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Integrys Energy Group, Inc (NYSE:TEG)

Q4 2007 Earnings Call

February 20 2007 11:30 am ET

Executives

Steven Eschbach - Vice President of Investor Relations

Larry Weyers – President, Chief Executive Officer

Joe O'Leary - Senior Vice President, Chief Financial Officer

Charlie Schrock - President of Wisconsin Public Service Corporation

Larry Borgard – President, Chief Operating Officer of Integrys Gas Group

Mark Radtke - President of Non-Regulated Subsidiary, Integrys Energy Services

Analysts

Michael Garrisons - Robert W. Baird

Faisel khan - Citi

Maurice May - Power Insight

Paul Patterson - Glenrock Associates

Mark Lunenburg - Talon Capital

Hassan Doza - Luminous Management

David Greenhouse - Scotia

Operator

Welcome to the Fourth Quarter Earnings Conference Call for Integrys Energy Group, Inc. All lines will remain in 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 at Integrys Energy Group. Sir, you may begin.

Steven Eschbach - Vice President of Investor Relations

Thank you. Good morning. Welcome to Integrys Energy Group’s 2007 fourth quarter earnings conference call. Delivering formal remarks with me today are Larry Weyers, our President and Chief Executive Officer; Joe O'Leary, our Senior Vice President and Chief Financial Officer; Charlie Schrock, President of Wisconsin Public Service Corporation; Larry Borgard, President and Chief Operating Officer of Integrys Gas Group; and Mark Radtke, President of our Non-Regulated Subsidiary, Integrys Energy Services. Other members of our executive management team are also present to assist in answering any questions you may have after our formal remarks are presented.

The slides supporting today’s presentation and an associated data package are located on our website at www.integrysgroup.com. Select Investors, select Presentations, 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 May 6, 2008.

I need to direct you to Slides 2 and 3 of our presentation and to point out that this presentation contains forward-looking statements within the definition of the Securities and Exchange Commission's Safe Harbor rules, including projected results for 2008 for Integrys Energy Group and its subsidiaries. Forward-looking statements 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 statements.

I also refer you to the forward-looking statement section of today's news release and to our filed Securities and Exchange Commission disclosure documents for further information. Except as may be required by federal securities laws, Integrys Energy Group and its subsidiaries undertake no obligation to publicly update or revise any forward-looking statement contained in this presentation, whether the result of new information, future events, or otherwise.

Slide 4 indicates that today’s presentation includes non-GAAP financial information related to diluted earnings per share from continuing operations, adjusted, forward book value, and managerial gross margin. We believe that diluted earnings per share from continuing operations, adjusted, forward book value, and managerial gross margin are useful measures for providing investors with additional insight into our operating performance and the effects of certain items that are not comparable from one period to the next. Please review the text of this slide regarding non-GAAP financial information.

I will now turn this call over to Larry Weyers. Larry?

Larry Weyers - President, Chief Executive Officer

Thanks, Steve. Good morning, everyone, and thanks for joining us on the call today. Please turn to Slide 5. At Integrys Energy Group, we are focused on providing a high level of service to our customers, continuing to engage a dedicated employee base, maintaining a strong balance sheet, delivering long-term earnings per share growth of between 6% and 8% on an average annualized basis, and continuing to enhance long-term value for our shareholders.

Our discussion today will you the steps that we are taking to achieve these goals. I’ll begin with a quick look at our accomplishments during the fourth quarter and the past year. I will also tell you about our 2008 initiatives. Then Joe O'Leary will provide more detailed information on the fourth quarter and the year 2007 as well as discuss our guidance for 2008. Joe will then be followed by Charlie Schrock, Larry Borgard, and Mark Radtke, who will each provide more insights about what is occurring in their business units.

So, beginning with Slide 6, you will see our major accomplishments during the fourth quarter of 2007, advancing our construction projects was a key driver of success, construction of Weston 4 was kept on schedule and on budget. We completed construction of the Wausau, Wisconsin, to Duluth, Minnesota, transmission line for the American Transmission Company and the construction of our landfill gas generation project in Rockford, Illinois.

The Guardian 2 Pipeline received the approvals necessary to proceed with the new pipeline project and we began preparations for constructing the laterals that will connect our system to the new pipeline.

Merger activities took a lot of our time. Cutover of our finance and accounting systems to a consolidated platform took place on January 1, 2008. We made major steps toward integrating the cultures of our entire portfolio of companies. We formally established Integrys Business Support to provide centralized services throughout the enterprise and received approvals to do so from state regulatory authorities in the three jurisdictions for which approval was necessary.

As I look over the last year, I am proud of the strides we’ve made, and Slide 7 highlights some of these. We completed the merger of WPS Resources and Peoples Energy on February 21 and changed our name to Integrys Energy Group. We announced that we would sell our oil and natural gas production business by year-end 2007 and actually completed it three months earlier in September 2007. We filed natural gas retail rate cases in Illinois in March 2007, the first rate cases Peoples Gas and North Shore Gas filed in that jurisdiction in 12 years, and the order was approved on February 5, 2008.4 And, we have been integrating the operations of the two companies with the anticipation that the combined company would generate significant synergy savings. We expect the five-year total cumulative synergy savings to exceed 400 million dollars by 2011, up from the approximate 366 million dollars we projected a year ago.

The table on Slide 8 updates information relating to the timing of synergy savings and costs to achieve. As you can see, we are projecting annual synergy savings of 106 million dollars in 2011, up from the 96 million dollars we projected last year at this time. The estimated cost to achieve those synergy savings has been reduced to 155 million dollars from 179 million dollars due to a decision to retain Peoples’ current customer service software and enhance it rather than abandoning it and writing it off. We have attained $38 million of pre-tax synergy savings through calendar year 2007. Additional details regarding our synergy savings and costs to achieve the savings can be found in the appendix to our slide presentation, on Slides 31 through 34.

Our initiatives for 2008 are highlighted on Slide 9. We will continue to advance our construction projects. The Wausau, Wisconsin, to Duluth, Minnesota, transmission line was energized and placed in service on January 23. We are close to completing construction of Weston 4 and expect it to be commercially operational by mid-year. We are on schedule to complete construction of the Guardian 2 Pipeline laterals in the fourth quarter of 2008.

Merger related activities will also continue. And, Integrys Business Support, the administrative support subsidiary that will capture many of the cost synergies identified, began operating on January 1, 2008. We will continue to streamline the organizational design as we complete transition projects. We are in the process of consolidating the finance and human resources software platforms providing great synergies for the companies. We will have new employee benefit plans in place for all non-union employees by the end of the first quarter of 2008.

The new rates resulting from the recent ruling on the Illinois rate case became effective during February 2008. We will also review the necessity for rate case filings for each of our utility operations so that we can earn our authorized return on equity in each jurisdiction.

I will now turn the call over to Joe O’Leary. Joe.

Joe O'Leary - Senior Vice President, Chief Financial Officer

Thank you, Larry. I will review the major financial and segment highlights for the quarter. Please keep in mind that it is challenging to make year-over-year comparisons this year given the increase in our portfolio of assets. We would like to remind you that our year-to-date 2007 results include the operations of Peoples Energy starting on February 22, 2007. Also note that for year-to-date comparability purposes, our regulated natural gas distribution operations in Michigan were acquired on April 1, 2006, and our regulated natural gas distribution operations in Minnesota were acquired on July 1, 2006.

Turning to Slide 10, during the fourth quarter of 2007, we recognized income available for common shareholders of $85.1 million compared with $21.3 million in the same quarter a year ago. With the increase in the weighted average diluted shares of common stock outstanding from 43.6 million in the fourth quarter of 2006 to 76.6 million in the fourth quarter of 2007, primarily as the result of the merger with Peoples Energy, this translates to diluted earnings per share of $1.11 for the fourth quarter of 2007 compared with $0.49 in the same quarter in 2006.

