**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q/A**

**(AmendmentNo. 1)**

 
| ý | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 or 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |   |
|--------|------------|----------------------------------------------------------------------------------------------------|--------|

 

**For thequarterly period ended June 30, 2004**

 

**OR**

 
| o | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934** |   |
|---|------------|--------------------------------------------------------------------------------------------------------|--------|

 

**For thetransition period from               to               **

 

**CommissionFile Number 001-14841**

 

**MARKWEST HYDROCARBON, INC.**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                                                     | ** ** | **84-1352233**                      |
|------------------------------------------------------------------|------------|-------------------------------------|
| (State or  other jurisdiction of  incorporation or organization) |       | (IRS  Employer  Identification No.) |

 

**155Inverness Drive West, Suite 200, Englewood, CO  80112-5000**

 (Address of principal executive offices)

 

Registrant’s telephone number,including area code**:  303-290-8700**

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes  o    No  ý

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Act).

Yes  o    No  ý

 

The registrant had 10,734,541 shares of common stock, $.01 per sharepar value, outstanding as of July 31, 2004.

 

 

----

 
|                                  |                                                                                                                                         |   |
|---------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------|--------|
| **PART I-FINANCIAL INFORMATION** | ** **                                                                                                                                   |
|                                  |                                                                                                                                         |   |
| Item 1.                               | Consolidated Financial  Statements                                                                                                           |   |
|                                  | Consolidated Balance Sheets at  June 30, 2004 and December 31, 2003 (unaudited)                                                    |   |
|                                  | Consolidated Statements of Operations for  the Three and Six Months Ended June 30, 2004 and 2003 (unaudited)                            |   |
|                                  | Consolidated Statements of Other  Comprehensive Income (Loss) for the Three and Six Months Ended June 30,  2004 and 2003 (unaudited)    |   |
|                                  | Consolidated Statements of Cash Flows for  the Six Months Ended June 30, 2004 and 2003 (unaudited)                                      |   |
|                                  | Consolidated Statement of Changes in  Stockholders’ Equity for the Six Months Ended June 30, 2004 (unaudited) March 31,  2004 |   |
|                                  | Notes to the Consolidated Financial  Statements (unaudited)                                                                                  |   |
|                                  |                                                                                                                                         |   |
| Item 2.                               | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                  |   |
| Item 4.                               | Controls and Procedures                                                                                                                      |   |
|                                  |                                                                                                                                         |   |
| **PART II-OTHER INFORMATION**    |                                                                                                                                         |
|                                  |                                                                                                                                         |   |
| Item 6. Exhibits                      |                                                                                                                                         |
|                                  |                                                                                                                                         |   |
| **SIGNATURE**                         |                                                                                                                                         |

 

#### **Glossaryof Terms**

 
| Bbl/d        |   | barrels of oil per day                                              |
|--------------|--------|---------------------------------------------------------------------|
| Btu          |   | British thermal units, an energy  measurement                       |
| Gal/d        |   | gallons per day                                                     |
| Gross margin |   | revenues less purchased product costs                               |
| Mcf          |   | thousand cubic feet of natural gas                                  |
| Mcf/d        |   | thousand cubic feet of natural gas per day                          |
| MMBtu        |   | million British thermal units, an energy  measurement               |
| MMcf         |   | million cubic feet of natural gas                                   |
| MMcf/d       |   | million cubic feet of natural gas per day                           |
| NGL          |   | natural gas liquids, such as propane, butanes  and natural gasoline |

 

----

 

##### **ExplanatoryNote**

##### ** **

We have determined that, in certain cases, we did notcomply with generally accepted accounting principles in the preparation of our2003 and 2004 second quarter consolidated financial statements and, accordingly,this Amendment No. 1 on Form 10-Q/A amends the Quarterly Report on Form 10-Qoriginally filed by MarkWest Hydrocarbon, Inc. (the “Company”) on August 12,2004 for the second quarter ended June 30, 2004.

 

The Company has determined that previouslyissued financial statements for the years 2002 and 2003 and the first threequarters of 2003 and 2004 should be restated to reflect compensation expensefor the sale of subordinated units of MarkWest Energy Partners, L.P. (“MarkWestEnergy Partners” or the “Partnership”) and interests in MarkWest Energy GP, LLC(the “general partner” of MarkWest Energy Partners, L.P., a consolidatedsubsidiary) to certain employees and directors of the Company from 2002 through2004 and for an error in accounting for natural gas inventory in the fourthquarter of 2003.  The Company is filingcontemporaneously with this Form 10-Q/A for the quarterly period ended June 30,2004, its Annual Report on Form 10-K for the year ended December 31,2004, which includes restated financial statements for the years ended December 31,2002 and 2003.

 

As discussedmore fully in Note 11, *Restatement andReclassifications of Consolidated Financial Statements*, to theconsolidated financial statements, we have restated our previously reported resultsto account for the sale by the Company of a portion of its interests in thegeneral partner to certain employees and directors of the Company, and the saleby the Company of its subordinated units of the Partnership to certainemployees and directors of the Company as compensatory arrangements consistentwith the guidance in Accounting Principles Board Opinion (“APB”) No. 25, *Accounting for Stock Issued to Employees*andEmerging Issues Task Force (“EITF”) No. 95-16, *Accounting for Stock Compensation Arrangements with Employer LoanFeatures under APB Opinion No. 25*.  This guidance requires MarkWest Hydrocarbonto record compensation expense based on the market value of the subordinatedpartnership units and the formula value of the general partner interests heldby these employees and directors at the end of each reporting period.  These transactions were previously reflectedas sales of assets.  In addition, certainother restatement adjustments have also been recorded to correct other errorsin the financial statements for the first three quarters of 2004, includingadjustments to accruals for revenue and purchased product costs, adjustmentsfor costs improperly capitalized as property, plant and equipment, adjustmentsto properly record capitalized interest on major construction projects inprocess, adjustments to record as a financing lease, a lease agreementpreviously entered into by an acquired business, an adjustment to reflectseparately restricted marketable securities, adjustments for dividends received on marketable securities improperlyrecorded as a reduction in the carrying value of marketable securities andadjustments to accrued property taxes. Adjustments were also made to record compensation expense as a result ofthe modification of the provisions of certain stock options for two officerswho terminated their employment with the Company but who continued to serve onits Board of Directors.  Compensationexpense was also recorded as a result of a policy change that required theCompany to account for all outstanding stock options as variable awards.  In April 2004, the Company changed itspolicy to allow participants to exercise their stock options using the cashlessexercise method.  Under APB 25, *Accounting for Stock Issued to Employees,*a fixed stock option plan that permits the use of a cashless exercise becomes avariable plan if a pattern of exercising stock options using the cashlessmethod is demonstrated.  Additionally,the Company made adjustments to reclassify a portion of dividends paid duringthe six months ended June 30, 2004 from retained earnings to additionalpaid in capital for the amount of dividends distributed in excess ofaccumulated earnings.  Other lesssignificant adjustments and reclassifications were identified and recorded inconjunction with the restatement process as discussed in Note 11.

 

In addition, on October 28, 2004, theCompany’s Board of Directors declared a stock dividend of one share of MarkWestHydrocarbon’s common stock for each ten shares owned by stockholders.  The stock dividend was paid on November 19,2004 to the stockholders of record as of the close of business on November 9,2004.  Common stock information in this Form 10-Q/Ahas been restated to give retroactive effect to stock dividend paid.  The Company is also filing contemporaneouslywith this Form 10-Q/A, its quarterly reports on Form 10-Q/A for thequarterly periods ending March 31, 2004 and September 30, 2004.

 

This Form 10-Q/A amends and restatesonly Items 1, 2 and 4 of Part I and Item 6 of Part II of the originalreport.  The remaining items are notamended hereby.  Except for the foregoingamended information, this Form 10-Q/A continues to describe conditions asof the date of the original report, and the Company has not updated the

 

----

 

disclosures contained herein to reflect events that occurredsubsequently.  Accordingly, this Form 10-Q/Ashould be read in conjunction with Company filings made with the Securities andExchange Commission subsequent to the filing of the original report, includingany amendments of those filings.

 

----

 

## **PART I—FINANCIAL INFORMATION**

## ** **

## **Item 1. Consolidated Financial Statements**

## ** **

**MARKWESTHYDROCARBON, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(UNAUDITED)**

**(inthousands, except share and per share data)**

** **
| ** **                                                                                                                                                       | ** ** | **June 30,  2004**         | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-----------------------------|------------|
|                                                                                                                                                             | ** ** | **(as  restated, see note 11)** | ** ** |
|                                                                                                                                                             |       |                            |       |                        |       |
| **ASSETS**                                                                                                                                                       |       |                            |       |                        |       |
|                                                                                                                                                             |       |                            |       |                        |       |
| Current  assets:                                                                                                                                                 |       |                            |       |                        |       |
| Cash and cash equivalents                                                                                                                                        |       | $                               | 36,277     |                        | $          | 42,144 |   |
| Marketable securities                                                                                                                                            |       | 11,375                          |       | —                      |       |
| Restricted marketable securities                                                                                                                                 |       | 2,500                           |       | 2,500                       |       |
| Receivables, net (including related party  receivables of $44 and $40, respectively, and net of allowance for doubtful  accounts of $111 and $120, respectively) |       | 29,170                          |       | 29,910                      |       |
| Inventories                                                                                                                                                      |       | 9,112                           |       | 5,548                       |       |
| Prepaid replacement natural gas                                                                                                                                  |       | 264                             |       | 5,940                       |       |
| Deferred income taxes                                                                                                                                            |       | 109                             |       | 534                         |       |
| Other current assets                                                                                                                                             |       | 415                             |       | 503                         |       |
| Total current  assets                                                                                                                                            |       | 89,222                          |       | 87,079                      |       |
|                                                                                                                                                             |       |                            |       |                        |       |
| Property,  plant and equipment                                                                                                                                   |       | 240,170                         |       | 232,257                     |       |
| Less:  accumulated depreciation, depletion and amortization                                                                                                      |       | (50,625                         | )          | (44,134                     | )          |
| Total property, plant and equipment, net                                                                                                                         |       | 189,545                         |       | 188,123                     |       |
|                                                                                                                                                             |       |                            |       |                        |       |
| Other  assets:                                                                                                                                                   |       |                            |       |                        |       |
| Intangibles and other assets, net                                                                                                                                |       | 136                             |       | 84                          |       |
| Deferred financing costs, net                                                                                                                                    |       | 3,178                           |       | 3,747                       |       |
| Deferred offering costs, net                                                                                                                                     |       | —                          |       | 995                         |       |
| Investment in and advances to equity investee                                                                                                                    |       | 232                             |       | 250                         |       |
| Notes receivable from officers                                                                                                                                   |       | 207                             |       | 217                         |       |
| Total assets                                                                                                                                                     |       | $                               | 282,520    |                        | $          | 280,495 |   |
|                                                                                                                                                             |       |                            |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                    |       |                            |       |                        |       |
|                                                                                                                                                             |       |                            |       |                        |       |
| Current  liabilities:                                                                                                                                            |       |                            |       |                        |       |
| Accounts payable (including related party  payables of $40 and $51, respectively)                                                                                |       | $                               | 32,957     |                        | $          | 24,052 |   |
| Accrued liabilities                                                                                                                                              |       | 16,578                          |       | 16,511                      |       |
| Fair value of derivative instruments                                                                                                                             |       | 748                             |       | 1,769                       |       |
| Current portion of long-term debt                                                                                                                                |       | 86,200                          |       | —                      |       |
| Total current liabilities                                                                                                                                        |       | 136,483                         |       | 42,332                      |       |
|                                                                                                                                                             |       |                            |       |                        |       |
| Deferred  income taxes                                                                                                                                           |       | 6,050                           |       | 5,594                       |       |
| Long-term  debt                                                                                                                                                  |       | —                          |       | 126,200                     |       |
| Fair value  of derivative instruments                                                                                                                            |       | 397                             |       | 125                         |       |
| Other  long-term liabilities                                                                                                                                     |       | 3,381                           |       | 2,901                       |       |
| Non-controlling  interest in consolidated subsidiary                                                                                                             |       | 92,967                          |       | 52,429                      |       |
| Commitments  and contingencies (Note 9)                                                                                                                          |       |                            |       |                        |       |
|                                                                                                                                                             |       |                            |       |                        |       |
| Stockholders’  equity:                                                                                                                                      |       |                            |       |                        |       |
| Preferred stock, par value $0.01, 5,000,000  shares authorized, no shares outstanding                                                                            |       | —                          |       | —                      |       |
| Common stock, par value $0.01, 20,000,000  shares authorized, 10,795,395 and 10,601,775 shares issued, respectively                                              |       | 108                             |       | 106                         |       |
| Additional paid-in capital                                                                                                                                       |       | 51,356                          |       | 50,705                      |       |
| Retained earnings (accumulated deficit)                                                                                                                          |       | (6,370                          | )          | 2,406                       |       |
| Accumulated other comprehensive loss, net  of tax                                                                                                                |       | (1,395                          | )          | (1,793                      | )          |
| Treasury stock, 68,780 and 75,930 shares,  respectively                                                                                                          |       | (457                            | )          | (510                        | )          |
| Total stockholders’ equity                                                                                                                                  |       | 43,242                          |       | 50,914                      |       |
| Total liabilities and stockholders’ equity                                                                                                                  |       | $                               | 282,520    |                        | $          | 280,495 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

1

----

 

**MARKWEST HYDROCARBON, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(UNAUDITED)**

**(inthousands, except per share data)**

** **
| ** **                                                                                                                      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                                      | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                      | ** ** | **(as restated, see note 11)**       | ** ** |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Revenues                                                                                                                        |       | $                                    | 89,024     |                               | $          | 48,241 |   | $ | 182,724 |   | $ | 99,472 |   |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Operating  expenses:                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Purchased product costs                                                                                                         |       | 77,262                               |       | 44,357                             |       | 152,750 |   | 90,360 |   |
| Facility expenses                                                                                                               |       | 5,975                                |       | 4,673                              |       | 12,061 |   | 9,305 |   |
| Selling, general and administrative  expenses                                                                                   |       | 5,070                                |       | 3,766                              |       | 10,385 |   | 6,390 |   |
| Depreciation                                                                                                                    |       | 3,657                                |       | 2,098                              |       | 7,185 |   | 3,700 |   |
| Amortization of intangible assets                                                                                               |       | 34                                   |       | —                             |       | 68 |   | — |   |
| Total operating expenses                                                                                                        |       | 91,998                               |       | 54,894                             |       | 182,449 |   | 109,755 |   |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Income (loss) from operations                                                                                                   |       | (2,974                               | )          | (6,653                             | )          | 275 |   | (10,283 | ) |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Other income  (expense):                                                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Interest expense, net                                                                                                           |       | (702                                 | )          | (1,494                             | )          | (1,697 | ) | (2,248 | ) |
| Amortization of deferred financing costs (a  component of interest expense)                                                     |       | (307                                 | )          | (504                               | )          | (614 | ) | (813 | ) |
| Dividend income                                                                                                                 |       | 83                                   |       | —                             |       | 83 |   | — |   |
| Other expense                                                                                                                   |       | (31                                  | )          | —                             |       | (5 | ) | (16 | ) |
| Loss from continuing operations before  non-controlling interest in net income of consolidated subsidiary and income  taxes     |       | (3,931                               | )          | (8,651                             | )          | (1,958 | ) | (13,360 | ) |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Provision  (benefit) for income taxes:                                                                                          |       |                                 |       |                               |       |   |   |   |   |
| Current                                                                                                                         |       | 126                                  |       | (3,646                             | )          | 112 |   | (5,791 | ) |
| Deferred                                                                                                                        |       | 365                                  |       | 160                                |       | 325 |   | 252 |   |
| Provision (benefit) for income taxes                                                                                            |       | 491                                  |       | (3,486                             | )          | 437 |   | (5,539 | ) |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Non-controlling interest in net income of  consolidated subsidiary                                                              |       | (1,946                               | )          | (812                               | )          | (3,255 | ) | (1,669 | ) |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Loss from continuing operations                                                                                                 |       | (6,368                               | )          | (5,977                             | )          | (5,650 | ) | (9,490 | ) |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Discontinued  operations:                                                                                                       |       |                                 |       |                               |       |   |   |   |   |
| Income from discontinued exploration and  production operations (net of income taxes in 2003 of $(188) and $955,  respectively) |       | —                               |       | 1,739                              |       | — |   | 3,868 |   |
| Gain from disposal of discontinued  exploration and production operations (less applicable income taxes of $5,423)              |       | —                               |       | 14,269                             |       | — |   | 14,269 |   |
| Income from discontinued operations                                                                                             |       | —                               |       | 16,008                             |       | — |   | 18,137 |   |
| Income (loss) before cumulative effect of  accounting change                                                                    |       | (6,368                               | )          | 10,031                             |       | (5,650 | ) | 8,647 |   |
| Cumulative effect of change in accounting  for asset retirement obligations, net of tax                                         |       | —                               |       | —                             |       | — |   | (29 | ) |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Net income (loss)                                                                                                               |       | $                                    | (6,368     | )                                  | $          | 10,031 |   | $ | (5,650 | ) | $ | 8,618 |   |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Loss from  continuing operations per share:                                                                                     |       |                                 |       |                               |       |   |   |   |   |
| Basic                                                                                                                           |       | $                                    | (0.60      | )                                  | $          | (0.58 | ) | $ | (0.53 | ) | $ | (0.92 | ) |
| Diluted                                                                                                                         |       | $                                    | (0.60      | )                                  | $          | (0.58 | ) | $ | (0.53 | ) | $ | (0.92 | ) |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Net income  (loss) per share:                                                                                                   |       |                                 |       |                               |       |   |   |   |   |
| Basic                                                                                                                           |       | $                                    | (0.60      | )                                  | $          | 0.98 |   | $ | (0.53 | ) | $ | 0.84 |   |
| Diluted                                                                                                                         |       | $                                    | (0.60      | )                                  | $          | 0.97 |   | $ | (0.53 | ) | $ | 0.84 |   |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Weighted average number of outstanding  shares of common stock:                                                                 |       |                                 |       |                               |       |   |   |   |   |
| Basic                                                                                                                           |       | 10,681                               |       | 10,286                             |       | 10,628 |   | 10,292 |   |
| Diluted                                                                                                                         |       | 10,681                               |       | 10,308                             |       | 10,628 |   | 10,314 |   |
|                                                                                                                            |       |                                 |       |                               |       |   |   |   |   |
| Cash  dividend per common share                                                                                                 |       | $                                    | 0.023      |                               | $          | — |   | $ | 0.477 |   | $ | — |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

2

----

 

**MARKWEST HYDROCARBON, INC.**

**CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME (LOSS)**

**(UNAUDITED)**

**(inthousands)**

 
| ** **                                                                  | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                  | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                  | ** ** | **(as restated, see note 11)**       | ** ** |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Net income  (loss)                                                          |       | $                                    | (6,368     | )                                  | $          | 10,031 |   | $ | (5,650 | ) | $ | 8,618 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Other  comprehensive income (loss), net of tax:                             |       |                                 |       |                               |       |   |   |   |   |
| Foreign currency translation                                                |       | —                               |       | 1,797                              |       | — |   | 4,061 |   |
| Unrealized gains (losses) on commodity  derivatives accounted for as hedges |       | (347                                 | )          | (131                               | )          | 768 |   | (524 | ) |
| Unrealized loss on marketable securities                                    |       | (280                                 | )          | —                             |       | (370 | ) | — |   |
| Total other comprehensive income (loss)                                     |       | (627                                 | )          | 1,666                              |       | 398 |   | 3,537 |   |
|                                                                        |       |                                 |       |                               |       |   |   |   |   |
| Other  comprehensive income (loss)                                          |       | $                                    | (6,995     | )                                  | $          | 11,697 |   | $ | (5,252 | ) | $ | 12,155 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

3

----

 

