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Integrys Energy Group, Inc. (NYSE:TEG)

Q2 2011 Earnings Call

August 4, 2011 9:00 AM ET

Executives

Steven Eschbach – VP, IR

Charles Schrock – Chairman, President and CEO

Joseph O’Leary – SVP and CFO

Daniel Verbanac – President, Integrys Energy Services

Analysts

Ali Agha – SunTrust

Operator

Welcome to the Second Quarter 2011 Earnings Conference Call for Integrys Energy Group Incorporated. All lines will remain on listen-only until the question and answer session. At that time, instructions will be given should you wish to participate. At the request of Integrys Energy Group, today’s call will be recorded for instant replay.

I would now like to introduce today’s host, Mr. Steve Eschbach, Vice President of Investor Relations of Integrys Energy Group. Sir, you may now begin.

Steven Eschbach

Thank you very much and good morning everyone. Welcome to Integrys Energy Group’s second quarter 2011 earnings conference call. Delivering formal remarks with me today are Charlie Schrock, our Chairman, President and Chief Executive Officer; and Joe O’Leary, our Senior Vice President and Chief Financial Officer. Other executives, including Larry Borgard, our President and Chief Operating Officer of Utilities; Mark Radtke, Executive Vice President and Chief Strategy Officer of Integrys Energy Group and Dan Verbanac, President of Integrys Energy Services are also available for the question and answer session at the conclusion of our formal remarks.

The slide supporting today’s presentation and an associated data package are located on our website at www.integrysgroup.com, select Investor, select Presentation, and then today’s presentation.

Before we begin, I will advise everyone that this call is being recorded and will be available for replay through November 1, 2011. I need to direct you to Slides 3 of our presentation and to point out that this presentation contains forward-looking statements within the definition of the United States Securities and Exchange Commission’s Safe Harbor rules, including projected results for Integrys Energy Group and its subsidiaries.

Forward-looking statements contain factors that are beyond the ability of Integrys Energy Group to control and, in many cases, Integrys Energy Group cannot predict what factors would cause actual results to differ materially from those indicated by forward-looking statement. Except as required by federal securities laws, Integrys Energy Group and its subsidiaries undertake no obligation to publicly update or revise any forward-looking statements contained in this presentation, whether the result of new information, future events or otherwise.

This slide is condensed commentary on forward-looking statements and all are encouraged to read and understand the more specific language that is contained in our filings with the Securities and Exchange Commission including quarterly report on Form 10-Q we filed this morning, the forward-looking statement section of yesterday news release and slide 49 in the appendix.

Slide 4 indicates that today’s presentation includes non-GAAP financial information related to diluted earnings per share adjusted and adjusted earnings or loss. We believe that these are useful financial measures for providing investors with additional insight into our operating performance because they eliminate the effects of certain items that are not comparable from one period to the next. Please review the text of this slide for information regarding these non-GAAP financial measures.

I will now turn this call over to Charlie Schrock. Charlie?

Charles Schrock

Thanks, Steve. Good morning everyone and thanks for joining us today. I will begin by providing a high-level overview of our 2011 second quarter financial and operating results. And then Joe O’Leary will then discuss our financial results for the quarter in more detail, and in addition he will provide us summary of our investment and financing plans for 2011. And we will leave plenty of time for your questions at the end of course.

So turning to Slide 5, our second quarter 2011 consolidated diluted earnings per share adjusted were lower than for the same periods a year ago. Due to the seasonal nature of our energy businesses the second quarter is traditionally the weakest quarter during our financial reporting year, because of the temperate whether typical for the second quarter and lower natural gas and electric sales less favorable and offsetting factors that affect our business tend to have a greater impact in the second quarter then they would in any other quarter. So I will summarize the drivers that caused our earnings to decline this year versus last year.

On the plus side all of our natural gas service territories experienced colder weather this quarter and usage per customer excluding the impact of whether was up, the decoupling mechanism we have in place don’t cover all jurisdictions are customer classes so some of this increased usage was reflected in our quarterly results. In addition, there was an overall increase in margins in the retail markets that Integrys Energy services continues to focus on.

Offsetting these pluses were consolidated operating and maintenance expense increases, this – in public services maintenance expense was higher due to the timing of schedule plant outages, the cost for our outages are included in our revenue requirements but these costs are collected evenly over 12 months, while the actual expenses occur with the scheduled outages.