There are five key items driving the quarter-over-quarter earnings change in 2007, and we have presented them in after-tax dollars. First, the electric margin at our nonregulated Integrys Energy Services segment increased $43.9 million and its natural gas margin increased $8.5 million.

Second, the addition of the Peoples Gas and North Shore Gas utilities effective February 22, 2007, contributed $11.0 million to earnings for the fourth quarter of 2007. Due to the seasonal nature of natural gas utilities, earnings are generally derived during the heating season, which occurs in the first and fourth quarters of the year.

Third, Wisconsin Public Service’s natural gas utility earnings increased by $6 million from $5.9 million to $11.9 million as a result of the retail natural gas rate case increase that was effective January 12, 2007, and natural gas volumes that were up 5.8 percent quarter-over-quarter due to colder weather in the fourth quarter of 2007 compared with last year.

Fourth, we recognized $5.1 million of after-tax income from synthetic fuel production in the fourth quarter of 2007, including gains on options used to hedge the economic value of federal tax credits, versus $1.3 million of after tax income in the same quarter the year before, resulting in a $3.8 million after-tax increase in the quarter-over-quarter comparison.

Integrys Energy Services took less production from the synthetic fuel facility in the fourth quarter of 2007, compared to the same quarter in 2006, reducing operating costs. Also crude oil prices increased, resulting in higher quarter-over-quarter gains on the oil options used to mitigate the risk of a phase-out of the tax credits generated from this facility.

Finally, we recognized a $6.1 million decrease in the gain on the sale of our oil and natural gas business, which took place on September 28, 2007, and had been reported in discontinued operations. Recall that the gain we reported last quarter was subject to post-closing adjustments, and this was the result of those adjustments.

Moving on to Slide 11, I will provide you with more details regarding our fourth quarter financial results. Our income from continuing operations was $91.9 million or $1.19 per diluted share. Special items in the fourth quarter of 2007 that are not comparable with fourth quarter 2006 results include: Earnings of $0.07 per diluted share from our synthetic fuel facility. A loss of $0.05 per diluted share for external costs to achieve synergy savings associated with the Peoples Energy merger. A net loss of $0.02 cents per share from purchase accounting adjustments due to the Peoples Energy merger.

Taking into consideration the items I mentioned, our diluted earnings per share from continuing operations – adjusted was $1.19 for the fourth quarter of 2007 compared with diluted earnings per share from continuing operations – adjusted of $0.52 in the comparable quarter last year. That’s an increase of 129%.

Turning to Slide 12, earnings for the regulated electric utility segment improved by $2.3 million in the fourth quarter of 2007 versus the fourth quarter of 2006 and the key drivers thereof, in after-tax dollars, are listed on the bottom of Slide 12. $14 million was attributable to the gross margin improvement related to the rate increase that went into effect for Wisconsin customers in January 2007. Partially offsetting this was $9.8 million of increased operating and maintenance expenses that included $2.3 million related to higher transmission costs, $1.6 million related to several unplanned outages at our generation plants, and $1.5 million related to costs to achieve the merger synergy savings.

Turning to Slide 13, earnings for the regulated natural gas utility segment increased by $18.6 million in the fourth quarter of 2007 versus the fourth quarter of 2006 and key drivers thereof, in after-tax dollars, are listed on the bottom of Slide 13. The primary driver was $11.0 million in earnings at the Peoples Gas and North Shore Gas regulated utilities.

Earnings at Wisconsin Public Service increased $6 million primarily as a result of a natural gas retail rate increase that was effective on January 12, 2007, and a 5.8 percent increase in quarter-over-quarter volumes due to colder weather in the fourth quarter of 2007 compared with the same period in 2006.

Earnings at Michigan Gas Utilities and Minnesota Energy Resources also increased slightly quarter-over-quarter primarily as a result of improved collection efforts relating to past due customer accounts.

Turning to Slide 14, earnings for the non-regulated Integrys Energy Services segment increased by $48.4 million in the fourth quarter of 2007 versus the fourth quarter of 2006 and the key drivers thereof, in after-tax dollars, are listed on the bottom of Slide 14.

The retail and wholesale electric margin increased earnings by $43.9 million in the fourth quarter of 2007 versus the fourth quarter of 2006. The natural gas margin increased earnings by $8.5 million in the fourth quarter of 2007 compared with the fourth quarter of 2006.

Quarter-over-quarter earnings related to Integrys Energy Services’ investment in a synthetic fuel facility increased $3.8 million. These items were partially offset by the impact of a $10.7 million increase in operating and maintenance expenses driven by higher payroll, benefit costs, and consulting fees related to continued business expansion activities at Integrys Energy Services, the most significant of which was the acquisition of Peoples Energy Corporation’s non-regulated operations.

Turning to our Holding Company and Other segment on Slide 15, results improved by $600,000 from a net loss of $4.5 million in the fourth quarter of 2006 to a net loss of $3.9 million in the same period in 2007. The key drivers thereof, in after-tax dollars, are listed on the bottom of Slide 15. The net loss decreased as a result of increased American Transmission Company earnings of $2.2 million.

Moving on to Slide 16, you will see the key drivers for the full year 2007 versus 2006. In 2007, we recognized income available for common shareholders of $251.3 million, compared with $155.8 million in 2006. With the increase in weighted average diluted shares of common stock outstanding increasing from 42.4 million in 2006 to 71.8 million in 2007, primarily as the result of the merger with Peoples Energy, this translates to diluted earnings per share of $3.50 for 2007 compared with $3.67 for 2006.

There are seven key items driving the year-over-year earnings change in 2007. We’ve again presented this in after-tax dollars. First, our non-regulated Integrys Energy Services segment increased its electric margin by $49.5 million and its natural gas margin by $11.1 million.

Second, earnings for our natural gas distribution companies in Minnesota and lower Michigan increased by $18.1 million dollars year-over-year, with earnings of $6.8 million in 2007 compared with a loss of $11.3 million in 2006. The positive change in earnings was driven by the fact that these natural gas utilities operated during the first quarter heating season in 2007, but were not acquired by Integrys Energy Group until after the first quarter 2006 heating season. Also, the companies incurred a combined 7.1 million dollars of after-tax transition costs in 2006 for the start-up of outsourcing activities and other legal and consulting fees.

Third, earnings from Wisconsin Public Service’s natural gas utility increased by $13.5 million as a result of a natural gas retail rate increase that was effective January 12, 2007, and colder weather conditions during the heating season compared to last year.

Fourth, we recognized $17.1 million of after-tax income from synthetic fuel production in 2007 versus $19.8 million of after tax income in 2006, resulting in a $2.7 million after-tax decrease in the year-over-year comparison.

Fifth, after-tax financial results from our Holding Company and Other segment decreased $19.1 million, driven by a $25.2 million after-tax increase in interest expense, partially offset by a $6.9 million increase in after-tax earnings from our equity investment in American Transmission Company.

Sixth, operating expenses increased $46.7 million dollars at our non-regulated Integrys Energy Services segment primarily as a result of business expansion, including the merger with Peoples.

Finally, earnings from discontinued operations increased $66 million dollars year-over-year primarily related to the operations of our oil and natural gas production business, which was sold in the third quarter of 2007.

Now we would like to review our potential financing plans and we have that for you on Slide 17. As far as issuing long-term debt in 2008, Integrys Energy Group expects to issue about $200 million, Wisconsin Public Service expects to issue about $100 million, Peoples Gas will issue about $50 million, and North Shore Gas will issue about $5 million.