**MARKWEST HYDROCARBON, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

**(in thousands)**

 
| ** **                                                                                | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                | ** ** | **2004**                           | ** ** | **2003** | ** ** |
| ** **                                                                                | ** ** | **(as restated, see note 11)**     | ** ** |
| **Cash  flows from operating activities:**                                                |       |                               |       |   |   |
| Net income (loss)                                                                         |       | $                                  | (5,650     | ) | $ | 8,618 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |       |                               |       |   |   |
| Cumulative effect of change in accounting                                                 |       | —                             |       | 29 |   |
| Depreciation and depletion                                                                |       | 7,185                              |       | 11,138 |   |
| Amortization of deferred financing costs                                                  |       | 614                                |       | 813 |   |
| Amortization of intangible assets                                                         |       | 68                                 |       | — |   |
| Stock option compensation expense                                                         |       | 1,026                              |       | — |   |
| Restricted unit compensation expense                                                      |       | 344                                |       | 400 |   |
| Participation Plan compensation expense                                                   |       | 489                                |       | 434 |   |
| Contribution of treasury shares to 401(k)  benefit plan                                   |       | 89                                 |       | 149 |   |
| Equity in investee losses                                                                 |       | 18                                 |       | — |   |
| Gain from sale of property, plant and  equipment                                          |       | (42                                | )          | — |   |
| Non-controlling interest in net income of  consolidated subsidiary                        |       | 3,255                              |       | 1,669 |   |
| Unrealized losses (gains) on derivative  instrument                                       |       | 732                                |       | (1,475 | ) |
| Reclassification of Enron hedges to  purchased gas costs                                  |       | —                             |       | (154 | ) |
| Deferred income taxes                                                                     |       | 325                                |       | (6,944 | ) |
| Gain on sale of San Juan Basin properties                                                 |       | —                             |       | (19,692 | ) |
| Gain on sale of assets to related parties                                                 |       | —                             |       | — |   |
| Other                                                                                     |       | —                             |       | 238 |   |
| Changes in  operating assets and liabilities:                                             |       |                               |       |   |   |
| Decrease in receivables                                                                   |       | 748                                |       | 10,763 |   |
| Increase in inventories                                                                   |       | (3,564                             | )          | (897 | ) |
| Decrease in prepaid replacement natural gas                                               |       | 5,676                              |       | 388 |   |
| Decrease in other current assets                                                          |       | 97                                 |       | — |   |
| Increase in accounts payable and accrued  liabilities                                     |       | 9,928                              |       | 6,438 |   |
| Net cash flow provided by operating  activities                                           |       | 21,338                             |       | 11,915 |   |
| **Cash  flows from investing activities:**                                                |       |                               |       |   |   |
| Purchase of marketable securities                                                         |       | (11,745                            | )          | — |   |
| Pinnacle acquisition, net of cash acquired                                                |       | —                             |       | (38,238 | ) |
| Hobbs Lateral  acquisition                                                                |       | (2,275                             | )          | — |   |
| Proceeds from sale of San Juan Basin  properties, net of disposal costs                   |       | —                             |       | 49,470 |   |
| Capital expenditures                                                                      |       | (7,813                             | )          | (14,023 | ) |
| Proceeds from sale of assets                                                              |       | 195                                |       | 105 |   |
| Proceeds on financing lease receivable                                                    |       | 133                                |       | — |   |
| Other                                                                                     |       | 8                                  |       | — |   |
| Net cash used in investing activities                                                     |       | (21,497                            | )          | (2,686 | ) |
| **Cash flows from financing activities:**                                                 |       |                               |       |   |   |
| Proceeds from long-term debt                                                              |       | 3,000                              |       | 68,235 |   |
| Repayment of long-term debt                                                               |       | (43,000                            | )          | (56,424 | ) |
| Payments for debt issuance costs                                                          |       | —                             |       | (809 | ) |
| Proceeds from MarkWest Energy Partners’  secondary public offering                   |       | 44,103                             |       | — |   |
| Proceeds from private placement of MarkWest  Energy Partners’ common units, net      |       | —                             |       | 7,807 |   |
| Distribution to MarkWest Energy Partners’  unitholders                               |       | (6,110                             | )          | (3,199 | ) |
| Exercise of stock options                                                                 |       | 1,380                              |       | 167 |   |
| Repurchase of treasury shares                                                             |       | (36                                | )          | (219 | ) |
| Payment of dividends                                                                      |       | (5,045                             | )          | — |   |
| Net cash provided by (used in) financing  activities                                      |       | (5,708                             | )          | 15,558 |   |
|                                                                                      |       |                               |       |   |   |
| Effect of  exchange rate changes on cash                                                  |       | —                             |       | 105 |   |
|                                                                                      |       |                               |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                     |       | (5,867                             | )          | 24,892 |   |
| Cash and  cash equivalents at beginning of period                                         |       | 42,144                             |       | 6,410 |   |
| Cash and  cash equivalents at end of period                                               |       | $                                  | 36,277     |   | $ | 31,302 |   |
| ** **                                                                                | ** ** | ** **                         | ** ** | ** ** | ** ** |
| **Supplemental  cash flow information:**                                                  | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Construction  projects in progress obligation                                             |       | $                                  | 179        |   | — |   |
| Cash paid  for interest, net of amount capitalized                                        |       | $                                  | 2,077      |   | $ | 941 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

4

----

** **

**MARKWEST HYDROCARBON, INC.**

**CONSOLIDATED STATEMENTOF CHANGES IN**

**STOCKHOLDERS’EQUITY**

**(UNAUDITED)**

**(inthousands)**

 
| ** **                                                 | ** ** | **Shares  of  Common  Stock** | ** ** | **Shares  of  Treasury  Stock** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings  (Accumulated Deficit)** | ** ** | **Accumulated  Other  Comprehensive  Income  (Loss)** | ** ** | **Treasury  Stock** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|------------------------------------------------------------|------------|-------------------------------|------------|---------------------------------|------------|-------------------|------------|----------------------------------|------------|-----------------------------------------------|------------|-------------------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
|                                                       |       |                          |       |                            |       |              |       |                             |       |                                          |       |                                                  |       |                |       |                                  |       |
| Balance,  December 31, 2003, as restated, see note 11 |       | 10,602                        |       | (76                             | )          | $                 | 106        |                             | $          | 50,705                                        |       | $                                                     | 2,406      |                | $          | (1,793                                | )          | $ | (510 | ) | $ | 50,914 |   |
|                                                       |       |                          |       |                            |       |              |       |                             |       |                                          |       |                                                  |       |                |       |                                  |       |
| Stock option exercises                                     |       | 193                           |       | —                          |       | 2                 |       | 1,544                            |       | —                                        |       | —                                                |       | —              |       | 1,546                                 |       |
|                                                       |       |                          |       |                            |       |              |       |                             |       |                                          |       |                                                  |       |                |       |                                  |       |
| Modification of  options, as restated, see note 11         |       | —                        |       | —                          |       | —            |       | 1,026                            |       | —                                        |       | —                                                |       | —              |       | 1,026                                 |       |
|                                                       |       |                          |       |                            |       |              |       |                             |       |                                          |       |                                                  |       |                |       |                                  |       |
| Treasury stock  acquired                                   |       | —                        |       | (3                              | )          | —            |       | —                           |       | —                                        |       | —                                                |       | (36                 | )          | (36                                   | )          |
|                                                       |       |                          |       |                            |       |              |       |                             |       |                                          |       |                                                  |       |                |       |                                  |       |
| Treasury stock  reissued                                   |       | —                        |       | 10                              |       | —            |       | —                           |       | —                                        |       | —                                                |       | 89                  |       | 89                                    |       |
|                                                       |       |                          |       |                            |       |              |       |                             |       |                                          |       |                                                  |       |                |       |                                  |       |
| Dividends, as  restated, see note 11                       |       | —                        |       | —                          |       | —            |       | (1,919                           | )          | (3,126                                        | )          | —                                                |       | —              |       | (5,045                                | )          |
|                                                       |       |                          |       |                            |       |              |       |                             |       |                                          |       |                                                  |       |                |       |                                  |       |
| Net loss, as  restated, see note 11                        |       | —                        |       | —                          |       | —            |       | —                           |       | (5,650                                        | )          | —                                                |       | —              |       | (5,650                                | )          |
|                                                       |       |                          |       |                            |       |              |       |                             |       |                                          |       |                                                  |       |                |       |                                  |       |
| Other  comprehensive income                                |       | —                        |       | —                          |       | —            |       | —                           |       | —                                        |       | 398                                                   |       | —              |       | 398                                   |       |
|                                                       |       |                          |       |                            |       |              |       |                             |       |                                          |       |                                                  |       |                |       |                                  |       |
| Balance,  June 30, 2004, as restated, see note 11     |       | 10,795                        |       | (69                             | )          | $                 | 108        |                             | $          | 51,356                                        |       | $                                                     | (6,370     | )                   | $          | (1,395                                | )          | $ | (457 | ) | $ | 43,242 |   |

** **

The accompanying notes are anintegral part of these consolidated financial statements.

 

5

----

 

MARKWEST HYDROCARBON, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

**1.****              General**

 

MarkWest Hydrocarbon, Inc. (“MarkWestHydrocarbon” or the “Company”) manages MarkWest Energy Partners, L.P. (“MarkWestEnergy Partners” or the “Partnership”), a publicly traded master limitedpartnership engaged in the gathering, processing and transmission of naturalgas; the transportation, fractionation and storage of natural gas liquids(NGLs); and the gathering and transportation of crude oil.   The Company also market natural gas andNGLs. MarkWest Hydrocarbon and MarkWest Energy Partners provide servicesprimarily in the Southwest, Appalachia and Michigan.

 

The Company’s assets consist primarily ofpartnership interests in MarkWest Energy Partners.  As of June 30, 2004, the Company’spartnership interests consisted of 2,469,496 subordinated units, representing a35% limited partner interest in the Partnership and a 90% membership(ownership) interest in MarkWest Energy GP, L.L.C., the general partner of thePartnership, which owns a 2% general partner interest and all of the incentivedistribution rights in the Partnership. As of July 30, 2004, after the common unit offering (see Note 3),the Company owned a 29% limited partner interest in the Partnership.  The Company’s ownership interest in thegeneral partner remained unchanged as of July 30, 2004.

 

Theconsolidated financial statements include the accounts of MarkWest Hydrocarbonand its subsidiaries, including MarkWest Energy Partners. Throughconsolidation, the Company has eliminated all significant intercompany accountsand transactions.

 

The Company hasprepared the unaudited financial statements presented herein in accordance withthe instructions to Form 10-Q.  Thestatements do not include all the information and note disclosures required bygenerally accepted accounting principles for complete financialstatements.  You should read theseconsolidated financial statements and notes thereto along with the auditedfinancial statements and notes thereto as of and for the year ended December 31,2003 (which have been restated) included in the Company’s December 31,2004 Annual Report on Form 10-K.  Inthe opinion of management, the Company has made all necessary adjustments for afair statement of the results for the unaudited interim periods.  All said adjustments are of a recurringnature.  Results for the three and sixmonths ended June 30, 2004, are not necessarily indicative of results forthe full year 2004 or any other future period.

 

The Companybases the effective corporate tax rate for interim periods on the estimatedannual effective corporate tax rate.

 

**2.****              MarketableSecurities**

 

Marketablesecurities are classified as available-for-sale and stated at market based onthe closing price of the securities at the balance sheet date.  Accordingly, unrealized gains or losses arereflected in other comprehensive income (loss), net of applicable incometaxes.  For losses that are other thantemporary, the cost basis of the securities is written down to fair value andthe amount of the write-down is reflected in the statement of operations.  The Company utilizes a weighted-average costbasis to compute realized gains and losses. Realized gains and losses, and dividend and interest income, arereflected in earnings.

 

The accompanying notes are an integral part of these financialstatements.

 

6

----

 

Debt and equitysecurities are classified as available-for-sale.  The following are the components ofmarketable securities and restricted marketable securities (in thousands):

 
| **June 30, 2004 (as  restated, see note 11)**                  | ** ** | **Cost Basis** | ** ** | **Unrealized  gains** | ** ** | **Unrealized  losses** | ** ** | **Recorded  Basis** | ** ** |
|---------------------------------------------------------------------|------------|----------------|------------|-----------------------|------------|------------------------|------------|---------------------|------------|
| **Equity  securities:**                                             |       |           |       |                  |       |                   |       |                |       |
| Master limited partnership units                                    |       | $              | 4,976      |                  | $          | 27                     |       | $                   | (241       | ) | $ | 4,762 |   |
| Equity securities, classified as current                            |       | 4,976          |       | 27                    |       | (241                   | )          | 4,762               |       |
| **Fixed  maturities:**                                              |       |           |       |                  |       |                   |       |                |       |
| Mortgage backed securities (due after one  year through five years) |       | 6,752          |       | —                |       | (139                   | )          | 6,613               |       |
| Mortgage back securities, classified as  non-current                |       | 6,752          |       | —                |       | (139                   | )          | 6,613               |       |
| Total marketable securities                                         |       | $              | 11,728     |                  | $          | 27                     |       | $                   | (380       | ) | $ | 11,375 |   |
|                                                                |       |           |       |                  |       |                   |       |                |       |
| **Restricted  fixed maturities:**                                   |       |           |       |                  |       |                   |       |                |       |
| Mortgage backed securities (due  December 2007)                |       | $              | 2,500      |                  | $          | —                 |       | $                   | —     |   | $ | 2,500 |   |
| Total restricted marketable securities                              |       | $              | 2,500      |                  | $          | —                 |       | $                   | —     |   | $ | 2,500 |   |

 
| **December 31, 2003 (as  restated, see note 11)** | ** ** | **Cost Basis** | ** ** | **Unrealized  gains** | ** ** | **Unrealized  losses** | ** ** | **Recorded  Basis** | ** ** |
|--------------------------------------------------------|------------|----------------|------------|-----------------------|------------|------------------------|------------|---------------------|------------|
| **Restricted  fixed maturities:**                      |       |           |       |                  |       |                   |       |                |       |
| Mortgage backed securities (due  December 2007)   |       | $              | 2,500      |                  | $          | —                 |       | $                   | —     |   | $ | 2,500 |   |
| Total restricted marketable securities                 |       | $              | 2,500      |                  | $          | —                 |       | $                   | —     |   | $ | 2,500 |   |

 

At June 30, 2004, unrealized losses of$0.3 million relate primarily to investments in domestic equity securities inenergy partnerships.  Unrealized lossesof $0.1 million relate primarily to mortgage backed securities and are primarilyattributable to changes in interest rates.

 

**3.****              Subsequent Event - MarkWest Energy Partners’Acquisition**

 

On July 30,2004, the Partnership completed the East Texas System acquisition consisting ofAmerican Central Eastern Texas’ Carthage gathering system and gas processingassets located in east Texas for approximately $240.7 million.  The Company’s consolidated financialstatements will include American Central Eastern Texas’ results of operationsfrom July 30, 2004.  The assetsacquired consist of processing plants, gathering systems, a processing facilitycurrently under construction and a NGL pipeline to be constructed in 2005.

 

In conjunction with the closing of theacquisition, the Partnership completed a private offering of 1.3 million commonunits, at $34.50 per unit, representing approximately $45.0 million in proceedsafter transaction costs of approximately $0.9 million and including acontribution from the general partner of $0.9 million to maintain its ownershipinterest.  In addition, the Partnershipamended and restated its credit facility, increasing its maximum lending limitfrom $140.0 million to $315.0 million. The credit facility included a $265.0 million revolving facility and a$50.0 million term loan facility.  ThePartnership used the proceeds from the private offering and borrowings of$195.7 million under the credit facility to finance the East Texas Systemacquisition.

 

**4.****              MarkWest Energy Partners’ Acquisitions**

 

*Hobbs Lateral Acquisition*

 

The accompanying notes are an integral part of these financialstatements.

 

7

----

 

On April 1, 2004, the Partnership acquired the Hobbs Lateralpipeline for approximately $2.3 million. The Hobbs Lateral consists of a four-mile pipeline, with a capacity of160 million cubic feet of natural gas per day, connecting the Northern NaturalGas interstate pipeline to Southwestern Public Service’s Cunningham and Maddoxpower generating stations in Hobbs, New Mexico. The Hobbs Lateral is a New Mexico intrastate pipeline regulated by theFederal Energy Regulatory Commission. The pro forma results of operations of the Hobbs Lateral acquisitionhave not been presented, as they are not significant.

 

###### *PinnacleAcquisition*

###### * *

On March 28, 2003, the Partnershipcompleted the acquisition (the “Pinnacle Acquisition”) of Pinnacle Natural GasCompany, Pinnacle Pipeline Company, PNG Transmission Company, Inc., PNGUtility Company and Bright Star Gathering, Inc. (collectively, “Pinnacle”or the “Sellers”).  Pinnacle’s results ofoperations have been included in the Company’s consolidated financialstatements since that date.

 

The Pinnacle Acquisition was accomplishedthrough a merger under Texas law of the Sellers and four newly formed whollyowned subsidiaries of the Partnership as buyers. In the merger, most of theassets and liabilities of the Sellers were allocated to the Partnershipentities, and all entities survived the merger. The assets acquired from theSellers, primarily located in the State of Texas, with the balance located inNew Mexico, Louisiana, Mississippi and Kansas, were comprised of three lateralnatural gas pipelines and twenty gathering systems.

 

The purchase price wasallocated as follows (in thousands):

 
| Acquisition costs:                            |   |   |   |
|-----------------------------------------------|--------|--------|--------|
| Long-term debt incurred                       |   | $      | 39,471 |   |
| Direct acquisition costs                      |   | 450    |   |
| Current liabilities assumed                   |   | 8,945  |   |
| Total                                         |   | $      | 48,866 |   |
|                                          |   |   |   |
| Allocation  of acquisition costs:             |   |   |   |
| Current assets                                |   | $      | 10,643 |   |
| Fixed assets (including long-term  contracts) |   | 38,223 |   |
| Total                                         |   | $      | 48,866 |   |

###### * *

###### *WesternOklahoma Acquisition*

###### * *

On December 1, 2003, the Partnership completed theacquisition of certain assets of American Central Western Oklahoma Gas Company,L.L.C. (“AWOC”) for approximately $38.0 million. Results of operations for the acquired assets have been included in thePartnership’s consolidated financial statements since that date.

 

The assets include the Foss Lake gathering systemlocated in the western Oklahoma counties of Roger Mills and Custer.  The gathering system is comprised ofapproximately 167 miles of pipeline, connected to approximately 270 wells, and11,000 horsepower of compression facilities.  The assets also include the Arapaho gas processing plant that wasinstalled during 2000.

 

The purchase price of approximately $38.0 million was financedthrough borrowings under the Partnership line of credit, which was amended atthe closing of the acquisition to increase availability under the creditfacility from $75.0 million to $140.0 million. Substantially all of the acquired assets are pledged to the creditfacility lenders to secure the repayment of the outstanding borrowings underthe credit facility.

 

The accompanying notes are an integral part of these financialstatements.

 

8

----

 

The purchase price was comprised of$38.0 million paid in cash, and was allocated as follows (in thousands):

 
| Acquisition costs:               |   |   |   |
|----------------------------------|--------|--------|--------|
| Cash consideration               |   | $      | 37,850 |   |
| Direct acquisition costs         |   | 101    |   |
| Total                            |   | $      | 37,951 |   |
| Allocation of acquisition costs: |   |   |   |   |
| Property, plant and equipment    |   | $      | 37,951 |   |

 

###### *MichiganCrude Pipeline*

###### * *

On December 18, 2003, the Partnershipcompleted the acquisition (the “Michigan Crude Pipeline acquisition”) of ShellPipeline Company, LP’s and Equilon Enterprises, LLC’s, doing business as ShellOil Products US (“Shell”), Michigan Crude Gathering Pipeline (the “System”),for approximately $21.3 million. The System’s results of operations have beenincluded in the Company’s consolidated financial statements since December 18,2003. The $21.3 million purchase price was financed through borrowings underthe Partnership’s line of credit.

 

The System extends from production facilitiesnear Manistee, Michigan to a storage facility near Lewiston, Michigan.  The trunk line consists of approximately 150miles of pipe.  Crude oil is gatheredinto the System from 57 injection points, including 52 central productionfacilities and five truck unloading facilities, and approximately 100 miles ofpipe.  The System also includestruck-unloading stations at Manistee, Seeley Road and Junction, and the SamariaTruck Unloading Station located in Monroe County, Michigan, near Toledo, Ohio.

 

The System is a common carrier Michiganintrastate pipeline and gathers light crude oil from wells.  The oil is transported for a fee to theLewiston, Michigan station where it is batch injected into the EnbridgeLakehead Pipeline.

 

The purchase price was comprised of$21.3 million paid in cash to Shell and was allocated as follows (inthousands):

 
| Acquisition costs:                | ** ** | ** ** | ** ** |
|-----------------------------------|------------|------------|------------|
| Cash consideration                |       | $          | 21,155     |   |
| Direct acquisition costs          |       | 128        |       |
| Total                             |       | $          | 21,283     |   |
|                              |       |       |       |
| Allocation  of acquisition costs: |       |       |       |
| Property, plant and equipment     |       | $          | 21,283     |   |

 

*Pro Forma Results ofOperations (Unaudited)*

 

Thefollowing table reflects the unaudited pro forma consolidated results ofoperations for the comparable period presented, as though the Pinnacleacquisition, the Western Oklahoma acquisition and Michigan Crude Pipelineacquisition each had occurred on January 1, 2003.  The unaudited pro forma results have beenprepared for comparative purposes only and may not be indicative of futureresults.

 
| ** **                    | ** ** | **Three Months Ended  June 30, 2003** | ** ** | **Six Months Ended  June 30, 2003** | ** ** |
|-------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                    | ** ** | **(in thousands, except per share data)**  | ** ** |
| ** **                    | ** ** | **(as restated, see  note 11)**            | ** ** | **(as restated, see  note 11)**          | ** ** |
| Revenue                       |       | $                                          | 59,320     |                                     | $          | 140,531 |   |
| Net income                    |       | $                                          | 9,541      |                                     | $          | 8,455 |   |
| Basic net  income per share   |       | $                                          | 0.93       |                                     | $          | 0.82 |   |
| Diluted net  income per share |       | $                                          | 0.93       |                                     | $          | 0.82 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

9

----

 

##### **5.**              Property,Plant and Equipment

##### ** **

The following provides the composition of theCompany’s property, plant and equipment at:

 
| ** **                                                              | ** ** | **June 30, 2004**          | ** ** | **December 31, 2003** | ** ** |
|-------------------------------------------------------------------------|------------|---------------------------------|------------|----------------------------|------------|
| ** **                                                              | ** ** | **(in thousands)**              | ** ** |
| ** **                                                              | ** ** | ** **                      | ** ** | ** **                 | ** ** |
| ** **                                                              | ** ** | **(as restated,  see note 11)** | ** ** | ** **                 | ** ** |
| Property,  plant and equipment:                                         |       |                            |       |                       |       |
| Gas gathering facilities                                                |       | $                               | 81,895     |                       | $          | 73,424 |   |
| Gas processing plants                                                   |       | 56,322                          |       | 55,888                     |       |
| Fractionation and storage facilities                                    |       | 22,524                          |       | 22,160                     |       |
| Natural gas pipelines                                                   |       | 38,848                          |       | 38,790                     |       |
| Crude oil pipeline                                                      |       | 18,437                          |       | 18,352                     |       |
| NGL transportation facilities                                           |       | 4,415                           |       | 4,415                      |       |
| Marketing assets                                                        |       | 1,606                           |       | 1,987                      |       |
| Oil and gas properties and equipment, full  cost method                 |       | 2,499                           |       | 2,380                      |       |
| Land, buildings and other equipment                                     |       | 10,716                          |       | 12,499                     |       |
| Construction in-progress                                                |       | 2,908                           |       | 2,362                      |       |
|                                                                    |       | 240,170                         |       | 232,257                    |       |
| Less: Accumulated depreciation, depletion,  amortization and impairment |       | (50,625                         | )          | (44,134                    | )          |
| Total property, plant and equipment, net                                |       | $                               | 189,545    |                       | $          | 188,123 |   |

 

#### **6.**              Adoptionof SFAS No. 143

#### ** **

In June 2001,the Financial Accounting Standards Board issued Statement No. 143, *Accounting for**Asset Retirement Obligations*.  The Company adopted SFAS No. 143beginning January 1, 2003.  The mostsignificant impact of this standard on the Company was a change in the methodof accruing for site restoration costs. Under SFAS No. 143, the fair value of asset retirement obligationsis recorded as a liability when incurred, which is typically at the time theassets are placed in service.  Amountsrecorded for the related assets are increased by the amount of theseobligations.  Over time, the liabilitiesare accreted for the change in their present value and the initial capitalizedcosts are depreciated over the useful lives of the related assets.

