**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

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

 

**For the quarterly period ended March 31, 2005**

 

**OR**

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

 

**For the transition period from                    to                   **

 

**Commission File Number 001-14841**

 

**MARKWESTHYDROCARBON, INC.**

(Exact name of registrant as specified in its charter)

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

 

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

(Address of principal executive offices)

 

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

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

Yes   o    No  ý

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).

Yes   o    No  ý

 

Indicateby check mark whether the registrant is a shell company (as defined in ExchangeAct Rule 12b-2 of the Exchange Act)

Yes   o    No  ý

 

Theregistrant had 10,798,407 shares of common stock, $0.01 per share par value,outstanding as of October 31, 2005.

 

 

----

 
| **PART I—FINANCIAL INFORMATION**                                                                                            |
|----------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                             |
| Item 1. Condensed  Consolidated Financial Statements (unaudited)                                                                 |
| Condensed  Consolidated Balance Sheets at March 31, 2005 and December 31, 2004                                                   |
| Condensed  Consolidated Statements of Operations for the Three Months Ended March 31,  2005 and 2004                             |
| Condensed  Consolidated Statements of Comprehensive Income for the Three Months Ended  March 31, 2005 and 2004                   |
| Condensed Consolidated Statements of Cash Flows for  the Three Months Ended March 31, 2005 and 2004                              |
| Condensed  Consolidated Statement of Changes in Stockholders’ Equity for the Three  Months Ended March 31, 2005 (unaudited) |
| Notes  to the Condensed Consolidated Financial Statements                                                                        |
|                                                                                                                             |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations                             |
| Item 3.  Quantitative and Qualitative Disclosures about Market Risk                                                              |
| Item 4. Controls  and Procedures                                                                                                 |
|                                                                                                                             |
| **PART II—OTHER  INFORMATION**                                                                                              |
|                                                                                                                             |
| Item 1. Legal  Proceedings                                                                                                       |
| Item 6. Exhibits                                                                                                                 |
|                                                                                                                             |
| **SIGNATURE**                                                                                                                    |

 

#### **Glossary of Terms**

 
| Bbl/d                                             |   | barrels  of oil per day                                             |
|---------------------------------------------------|--------|---------------------------------------------------------------------|
| Btu                                               |   | British  thermal units, an energy measurement                       |
| Gal/d                                             |   | gallons  per day                                                    |
| 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                          |
| Net operating margin (non-GAAP financial measure) |   | revenues  less purchased product costs                              |
| NGL                                               |   | natural  gas liquids, such as propane, butanes and natural gasoline |

 

2

----

 

## **PART I—FINANCIALINFORMATION**

 

**Item1.  Condensed Consolidated FinancialStatements**

 

**MARKWEST HYDROCARBON, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(UNAUDITED)**

**(in thousands, except share and per share data)**

** **
| ** **                                                                                                                                                | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------|------------|
| **ASSETS**                                                                                                                                                |       |                |       |                   |       |
| Current assets:                                                                                                                                           |       |                |       |                   |       |
|                                                                                                                                                      |       |                |       |                   |       |
| Cash and cash equivalents                                                                                                                                 |       | $                   | 21,548     |                   | $          | 12,844 |   |
| Restricted cash                                                                                                                                           |       | 15,000              |       | 15,000                 |       |
| Marketable securities                                                                                                                                     |       | 20,544              |       | 14,815                 |       |
| Receivables, net (including related party receivables of $91 and $44,  respectively, and allowance for doubtful accounts of $253 and $249,  respectively) |       | 45,146              |       | 64,856                 |       |
| Inventories                                                                                                                                               |       | 7,336               |       | 11,292                 |       |
| Prepaid replacement natural gas                                                                                                                           |       | 4,058               |       | 10,245                 |       |
| Deferred income taxes                                                                                                                                     |       | 660                 |       | 25                     |       |
| Other assets                                                                                                                                              |       | 1,854               |       | 1,898                  |       |
| Total current assets                                                                                                                                      |       | 116,146             |       | 130,975                |       |
|                                                                                                                                                      |       |                |       |                   |       |
| Property, plant and equipment                                                                                                                             |       | 357,856             |       | 342,636                |       |
| Less: accumulated depreciation, depletion, amortization and impairment                                                                                    |       | (63,976             | )          | (59,443                | )          |
| Total property, plant and equipment, net                                                                                                                  |       | 293,880             |       | 283,193                |       |
|                                                                                                                                                      |       |                |       |                   |       |
| Other assets:                                                                                                                                             |       |                |       |                   |       |
| Investment in Starfish                                                                                                                                    |       | 41,688              |       | —                 |       |
| Intangible assets, net of accumulated amortization of $5,714 and  $3,640, respectively                                                                    |       | 159,907             |       | 162,001                |       |
| Deferred financing costs, net of accumulated amortization of $6,275  and $5,541, respectively                                                             |       | 13,259              |       | 13,849                 |       |
| Deferred contract costs, net of accumulated amortization of $156 and  $78, respectively                                                                   |       | 3,094               |       | 3,172                  |       |
| Notes receivable from officers                                                                                                                            |       | 207                 |       | 207                    |       |
| Investment in and advances to other equity investee                                                                                                       |       | 179                 |       | 177                    |       |
| Other assets                                                                                                                                              |       | 9                   |       | —                 |       |
| Total other assets                                                                                                                                        |       | 218,343             |       | 179,406                |       |
|                                                                                                                                                      |       |                |       |                   |       |
| Total assets                                                                                                                                              |       | $                   | 628,369    |                   | $          | 593,574 |   |
|                                                                                                                                                      |       |                |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                            |       |                |       |                   |       |
| Current liabilities:                                                                                                                                      |       |                |       |                   |       |
| Accounts payable (including related party payables of $22 and $30,  respectively)                                                                         |       | $                   | 41,664     |                   | $          | 45,103 |   |
| Accrued liabilities                                                                                                                                       |       | 28,391              |       | 30,908                 |       |
| Fair value of derivative instruments                                                                                                                      |       | 1,946               |       | 1,057                  |       |
| Asset retirement obligation                                                                                                                               |       | 450                 |       | —                 |       |
| Total current liabilities                                                                                                                                 |       | 72,451              |       | 77,068                 |       |
|                                                                                                                                                      |       |                |       |                   |       |
| Deferred income taxes                                                                                                                                     |       | 7,029               |       | 6,258                  |       |
| Senior notes                                                                                                                                              |       | 225,000             |       | 225,000                |       |
| Long-term debt                                                                                                                                            |       | 40,000              |       | —                 |       |
| Other long-term liabilities                                                                                                                               |       | 8,856               |       | 7,487                  |       |
| Non-controlling interest in consolidated subsidiary                                                                                                       |       | 224,663             |       | 228,000                |       |
|                                                                                                                                                      |       |                |       |                   |       |
| Commitments and contingencies (Note 13)                                                                                                                   |       |                |       |                   |       |
|                                                                                                                                                      |       |                |       |                   |       |
| 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,  10,838,894 and 10,821,760 shares issued, respectively                                       |       | 108                 |       | 108                    |       |
| Additional paid-in capital                                                                                                                                |       | 51,553              |       | 51,455                 |       |
| Deferred compensation                                                                                                                                     |       | (120                | )          | —                 |       |
| Accumulated deficit                                                                                                                                       |       | (84                 | )          | (1,623                 | )          |
| Accumulated other comprehensive income (loss), net of tax                                                                                                 |       | (591                | )          | 246                    |       |
| Treasury stock, at cost; 59,027 and 63,586 shares, respectively                                                                                           |       | (469                | )          | (425                   | )          |
| Total stockholders’ equity                                                                                                                           |       | 50,370              |       | 49,761                 |       |
|                                                                                                                                                      |       |                |       |                   |       |
| Total liabilities and stockholders’ equity                                                                                                           |       | $                   | 628,369    |                   | $          | 593,574 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

