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Integrys Energy Group, Inc (NYSE:TEG)

Q2 2012 Earnings Call

August 09, 2012 09:00 a.m. ET

Executives

Steven Eschbach – Vice President, Investor Relations

Charles Schrock – Chairman, President and Chief Executive Officer

Joseph O'Leary – Senior Vice President and Chief Financial Officer

Daniel Verbanac – President, Integrys Energy Services, Inc.

Mark Radtke – Executive Vice President and Chief Strategy Officer

Analysts

Paul Patterson – Glenrock Associates

Ali Agha – SunTrust Robinson Humphrey

Ashar Khan – Visium Asset Management

Michael Jin – Epoch Investment Partners

Steven Gambuzza – Millennium Partners

Operator

Welcome to the Second Quarter 2012 Earnings Conference Call for Integrys Energy Group Incorporated. 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 now begin.

Steven Eschbach

Thank you very much and good morning everyone. Welcome to the Integrys Energy Group’s second quarter 2012 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, Utilities; Mark Radtke, Executive Vice President and Chief Strategy Officer of Integrys Energy Group; and Dan Verbanac, President of Integrys Energy Services are 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 Investors, select presentations and then today’s presentation. Before we begin, I will advice everyone that this call is being recorded and will be available for audio replay through November 2, 2012.

I need to direct you to slide three of our presentation and to point out that the 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 our ability to control and in many cases we cannot predict what factors would cause actual results to differ materially from those indicated by forward-looking statements. Except as maybe required by federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements contained in this presentation whether as a result of new information, future events or otherwise.

This slide is a condensed commentary on the forward-looking statements and you are encouraged to read and understand the more specific language that is contained in our filings with the Securities and Exchange Commission, including the quarterly report on form 10-Q we filed and the forward-looking statement section of yesterday’s news release and slide 46 in the appendix.

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

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

Charles Schrock

Thank you, Steve. Good morning, everyone, and thanks for joining us on the call today. I am going to begin with our high-level overview of our second quarter 2012 financial results and operational highlights. Joe will then discuss our financial results in more detail and provide a summary of our financial outlook for the remainder of 2012, and as usual we will conclude with a question-and-answer session.

Before I begin, there are two key messages I would like you to keep in mind. First, as seen from our earnings release, we saw a decline in earnings from the quarter and first half of the year compared to 2011. The reason for this on the utility side is weather, and the reason on retail marketing side is the effects of competitive pressures.

My second key message is that the fundamentals of our businesses are strong. We are continuing to execute on our plan to provide value primarily from our utilities with the complimentary earnings provided by our non-utility operations.

So please turn to slide five. In the second quarter of 2012 we posted diluted earnings per share adjusted on a consolidated basis of $0.26, down $0.12 per share versus the same quarter a year ago. The primary driver of the quarter-over-quarter decline was unseasonably warm weather impacting our regulated natural gas utilities. Warmer than normal weather had a $12 million or $0.15 negative impact on our consolidated financial results for the quarter.

For the first half of 2012, the 20% to 25% warmer than normal weather had an approximate $27 million or $0.34 negative impact on our consolidated financial results compared to normal weather. With this adverse weather impact on our natural gas utility segment, along with increased competitive pressure on our non-regulated energy services business unit, after the revision of our 2012 guidance range for diluted earnings per share adjusted to between $3 and $3.15. And Joe will have more to say on this in Joe’s formal remarks.

Despite the reduced guidance range our primary businesses, the regulated utilities are executing according to plan and our non-regulated business unit is establishing a strong foundation for future growth. And the next couple of slides will illustrate this.

Let's look at the operations of our regulated utilities summarized on slide six. Our Peoples Gas accelerated Main Replacement Activity in Chicago continues to outpace what we accomplished a year ago. In the second quarter of 2012 we installed another 55 miles of main, 17 miles more than we installed in the second quarter of 2011. During the first six months of 2012, we replaced 80 miles of main and are on-track to achieve our 200 mile target for 2012.

At Wisconsin Public Service, the environmental retrofit project for our jointly owned Columbia power plant continues to progress as planned. We are also seeking approval from the Public Service Commission of Wisconsin for environmental retrofits at our Weston 3 power plant. We anticipate a decision from the Commission in early 2013, which will allow construction to begin shortly thereafter.

On the rate case front, we received a written order from Minnesota Energy Resources rate case in July and we expect new rates to be implemented in the fall of 2012. The Public Service Commission of Wisconsin completed its audit of our WPS rate case in July. Finally, we filed rate cases for Peoples Gas and North Shore Gas on July 31. Summary of the recent rate cases can be found on slides 21 through 24 in the appendix.