 

The cumulativeeffect of this accounting change for years prior to 2003 was less than $0.1million and is reflected in the Company’s statement of operations for the threemonths ended March 31, 2003.  At thetime of the adoption the Company recorded an asset retirement obligation of $3.4million, decreased a site restoration liability of $0.9 million that wasrecorded prior to the implementation of SFAS No. 143 and increased netproperty, plant and equipment of $2.4 million in accordance with the provisionsof SFAS No. 143.  There was noimpact on its cash flows as a result of adopting SFAS No. 143.  For the year ended December 31, 2003,the impact on earnings per share from the cumulative effect of the change inaccounting for asset retirement obligations was not significant.  The asset retirement obligation, which isincluded on the consolidated balance sheet in other long-term liabilities, was$0.5 million and $3.3 at June 30, 2004 and 2003, respectively.

 

**7.****              MarkWestEnergy Partners’ Common Unit Offerings**

 

On January 12, 2004 the Partnership priced its offering of1,148,000 common units at $39.90 per unit. Of the 1,148,000  common units,1,100,444 were sold by the Partnership for gross proceeds of $43.9 million.  The remaining 47,556 were sold by certainselling unitholders, proceeds of which were retained by them.   In connection with the over-allotmentprovisions of the underwriting agreement, the Partnership issued an additional72,500 common units for gross proceeds of $2.9 million.  Aggregate gross proceeds of $46.8 millionwere reduced by underwriters’ fees of $2.5 million and professional fees andother offering costs of $1.3 million, resulting net proceeds of $43.0million.  The net proceeds of $43.0million and the $0.9 million contributed by the general partner to maintain its2% interest resulted in total net proceeds to the Partnership associated withthe offering of $43.9 million, which were used to pay down the Partnership’scredit facility.

 

The accompanying notes are an integral part of these financialstatements.

 

10

----

 

During July 2004, thePartnership completed an additional offering of its common units.  See Note 3.

 

**8.****              Segment Reporting**

 

The Company’s operations are classified into tworeportable segments:

 

(1)          ManagingMarkWest Energy Partners — the Company operates MarkWest Energy Partners, apublicly-traded master limited partnership engaged in the gathering, processingand transmission of natural gas; the transportation, fractionation and storageof natural gas liquids; and the gathering and transportation of crude oil.

 

(2)          Marketing— the Company sells its equity and third-party NGLs, purchases third-partynatural gas and sells its equity and third-party natural gas.  Since February 2004, the Company is alsoengaged in the wholesale marketing of propane.

 

During 2003, the Company discontinued its explorationand production business segment. The Company’s continuing operations areconducted solely in the United States.

 

The table belowpresents information about operating income (loss) for the reported segmentsfor the three and six months ended June 30, 2004 and 2003. Segmentoperating income (loss) includes total revenues less purchased product costs,facility expenses, depreciation and amortization of intangible assets. Itemsexcluded from segment operating income (loss) are reflected in thereconciliation of total segment operating income (loss) to income (loss) fromcontinuing operations before taxes. The Company has not reported assetinformation by reportable segment because it does not produce such informationinternally.

 
| ** **                                         | ** ** | ** **         | ** ** | **MarkWest** | ** ** | ** **      | ** ** | ** ** | ** ** |
|----------------------------------------------------|------------|--------------------|------------|--------------|------------|-----------------|------------|------------|------------|
| ** **                                         | ** ** | ** **         | ** ** | **Energy**   | ** ** | **Eliminating** | ** ** | ** ** | ** ** |
| ** **                                         | ** ** | **Marketing**      | ** ** | **Partners** | ** ** | **Entries**     | ** ** | **Total**  | ** ** |
| ** **                                         | ** ** | **(in thousands)** | ** ** |
| **Three  Months Ended June 30, 2004****(1):** |       |               |       |         |       |            |       |       |       |
| Revenues  from external customers                  |       | $                  | 37,170     |         | $          | 51,854          |       | $          | —     |   | $ | 89,024 |   |
| Intersegment  revenues                             |       | $                  | 114        |         | $          | 13,805          |       | $          | (13,919    | ) | $ | — |   |
| Segment  operating income (loss)                   |       | $                  | (4,531     | )            | $          | 6,627           |       | $          | —     |   | $ | 2,096 |   |
|                                               |       |               |       |         |       |            |       |       |       |
| **Three  Months Ended June 30, 2003****(1):** |       |               |       |         |       |            |       |       |       |
| Revenues  from external customers                  |       | $                  | 28,687     |         | $          | 19,554          |       | $          | —     |   | $ | 48,241 |   |
| Intersegment  revenues                             |       | $                  | 178        |         | $          | 10,082          |       | $          | (10,260    | ) | $ | — |   |
| Segment  operating income (loss)                   |       | $                  | (7,073     | )            | $          | 4,186           |       | $          | —     |   | $ | (2,887 | ) |

 
| ** **                                       | ** ** | ** **         | ** ** | **MarkWest** | ** ** | ** **      | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|--------------------|------------|--------------|------------|-----------------|------------|------------|------------|
| ** **                                       | ** ** | ** **         | ** ** | **Energy**   | ** ** | **Eliminating** | ** ** | ** ** | ** ** |
| ** **                                       | ** ** | **Marketing**      | ** ** | **Partners** | ** ** | **Entries**     | ** ** | **Total**  | ** ** |
| ** **                                       | ** ** | **(in thousands)** | ** ** |
| **Six  Months Ended June 30, 2004****(1):** |       |               |       |         |       |            |       |       |       |
| Revenues  from external customers                |       | $                  | 81,339     |         | $          | 101,385         |       | $          | —     |   | $ | 182,724 |   |
| Intersegment  revenues                           |       | $                  | 338        |         | $          | 28,099          |       | $          | (28,437    | ) | $ | — |   |
| Segment  operating income (loss)                 |       | $                  | (2,470     | )            | $          | 13,130          |       | $          | —     |   | $ | 10,660 |   |
|                                             |       |               |       |         |       |            |       |       |       |
| **Six  Months Ended June 30, 2003****(1):** |       |               |       |         |       |            |       |       |       |
| Revenues  from external customers                |       | $                  | 75,619     |         | $          | 23,853          |       | $          | —     |   | $ | 99,472 |   |
| Intersegment  revenues                           |       | $                  | 445        |         | $          | 23,476          |       | $          | (23,921    | ) | $ | — |   |
| Segment  operating income (loss)                 |       | $                  | (11,698    | )            | $          | 7,805           |       | $          | —     |   | $ | (3,893 | ) |

 

The accompanying notes are anintegral part of these financial statements.

 

11

----

 

A reconciliation oftotal segment operating income (loss) to loss from continuing operations beforenon-controlling interest in net income of consolidated subsidiary and incometaxes is as follows:

 
| ** **                                                                                                                  | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                                  | ** ** | **2004 (1)**                         | ** ** | **2003 (1)**                       | ** ** | **2004 (1)** | ** ** | **2003 (1)** | ** ** |
| ** **                                                                                                                  | ** ** | **(in thousands)**                   | ** ** |
| Segment  operating income (loss)                                                                                            |       | $                                    | 2,096      |                               | $          | (2,887 | ) | $ | 10,660 |   | $ | (3,893 | ) |
| Selling,  general and administrative expenses                                                                               |       | (5,070                               | )          | (3,766                             | )          | (10,385 | ) | (6,390 | ) |
| Interest  expense, net                                                                                                      |       | (702                                 | )          | (1,494                             | )          | (1,697 | ) | (2,248 | ) |
| Amortization  of deferred financing costs                                                                                   |       | (307                                 | )          | (504                               | )          | (614 | ) | (813 | ) |
| Dividend  income                                                                                                            |       | 83                                   |       | —                             |       | 83 |   | — |   |
| Other  expense                                                                                                              |       | (31                                  | )          | —                             |       | (5 | ) | (16 | ) |
| Loss from continuing operations before  non-controlling interest in net income of consolidated subsidiary and income  taxes |       | $                                    | (3,931     | )                                  | $          | (8,651 | ) | $ | (1,958 | ) | $ | (13,360 | ) |

 

----

(1)  As restated, see note11.

 

**9.****              Commitments and Contingencies**

 

The Company is involved in various litigationand administrative proceedings arising in the normal course of business. In theopinion of management, any liabilities that may result from these claims willnot, individually or in the aggregate, have a material adverse effect on theCompany’s financial position or results of operations.

 

**10.****       Stock and Unit Compensation**

 

As permitted under SFAS No. 123, *Accounting for Stock-Based Compensation,*the Company haselected to continue to measure compensation costs for stock-based andunit-based employee compensation plans as prescribed by APB No. 25, *Accounting for Stock Issued to Employees*, as permitted under SFAS No. 123, *Accounting for Stock Based Compensation*, and SFAS No. 148, *Accounting for Stock Based Compensation – Transition andDisclosure. *The Company hasfour stock-based compensation plans, one of which is through our consolidatedsubsidiary, MarkWest Energy.  The Companyaccounts for these plans using fixed and variable accounting as appropriate.

 

*Stock Option Plans*

 

Stock options are issuedunder the Company’s 1996 Stock Incentive Plan and 1996 Non-employee DirectorStock Option Plan.  The plans allow forthe exercise of stock options using the cashless method, but only at thediscretion of the Company.  Under acashless exercise, the Company withholds from shares that otherwise would beissued upon the exercise of the option, the number of shares with a fair marketvalue equal to the option exercise price and remits the remaining shares to theemployee.  Prior to April 2004, theCompany did not allow participants to exercise their stock options using thecashless method.  Accordingly,compensation expense was not recognized for stock options granted unless theoptions were granted at an exercise price less than the quoted market price ofthe Company’s stock on the grant date. In April 2004, the Company changed its policy to allow participantsto exercise their stock options using the cashless method.  Under APB 25, *Accounting for Stock Issued to Employees,*a fixed stockoption plan that permits the use of a cashless exercise becomes variable if apattern of exercising the stock options using the cashless method isdemonstrated.  As a result, in April 2004,the Company was required to account for stock options issued under the plans asvariable awards.  Compensation expensefor stock options accounted for as variable awards is measured as thedifference in the market value of the Company’s common stock and the exerciseprice of the stock options.  Thedifference is amortized into earnings over the period of service, adjustedquarterly for the change in the fair value of the unvested stock optionsawarded.  Increases or decreases in themarket value of the Company’s common stock between April of 2004 and theend of each reporting period result in a change in the measure of compensationfor vested awards, which is reflected currently in operations.  The Company recorded compensation expense foroptions granted under the plans accounted for as variable awards of $0.7million for the three and six months ended June 30, 2004 and nocompensation expense for the three and six months ended

 

The accompanying notes are an integral part of these financial statements.

 

12

----

 

June 30, 2003.  During the six months ended June 30,2004, recipients exercised their options to purchase an aggregate of 193,000shares of the Company’s common stock. Recipients exercised options for 46,437 shares using the cashless methodresulting in the net issuance of 17,537 shares of common stock.  During the three months ended March 31,2004, two officers resigned from the Company. As the former officers continued to serve on the Company’s Board ofDirectors, the Company agreed that the individual’s stock options wouldcontinue to vest and be exercisable in accordance with the original vesting andexercise provisions.  As a result of themodification to the stock options for these officers the outstanding stockoptions are to be accounted for as variable awards, and as a result, theCompany recorded compensation expense of $0.4 million for the three monthsended March 31, 2004, measured as the difference in the market value ofthe Company’s common stock on the date the officer’s status changed and thestrike price of the outstanding stock options. These charges are included in selling, general and administrativeexpenses.

 

*Participation Plan*

 

The Company has also entered into agreementswith certain directors and officers of the Company.  These arrangements are referred to as theParticipation Plan.  Under theParticipation Plan, MarkWest Hydrocarbon sells subordinated partnership unitsof the Partnership and interests in the Partnership’s general partner toemployees and directors of the Company under a purchase and saleagreement.  In accordance with theprovisions of APB No. 25,**theParticipation Plan is accounted for as a variable plan.  Since the employee and director are 100%vested on the date they purchase the subordinated units or general partnerinterests, compensation expense for the subordinated units is measured as thedifference in the market value of the subordinated Partnership units and theamount paid by those individuals.  Compensationrelated to the general partner interest is calculated as the difference in theformula value and the amount paid by those individuals.  The formula value is the amount MarkWestHydrocarbon would have to pay the directors and employees to repurchase thegeneral partner interests and is based on the current market value of thePartnership’s common units and the current quarterly distribution paid by thePartnership.  Increases or decreases inthe market value of the subordinated units and the formula value of the generalpartner interests between the date they are acquired and the end of eachreporting period result in a change in the measure of compensation, which isreflected currently in operations.  The Companyrecorded compensation expense of $0.1 million and $0.4 million for the threemonths ended June 30, 2004 and 2003, respectively. For the six monthsended June 30, 2004 and 2003, the Company recorded compensation expense of$0.5 million and $0.4 million, respectively. These charges are included in selling, general and administrativeexpenses.

 

*MarkWest EnergyPartners Long-Term Incentive Plan*

 

The Partnership issues restricted units underthe MarkWest Energy Partners, L.P. Long-Term Incentive Plan.  A restricted unit is a “phantom” unit thatentitles the grantee to receive a common unit upon the vesting of the phantomunit, or at the discretion of the Compensation Committee, cash equivalent tothe value of a common unit.  Inaccordance with APB No. 25, the Partnership applies variable accountingfor the plan because a phantom unit is an award to an employee entitling themto increases in the market value of the Partnership’s units subsequent to thedate of grant without issuing units to the employees, similar to a stockappreciation right.  As a result, thePartnership is required to mark to market the awards at the end of eachreporting period.  Compensation expenseis measured for the phantom unit grants using the market price of MarkWestEnergy’s common units on the date the units are granted.  The fair value of the units awarded isamortized into earnings over the period of service, adjusted quarterly for thechange in the fair value of the unvested units granted.  The phantom units vest over a statedperiod.  For certain employees vesting isaccelerated if certain performance measures are met.  The accelerated vesting criteria provisionsare based on annualized distribution goals. If the Partnership’s distributions are at or above the goal for acertain number of consecutive quarters, vesting of the employee’s phantom unitsis accelerated.  However, the vesting ofany phantom units may not occur until at least one year following the date ofgrant.  The general partner of thePartnership may also elect to accelerate the vesting of outstanding awards,which results in an immediate charge to operations for the unamortized portionof the award.  During the three monthsended June 30, 2004 and 2003, 5,500 and 2,000 restricted units,respectively, were granted.  During thesix months ended June 30, 2004 and 2003, 8,000 and 3,000 restricted units,respectively, were granted.  ThePartnership recorded compensation income of less than $0.1 million andcompensation expense of $0.2 million for the three months ended June 30,2004 and 2003, respectively.  For the sixmonths ended June 30, 2004 and 2003, the Company recorded compensationexpense of

 

The accompanying notes are an integral part of these financialstatements.

 

13

----

 

$0.3 million and $0.4 million, respectively.  These charges are included in selling,general and administrative expenses.

 

Had compensation cost for the Company’sstock-based and unit-based compensation plans been determined based on the fairvalue at the grant dates under those plans consistent with the methodprescribed by SFAS No. 123, the Company’s net income (loss) and net income(loss) per share would have been revised to the pro forma amounts listed below:

 
| ** **                                                                                                                                   | ** ** | **Three Months Ended June 30,**      | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **2004**                                  | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                                   | ** ** | **(in thousands, except per share data)** | ** ** |
| ** **                                                                                                                                   | ** ** | **(as restated,  see note 11)**           | ** ** | **(as restated, see  note 11)**    | ** ** | **(as restated,  see note 11)** | ** ** | **(as restated, see  note 11)** | ** ** |
| ** **                                                                                                                                   | ** ** | ** **                                | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss), as reported                                                                                                               |       | $                                         | (6,368     | )                                  | $          | 10,031 |   | $ | (5,650 | ) | $ | 8,618 |   |
| Add: compensation expense included in  reported net income                                                                                   |       | 725                                       |       | 569                                |       | 1,859 |   | 834 |   |
| Deduct: total stock-based employee  compensation expense determined under fair value based method for all  awards, net of related tax effect |       | (40                                       | )          | (679                               | )          | (845 | ) | (1,017 | ) |
| Pro forma net income (loss)                                                                                                                  |       | $                                         | (5,683     | )                                  | $          | 9,921 |   | $ | (4,636 | ) | $ | 8,435 |   |
|                                                                                                                                         |       |                                      |       |                               |       |   |   |   |   |
| Net income (loss) per share:                                                                                                                 |       |                                      |       |                               |       |   |   |   |   |
| Basic:                                                                                                                                       |       |                                      |       |                               |       |   |   |   |   |
| As reported                                                                                                                                  |       | $                                         | (0.60      | )                                  | $          | 0.98 |   | $ | (0.53 | ) | $ | 0.84 |   |
| Pro forma                                                                                                                                    |       | $                                         | (0.53      | )                                  | $          | 0.96 |   | $ | (0.44 | ) | $ | 0.82 |   |
| Diluted:                                                                                                                                     |       |                                      |       |                               |       |   |   |   |   |
| As reported                                                                                                                                  |       | $                                         | (0.60      | )                                  | $          | 0.97 |   | $ | (0.53 | ) | $ | 0.84 |   |
| Pro forma                                                                                                                                    |       | $                                         | (0.53      | )                                  | $          | 0.96 |   | $ | (0.44 | ) | $ | 0.82 |   |

 

**11.          Restatementand Reclassifications of Consolidated Financial Statements**

 

The Company has determined that, in certain cases, itdid not comply with generally accepted accounting principles in the preparationof its 2003 and 2004 consolidated financial statements and, accordingly, theCompany has restated its consolidated financial statements for the quarterlyperiods ended June 30, 2004 and 2003.

 

The restatements primarily result fromcompensation expense attributed to the sale of a portion of MarkWestHydrocarbon’s subordinated Partnership units and interests in the Partnership’sgeneral partner to certain of its employees and directors from 2002 through2004.  MarkWest Hydrocarbon hadhistorically recorded the sale of the subordinated Partnership units andinterests in the Partnership’s general partner to certain of MarkWestHydrocarbon’s employees and directors as a sale of an asset.  These arrangements are referred to as theParticipation Plan.  However, MarkWestHydrocarbon determined that these transactions should be accounted for ascompensatory arrangements, pursuant to the guidance in APB No. 25, *Accounting for Stock Issued to Employees*andEITF No. 95-16, *Accounting for StockCompensation Arrangements with Employer Loan Features under APB Opinion No. 25. *This guidance requires MarkWestHydrocarbon to record compensation expense based on the market value of thesubordinated Partnership units and the formula value of the general partnerinterests held by the employees and directors at the end of each reportingperiod.  In addition, certain otherrestatement adjustments have also been recorded to correct other errors in thefinancial statements for the first three quarters of 2004, includingadjustments to accruals for revenue and purchased product costs, adjustmentsfor costs improperly capitalized as property, plant and equipment, adjustmentsto properly record capitalized interest on major construction projects inprocess, adjustments to record as a financing lease, a lease agreementpreviously entered into by an acquired business (“Blackhawk pipeline”), anadjustment to record natural gas inventory at cost, an adjustment to reflectseparately restricted marketable securities, adjustments for dividends receivedon marketable securities improperly

 

The accompanying notes are an integral part of these financialstatements.

 

14

----

 

recorded as a reduction in the carrying value of marketable securities,adjustments to accrued property taxes payable and adjustments to deferred andcurrent taxes payable.  Adjustments werealso made to record compensation as a result of the modification of theprovisions of certain stock options for two officers who terminated theiremployment with the Company but who continued to serve on its Board ofDirectors.  Compensation expense was alsorecorded as a result of a policy change that required the Company to accountfor all outstanding stock options as variable awards.  In April 2004, the Company changed itspolicy to allow participants to exercise their stock options using the cashlessexercise method.  Under APB 25, *Accounting for Stock Issued to Employees,*a fixed stock option plan that permits the use of a cashless exercise becomesvariable if a pattern of exercising stock options using the cashless method isdemonstrated.  Additionally, the Companymade an adjustment to reclassify a portion of dividends paid during the sixmonths ended June 30, 2004 from retained earnings to additional paid incapital for the amount of dividends distributed in excess of accumulatedearnings.

 

In addition, on October 28, 2004, theCompany’s Board of Directors declared a stock dividend of one share of MarkWestHydrocarbon’s common stock for each ten shares owned by stockholders.  The stock dividend was paid on November 19,2004 to the stockholders of record as of the close of business on November 9,2004.  Common stock information in the Form 10-Q/Ahas been adjusted to give retroactive effect to the stock dividend paid.

 

The Company has reclassified certain prioryear amounts to conform to the current year’s presentation.  The Company has reclassified intangible andother assets to a separate line item on the consolidated balance sheet. TheCompany has also reclassified interest income and amortization of deferredfinancing costs to separate line items on the consolidated income statement.

 

All amounts inthe accompanying notes have been restated or reclassified for theseadjustments.  The following tablespresent the consolidated balance sheets as of June 30, 2004 and December 31,2003 as previously reported and as restated, and the consolidated statements ofincome for the three months and six months ended June 30, 2004 and 2003 aspreviously reported and as restated and the consolidated statement of cashflows for the six months ended June 30, 2004 and 2003 as previouslyreported and as restated.  The tablesalso reflect the amounts reported for changes in stockholders’ equity for thesix months ended June 30, 2004, as previously reported and asrestated.  The impact of these restatements was todecrease net income per basic and diluted share by $0.30 for the three and six monthsended June 30, 2004.  In addition,the impact of these restatements was to increase net income per basic share by$0.01 for the three months ended June 30, 2003 and to decrease net incomeper basic and diluted share by $0.03 for the six months ended June 30,2004.