 

3

----

 

**MARKWEST HYDROCARBON, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(UNAUDITED)**

**(in thousands, except per share data)**

** **
| ** **                                                                                        | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                        | ** ** | **2005**                         | ** ** | **2004** | ** ** |
|                                                                                              |       |                             |       |   |   |
| Revenues                                                                                          |       | $                                | 138,353    |   | $ | 93,700 |   |
|                                                                                              |       |                             |       |   |   |
| Operating expenses:                                                                               |       |                             |       |   |   |
| Purchased product costs                                                                           |       | 104,699                          |       | 75,488 |   |
| Facility expenses                                                                                 |       | 9,260                            |       | 6,086 |   |
| Selling, general and administrative expenses                                                      |       | 8,102                            |       | 5,314 |   |
| Depreciation                                                                                      |       | 4,741                            |       | 3,528 |   |
| Amortization of intangible assets                                                                 |       | 2,095                            |       | 34 |   |
| Accretion of asset retirement and sublease obligations                                            |       | 10                               |       | — |   |
| Total operating expenses                                                                          |       | 128,907                          |       | 90,450 |   |
|                                                                                              |       |                             |       |   |   |
| Income from operations                                                                            |       | 9,446                            |       | 3,250 |   |
|                                                                                              |       |                             |       |   |   |
| Other income (expense):                                                                           |       |                             |       |   |   |
| Interest income                                                                                   |       | 249                              |       | 135 |   |
| Interest expense                                                                                  |       | (3,704                           | )          | (1,130 | ) |
| Amortization of deferred financing cost (a component of interest expense)                         |       | (536                             | )          | (307 | ) |
| Dividend income                                                                                   |       | 92                               |       | — |   |
| Other income                                                                                      |       | 87                               |       | 25 |   |
|                                                                                              |       |                             |       |   |   |
| Income before non-controlling interest in net income of consolidated  subsidiary and income taxes |       | 5,634                            |       | 1,973 |   |
|                                                                                              |       |                             |       |   |   |
| Provision (benefit) for  income taxes:                                                            |       |                             |       |   |   |
| Current                                                                                           |       | —                           |       | (14 | ) |
| Deferred                                                                                          |       | 770                              |       | (42 | ) |
| Provision (benefit) for income taxes                                                              |       | 770                              |       | (56 | ) |
|                                                                                              |       |                             |       |   |   |
| Non-controlling interest in  net income of consolidated subsidiary                                |       | (3,325                           | )          | (1,309 | ) |
|                                                                                              |       |                             |       |   |   |
| Net income                                                                                        |       | $                                | 1,539      |   | $ | 720 |   |
|                                                                                              |       |                             |       |   |   |
| Net income per share:                                                                             |       |                             |       |   |   |
| Basic                                                                                             |       | $                                | 0.14       |   | $ | 0.07 |   |
| Diluted                                                                                           |       | $                                | 0.14       |   | $ | 0.07 |   |
|                                                                                              |       |                             |       |   |   |
| Weighted average number of  outstanding shares of common stock:                                   |       |                             |       |   |   |
| Basic                                                                                             |       | 10,766                           |       | 10,577 |   |
| Diluted                                                                                           |       | 10,917                           |       | 10,595 |   |
|                                                                                              |       |                             |       |   |   |
| Cash dividend per common  share                                                                   |       | $                                | 0.075      |   | $ | 0.455 |   |

 

The accompanying notes are an integral part ofthese condensed consolidated financial statements.

 

4

----

 

**MARKWEST HYDROCARBON, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME**

**(UNAUDITED)**

**(in thousands)**

** **
| ** **                                                                                             | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                             | ** ** | **2005**                         | ** ** | **2004** | ** ** |
|                                                                                                   |       |                             |       |   |   |
| Net income                                                                                             |       | $                                | 1,539      |   | $ | 720 |   |
|                                                                                                   |       |                             |       |   |   |
| Other comprehensive income  (loss), net of tax:                                                        |       |                             |       |   |   |
| Risk management activities, net of income tax benefit of $542 and income  tax provision of $543        |       | (753                             | )          | 872 |   |
| Marketable securities, net of income tax benefit of $51 and income tax  provision of $57, respectively |       | (84                              | )          | 153 |   |
| Total other comprehensive income (loss)                                                                |       | (837                             | )          | 1,025 |   |
|                                                                                                   |       |                             |       |   |   |
| Comprehensive income                                                                                   |       | $                                | 702        |   | $ | 1,745 |   |

 

The accompanying notes are an integral part ofthese condensed consolidated financial statements.