Please turn to slide 7 as I discuss the operations of Integrys Energy Services. Despite the challenges of increased competition and warmer than normal weather, Integrys Energy Services was able to slightly improve its performance over the same quarter last year and showed growth in contracted volumes for the period. Our total retail forward book volumes are also greater for both natural gas and electric as of June 30th of this year compared to last year.

Our customer retention rate remain strong as measured by customer counts, volume and margins. Although our contracted margins are up, delivered volumes for retail natural gas are bound in the first half of 2012 compared with the first half of 2011 and delivered retail electric volumes are virtually flat over the same period.

The decline on the natural gas volumes is primarily due to the unseasonably warm winter weather which mainly affects our smaller weather sensitive customers. Delivered retail electric volumes were a little less than what we expected primarily due to increased competition. Increased competition is also the driver for the declines in retail electric unit margins over the comparison periods. We have included some details on delivered and contracted volumes and on margins on slides 26 and 27 in the appendix.

Given the current competitive environment, retail electric municipal acquisition results in Illinois are slightly behind our 2012 expectations. As of June 30, 2012 we have 32 communities contracted under the Illinois municipal aggregation program and about 243,000 small electric customers in Illinois.

We expect these growth opportunities to extend into 2013 due to more than 100 additional Illinois communities of size that are expected to put electric aggregation under municipal belt in November. The performance of Integrys Energy Services over these last few months in the face of stiff competition demonstrates that we have the foundation ion place to compete effectively and we are poised for controlled growth consistent with the change in strategy that we began three years ago.

Before I turn the call over to Joe, I would like to repeat that despite the change in our guidance range, the fundamentals of our businesses remain solid. Our utilities including our interest in The American Transmission Company are performing well and providing the bulk of our earnings and our retail marketing businesses positioned for controlled growth to provide complimentary earning stream with an appropriate risk and returns.

I will now turn the call over to Joe. Joe?

Joseph O’Leary

Thank you, Charlie I’ll cover our financial results for 2012 and discuss our guidance for 2012 diluted earnings per share adjusted. Beginning with slide eight, during the second quarter of 2012, we recognized GAAP diluted earnings per share of $0.62 for the quarter ended June 30, 2012 compared with $0.37 for the same quarter in 2011.

This slide also sets forth the additions and subtractions we had made to arrive at diluted earnings per share adjusted for the second quarter of 2012. Our diluted earnings per share adjusted for the second quarter 2012 is $0.26 compared with $0.38 in the same period in 2011. More comparative information on the second quarters of 2012 and 2011 is reported by segment on slides 29 and 30 in the appendix.

For the six months ended June 30, 2012 we recognized GAAP diluted earnings per share of $1.86 compared with $1.93 for the comparable period in 2011. We’ve also shown the additions and subtractions to arrive at diluted earnings per share adjusted for the six month period in 2012 and 2011. Our six months 2012 diluted earnings per share adjusted was $1.80 for 2012 versus $1.95 in 2011. More comparative information on the six months results for 2012 and 2011 reported by segment can be found on slide 36 and 37 in the appendix.

Note that we have now included separate charts on slide eight to show the impact of the unusually warm weather compared to normal weather net of decoupling in both dollars and diluted earnings per share. As we have said in the past, decoupling at each of our jurisdictions is not perfect, and given the Illinois commerce commission’s amended order and the Peoples Gas and North Shore Gas 2012 rate cases, our financial results are now more sensitive to weather than it had been in the past.

As Charlie mentioned, in the first half of 2012, the negative weather impact across the Integrys Energy Group net of decoupling was approximately $27 million or $0.34 per share. This reflects a negative financial impact of reserves established in the second quarter against regulatory assets for the decoupling earnings that we may not be able to retain due to recent ICC and court decisions in Illinois. We believe we have a strong argument that the ICC had authority to approve a permanent decoupling mechanism and continue to defend a decoupling mechanism in the [inaudible] process.

However, based on the current situation which the ICC stated that the decoupling revenues are now subject to refund in Illinois as the Illinois Appellate Court overturns the decoupling mechanism in order to refund if any amounts collected, and the fact that several other but different riders have recently been overturned, we believe that recovery of amounts calculated as recoverable. Under the permanent decoupling mechanism is not certain enough to record the reserve.

On slide 9 and 10 we show the changes in adjusted earnings by segments for the second quarter 2012 compared with the second quarter of 2011 and six months 2012 compared with the six months 2011 respectively. Additional detail on the key variance drivers for each segment can be found in the appendix on slides 31 through 35 for the quarter-over-quarter comparisons and slide 38 through 42 for the six months over six months comparison.

Moving to slide 11, we provided our capital expenditure plans for 2012 through 2014. The key segment drivers remain the same with environmental retrofits at Wisconsin Public Service for the electric utilities and the Accelerated Main Replacement Program at Peoples Gas in Chicago for the natural gas utilities.