Natural gas distribution expenses were up Peoples Gas because certain cost related to the accelerated main replacement program are not included in the writer. And finally there was decrease in wholesale margins for Integrys Energy services due to the sale of the whole sale business in prior periods.

The key takeaway from today’s call is that we have narrowed our guidance for 2011 diluted earnings per share adjusted to a range of $3.30 and $3.50 and we are seeing some shifts among our reporting segments, we reduced our core earnings expectation for Integrys Energy services, although we still expect its core 2011 earnings to be more than twice what it contributed to consolidated earnings in 2010. And we have increased the earnings expectation for our natural gas utility segment. Joe will summarize the details of this in his formal remarks.

Other item I would note is the payment of our quarterly common stock divided on June 20 which marked its 71st consecutive year we have paid a dividend to our shareholder a tradition that we are proud to continue.

Slide 6, provides a brief overview of the second quarter achievements for our regulated utilities. For our regulated natural gas utility segment, our Accelerated Main Replacement program is off to a good start. As I previously mentioned we are seeing construction cost much lower than we originally budgeted, this gives us the opportunity to install more and new pipe for the same dollars, the program began in early April of this year and we are currently ramping up construction with an expected steady state rate of approximately 1 mile of new main installed per day here in Chicago.

At our regulated electric utility segment, we continued to maximize the performance of our generating plant and the interaction of those plants with the Midwest independent system operator market. Our power plants have been available when needed and we’ve been able to cycle in response to market dynamics such as on the weekends and at night when prices are lower, this operational flexibility helps to minimize our fuel and purchase power costs which provides savings for our customers.

The balance of slide 6 summarizes our current rate case activities in the various jurisdiction, at the moment we have five rate case proceedings in various stages. Additional details regarding our original filings and positions other regulators and interveners can be found in the appendix on slide 23 through 28.

Turning to slide 7, let me recap the accomplishments related to our non-regulated operations at Integrys Energy Services. Our volumes have increased by more than 6% quarter-over-quarter for retained retailed natural gas markets and retail electric volumes are essentially flat for the retained electric markets. Unit margins for both natural gas and electric increased quarter-over-quarter, there is good news regarding business retention which is holding above 95% so far this year. Dan Verbanac and his team have done a tremendous job from a transition and operational standpoint with our retail energy and marketing business.

With that said, the combination of market ways and changing market dynamics in some of the regions where we operate has resulted in growth taking longer than we originally expected. An example of one of these delays is in Illinois.

We anticipated that the regulatory framework to better facilitate retail access for small customer classes would be in place in 2010 rather than the first quarter of 2011. Consequently we do not begin offering Illinois residents electricity from Integrys Energy services until the second quarter of 2011 rather than early in the first quarter as we had originally planned.

There were so many challenges with growth initiatives that we’re implementing in other geographic markets. We’re continuing to enhance our product offerings in the markets where we operate and we’re adapting to the changing market dynamics which will help us meet our long-term growth objectives.

On a final note, the development of our solar projects is continuing according to plan. At this point our solar projects are not a meaningful contributor to our earnings, but we’re gaining experience on what we believe will eventually be a growing business as this technology continues to mature.

I’ll now turn the call over to Joe O’Leary

Joseph O’Leary

Thank you, Charlie. I will cover our financial results for the second quarter 2011 and review our guidance for 2011 diluted earnings per share adjusted.

Beginning with slide 8, during the second quarter of 2011, in accordance with Generally Accepted Accounting Principles or GAAP, we recognized diluted earnings per share of $0.37 for the quarter ended June 30th, 2011 compared with $1.02 for the same quarter in 2010.

This slide also sets forth the additions and subtractions we’ve made to arrive at diluted earnings per share adjusted for the second quarter of 2011. As this slide indicates our diluted earnings per share adjusted for the second quarter 2011 was $0.38 versus $0.48 in the same period in 2010.

I’ll gladly answer any questions you may have in our quarterly results during our question-and-answer session at the completion of our formal remarks. More information on the comparative second quarters of 2011 and 2010 adjusted earnings and diluted earnings per share adjusted is reported by segment on slide 33 and 34 in the appendix. You will also find the six month 2011 and 2010 comparative data for adjusted earnings and diluted earnings per share adjusted on slides 40 and 41 in the appendix.