In 2009, Wisconsin Public Service expects to issue an additional $100 million of long-term debt. Debt issuances by Integrys Energy Group, the holding company, will be used to fund the capital growth of our subsidiaries, primarily Wisconsin Public Service, and to manage short-term debt levels. Debt issuances by our regulated utilities will be executed to maintain target capital structures in accordance with regulatory approvals. At this point, we do not anticipate going to market for any additional equity through 2009.

Slide 18 is our capital expenditure program for 2008 through 2010. I call to your attention that projected capital expenditures decrease in 2010, primarily for Wisconsin Public Service, due to expected completion of our wind farm projects. Expenditures for Peoples Gas include the accelerated cast iron replacement program. You’ll also note that Integrys Business Support has been added to the chart and expenditures here are primarily related to information technology improvements. We expect to make equity contributions to American Transmission Company, or ATC, of about 47 million dollars for the three years ended 2010 and currently own 34.5% of the ATC. Slide 35 in the appendix contains estimated utility depreciation through 2010.

Now we will move on to our 2008 financial guidance, which is covered in Slide 19. We expect our 2008 diluted earnings per share to be between $3.33 and $3.78 for Integrys Energy Group. Our guidance assumes normal weather for 2008, the continued availability of generating units, achieving the projected net merger synergy savings, and recently obtained rate relief for Peoples Gas and North Shore Gas.

Our diluted earnings per share guidance does not include the impact of mark-to-market volatility, which will include about 20 million dollars of net market-to-market after-tax losses in 2008 relating to contracts terminating in 2008 that had net market-to-market after-tax gains recognized in the prior year. See our news release and supplemental data package relating to this guidance.

Also included in the news release and supplemental data package is the projected guidance range for 2008 diluted earnings per share from continuing operations, adjusted, which is anticipated to be between $3.60 and $4.05. The diluted earnings per share from continuing operations adjusted guidance indicates the financial results we anticipate will come from our continuing operations after excluding the negative impacts of the Peoples Energy merger transition costs to achieve merger synergy savings and merger purchase accounting adjustments. See our news release and supplemental data package for further details relating to the special items.

In Slide 20, I summarized the key drivers in the change in the 2008 earnings guidance details I just described for you as compared to what we provided as guidance last November. Primarily, the key driver behind the change in our 2008 guidance has to do with the recent outcome of the rate cases for Peoples Gas and North Shore Gas versus what we requested in our revised filings last September.

We have also removed the impact on earnings of market-to-market volatility relating to contracts terminating in 2008. The balance of the revision represents a number of different projects and initiatives throughout our regulated and nonregulated segments.

I will now turn this call over to Charlie Schrock, President of Wisconsin Public Service, for an update on our regulated electric utility segment.

Charlie Schrock - President of Wisconsin Public Service Corporation

Thank you, Joe, and I ask our listeners to refer to Slide 21. I am pleased to report that our major projects continue to progress well. Wisconsin Public Service managed construction of the Wausau, Wisconsin, to Duluth, Minnesota, transmission line on behalf of ATC.

I’m happy to report that the efforts of our project management team paid off. We completed construction of this 220-mile transmission line in November 2007 and the line was energized on January 23, 2008. The line is now in service, fully operational, and improving reliability to our previously constrained electric system in northeast Wisconsin.

Our Weston 4 project, a 500-megawatt, supercritical pulverized coal plant, is nearing completion. Weston 4 is expected to begin firing on coal in the very near future and is scheduled to be considered in-service, from an accounting and tax perspective, by early March 2008.

There will be a period of time spanning the first and second quarters of 2008 during which Weston 4 will undergo rigorous start-up testing, both independent of the grid and while connected to the grid. During this time, Weston 4 will be considered an intermittent resource for MISO dispatch.

Everything is not going perfectly, however; as we recently experienced a premature failure of one of two forced draft fans, which will limit power to approximately 50 percent until it is repaired. Although it is too soon to estimate what effect this event will have on our startup test schedule, it is likely that the event will cause that schedule to be extended. However, we do expect the required repair to be covered under the fan’s warranty, and that the event and its effect on the startup test schedule will not have a material impact on earnings.

Another of our construction projects is construction of laterals to the Guardian 2 pipeline. The Guardian 2 pipeline will create competition by having an alternate natural gas transportation source for our Wisconsin customers and will create additional, much needed pipeline capacity in our regulated natural gas business territory.

We have received regulatory approval from the Public Service Commission of Wisconsin and permit approval from the Wisconsin Department of Natural Resources for construction of the laterals that will connect to the Guardian 2 pipeline. We began construction of the laterals on January 2, 2008. Our laterals project is estimated to cost about 75 million dollars and is progressing on schedule and on budget to date. We expect this project to be in service near the end of 2008.

On August 14, 2007, Wisconsin Public Service made a fuel filing with the Public Service Commission of Wisconsin requesting a rate increase of $33.3 million for 2008, a 3.6 % increase. The rate increase request included recovery of higher network transmission charges from ATC, recovery of deferred Midwest Independent System Operator costs, and a reduction in fuel and purchase power costs due to lower natural gas prices and the expected startup of the new Weston 4 generating plant.

On January 15, 2008, the Public Service Commission of Wisconsin issued an order authorizing an increase in electric rates of $23 million or 2.5 %. The order essentially accepted the company’s initial filing, updated for changes in fuel and purchased power prices. The Public Service Commission approved the requested recovery for the 2008 increase in transmission costs. In addition, the commission approved recovery of deferred 2005 and 2006 MISO transition costs in 2008 rather than 2008 through 2010 as requested by the company.

Earlier this month, we filed with the Public Service Commission of Wisconsin for an increase in electric rates due to higher than expected actual and forecasted fuel and purchased power costs in 2008. Contributing factors for the request include increased purchased power costs due to a later start-up of the new Weston 4 power plant, increased coal and coal transportation costs, and increased natural gas costs.

Previously, we projected Weston 4 to begin generating start-up electricity in January 2008, and this did not materialize as planned. Consequently, we are requesting authority from the Public Service Commission of Wisconsin to recover approximately $13 million, pre-tax, relating to projected additional fuel and purchased power costs. If approved, the electric rate increase would become effective by mid-March.

Wisconsin Public Service is expecting to file its next Wisconsin retail electric and natural gas general rate case on April 1st, 2008, which we anticipate will result in new rates that would be effective January 1st, 2009.

On October 6, 2007, Weston 3, a 321.6-megawatt base load coal-fire generating facility located near Wausau, Wisconsin, sustained a major lightning strike that forced the facility out of service. The damage required repair of the generator rotor, the turbine rotors, and the boiler feed pumps.

This was completed and the plant was returned to full service on January 14th, 2008. The Public Service Commission of Wisconsin approved the deferral until a future rate proceeding of approximately $24.4 million of pre-tax fuel and purchase power costs incurred during the 14-week outage in addition to the $7.2 million of incremental pre-tax operation and maintenance costs that were incurred to repair and return the plant to service.

Other than our $1 million deductible, our insurance coverage will cover the equipment damage costs resulting from the lightning strike.

Assuming reasonable outcomes of the future rate proceeding for the recovery of deferred replacement purchased power and non-fuel operating and maintenance expenses, we do not expect this incident to have a material impact on future net income.

On December 27, 2007, Wisconsin Public Service applied for construction authorization approval to the Public Service Commission of Wisconsin to construct a 99-megawatt wind farm in Northeast Iowa. Wisconsin Public Service plans to purchase the wind farm from enXco Development Corporation who is developing the project and will engineer, procure, and construct the wind farm as a turnkey project for us. We would be responsible for interconnection of the wind farm to the high voltage transmission system, interconnection substation modifications, and any system enhancements required by the Midwest Independent System Operator.