We’ve adjusted the Wisconsin Public Service capital expenditures downward by $133 million to reflect the deduction of certain environmental expenditures in all three years. For example, we eliminated a number of projects scheduled for our Fulham [ph] and Weston generating plants based on the state of regulations and most notably fabric filters with Fulham units five, six, seven, and eight that represented significant dollars. We have determined that we can meet articulating mission requirements with modifications to existing equipment and has budgeted for those projects. We also made a minor adjustment downward to the capital expenditures for Upper Peninsula Power in 2012.

You will also note that we increased the projected capital expenditures for Integrys Energy Services by $9 million in 2012, and this was driven by anticipated solo investors. Additionally, we’ve revised our equity contribution to American Transmission Company to $19 million in 2012 from $14 million. The rest remains the same as presented in May with the exception of some shifting of capital expenditure dollars between 2012 and 2013 for Integrys Business Support.

Slide 12 shows our expected depreciation expense at the regulated utilities for 2012 through 2014. This slide has not changed since last quarter’s conference call. Our projected rate base for 2012 through 2014 has been reduced from our projections provided in May of this year and is reflected on slide 43 in the appendix.

Moving to Slide 13, you will see our financing summary for 2012. We renewed a number of credit facilities in June at the parent holding company as well as for Peoples Gas and Wisconsin Public Service in an aggregate amount to $100 million less than what was previously outstanding. This is by design due to our reducing for collateral support requirements. In early April we completed a $28 million 3.43% interest rate long-term financing for North Shore Gas which will mature in 15 years. We still expect to complete long-term financing transactions for Wisconsin Public Service and Peoples Gas in 2012 as we previously discussed, without the need to issue common stock in 2012.

Turning to slide 14, we have provided our revised 2012 guidance for diluted earnings per share adjusted with detail by segments. On slide 15 we have provided the changes in our 2012 guidance for diluted earnings per share adjusted. And you can see the biggest changes are reduction to the natural gas utility segment due to warmer weather earlier this year which includes the impact of recent ITC and court rulings in Illinois related to the decoupling and writers.

We also anticipate a reduction to Integrys Energy Services projected results in part and to increase competitive pressures for retail electric which impact both unit margins and volume growth expectations along with warmer than normal weather impacting retail natural gas sales. These reductions have been offset slightly by expected improvements in regulated electric utility and electric transmission segments.

Now, I’ll turn the call back over to Charlie Schrock. Charlie?

Charles Schrock

Thank you Joe. Before taking your questions, I’ll summarize a few highlights from our call today. Please turn to slide 16. First the execution of our business plan for the regulated utilities remains on track. And our 34% ownership in American Transmission Company continues to contribute to earnings as expected. We have a solid foundation for controlled growth at Integrys Energy Services. We expect our regulated businesses to contribute approximately 90% of our consolidated net income and our non-regulated businesses comprised almost entirely of Integrys Energy Services to contribute the remaining 10%. Our risk profile today is commensurate with that regulated, non-regulated mix.

Our guidance for 2012 diluted earnings per share adjusted on a consolidated basis is in the range of $3 and $3.15. Our portfolio of regulated and non-regulated businesses, our operational excellence initiatives and cost-control efforts will enable us to meet our revised 2012 consolidated financial objectives.

And we continue to work towards growth in diluted earnings per share adjusted of 4% to 6% on an average annualized basis with 2011 as the base year through 2015. Given our solid long term business plan and our portfolio of businesses, our current dividend is sustainable and our dividend payout ratio will decline to utility industry norms as our earnings flow over time.

We will now open the call for your questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question and answer session. [Operator Instructions] Our first question is from Paul Patterson with Glenrock Associates.

Paul Patterson – Glenrock Associates

Good morning.

Charles Schrock

Good morning Paul.

Paul Patterson – Glenrock Associates

The competitive outlook in the energy services business, could you just sort of describe exactly what happened between now and the first quarter and where you are seeing that competition from? Could you just give a little color as to exactly what’s going on and what the outlook is for that?

Charles Schrock

Yeah Paul. Let me start out kind of a high level and then I will have Dan Verbanac chime in a little bit as well. In the first quarter we were seeing some of the pressure and you would recall that we commented on the headwinds that we were seeing. But we still had opportunities in front of us in the second quarter. We have been seeing the competition reflected in terms of unit margins declining and then on the aggregation front in Illinois, the competition was pretty stiff there. Although I think we picked up a number of communities in a positive way. But kind of at a high level that’s where it happened. Dan you have any additional comment?

Dan Verbanac

Sure. Good morning Paul.

Paul Patterson – Glenrock Associates

Good morning.

Dan Verbanac

We take a disciplined approach to our retail business, pursuing business, where we can add value to our customers and to buy an adequate returns. Coming into 2012 we certainly had certain unit margin, volume retention and volume growth expectations which were based on historical performance, and as Charlie mentioned in his comments, comparative pressures in all three areas impacted 2012 results.