On slide 9, we present the changes in adjusted earnings by segment for the second quarter of 2011 compared with the second quarter of 2010. As you can see the primary driver of the decreased earnings is our Regulated Electric Utility segment. And this was due to increased maintenance expense driven by the timing of scheduled plant outages and decreased margins which were driven by rate order difference at Wisconsin Public Service. Additional detail on the key variance drivers for each segment can be found in the appendix on slides 35 through 39.

Again, I will answer any questions you may have related to the key drivers during our question and answer session.

Slide 10 presents the changes in adjusted earnings by segment for the six months of 2011 compared with the same period in 2010. Similar to the second quarter, the primary driver of the decreased earnings for the six months is our Regulated Electric Utility Segment. This was primarily due to decreased margins which were driven by rate order difference at Wisconsin Public Service, increased maintenance expense due to the timing of scheduled plant outages and other expenses mainly related to increased interest on deferred compensation.

Moving to slide 11, we have provided an update on our capital expenditure plan for all our subsidiaries. The key drivers remain the same as we discussed in the past. That is environmental retrofits and hydroelectric plant upgrades mandated by the Federal Energy Regulatory Commission for our Regulated Electric Utility Segment. The gas main replacement program for Peoples Gas and the renewable energy project investments predominantly solar for Integrys Energy Services.

There are some changes included in the schedule compared to what we presented to you during our last conference call. Wisconsin Public Services capital expenditures during the three year period were adjusted to reflect additional and biometal retrofit projects.

Integrys Energy services capital expenditures were also adjusted to remove the equity contributions which we will be making to Indu Solar for the three year period and we listed Indu Solar as a separate equity contribution item on the bottom of the chart.

Slide 12, sets forth our expected depreciation expense at the regulated utilities. This has not changed from what we presented in the first quarter of 2011. Slide 13 is a new slide for this quarterly call and it reflects our estimate of a projected rate base for all of our regulated utilities.

As we mentioned in our previous earnings conference call, due to the impact of bonus tax depreciation that is effective till 2013 as well as implementing a new tax strategy primarily related to Wisconsin Public Service our rate base is not projected to grow as it would have been in prior years without these tax advantage provisions in place.

Bonus tax depreciation and expensing of certain items that would otherwise be capitalized has the positive effect of increasing cash flow. It also increases accumulated deferred income taxes which is an offset to rate base.

We are making prudent use of the increased cash flow. For example, we are increasing funding to our employee benefit plans which will entirely reduce employee benefit expenses in the future as well as increased our rate base.

During the slide 14, what we summarized the slight changes to our financing plan for 2011, I will begin with our short-term credit facilities which we discussed in our last quarterly earnings conference call, the details are included in the first major and related sub bullets on this slide. With respect to our long-term debt financing we still planned to issue $50 million for Peoples Gas this year, new to this slide is the retention of approximately $30 million of Integrys Energy Groups junior subordinates notes in May of 2011 which was done to take advantage of the current low interest rate environment and reduce our overall interest expense.

As a reminder, the stock investment, dividend reinvestment and equity based compensation plans return to the use of open market purchases in May 2011. The intent of our financing plan is to provide adequate capital levels at reasonable costs and maintain our current credit ratings which are shown on slide 47 in the appendix of our slide doc.

Turning to slide 15, our guidance for 2011 diluted earnings per share adjusted on a consolidated basis is between $3.30 and $3.50, this slide depicts diluted earnings per share by segment as well as the removable of special items to arrive at diluted earnings per share adjusted. As Charlie mentioned there is been some movement among the different segments.

The key changes is indicated on slide 16, included lower than expected growth wrap up in Integrys Energy Services that Charlie discussed earlier which brings our projected core earnings for this segment down by $0.10 per share on both the low end and the high-end of the range. Offsetting this are expected to gain at the regulated utilities. For the regulated natural gas utility segment we see improvements due to our cost control and operational excellence efforts as well as improved margins due to a combination of higher use per customer, higher average customer counts and improved economic conditions for certain customer classes in certain service territories.