 

The accompanyingnotes are an integral part of these financial statements.

 

15

----

 

**Balance Sheet Amounts:**

 
| ** **                                                                             | ** ** | **June 30, 2004**                              | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                             | ** ** | **As Previously  Reported**                         | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| ** **                                                                             | ** ** | **(in thousands, except share and per share data)** | ** ** |
| **ASSETS**                                                                             |       |                                                |       |   |   |   |   |
| Current  assets:                                                                       |       |                                                |       |   |   |   |   |
| Cash and cash equivalents                                                              |       | $                                                   | 33,777     |   | $ | 2,500 | **(1)** | $ | 36,277 |   |
| Restricted cash                                                                        |       | 2,500                                               |       | (2,500 | )**(1)** | — |   |
| Marketable securities                                                                  |       | 13,809                                              |       | (2,434 | )**(2)** | 11,375 |   |
| Restricted marketable securities                                                       |       | —                                              |       | 2,500 | **(3)** | 2,500 |   |
| Receivables, net                                                                       |       | 28,300                                              |       | 870 | **(4)** | 29,170 |   |
| Inventories                                                                            |       | 9,112                                               |       | — |   | 9,112 |   |
| Prepaid replacement natural gas                                                        |       | 264                                                 |       | — |   | 264 |   |
| Deferred income taxes                                                                  |       | 178                                                 |       | (69 | )**(5)** | 109 |   |
| Other current assets                                                                   |       | 415                                                 |       | — |   | 415 |   |
| Total current  assets                                                                  |       | 88,355                                              |       | 867 |   | 89,222 |   |
|                                                                                   |       |                                                |       |   |   |   |   |
| Property,  plant and equipment                                                         |       | 241,088                                             |       | (918 | )**(6)** | 240,170 |   |
| Less: accumulated depreciation, depletion  and amortization                            |       | (51,188                                             | )          | 563 | **(7)** | (50,625 | ) |
| Total property, plant and equipment, net                                               |       | 189,900                                             |       | (355 | ) | 189,545 |   |
|                                                                                   |       |                                                |       |   |   |   |   |
| Other  assets:                                                                         |       |                                                |       |   |   |   |   |
| Intangibles and other assets, net                                                      |       | —                                              |       | 136 | **(8)** | 136 |   |
| Deferred financing costs, net                                                          |       | 3,178                                               |       | — |   | 3,178 |   |
| Deferred offering costs and other, net                                                 |       | 42                                                  |       | (42 | )**(9)** | — |   |
| Investment in and advances to equity investee                                          |       | 232                                                 |       | — |   | 232 |   |
| Notes receivable from officers                                                         |       | 207                                                 |       | — |   | 207 |   |
| Total assets                                                                           |       | $                                                   | 281,914    |   | $ | 606 |   | $ | 282,520 |   |
|                                                                                   |       |                                                |       |   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                          |       |                                                |       |   |   |   |   |
|                                                                                   |       |                                                |       |   |   |   |   |
| Current  liabilities:                                                                  |       |                                                |       |   |   |   |   |
| Accounts payable                                                                       |       | $                                                   | 31,237     |   | $ | 1,720 | **(10)** | $ | 32,957 |   |
| Accrued liabilities                                                                    |       | 16,863                                              |       | (285 | )**(11)** | 16,578 |   |
| Fair value of derivative instruments                                                   |       | 748                                                 |       | — |   | 748 |   |
| Current portion of long-term debt                                                      |       | 86,200                                              |       | — |   | 86,200 |   |
| Total current liabilities                                                              |       | 135,048                                             |       | 1,435 |   | 136,483 |   |
|                                                                                   |       |                                                |       |   |   |   |   |
| Deferred  income taxes                                                                 |       | 5,105                                               |       | 945 | **(12)** | 6,050 |   |
| Fair value  of derivative instruments                                                  |       | 397                                                 |       | — |   | 397 |   |
| Other  long-term liabilities                                                           |       | 501                                                 |       | 2,880 | **(13)** | 3,381 |   |
| Non-controlling  interest in consolidated subsidiary                                   |       | 94,140                                              |       | (1,173 | )**(14)** | 92,967 |   |
| Commitments  and contingencies                                                         |       |                                                |       |   |   |   |   |
|                                                                                   |       |                                                |       |   |   |   |   |
| Stockholders’  equity:                                                            |       |                                                |       |   |   |   |   |
| Preferred stock, par value $0.01, 5,000,000  shares authorized, no shares outstanding  |       | —                                              |       | — |   | — |   |
| Common stock, par value $0.01, 20,000,000  shares authorized, 10,795,395 shares issued |       | 108                                                 |       | — |   | 108 |   |
| Additional paid-in capital                                                             |       | 52,249                                              |       | (893 | )**(15)** | 51,356 |   |
| Retained earnings (accumulated deficit)                                                |       | (3,782                                              | )          | (2,588 | )**(16)** | (6,370 | ) |
| Accumulated other comprehensive loss, net  of tax                                      |       | (1,395                                              | )          | — |   | (1,395 | ) |
| Treasury stock, 68,780 shares                                                          |       | (457                                                | )          | — |   | (457 | ) |
| Total stockholders’ equity                                                        |       | 46,723                                              |       | (3,481 | ) | 43,242 |   |
| Total liabilities and stockholders’ equity                                        |       | $                                                   | 281,914    |   | $ | 606 |   | $ | 282,520 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

16

----

 
| ** **                                                                             | ** ** | **December 31, 2003**                          | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                             | ** ** | **As Previously  Reported**                         | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| ** **                                                                             | ** ** | **(in thousands, except share and per share data)** | ** ** |
| **ASSETS**                                                                             |       |                                                |       |   |   |   |   |
| Current assets:                                                                        |       |                                                |       |   |   |   |   |
| Cash and cash equivalents                                                              |       | $                                                   | 42,144     |   | $ | — |   | $ | 42,144 |   |
| Restricted cash                                                                        |       | 2,500                                               |       | (2,500 | )**(17)** | — |   |
| Restricted marketable securities                                                       |       | —                                              |       | 2,500 | **(17)** | 2,500 | ** ** |
| Receivables, net                                                                       |       | 30,750                                              |       | (840 | )**(18)** | 29,910 |   |
| Inventories                                                                            |       | 4,815                                               |       | 733 | **(19)** | 5,548 |   |
| Prepaid replacement natural gas                                                        |       | 5,940                                               |       | — |   | 5,940 |   |
| Deferred income taxes                                                                  |       | 603                                                 |       | (69 | )**(20)** | 534 |   |
| Other current assets                                                                   |       | 503                                                 |       | — |   | 503 |   |
| Total current  assets                                                                  |       | 87,255                                              |       | (176 | ) | 87,079 |   |
|                                                                                   |       |                                                |       |   |   |   |   |
| Property,  plant and equipment                                                         |       | 232,257                                             |       | — |   | 232,257 |   |
| Less:  accumulated depreciation, depletion and amortization                            |       | (44,134                                             | )          | — |   | (44,134 | ) |
| Total property, plant and equipment, net                                               |       | 188,123                                             |       | — |   | 188,123 |   |
|                                                                                   |       |                                                |       |   |   |   |   |
| Other  assets:                                                                         |       |                                                |       |   |   |   |   |
| Intangibles and other assets, net                                                      |       | 3,831                                               |       | (3,747 | )**(21)** | 84 |   |
| Deferred financing costs, net                                                          |       | —                                              |       | 3,747 | **(21)** | 3,747 |   |
| Deferred offering costs and other, net                                                 |       | 1,037                                               |       | (42 | )**(22)** | 995 |   |
| Investment in and advances to equity  investee                                         |       | 250                                                 |       | — |   | 250 |   |
| Notes receivable from officers                                                         |       | 217                                                 |       | — |   | 217 |   |
| Total assets                                                                           |       | $                                                   | 280,713    |   | $ | (218 | ) | $ | 280,495 |   |
|                                                                                   |       |                                                |       |   |   |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                         |       |                                                |       |   |   |   |   |
|                                                                                   |       |                                                |       |   |   |   |   |
| Current  liabilities:                                                                  |       |                                                |       |   |   |   |   |
| Accounts payable                                                                       |       | $                                                   | 24,052     |   | $ | — |   | $ | 24,052 |   |
| Accrued liabilities                                                                    |       | 16,751                                              |       | (240 | )**(23)** | 16,511 |   |
| Fair value of derivative instruments                                                   |       | 1,769                                               |       | — |   | 1,769 |   |
| Total current liabilities                                                              |       | 42,572                                              |       | (240 | ) | 42,332 |   |
|                                                                                   |       |                                                |       |   |   |   |   |
| Deferred  income taxes                                                                 |       | 6,346                                               |       | (752 | )**(24)** | 5,594 |   |
| Long-term  debt                                                                        |       | 126,200                                             |       | — |   | 126,200 |   |
| Fair value  of derivative instruments                                                  |       | 125                                                 |       | — |   | 125 |   |
| Other  long-term liabilities                                                           |       | 504                                                 |       | 2,397 | **(25)** | 2,901 |   |
| Non-controlling  interest in consolidated subsidiary                                   |       | 52,782                                              |       | (353 | )**(26)** | 52,429 |   |
|                                                                                   |       |                                                |       |   |   |   |   |
| Commitments  and contingencies                                                         |       |                                                |       |   |   |   |   |
|                                                                                   |       |                                                |       |   |   |   |   |
| Stockholders’  equity:                                                            |       |                                                |       |   |   |   |   |
| Preferred stock, par value $0.01, 5,000,000  shares authorized, no shares outstanding  |       | —                                              |       | — |   | — |   |
| Common stock, par value $0.01, 20,000,000  shares authorized, 10,601,775 shares issued |       | 106                                                 |       | — |   | 106 |   |
| Additional paid-in capital                                                             |       | 50,705                                              |       | — |   | 50,705 |   |
| Retained earnings                                                                      |       | 3,676                                               |       | (1,270 | ) | 2,406 |   |
| Accumulated other comprehensive loss, net  of tax                                      |       | (1,793                                              | )          | — |   | (1,793 | ) |
| Treasury stock, 75,930 shares                                                          |       | (510                                                | )          | — |   | (510 | ) |
| Total stockholders’ equity                                                        |       | 52,184                                              |       | (1,270 | ) | 50,914 |   |
| Total liabilities and stockholders’ equity                                        |       | $                                                   | 280,713    |   | $ | (218 | ) | $ | 280,495 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

17

----

 

**Income Statement Amounts:**

** **
| ** **                                                                                      | ** ** | **Three Months Ended June 30, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                      | ** ** | **As Previously  Reported**               | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| ** **                                                                                      | ** ** | **(in thousands, except per share data)** | ** ** |
|                                                                                            |       |                                      |       |   |   |   |   |
| Revenues                                                                                        |       | $                                         | 87,796     |   | $ | 1,228 | **(27)** | $ | 89,024 |   |
|                                                                                            |       |                                      |       |   |   |   |   |
| Operating  expenses:                                                                            |       |                                      |       |   |   |   |   |
| Purchased product costs                                                                         |       | 75,451                                    |       | 1,811 | **(28)** | 77,262 |   |
| Facility expenses                                                                               |       | 5,747                                     |       | 228 | **(29)** | 5,975 |   |
| Selling, general and administrative  expenses                                                   |       | 4,262                                     |       | 808 | **(30)** | 5,070 |   |
| Depreciation                                                                                    |       | 3,770                                     |       | (113 | )**(31)** | 3,657 |   |
| Amortization of intangible assets                                                               |       | —                                    |       | 34 | **(32)** | 34 |   |
| Total operating expenses                                                                        |       | 89,230                                    |       | 2,768 |   | 91,998 |   |
|                                                                                            |       |                                      |       |   |   |   |   |
| Loss from operations                                                                            |       | (1,434                                    | )          | (1,540 | ) | (2,974 | ) |
|                                                                                            |       |                                      |       |   |   |   |   |
| Other income  (expense):                                                                        |       |                                      |       |   |   |   |   |
| Interest expense, net                                                                           |       | (1,092                                    | )          | 390 | **(33)** | (702 | ) |
| Amortization of deferred financing costs (a  component of interest expense)                     |       | —                                    |       | (307 | )**(34)** | (307 | ) |
| Dividend income                                                                                 |       | —                                    |       | 83 | **(35)** | 83 |   |
| Other expense                                                                                   |       | (31                                       | )          | — |   | (31 | ) |
| Loss before non-controlling interest in net  income of consolidated subsidiary and income taxes |       | (2,557                                    | )          | (1,374 | ) | (3,931 | ) |
|                                                                                            |       |                                      |       |   |   |   |   |
| Provision  (benefit) for income taxes:                                                          |       |                                      |       |   |   |   |   |
| Current                                                                                         |       | (69                                       | )          | 195 |   | 126 |   |
| Deferred                                                                                        |       | (1,827                                    | )          | 2,192 |   | 365 |   |
| Provision (benefit) for income taxes                                                            |       | (1,896                                    | )          | 2,387 | **(36)** | 491 |   |
|                                                                                            |       |                                      |       |   |   |   |   |
| Non-controlling  interest in net income of consolidated Subsidiary                              |       | (2,549                                    | )          | 603 | **(37)** | (1,946 | ) |
|                                                                                            |       |                                      |       |   |   |   |   |
| Net loss                                                                                        |       | $                                         | (3,210     | ) | $ | (3,158 | ) | $ | (6,368 | ) |
|                                                                                            |       |                                      |       |   |   |   |   |
| Net loss per  share:                                                                            |       |                                      |       |   |   |   |   |
| Basic                                                                                           |       | $                                         | (0.30      | ) | $ | (0.30 | ) | $ | (0.60 | ) |
| Diluted                                                                                         |       | $                                         | (0.30      | ) | $ | (0.30 | ) | $ | (0.60 | ) |
|                                                                                            |       |                                      |       |   |   |   |   |
| Weighted  average number of outstanding shares of common stock:                                 |       |                                      |       |   |   |   |   |
| Basic                                                                                           |       | 10,681                                    |       |   |   | 10,681 |   |
| Diluted                                                                                         |       | 10,681                                    |       |   |   | 10,681 |   |
|                                                                                            |       |                                      |       |   |   |   |   |
| Cash  dividend per common share                                                                 |       | $                                         | 0.023      |   |   |   | $ | 0.023 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

18

----

 
| ** **                                                                                                         | ** ** | **Three Months Ended June 30, 2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                         | ** ** | **As Previously  Reported**               | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| ** **                                                                                                         | ** ** | **(in thousands, except per share data)** | ** ** |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Revenues                                                                                                           |       | $                                         | 47,888     |   | $ | 353 | **(38)** | $ | 48,241 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Operating expenses:                                                                                                |       |                                      |       |   |   |   |   |
| Purchased product costs                                                                                            |       | 44,357                                    |       | — |   | 44,357 |   |
| Facility expenses                                                                                                  |       | 4,417                                     |       | 256 | **(39)** | 4,673 |   |
| Selling, general and administrative  expenses                                                                      |       | 3,363                                     |       | 403 | **(40)** | 3,766 |   |
| Depreciation                                                                                                       |       | 2,041                                     |       | 57 | **(41)** | 2,098 |   |
| Total operating expenses                                                                                           |       | 54,178                                    |       | 716 |   | 54,894 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Loss from operations                                                                                               |       | (6,290                                    | )          | (363 | ) | (6,653 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Other income  (expense):                                                                                           |       |                                      |       |   |   |   |   |
| Interest expense, net                                                                                              |       | (1,998                                    | )          | 504 | **(42)** | (1,494 | ) |
| Amortization of deferred financing costs (a  component of interest expense)                                        |       | —                                    |       | (504 | )**(42)** | (504 | ) |
| Other income                                                                                                       |       | 105                                       |       | (105 | )**(43)** | **—** |   |
| Loss before non-controlling interest in net  income of consolidated subsidiary income taxes                        |       | (8,183                                    | )          | (468 | ) | (8,651 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Provision (benefit) for income taxes:                                                                              |       |                                      |       |   |   |   |   |
| Current                                                                                                            |       | (5,875                                    | )          | 2,229 |   | (3,646 | ) |
| Deferred                                                                                                           |       | 6,931                                     |       | (6,771 | ) | 160 |   |
| Provision (benefit) for income taxes                                                                               |       | 1,056                                     |       | (4,542 | )**(44)** | (3,486 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Non-controlling  interest in net income of consolidated subsidiary                                                 |       | (860                                      | )          | 48 | **(45)** | (812 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Loss from continuing operations                                                                                    |       | (10,099                                   | )          | 4,122 |   | (5,977 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Discontinued  operations:                                                                                          |       |                                      |       |   |   |   |   |
| Income from discontinued exploration and  production operations (net of income taxes of $(188))                    |       | 2,377                                     |       | (638 | ) | 1,739 |   |
| Gain from disposal of discontinued  exploration and production operations (less applicable income taxes of $5,423) |       | 17,701                                    |       | (3,432 | ) | 14,269 |   |
| Income from discontinued operations                                                                                |       | 20,078                                    |       | (4,070 | )**(46)** | 16,008 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Net income                                                                                                         |       | $                                         | 9,979      |   | $ | 52 |   | $ | 10,031 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Loss from  continuing operations per share:                                                                        |       |                                      |       |   |   |   |   |
| Basic                                                                                                              |       | $                                         | (0.98      | ) | $ | 0.40 |   | $ | (0.58 | ) |
| Diluted                                                                                                            |       | $                                         | (0.98      | ) | $ | 0.40 |   | $ | (0.58 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Net income  per share:                                                                                             |       |                                      |       |   |   |   |   |
| Basic                                                                                                              |       | $                                         | 0.97       |   | $ | 0.01 |   | $ | 0.98 |   |
| Diluted                                                                                                            |       | $                                         | 0.97       |   | $ | — |   | $ | 0.97 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Weighted  average number of outstanding shares of common stock:                                                    |       |                                      |       |   |   |   |   |
| Basic                                                                                                              |       | 10,286                                    |       |   |   | 10,286 |   |
| Diluted                                                                                                            |       | 10,308                                    |       |   |   | 10,308 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Cash  dividend per common share                                                                                    |       | $                                         | —     |   |   |   | $ | — |   |

 

The accompanying notes are anintegral part of these financial statements.

 

19

----

 
| ** **                                                                                               | ** ** | **Six Months Ended June 30, 2004**   | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                               | ** ** | **As Previously  Reported**               | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| ** **                                                                                               | ** ** | **(in thousands, except per share data)** | ** ** |
|                                                                                                     |       |                                      |       |   |   |   |   |
| Revenues                                                                                                 |       | $                                         | 181,484    |   | $ | 1,240 | **(47)** | $ | 182,724 |   |
|                                                                                                     |       |                                      |       |   |   |   |   |
| Operating  expenses:                                                                                     |       |                                      |       |   |   |   |   |
| Purchased product costs                                                                                  |       | 150,587                                   |       | 2,163 | **(48)** | 152,750 |   |
| Facility expenses                                                                                        |       | 11,866                                    |       | 195 | **(49)** | 12,061 |   |
| Selling, general and administrative  expenses                                                            |       | 8,746                                     |       | 1,639 | **(50)** | 10,385 |   |
| Depreciation                                                                                             |       | 7,410                                     |       | (225 | )**(51)** | 7,185 |   |
| Amortization of intangible assets                                                                        |       | —                                    |       | 68 | **(52)** | 68 |   |
| Total operating expenses                                                                                 |       | 178,609                                   |       | 3,840 |   | 182,449 |   |
|                                                                                                     |       |                                      |       |   |   |   |   |
| Income from operations                                                                                   |       | 2,875                                     |       | (2,600 | ) | 275 |   |
|                                                                                                     |       |                                      |       |   |   |   |   |
| Other income  (expense):                                                                                 |       |                                      |       |   |   |   |   |
| Interest expense, net                                                                                    |       | (2,450                                    | )          | 753 | **(53)** | (1,697 | ) |
| Amortization of deferred financing costs (a  component of interest expense)                              |       | —                                    |       | (614 | )**(54)** | (614 | ) |
| Dividend income                                                                                          |       | —                                    |       | 83 | **(55)** | 83 |   |
| Other income                                                                                             |       | 32                                        |       | (37 | )**(56)** | (5 | ) |
| Income (loss) before non-controlling  interest in net income of consolidated subsidiary and income taxes |       | 457                                       |       | (2,415 | ) | (1,958 | ) |
|                                                                                                     |       |                                      |       |   |   |   |   |
| Provision  (benefit) for income taxes:                                                                   |       |                                      |       |   |   |   |   |
| Current                                                                                                  |       | —                                    |       | 112 |   | 112 |   |
| Deferred                                                                                                 |       | (1,372                                    | )          | 1,697 |   | 325 |   |
| Provision (benefit) for income taxes                                                                     |       | (1,372                                    | )          | 1,809 | **(57)** | 437 |   |
|                                                                                                     |       |                                      |       |   |   |   |   |
| Non-controlling  interest in net income of consolidated subsidiary                                       |       | (4,242                                    | )          | 987 | **(58)** | (3,255 | ) |
|                                                                                                     |       |                                      |       |   |   |   |   |
| Net loss                                                                                                 |       | $                                         | (2,413     | ) | $ | (3,237 | ) | $ | (5,650 | ) |
|                                                                                                     |       |                                      |       |   |   |   |   |
| Net loss per  share:                                                                                     |       |                                      |       |   |   |   |   |
| Basic                                                                                                    |       | $                                         | (0.23      | ) | $ | (0.30 | ) | $ | (0.53 | ) |
| Diluted                                                                                                  |       | $                                         | (0.23      | ) | $ | (0.30 | ) | $ | (0.53 | ) |
|                                                                                                     |       |                                      |       |   |   |   |   |
| Weighted  average number of outstanding shares of common stock:                                          |       |                                      |       |   |   |   |   |
| Basic                                                                                                    |       | 10,628                                    |       |   |   | 10,628 |   |
| Diluted                                                                                                  |       | 10,628                                    |       |   |   | 10,628 |   |
|                                                                                                     |       |                                      |       |   |   |   |   |
| Cash  dividend per common share                                                                          |       | $                                         | 0.477      |   |   |   | $ | 0.477 |   |
|                                                                                                          |            |                                           |            |  |  |  |  |  |  |  |  |

 

The accompanying notes are anintegral part of these financial statements.