We expect this project would be commercially operational by January 1st, 2010. Recent additions to our renewable portfolio including purchases of renewable energy from biomass-fired generators and a wind project near Brownsville, Wisconsin, have decreased our near-term Renewable Portfolio Standard compliance exposure in Wisconsin, which will allow adequate time for planning to meet the 10% Renewable Portfolio Standard requirement in 2015.

Now I’ll turn the call over to Larry Borgard, President of Integrys Gas Group.

Larry Borgard – President, Chief Operating Officer of Integrys Gas Group

Thanks Charlie. Beginning on slide 22, I will give you an update on the outcome of the Illinois rate cases. On February 5, 2008, the Illinois Commerce Commission approved a rate increase for Peoples Gas of approximately $71.2 million and a rate decrease for North Shore Gas of $200, 000. The new rates went into effect February 14th 2008.

The new rates are based on a return on equity of 10.19%r for Peoples Gas and 9.99% for North Shore Gas and a 56% equity ratio for both companies. In addition, the Commission approved a four-year pilot of our proposed decoupling mechanism, the Volume Balancing Adjustment rider, referred to as Rider VBA, for both companies. Rider VBA basically breaks the link between utility revenues and customers’ energy consumption providing the revenues necessary to run the company’s 6,000-mile natural gas delivery system in Illinois.

The mechanism will allow the companies to adjust rates to recover or return under or over collections of margin revenues due to variations from those revenues that are approved in the rate case. Such variations result from weather, customer conservation, or factors other than the addition or loss of customers. Decoupling does not shelter the utility from the impact of increased costs nor does it guarantee the company’s profits.

Overall, customers pay no more or no less than what the utility is authorized to recover by state regulators. The approval of the decoupling mechanism reflects the Commission’s support for the long-term financial health of the company and recognition of the importance of innovative rate mechanisms in the current environment.

The Commission also approved Rider EEP, covering funding for Enhanced Efficiency Programs that would be used to encourage energy efficiency and conservation, thereby lowering usage and helping to protect the environment for the future. The programs will be administered by a governing board that is to include members of government and consumer advocacy groups as well as the utilities.

The Commission did not approve Rider ICR, our tracker mechanism for the costs of accelerating replacement of the aging natural gas pipe infrastructure in Chicago, but did set forth in its decision the key criteria they will be looking for in order to approve the ICR or similar riders in the future.

We are still very much interested in accelerating the replacement of the infrastructure and will explore various alternatives for recovery of those costs. The Commission did not approve Rider UBA, the requested uncollectible balance adjustment mechanism, which would allow recovery of the actual natural gas cost portion of bad debt expenses.

At Minnesota Energy Resources and Michigan Gas Utilities, we have measurably improved the bad debt issues. Both service territories, like all natural gas local distribution companies, are being affected by declining use per customer due to customer conservation.

In addition, local economic conditions, particularly in Michigan, are affecting our customers’ use of natural gas. While we have examined and refined all of our key operational processes, we are still falling short of our financial expectations.

As a result, we anticipate filing retail natural gas rate cases for Minnesota Energy Resources and Michigan Gas Utilities in the summer of 2008. Rates for our Minnesota customers last increased in 2000, while rates for our lower Michigan customers were last increased in 2003.

We acquired these utilities in 2006 to expand our footprint and add geographic diversity to our regulated natural gas utility segment and still expect these companies to contribute to the long-term value of Integrys Energy Group.

Now Mark Radtke, President of Integrys Energy Services, will discuss our non-regulated operations.

Mark Radtke - President of Non-Regulated Subsidiary, Integrys Energy Services

Thanks, Larry. We are in the final stages of fully integrating the nonregulated portion of the Peoples Energy and WPS Energy Services organizations. Our systems integration is substantially complete and we are working on wrapping up related operational items. Following that integration, we are working to implement two significant systems infrastructure projects that, we expect, will facilitate future growth through improved business processes and customer care.

We have delayed those projects from the estimate I gave you last quarter, to concentrate on final integration of existing business, and now expect those projects to be in operation late this year. We have placed significant focus on creating sustainable growth and value through our integration efforts and our reported results for the fourth quarter of 2007 reflect that value. You can see our volume growth illustrated on slide 23. Both wholesale and wholesale and retail forward natural gas volumes under contract have increased from this time last year. Certainly, the merger was one of the drivers of that increase, but even excluding the approximately 44 billion cubic feet of forward contracted natural gas volume gained with the merger, year-over-year contracted volume growth is over 14 percent.

Electric forward contracted volumes increased dramatically compared to December 31, 2006. Wholesale electric volumes increased 39%. Retail forward electric sales volumes are up nearly 102% partially due to the merger with Peoples Energy, contributing approximately 7 million megawatt-hours to forward contracted volumes on the merger date. If you exclude the merger volume, year-over-year contracted volume growth is up about 38%.

Not only has the business grown larger, we believe it has grown stronger through product and geographic diversification. Our retail electric business delivered 14.6 million megawatt-hours in 2007, a 10 million megawatt-hour increase from 2006. You can see our geographical delivery mix and the distribution of forward contract commitments illustrated on slide 24.

While you can see our continued sales growth, the accounting for this business can make it difficult to quantify the real commercial value creation. The biggest culprit is the disconnect that can occur between customer sales contracts that are not derivatives and the supply contracts that receive derivative accounting treatment. One approach is to ignore the $74 million of pre-tax non-cash mark-to-market altogether, and while that gets you part of the way there, it doesn’t complete the picture.

Slide 25 shows the metric that we have discussed in previous quarters called managerial gross margin, which provides a more complete picture than margin presented on GAAP financial statements. Managerial gross margin is the economic value that was actually created during the period, including the change in forward book value and realized or cash margin of transactions that settled or went to delivery during the period. This measure is void of any derivative accounting impacts, and unable to be distorted by simply transferring value from the forward book to realized margin. We’ve provided the total 2006 number for comparison purposes, and please note that 2006 does not include any business added with the merger since that was a 2007 event. The year 2007 includes business added with the merger, both in the forward book and any margins realized after the February 21 merger date.

So during 2007, we created $271.2 million of new value between realized cash and forward book growth. You can further see the fairly even distribution of that value across the 4 major categories of the business.

You can refer to Slides 36 through 38 in the Appendix for reconciliations of the non-

GAAP portions of this slide to the GAAP financial statements.

While this is the view that I believe gives the better insight into the performance of the business, there is understandable interest in how and when this translates into GAAP margin.

Slide 26 provides that view in this case as of the end of 2008. You can see that we have $57.1 million of accounting gross margin to be recognized in 2008 on transactions that have already been executed in previous years. It is our expectation that this amount will flow through earnings in addition to the value of new transactions that are entered into and recognized during 2008. Purchase accounting relating to the merger will offset this margin by $13.3 million in 2008.

Now, let’s take a quick look at our operations, which I have highlighted on slide 27.

Our Denver office is fully operational, supporting Midwest and Western electric market originated customer business. We are leveraging our market and product knowledge to respond to customer’s increasing interest in renewable or “green” energy products.

Our newly developed Winnebago Energy Center became commercially operational in December 2007.

Our strategy for the future includes transitioning and growing our asset base to focus on clean fuel and renewable or green energy sources.

We are developing renewable products that can be pulled by customers through our existing channels. We intend to expand our renewable product suite to be responsive to growing customer demand for clean energy and as governmental mandates expand renewable requirements in the markets in which we operate.