We also talked or discussed in the first quarter that at the end of the year there were some very large customers that we did not retain, which would certainly hurt our volume retention metrics. So, basically we are seeing the most pressures on our [inaudible] power business.

Paul Patterson – Glenrock Associates

Is it coming from one or two particular competitors that you are finding here or is this just the general environment that you are encountering? And if could tell us, who are your biggest competitors?

Dan Verbanac

You know what we are seeing is that unit margin compression or pressures, most regions are different depending on customer class and region. But in general we are seeing it across all the regions. Certain regions certainly more competitive than others. And some of our largest competitors, and it depends again on the region that we are talking about, but we see some of the major competitors of [inaudible] cancellations and direct energies across most of our regions, and then we see regional players in each of the areas.

Paul Patterson – Glenrock Associates

Okay. Is there a competitive advantage or something we should be thinking about that you guys – a new product or something that you are going to be rolling out to reverse this or how should we think about what your prospects are in this business going forward?

Dan Verbanac

Sure. We’ve made changes to adjust to this ever changing competitive environment. We have been in this business a long time. We’ve seen this before. It typically happens in cycles. So we’ve adjusted our pricing assumptions to be more competitive but still providing an acceptable return. Again being disciplined about that pricing, we’ve expanded our natural gas business to additional states within the mid-Atlantic region, and for the first time we are flowing natural gas to customers in that region, we [inaudible] gas in July. We have expanded our electric offerings behind additional utilities, People – AEP Ohio and AEP Michigan and we are looking at other utilities, and we are continuing to increase the number of sales staff in all the regions in which we currently do business, and to continue to grow business organically. These changes are starting to have positive results. As Charlie mentioned, our forward book volumes are up 28% for electric and 10% for gas as of June 30, 2012, compared to June 30, 2011 which is shown in the supplemental data packet of the earnings release.

Paul Patterson – Glenrock Associates

Okay. Just finally at the – I noticed that the comments on the 4% to 6% growth longer term seems a little bit more muted this quarter over last, which I guess isn't really surprising. I was wondering if you could sort of elaborate a little bit about how much more challenging the 4% to 6% growth is and how we should maybe think about, how it’s going to be distributed, doesn’t mean any more feeling about that considering the sort of earnings revision that we have here now and just what you are saying about the competitive business?

Charles Schrock

Yeah, Paul I’ll comment on that. This is Charlie. We are still working towards that 4% to 6% growth, but clearly we thought more contribution of that would come from the non-utility business that’s probably not going to be as much as we originally thought from a few years ago, and on the other hand we expect more to come out of our utilities. We do have – if you think back just a couple of years we have had challenges in front of us. Bonus depreciation doesn’t help utility growth that much, reduced ROEs in our utilities. But we’ve been able to overcome those things and as I look ahead as our generation strategy, I mean utility side evolves there is potential opportunity there, and there is other things that we are looking at that could give us prudent investment opportunities that would also help our growth. So kind of the bottom line is we are still working towards it. We see opportunities that will help us get there, but the mix of utility, non-utility will be a little bit different.

Paul Patterson – Glenrock Associates

Should we think that perhaps it’s more likely to be lower at this than higher in terms of the range?

Charles Schrock

I think that’s a level of precision that is probably a little bit difficult to estimate at this point in time. You know, it depends on our ability to execute on rate cases and get those prudent investments gone in all sorts of things. At this point I would just say we are still looking at that 4% to 6% growth window as achievable, but I wouldn’t want to try to pin it down much more than that.

Paul Patterson – Glenrock Associates

Okay. Thank you very much.

Charles Schrock

Thanks for your question.

Operator

Thank you. Our next question is from Ali Agha with SunTrust.

Ali Agha - SunTrust Robinson Humphrey

Thank you. Good morning.

Charles Schrock

Good morning Ali.

Ali Agha - SunTrust Robinson Humphrey

A couple of questions. First, going back to the gas utility and the lowering of the guidance there, the $0.20 or so that you lowered that. Just to be clear on that as your commentary suggested you feel you will get that full decoupling in Illinois ultimately back. So assuming that doesn’t happen how much of that reduction is tied that? Is it about the $0.10 that you took in the first half, or in other words if Illinois decoupling was there and not gone, you know the $0.20 reduction would have been what?

Charles Schrock

Ali, I think the simple answer is the changing guidance is assumed that we won't be able to keep those reserves that Joe mentioned in his comments. Let me have Larry comment a little bit more on that.

Lawrence Borgard

Ali, if you look at slide eight, where we describe the weather impacts and in particular the natural gas utility segment. We are seeing about $22 million is what the impact is in natural gas segment. About $12 million of that comes from Illinois. The vast majority of that is related to the decoupling issue that’s tied up in the courts right now. Does that help?