 

20

----

 
| ** **                                                                                                         | ** ** | **Six Months Ended June 30, 2003**   | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                         | ** ** | **As Previously  Reported**               | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| ** **                                                                                                         | ** ** | **(in thousands, except per share data)** | ** ** |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Revenues                                                                                                           |       | $                                         | 98,539     |   | $ | 933 | **(59)** | $ | 99,472 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Operating  expenses:                                                                                               |       |                                      |       |   |   |   |   |
| Purchased product costs                                                                                            |       | 90,360                                    |       | — |   | 90,360 |   |
| Facility expenses                                                                                                  |       | 8,779                                     |       | 526 | **(60)** | 9,305 |   |
| Selling, general and administrative  expenses                                                                      |       | 5,913                                     |       | 477 | **(61)** | 6,390 |   |
| Depreciation                                                                                                       |       | 3,571                                     |       | 129 | **(62)** | 3,700 |   |
| Total operating expenses                                                                                           |       | 108,623                                   |       | 1,132 |   | 109,755 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Loss from operations                                                                                               |       | (10,084                                   | )          | (199 | ) | (10,283 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Other income  (expense):                                                                                           |       |                                      |       |   |   |   |   |
| Interest expense, net                                                                                              |       | (3,061                                    | )          | 813 | **(63)** | (2,248 | ) |
| Amortization of deferred financing costs (a  component of interest expense)                                        |       | —                                    |       | (813 | )**(63)** | (813 | ) |
| Other income (expense)                                                                                             |       | 90                                        |       | (106 | )**(64)** | (16 | ) |
| Loss before non-controlling interest in net  income of consolidated subsidiary and income taxes                    |       | (13,055                                   | )          | (305 | ) | (13,360 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Provision  (benefit) for income taxes:                                                                             |       |                                      |       |   |   |   |   |
| Current                                                                                                            |       | (6,045                                    | )          | 254 |   | (5,791 | ) |
| Deferred                                                                                                           |       | 4,649                                     |       | (4,397 | ) | 252 |   |
| Provision (benefit) for income taxes                                                                               |       | (1,396                                    | )          | (4,143 | )**(65)** | (5,539 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Non-controlling  interest in net income of consolidated subsidiary                                                 |       | (1,734                                    | )          | 65 | **(66)** | (1,669 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Loss from continuing operations                                                                                    |       | (13,393                                   | )          | 3,903 |   | (9,490 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Discontinued  operations:                                                                                          |       |                                      |       |   |   |   |   |
| Income from discontinued exploration and  production operations (net of income taxes of $955)                      |       | 4,658                                     |       | (790 | ) | 3,868 |   |
| Gain from disposal of discontinued  exploration and production operations (less applicable income taxes of $5,423) |       | 17,701                                    |       | (3,432 | ) | 14,269 |   |
| Income from discontinued operations                                                                                |       | 22,359                                    |       | (4,222 | )**(67)** | 18,137 |   |
| Income (loss) before cumulative effect of  accounting change                                                       |       | 8,966                                     |       | (319 | ) | 8,647 |   |
| Cumulative effect of change in accounting  for asset retirement obligations, net of tax                            |       | (29                                       | )          | — |   | (29 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Net income                                                                                                         |       | $                                         | 8,937      |   | $ | (319 | ) | $ | 8,618 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Loss from  continuing operations per share:                                                                        |       |                                      |       |   |   |   |   |
| Basic                                                                                                              |       | $                                         | (1.30      | ) | $ | 0.38 |   | $ | (0.92 | ) |
| Diluted                                                                                                            |       | $                                         | (1.30      | ) | $ | 0.38 |   | $ | (0.92 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Net income  (loss) per share:                                                                                      |       |                                      |       |   |   |   |   |
| Basic                                                                                                              |       | $                                         | 0.87       |   | $ | (0.03 | ) | $ | 0.84 |   |
| Diluted                                                                                                            |       | $                                         | 0.87       |   | $ | (0.03 | ) | $ | 0.84 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Weighted  average number of outstanding shares of common stock:                                                    |       |                                      |       |   |   |   |   |
| Basic                                                                                                              |       | 10,292                                    |       |   |   | 10,292 |   |
| Diluted                                                                                                            |       | 10,314                                    |       |   |   | 10,314 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |
| Cash  dividend per common share                                                                                    |       | $                                         | —     |   |   |   | $ | — |   |

 

The accompanying notes are anintegral part of these financial statements.

 

21

----

 

 

**Cash Flow Amounts**

 
| ** **                                                                                                                              | ** ** | **Six Months Ended June 30,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                                              | ** ** | **As Previously Reported**               | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| ** **                                                                                                                              | ** ** | **(in thousands)**                       | ** ** |
| **Cash flows from operating activities:**                                                                                               |       |                                     |       |   |   |   |   |
| Net loss                                                                                                                                |       | $                                        | (2,413     | ) | $ | (3,237 | ) | $ | (5,650 | ) |
| Adjustments  to reconcile net loss to net cash provided by operating activities:                                                        |       |                                     |       |   |   |   |   |
| Depreciation  and depletion                                                                                                             |       | 7,410                                    |       | (225 | ) | 7,185 |   |
| Gain from  sale of property, plant and equipment                                                                                        |       | (42                                      | )          | — |   | (42 | ) |
| Amortization  of deferred financing costs                                                                                               |       | 627                                      |       | (13 | ) | 614 |   |
| Amortization  of intangible assets                                                                                                      |       | —                                   |       | 68 |   | 68 |   |
| Stock option  compensation expense                                                                                                      |       | —                                   |       | 1,026 |   | 1,026 |   |
| Restricted  unit compensation expense                                                                                                   |       | 344                                      |       | — |   | 344 |   |
| Participation  Plan compensation expense                                                                                                |       | —                                   |       | 489 |   | 489 |   |
| Contribution  of treasury shares to 401(k) benefit plan                                                                                 |       | —                                   |       | 89 |   | 89 |   |
| Equity in  investee losses                                                                                                              |       | 18                                       |       | — |   | 18 |   |
| Non-controlling  interest in net income of consolidated subsidiary                                                                      |       | 4,242                                    |       | (987 | ) | 3,255 |   |
| Unrealized  losses on derivative instrument                                                                                             |       | 732                                      |       | — |   | 732 |   |
| Deferred  income taxes                                                                                                                  |       | (1,372                                   | )          | 1,697 |   | 325 |   |
| Changes in  operating assets and liabilities:                                                                                           |       |                                     |       |   |   |   |   |
| Decrease in  receivables                                                                                                                |       | 2,458                                    |       | (1,710 | ) | 748 |   |
| Increase in  inventories                                                                                                                |       | (4,297                                   | )          | 733 |   | (3,564 | ) |
| Decrease in  prepaid replacement natural gas                                                                                            |       | 5,676                                    |       | — |   | 5,676 |   |
| Decrease in  other current assets                                                                                                       |       | 88                                       |       | 9 |   | 97 |   |
| Increase in  accounts payable and accrued liabilities                                                                                   |       | 7,328                                    |       | 2,600 |   | 9,928 |   |
| Net cash  flow provided by operating activities                                                                                         |       | 20,799                                   |       | 539 | **(68)** | 21,338 |   |
|                                                                                                                                    |       |                                     |       |   |   |   |   |
| **Cash flows from investing activities:**                                                                                               |       |                                     |       |   |   |   |   |
| Payments for  marketable securities                                                                                                     |       | (11,679                                  | )          | (66 | ) | (11,745 | ) |
| Hobbs Lateral acquisition                                                                                                               |       | (2,275                                   | )          | — |   | (2,275 | ) |
| Capital  expenditures                                                                                                                   |       | (7,049                                   | )          | (764 | ) | (7,813 | ) |
| Proceeds  from sale of assets                                                                                                           |       | 195                                      |       | — |   | 195 |   |
| Proceeds on  financing lease receivable                                                                                                 |       | —                                   |       | 133 |   | 133 |   |
| Other                                                                                                                                   |       | 8                                        |       | — |   | 8 |   |
| Net cash  used in investing activities                                                                                                  |       | (20,800                                  | )          | (697 | )**(69)** | (21,497 | ) |
|                                                                                                                                    |       |                                     |       |   |   |   |   |
| **Cash  flows from financing activities:**                                                                                              |       |                                     |       |   |   |   |   |
| Proceeds  from long-term debt                                                                                                           |       | 3,000                                    |       | — |   | 3,000 |   |
| Repayment of  long-term debt                                                                                                            |       | (43,000                                  | )          | — |   | (43,000 | ) |
| Proceeds  from MarkWest Energy Partners’ secondary public offering                                                                 |       | 44,103                                   |       | — |   | 44,103 |   |
| Distribution  to MarkWest Energy Partners’ unitholders                                                                             |       | (6,210                                   | )          | 100 |   | (6,110 | ) |
| Acquisition  of general partner’s membership interests and MarkWest Energy Partners’  subordinated units from related parties |       | (147                                     | )          | 147 |   | — |   |
| Exercise of  stock options                                                                                                              |       | 1,380                                    |       | — |   | 1,380 |   |
| Repurchase  of treasury shares                                                                                                          |       | 53                                       |       | (89 | ) | (36 | ) |
| Payment of  dividends                                                                                                                   |       | (5,045                                   | )          | — |   | (5,045 | ) |
| Net cash  used in financing activities                                                                                                  |       | (5,866                                   | )          | 158 | **(70)** | (5,708 | ) |
|                                                                                                                                    |       |                                     |       |   |   |   |   |
| Net decrease in cash and cash equivalents                                                                                               |       | (5,867                                   | )          | — |   | (5,867 | ) |
| Cash and cash equivalents at beginning of  period                                                                                       |       | 42,144                                   |       | — |   | 42,144 |   |
| Cash and cash equivalents at end of period                                                                                              |       | $                                        | 36,277     |   | $ | — |   | $ | 36,277 |   |
| ** **                                                                                                                              | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Supplemental cash flow information:**                                                                                                 | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Construction projects in progress  obligation                                                                                           |       | $                                        | —     |   | $ | 179 |   | $ | 179 |   |
| Cash paid for interest, net of amounts  capitalized                                                                                     |       | $                                        | 2,077      |   | $ | — |   | $ | 2,077 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

22

----

 
| ** **                                                                           | ** ** | **Six Months Ended June 30,  2003** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                           | ** ** | **As Previously Reported**               | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| ** **                                                                           | ** ** | **(in thousands)**                       | ** ** |
| **Cash flows from operating activities:**                                            |       |                                     |       |   |   |   |   |
| Net income                                                                           |       | $                                        | 8,937      |   | $ | (319 | ) | $ | 8,618 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities:   |       |                                     |       |   |   |   |   |
| Cumulative  effect of change in accounting                                           |       | 29                                       |       | — |   | 29 |   |
| Depreciation  and depletion                                                          |       | 11,138                                   |       | — |   | 11,138 |   |
| Amortization  of deferred financing costs                                            |       | 813                                      |       | — |   | 813 |   |
| Restricted  unit compensation expense                                                |       | 400                                      |       | — |   | 400 |   |
| Participation  Plan compensation expense                                             |       | —                                   |       | 434 |   | 434 |   |
| Contribution  of treasury shares to 401(k) benefit plan                              |       | —                                   |       | 149 |   | 149 |   |
| Non-controlling  interest in net income of consolidated subsidiary                   |       | 1,735                                    |       | (65 | ) | 1,670 |   |
| Unrealized  gains on derivative instrument                                           |       | (1,475                                   | )          | — |   | (1,475 | ) |
| Reclassification  of Enron hedges to purchased gas costs                             |       | (154                                     | )          | — |   | (154 | ) |
| Deferred  income taxes                                                               |       | (2,552                                   | )          | (4,393 | ) | (6,945 | ) |
| Gain on sale  of San Juan Basin properties                                           |       | (19,692                                  | )          | — |   | (19,692 | ) |
| Other                                                                                |       | 237                                      |       | 1 |   | 238 |   |
| Changes in  operating assets and liabilities:                                        |       |                                     |       |   |   |   |   |
| Decrease in  receivables                                                             |       | 10,763                                   |       | — |   | 10,763 |   |
| Increase in  inventories                                                             |       | (897                                     | )          | — |   | (897 | ) |
| Decrease in  prepaid                                                                 |       | 388                                      |       | — |   | 388 |   |
| Increase in  accounts payable and accrued liabilities                                |       | 1,910                                    |       | 4,528 |   | 6,438 |   |
| Net cash  flow provided by operating activities                                      |       | 11,580                                   |       | 335 | ** (71)** | 11,915 |   |
| **Cash flows from investing activities:**                                            |       |                                     |       |   |   |   |   |
| Pinnacle  acquisition, net of cash acquired                                          |       | (38,238                                  | )          | — |   | (38,238 | ) |
| Proceeds  from sale of San Juan Basin properties, net of disposal costs              |       | 49,470                                   |       | — |   | 49,470 |   |
| Capital  expenditures                                                                |       | (14,023                                  | )          | — |   | (14,023 | ) |
| Proceeds  from sale of assets                                                        |       | 105                                      |       | — |   | 105 |   |
| Proceeds  from sale of assets to related parties                                     |       | 229                                      |       | (229 | ) | — |   |
| Net cash  used in investing activities                                               |       | (2,457                                   | )          | (229 | )**(72)** | (2,686 | ) |
| **Cash flows from financing activities:**                                            |       |                                     |       |   |   |   |   |
| Proceeds  from long-term debt                                                        |       | 68,235                                   |       | — |   | 68,235 |   |
| Repayment of  long-term debt                                                         |       | (56,424                                  | )          | — |   | (56,424 | ) |
| Debt  issuance costs                                                                 |       | (809                                     | )          | — |   | (809 | ) |
| Proceeds  from private placement of MarkWest Energy Partners’ common units, net |       | 7,807                                    |       | — |   | 7,807 |   |
| Distribution  to MarkWest Energy Partners’ unitholders                          |       | (3,242                                   | )          | 43 |   | (3,199 | ) |
| Exercise of  stock options                                                           |       | 167                                      |       | — |   | 167 |   |
| Repurchase  of treasury shares                                                       |       | (70                                      | )          | (149 | ) | (219 | ) |
| Net cash  provided by financing activities                                           |       | 15,664                                   |       | (106 | )**(73)** | 15,558 |   |
| Effect of exchange rate on changes in cash                                           |       | 105                                      |       | — |   | 105 |   |
| Net increase in cash and cash equivalents                                            |       | 24,892                                   |       | — |   | 24,892 |   |
| Cash and cash equivalents at beginning of period                                     |       | 6,410                                    |       | — |   | 6,410 |   |
| Cash and cash equivalents at end of period                                           |       | $                                        | 31,302     |   | $ | — |   | $ | 31,302 |   |
| **Supplemental cash flow information:**                                              | ** ** | ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash paid for interest                                                               |       | $                                        | 709        |   | $ | 232 | **(74)** | $ | 941 |   |

 

23

----

 

**Changes in Stockholders’ Equity Amounts:**

 
| ** **                                                                         | ** ** | **Shares of  Common  Stock** | ** ** | **Shares of  Treasury  Stock** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Income  (Loss)** | ** ** | **Treasury  Stock** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------|------------|--------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|-------------------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
| ** **                                                                         | ** ** | **(in thousands)**           | ** ** |
| Balance, as previously reported, June 30, 2004                                |       | 9,814                        |       | (69                            | )          | $                 | 98         |                             | $          | 52,259                 |       | $                                                     | (3,782     | )                   | $          | (1,395                                | )          | $ | (457 | ) | $ | 46,723 |   |
|                                                                               |       |                         |       |                           |       |              |       |                             |       |                   |       |                                                  |       |                |       |                                  |       |
| Stock dividend                                                                     |       | 981                          |       | —                         |       | 10                |       | (10                              | )          | —                 |       | —                                                |       | —              |       | —                                |       |
|                                                                               |       |                         |       |                           |       |              |       |                             |       |                   |       |                                                  |       |                |       |                                  |       |
| Reclassification of dividends paid                                                 |       | —                       |       | —                         |       | —            |       | (1,919                           | )          | 1,919                  |       | —                                                |       | —              |       | —                                |       |
|                                                                               |       |                         |       |                           |       |              |       |                             |       |                   |       |                                                  |       |                |       |                                  |       |
| Modification of stock options                                                      |       | —                       |       | —                         |       | —            |       | 1,026                            |       | —                 |       | —                                                |       | —              |       | 1,026                                 |       |
|                                                                               |       |                         |       |                           |       |              |       |                             |       |                   |       |                                                  |       |                |       |                                  |       |
| Restatement adjustment to net income for the year  ended December 31, 2002    |       | —                       |       | —                         |       | —            |       | —                           |       | (213                   | )          | —                                                |       | —              |       | (213                                  | )          |
|                                                                               |       |                         |       |                           |       |              |       |                             |       |                   |       |                                                  |       |                |       |                                  |       |
| Restatement adjustment to net income for the year  ended December 31, 2003    |       | —                       |       | —                         |       | —            |       | —                           |       | (1,057                 | )          | —                                                |       | —              |       | (1,057                                | )          |
|                                                                               |       |                         |       |                           |       |              |       |                             |       |                   |       |                                                  |       |                |       |                                  |       |
| Restatement adjustments to net income for the six  months ended June 30, 2004 |       | —                       |       | —                         |       | —            |       | —                           |       | (3,237                 | )          | —                                                |       | —              |       | (3,237                                | )          |
|                                                                               |       |                         |       |                           |       |              |       |                             |       |                   |       |                                                  |       |                |       |                                  |       |
| Balance, as restated, June 30, 2004                                           |       | 10,795                       |       | (69                            | )          | $                 | 108        |                             | $          | 51,356                 |       | $                                                     | (6,370     | )                   | $          | (1,395                                | )          | $ | (457 | ) | $ | 43,242 |   |

 

***June 30, 2004 Balance Sheet***

 

**1.****             **Restrictedcash was reduced by $2.5 million and cash and cash equivalents increased by acorresponding amount as a result of reclassifying non-restricted cash fromrestricted cash to cash and cash equivalents.

 

**2.****             **Marketablesecurities was reduced by $2.4 million primarily as a result of the followingrestatement adjustments:

 

•                  adecrease of $2.5 million to reclassify restricted marketable securities frommarketable securities to restricted marketable securities.

**•****                 **an increaseof $0.1 million to properly record dividends received as dividend income.  Previously, the dividends received wereincorrectly recorded as a reduction to carrying value of marketable securities.

 

**3.****             **Restrictedmarketable securities was increased by $2.5 million as a result of reclassifyingrestricted marketable securities from marketable securities to restrictedmarketable securities.

 

**4.**              Receivables,net, were adjusted by $0.9 million primarily to correct the amounts recordedfor accrued revenue.

 

**5.**              The current deferred income tax asset was decreased by $0.1million to reflect the tax effect of the restatement adjustments.

 

**6.**              Property, plant and equipment, net, was reduced by $0.9million primarily as a result of the following restatement adjustments:

 

24

----

 

•                  adecrease of $0.7 million.  During 2003,as a part of the Pinnacle acquisition, the Partnership acquired the Blackhawkpipeline.  The pipeline was subject to alease with a third party.  ThePartnership incorrectly recorded the pipeline as property and equipment anddepreciated it over its estimated useful life. The lease has now been accounted for as a sales-type financing lease.

•                  adecrease of $0.2 million to reclassify repair expense improperly capitalized asproperty, plant and equipment.

 

**7.**              Accumulated depreciation was reduced by $0.6 million toreverse the depreciation previously recorded on the Blackhawk pipeline.

 

**8.****             **Intangibles and other assets,net were increased by $0.1 million to record an intangible asset relating to a customercontract acquired as a part of the Pinnacle acquisition.

 

**9.**              Other assets were decreased by $0.04 million to eliminate theexcess cost recorded on the repurchase of an interest in the Partnership’sgeneral partner and subordinated Partnership units previously sold to anofficer under the Participation Plan. The Participation Plan has now been accounted for as a compensatoryarrangement.

 

**10.**       Accountspayable were adjusted by $1.7 million to correct amounts recorded for accruedproduct costs.

 

**11.**       Accruedliabilities were decreased by $0.3 million primarily as a result of thefollowing restatement adjustments:

 

•                  anincrease of $0.1 million to reflect to reflect the tax effect of therestatement adjustments.

•                  adecrease of $0.3 million to reverse deferred income to other long-termliabilities as a result of accounting for the Participation Plan as acompensatory arrangement.  Previously thesale of subordinated partnership units and interests in the Partnership’sgeneral partner to certain employees and directors of the Company wasincorrectly recorded as a sale of an asset. The Company recorded deferred income to the extent the Company loanedthe employees and directors a portion of the purchase price.

•                  adecrease of $0.1 million to correct amounts recorded for accrued propertytaxes.

 

**12.****      **Thenon-current deferred income tax liability was increased by $0.9 million toreflect the tax effect of the restatement adjustments.

 

**13.****      **Otherlong-term liabilities were increased by $2.9 million to reflect compensationexpense accrued under the Participation Plan.

 

**14.****      **Non-controllinginterest in consolidated subsidiary was decreased by $1.2 million to reflectthe impact of the portion of the restatement adjustments attributable to thenon-controlling interest in MarkWest Energy Partners and to eliminate theeffect of the subordinated units and general partner interests owned by theemployees and directors under the Participation Plan, which were previouslyaccounted for as non-controlling interests. The Participation Plan is now accounted for as a compensatoryarrangement and as a result the Company records a separate liability for thefair value of the subordinated units and general partner interests held byparticipants in the Plan.