Our wholesale natural gas business is continuing to grow. We have added experienced individuals to our natural gas producer originator team in the fourth quarter of 2007, and they are already contributing to the growth in our producer services business. In addition, we are focusing on and having success building out the wholesale customer origination business that was acquired with the Peoples transaction.

Throughout 2007, we spent a lot of time and money building our core business. That is evident in our increased operating expenses which rose from $98 million in 2006 to approximately $181 million in 2007, largely from the addition of the Peoples Energy business and complementary organic growth. We plan to moderate the increase in operating expense in 2008 to 7% as we focus on the productivity of our resources.

On balance, I’m pleased with how we are preparing to achieve our targeted 10% to 15% annual core earnings growth over the long term. As we capitalize on our 2007 growth initiatives, we expect 2008 to deliver above target growth in core earnings, earnings that exclude asset divestiture impacts, synthetic fuel contributions, mark-to-market volatility, and non-recurring costs associated with the merger.

We are focused on organic growth within our existing markets, and will consider opportunities to expand our footprint if the circumstances are right. Talent is the lifeblood of an organization like ours, and we are pleased with the quality of our recruitment efforts this year. In our retail businesses, we have added 17 new account executives to our team this year, outside of the merger. Once we bring talent like this on board, we are very pleased with our historical retention rate aiding the growing contribution of that team in 2008 and beyond.

I will now turn the call back to Larry Weyers. Larry?

Larry Weyers - President, Chief Executive Officer

Thanks Mark. In 2008, we plan to attain the $73 million of synergy savings mentioned earlier, establish operational excellence throughout the organization, and file rate cases in perhaps three of our jurisdictions. We will also continue to streamline our organizational design.

Let me remind you of the key points from today’s discussion relating to the drivers of our future earnings growth. First, we will advance our construction projects, the 500- megawatt Weston 4 power plant and the Guardian 2 pipeline laterals, among others. Second, we will move forward with rate cases as needed to ensure opportunities to earn reasonable returns on these investments. Third, we will continue to optimize the operational excellence of Integrys Business Support, the administrative support subsidiary for all of our operating segments that we believe will capture many of the cost synergies we have identified. Fourth, as Mark explained, our expansion into developed markets in the United States and Canada is expected to grow core earnings for Integrys Energy Services by 10% to 15%.

Finally, as set forth in slide 28, our earnings guidance for 2008 for diluted earnings per share from continuing operations adjusted is between $3.60 and $4.5.

We appreciate you listening to our prepared remarks, and now we would like to open the floor to questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Your first question comes from Michael Garrisons with Robert W. Baird.

Michael Garrisons

Good morning, gentlemen.

Larry Weyers

Good morning.

Michael Garrisons

In terms of the operating expenses, I guess, I was a little bit surprised first primarily on the gas utility side, what was the reason even after adjusting for the Peoples inclusion for the fairly significant O&M increase this quarter?

Joe O'Leary

Hi, this is Joe, you are talking about the fact the natural gas utility segment.

Michael Garrisons

Right. I have a few adjust for the last year’s fourth quarter of ’06 including what they reported prior to being merged. I have 15% to 20% increase in O&M expenses on the gas utility side?

Joe O'Leary

One of the increases in costs overs as Peoples related to the new requirements with regards to repaving that they never required to do.

Michael Garrisons

Okay.

Joe O'Leary

As it revolves in the city and it increases the expense relating to that.

Michael Garrisons

All right. And, is there a capital expense or operating expense?

Joe O'Leary

That would be an operating expense.

Michael Garrisons

Okay. The second question I had Peoples, last year it appears that they earned net income of 23.5 million from there filings again and this year they're at 11 million. And it’s the paving one of the key drivers of that decline?

Joe O'Leary

Well, you’ve got a combination of the paving and then you also just got overall inflation in general that’s driving their expenses higher and the revenue requirement being locked in for the last 10 years. 12 year I am sorry.

Michael Garrisons

All right. And then the last question. After the rate release now for the Illinois gas utilities, you got the roughly 10% allowed ROE. But what do you expect the actual earned ROE to roughly be for the coming year?

Joe O'Leary

You know, at this point I don’t have that information handy.

Michael Garrisons

Okay. Thank you.

Operator

Our next question comes from Faisel khan with Citi. Your line is open.

Faisel khan

Thanks, good afternoon.

Joe O'Leary

Hello Faisel.

Faisel khan

Joe, is there way for you to quantify that paving amount in terms of O&M because it’s just to follow-up on the last question. If I go back to the fourth quarter of last year Peoples earned $48 million operating profit and last year you guys earned $9.5 million. If I add that up I get to kind of $56 million and you reported 28 in the quarter. So I try to understand the amount and if it’s a just ample O&M kind of number that we should we expecting or projecting numbers?

Joe O'Leary

Hold on for a minute, we are trying to get that number altogether there. Larry do you Borgard do you have that?

Larry Borgard

Well its both operational cost as well as construction cost related to the replacement of Maine in the city.

Faisel khan

Okay.

Larry Borgard

I will tell you that, of the top of my head I am guessing it's around 5 to $7 million for 2007.

Faisel khan

Okay.

Larry Borgard

Pre-tax number by the way.

Faisel khan

Sorry, say again.

Larry Borgard

It’s a pre-tax number.

Faisel khan

It’s a pre-tax number right. Okay I'll follow up with you guys later on that particular issue. If I can ask also a question on the electric side of the equation. In terms of the margins that you guys reported in the fourth quarter. Was there any impact from the margin of this outage you had at Weston 3 or any other differences in kind of wholesale margins if you may reported in the previous year?

Charlie Schrock

This is Charlie Schrock. The impact of Weston 3 was really minor if anything at all because we pulled it out with a deferral we had. So, there wouldn’t be any impact from there.

Faisel khan

Okay, gotcha. And in terms of the capital contributions to ATC in 2010. That goes to zero for you guys can you just explain how that works?

Joe O'Leary

Well at least the capital contributions are for the ATC, are driven by their construction program.

Faisel khan

Okay.

Joe O'Leary

….which has a bit of a low. But there are also earning money and they're able to fund a lot of it internally as well. So as a result that we are not required to invest in incremental share, the other reason is that we are ramping up work on the Wausau to Duluth transmission line. We wrap up that in 2008 so that quite pushes that up a little higher than the normal.

Faisel khan

Okay.

Charlie Schrock

It will depend on the capital needs of ATC, which right now based on their current schedules will diminish when you get into 2010 and 2011. However there's other projects that they are potentially going to be involved in which might include additional transmission that has to be built up to the wind farms. As well as some of the major transmission lines that may carry some other wind energy back to the East Coast. So we are looking at ways to improve their ability to grow in 2010 and beyond. But right now the major improvement in the transformation system in Wisconsin and their current head footprint will diminish the capital needs will diminish in 2010, ‘11.

Faisel khan

Okay. Got you. And then, you talked about it, some of your prepared remarks of the economic condition of your service territory. Do you think that you have the proper bad debt reserves in place right now to take sort of economic conditions into account?

Larry Borgard

Yeah, this is Larry Borgard with the respect to the gas companies. We’ve obviously taken a hard look at that with respect to the, the way the economies forecasted to go and we do believe that we have adequate reserves in our numbers.

Charlie Schrock

We’ve also been very aggressive to seek whatever aid is available to help these people pay their bills along the away such as like e-pay and other programs.

Faisel khan

Okay. But so far and I guess it’s too early to the billing season to figure out how long these bills can be extended for, but have you seen any sort of indications ahead of people issues paying their bills?

Charlie Schrock

Not to my knowledge, I believe we will probably have much better information probably in April when we tend start cutoffs to determine who has problems and hopefully we will see some activity ahead of that if people are going to have problems with they are seeking aid to help them.

