"Management's Discussion and Analysis of Financial Condition and Results of Operations" should be read in conjunction with the accompanying consolidated financial statements and "Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report on Form 10-K of Inergy, L.P. for the fiscal year ended September 30, 2008.

The statements in this Quarterly Report on Form 10-Q that are not historical facts, including most importantly, those statements preceded by, or that include the words "may", "believes", "expects", "anticipates" or the negation thereof, or similar expressions, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 ("Reform Act"). Such forward-looking statements include, but are not limited to, statements that: (i) we believe our wholesale supply, marketing and distribution business complements our retail distribution business, (ii) we expect recovery of goodwill through future cash flows associated with acquisitions, and (iii) we believe that anticipated cash from operations and borrowings under our credit facility will be sufficient to meet our liquidity needs for the foreseeable future. Such forward-looking statements involve risks, uncertainties and other factors which may cause the actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the following: weather in our area of operations; market price of propane; availability of financing; changes in, or failure to comply with, government regulations; the costs, uncertainties and other effects of legal and administrative proceedings and other risks and uncertainties detailed in our Securities and Exchange Commission filings. For those statements, we claim the protections of the safe harbor for forward-looking statements contained in the Reform Act. We will not undertake and specifically decline any obligation to publicly release the result of any revisions to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect events or circumstances after anticipated or unanticipated events.

Overview

We are a growing retail and wholesale propane supply, marketing and distribution business. We also own and operate a growing midstream business that includes two natural gas storage facilities ("Stagecoach" and "Steuben"), a liquefied petroleum gas ("LPG") storage facility, a natural gas liquids ("NGL") business and a solution-mining and salt production company ("US Salt"). We further intend to pursue our growth objectives through, among other things, future acquisitions, operating in attractive markets and focusing our operations under established and locally recognized trade names.

We have grown primarily through acquisitions and to a lesser extent through organic expansion projects. Since the inception of our predecessor in November 1996 through December 31, 2008, we have acquired 81 companies, including 75 retail propane companies and 6 midstream businesses, for an aggregate purchase price of approximately $1.7 billion, including working capital, assumed liabilities and acquisition costs.

In October 2008, we acquired the assets of the Blu-Gas group of companies ("Blu-Gas") headquartered in Denver, North Carolina. Blu-Gas delivers propane to approximately 9,300 customers. In conjunction with the acquisition, we issued 309,194 common units to Blu-Gas in a private placement as a portion of the purchase price. The purchase price allocation for this acquisition has been prepared on a preliminary basis pending final asset valuation and asset rationalization, and changes are expected when additional information becomes available. Changes to final asset valuation of prior fiscal year acquisitions have been included in our consolidated financial statements but are not material.

The retail propane distribution business is largely seasonal due to propane's primary use as a heating source in residential and commercial buildings. As a result, cash flows from operations are generally highest from November through April when customers pay for propane purchased during the six-month peak heating season of October through March.

Because a substantial portion of our propane is used in the weather-sensitive residential markets, the temperatures realized in our areas of operations, particularly during the six-month peak heating season of October through March, have a significant effect on our financial performance. In any given area, warmer-than-normal temperatures will tend to result in reduced propane use, while sustained colder-than-normal temperatures will tend to result in greater propane use. Therefore, we use information on normal temperatures in understanding how historical results of operations are affected by temperatures that are colder or warmer than normal and in preparing forecasts of future operations, which are based on the assumption that normal weather will prevail in each of our operating regions. "Heating degree days" are a general indicator of how weather impacts propane usage and are calculated for any given period by adding the difference between 65 degrees and the average temperature of each day in the period (if less than 65 degrees). While a substantial portion of our propane is used by our customers for heating needs, our propane operations are geographically diversified and not all of our propane sales are weather sensitive. Together, these factors may make it difficult to draw definitive conclusions as to the correlation of our gallon sales to weather calculations comparing weather in a year to normal or to the prior year.

The retail propane business is a "margin-based" business where the level of profitability is largely dependent on the difference between sales prices and product costs. The unit cost of propane is subject to volatile changes as a result of product supply or other market conditions. Propane unit cost changes can occur rapidly over a short period of time and can impact margins as sales prices may not change as rapidly. There is no assurance that we will be able to fully pass on product cost increases, particularly when product costs increase rapidly. We have generally been successful in passing on higher propane costs to our customers and have historically maintained or increased our gross margin per gallon in periods of rising costs. In periods of increasing costs, we have experienced a decline in our gross profit as a percentage of revenues. In addition, during those periods we have historically experienced conservation of propane gallons used by our customers which has resulted in a decline in gross profit. In periods of decreasing costs, we have experienced an increase in our gross profit as a percentage of revenues. There is no assurance that because propane prices decline customers will use more propane and thus historical gallon sales declines we've attributed to customer conservation will reverse.