 

5

----

 

**MARKWEST HYDROCARBON, INC.**

**CONDENSED CONSOLIDATEDSTATEMENT OF CHANGES IN**

**STOCKHOLDERS’ EQUITY**

**(UNAUDITED)**

**(in thousands)**

** **
| ** **                            | ** ** | **Shares of  Common  Stock** | ** ** | **Shares of  Treasury  Stock** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Deferred  Compensation** | ** ** | **Accumulated  Earnings  (Deficit)** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Treasury  Stock** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|---------------------------------------|------------|------------------------------|------------|--------------------------------|------------|-------------------|------------|----------------------------------|------------|----------------------------|------------|--------------------------------------|------------|------------------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
|                                  |       |                         |       |                           |       |              |       |                             |       |                       |       |                                 |       |                                                 |       |                |       |                                  |       |
| Balance, December 31, 2004            |       | 10,822                       |       | (64                            | )          | $                 | 108        |                             | $          | 51,455                     |       | $                                    | —     |                                                 | $          | (1,623              | )          | $                                     | 246        |   | $ | (425 | ) | $ | 49,761 |   |
|                                  |       |                         |       |                           |       |              |       |                             |       |                       |       |                                 |       |                                                 |       |                |       |                                  |       |
| Stock option exercises                |       | 17                           |       | —                         |       | —            |       | 37                               |       | —                     |       | —                               |       | —                                               |       | —              |       | 37                                    |       |
|                                  |       |                         |       |                           |       |              |       |                             |       |                       |       |                                 |       |                                                 |       |                |       |                                  |       |
| Issuance of restricted stock          |       | —                       |       | 7                              |       | —            |       | 77                               |       | (134                       | )          | —                               |       | —                                               |       | 57                  |       | —                                |       |
|                                  |       |                         |       |                           |       |              |       |                             |       |                       |       |                                 |       |                                                 |       |                |       |                                  |       |
| Amortization of deferred compensation |       | —                       |       | —                         |       | —            |       | —                           |       | 14                         |       | —                               |       | —                                               |       | —              |       | 14                                    |       |
|                                  |       |                         |       |                           |       |              |       |                             |       |                       |       |                                 |       |                                                 |       |                |       |                                  |       |
| Cashless stock options                |       | —                       |       | —                         |       | —            |       | 720                              |       | —                     |       | —                               |       | —                                               |       | —              |       | 720                                   |       |
|                                  |       |                         |       |                           |       |              |       |                             |       |                       |       |                                 |       |                                                 |       |                |       |                                  |       |
| Treasury stock acquired               |       | —                       |       | (7                             | )          | —            |       | —                           |       | —                     |       | —                               |       | —                                               |       | (161                | )          | (161                                  | )          |
|                                  |       |                         |       |                           |       |              |       |                             |       |                       |       |                                 |       |                                                 |       |                |       |                                  |       |
| Treasury stock reissued               |       | —                       |       | 5                              |       | —            |       | 72                               |       | —                     |       | —                               |       | —                                               |       | 33                  |       | 105                                   |       |
|                                  |       |                         |       |                           |       |              |       |                             |       |                       |       |                                 |       |                                                 |       |                |       |                                  |       |
| Net income                            |       | —                       |       | —                         |       | —            |       | —                           |       | —                     |       | 1,539                                |       | —                                               |       | —              |       | 1,539                                 |       |
|                                  |       |                         |       |                           |       |              |       |                             |       |                       |       |                                 |       |                                                 |       |                |       |                                  |       |
| Other comprehensive loss              |       | —                       |       | —                         |       | —            |       | —                           |       | —                     |       | —                               |       | (837                                                 | )          | —              |       | (837                                  | )          |
|                                  |       |                         |       |                           |       |              |       |                             |       |                       |       |                                 |       |                                                 |       |                |       |                                  |       |
| Dividends paid                        |       | —                       |       | —                         |       | —            |       | (808                             | )          | —                     |       | —                               |       | —                                               |       | —              |       | (808                                  | )          |
|                                  |       |                         |       |                           |       |              |       |                             |       |                       |       |                                 |       |                                                 |       |                |       |                                  |       |
| Balance, March 31, 2005               |       | 10,839                       |       | (59                            | )          | $                 | 108        |                             | $          | 51,553                     |       | $                                    | (120       | )                                                    | $          | (84                 | )          | $                                     | (591       | ) | $ | (496 | ) | $ | 50,370 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

 

6

----

 