Ali Agha - SunTrust Robinson Humphrey

Yeah, but that $12 million presumably would grow, right, versus your original budget since you are going to continue reserve until you get some clarity. So is that percentage the way to think about it, in terms of 12 out of 22, so is that the percentage of the total decline we should attribute to the Illinois issue?

Lawrence Borgard

Yeah, 12 is the Illinois contribution to the $22 million on page eight. We would expect normal weather throughout the remainder of the year though.

Ali Agha - SunTrust Robinson Humphrey

Okay. I will come back to that. So, in another words this Illinois decoupling stays, right? Let’s keep it simple. What kind of change would that be in your guidance for utility for the year, does that add to 12 million?

Lawrence Borgard

10 to 12 roughly in that range, yes.

Ali Agha - SunTrust Robinson Humphrey

Okay. Then, Charlie, coming back to the energy services side, and even your new ’12 guidance I think it is down about 40% year-over-year. Clearly it is telling us 6% to 8% growth is probably not achievable for this business. Competitive pressures are not going away anywhere. I mean the names that you cited for your competitors these are big companies, they are there in for the long haul. What gives you comfort that this is one of your growth business going forward or should we really think of this as the 12 as a new base and then your grow from that over the next couple of years. I mean you know where is the confidence there?

Charles Schrock

Ali, let me start with the confidence side of it. Actually I was pretty pleased with what we saw coming out of our non utility business, the retail business. Given the pressures it was a very disciplined approach that we took to understand the market to make sure that we adjusted our margins, our pricing accordingly, but not sacrifice the returns that we think are appropriate for that business. And even doing all of that we were able to grow our contracted volumes for the year and for our total forward book. So to me that’s very promising. And as Dan described we have a number of tools if you will of opportunities to offer services in different areas and services to customers who really appreciate the type of things that we provide. So I am confident that we are going to be able to continue to grow this business, but you are correct. I think from an expectations standpoint the growth is going to be more modest, and what we saw – what we’ve seen a couple of years ago given these competitive pressures.

Ali Agha – SunTrust Robinson Humphrey

And so to be clear I think you generated $34 million in net income in this business last year. Do you think that by 2014 you will be at or above that level?

Charles Schrock

I think it’s premature to try to estimate a specific amount Ali. The other thing that we do have, one – special items that occur year-over-year, either up or down, and when you look at all those different impacts, the $34 million base from last year is not all from the retail business. We have legacy assets and things like that going on here as well. But as we think about the future I think about growth also this year, and as I mentioned earlier it’s probably going to be more modest than what we originally thought.

The other comment I would make about our ability to grow is that being small is not necessarily a huge detriment to us. It’s not just about being big or – and it’s not all on price for our customers. We have a lot of customers who likes the products and services that we are offering.

Ali Agha – SunTrust Robinson Humphrey

Okay. Then lastly, I hear your point that the utilities business obviously is still the biggest overall from a mix perspective. But if you look at the discussions, the causes for numbered movements, etcetera, never did the energy services that [inaudible]. And if anything, numbers have generally tended to come down, not up. From a overall value perspective for TEG as a whole how confident are you in that business today than you were maybe even six, nine months ago and at what point do you see that as a distraction from the core utilities story that you are focused on?

Charles Schrock

Yeah. And I'm glad you captured my major point there that we are primarily a utilities business, 90% or more of our earnings coming from the utility operations, and those utilities remain strong. Our electric business is performing quite well but for this weather issue, the gas business is performing well also. But then our strategy and we think it’s a good one is to have a complimentary earnings stream coming from our non-utility businesses as long as we can maintain an appropriate risk profile and return profile, and we are doing that. So I think overall it’s a sound strategy that provides value to our shareholders.

Ali Agha – SunTrust Robinson Humphrey

Thank you.

Charles Schrock

Thank you for the question Ali.

Operator

Thank you. [Operator Instructions] Our next question is from Ashar Khan with Visium.

Ashar Khan - Visium Asset Management

Hi, how are you doing? I just wanted to get a sense as we look at Illinois, the electrics under their plants are now earning 9.0 ROE and in some cases 8.9 going into next year. What confidence do you have that – I guess last allowed we got was 9.45 but what confidence do you have that the ROE does not get ratcheted down to more equal to electrics in Illinois?

Unidentified Company Representative

I'm sorry. I think you know it’s very difficult to predict the outcomes of these rate cases. We believe we have sound arguments for the rates of return that we requested. And we worked through the process with the Illinois Commerce Commission and its staff to make sure they understand the importance of getting acceptable returns as well as the basis for what our numbers are. So, without trying to pinpoint a number I still think we have good approaches with our regulators, we have good sound arguments and we remain optimistic that we will get reasonable rates of return out of the process.