Faisel khan

Okay. Thanks. And on your -- you mostly put the slide back in your presentation which we appreciate on the energy services margin on Slide 39. Can you just kind of help me understand like the large unrealized gains for the natural gas margins on the wholesale side? Help me understand kind of what caused that? I guess its at $30.8 million.

Larry Borgard

I believe some of that relates to transport and storage as well and Mark do have any additional comments on that.

Mark Radtke

Yeah, within the wholesale business there are going to be two things that go on there. There will be some transactions that receive what I would characterize as matched derivative accounting treatments. So you will recognize in the current period, some of the value of that long-term transaction and that will be reflected in a mark-to-market gain?

Faisel khan

Sure.

Mark Radtke

And you will also have some transactions that there are disconnects and pipeline capacity transportation is a great example of that when we buy physical transport, long data physical transport and then hedge that with derivatives, the transport itself doesn’t get derivative treatment, but the hedges do, so as basis markets move you will get some of that disconnect effect there as well.

Faisel khan

Okay.

Mark Radtke

Couple of thing on storage.

Faisel khan

That makes sense. On the electric side, on the retail side, there also is a large unrealized gain on the electric side. So I think you help me understand that too, that would be great?

Mark Radtke

Right, on the electric side, a large percentage of our retail electric business has hedges that receive derivative accounting treatment and the customer contracts almost never received derivative accounting treatment.

Faisel khan

Okay.

Mark Radtke

So there we see the full disconnect and that’s the reason that, we go down this path of explaining our managerial gross margin.

Faisel khan

Sure.

Mark Radtke

It’s GAAP gross margin in the -- particularly in the retail electric business just doesn’t make a lot of sense.

Faisel khan

Fair enough.

Mark Radtke

When we look at our 2007 results, we -- and we look at our forward contracts there was approximately this $20 million of after-tax margin effect that Joe mentioned in his earnings guidance that was recognized in 2007 that on a normalized basis would have been expected to be recognized in 2008 and so that reversal will occur.

Faisel khan

Okay, I got you. One last question, going back to the electric side of the equation, the O&M increases you saw in the fourth quarter for transmission cost unplanned outages, would you say that those are more one-time in nature and then going forward, we shouldn't see that sort of higher cost in our numbers.

Charlie Schrock

Hi, this is Charlie Schrock again. Generally I would say yes, although we have a number of power plants in each of those is on it’s own schedule for outages and things like that. So it’s not so much predictable year-to-year, because it depends on those outage schedules that we have.

Faisel khan

Okay, got you. Thanks for the time.

Charlie Schrock

Thanks.

Operator

Our next question comes from Maurice May with Power Insight.

Maurice May

Yes, good morning gentlemen.

Company Representative

Good afternoon.

Maurice May

Couple of questions here. First of all on the cash, I’m sorry the short term debt balance at the end of the year was 468 million. And I was wondering if you could walk me through, first of all the net cash proceeds from the sale of the E&P operation. And second of all, why that net cash didn’t bring the short-term debt down to, I don’t know between 1 or 200 million?

Joe O'Leary

Well, to some extent your short-term debt is based on the working capital leads that you have as of a given year end, so we did use the after-tax proceeds to pay down a significant portion of the short-term debt earlier in the year, and then we've got GAAP in storage that requires us to take on some additional short-term debt. Once that GAAP is delivered, you'll see those short-term debt levels come back down again.

Maurice May

So the March 31 short-term debt number should be a lot lower than 468?

Joe O'Leary

We anticipate that, yes.

Maurice May

Okay. And what is your cost of short-term days with the lower interest rates?

Joe O'Leary

It is somewhere around 3.5%.

Maurice May

All right. Second of all, on Integrys energy services, the O&M projection. I think you said that O&M was about 175 million last year, is that correct?

Larry Borgard

In 2007 it was about 181 million.

Maurice May

181…and did you give us a projection of what that might be in '08.

Larry Borgard

I said that we would expect to grow it by about 7%.

Maurice May

Grow what, the O&M?

Larry Borgard

Our total operating expense, yes.

Maurice May

Okay, and so where do we get some synergies from the merger?

Charlie Schrock

Synergies are included in that number. We saw synergies of about $7.5 million in 2007, and they will continue in 2008 about that level. Keep in mind that in this business, and we have been challenged by that internally, to track synergies while at the same time you're continuing to grow the business.

Maurice May

Okay.

Charlie Schrock

I think that when you look at the growth, the core earnings growth that we expect in 2008, it is much, much larger than that expense increase that we are anticipating, and synergies are a contributing factor to that.

Maurice May

Okay. And depreciation continues at around 15 million or higher?

Larry Weyers

It will continue but at that similar rate.

Maurice May

And then you talk about a growth rate of 10 to 15% in '08. What is your idea of core earnings? Is it about $60 million for IES?

Larry Borgard

No, and I want to clarify that growth rate. I think that when we talk about a 10 to 15% growth rate, we first need to be clear on the starting point. When we look at 2007 earnings for instance, we reported $98 million, of course we would back out the gain on the sales Niagara, $14.8 million, synth fuel is done so we back out the $17.2 million that it contributed in 2007. And then finally, I tried to eliminate the derivative accounting effects that I talked about, and using the managerial gross margin that we stepped through on slide 25, that adjustment is a reduction of about $19.5 million after tax. So we've got a total of about $51.5 million dollars of after-tax adjustments, which result in core earnings of $46.5 million for 2007.

Now in 2008, as we were building our business plans, we had a goal to grow our core earnings sufficient to replace the loss of synth fuel. The last couple of years we have counted on synth fuel for about $20 million of net income. So in order to accomplish that, with a 2007 core earnings base of 46.5, we are looking at something like 43% growth in 2008. That is what I was referring to when I said our 2008 growth is above the targeted range.

Now we would not have been able to accomplish that, had we not grown our resource space the way we did in 2006 and 2007. So going forward, we expect that growth to occur on an economic basis. In other words, when we apply our managerial gross margin results in 2008. However, I referred to our year-end 2007 analysis of the GAAP accounting treatment of our 2008 contracts, and that suggests we recognize in the fourth quarter of 2007 about $20 million of after tax value associated with our 2008 contract. That's what Joe referred to in his guidance. So that value will reverse in 2008. So, the good news is the income is present in our very strong 2007 results, the bad new is, it confuses the growth trajectory discussion.

My 10 to 15% growth is predicated on the assumption that we achieve our 43% economic or normalized earnings growth in 2008, to replace synth fuel, and that means we will essentially ignore the $20 million contract reversal and then grow 10% to 15% per year in 2009 and beyond.

Maurice May

Okay. So, 43% growth on Co-earnings of 46.5 is 66.5 million in ’08 and you think you can grow that 10% to 15% in ’09?

Mark Radtke

Correct. That’ a bottom line.

Maurice May

Okay, great. Thanks Mark.

Mark Radtke

And the only thing to keep in mind in your '08 number is that, that does not include that 20 million reversal, but…

Maurice May

And that's reversal of the mark-to-market.

Mark Radtke

Correct.

Maurice May

Okay. Good, thank you very much.

Mark Radtke

Thanks Mark.

Operator

Our next question comes from Paul Patterson with Glenrock Associates.

Paul Patterson

Good morning guys.

Larry Weyers

Good morning Paul.

Paul Patterson

I want to touch base with you again on that $20 million that of mark-to-market losses that excluded from 2008 which was a gain in 2007, when I look at slide 19, where is that $20 million of gain? How is that excluded from 2007?

Joe O'Leary

It’s not excluded from 2007.