**MARKWEST HYDROCARBON, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

**(in thousands)**

** **
| ** **                                                                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **March 31,**          | ** ** |
| ** **                                                                         | ** ** | **2005**               | ** ** | **2004** | ** ** |
| **Cash flows from operating activities:**                                          |       |                   |       |   |   |
| Net income                                                                         |       | $                      | 1,539      |   | $ | 720 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                   |       |   |   |
| Depreciation                                                                       |       | 4,741                  |       | 3,528 |   |
| Amortization of deferred financing cost                                            |       | 536                    |       | 307 |   |
| Amortization of intangible assets                                                  |       | 2,095                  |       | 34 |   |
| Amortization of gas purchase contract                                              |       | 78                     |       | — |   |
| Accretion of asset retirement and sublease obligations                             |       | 10                     |       | — |   |
| Gain from sale of marketable securities                                            |       | (60                    | )          | — |   |
| Restricted unit compensation expense                                               |       | 230                    |       | 358 |   |
| Restricted stock compensation expense                                              |       | 14                     |       | — |   |
| Stock option compensation expense                                                  |       | 720                    |       | 374 |   |
| Participation Plan compensation expense                                            |       | 1,607                  |       | 402 |   |
| Contribution of treasury shares to 401(k) benefit plan                             |       | 105                    |       | 72 |   |
| Equity in loss (gain) of other equity investee                                     |       | (3                     | )          | 5 |   |
| Gain from sale of property, plant and equipment                                    |       | (39                    | )          | (63 | ) |
| Non-controlling interest in net income of consolidated subsidiary                  |       | 3,325                  |       | 1,309 |   |
| Unrealized losses (gains) on derivative instruments                                |       | (766                   | )          | 476 |   |
| Deferred income taxes                                                              |       | 770                    |       | (41 | ) |
| Changes in operating assets and liabilities:                                       |       |                   |       |   |   |
| Decrease in receivables                                                            |       | 19,710                 |       | 5,096 |   |
| Decrease in inventories                                                            |       | 3,956                  |       | 4,100 |   |
| Decrease in prepaid replacement natural gas                                        |       | 6,187                  |       | 5,925 |   |
| Decrease (increase) in other current assets                                        |       | 44                     |       | (535 | ) |
| Decrease in accounts payable and accrued liabilities                               |       | (5,548                 | )          | (4,694 | ) |
| Increase in other long-term liabilities                                            |       | 225                    |       | — |   |
| Net cash flow provided by operating activities                                     |       | 39,476                 |       | 17,373 |   |
|                                                                               |       |                   |       |   |   |
| **Cash flows from investing  activities:**                                         |       |                   |       |   |   |
| Starfish acquisition                                                               |       | (41,688                | )          | — |   |
| Purchase of marketable securities                                                  |       | (7,437                 | )          | (4,277 | ) |
| Proceeds from the sale of marketable securities                                    |       | 1,634                  |       | — |   |
| Capital expenditures                                                               |       | (16,000                | )          | (1,629 | ) |
| Proceeds from sale of assets                                                       |       | 39                     |       | 94 |   |
| Proceeds on financing lease receivable                                             |       | —                 |       | 133 |   |
| Other                                                                              |       | —                 |       | 3 |   |
| Net cash used in investing activities                                              |       | (63,452                | )          | (5,676 | ) |
|                                                                               |       |                   |       |   |   |
| **Cash flows from financing  activities:**                                         |       |                   |       |   |   |
| Proceeds from long-term debt                                                       |       | 40,000                 |       | — |   |
| Repayment of long-term debt                                                        |       | —                 |       | (42,000 | ) |
| Payment of deferred financing costs and registration costs                         |       | (50                    | )          | — |   |
| Proceeds from MarkWest Energy Partners’ secondary public offering             |       | —                 |       | 44,102 |   |
| Net proceeds from issuance of units of the Partnership                             |       | 37                     |       | — |   |
| Distribution to MarkWest Energy Partners’ unitholders                         |       | (6,375                 | )          | (3,007 | ) |
| Exercise of stock options                                                          |       | 37                     |       | 1,017 |   |
| Acquisition of treasury shares                                                     |       | (161                   | )          | (36 | ) |
| Payment of dividends                                                               |       | (808                   | )          | (4,802 | ) |
| Net cash provided by (used in) financing activities                                |       | 32,680                 |       | (4,726 | ) |
|                                                                               |       |                   |       |   |   |
| Net increase in cash and cash  equivalents                                         |       | 8,704                  |       | 6,971 |   |
| Cash and cash equivalents at  beginning of period                                  |       | 12,844                 |       | 42,144 |   |
|                                                                               |       |                   |       |   |   |
| Cash and cash equivalents at  end of period                                        |       | $                      | 21,548     |   | $ | 49,115 |   |

 

The accompanying notes are an integral part ofthese condensed consolidated financial statements.

 

7

----

** **
| ** **                                          | ** ** | **Three Months Ended** | ** **  |
|-----------------------------------------------------|------------|------------------------|-------------|
| ** **                                          | ** ** | **March 31,**          | ** **  |
| ** **                                          | ** ** | **2005**               | ** **  | **2004** | ** ** |
| **Supplemental cash flow  information:**            |       |                   |        |   |   |
| Construction projects in progress  obligation       |       | $                      |  3,401 |   | $ |  1,199 |   |
| Cash paid for interest, net  of amounts capitalized |       | $                      |  4,147 |   | $ |  1,459 |   |

 

The accompanying notes are an integral part of thesecondensed consolidated financial statements.

 

8

----

 

**MARKWEST HYDROCARBON, INC.**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**1.  Organization**

 

MarkWestHydrocarbon, Inc. (“MarkWest Hydrocarbon” or the “Company”) manages MarkWestEnergy Partners, L.P. (“MarkWest Energy Partners” or the “Partnership”), apublicly-traded master limited partnership engaged in the gathering, processingand transmission of natural gas; the transportation, fractionation and storageof natural gas liquids (“NGLs”); and the gathering and transportation of crudeoil.   The Company also markets naturalgas and NGLs. MarkWest Hydrocarbon and MarkWest Energy Partners provideservices primarily in Appalachia, Michigan, East Texas, Western Oklahoma andother areas of the Southwest.  Througheight acquisitions completed by MarkWest Energy Partners from 2003 throughNovember 2005, the Company has significantly expanded its natural gas activities.

 

**2.  Basis of Presentation**

 

Thecondensed consolidated financial statements include the accounts of MarkWestHydrocarbon and its subsidiaries, including MarkWest Energy Partners (collectively“MarkWest Hydrocarbon” or the “Company”). Through consolidation, MarkWestHydrocarbon has eliminated all significant intercompany accounts andtransactions. Equity investments, in which the Company exercises significantinfluence but does not control and is not the primary beneficiary, areaccounted for using the equity method. The Company regularly reviews itsinvestments to determine whether a decline in fair value below the cost basisis other than temporary.  The Company’saccounting policy requires it to evaluate operating losses (if any), creditdefaults and other factors that may be indicative of a decrease in value of theinvestment that may have occurred which is other than temporary.  The primary factors the Company considers inits determination of an impairment that is other than temporary are the lengthof time that the fair value of the investment is below the Company’s carryingvalue and the financial condition, operating performance and near-termprospects of the investee. In addition, the Company considers the reason forthe decline in fair value, be it general market conditions, industry-specificor investee-specific; and the Company’s intent and ability to hold theinvestment for a period of time sufficient to allow for a recovery in fairvalue.  The Company evaluates fair valuebased on specific information (valuation methodologies, financial statements,estimates of appraisals, etc.). Due to a lack of a public market price for theCompany’s current investments, it uses its best estimates and assumptions toarrive at the estimated fair value of such investment. If the decline in fairvalue is deemed to be other than temporary, the cost basis of the security iswritten down to fair value.  The Company’sassessment of the foregoing factors involves a high degree of judgment and,accordingly, actual results may differ materially from the Company’s estimatesand judgments.