 

**15.****      **Additionalpaid-in capital decreased by $0.9 million as a result of the followingrestatement adjustments:

 

•                  adecrease of $1.9 million as a result of restating dividends paid during the sixmonths ended June 30, 2004 from retained earnings to additional paid incapital for dividends distributed in excess of accumulated earnings.

•                  anincrease of $1.0 million to record compensation expense for stock optionsoutstanding that were required to be accounted for as variable awards.  In April 2004, the Company changed itspolicy to allow participants to exercise their stock options using the cashlessmethod.  Under APB 25, a fixed

 

25

----

 

stock option plan thatpermits the use of a cashless exercise becomes variable if a pattern of exercisingstock options using the cashless method is demonstrated.

 

**16.****      **Accumulated deficitincreased $2.6 million as a result of the following restatement adjustments:

 

•                  andecrease of $1.9 million as a result of restating dividends paid from retainedearnings to additional paid in capital for dividends distributed in excess ofaccumulated earnings.

•                  aincrease of $0.2 million and $1.3 million to reflect the effect of therestatement adjustments on net income for the years ended December 31,2002 and 2003, respectively.

•                  aincrease of $3.2 million to reflect the effect of the restatement adjustmentson net income for the six months ended June 30, 2004.

 

***December 31, 2003 Balance Sheet***

 

**17.**       Restrictedcash was reduced by $2.5 million and restricted marketable securities increasedby a corresponding amount as a result of restating restricted marketablesecurities from restricted cash to restricted marketable securities.

 

**18.****      **Receivables,net were reduced by $0.8 million primarily to restate natural gas inventory fromreceivables to inventory.  Previously theinventory was incorrectly identified as a pipeline imbalance and was recordedas a receivable.

 

**19.**       Inventorieswere increased by $0.7 million as a result of the following restatementadjustments:

 

•                  anincrease of $0.8 million to restate natural gas inventory from receivables toinventory.  Previously the inventory wasincorrectly identified as a pipeline imbalance and was recorded at marketvalue.

•                  adecrease of $0.1 million to record natural gas inventory at cost.  The inventory was previously incorrectlyidentified as a pipeline imbalance and was recorded at market value.

 

**20.****      **Thecurrent deferred income tax asset was decreased by $0.1 million to reflect thetax effect of the restatement adjustments.

 

**21**.       Deferredfinancing costs, net increased by $3.7 million and intangibles and other assetsdecreased by a corresponding amount as a result of reclassifying deferredfinancing costs, net to a separate line item on the consolidated balance sheet.

 

**22.**       Otherassets were decreased by $0.04 million to eliminate the excess cost recorded onthe repurchase of an interest in the Partnership’s general partner andsubordinated Partnership units previously sold to an officer under theParticipation Plan.  The ParticipationPlan has now been accounted for as a compensatory arrangement and payments torepurchase the general partnership interests and subordinated units are appliedagainst the liability recorded for the Participation Plan.

 

**23.**       Accruedliabilities were decreased by $0.2 million primarily as a result of thefollowing restatement adjustments:

 

•                  adecrease of $0.22 million to eliminate deferred income as a result ofaccounting for the Participation Plan as a compensatory arrangement.  Previously the sale of subordinatedpartnership units and interests in the Partnership’s general partner to certainemployees and directors of the Company was incorrectly recorded as a sale of anasset.  The Company recorded deferredincome to the extent the Company had loaned the employees and directors aportion of the purchase price.

•                  adecrease of $0.02 million to reflect the current tax effect of the restatementadjustments.

 

26

----

 

**24.**       Thenon-current deferred income tax liability was decreased by $0.8 million toreflect the tax effect of the restatement adjustments.

 

**25.**       Otherlong-term liabilities were increased by $2.4 million to reflect compensationexpense accrued under the Participation Plan.

 

**26.**       Non-controllinginterest in consolidated subsidiary was decreased by $0.4 million to reflectthe impact of the portion of the restatement adjustments attributable to thenon-controlling interest in MarkWest Energy Partners, and to eliminate theeffect of the subordinated units and general partner interest owned byemployees and directors under the Participation Plan, which were previouslyaccounted for as non-controlling interests. The Participation Plan is now accounted for as a compensatory arrangementand as a result the Company records a separate liability for the fair value of the subordinated units and generalpartner interests held by participants in the Plan.

 

***Three months ended June 30, 2004 Income Statement***

 

**27.**       Revenuesfor the second quarter of 2004 increased by $1.2 million primarily as a resultof the following restatement adjustments:

 

•                  an increase of $0.8 million to correct theamounts recorded for accrued revenue.

•                  an increase of $0.5 million to restate apipeline imbalance credit that was improperly recorded as product costs.

•                  adecrease of $0.1 million to restate the settlement of a commodity derivativefrom interest expense to revenue.

 

**28.**       Purchasedproduct costs for the second quarter of 2004 increased by $1.8 millionprimarily as a result of the following restatement adjustments:

 

•                  anincrease of $1.3 million to correct amounts recorded for accrued product costs.

•                  anincrease of $0.5 million to restate a pipeline imbalance that was improperlyrecorded as product cost.

 

**29.****      **Facilityexpense increased by $0.2 million to record repair expense improperlycapitalized as property, plant and equipment.

 

**30.****      **Selling,general and administrative expenses increased by $0.8 million for the secondquarter of 2004 primarily as a result of the following restatement adjustments:

 

•                  anincrease of $0.7 million to record compensation expense for stock optionsissued as variable awards.  In April 2004,the Company changed its policy to allow participants to exercise their stockoptions using the cashless method.  UnderAPB 25, a fixed stock option plan that permits the use of a cashless exercisebecomes variable if a pattern of exercising stock options using the cashlessmethod is demonstrated.

•                  anincrease of $0.1 million to reflect the compensation expense under theParticipation Plan.

 

**31.**       Depreciationexpense decreased by $0.1 million for the reversal of depreciation expensepreviously recorded on the Blackhawk pipeline.

 

**32.****      **Amortization of intangible assets expenseincreased by $0.03 million to record amortization of a customer contract thatwas acquired with the Blackhawk pipeline.

 

**33.****      **Interest expense decreased by $0.4 millionfor the second quarter of 2004 primarily as a result of the followingrestatement adjustments:

 

27

----

 

•                  adecrease of $0.3 million to reclassify amortization of deferred financing coststo a separate line item on the consolidated income statement.

•                  adecrease of $0.1 million to restate the settlement of a commodity derivativefrom interest expense to revenue.

 

**34.****      **Amortization of deferredfinancing costs increased $0.3 million as a result of reclassifying theamortization of deferred financing costs from interest expense to a separateline item on the consolidated income statement.

 

**35.****      **Dividend income increased by$0.1 million as a result of recording dividends received on marketablesecurities as dividend income. Previously, the dividends received were improperly recorded as areduction to the carrying value of marketable securities.

 

**36.****      **The benefit for income taxeswas decreased by $2.4 million to reflect the tax effect of the restatementadjustments.

 

**37.****      **Non-controllinginterest in consolidated subsidiary was increased by $0.6 million to reflectthe portion of the restatement adjustments attributable to the non-controllinginterest in MarkWest Energy Partners and to eliminate the effect of thesubordinated units and general partner interests held by employees anddirectors under the Participation Plan, which were previously accounted for asnon-controlling interests.  TheParticipation Plan is now accounted for as a compensatory arrangement and as aresult the Company records a separate liability for the fair value of thesubordinated units and general partner interests held by participants in thePlan.

 

***Three months ended June 30, 2003 Income Statement***

 

****38.********      ********Revenues increased by $0.4 million**** to reclassify gas revenuesfrom discontinued operations to continuing operations.  The Company retained its interests in threewells in Michigan, which it originally intended to dispose of in connectionwith the discontinuance of its exploration and production business.

 

****39.********      ********Facility expenses increased by $0.3 million**** to reclassify expenses relatedto the retained exploration and production operations from discontinued operationsto continuing operations.

 

****40.********      ********Selling,general and administrative expenses increased by $0.4 million to reflect thecompensation expense under the Participation Plan.****

 

**41.****      **Depreciationexpense increased by $0.1 million to reclassify expenses related to theretained exploration and production operations from discontinued operations tocontinuing operations.

 

**42.****      **Interestexpense decreased by $0.5 million and the amortization of deferred financingcosts increased by a corresponding amount as a result of reclassifyingamortization of deferred financing costs from interest expense to a separateline item on the consolidated income statement.

 

**43.****      **Otherincome was decreased by $0.1 million primarily as a result of the followingrestatement adjustments:

 

•                  adecrease of $0.2 million to reverse a gain improperly recognized on the sale ofsubordinated partnership units and interests in the Partnership’s generalpartner to certain employees and directors. The Participation Plan has now been accounted for as a compensatoryarrangement.

•                  anincrease of $0.1 million to restate miscellaneous income that was improperlyrecorded as discontinued operations.

 

**44.****      **Theprovision for income taxes was decreased by $4.5 million primarily as a resultof the following restatement adjustments;

 

•                  adecrease of $4.0 million to restate income taxes to an effective rate of 37%.Previously, the Company used an incorrect effective tax rate of (12)%.

•                  andecrease of $0.5 million to reflect the tax effect of the restatement adjustments.

 

28

----

 

**45.**       Non-controllinginterest in consolidated subsidiary was decreased by $0.05 million to reflectthe impact of the portion of the restatement adjustments attributable to thenon-controlling interest in MarkWest Energy Partners and to eliminate theeffect of the subordinated units and general partner interests held byemployees and directors under the Participation Plan, which were previouslyaccounted for as non-controlling interests. The Participation Plan is now accounted for as a compensatoryarrangement and as a result the Company records a separate liability for thefair value of the subordinated units and general partner interests held byparticipants in the Plan.

 

**46.****      **Incomefrom discontinued exploration and production operations was decreased by $4.1million primarily as a result of the following restatement adjustments:

 

•                  adecrease of $4.0 million to restate income taxes attributable to discontinuedoperations using the correct tax rate of 26%. Previously, the Company incorrectly used a tax rate of 6%.

•                  adecrease of $0.1 million to restate miscellaneous income that was improperlyrecorded as discontinued operations.

 

***Six months ended June 30, 2004 Income Statement***

 

**47.****      **Revenues for the six months ended June 30,2004 increased by $1.2 million primarily as a result of the followingrestatement adjustments:

 

•                  anincrease of $0.9 million to correct the amounts recorded for accrued revenue.

•                  anincrease of $0.5 million to restate a pipeline imbalance credit that wasimproperly recorded as product cost.

•                  anincrease of $0.1 million to record natural gas inventory at cost.  Previously the inventory was incorrectlyidentified as a pipeline imbalance and was recorded at market value.

•                  adecrease of $0.1 million to reduce revenue for the proceeds on the Blackhawkpipeline financing lease receivable.

•                  adecrease of $0.1 million to restate the settlement of a commodity hedge frominterest expense to revenue.

•                  adecrease of $0.1 million related to miscellaneous other adjustments.

 

**48.****      **Purchasedproduct costs for the six months ended June 30, 2004 increased by $2.2million primarily as a result of the following restatement adjustments:

 

•                  anincrease of $1.7 million to correct amounts recorded for accrued product costs.

•                  anincrease of $0.5 million to restate an imbalance credit that was improperlyrecorded as product cost.

 

**49.****      **Facilitycosts for the six months ended June 30, 2004 were increased by $0.2million primarily as a result of the following restatement adjustments:

 

•                  a decrease of $0.08 million to correctamounts recorded for accrued property taxes.

•                  an increase of $0.03 million to recordstorage fees related to inventory the Partnership held for sale.

•                  anincrease of $0.22 million to record repair expense improperly capitalized asproperty, plant and equipment.

•                  anincrease of $0.02 related to miscellaneous other adjustments.

 

****50.********      ********Selling,general and administrative expenses increased by $1.6 million for the sixmonths ended June 30, 2004 primarily as a result of the following restatement adjustments:****

 

•                  anincrease of $0.6 million to record compensation expense for stock optionsissued as variable awards.  In April 2004,the Company changed its policy to allow participants to exercise their stockoptions using the cashless method.  UnderAPB 25, a fixed stock option plan that permits the use of a cashless exercisebecomes variable if a pattern of exercising stock options using the cashless methodis demonstrated.

 

29

----

 

•                  anincrease of $0.4 million to record compensation for the modification of stockoptions for two officers who terminated their employment with the Company butwho continued to serve on the Company’s Board of Directors.

****•********                 ********an increase of $0.6million to reflect the compensation expense under the Participation Plan.****

 

**51.**       Depreciationexpense decreased by $0.2 million for the reversal of depreciation expensepreviously recorded on the Blackhawk pipeline.

 

**52.**       Amortizationof intangible assets expense increased by $0.1 million to record amortizationof a customer contract that was acquired with the Blackhawk pipeline.

 

**53.**       Interestexpense decreased by $0.8 million for the second quarter of 2004 primarily as aresult of the following restatement adjustments:

 

•                  adecrease of $0.6 million to reclassify amortization of deferred financing coststo a separate line item on the consolidated income statement.

•                  adecrease of $0.1 million to restate the settlement of a commodity hedge frominterest expense to revenue.

•                  adecrease of $0.1 million related to miscellaneous other adjustments.

 

**54.****      **Amortization of deferredfinancing costs increased by $0.6 million as a result of reclassifyingamortization of deferred financing costs from interest expense to a separateline item on the consolidated income statement.

 

**55.****      **Dividend income increased by$0.1 million as a result of recording dividends received on marketablesecurities as dividend income. Previously, the dividends received were improperly recorded as areduction to the carrying value of marketable securities.

 

**56.****      **Other income decreased by $0.04million to reflect an additional adjustment relating to the financing lease forthe Blackhawk pipeline.

 

**57.****      **The benefit for income taxes wasdecreased by $1.8 million to reflect the tax effect of the restatementadjustments.

 

**58.**       Non-controllinginterest in consolidated subsidiary was decreased by $1.0 million to reflectthe impact of the portion of the restatement adjustments attributable to thenon-controlling interest in MarkWest Energy Partners, and to eliminate theeffect of the subordinated units and general partner interests held byemployees and directors under the Participation Plan, which were previouslyaccounted for as non-controlling interests.   The Participation Plan is now accounted for as a compensatoryarrangement and as a result the Company records a separate liability for thefair value of the subordinated units and general partner interests held byparticipants in the Plan.

 

***Six months ended June 30, 2003 Income Statement***

 

**59.****      ******Revenues increased by $0.9 million**** to reclassify gas revenuesfrom discontinued operations to continuing operations.  The Company retained its interests in threewells in Michigan, which it originally intended to dispose of in connectionwith the discontinuance of its exploration and production business.

 

**60.****      ******Facility expenses increased by $0.5 million**** to reclassify expenses relatedto the retained exploration and production operations from discontinuedoperations to continuing operations.

 

**61.****      **Selling,general and administrative expense increased by $0.5 million to reflect thecompensation expense under the Participation Plan.

 

30

----

 

**62.****      **Depreciationexpense increased by $0.1 million to reclassify expenses related to theretained exploration and production operations from discontinued operations tocontinuing operations.

 

**63.****      **Interestexpense decreased by $0.8 million and amortization of deferred financing costsincreased by a corresponding amount as a result of reclassifying amortizationof deferred financing costs from interest expense to a separate line item onthe consolidated income statement.

 

**64.**       Otherincome was decreased by $0.1 million primarily as a result of the followingrestatement adjustments:

 

•                  adecrease of $0.2 million to reverse a gain improperly recognized on the sale ofsubordinated partnership units and interests in the Partnership’s generalpartner to certain employees and directors.  The Participation Plan has now been accountedfor as a compensatory arrangement.

•                  anincrease of $0.1 million to restate miscellaneous income that was improperlyrecorded as discontinued operations.

 

**65.****      **Thebenefit for income taxes was increased by $4.1 million as a result of thefollowing restatement adjustments:

 

•                  anincrease of $4.0 million to restate income taxes to an effective rate of37%.  Previously, the Company used anincorrect effective tax rate of 9%.

•                  anincrease of $0.2 million to reflect the tax effect of the restatementadjustments.

•                  adecrease of $0.1 million to reclassify expenses related to the retainedexploration and production operations from discontinued operations to continuedoperations.

 

**66.****      **Non-controlling interest inconsolidated subsidiary was increased by $0.1 million to reflect the impact ofthe portion of the restatement adjustments attributable to the non-controllinginterest in MarkWest Energy Partners, and to eliminate the effect of thesubordinated units and general partner interests held by employees anddirectors under the Participation Plan, which were previously accounted for asnon-controlling interests.  TheParticipation Plan is now accounted for as a compensatory arrangement and as aresult the Company records a separate liability for the fair value of thesubordinated units and general partner interests held by participants in thePlan.

 

**67.****      **Incomefrom discontinued exploration and production operations (net of income taxes of$0.4 million) was decreased by $4.2 million primarily as a result of thefollowing restatement adjustments:

 

•                  adecrease of $4.0 million to restate income taxes attributable to discontinuedoperations using the correct tax rate of 26%. Previously the Company incorrectly used a tax rate of 10%.

•                  adecrease of $0.1 million to restate miscellaneous income that was improperlyrecorded as discontinued operations.

•                  adecrease of $0.1 million to reclassify income related to the retainedexploration and production operations from discontinued operations to continuedoperations.

 

***Six months ended June 30, 2004 Cash Flow Statement***

 

**68.****      **Net cash provided by operating activities increasedby $0.54 million to adjust obligationsfor construction projects in process, to reflect a portion of amounts receivedunder the lease for the Blackhawk pipeline as payments on the financing leasereceivable, to reflect the capitalization of interest expense, to record repairexpense improperly capitalized as property, plant and equipment, to reclassifythe contribution of treasury shares to the 401(k) benefit plan from financingactivities to operating activities, to reflect dividends received on marketablesecurities as income, to reflect the repurchase of membership interests in thePartnership’s general partner and subordinated units in the Partnership from arelated party as an operating activity and to adjust the distributions paid todirectors and officers under the Participation Plan from financing activitiesto operating activities.

 

31

----

 

**69.**       Net cash used in investing activities increased by$0.7 million to adjust obligationsfor construction projects in process, to reflect a portion of amounts receivedunder the lease for the Blackhawk pipeline as payments on the financing leasereceivable, to reflect for the capitalization of interest expense, to recordrepair expense improperly capitalized as property, plant and equipment and toreflect dividends received on marketable securities as income.

 

**70.**       Netcash used in financing activities decreased by $0.16 million to reflect therepurchase of membership interests in the Partnership’s general partner andsubordinated units in the Partnership from a related party as an operatingactivity, to reclassify the contribution of treasury shares to the 401(k)benefit plan from financing activities to operating activities and to reflectthe distributions paid to directors and officers under the Participation Planas an operating activity.

 

***Six months ended June 30, 2003 Cash Flow Statement***

 

**71.****      **Netcash provided by operating activities increased by $0.3 million to reflect thesale of membership interests in the Partnership’s general partner andsubordinated units in the Partnership from a related party as an operatingactivity, to reclassify the contribution of treasury shares to the 401(k)benefit plan from financing activities to operating activities and to reflectthe distributions paid to directors and officers under the Participation Planas an operating activity.

 

**72.****      **Netcash used in investing activities increased by $0.2 million to reflect the saleof membership interests in the Partnership’s general partner and subordinatedunits in the Partnership from a related party as an operating activity.

 

**73.****      **Netcash provided by financing activities decreased by $0.1 million to reclassifythe contribution of treasury shares to the 401(k) benefit plan from financingactivities to operating activities and to reflect the distributions paid todirectors and officers under the Participation Plan as an operating activity.

 

**74. **Cashpaid for interest, under supplemental cash flow information, was increased by$0.2 million to properly state cash paid for interest.

 

32

----

 

##### **Item 2.   Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

##### ** **

OnApril 11, 2005, management, after discussion with the Audit Committee ofour Board of Directors, determined that previously issued financial statementsfor the years ended December 31, 2002 and 2003 and for each of the firstthree quarters of 2003 and 2004 should be restated to reflect compensationexpense for the sale of subordinated partnership units and interests in thePartnership’s general partner to certain employees and directors of the Companythat occurred during 2002, 2003 and 2004. Inaddition, certain other restatement adjustments have also been recorded tocorrect other errors in the consolidated financial statements, includingadjustments to accruals for revenue and purchased product costs, adjustmentsfor cost improperly capitalized as property, plant and equipment, adjustmentsto properly record capitalized interest on major construction projects inprocess, adjustments to record as a financing lease, a lease agreement previouslyentered into by an acquired business, an adjustment to record natural gasinventory at cost, an adjustment to reflect separately restricted marketablesecurities, adjustments for dividends received on marketable securitiesimproperly recorded as a reduction in the carrying value of marketablesecurities and adjustments to accrued property taxes.  Adjustments were also made to recordcompensation expense as a result of the modification of the provisions of certainstock options for two officers who terminated their employment with the Companybut who continued to serve on its Board of Directors.  Compensation expense was also recorded forstock options issued as variable awards. In April 2004, the Company changed its policy to allow participantsto exercise their stock options using the cashless exercise method.  Under APB 25, *Accounting for Stock Issued to Employees,* a fixed stockoption plan that permits the use of a cashless exercise becomes variable if apattern of exercising stock options using the cashless method isdemonstrated.  Additionally, the Companymade an adjustment to reclassify a portion of dividends paid during the sixmonths ended March 31, 2004 from retained earnings to additional paid incapital for the amount of the dividends distributed in excess of accumulatedearnings.

 

In addition, on October 28, 2004, theCompany’s Board of Directors declared a stock dividend of one share of MarkWestHydrocarbon’s common stock for each ten shares owned by stockholders.  The stock dividend was paid on November 19,2004.  Common stock information in the Form 10Q/Ahas been restated to give retroactive effect to stock dividend paid. Other lesssignificant adjustments and reclassifications were identified and recorded inconjunction with the restatement process.