For the regulated electric segment we see improvements due to anticipated operating and maintenance reductions for the remainder of the year, for holding company that other declined in the low end and the high end of the range is primarily related to the increased expense resulting from the tax law change at Michigan. However, you will see that we have added back the incremental $0.05 per share and arriving diluted earnings per share adjusted, because the write-off of the deferred income tax asset is an usual event, and this impact on earnings is not expected to continue in future years.

In summary, our 2011 guidance for diluted earnings per share adjusted has been revised to narrow the range. The range for our 2011 guidance for diluted earnings per share adjusted on a consolidated basis now stands at $3.30 to $3.50.

Now I will turn the call back over to Charlie.

Joseph O’Leary

Thanks, Joe. Before we taking your questions, I will highlight some of the points we made this morning. If you are following along please turn to Slide 17.

First, we continued the execution of our business plan to our operational excellence initiative our cost control efforts and the timely filing of rate cases. Our quarter-over-quarter performance is down for the reasons we explained earlier in this call. We have adjusted our guidance to reflect the performance of our various segments thus far this year and our expectations for the remainder of the year and we have narrowed the range.

Our 34% ownership in the American Transmission Company will continue to contribute to earnings. The American Transmission Company is also working to expand outside its traditional footprint, but at this point it is still too early to project the timing or the impact of such growth.

Regarding our non-regulated operations, the successful transition to a smaller retail focused and non-regulated energy services company is mostly behind us. The growth of this segment is not as strong as our earlier projections, but the segment continues to grow and we expect that it will continue to do so over the next few years and reach our expectations overtime.

Our portfolio of businesses helps us to meet our financial projections on a consolidated basis. Our portfolio includes 6 regulated utilities operating in four Midwest states our non-regulated operations operating throughout the northeast quadrant of the United States and our equity investment in ATC.

Our guidance for 2011, diluted earnings per share adjusted consolidated basis is $3.30 to $3.50, the payment of our June 20 quarterly common stock dividend marked the 71st consecutive year that we have paid a divided to our shareholders.

And finally we continue to expect to growth in diluted earnings per share adjusted of 46% on an average annualized basis due 2015 with 2011 as the base here.

We will now be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Ali Agha with SunTrust, you may ask your question.

Ali Agha – SunTrust

Thank you, good morning.

Unidentified Company Representative

Hi Ali.

Ali Agha – SunTrust

I wanted to dwell a little more into your energy services business, if I look at the dynamics there, the first quarter results, you were significantly up year-over-year, second quarter you are actually down year-over-year, obviously you lowered your guidance for the year as well.

And I think you also may be more thinking into those business, we’ve been hearing from other folks about margin pressure and lack of volatility hurting the business, I thought you guys were talking about margin increasing. So give us a little more insight into what happened there, and given your revised outlook, should we still think of that as a core business wasn’t that caused too much volatility in your numbers the way that business moves around quarter-to-quarter.

Charles Schrock

Let me start kind of working backwards on your questions. On your last points and I also have Dan Verbanac kind of step in here and give you some more detail. But on your last point, we do like the portfolio aspect that we have and Integrys Energy Services is a key piece of that and what we are seeing this quarter and what we see in prior years is sometimes when some segments are up other segments are down. But on the whole it’s providing a nice study consolidated earnings stream.

And the other thing that we see is overtime.

Ali Agha – SunTrust

Hello, Hello.

Operator

One moment please.

Ali Agha – SunTrust

Hello, okay I seem to be cut off.

Operator

One moment please.

Ali Agha – SunTrust

Charlie can you hear us.

Operator

I can hear you now.

Ali Agha – SunTrust

Hello I think I will go back now. Hello.

Operator

(Operator Instructions) And Ali were you done with your question.

Ali Agha – SunTrust

No. Charlie, can you hear?

Charles Schrock

I can hear you, I don’t know if you can hear us.

Ali Agha – SunTrust

I can hear you, I think unfortunately you got completing cut off right at the beginning, so I apologize I just could not hear your full answer.

Charles Schrock

My apologize I don’t know what happened there. You can hear me now right.

Ali Agha – SunTrust

I can hear you now yes.