We believe our wholesale supply, marketing and distribution business complements our retail distribution business. Through our wholesale operations, we distribute propane and also offer price risk management services to propane retailers, resellers and other related businesses as well as energy marketers and dealers, through a variety of financial and other instruments, including:

• forward contracts involving the physical delivery of propane;

• swap agreements which require payments to (or receipt of payments from) counterparties based on the differential between a fixed and variable price for propane; and

• options, futures contracts on the New York Mercantile Exchange and other contractual arrangements.

We engage in derivative transactions to reduce the effect of price volatility on our product costs and to help ensure the availability of propane during periods of short supply. We attempt to balance our contractual portfolio by purchasing volumes only when we have a matching purchase commitment from our wholesale customers. However, we may experience net unbalanced positions from time to time.

Results of Operations

Three Months Ended December 31, 2008 Compared to Three Months Ended December 31,
2007

The following table summarizes the consolidated income statement components for
the three months ended December 31, 2008 and 2007, respectively (in millions):



                                                 Three Months Ended
                                                    December 31,                     Change
                                                  2008          2007        In Dollars      Percentage
Revenue                                        $    534.0      $ 514.6     $       19.4            3.8 %
Cost of product sold                                359.7        377.4            (17.7 )         (4.7 )

Gross profit                                        174.3        137.2             37.1           27.0
Operating and administrative expenses                72.8         63.2              9.6           15.2
Depreciation and amortization                        26.3         22.8              3.5           15.4
Gain (loss) on disposal of assets                    (0.7 )        1.1             (1.8 )       (163.6 )

Operating income                                     74.5         52.3             22.2           42.4
Interest expense, net                               (16.8 )      (14.9 )           (1.9 )        (12.8 )
Other income                                           -           0.1             (0.1 )       (100.0 )

Income before income taxes and interest of
non-controlling partners in ASC                      57.7         37.5             20.2           53.9
Provision for income taxes                           (0.1 )       (0.3 )            0.2           66.7
Interest of non-controlling partners in
ASC's consolidated net income                        (0.4 )       (0.3 )           (0.1 )        (33.3 )

Net income                                     $     57.2      $  36.9     $       20.3           55.0 %

The following table summarizes revenues, including associated volume of gallons sold, for the three months ended December 31, 2008 and 2007, respectively (in millions):

                                                         Revenues                                          Gallons
                                         Three Months Ended                                Three Months Ended
                                            December 31,               Change                 December 31,              Change
                                                                   In
                                          2008         2007     Dollars      Percent       2008         2007      In Units   Percent
Retail propane                         $    267.7    $  249.9   $   17.8         7.1 %       104.4        104.4         -         -  %
Wholesale propane                           141.5       152.7      (11.2 )      (7.3 )       119.9        108.6       11.3      10.4
Other retail                                 69.3        56.8       12.5        22.0            -            -          -         -
Storage, fractionation and midstream         55.5        55.2        0.3         0.5            -            -          -         -

Total                                  $    534.0    $  514.6   $   19.4         3.8 %       224.3        213.0       11.3       5.3 %

Volume. During each of the three months ended December 31, 2008 and 2007, we sold approximately 104.4 million retail gallons of propane. Gallons sold during the three months ended December 31, 2008 remained relatively unchanged as compared to the same prior year period as a result of a 4.8 million gallon increase from acquisition-related volume offset by a 4.8 million decline in volume sold at our existing locations. Although the weather in our areas of operations was approximately 3% colder than normal and 16% colder than the prior year period by our calculations using degree day data provided by NOAA, the increase in gallon sales associated with this colder weather was more than offset by (1) continued customer conservation, which we believe resulted primarily from the lingering effects of the higher cost of propane that existed at the end of our fiscal year 2008 and into the early part of our first fiscal quarter of 2009 before costs declined substantially, as well as the current overall weak United States economic environment, and (2) volume declines from net customer losses during these periods of high propane costs, including low margin and less profitable customers. Further, we believe it takes an approximate full winter season (i.e., October through March) to assess the impact of the winter weather on retail propane gallon sales for that same six-month period.

Wholesale gallons delivered increased 11.3 million gallons, or 10.4%, to 119.9 million gallons in the three months ended December 31, 2008 from 108.6 million gallons in the three months ended December 31, 2007. The increase was due primarily to greater volumes sold to existing customers and addition of new customers.