Paul Patterson

It’s not excluded from 2007, when it’s a gain but when it’s a loss in 2008 it is excluded?

Joe O'Leary

Well, I guess in 2008when we record earnings for the year we will see mark-to-market volatility relating to what’s going on with the derivatives. Part of that is going to be the turn around of mark-to-market gains recognized in ’07, they turn around in ’08 and that’s going to be about $20 million after tax.

But there is also going to be, most likely, mark-to-market relating to new business brought on and mark-to-market created by the book of businesses, if I had now that doesn’t terminate until after 2008 and we do not try to attempt to estimate what the impact of those other parts of mark-to-market volatility so we've decided to exclude all of it from part of our guidance for 2008.

Paul Patterson

So there is no mark-to-market gains or losses in the 2008 guidance is that a way to look at it?

Joe O'Leary

Yes, that’s correct.

Paul Patterson

Okay, but there was in terms of the reported earnings there was a $20 million benefit that I guess its reversing out in 2008.

Joe O'Leary

That’s correct.

Paul Patterson

Okay but that hasn't been carved out when we look at the actual numbers.

Joe O'Leary

Oh! No its part of the actual numbers. We require it to record that for 2007. We have not tried to depict it is being pulled out in any of these schedules either I think is what your questions.

Paul Patterson

Okay and so when we actually see the numbers come in, we might see obviously some variation from mark-to-market, the performance might be obviously augmented by that but I guess you guys will going forward, carve that out for us so that we can see what the mark-to-market impact is compared to what your guidance numbers are?

Joe O'Leary

Yeah, I think if you go to slide 39, there is a real good breakout for ’07 and ’06 of what the mark-to-market activity was. And we are trying to continue to give you that information so that you folks can do whatever you want with regards to mark-to-market. One thing you can count on as mark-to-market is going to be different each year and it depends upon the types of derivatives you have in place, your book of business and moves in the marketplace.

Paul Patterson

I got you. Okay, on slide 20, could you just elaborate a little bit more on the timing when you guys mention the key drivers that have changed the guidance in ’08 versus the previous guidance that you had for ’08. The timing of other products and initiatives, I guess you now see a $0.23 range, I guess in that. Could you give us a little bit more of the flavors to what's causing that?

Joe O'Leary

There are an awful lot of smaller projects that are in there. They individually are not real significant, I will just give you an idea in terms of the number of people that we have today just give you ideas and numbers. We have got about maybe 5,475 employees that we are expecting to have in 2008. If they could save $10 a day, per work day not for their calendar day, but per work day between now and the end of the year, that generates us almost $7.4 million in that income.

Paul Patterson

Okay.

Joe O'Leary

I mean I tried to give you that as an idea as we've got a larger company here, we've got several projects and initiatives underway and the timing of when those kick in and provide some cost reductions or enhance revenues they do vary and we blend that into our guidance range.

Paul Patterson

So, this increase of $0.20 negative that’s relating to I guess that you guys had previously expected the timing to be coming in a little earlier than what you are now looking at. Is that the idea, when you look at these revenues enhancements?

Joe O'Leary

Yes, it is. Like I said is the combination of multiple projects, I mean they target pinpoint and on one particular event.

Paul Patterson

Okay, okay, fine, good enough. And then just finally, the volume sales, could you just remind us what that is in 2008, what the expectation is for that?

Joe O'Leary

I need just a moment here. We don’t know that we had much in the way of, let's see for ‘08, we’ll have about may be $0.14 a share in ‘08.

Paul Patterson

Okay.

Joe O'Leary

That’s our target, that’s what we are shooting for. Obviously, the economic conditions will have an impact on that and we’ll try to work through that.

Paul Patterson

I appreciate it guys. Thanks a lot.

Joe O'Leary

Thank you.

Operator

Our next question comes from Mark Lunenburg with Talon Capital.

Mark Lunenburg

You are right. There are a lot of moving pieces, thanks very much for the detail. If I could take you to slide 19 for you walk us from continuing operations to adjusted operations, both the $0.15 in the external transition cost and the purchase accounting, could you go through those in a little more detail, define external and to they go away and over what period and same questions really for the purchase accounting adjustments?

Larry Weyers

Okay. On the external transition costs, I think we had a schedule earlier that gave the detail of when those unwind, when they stop and let me see if I can get the exact slide number for you, that would be on slide #8.

Mark Lunenburg

Okay.

Larry Weyers

And in terms of external costs, I mean there are primarily external costs, consulting fees or maybe temporary help that’s been brought in to help us out on some of the projects that we were working on. And then, with regards to purchase accounting, one of the largest pieces of the purchase accounting adjustment is that as of the merger date, we have to take the book of business that we got from the energy marketing business that Peoples had, and putting on the books at a fair value and then each one of their contracts got put on the books at a fair value and then the net fair value amortization takes place over the life of the contract. So, when a contract is terminated by that time, you have no more purchase accounting adjustments related to it and most of that ends you see by the end of 2008 as it relates to Energy Services.

Mark Lunenburg

All right. So, going forward, it really if we start to look at ‘09 and 2010 really be using the adjusted numbers is more of the base which gets me to my question, your 6% to 8% corporate growth aspiration, that’s up to 360 to 405, correct and not off for the 333 to 378?

Larry Weyers

Yes.

Mark Lunenburg

Okay. And then, my final question is the next…

Larry Weyers

Keep in mind that 6% to 8% that’s a long-term growth. We are going to get some fluctuations in that from time-to-time.

Mark Lunenburg

No, I got you. I’m just trying to figure out if that, the amortization going away is included in that 6% to 8% growth, or the 6% to 8% growth is really sort of on a apples-to-apples with the adjusted number?

Larry Weyers

Yes, you have it correct.

Mark Lunenburg

Okay, all right. And then, my final question is on your next rate case for Illinois, that’s the one you didn’t discuss?

Larry Borgard

Yes, this is Larry Borgard again. As part of the merger agreement, we won’t be able to file our next rate case until later in 2009 with rates effective January 1, 2010.

Mark Lunenburg

And you expect to do that then?

Larry Borgard

That, we haven't made a definitive decision about that, but I would suggest that’s probably where we are going.

Mark Lunenburg

All right. Thanks very much.

Larry Weyers

Thank you.

Operator

(Operator Instructions). And our next question comes from Hassan Doza with Luminous Management.

Hassan Doza

Hi guys.

Larry Weyers

Hello.

Hassan Doza

I just wanted to understand that synergies assumed in ‘08 and going forward, Joe can you give us a sense as you file for rate cases in Wisconsin, Minnesota, and Michigan next year, I mean how should we think about the retention of the synergies as you go through these rate cases?

Joe O'Leary

If I could you tell you that I could do something else for a living. Primarily, I would expect that I would not anticipate that we are going to be able to maintain a lot of those synergies. But I also think that they won’t take synergies from us without also taking the cost to achieve that are associated with them.

Hassan Doza

I mean it is like a 50-50 kind of a top process, the best assumption to you as going forward for these three jurisdictions as you see how the rate cases or..?

Charlie Schrock

When you talk about Wisconsin and Michigan and Minnesota, I would anticipate that they would just -- they would probably keep most of the savings.

Hassan Doza

Okay.

Charlie Schrock

But again, as I mentioned if there is any projected cost relating to cost-to-achieve to gain those synergies, I think you will probably get the net of those two numbers.

Hassan Doza

And Joe, what’s the contribution that you had built in, that’s embedded in your ’08 guidance for synergies for just 2008?

Joe. O'Leary

Well, I think we go back to that slide where we laid out the synergies that got most the information there – that will be back on Slide 8.