Ashar Khan - Visium Asset Management

But historically have gas companies been given higher returns than electric in Illinois or is it the same?

Unidentified Company Representative

I guess I'm not exactly familiar with that, given my background. I think they have been comparable but beyond that I'm not sure if I have the exact data.

Charles Schrock

Larry, do you have a comment there?

Lawrence Borgard

Yeah. The electrics in Illinois obviously are under the formula rate mechanism today. So that presents a different dynamics and those of us in the gas business who aren’t under that kind of mechanism.

Ashar Khan - Visium Asset Management

I understand. But that’s being linked to what treasuries are, right? And treasuries are I guess lower when you got your last decision as we said over here. So I'm just trying to understand what kind of ROE – if electrics are getting 8.9 and 9, what should we kind of think for ourselves going into this rate case?

Unidentified Company Representative

I guess I just would point it back to the fact that we’ve got different kind of regulatory constructs between companies that are under formula rates, and companies that are not under formula based rates.

Ashar Khan - Visium Asset Management

Okay.

Unidentified Company Representative

And I think if you look across the country you will see differences in ROEs under that scenario.

Ashar Khan - Visium Asset Management

My second question is going back to the retail business and the margins, some of your competitors especially talking of margins in the $4 to $5 range. What gives you the confidence that you will be able to be higher than that range in the retail side of the business?

Charles Schrock

I’m going to have Dan address that. But just to kind of introduce the topic. Now, we have a pretty disciplined approach to how we set our margins working with our customers depending on a number of different factors. And so far we’ve had the ability to figure out the markets and come up with margins that makes sense for us from a return standpoint. It depends on customer selection, the types of markets that you are working and all sorts of things. Let me have Dan add a little more color.

Daniel Verbanac

Yeah, I think it should be four. We are turning in customers where we can add value to the business beyond just the commodity. New price alone does not always ensure the best value. Certainly we are seeing different unit margin levels depending on customer class. Large customers obviously, lower margins versus smaller customers in it. The customer mix that we are marketing to we think gives us a unit margin that works. When we look going forward, looking at our volume growth in order to achieve our long term target we think that we can keep those targets based on those unit margins in your assumptions.

Ashar Khan - Visium Asset Management

Let me ask you this question in another way as you look at it. At what margin level – if you are getting something X4 will you decline it? What is the cutoff point from your cost of capital and how you do your business? What is your cut off point that you would not add an incremental customer? What margin level? Can you tell us what the breakeven point is right now?

Joseph O'Leary

It doesn’t make sense for us to talk about that comparative information, but what it can say is those parameters are built into our pricing models and certainly as I mentioned before and Charlie has mentioned, we are looking for returns that are acceptable to us. So that is part of our overall calculations in how we price customers. And if you look at slide 28, that shows our unit margins to-date ,and over time you are going to see our electric new margins continue to decrease somewhat as some of our higher margin business that we put on the books in the last couple of years rose off, but again the new business we are putting on it’s certainly meeting our return expectations and it’s part of our overall pricing strategy.

Ashar Khan - Visium Asset Management

Okay. But is it – so I guess not to come. I'm assuming four to five is still a good margin business, right? Just kind of like trying to get – because if it’s good for Exelon I'm assuming it’s good for you guys unless you have a higher cost structure?

Joseph O’Leary

Yes. Those unit margins are consistent with what we think today. Again it vary depending on customer classes and size of customer and region. But that’s in a range what we have experienced through the first six months of the year.

Ashar Khan - Visium Asset Management

Okay. Thank you so much.

Charles Schrock

Thank you for your questions. Appreciate it.

Operator

Thank you. Our next question is from [inaudible] Capital.

Unidentified Analyst

Thank you very much. I notice that the year your utility guidance dropped $0.23 I'm trying to find the slide, but then you said weather was down $0.34. I'm sorry if I missed this earlier, but what was the offset to the bad weather you had?

Charles Schrock

Yeah Reza, the basic offsets are our electric business is doing a little bit better. Then we had little look at earlier in the year, and then cost controls and cost management has also helped us mitigate the offsets of that weather.

Unidentified Analyst

And I found the slide. It seems like it’s mostly is a natural gas segment where you had your cost of management and so forth that seems to be where the earnings was down $0.22 year-to-date or the changing guidance.

Charles Schrock

Yeah, that is correct.

Unidentified Analyst

I guess these cost offsets – and remind us your next rate case filings. What test here they will use and when are you filing them again?

Charles Schrock

On the – hold on just a second. Let me ask Larry to jump in here and explain in a little bit more detail on the guidance range.

Lawrence Borgard

Yes, so if you look at slide 8, the weather impact on the natural gas segment for the first six months of this year is less than 28%, net of the decoupling issue here in Illinois. We have got a number of slides in the appendix as the detail, the various rate filings that we have made. Let me just kind of summarize real quickly for you. In April we filed for Wisconsin Public Service Corporation obviously in Wisconsin, and then in July we filed for Peoples Gas and North Shore Gas here in the State of Illinois. So those are our most recent rate filings.