The total natural gas liquid gallons sold or processed by our West Coast NGL operations increased 10.2 million gallons, or 18.6%, to 65.0 million gallons during the three months ended December 31, 2008 from 54.8 million gallons during the same three-month period in 2007. This increase was attributable to the addition of natural gas liquid processing contracts in late fiscal 2008 and early fiscal 2009 which became effective this fiscal year. During the three months ended December 31, 2008 and 2007, Stagecoach had 26.25 bcf of working gas storage capacity and the storage services were 100% contracted during each of those periods. Steuben, which we acquired a controlling interest in on October 5, 2007, had 6.2 bcf of working gas storage capacity and the storage services were 100% contracted during the three months ended December 31, 2008 and 2007. The Bath LPG Storage Facility had a storage capacity of 1.5 million barrels and storage services were 100% contracted during the three months ended December 31, 2008 and 2007.

Revenues. Revenues for the three months ended December 31, 2008 were $534.0 million, an increase of $19.4 million, or 3.8%, from $514.6 million during the same three-month period in 2007.

Revenues from retail propane sales were $267.7 million for the three months ended December 31, 2008 compared to $249.9 million during the same three-month period in 2007. This $17.8 million, or 7.1%, increase resulted primarily from a higher overall average selling price of propane and acquisition-related sales, which resulted in higher revenues of $16.9 million and $12.3 million, respectively. These factors were partially offset by an $11.4 million reduction in retail propane revenues arising from lower retail volume sales at our existing locations as discussed above.

Revenues from wholesale propane sales were $141.5 million in the three months ended December 31, 2008, a decrease of $11.2 million or 7.3%, from $152.7 million in the three months ended December 31, 2007. This decrease resulted primarily from the lower average selling price of propane, which contributed $27.1 million to the decrease in revenues. The lower selling price in our wholesale division in 2008 compared to 2007 was the result of the lower cost of propane. This decrease was partially offset by increases in volume sold to existing and new customers.

Revenues from other retail sales, which primarily includes distillates, service, rental, appliance sales and transportation services, were $69.3 million for the three months ended December 31, 2008, an increase of $12.5 million, or 22.0%, from $56.8 million during the same three-month period in 2007. Approximately $22.5 million of this increase was due to acquisition-related sales, partially offset by a decline in distillate revenues from existing locations of approximately $8.5 million. Distillate revenues decreased at existing locations as a result of lower volume sold coupled with a slight decline in our average selling price.

Revenues from storage, fractionation and other midstream activities were $55.5 million for the three months ended December 31, 2008, an increase of $0.3 million or 0.5% from $55.2 million during the same three-month period in 2007. Approximately $10.9 million of this increase was due to the acquisition of US Salt. Revenues at our Bath LPG Storage Facility and Stagecoach Storage Facility increased slightly due to an increase in contractual rates and the commencement of operations on North Lateral in December 2008, respectively. Partially offsetting these increases were $11.0 million lower revenues from our West Coast NGL operations primarily as a result of decreases in commodity cost and expected changes in the variety of natural gas liquid products sold.

Cost of Product Sold. Cost of product sold for the three months ended December 31, 2008 was $359.7 million, a decrease of $17.7 million, or 4.7%, from $377.4 million during the same three-month period in 2007.

Retail propane cost of product sold was $147.4 million for the three months ended December 31, 2008 compared to $157.8 million for the same three-month period in 2007. This $10.4 million, or 6.6%, decrease in retail cost of product sold was driven by a 7% decline in the average per gallon cost of propane along with lower volume sales at our existing locations as discussed above, which together reduced costs by approximately $16.4 million. These factors were partially offset by a $5.7 million increase in the cost of product sold associated with acquisition-related volume.

Wholesale propane cost of product sold in the three months ended December 31, 2008 was $135.8 million, a decrease of $13.7 million or 9.2%, from wholesale cost of product sold of $149.5 million in 2007. These lower costs were primarily a result of an approximate $29.3 million decrease due to the lower average cost of propane, partially offset by a $15.6 million increase in volume sold to existing and new customers.

Other cost of product sold was $43.0 million for the three months ended December 31, 2008 compared to $35.0 million during the same three-month period in 2007. This $8.0 million, or 22.9%, increase was primarily due to higher costs associated with acquisitions of $17.1 million, partially offset by lower costs from distillate sales at existing locations of $8.6 million and a decline in costs for other products and services of $0.5 million.

Storage, fractionation and other midstream cost of product sold was $33.5 million for the three months ended December 31, 2008, a decrease of $1.6 million, or 4.6%, from $35.1 million during the same three-month period in 2007. Costs from our West Coast NGL operations were $10.7 million lower primarily as a result of decreases in commodity cost and expected changes in the variety of natural gas liquid products sold due to additional contracts. Partially offsetting this decrease was a $7.6 million increase in cost due to the acquisition of US Salt and slight increases in costs at the Stagecoach Storage Facility and the Bath LPG Storage Facility.