 

These financial statements have been prepared in accordance withaccounting principles generally accepted in the United States of America forinterim financial reporting.  Theyear-end consolidated balance sheet data was derived from audited financialstatements.  In management’s opinion, wehave made all adjustments necessary for a fair presentation of the Company’s resultsof operations, financial position and cash flows for the periods shown.  These adjustments are of a normal recurringnature. In addition to reviewing these condensed consolidated financialstatements and accompanying notes, you should also consult the auditedfinancial statements and notes that make up the Company’s December 31, 2004Annual Report on Form 10-K.  Finally,results for the three months ended March 31, 2005 are not necessarilyindicative of results for the full year 2005, or for any other future period.

 

**3.****     Recent Accounting Pronouncements**

 

InDecember 2004, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standards (“SFAS”) No. 123 (revised 2004), *Share-Based Payment* (“SFAS 123(R)”).  Thisstatement addresses the accounting for share-based payment transactions inwhich an enterprise receives employee services in exchange for (a) equity instrumentsof the enterprise, or (b) liabilities that are based on the fair value of theenterprise’s equity instruments or that may be settled by the issuance of suchequity instruments.  SFAS No. 123(R)requires an entity to recognize the grant-date fair-value of stock options andother equity-based compensation issued to employees in the income statement.  The revised Statement generally requires thatan entity account for those transactions using the fair-value-based method, andeliminates the intrinsic value method of accounting in Accounting PrinciplesBoard Opinion (“APB”) No. 25, *Accounting forStock Issued to Employees*, which was permitted under SFAS No. 123,as originally issued.  The revisedStatement requires entities to disclose information about the nature of theshare-based payment transactions 

 

9

----

 

and the effects of those transactions on thefinancial statements.  SFAS 123(R) iseffective for public companies for the first fiscal year beginning afterDecember 15, 2005.  All public companiesmust use either the modified prospective or the modified retrospective transitionmethod.  On March 29, 2005, the SEC staffissued Staff Accounting Bulletin (“SAB”) No. 107, “Share-Based Payment” toexpress the views of the staff regarding the interaction between SFAS No.123(R) and certain SEC rules and regulations and to provide the staff’s viewsregarding the valuation of share-based payment arrangements for publiccompanies.  The Company will take intoconsideration the additional guidance provided by SAB 107 in connection withthe implementation of SFAS No. 123(R). The Company has not yet evaluated the impact of the adoption of thispronouncement, which must be adopted in the first quarter of calendar year2006.

 

In March2005, the FASB issued FASB Interpretation (FIN) No. 47, *Accounting for Conditional Asset Retirement Obligations*,which clarifies the accounting for conditional asset retirement obligations asused in SFAS No. 143, *Accounting for AssetRetirement Obligations*.  Aconditional asset retirement obligation is an unconditional legal obligation toperform an asset retirement activity in which the timing and (or) method ofsettlement are conditional on a future event that may or may not be within thecontrol of the entity.   An entity isrequired to recognize a liability for the fair value of a conditional assetretirement obligation under SFAS No. 143 if the fair value of the liability canbe reasonably estimated.  FIN 47 permits,but does not require, restatement of interim financial information.  The provisions of FIN 47 are effective forreporting periods ending after December 15, 2005.  The Company has not yet assessed the impactof adopting FIN 47 on its condensed consolidated financial statements.

 

In May 2005,the FASB issued SFAS No. 154, *AccountingChanges and Error Corrections—a replacement of APB Opinion No. 20 and FASBStatement No. 3*. SFAS No. 154 replaces Accounting**Principles Board Opinion No. 20, *Accounting Changes*, and SFAS No. 3, *Reporting Accounting Changes in Interim FinancialStatements*, and changes the requirements for the accounting for andreporting of a**change inaccounting principle. This statement applies to all voluntary changes inaccounting principle**and alsoapplies to changes required by an accounting pronouncement in the unusualinstance that the**pronouncementdoes not include specific transition provisions. The statement is effective foraccounting**changes andcorrections of errors made in fiscal years beginning after December 15,2005. The**Company will adopt theprovisions of SFAS No. 154 beginning in calendar year 2006. Management**believes that the adoption of theprovisions of SFAS No. 154 will not have a material impact on the**Company’s condensed consolidatedfinancial statements.

 

**4.****     Stock and Unit Compensation**

 

Aspermitted under Financial Accounting Standards Statement (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 Accounting PrinciplesBoard Opinion No. 25, *Accounting for Stock Issuedto Employees,* as permittedunder SFAS No. 123, and SFAS No. 148, *Accountingfor Stock Based Compensation – Transition and Disclosure. *The Company has two fixedcompensation plans and two variable plans, one of which is through ourconsolidated subsidiary, MarkWest Energy Partners.  The Company accounts for these plans usingfixed and variable accounting as appropriate*.*

 