Unidentified Analyst

Are these cost savings that you have been able to achieve sort of incorporated in the rate case or how should we think about that in terms of the test year?

Lawrence Borgard

Our test years are forward looking I believe in both of those jurisdictions for sure. So it’s obviously our projections as to what our costs are going forward.

Unidentified Analyst

Okay. And then just lastly, I think in the past you have said you don’t need any equity or anything like that. Has that changed at all or is there any triple that you have or you will need? Can you just refresh us on that?

Joseph O'Leary

Hi, this is Joe. With regards to equity we stated that we didn’t need to issue any equity this year and we haven't given any guidance related to future equity issuances or the timing of those. Although you can expect on a long-term basis we will try to maintain an equity ratio of around 50% to 55% equity for our Integrys consolidated company.

Unidentified Analyst

Okay. Got it. Okay I appreciate it, thank you.

Charles Schrock

Okay. And thank you for your question.

Operator

Thank you [Operator Instructions] Our next question is from Michael Jin with Epoch. Mr. Jin, please check your mute button.

Michael Jin – Epoch Investment Partners

All right, good morning. I have some questions. One is on the timing of your earnings adjustment for the full year. And I'm looking at slide 27 and aside from the unrealized gain your second quarter gross margin pretty much on par with the year before. The shortfall seems to be coming from the first quarter. And then in terms of weather, when you made earnings on the – first quarter earnings in May, most of the weather was behind you. So I wonder whether at the time of May you were able to look at what happened in the first quarter on the services segment, and also look at the weather, whether you were able to actually make an announcement, the downward adjustment at that time or why did you have to wait till second quarter? And I have two other questions.

Charles Schrock

So Michael there is a few different things going on there. So let me talk about the weather first. What happened is in the second quarter there was an ICC order that because of accounting rules caused us to interpret that order as requiring us – and I don’t know the exact accounting terms Joe does, but basically to say that we probably won’t be able to collect those decoupling revenues. Fundamentally that’s what it’s saying. So that happened in the second quarter and in fact if you look in our first quarter 10-Q there were some preliminary orders from the ICC that we had actually disclosed at that time saying that we were watching those things.

On the Integrys Energy Services side we did talk about the headwinds or the competitive pressures that we were seeing in the first quarter, but we also had a number of opportunities opening up to us in the second quarter, Illinois aggregation was the biggest of those and there are a handful of others that as we looked at it, it looked very promising. So it was only until after we went through those various opportunities and looked at where we were at for the rest of the year that we concluded it was time to make a change.

Michael Jin – Epoch Investment Partners

Okay. And then the second question is regarding the cash flow statement. You made a large pension contribution for the first six months, and can you just give us a sense in terms of why that was – what are the assumptions that went in or why did you increase that, and also how should I think about it going forward? I'm also going to put in the third question which is kind of related to that. As a result of the pension and CapEx and the other factors, your cash is now somewhere around $25 million and already you said that you don’t foresee any equity need for this year. How does that change your debt and equity need for the rest of the year and also going forward?

Charles Schrock

I will have Joe explain what's going on there.

Joseph O'Leary

Thanks for the questions. Let me see if I can recap some of those. First of all you asked what's driving our contributions to the pension and benefit plans and we still have quite a bit of cash coming in as a result of bonus appreciation allowed by the current income tax rules. And we are utilizing some of that to make contributions into those forms to help increase the funding levels which we think is appropriate to do. I think the next question was what impact is that going to have on our equity needs for 2012?

As I mentioned before we don’t plan on issuing any equity in 2012 for the remainder of the year. We have not given any guidance relative to the timing of any future equity issuances. However, on a consolidated basis we generally try to maintain our equity at about a 50% to 55% level of our total capital.

Michael Jin – Epoch Investment Partners

Okay. Got it. I think it sounds like the fact that you – knowing that you are going to have the benefit of bonus appreciation that you plan ahead of time in terms of the pension and you foresee that you are not going to need an additional equity. And that’s how – how you get to [inaudible] today, okay, good.

Joseph O’Leary

That’s right. That was the plan. A planned contribution is a big way to look at.

Michael Jin – Epoch Investment Partners

Yeah. Got it. Okay. Thank you.

Charles Schrock

Michael, thank you for your questions.

Operator

Thank you. Our next question is from Steven Gambuzza with Millennium.

Steven Gambuzza - Millennium Partners

Good morning.

Charles Schrock

Good morning Steve.

Steven Gambuzza - Millennium Partners

Sir, a few questions. There was this gain – a casual statement there is like a $1.9 million gain from an asset sale in this quarter. I'm just curious if you could just comment on what segment it was in and if that wasn’t part of adjusted earnings or was that pulled out of adjusted earnings?