Our retail and wholesale cost of product sold consists primarily of tangible products sold including all propane, distillates and other natural gas liquids sold and all propane-related appliances sold. Other costs incurred in conjunction with the distribution of these products are included in operating and administrative expenses and consist primarily of wages to delivery personnel, delivery vehicle costs consisting of fuel costs, repair and maintenance and lease expense, and depreciation on tanks being rented to customers. Costs associated with delivery vehicles approximated $17.3 million and $17.9 million for the three months ended December 31, 2008 and 2007, respectively. In addition, the depreciation expense associated with the delivery vehicles and customer tanks is reported within depreciation and amortization expense and amounted to $7.6 million for the three months ended December 31, 2008 and 2007. Since we include these costs in our operating and administrative expense and depreciation and amortization expense rather than in cost of product sold, our results may not be comparable to other entities in our lines of business if they include these costs in cost of product sold.

Our storage, fractionation and other midstream cost of product sold consists primarily of commodity and transportation costs. Other costs incurred in conjunction with these services are included in operating and administrative expense and depreciation and amortization expense and consist primarily of depreciation, vehicle costs consisting of fuel costs and repair and maintenance and wages. Depreciation expense for storage, fractionation and other midstream amounted to $7.4 million and $6.2 million for the three months ended December 31, 2008 and 2007, respectively. Vehicle costs and wages for personnel directly involved in providing midstream services amounted to $0.8 million and $1.3 million for the three months ended December 31, 2008 and 2007, respectively. Since we include these costs in our operating and administrative expense and depreciation and amortization expense rather than in cost of product sold, our results may not be comparable to other entities in our lines of business if they include these costs in cost of product sold.

Gross Profit. Gross profit for the three months ended December 31, 2008 was $174.3 million, an increase of $37.1 million, or 27.0%, from $137.2 million during the same three-month period in 2007.

Retail propane gross profit was $120.3 million for the three months ended December 31, 2008 compared to $92.1 million in the same three-month period in 2007. This $28.2 million, or 30.6%, increase in retail propane gross profit was mostly attributable to higher cash margin per gallon of approximately $26.1 million and $6.6 million associated with acquisitions, partially offset by a $4.2 million decline in gross profit resulting from lower retail gallon sales at existing locations as discussed above. The increase in cash margin per gallon was primarily the result of higher selling prices in certain markets in excess of the declining cost of propane.

Wholesale propane gross profit was $5.7 million in the three months ended December 31, 2008 compared to $3.2 million in the three months ended December 31, 2007, an increase of $2.5 million or 78.1%. This increase was primarily the result of higher margins we were able to attain in a period of market volatility.

Other gross profit was $26.3 million for the three months ended December 31, 2008 compared to $21.8 million for the same three-month period in 2007. This $4.5 million, or 20.6%, increase was due primarily to acquisitions.

Storage, fractionation and other midstream gross profit was $22.0 million in the three months ended December 31, 2008 compared to $20.1 million in the same three-month period in 2007, an increase of $1.9 million, or 9.5%. Approximately $3.3 million of this increase was due to the acquisition of US Salt. This increase was partially offset by slight decreases at our West Coast NGL operations and Stagecoach Storage Facility.

Operating and Administrative Expenses. Operating and administrative expenses were $72.8 million for the three months ended December 31, 2008 compared to $63.2 million in the same three-month period in 2007. This $9.6 million, or 15.2%, increase in operating expenses was primarily the result of a $6.1 million increase arising from acquisitions. The remaining increase was primarily the result of higher wages and other personnel expenses.

Depreciation and Amortization. Depreciation and amortization was $26.3 million for the three months ended December 31, 2008 compared to $22.8 million during the same three-month period in 2007. This $3.5 million, or 15.4%, increase resulted primarily from acquisitions and the expansion projects in our midstream segment.

Interest Expense. Interest expense was $16.8 million for the three months ended December 31, 2008 compared to $14.9 million during the same three-month period in 2007. This $1.9 million, or 12.8%, increase was due to an increase in the average debt outstanding associated with acquisitions, capital improvement projects and working capital needs, partially offset by lower average interest rates. Additionally, during the three months ended December 31, 2008 and 2007, we capitalized $2.3 million and $0.8 million, respectively, of interest related to certain capital improvement projects in our midstream segment as further described below in "Liquidity and Sources of Capital - Capital Resource Activities."

Net Income. Net income was $57.2 million for the three months ended December 31, 2008 compared to net income of $36.9 million for the same three-month period in 2007. The $20.3 million, or 55.0%, increase in net income was primarily attributable to a higher gross profit, partially offset by higher operating expenses, depreciation and amortization and interest expense in the 2008 period.

EBITDA and Adjusted EBITDA. The following table summarizes EBITDA and Adjusted EBITDA for the three months ended December 31, 2008 and 2007, respectively (in millions):