 

Referto Note 11, *Restatement andReclassifications of Consolidated Financial Statements*, to theConsolidated Financial Statements in Part 1, Item 1 of this Form 10-Q/Afor further information regarding the restatement of our previously issuedfinancial statements.

 

##### **ManagementOverview of the Three and Six Months Ended June 30, 2004**

##### ** **

 Wereported a net loss for the three months ended June 30, 2004 of $6.4million, or $0.60 per diluted share, compared to net income of $10.0 million,or $0.97 per diluted share, for the second quarter of 2003.  For the six months ended June 30, 2004,the Company reported a net loss of $5.7 million, or $0.53 per diluted share,compared to net income of $8.6 million, or $0.84 per diluted share, for the sixmonths ended June 30, 2003.

 

The decrease in results from 2003 to 2004primarily relates to the sale of most of the Company’s San Juan Basinproperties on June 30, 2003 for a pretax gain of $19.7 million.

 

The Company reported a net loss fromcontinuing operations of $6.4 million, or $0.60 per diluted share, for thethree months ended June 30, 2004, compared to a net loss from continuingoperations of $6.0 million, or $0.58 per diluted share, for the second quarterof 2003.  For the six months ended June 30,2004, the Company reported a net loss from continuing operations of $5.7million, or $0.53 per diluted share, compared to a net loss from continuingoperations of $9.5 million, or $0.92 per diluted share, for the same periodlast year.

 

On July 22, 2004, the board of directorsof the Company declared a cash dividend of $0.025 per share of its common stockpayable on August 19, 2004 to the stockholders of record as of the closeof business on August 5, 2004. Consistent with the board’s objective to maintain a regular quarterlydividend, this is the second consecutive dividend declared in 2004.  However, any such future declaration will bedependent upon the financial performance of the Company.

 

33

----

 

In addition, on July 30, 2004, MarkWestEnergy Partners expanded its midstream business by completing the acquisitionof American Central East Texas Gas Company, L.P.’s Carthage gathering systemand gas processing assets for approximately $240.7 million.  The acquisition was funded with a combinationof private equity and interim debt financing. Consistent with its long-term strategy of maintaining adebt-to-total-capital ratio of less than 50%, the Partnership intends in thenear term to replace the interim debt financing with additional equity andlong-term debt financing.  The Carthagegathering system offers both low- and high-pressure service to producers in theCarthage Field, gathering gas from the Cotton Valley, Pettit and Travis Peakformations.  The system consists ofapproximately 180 miles of pipeline connected to approximately 1,700 wells withan additional 82 miles of pipeline currently under construction.  The gathering system also includesapproximately 65,000 horsepower of compression with an additional 35,000horsepower currently being installed. Current system through put is approximately 245 MMcf/d and isanticipated to increase to approximately 255 MMcf/d by the end of 2004.  The gathering system has a capacity ofapproximately 350 MMcf/d.

 

## **Our Business**

 

We were foundedin 1988 as a partnership and later incorporated in Delaware.  We completed our initial public offering in1996.

 

We are anenergy company primarily focused on growing the value of our investment inMarkWest Energy Partners, L.P., a publicly-traded master limited partnershipengaged in the gathering, processing and transmission of natural gas, thetransportation, fractionation and storage of natural gas liquids (“NGLs”) andthe gathering and transportation of crude oil. We also market NGLs and naturalgas. We discontinued our exploration and production activities during 2003.

 

Our assets consist almost entirely ofpartnership interests in MarkWest Energy Partners.  As of June 30, 2004, our partnershipinterests consisted of the following:

 

•                  2,469,496subordinated units, representing a 35% limited partner interest in thePartnership; and

•                  A90% ownership interest in MarkWest Energy GP, L.L.C., the general partner ofthe Partnership, which owns a 2% general partner interest and all of the incentivedistribution rights in the Partnership.

 

The Company’s operations are classified intotwo reportable segments;

 

(1)          Managing MarkWest Energy– The Company operates MarkWest Energy, a publicly traded limited partnershipengaged in the gathering, processing and transmission of natural gas, thetransportation, fraction and storage of natural gas liquids, and the gatheringand transpiration of crude oil.

(2)          Marketing – The Companysells its equity and third party NGLs, purchases third-party natural gas andsells its equity and third-party natural gas. Since February 2004, the Company is also engaged in the wholesalemarketing of propane.

 

During 2003, the Company discontinued it’sexploration and production business segment.

 

To better understand our business and theresults of operations discussed below, it is important to have an understandingof three factors:

 

•                  Thenature of our relationship with MarkWest Energy Partners;

•                  Thenature of the contracts from which we derive our revenues and from whichMarkWest Energy Partners derives its revenues; and

•                  Thecomparability within our results of operations across periods because ofMarkWest Energy Partners significant and recent acquisition activity.

 

34

----

 

***OurRelationship with MarkWest Energy Partners***

 

We spun off the majority of our then-existingnatural gas gathering and processing and NGL transportation, fractionation andstorage assets into MarkWest Energy Partners in May 2002, just before thePartnership completed its initial public offering. At the time of its formationand initial public offering, we entered into four contracts with MarkWestEnergy Partners whereby MarkWest Energy Partners provides midstream services inAppalachia in exchange for a fee. Additionally, MarkWest Energy Partnersreceives 100% of all fee and percent-of-proceeds consideration for the first 10MMcf/d that it gathers and processes in Michigan. MarkWest Hydrocarbon retainsa 70% net profits interest in the gathering and processing income earned onquarterly pipeline throughput in excess of 10 MMcf/d. In accordance withgenerally accepted accounting principles, MarkWest Energy Partners’ financialresults are included in our consolidated financial statements.  All intercompany accounts and transactionsare eliminated during consolidation.

 

As a result ofour contracts with MarkWest Energy Partners mentioned above, we are thePartnership’s largest customer, accounting for 22% of its revenues and 43% ofits gross margin for the six months ended June 30, 2004. We expect we willaccount for less of MarkWest Energy Partners’ business in the future as itcontinues to acquire assets and increase its customer and businessdiversification.

 

Also at the time of the initial publicoffering, we entered into an Omnibus Agreement with MarkWest Energy Partnersand related parties that governs potential competition and indemnificationobligations among the parties.

 

Through our majority ownership in thePartnership’s general partner, we control and operate MarkWest Energy Partners.Our employees are responsible for conducting the Partnership’s business andoperating its assets pursuant to a Services Agreement, which was formalizedeffective January 1, 2004. We receive $5,000 annually from MarkWest EnergyPartners for services provided under the Services Agreement. We also arereimbursed for any reasonable costs incurred in the operation of thePartnership.

 

***OurContracts***

 

Excluding the revenues and gross margin(defined as revenues less purchased product costs) derived by MarkWest EnergyPartners, we generate the majority of our revenues and gross margin from themarketing of NGLs and, to a lesser extent, natural gas. As compensation forproviding processing services to our Appalachian producers (we have sinceoutsourced these services to MarkWest Energy Partners as discussed below), weearn a fee and receive title to the NGLs produced. In return, we are requiredto replace, in dry natural gas, the Btu value of the NGLs extracted. This Btureplacement obligation is referred to in the industry as a “keep-whole”arrangement. In keep-whole arrangements, our principal cost is the replacementof the Btus extracted from the gas stream in the form of NGLs or consumed asfuel during processing with dry gas of an equivalent Btu content. The spreadbetween the NGL product sales price and the purchase price of natural gas withan equivalent Btu content is called the “frac spread.” Generally, the fracspread and, consequently, the operating margins are favorable under thesecontracts. In the event natural gas becomes more expensive on a Btu equivalentbasis than NGL products, the cost of keeping the producer “whole” results inoperating losses.

 

At the closing of MarkWest Energy Partners’initial public offering on May 24, 2002, we outsourced our midstreamservices to the Partnership. Pursuant to the terms of the operating agreements,we retained all the benefits and associated risks of our keep-whole contractswith producers. Our NGL and gas marketing operations were retained by us andnot contributed to MarkWest Energy Partners.

 

Our keep-whole contracts expose us tocommodity price risk, both on the sales side (of NGLs) and on the purchase side(of natural gas), which may increase the volatility of our marketing resultsand cash flows. We attempt to mitigate our commodity price risk through ourhedging program. Under a hedging strategy implemented approximately two yearsago that was based on our then-existing natural gas production and historicalpricing data through that point in time, we incurred significant hedginglosses. For the six months ended June 30, 2004 and 2003, we lostapproximately $2.7 million and $8.2 million, respectively, as a result of thathedging strategy.  The last transactionsassociated with this hedging strategy settled in April 2004.

 

35

----

 

### ***MarkWest Energy Partners’ Contracts***

 

The Partnership generates the majority of itsrevenues and gross margin (defined as revenues less purchased product costs)from natural gas gathering, processing and transmission, NGL transportation,fractionation and storage, and crude oil gathering and transportation. Whileall of these services constitute midstream energy operations, the Partnershipprovides its services pursuant to four different types of contracts.

 

•                  *Fee-based contracts.*  Under fee-based contracts, the Partnershipreceives a fee or fees for one or more of the following services: gathering,processing, and transmission of natural gas, transportation, fractionation andstorage of NGLs, and gathering and transportation of crude oil. The revenueMarkWest Energy Partners earns from these contracts is generally directlyrelated to the volume of natural gas, NGLs or crude oil that flows through itssystems and facilities and is not directly dependent on commodity prices. Incertain cases, the Partnership’s contracts provide for minimum annual paymentsby our customers. To the extent a sustained decline in commodity prices resultsin a decline in volumes, however, the Partnership’s revenues from thesecontracts would be reduced.

 

•                  *Percent-of-proceeds contracts.*  Under percent-of-proceeds contracts, MarkWestEnergy Partners generally gathers and processes natural gas on behalf ofproducers, sells the resulting residue gas and NGLs at market prices and remitsto producers an agreed upon percentage of the proceeds based on an index price.In other cases, instead of remitting cash payments to the producer, thePartnership delivers an agreed upon percentage of the residue gas and NGLs tothe producer and sells the volumes it keeps to third parties at market prices.Under these types of contracts, MarkWest Energy Partners’ revenues and grossmargins increase as natural gas prices and NGL prices increase, and itsrevenues and gross margins decrease as natural gas prices and NGL pricesdecrease.

 

•                  *Percent-of-index contracts.*  Under percent-of-index contracts, thePartnership generally purchases natural gas at either (1) a percentagediscount to a specified index price, (2) a specified index price less afixed amount or (3) a percentage discount to a specified index price lessan additional fixed amount. MarkWest Energy Partners then gathers and deliversthe natural gas to pipelines where it resells the natural gas at the indexprice, or at a different percentage discount to the index price. With respectto (1) and (3) above, the gross margins the Partnership realizesunder the arrangements decrease in periods of low natural gas prices becausethese gross margins are based on a percentage of the index price. Conversely,MarkWest Energy Partners’ gross margins increase during periods of high naturalgas prices.

 

•                  *Keep-whole contracts.*  Under keep-whole contracts, the Partnershipgathers natural gas from the producer, processes the natural gas and sells theresulting NGLs to third parties at market prices. Because the extraction of theNGLs from the natural gas during processing reduces the Btu content of thenatural gas, MarkWest Energy Partners must either purchase natural gas atmarket prices for return to producers or make cash payment to the producersequal to the value of this natural gas. Accordingly, under these arrangements,the Partnership’s revenues and gross margins increase as the price of NGLsincreases relative to the price of natural gas, and its revenues and grossmargins decrease as the price of natural gas increases relative to the price ofNGLs.

 

Inits current areas of operations, MarkWest Energy Partners has a combination ofcontract types, including limited keep-whole arrangements. The only keep-wholecontracts of MarkWest Energy Partners are associated with the Arapahoprocessing plant that were assumed as a part of its December 2003 Oklahomaacquisition.  At the Arapaho processingplant inlet, the Btu content of the natural gas meets the downstream pipelinespecifications, however, MarkWest Energy Partners has the option of extractingNGLs when the processing margin environment is favorable.  In addition, approximately half, as measuredin volumes, of the related gas gathering contracts include additional fees tocover plant operating costs, fuel costs and shrinkage costs in a low processingmargin environment.  Because of itsability to operate the plant in several recovery modes, including turning itoff, coupled with the additional fees provided

 

36

----

 

for in the gas gathering contracts, thePartnership’s overall keep-whole contract exposure is limited to a portion ofthe operating costs of the plant.

 

In many cases, MarkWest Energy Partnersprovides services under contracts that contain a combination of more than oneof the arrangements described above. The terms of its contracts vary based ongas quality conditions, the competitive environment at the time the contractsare signed and customer requirements. The Partnership’s contract mix and,accordingly, its exposure to natural gas and NGL prices, may change as a resultof changes in producer preferences, its expansion in regions where some typesof contracts are more common and other market factors. Any change in mix mayimpact MarkWest Energy Partners’ financial results.

 

***RecentMarkWest Energy Partners Acquisition Activity***

 

In reading the discussion of our historicalresults of operations, you should be aware of MarkWest Energy Partners’ recentsignificant acquisitions, which impact the comparability of our results ofoperations for the periods discussed.

 

From its initial public offering through June 30,2004, the Partnership has completed five acquisitions for an aggregate purchaseprice of approximately $112.3 million. These five acquisitions include:

 

•                  ThePinnacle acquisition, which closed on March 28, 2003, for consideration of$38.5 million;

•                  TheLubbock pipeline acquisition (also known as the Power-Tex Lateral pipeline),which closed September 2, 2003, for consideration of $12.2 million;

•                  Thewestern Oklahoma acquisition, which closed December 1, 2003, forconsideration of $38.0 million;

•                  TheMichigan Crude Pipeline acquisition, which closed December 18, 2003, forconsideration of $21.3 million; and

•                  TheHobbs Lateral acquisition, which closed on April 1, 2004, forconsideration of $2.3 million.

 

Thefirst acquisition closed during the last few days of the first quarter of2003.  Three acquisitions closed duringthe second half of 2003 and one acquisition closed in the second quarter of2004.  Accordingly, our historicalresults of operations for the six months ended June 30, 2003, save forthree months of activity from the Partnership’s Pinnacle acquisition, do notreflect the impact of these acquisitions on our operations.  However, our results of operations for thethree and six months ended June 30, 2004, do reflect the impact from thePartnership’s four 2003 acquisitions.

 

37

----

 

##### **Results of Operations**

 

***Operating Data***

 
| ** **                                    | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|
| ** **                                    | ** ** | **2004**                              | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Marketing**                                 |       |                                  |       |                               |       |   |   |   |   |
| NGL product sales-Siloam plant (gallons)      |       | 35,700,000                            |       | 30,900,000                         |       | 87,200,000 |   | 84,900,000 |   |
|                                          |       |                                  |       |                               |       |   |   |   |   |
| **MarkWest Energy Partners**                  |       |                                  |       |                               |       |   |   |   |   |
| Appalachia:                                   |       |                                  |       |                               |       |   |   |   |   |
| Natural gas  processed (Mcf/d) (1)       |       | 197,000                               |       | 189,000                            |       | 202,000 |   | 196,000 |   |
| NGLs  fractionated (Gal/d)                    |       | 480,000                               |       | 391,000                            |       | 469,000 |   | 418,000 |   |
| Michigan:                                     |       |                                  |       |                               |       |   |   |   |   |
| Natural gas  volumes transported (Mcf/d)      |       | 12,200                                |       | 14,500                             |       | 13,000 |   | 14,900 |   |
| NGL product  sales (gallons)                  |       | 2,390,000                             |       | 2,917,000                          |       | 5,103,000 |   | 5,859,000 |   |
| Crude oil  transported (Bbl/d) (2)       |       | 14,700                                |       | —                             |       | 14,700 |   | — |   |
| Southwest:                                    |       |                                  |       |                               |       |   |   |   |   |
| Gathering  system throughput (Mcf/d) (3) |       | 103,900                               |       | 44,600                             |       | 100,900 |   | NM |   |
| Lateral  pipeline throughput (Mcf/d) (4) |       | 119,300                               |       | —                             |       | 74,100 |   | — |   |
| NGL product  sales (gallons) (5)              |       | 8,317,000                             |       | —                             |       | 16,512,000 |   | — |   |

 

----

NM – Not meaningful.

(1)          Includes throughput from the Kenova, Cobb, and Boldman processing plants.

(2)          The Partnership acquired its Michigan Crude Pipeline in December 2003.

(3)          Includes volumes from the Partnership’s Pinnacle gathering systems, whichwere acquired in late March 2003, and its Foss Lake (OK) gathering system,which was acquired in December 2003.

(4)          Includes volumes from the Partnership’s Power-Tex Lateral pipeline, whichwas acquired in September 2003, and our Hobbs Lateral pipeline, which wasacquired in April 2004. The Power-Tex and Hobbs Lateral pipelines are theonly laterals the Partnership own that produce revenue on aper-unit-of-throughput basis. MarkWest Energy Partners receives a flat fee fromthe other three lateral pipelines it owned during the first and second quartersof 2004 and, therefore, the throughput data from these lateral pipelines isexcluded from this statistic.

(5)          Includes sales from the Partnership’s Arapaho (OK) processing plant,which was acquired in December 2003.

 

38

----

 

***Three Months EndedJune 30, 2004 Compared to the Three Months Ended June 30, 2003***

 
| ** **                                    | ** ** | **Marketing**      | ** ** | **MarkWest  Energy  Partners** | ** ** | **Eliminating  Entries** | ** ** | **Total**  | ** ** |
|-----------------------------------------------|------------|--------------------|------------|--------------------------------|------------|--------------------------|------------|------------|------------|
| ** **                                    | ** ** | **(in thousands)** | ** ** |
| **Three Months Ended June 30, 2004(1):** | ** ** | ** **         | ** ** | ** **                     | ** ** | ** **               | ** ** | ** ** | ** ** |
| Revenues                                      |       | $                  | 37,284     |                           | $          | 65,659                   |       | $          | (13,919    | ) | $ | 89,024 |   |
|                                          |       |               |       |                           |       |                     |       |       |       |
| Purchased product costs                       |       | 35,620             |       | 49,371                         |       | (7,729                   | )          | 77,262     |       |
| Facility expenses                             |       | 5,839              |       | 6,326                          |       | (6,190                   | )          | 5,975      |       |
| Depreciation                                  |       | 356                |       | 3,301                          |       | —                   |       | 3,657      |       |
| Amortization of intangible assets             |       | —             |       | 34                             |       | —                   |       | 34         |       |
| Total segment  operating expenses             |       | 41,815             |       | 59,032                         |       | (13,919                  | )          | 86,928     |       |
|                                          |       |               |       |                           |       |                     |       |       |       |
| Segment operating income (loss)               |       | $                  | (4,531     | )                              | $          | 6,627                    |       | $          | —     |   | $ | 2,096 |   |
|                                          |       |               |       |                           |       |                     |       |       |       |
| **Three Months Ended June 30, 2003(1):** |       |               |       |                           |       |                     |       |       |       |
| Revenues                                      |       | $                  | 28,865     |                           | $          | 29,636                   |       | $          | (10,260    | ) | $ | 48,241 |   |
|                                          |       |               |       |                           |       |                     |       |       |       |
| Purchased product costs                       |       | 30,585             |       | 18,423                         |       | (4,651                   | )          | 44,357     |       |
| Facility expenses                             |       | 5,115              |       | 5,167                          |       | (5,609                   | )          | 4,673      |       |
| Depreciation                                  |       | 238                |       | 1,860                          |       | —                   |       | 2,098      |       |
| Total  segment operating expenses             |       | 35,938             |       | 25,450                         |       | (10,260                  | )          | 51,128     |       |
|                                          |       |               |       |                           |       |                     |       |       |       |
| Segment operating income (loss)               |       | $                  | (7,073     | )                              | $          | 4,186                    |       | $          | —     |   | $ | (2,887 | ) |

 
| ** **                                                                                       | ** ** | **Three Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                       | ** ** | **2004****(1)**                       | ** ** | **2003****(1)** | ** ** |
| ** **                                                                                       | ** ** | **(in thousands)**                    | ** ** |
| Segment  operating income (loss)                                                                 |       | $                                     | 2,096      |   | $ | (2,887 | ) |
| Selling,  general and administrative expenses                                                    |       | (5,070                                | )          | (3,766 | ) |
| Interest  expense, net                                                                           |       | (702                                  | )          | (1,494 | ) |
| Amortization  of deferred financing costs                                                        |       | (307                                  | )          | (504 | ) |
| Dividend  income                                                                                 |       | 83                                    |       | — |   |
| Other  expense                                                                                   |       | (31                                   | )          | — |   |
| Loss before  non-controlling interest in net income of consolidated subsidiary and income  taxes |       | $                                     | (3,931     | ) | $ | (8,651 | ) |

 

----

(1)          As restated.  See Note 11, *Restatementand Reclassifications of Consolidated Financial Statements*, to Notesto the Consolidated Financial Statements.

 

*Marketing.*Our marketing segmentoperating loss was $4.5 million for the three months ended June 30, 2004,compared to $7.1 million for the three months ended June 30, 2003, adecrease of $2.6 million. The decrease is partially attributable to a $1.2million reduction in our hedging losses. The remainder of the change is primarily attributable to marketinginitiatives which maximized storage and other transactional opportunitiesafforded by a more favorable NGL market environment.

 

*MarkWest Energy Partners.*Segment operating income from MarkWestEnergy Partners was $6.6 million for the three months ended June 30, 2004,compared to $4.2 million for the three months ended June 30, 2003, anincrease of $2.4 million, or 57%. The increase is primarily attributable to thePartnership’s 2003 acquisitions.

 

*Selling,*g*eneral and administrative expenses.* Selling, general andadministrative expenses were $5.1 million for the three months ended June 30,2004, compared to $3.8 million for the three months ended June 30, 2003,an increase of $1.3 million, or 34%.  Theincrease is attributable to several factors, including increased back officecosts

 

39

----

 

associated with the growth of MarkWest Energy Partners, compensationexpense associated with the Participation Plan, compliance costs, compensationexpense associated with the modification of certain stock options, compensationexpense for stock options accounted for as variable awards (the Company changeda policy to allow for the cashless exercise of stock options), bonus and profitsharing (bonus was not accrued during the three months ended June 30,2003) and severance.