Charles Schrock

Yeah Steve, just a second. Let me make sure we get the right number there. That was in our non-regulated business unit at [inaudible]. It was a gain on the sale that was not adjusted out of our earnings.

Steven Gambuzza - Millennium Partners

Okay. So that’s part of adjusted earnings. So $1.9 million of net income in added services was related to an asset sale gain.

Joseph O’Leary

That’s correct. This is Joe. That was for instance sale of renewable energy credit, which is kind of part of our normal continuing operations.

Steven Gambuzza - Millennium Partners

Should we expect to see a similar amount of gain on sale going forward? I guess a quarterly run rate we should expect?

Joseph O’Leary

Steve, I don’t know if I would try to make any prediction around it. It’s small and it kind of moves around quarter-over-quarter so.

Steven Gambuzza - Millennium Partners

So presumably it’s part of your guidance when you…

Charles Schrock

Yeah.

Steven Gambuzza - Millennium Partners

Okay. There is also one of the drivers for the lower OpEx, energy services was low profit [inaudible] you could comment on that?

Charles Schrock

Yeah. Dan, are you familiar with that one. Hold on a second Steve, we’ve got a couple of people looking it up.

Steven Gambuzza - Millennium Partners

Sure.

Daniel Verbanac

I think what you are referring to is that the taxes were a little lower this year.

Steven Gambuzza - Millennium Partners

No, I'm referring to, in the presentation it actually describes the – the reason for the O&M decline is lower property taxes. On page – in the earnings release it says decrease in operating expenses driven by decreases in taxes other than income taxes of $1.7 million.

Charles Schrock

Steve I think what that was is, year-over-year we had a higher tax from New York last year than what we had this year. So in comparison to last year it was a decrease.

Daniel Verbanac

And Steve, this is Dan. That’s related to our New York assets.

Steven Gambuzza - Millennium Partners

Okay. So you sold some assets you don’t have the tax go away or did tax rates go down?

Charles Schrock

It wasn’t the sale. It was really just kind of a onetime drop kind of a thing.

Steven Gambuzza - Millennium Partners

Okay. So actually what we think about is kind of a non-recurring asset?

Charles Schrock

Yes.

Steven Gambuzza - Millennium Partners

Okay. And then just on overall taxes. What tax rate should we use for – what is the expected tax rate for the 2012 consolidated earnings guidance?

Unidentified Company Representative

I guess I’d have to ask you in terms of how you are trying utilize that information, we generally assume an overall rate of somewhere around – probably around 39-40%.

Steven Gambuzza - Millennium Partners

Okay. And then I saw that you raised the ATC guidance a bit. Is that just reflecting better load growth to the weather or just trying to understand, you know it seems to be very easy business to predict given the regulation and CapEx. Just curious why the guidance for ATC would increase.

Charles Schrock

Steve that was a pretty small change, and it does reflect the latest projections for the year from ATC. Well within kind of their balance of or their range of what they would look at in terms of what the capital investment looks like.

Steven Gambuzza - Millennium Partners

Okay. And then finally, I was wondering if you could – you had mentioned some of the CapEx changes were driven by changes in your environmental compliant strategy. I was hoping if you could just review those changes again and then review kind of what is in the forecast for projected environmental capital expenditures, and what the regulatory approvals related to those expenditures or what is required may be its excellent timing of those approvals?

Charles Schrock

Let me have Larry start on that answer.

Lawrence Borgard

Yes. The changes that we made in the forecast period over the next three years are relatively minor. I think Joe described it as about a $130 million on a base of over a billion in that period. The major expenditures in terms of CapEx come on the natural gas side from the accelerated being replacement project here in Chicago. On the electric side they are related to environmental retrofits. Principally at the Columbia power plant that Charlie described in his comments as well as the Weston 3 power plant, those are the majority of the dollars on the electric side, so I hope that helps.

Steven Gambuzza - Millennium Partners

And you mentioned the approval you are filing for Weston 3 when will that be resolved I guess?

Lawrence Borgard

Yeah, I think we expect that approval early next year.

Steven Gambuzza - Millennium Partners

Early next year. Okay. Thanks very much for your time.

Charles Schrock

Thank you Steve.

Operator

And I'm showing no further questions. I will now turn the call back over to Steve Eschbach for closing remarks.

Steven Eschbach

Thank you very much and thank you for being part of our second quarter earnings conference call. A replay of this conference call will be available until November 2, 2012 by dialing toll free 888-568-0883. The full transcript of today’s conference call will be available on our website at www.integrysgroup.com, before the end of the day on Wednesday, August 15, 2012. Just select Investors and then Presentation. If you have additional questions you may contact me directly 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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