Stockoptions are issued under the Company’s 1996 Stock Incentive Plan and 1996Non-employee Director Stock Option Plan. The plans allow for the exercise of stock options using the cashlessmethod, but only at the discretion of the Company.  Under a cashless exercise, the Companywithholds those shares that otherwise would be issued upon the exercise of theoption, the number of shares with a fair market value equal to the optionexercise price and remits the remaining shares to the employees.  Prior to April 2004, the Company did notallow participants to exercise their stock options using the cashlessmethod.  Accordingly, compensation expensewas not recognized for stock options granted unless the options were granted atan exercise price less than the quoted market price of the Company on the grantdate.  In April 2004, the Company changedits policy to allow participants to exercise their stock options using thecashless 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 the stock options using the cashless methodis demonstrated.  As a result, in April2004, the Company was required to account for stock options issued under theplans as variable awards.  Compensationexpense for stock options issued as variable awards is measured as thedifference in the market value of the Company’s common stock and the exerciseprice of 

 

10

----

 

the stock options. The difference is amortized into earnings over the period of service,adjusted quarterly for the change in the fair value of the unvested stockoptions awarded.  Increases or decreasesin the market value of the Company’s common stock between April 2004 and theend of each reporting period, resulting in a change in the measure ofcompensation for vested awards, are reflected currently in operations.   The Company recorded compensation expensefor options granted under the plans accounted for as variable awards of $0.7million for the three months ended March 31, 2005.

 

Duringthe three months ended March 31, 2005, recipients exercised their options topurchase an aggregate 24,895 of shares of the Company’s common stock.  Recipients exercised options for 19,947shares using the cashless method, resulting in the net issuance of 12,182shares of common stock.  During the threemonths ended March 31, 2004, two officers resigned from the Company.  As the former officers continued to serve onthe Company’s Board of Directors, the Company agreed that the individual’sstock options would continue to vest and be exercisable in accordance with theoriginal vesting and exercise provisions. As a result of the modification to the stock options for these officers,the outstanding stock options are to be accounted for as variable awards, and,as a result, the Company recorded compensation expense of $0.4 million for thethree months ended March 31, 2004, measured as the difference in the marketvalue of the Company’s common stock on the date the officers’ status changedand the strike price of the outstanding stock options.  These charges are included in selling,general and administrative expenses.

 

TheCompany also issues restricted stock under the Company’s 1996 Stock IncentivePlan and 1996 Non-employee Director Stock Option Plan.  In accordance with APB No. 25, the Companyapplies fixed accounting for the plan. As a result, since the restricted stockis granted for no consideration, compensation expense is recognized on the dateof grant equal to the market price of the Company’s common stock.  The fair value of the stock awarded is amortizedinto earnings over the period of service. The restricted stock vests over a stated period.  During the three months ended March 31, 2005,the Company granted 6,973 shares of restricted stock.  The Company recorded compensation expense ofless than $0.1 million for the three months ended March 31, 2005.  These charges are included in selling,general and administrative expenses.

 

TheCompany has also entered into arrangements with certain directors and employeesof the Company.  These arrangements are referredto as the Participation Plan.  Under theParticipation Plan, the Company sells subordinated partnership units of thePartnership and interests in the Partnership’s general partner to employees anddirectors of the Company under a purchase and sale agreement.  In accordance with the provisions of APB No.25, *Accounting for Stock Issued to Employees,*and EITF No. 95-16, *Accountingfor Stock Compensation Arrangements with Employer Loan Features,*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 partnerinterest, 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. Compensation related to the general partner interest is calculated asthe difference in the formula value and the amount paid by thoseindividuals.  The formula value is theamount MarkWest Hydrocarbon would have to pay the directors and employees torepurchase the general partners interests and is based on the current marketvalue of the Partnership’s common units and the current quarterly distributionpaid by the Partnership.  Increases or decreasesin the market value of the subordinated units and the formula value of thegeneral partner interests between the date they are acquired and the end ofeach reporting period result in a change in the measure of compensation, whichis reflected currently in operations. The Company recorded compensation expense under the Participation Planof $1.6 million and $0.4 million for the three months ended March 31, 2005 and2004, respectively.  These charges areincluded in selling, general and administrative expense.

 

ThePartnership issues restricted units under the MarkWest Energy Partners, L.P.Long-Term Incentive Plan.  A restrictedunit is a “phantom” unit that entitles the grantee to receive a common unitupon the vesting of the phantom unit, or, at the discretion of the CompensationCommittee, cash equivalent to the market value of a common unit.  In accordance with APB No. 25, thePartnership applies variable accounting for the plan because a phantom unit isan award to an employee entitling the employee to increases in the market valueof the Partnership’s units subsequent to the date of grant without issuingunits to the employees, similar to a stock appreciation right.  As a result, the Partnership is required tomark to market the awards at the end of each reporting period.  Compensation expense is measured for thephantom unit grants using the market price of MarkWest Energy Partner’s commonunits on the date the units are granted. The fair value of the units awarded is amortized into earnings over theperiod of service, adjusted quarterly for the change in the fair value of theunvested units granted.

 

11

----

 

The phantom units vest over a statedperiod.  For certain employees, vestingof Partnership units is accelerated if certain performance measures aremet.  The accelerated vesting criteriaprovisions are based on annualized distribution goals.  If the Partnership’s distributions are at orabove the goal for a certain number of consecutive quarters, vesting of theemployee’s phantom units is accelerated. However, the vesting of any phantom units may not occur until at leastone year following the date of grant. The general partner of the Partnership may also elect to accelerate thevesting of outstanding awards, which results in an immediate charge tooperations for the unamortized portion of the award.  The Partnership recorded compensation expenseunder the Long-Term Incentive Plan of $0.2 million and $0.4 million for thethree months ended March 31, 2005 and 2004, respectively.