 

*Interest expense, net.*  Interest expense, net was $0.7 million forthe three months ended June 30, 2004, compared to $1.5 million for thethree months ended June 30, 2003, a decrease of $0.8 million, or 53%. Thedecrease was principally attributable to a reduction of average outstandingconsolidated debt levels.  Additionally,we generated $0.2 million in interest income during the three months ended June 30,2004, compared to less than $0.1 million for the three months ended June 30,2003.

 

*Income**from discontinued operations.*Income from discontinuedoperations was $16.0 million for the three months ended June 30, 2003. Theamounts recorded for discontinued operations was a result of the sale ofsubstantially all of our U.S. exploration and production business near the endthe second quarter of 2003.

 

***Six Months Ended June 30,2004, Compared to the Six Months Ended June 30, 2003***

 
| ** **                                  | ** ** | **Marketing**      | ** ** | **MarkWest  Energy  Partners** | ** ** | **Eliminating  Entries** | ** ** | **Total**  | ** ** |
|---------------------------------------------|------------|--------------------|------------|--------------------------------|------------|--------------------------|------------|------------|------------|
| ** **                                  | ** ** | **(in thousands)** | ** ** |
| **Six Months Ended June 30, 2004(1):** | ** ** | ** **         | ** ** | ** **                     | ** ** | ** **               | ** ** | ** ** | ** ** |
| Revenues                                    |       | $                  | 81,677     |                           | $          | 129,484                  |       | $          | (28,437    | ) | $ | 182,724 |   |
|                                        |       |               |       |                           |       |                     |       |       |       |
| Purchased product costs                     |       | 71,471             |       | 97,224                         |       | (15,945                  | )          | 152,750    |       |
| Facility expenses                           |       | 11,937             |       | 12,616                         |       | (12,492                  | )          | 12,061     |       |
| Depreciation                                |       | 739                |       | 6,446                          |       | —                   |       | 7,185      |       |
| Amortization of intangible assets           |       | —             |       | 68                             |       | —                   |       | 68         |       |
| Total  segment operating expenses           |       | 84,147             |       | 116,354                        |       | (28,437                  | )          | 172,064    |       |
|                                        |       |               |       |                           |       |                     |       |       |       |
| Segment operating income (loss)             |       | $                  | (2,470     | )                              | $          | 13,130                   |       | $          | —     |   | $ | 10,660 |   |
|                                        |       |               |       |                           |       |                     |       |       |       |
| **Six Months Ended June 30, 2003(1):** |       |               |       |                           |       |                     |       |       |       |
| Revenues                                    |       | $                  | 76,064     |                           | $          | 47,329                   |       | $          | (23,921    | ) | $ | 99,472 |   |
|                                        |       |               |       |                           |       |                     |       |       |       |
| Purchased product costs                     |       | 75,795             |       | 26,815                         |       | (12,250                  | )          | 90,360     |       |
| Facility expenses                           |       | 11,472             |       | 9,504                          |       | (11,671                  | )          | 9,305      |       |
| Depreciation                                |       | 495                |       | 3,205                          |       | —                   |       | 3,700      |       |
| Total  segment operating expenses           |       | 87,762             |       | 39,524                         |       | (23,921                  | )          | 103,365    |       |
|                                        |       |               |       |                           |       |                     |       |       |       |
| Segment operating income (loss)             |       | $                  | (11,698    | )                              | $          | 7,805                    |       | $          | —     |   | $ | (3,893 | ) |

 

40

----

 
| ** **                                                                                       | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                       | ** ** | **2004****(1)**                    | ** ** | **2003****(1)** | ** ** |
| ** **                                                                                       | ** ** | **(in thousands)**                 | ** ** |
| Segment  operating income (loss)                                                                 |       | $                                  | 10,660     |   | $ | (3,893 | ) |
| Selling,  general and administrative expenses                                                    |       | (10,385                            | )          | (6,390 | ) |
| Interest  expense, net                                                                           |       | (1,697                             | )          | (2,248 | ) |
| Amortization  of deferred financing costs                                                        |       | (614                               | )          | (813 | ) |
| Dividend  income                                                                                 |       | 83                                 |       | — |   |
| Other  expense                                                                                   |       | (5                                 | )          | (16 | ) |
|                                                                                             |       |                               |       |   |   |
| Loss before  non-controlling interest in net income of consolidated subsidiary and income  taxes |       | $                                  | (1,958     | ) | $ | (13,360 | ) |

 

----

(1)          As restated.  See Note 11, *Restatementand Reclassifications of Consolidated Financial Statements*, to Notesto the Consolidated Financial Statements.

 

*Marketing.*Our marketing segmentoperating loss was $2.5 million for the six months ended June 30, 2004,compared to a loss of $11.7 million for the six months ended June 30,2003, a decrease of $9.2 million, or 79%. Approximately $5.4 million of thechange was attributable to a reduction in our hedging losses.  The remainder of the change is primarily attributableto marketing initiatives which maximized storage and other transactionalopportunities afforded by a more favorable NGL market environment.

 

*MarkWest Energy Partners.*Segment operating income from MarkWestEnergy Partners was $13.1 million for the six months ended June 30, 2004,compared to $7.8 million for the six months ended June 30, 2003, anincrease of $5.3 million, or 68%. The increase is primarily attributable to thePartnership’s 2003 acquisitions.

 

*Selling,*g*eneral and administrative expenses.* Selling, general andadministrative expenses were $10.4 million for the six months ended June 30,2004, compared to $6.4 million for the six months ended June 30, 2003, anincrease of $4.0 million, or 63%. The increase is attributable to increased backoffice costs associated with the growth of MarkWest Energy Partners,compensation expense associated with the Participation Plan, compensationexpense associated with the modification of certain stock options, compensationexpense for stock options issued as variable awards (the Company changed apolicy to allow for the cashless exercise of stock options), compliance costs,bonus and profit sharing (a bonus was not accrued during the six months ended June 30,2003), and severance.

 

*Interest expense, net.* Interest expense, net was $1.7 millionfor the six months ended June 30, 2004, compared to $2.2 million for thesix months ended June 30, 2003, a decrease of $0.5 million, or 23%. Thedecrease was principally attributable to a reduction of average outstandingconsolidated debt levels.  Additionally,we generated $0.4 million in interest income during the six months ended June 30,2004, compared to less than $0.1 million for the six months ended June 30,2003.

 

*Income**from discontinued operations.*Income from discontinuedoperations was $18.1 million for the six months ended June 30, 2003. Theamounts recorded for discontinued operations was a result of the sale ofsubstantially all of our U.S. exploration and production business near the endthe second quarter of 2003.

 

41

----

 

**Liquidity and Capital Resources**

 

During 2003, wediscontinued our exploration and production activities and sold all of ourrelated Canadian oil and gas properties and substantially all of our U.S. oiland gas properties.  The sales netted us$106.7 million in cash.  The proceedswere primarily used to pay off and terminate our existing credit facility inits entirety in December 2003. We also had $36.3 million in unrestrictedcash on hand at December 31, 2003. As a result, exclusive of MarkWestEnergy Partners’ debt, we had no debt as of June 30, 2004 and December 31,2003. In February 2004, we disbursed approximately $4.8 million to pay aspecial one-time dividend of $0.50 per share to our common stockholders. In May 2004,we disbursed approximately $0.2 million to pay the first quarterly dividend of$0.025 per common share to our common shareholders. On July 22, 2004, ourboard of directors declared a dividend of $0.025 per common share to be paid August 19,2004, to stockholders of record as of the close of business on August 5,2004.

 

Going forward,we expect MarkWest Hydrocarbon’s primary sources of liquidity to be quarterlydistributions received from MarkWest Energy Partners and cash flows generatedprincipally from the marketing of natural gas and NGLs.

 

We own 90.2% of the general partner ofMarkWest Energy Partners.  The generalpartner of MarkWest Energy Partners owns a 2% general partner interest and allof the incentive distribution rights in MarkWest Energy Partners.  The incentive distribution rights entitle usto receive an increasing percentage of cash distributed by the Partnership uponattainment of target distribution levels. Specifically, they entitle us toreceive 13.0% of all cash distributed in a quarter after each unit has received$0.55 for that quarter, 23.0% of all cash distributed after each unit hasreceived $0.625 for that quarter and 48.0% of all cash distributed after eachunit has received $0.75 for that quarter. For the six months ended June 30,2004, we received $3.4 million in distributions for our subordinated units, andthe general partner received $0.5 million, including $0.4 million representingpayments on incentive distribution rights. If the Partnership continues to growand increase its quarterly distributions per limited partner unit, we expectour distributions to increase accordingly.

 

Cash flowsgenerated from our marketing operations are subject to volatility primarily inNGLs and natural gas prices.  Our cashflows are enhanced in periods when the prices received for NGLs exceed theprices paid for natural gas we purchase to satisfy our “keep-whole” contractualarrangements in Appalachia, and are reduced in periods when the prices receivedfor NGLs are low relative to the price of natural gas we purchase to satisfysuch contractual arrangements. Under “keep-whole” contracts, we retain and sellthe NGLs produced in our processing operations for third-party producers, andthen reimburse or “keep whole” the producers for the Btu content of the NGLsremoved through the re-delivery to the producers of an equivalent amount (on aBtu basis) of dry natural gas. Generally, the frac spread and, consequently,the operating margins, are favorable. Periodically, when natural gas becomesmore expensive, on a Btu equivalent basis, than NGL products, the cost ofkeeping the producer “whole” can result in operating losses. We, however,cannot predict with any certainty what the pricing environment will be in thefuture.

 

We believe that cash on hand, cash receivedfrom quarterly distributions (including the incentive distribution rights) fromMarkWest Energy Partners, and cash generated from our marketing operations willbe sufficient to meet our working capital requirements and fund our requiredcapital expenditures for the foreseeable future. Most of our future capitalexpenditures are discretionary and minimal in nature.  During 2004, MarkWest Hydrocarbon hasbudgeted $1.7 million for our contribution to the Cobb plant replacement and anadditional $0.3 million for other miscellaneous projects.  Cash generated from our marketing operationswill depend on our operating performance, which will be affected by prevailingcommodity prices and other factors, some of which are beyond our control.

 

In an effort toincrease our liquidity, we may seek to establish a bank credit facility andrenegotiate certain keep-whole contracts in order to reduce our commodity pricerisk.

 

42

----

 

***MarkWestEnergy Partners***

 

The Partnership expects to finance futureacquisitions through a combination of debt and issuance of additional units, asis common practice with master limited partnerships.

 

The Partnership paid down its debt byapproximately $42.0 million in January 2004 with the proceeds from its January 2004offering of common units.

 

During July 2004, the Partnershipcompleted a private offering of 1.3 million common units, at $34.50 per unit,representing approximately $45.0 million in proceeds after transaction costs ofapproximately $0.9 million and including a contribution from the generalpartner of $0.9 million to maintain its ownership interest.  In addition, the Partnership amended andrestated its credit facility, increasing its maximum lending limit from $140.0million to $315.0 million.  The creditfacility included a $265.0 million revolving facility and a $50.0 million termloan facility.  The Partnership used theproceeds from the private offering and borrowings of $195.7 million under thecredit facility to finance the American Central East Texas acquisition.

 

The credit facility includes a $265.0 millionrevolving facility and a $50.0 million term-loan facility.  The term-loan portion of the amended andrestated credit facility matures in December 2004 and therevolving-portion matures in May 2005. At August 2, 2004, $287.0 million was outstanding, and $28.0million was available, under the credit facility.  The Partnership intends to permanentlyfinance this acquisition in the near term with additional equity and long-termdebt.  The goal remains for thePartnership to maintain a debt-to-capital ratio of less than 50 percent inkeeping with its long-term balance sheet objectives.

 

## ***Cash Flows***

 
| ** **                                           | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                           | ** ** | **2004****(1)**                    | ** ** | **2003****(1)** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                 | ** ** |
| Net cash provided by operating activities            |       | $                                  | 21,338     |   | $ | 11,915 |   |
| Net cash used in investing activities                |       | $                                  | (21,497    | ) | $ | (2,686 | ) |
| Net cash provided by (used in) financing  activities |       | $                                  | (5,078     | ) | $ | 15,558 |   |

 

----

(1)          Asrestated.  See Note 11, *Restatement and Reclassifications of ConsolidatedFinancial Statements*, to Notes to the Consolidated FinancialStatements.

 

Net cash****providedby operating activities for the six months ended June 30, 2004, increasedrelative to the same period in the prior year principally due to an increase innet income (loss) from continuing operations.

 

Net cash used in investing activities for thesix months ended June 30, 2004, increased relative to the same period inthe prior year primarily due to the proceeds received in 2003 from the sale ofour U.S. exploration and production business.

 

Net cash used in financing activities for thesix months ended June 30, 2004, was primarily attributable to quarterlydistributions paid by the Partnership and quarterly dividends paid by theCompany. Net cash provided by financing activities for the six months ended June 30,2003, was primarily attributable to borrowings of long-term debt exceedingrepayments of long-term debt.

 

43

----

 

**Forward-LookingInformation**

 

Statements included in this Management’sDiscussion and Analysis that are not historical facts are forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities and Exchange Act of1934, as amended.  We use words such as “may,”“believe,” “estimate,” “expect,” “plan,” “intend,” “project,” “anticipate,” andsimilar expressions to identify forward-looking statements.

 

These forward-looking statements are madebased upon management’s current plans, expectations, estimates, assumptions andbeliefs concerning future events impacting us and therefore involve a number ofrisks and uncertainties. We caution that forward-looking statements are notguarantees and that actual results could differ materially from those expressedor implied in the forward-looking statements as a result of certain factors asmore fully discussed under the heading “Risk Factors” contained in our annualreport on Form 10-K filed on March 15, 2004 with the Securities andExchange Commission (File No. 001-31239) for the Company’s fiscal yearended December 31, 2003. Forward-looking statements include statementsrelating to, among other things:

 

•                  Our expectations regardingMarkWest Energy Partners, L.P.

•                  Our ability to grow MarkWestEnergy Partners, L.P. and successfully integrate its acquisitions.

•                  Our ability to amend certainproducer contracts.

•                  Our expectations regardingnatural gas, NGL product and prices.

•                  Our efforts to increasefee-based contract volumes.

•                  Our ability to manage ourcommodity price risk.

•                  Our ability to maximize thevalue of our NGL output.

•                  The adequacy of our generalpublic liability, property, and business interruption insurance.

•                  Our ability to comply withenvironmental and governmental regulations.

•                  Our ability to raise sufficientcapital to execute our business plan through borrowing or issuing equity.

 

Important factors that could cause our actualresults of operations or our actual financial condition to differ include, butare not necessarily limited to:

 

•                  Changesin general economic conditions in regions in which our products are located.

•                  Theavailability and prices of NGL and competing commodities.

•                  Theavailability and prices of raw natural gas supply.

•                  Ourability to negotiate favorable marketing agreements.

•                  Therisks that third party natural gas exploration and production activities willnot occur or be successful.

•                  Ourdependence on certain significant customers, producers, gatherers, treaters,and transporters of natural gas.

•                  Competitionfrom other NGL processors, including major energy companies.

•                  Ourability to identify and consummate grass-roots projects or acquisitionscomplementary to our business.

•                  Winterweather conditions.

 

Forward-looking statements involve manyuncertainties that are beyond our ability to control. In many cases, we cannotpredict what factors would cause actual results to differ materially from thoseindicated by the forward-looking statements.

 

44

----

 

##### **Item4. Controls and Procedures**

 

Overview

 

This Form 10-Q/Areflects adjustments to the consolidated financial report for the secondquarter of each of the years 2003 and 2004. Please refer to Note 11, *Restatementand Reclassifications of Consolidated Financial Statements,*to theconsolidated financial statements for further information.

 

Restatements

 

The Company has determined that previously issuedfinancial statements for the years 2002 and 2003 and the first three quartersof 2003 and 2004 should be restated to reflect compensation expense for thesale of subordinated partnership units and interests in the Partnership’sgeneral partner to certain employees and directors of MarkWest Hydrocarbon from2002 through 2004 and for an error in accounting for natural gas inventory inthe fourth quarter of 2003.  In addition,certain other restatement adjustments have also been recorded to correct othererrors in the financial statements for the first three quarters of 2004,including adjustments to accruals for revenue and purchased product costs,adjustments for cost improperly capitalized as property and equipment,adjustments to properly record capitalized interest on major constructionprojects in process, adjustments to record as a financing lease, a leaseagreement previously entered into by an acquired business, an adjustment to reflectseparately restricted marketable securities, adjustments for dividendsreceived on marketable securities improperly recorded as a reduction in thecarrying value of marketable securities andadjustments to accrued property taxes. Adjustments were also made to record compensation expense as a result ofthe modification of certain stock options for two officers who terminated theiremployment with the Company but who continued to serve on its Board ofDirectors.  Compensation expense was alsorecorded for stock options issued as variable awards.  In April 2004, the Company changed itspolicy to allow participants to exercise their stock options using the cashlessexercise method.  Under APB 25, *Accounting for Stock Issued to Employees,*afixed stock option plan that permits the use of a cashless exercise becomesvariable if a pattern of exercising stock options using the cashless method isdemonstrated.  Additionally, the Company made an adjustment toreclassify a portion of dividends paid during the three months ended June 30,2004 from retained earnings to additional paid in capital for the amount ofdividends distributed in excess of accumulated earnings.

 

In addition, on October 28, 2004, theCompany’s Board of Directors declared a stock dividend of one share of MarkWestHydrocarbon’s common stock for each ten shares owned by stockholders.  The stock dividend was paid on November 19,2004 to the stockholders of record as of the close of business on November 9,2004.  Stock information has beenrestated to give retroactive effect to stock dividends paid.  TheCompany is filing contemporaneously with this Form 10-Q/A for the quarterlyperiod ended June 30, 2004, its Annual Report on Form 10-K for theyear ended December 31, 2004, which includes restated financial statementsfor the years ended December 31, 2002 and 2003.  The Company is also filing contemporaneouslywith this Form 10-Q/A, its quarterly reports on Form 10-Q/A for thequarterly periods ending March 31, 2004 and September 30, 2004.

 

Disclosure Controls and Procedures

 

In connection with the preparation of our quarterly report onForm 10-Q, as amended by this Form 10-Q/A, our senior management,with participation of our Chief Executive Officer, Chief Financial Officer andChief Accounting Officer, evaluated the effectiveness of the design andoperation of our disclosure controls and procedures as of June 30,2004.  Based upon that evaluation, our Chief Executive Officer, ChiefFinancial Officer and Chief Accounting Officer concluded that our disclosurecontrols and procedures were ineffective, as of June 30, 2004, to providereasonable assurance that information required to be disclosed by us in reportsthat we file or submit under the Security Exchange Act of 1934 (the “Act”), isrecorded, processed, summarized and reported, within the time periods specifiedin the SEC’s rules and forms and to ensure that information required to bedisclosed by us in the reports that we file under the Act is accumulated andcommunicated to management, including our certifying officers, as appropriate,to allow timely decisions regarding required disclosures.  Through the date of the filing of this Form 10-Q/A,we have adopted certain measures to address the deficiencies in our internalcontrols that existed on June 30, 2004 and have applied compensatingprocedures and processes as necessary to ensure the

 

45

----

 

reliabilityof our financial reporting.  We believethat this quarterly report on Form 10-Q as amended by this Form 10-Q/Aproperly reports all information required to be included in such report.

 

Changes in Internal Controls over Financial Reporting

 

During the period covered by this quarterly report on Form 10-Qas amended by this Form 10-Q/A, there were no changes in our internalcontrol over financial reporting during the period covered by the originalreport that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

46

----

 

**PART II—OTHER INFORMATION**

 

**Item6.  Exhibits**

 
| 31.1   |   | Certification  of the Chief Executive Officer pursuant to Rule 13a-14(a) of the  Securities Exchange Act.                                                 |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                |
| 31.2   |   | Certification  of the Chief Financial Officer pursuant to Rule 13a-14(a) of the  Securities Exchange Act.                                                 |
|   |   |                                                                                                                                                                |
| 31.3   |   | Certification  of the Chief Accounting Officer pursuant to Rule 13a-14(a) of the  Securities Exchange Act.                                                |
|   |   |                                                                                                                                                                |
| 32.1   |   | Certification  of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  |
|   |   |                                                                                                                                                                |
| 32.2   |   | Certification of the Chief Financial  Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.  |
|   |   |                                                                                                                                                                |
| 32.3   |   | Certification of the Chief Accounting  Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

47

----

 

**SIGNATURE**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, MarkWestHydrocarbon, as registrant, has duly caused this report to be signed on itsbehalf by the undersigned, thereunto authorized.

 

 
|                               |   | MarkWest Hydrocarbon, Inc. |
|------------------------------------|--------|---------------------------------|
|                               |   | (Registrant)                    |
|                               |   |                            |
| Date:   October 20, 2005 |   | /s/ JAMES G.  IVEY              |   |
|                               |   | James G.  Ivey                  |
|                               |   | Chief  Financial Officer        |

 

48

----

 
| **Exhibit  Number** | ** ** | **Exhibit Index**                                                                                                                                              |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                |
| 31.1                |       | Certification of  the Chief Executive Officer pursuant to Rule 13a-14(a) of the  Securities Exchange Act.                                                 |
|                |       |                                                                                                                                                                |
| 31.2                |       | Certification of  the Chief Financial Officer pursuant to Rule 13a-14(a) of the  Securities Exchange Act.                                                 |
|                |       |                                                                                                                                                                |
| 31.3                |       | Certification of  the Chief Accounting Officer pursuant to Rule 13a-14(a) of the  Securities Exchange Act.                                                |
|                |       |                                                                                                                                                                |
| 32.1                |       | Certification of  the Chief Executive Officer pursuant to 18 U.S. C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|                |       |                                                                                                                                                                |
| 32.2                |       | Certification of  the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  |
|                |       |                                                                                                                                                                |
| 32.3                |       | Certification of  the Chief Accounting Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

49

----