SR

Business Context and Reporting Period

This Form 10-Q is a combined quarterly report for The Laclede Group, Inc. (the holding company) and Laclede Gas Company (the regulated utility subsidiary) for the quarter and nine months ended June 30, 2002. Effective October 1, 2001, Laclede Gas became a subsidiary of The Laclede Group. The Group's operations are dominated by the seasonal natural gas distribution business of Laclede Gas, which typically generates earnings in the first half of the fiscal year (heating season) and losses in the second half. The Group diversified its portfolio in January 2002 by acquiring SM&P Utility Resources, Inc., a facility locating and marking business with counter-seasonal earnings.

Key Financial Metrics (Nine Months Ended June 30, 2002)

Material Changes vs. Prior Period

• Revenue Decline: Total operating revenues decreased $281.3 million (30.9%) compared to the prior year. This was primarily driven by a $316.8 million decrease in utility operating revenues due to significantly warmer weather (15% warmer than normal) and lower wholesale natural gas prices passed through to customers.
• Non-Utility Growth: Non-utility operating revenues increased $35.6 million to $102.1 million, largely attributable to the inclusion of SM&P Utility Resources, Inc. since its January 2002 acquisition.
• Profitability: Net income decreased $7.9 million (22.4%) to $27.5 million. The decline was caused by lower gas sales volumes due to warm weather and the expiration of the Gas Supply Incentive Plan (GSIP). These factors were partially offset by a general rate increase implemented in December 2001 and income from off-system sales.
• Expense Reduction: Total operating expenses decreased $167.1 million, primarily due to a $287.3 million reduction in natural and propane gas costs, reflecting lower supplier rates and reduced volumes purchased.
• Cash Flow Improvement: Net cash provided by operating activities increased significantly to $109.6 million from $41.5 million in the prior year, driven by changes in working capital, specifically a reduction in natural gas stored underground and improved accounts receivable collection.

Guidance, Outlook, Risks, and Contingencies

• Regulatory Risks:
  • Rate Case: Laclede Gas filed a request for a general rate increase of $36.1 million annually. The Missouri Public Service Commission (MoPSC) suspended the request pending review, with a decision expected by December 25, 2002.
  • Cost Disallowance: The MoPSC Staff recommended disallowing approximately $4.9 million in pre-tax gains from the Price Stabilization Program (PSP). Laclede Gas intends to vigorously oppose this, noting the outcome could materially affect future financial results.
  • GSIP Expiration: The MoPSC denied a rehearing request to extend the Gas Supply Incentive Plan. Laclede Gas is pursuing judicial review, though the plan has expired.
  • Investigation: The MoPSC established a case to investigate the delegation of gas supply administrative functions to a subsidiary (LES). Management does not believe this will have a material financial effect.
• Credit Ratings: In April and May 2002, S&P and Moody's downgraded Laclede Gas' First Mortgage Bonds (to A+ and A1, respectively) and commercial paper ratings. Cited reasons include eroded bondholder protection due to successive warm winters and increased debt leverage. Ratings remain investment grade.
• Environmental Contingencies: Laclede Gas is involved in cleanup at two former manufactured gas plant sites (Shrewsbury and Carondelet). Estimated costs are approximately $2.3 million and $0.6 million, respectively. A third site is under assessment with unknown potential costs that could be material if insurance coverage is denied.
• Outlook: Management expects the acquisition of SM&P to be accretive to earnings for the full fiscal year, tempering the seasonal volatility of the utility business. No specific earnings guidance was provided for the remainder of the fiscal year.

Investor Verification Checklist

• Weather Sensitivity: Verify the impact of the 15% warmer-than-normal weather on gas sales volumes and the resulting revenue shortfall.
• Regulatory Outcomes: Monitor the MoPSC's final decision on the $36.1 million rate increase request and the $4.9 million PSP cost disallowance recommendation.
• SM&P Integration: Assess the financial performance and accretion of the newly acquired SM&P Utility Resources, Inc. to ensure it offsets utility seasonality as projected.
• Credit Rating Triggers: Review the impact of recent credit downgrades on borrowing costs and the potential activation of rating triggers on the $42.8 million SM&P acquisition loan and $20 million working capital line.
• Environmental Liabilities: Confirm the status of insurance claims for the Carondelet and third-party gas plant sites, as denials could result in material, unrecoverable costs.