 

Hadcompensation cost for the Company’s stock-based compensation plans beendetermined based on the fair value at the grant dates under those plansconsistent with the method prescribed by SFAS No. 123,**ournet income and net income per share would have been revised to the pro formaamounts listed below:

 
| ** **                                                                                                                                  | ** ** | **Three Months Ended March 31,**           | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                  | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| ** **                                                                                                                                  | ** ** | **(in thousands, except per share  data)** | ** ** |
|                                                                                                                                        |       |                                       |       |   |   |
| Net income, as reported                                                                                                                     |       | $                                          | 1,539      |   | $ | 720 |   |
| Add: compensation expense included in reported net income, net of  related tax effect                                                       |       | 1,712                                      |       | 1,229 |   |
| Deduct: total stock-based employee compensation expense determined  under fair value based method for all awards, net of related tax effect |       | (1,257                                     | )          | (898 | ) |
| Pro forma net income                                                                                                                        |       | $                                          | 1,994      |   | $ | 1,051 |   |
|                                                                                                                                        |       |                                       |       |   |   |
| Net income per share:                                                                                                                       |       |                                       |       |   |   |
| Basic:                                                                                                                                      |       |                                       |       |   |   |
| As reported                                                                                                                                 |       | $                                          | 0.14       |   | $ | 0.07 |   |
| Pro forma                                                                                                                                   |       | $                                          | 0.19       |   | $ | 0.10 |   |
| Diluted:                                                                                                                                    |       |                                       |       |   |   |
| As reported                                                                                                                                 |       | $                                          | 0.14       |   | $ | 0.07 |   |
| Pro forma                                                                                                                                   |       | $                                          | 0.18       |   | $ | 0.10 |   |

 

**5.****     Marketable Securities**

 

Marketable securities are classified as available for sale and stated atmarket, based on the closing price of the securities at the balance sheetdate.  Accordingly, unrealized gains ortemporary losses are reflected in other comprehensive income, net of applicableincome taxes.  For losses that are otherthan temporary, the cost basis of the securities is written down to fair valueand the amount of the write down is reflected in the statement of operations.The Company utilizes a first-in first-out cost basis to compute realized gainsand losses.  Realized gains and losses, dividend and interest income, andthe amortization of premiums and discounts, are reflected in earnings.

 

12

----

 

Thefollowing are the components of marketable securities (in thousands):

 
| **March 31, 2005**                                                 | ** ** | **Cost Basis** | ** ** | **Unrealized  gains** | ** ** | **Unrealized  losses** | ** ** | **Recorded  Basis** | ** ** |
|--------------------------------------------------------------------|------------|----------------|------------|-----------------------|------------|------------------------|------------|---------------------|------------|
| **Equity securities:**                                             |       |           |       |                  |       |                   |       |                |       |
| Master limited partnership unit securities                         |       | $              | 5,174      |                  | $          | 845                    |       | $                   | (6         | ) | $ | 6,013 |   |
| Equity securities                                                  |       | 5,174          |       | 845                   |       | (6                     | )          | 6,013               |       |
| **Fixed maturities:**                                              |       |           |       |                  |       |                   |       |                |       |
| Mortgage backed securities (due after one year through five years) |       | 14,688         |       | —                |       | (157                   | )          | 14,531              |       |
| Mortgage backed securities                                         |       | 14,688         |       | —                |       | (157                   | )          | 14,531              |       |
| Total marketable securities classified as current                  |       | $              | 19,862     |                  | $          | 845                    |       | $                   | (163       | ) | $ | 20,544 |   |

** **
| **December 31, 2004**                                               | ** ** | **Cost Basis** | ** ** | **Unrealized  gains** | ** ** | **Unrealized  losses** | ** ** | **Recorded  Basis** | ** ** |
|---------------------------------------------------------------------|------------|----------------|------------|-----------------------|------------|------------------------|------------|---------------------|------------|
| **Equity securities:**                                              |       |           |       |                  |       |                   |       |                |       |
| Master limited partnership units                                    |       | $              | 5,248      |                  | $          | 872                    |       | $                   | (19        | ) | $ | 6,101 |   |
| Equity securities                                                   |       | 5,248          |       | 872                   |       | (19                    | )          | 6,101               |       |
| **Fixed maturities:**                                               |       |           |       |                  |       |                   |       |                |       |
| Mortgage backed securities (due after one year through five years), |       | 8,750          |       | 10                    |       | (46                    | )          | 8,714               |       |
| Mortgage backed securities                                          |       | 8,750          |       | 10                    |       | (46                    | )          | 8,714               |       |
| Total marketable securities classified as current                   |       | $              | 13,998     |                  | $          | 882                    |       | $                   | (65        | ) | $ | 14,815 |   |

 

AtMarch 31, 2005, unrealized gains of $0.8 million relate primarily toinvestments in equity securities of domestic energy partnerships. Unrealized losses of $0.2 million relate primarily to mortgage backedsecurities and are primarily attributable to changes in interest rates. Net unrealized gains on marketable securities of $0.7 million, net of therelated tax effect of $0.3 million, are reflected as a component of accumulatedother comprehensive loss at March 31, 2005.

 

AtDecember 31, 2004, unrealized gains of $0.9 million relate primarily toinvestments in equity securities of domestic energy partnerships. Unrealized losses of $0.1 million relate primarily to mortgage backedsecurities and are primarily attributable to changes in interest rates. Net unrealized gains on marketable securities of $0.8 million, net of therelated tax effect of $0.3 million, are reflected as a component of accumulatedother comprehensive income at December 31, 2004.

 

**6.****     Income Taxes**

 

The Company accounts for incometaxes under the asset and liability method pursuant to SFAS No. 109, *Accounting for Income Taxes*. Under SFASNo. 109, deferred income taxes are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax basis and netoperating loss and credit carryforwards. Deferred tax assets and liabilitiesare measured using enacted tax rates expected to apply to taxable income in theyears in which those temporary differences are expected to be recovered orsettled. The effect of any tax rate change on deferred taxes is recognized as incomein the period that includes the enactment date of the tax rate change.  Realizability of deferred tax assets is assessedand, if not more likely than not, a valuation allowance is recorded to writedown the deferred tax assets to their net realizable value. The Company basesthe effective corporate tax rate for interim periods on the estimated annualeffective corporate tax rate.  Income taxexpense totaled $0.8 million for the first three months of 

 

13

----

 

2005 and an income tax benefit of $0.1 million for the same period in2004, resulting in effective income tax rates of 33.4% and (8.4)% for eachrespective period.