Hassan Doza

Okay. So, your 2008 kind of assumes like almost 100% retention after synergies for just for 2008?

Joe. O'Leary

In ’08, yeah.

Hassan Doza

Okay. And that’s in your range of 360 to 405?

Joe. O'Leary

That’s correct.

Hassan Doza

Okay. But going forward we should think about how those synergies could be shared by customers in those three jurisdictions?

Joe. O'Leary

You know, they will be sharing as they are related to Illinois. At least so far that’s what we are seeing going forward, and the other jurisdictions, probably not much.

Hassan Doza

What are the actual ROEs earned in Wisconsin, Minnesota, and Michigan in 2007?

Charlie Schrock

Wisconsin, I got a blended overall profit into return which is a little different in the authorized, because it takes into consideration a couple of different aspects of their business but Wisconsin Public Service Corp is probably at about around 10%, 10.02%. I think MERC and MGU were both considerably under what we had anticipated, considerably under their authorized returns. MERC is somewhere around, you know, 1.3% and MGU is probably around 2.2%.

Hassan Doza

Okay. And their authorized are like close to like, they are around what 10% to 11%?

Charlie Schrock

In their current rate design their authorized, 11.71% at MERC and it’s 11.4% at MGU.

Hassan Doza

And what was the ROE earning in UPPCO last year?

Charlie Schrock

UPPCO was a little higher; it was around 11.7% and their authorized is about 10.75.

Hassan Doza

And one last question. You earned about 30 million equity income from ATC, I think in ’07. When we think about ’08, what kind of a growth are you building in for ’08 from ATC?

Charlie Schrock

Give me a moment. I will ask for that number; I don’t have it readily available at the moment. So, it would be about 41?

Hassan Doza

All right. Thanks guys.

Company Representative

Thank you.

Operator

Our next question comes from David Greenhouse with Scotia.

David Greenhouse

Good morning guys.

Larry Weyers

Hi, David.

David Greenhouse

Couple of questions for you. Just going back to this 20 million of mark-to-market; so Joe, you will not break that out in your adjusted earnings you know as we go through the year? That will just be standalone and we should just take out of the sort of 360 to 405 guidance with the 25 cents there?

Joe O'Leary

Yeah, and the reason that I – that we are leaving it out is because we can’t predict the rest of the mark-to-market volatility that’s going to be involved; that’s just one component of mark-to-market activity in any given year.

David Greenhouse

Right. But if nothing else changes, your adjusted guidance will be down by 25 cents from the 360 to 405.

Joe O'Leary

If nothing else happens, there is no new business brought down, and there is no other fluctuations in the market place, yeah.

David Greenhouse

Okay. That’s helpful. In terms of, Mark, on the 10% to 15% growth, can we just take that off of your managerial gross margin and assume that sort of going forward what we should think about?

Mark A. Radtke

Yeah, I think that’s fair in terms of – that’s the growth of essentially the value creation on the economic margin of the business; then there will be a commensurate growth of operating expense as we project the business long term. We don’t model in you know significant improvement in results because of economies that scale or anything like that.

David Greenhouse

Okay.

Mark A. Radtke

So I think that’s a fair approach.

David Greenhouse

Okay. On the rate base slide you included and 42, the three jurisdictions that you will be going in for rate cases on which is obviously WPS, MERC, and MGUC. Can you give us sort of updated rate base numbers? You’ve given us last authorized and I assume is it going up. Can you give us about where they are right now?

Mark A. Radtke

You go to slide 41, you will see an update and where we are currently at the estimated rate based investments. You turn to the middle of the slide.

David Greenhouse

I missed it. Okay. I got it. That’s helpful. Your holding company I think it was about a $4.5 million expense this quarter. Is that a good sort of quarterly run rate number to think about?

Mark A. Radtke

Yeah, that’s probably close to the ballpark.

David Greenhouse

And then last question for you, you know, with Weston 4 coming on this year, you know, for accounting reasons in January and no rate case, when we think about sort of earnings at you know WPSCO, is that going to be sort of a flat to down here this year or there’s things that will, you know, add to the earnings?

Mark A. Radtke

Well, keep in mind there is only one thing is that we just did that fuel filing so to the extent that our purchase power costs are up a little higher than what we originally anticipated we hope to recover a good portion of that with this most recent fuel filing and we just did get a rate increase to help cover some of the other costs with regards to transmission and it’s an increase of generation cost and purchased power cost.

Mark A. Radtke

Yes, and remember that Weston 4 is completely on rate base because of (Inaudible) so when it goes online it’s completely on rate base so there won’t be any negative rate impact from that and we will adjust whatever fuel cost changes need to be adjusted based on its availability.

David Greenhouse

So you get the (Inaudible) on Weston 4 even though you haven’t filed? You automatically can take rates up for that?

Mark A. Radtke

That’s correct.

Charlie Schrock

That was approved with the order to build Weston 4.

David Greenhouse

Okay. I still felt you had to settle though with the rate case. So, you are actually increasing rates then in ’08 to get Weston 4 in?

Charlie Schrock

It’s kind of a technicality, and Wisconsin, it’s not part of rate base until it’s operational. So what they did is they allowed us to run a return on the investment and construction work in progress while it’s being built.

Larry Borgard

And most of the capital dollars were spent by the end of 2007.

David Greenhouse

Okay. But you still have capital dollars for half of 2007 and then what you are spending in ’08 that would not be in yet, right?

Larry Borgard

’07 was – the rates for ‘07 were based on a projected test year, so we projected what the capital expenditures were going to be relative to Weston 4. As you heard Larry say earlier, we’ve been on budget and on schedule with that. So, you know, it’s pretty much tied in with the way that they design the rates.

David Greenhouse

So you didn’t get sort of – they don’t sort of average that expenditure over the course of ’07? They give you the full ’07 on January 01?

Larry Borgard

Yes, projected test year.

David Greenhouse

Okay, all right. So, that is not a half year, you actually got the full benefit of that. Okay. So then Weston 4 is all in. So when you re-file rates next year there is really going to be no – or this year there is really going to be no increase for Weston 4. It’s just going to be moving at some (Inaudible) in the rate base case transfer.

Larry Borgard

Fairly minor adjustments. Danny?.

Daniel J. Verbanac

Yeah, I mean there will be some capital expenditures as we wrap up the construction.

Joe O'Leary

Depreciation will be impacted by the end of service date and of course the energy cost would be impacted.

David Greenhouse

Okay. So we should I guess getting back to my original question, we should see some pickup then at WCMCO this year in earnings from less than 4 or 5, you know, rate case and despite having – picking up the full year depreciation.

Joe O'Leary

Yeah we factored it in with our earnings per share guidance. So we’ve got something in there relative to Weston 4 and what we’ve got – and again we got a range out there and some of that relates to what we anticipate we are going to be recovering.

David Greenhouse

Can you – for the third (Inaudible) can you give me some hints about what that might look like?

Joe O'Leary

No, we don’t have that information by legal entity.

David Greenhouse

All right. Thanks for the time.

Joe O'Leary

Thanks, David.

Operator: There are no further questions at this time.

Steven Eschbach

Yeah this is Steve Eschbach. Thank you very much for being a part of our fourth quarter earnings conference call. A replay of this conference call will be available until May 6, 2008 by dialing toll free 866-491-9108.

The text for today’s presentation is available on our website at www.integrysgroup.com. Just select Investors and then Presentations. If you have any additional questions, you may contact me at 312-228-5408 or Donna Sheedy at 920-433-1857. Thank you.

Operator: Thank you for participating in today’s call. The conference has now ended. You may disconnect at this time.

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Source: Integrys Energy Group, Inc. Q4 2007 Earnings Call Transcript
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