equipment projects that in accordance with GAAP were deferred and will be recognized in income over the 10-year life of the related leases.

- After-tax restructuring expenses recorded at Integrys Energy Services of $11.9 million, which included anticipated employee costs, the write-off of capitalized development costs related to software that will not be utilized because of the restructuring, and consulting and legal costs.

- Realized natural gas margins decreased $3.2 million after-tax, driven by a reduction in wholesale transactions as a result of the strategy change announced earlier this year.

- A small decrease in other income and an increase in interest expense also negatively impacted Integrys Energy Services' earnings by an after-tax combined $2.4 million period-over-period.

- Partially offsetting the decrease, realized retail and wholesale electric margin increased $19.1 million after-tax:

Realized retail electric margin increased $13.0 million after-tax. Higher period-over-period realized retail per unit electric margins were experienced in Illinois, New England, and New York, as a result of including higher capital costs in pricing. Margins were also higher in the Mid-Atlantic region, as Integrys Energy Services continued to realize volume growth in this newer market and also realized higher average per unit margins in 2009.

The realized wholesale electric margin increased $6.1 million after-tax. In general, realized margins are impacted by transaction activity in prior periods. Wholesale transactions increased at the end of 2007 and the beginning of 2008, but were scaled back in conjunction with the global credit crisis in the latter half of 2008 and continue to be scaled back with the announced Integrys Energy Services strategy change. The scaled back transaction activity will negatively impact realized margin in subsequent periods.

· Financial results at the holding company and other segment decreased $6.6 million, from net income of $6.0 million for the six months ended June 30, 2008, to a net loss of $0.6 million for the same period 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 period was the negative impact of a February 2009 tax law change in Wisconsin that requires combined income tax computations and reporting beginning in 2009. Increases in interest expense and legal and settlement expenses at the holding company and other segment also decreased financial results, but were partially offset by higher earnings from Integrys Energy Group's investment in ATC, intercompany interest income, and gains from land sales.

Utility Operations

For the three and six months ended June 30, 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              %               Six Months Ended              %
                                  June 30                Increase                June 30               Increase
 (Millions, except
heating degree days)        2009           2008         (Decrease)         2009          2008         (Decrease)

Revenues                 $    308.8      $   515.8            (40.1 %)   $ 1,405.6     $ 1,776.3            (20.9 %)
Purchased natural gas
costs                         142.4          347.7            (59.0 %)       918.7       1,286.5            (28.6 %)
Margins                       166.4          168.1             (1.0 %)       486.9         489.8             (0.6 %)

Operating and
maintenance expense           126.8          123.5              2.7 %        277.9         279.1             (0.4 %)
Goodwill impairment
loss *                            -            6.5           (100.0 %)       291.1           6.5          4,378.5 %
Depreciation and
amortization expense           26.6           27.1             (1.8 %)        52.4          52.5             (0.2 %)
Taxes other than
income taxes                    7.3            7.6             (3.9 %)        16.3          16.5             (1.2 %)

Operating income
(loss)                          5.7            3.4             67.6 %       (150.8 )       135.2              N/A

Miscellaneous income            0.6            2.2            (72.7 %)         1.8           3.8            (52.6 %)
Interest expense              (12.6 )        (12.4 )            1.6 %        (26.2 )       (26.7 )           (1.9 %)
Other expense                 (12.0 )        (10.2 )           17.6 %        (24.4 )       (22.9 )            6.6 %

Income (loss) before
taxes                    $     (6.3 )    $    (6.8 )           (7.4 %)   $  (175.2 )   $   112.3              N/A

Throughput in therms
 Residential                  216.7          217.7             (0.5 %)     1,012.6       1,060.5             (4.5 %)
 Commercial and
industrial                     64.1           71.8            (10.7 %)       317.4         340.3             (6.7 %)
 Interruptible                  6.1           12.5            (51.2 %)        24.1          35.7            (32.5 %)
 Interdepartmental              2.3            9.0            (74.4 %)         4.4          18.4            (76.1 %)
 Transport                    296.1          354.6            (16.5 %)       909.5       1,023.9            (11.2 %)
 Total sales in therms        585.3          665.6            (12.1 %)     2,268.0       2,478.8             (8.5 %)

Weather
 Average heating
degree days                     852            836              1.9 %        4,439         4,501             (1.4 %)

* See Note 8, "Goodwill and Other Intangible Assets," for more information.

Second Quarter 2009 Compared with Second Quarter 2008

Revenue

Regulated natural gas utility segment revenue decreased $207.0 million, driven by:

· An approximate $177 million decrease in revenue as a result of an approximate 57% average decrease in the per-unit cost of natural gas sold by the regulated natural gas utilities in the second quarter of 2009, compared with the same quarter in 2008. For all of Integrys Energy Group's regulated natural gas utilities, prudently incurred natural gas commodity costs are directly passed through to customers in current rates.

· An approximate $30 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 $22 million decrease related to lower volumes sold to residential customers resulting from energy conservation efforts, lower volumes sold to commercial and industrial and transportation customers resulting from changes in plant operations, and a decrease in customer base at PGL, which Integrys Energy Group attributed to the general economic slowdown.

- An approximate $8 million decrease related to a quarter-over-quarter reduction in volumes sold to the electric utility segment because of lower electricity usage by residential and commercial and industrial customers, the availability of lower cost power from MISO, and the availability of WPS's Weston 4 coal-fired generating facility that became commercially operational in June 2008, all of which resulted in a decrease in the need for the electric utility to run its peaking generation units.

· An approximate $2 million quarter-over-quarter decrease in revenue from 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 at MGU and MERC. Effective January 14, 2009, MGU received a final rate order from the MPSC for a natural gas distribution rate . . .