Charles Schrock

Okay. Let me start off while I will try to brief, but on your last point, we like our portfolio of businesses and Integrys Energy Services is a piece of that and overtime we will see some segments go up and compensated by other segments going down and vice a versa and as we look to the future, I will expect our portfolio to continue to perform as we expect, but we will see changes in segments. Let me kind of stop there on that point and I will have Dan comment a little bit on the dynamics that we are seeing over the last quarter or two.

Daniel Verbanac

Good morning Ali.

Ali Agha – SunTrust

Good morning.

Daniel Verbanac

There is two primary drivers related to the change this quarter and Integrys Energy Service, just as Charlie mentioned that, the changing market dynamics, it certainly has effected in really all market participants and in second we had higher operating and maintenance costs in the second quarter of 2011, during the first half of 2011, there was some additional cost incurred that are now expected to reoccur in the balance of 2011.

We believe we’ve made the necessary adjustments and with combined with the high retention rates which Charlie mentioned over 95% for the first six months of 2011. We believe that our expected growth expectations of 6 to 8% net income on an average annual 2011 basis is achievable.

Ali Agha – SunTrust

Okay, we will track that and Charlie if I may one other question. Given your revised outlook for the utility portfolio, could you also update us to where you stand in terms of the regulatory lag that you guys track in that business. And any updates on your thinking on how the Peoples Gas business is progressing?

Daniel Verbanac

Ali may be a high level comment then I will let O’Leary will have some additional thoughts as well. In terms of the regulatory lag, we are making progress, we are continuing to focus on those different components that we talked about cost control, and cost management as well timely filing of rate cases.

So we are making progress and as you and I have talked in the past, we will probably never get to zero on a consistent basis but we will always keep trying to make it as small as we can. And Leary you can comment on the rate case.

Joseph O’Leary

Yeah, Ali. The people say North Shore rate cases are really progressing as our prior two rate cases have progressed and about as we had expected. So no surprises there to-date.

Ali Agha – SunTrust

And we should expect a fully litigated case right not settlement is not an option here?

Joseph O’Leary

Yeah that’s the normal Illinois correct.

Ali Agha – SunTrust

Thank you.

Joseph O’Leary

Thank you, Ali.

Operator

(Operator Instructions) Next question comes from (inaudible). You may ask your question.

Unidentified Analyst

Good morning.

Daniel Verbanac

Good morning John.

Unidentified Analyst

Quick question, you guys reaffirmed the overall growth rate of – was 4% to 6% what about the 6 to 8 from the writings?

Joseph O’Leary

John as we look forward we think that 6 to 8 on the unreg is a reasonable expectation over the next few years starting with 2011 as a base year. Dan, any additional thoughts on that?

Daniel Verbanac

No, no as we look at the business that we have contracted in our forward book, we are certainly comfortable with that expectation going forward.

Unidentified Analyst

And is that also through 2015?

Daniel Verbanac

Correct.

Unidentified Analyst

Okay. And any color so to the competitive landscape?

Daniel Verbanac

Sure, certainly over the last few years, we continued to experience low energy prices, low volatility, credit capital costs are levels at pre-crisis levels as a result certainly we are seeing more competitors and more competition, but this is a dynamic that’s nothing new to us we’ve been doing with this over 17 years as we’ve been in this business.

And we think we’ve responded with the necessary adjustments and changes to our plan, which includes new product offerings and certain areas and wrapping up some of our marketing campaign. So overall we feel good that we can achieve our expectations going forward.

Unidentified Analyst

Do you sell the Integrys brand?

Daniel Verbanac

Yes, we sell under Integrys Energy services in all the area that we sell.

Unidentified Analyst

Okay, thank you guys. I appreciate it.

Daniel Verbanac

Thank you John.

Operator

Thank you. (Operator Instructions) And at this time I am showing no further questions. I will turn the call back over to Steve Eschbach. I apologies one moment please. And Steve Eschbach you may take the call.

Steven Eschbach

Well thank you very much for being part of our second quarter earnings conference call, a replay of this conference call will be available until November 1, 2011 by dialing toll free 888-562-7630. The full transcript for today’s conference call will be available on our website at www.integrysgroup.com before the end of the day on Tuesday August 9, 2011. Just select investor and then presentations. If you have any additional questions, you may contact me at 312-228-5408 or Dan at 920-433-1857. Thank you.

Operator

Thank you for participating in today’s call, this conference is now ended. You may disconnect at this time.

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