 

**7.****     MarkWest Energy Partners’ Acquisitions**

 

*Starfish Acquisition*

 

OnMarch 31, 2005, MarkWest Energy Partners completed the acquisition of a 50%non-operating membership interest in Starfish Pipeline Company, LLC, (“Starfish”)from an affiliate of Enterprise Products Partners L.P. for $41.7 million.  Starfish is a joint venture with EnbridgeOffshore Pipelines LLC, which we account for using the equity method.  Starfish owns the FERC-regulated Stingraynatural gas pipeline and the unregulated Triton natural gas gathering systemand West Cameron dehydration facility, all located in the Gulf of Mexico andSouthwestern Louisiana.

 

*East Texas System Acquisition*

 

On July 30, 2004, MarkWest Energy Partnerscompleted the acquisition of American Central Eastern Texas’ Carthage gatheringsystem located in East Texas (the “East Texas System”) for approximately $240.7million.  TheCompany’s condensed consolidated financial statements include American CentralEastern Texas’ results of operations from July 30, 2004.  The assets acquired consist of gatheringsystems, compressor stations and a processing facility currently underconstruction, as well as an NGL pipeline being constructed in 2005.

 

The total adjusted purchase price was$240.7 million, and was allocated as follows (in thousands):

 
| Acquisition costs:                |   |   |    |
|-----------------------------------|--------|--------|---------|
| Cash consideration                |   | $      | 240,269 |   |
| Direct acquisition costs          |   | 457    |    |
| Total                             |   | $      | 240,726 |   |
|                              |   |   |    |
| Allocation of acquisition  costs: |   |   |    |
| Customer contracts                |   | $      | 165,379 |   |
| Property, plant and equipment     |   | 76,012 |    |
| Inventory                         |   | 65     |    |
| Imbalance payable                 |   | (337   | )       |
| Property taxes payable            |   | (393   | )       |
| Total                             |   | $      | 240,726 |   |

 

14

----

 

*Pro Forma Results of Operations (unaudited)*

 

Thefollowing table reflects the unaudited pro forma consolidated results ofoperations for the comparable period presented, as though the East Texas andStarfish acquisitions had occurred on January 1, 2004.  The unaudited pro forma results have beenprepared for comparative purposes only and may not be indicative of futureresults.

 
| ** **                   | ** ** | **Three Months Ended March 31,  2005**     | ** ** |
|------------------------------|------------|--------------------------------------------|------------|
| ** **                   | ** ** | **MarkWest  Hydrocarbon**                  | ** ** | **Starfish** | ** ** | **Adjustments****(1)** | ** ** | **Total** | ** ** |
| ** **                   | ** ** | **(in thousands, except per share  data)** | ** ** |
| Revenue                      |       | $                                          | 138,353    |   | $ | — |   | $ | — |   | $ | 138,353 |   |
| Net income                   |       | $                                          | 1,539      |   | $ | 984 |   | $ | (1,002 | ) | $ | 1,521 |   |
| Basic net income per share   |       | $                                          | 0.14       |   |   |   |   |   | $ | 0.14 |   |
| Diluted net income per share |       | $                                          | 0.14       |   |   |   |   |   | $ | 0.14 |   |

** **
| ** **                   | ** ** | **Three Months Ended March 31,  2004**     | ** ** |
|------------------------------|------------|--------------------------------------------|------------|
| ** **                   | ** ** | **MarkWest  Hydrocarbon**                  | ** ** | **East Texas** | ** ** | **Starfish** | ** ** | **Adjustments****(1)** | ** ** | **Total** | ** ** |
| ** **                   | ** ** | **(in thousands, except per share  data)** | ** ** |
| Revenue                      |       | $                                          | 93,700     |   | $ | 7,857 |   | $ | — |   | $ | — |   | $ | 101,557 |   |
| Net income                   |       | $                                          | 720        |   | $ | 3,859 |   | $ | 1,074 |   | $ | (5,267 | ) | $ | 386 |   |
| Basic net income per share   |       | $                                          | 0.07       |   |   |   |   |   |   |   | $ | 0.04 |   |
| Diluted net income per share |       | $                                          | 0.07       |   |   |   |   |   |   |   | $ | 0.04 |   |

 

----

(1)           Adjustments primarily foramortization and financing costs.

 

**8.****     Related Party Transactions**

 

Through the Company’s wholly ownedsubsidiary, Matrex, LLC, the Company holds interests in certain exploration andproduction assets in which MAK-J Energy Partners Ltd. (“MAK-J”) also ownsinterests.  The general partner of MAK-Jis a corporation owned and controlled by the Company’s former President andChief Executive Officer and current Chairman of the Board of Directors.  Two former officers, both of whom left theCompany during 2003, were limited partners in MAK-J.  Both parties are participants in jointoperating agreements involving other third parties.  Matrex, LLC, was sold by the Company inOctober 2005.

 

The Company has receivables due from MAK-J, representing its share ofoperating and capital costs generated in the normal course of business, of $0.1million and less than $0.1 million as of March 31, 2005 and December 31, 2004,respectively. The Company also has payables to MAK-J, representing its share ofrevenues generated in the normal course of business, of less than $0.1 millionas of both March 31, 2005 and December 31, 2004.

 

**9.****     Asset Retirement Obligations**

 

InJune 2001, the FASB issued Statement No. 143, *Accountingfor Asset Retirement Obligations. *TheCompany adopted SFAS No. 143 beginning January 1, 2003. The most significantimpact of this standard on the Company was a change in the method of accruingfor site restoration costs.  Under SFASNo. 143, the fair value of asset retirement obligations is recorded as aliability when incurred, which is typically at the time the assets are placedin service.  Amounts recorded for therelated assets are increased by the amount of these obligations.  Over time, the liabilities are accreted forthe change in their present value and the initial capitalized costs aredepreciated over the useful lives of the related assets.

 

ThePartnership reviewed current laws and regulations governing obligations forasset retirements as well as leases. Based on that review, the Partnership identified certain land leases inEast Texas that contain provisions 

 

15

----

 

requiring the Partnership to returnthe land to its original condition upon the termination of the lease.  Based on the review of the leases, thePartnership recorded an asset retirement obligation of $0.4 million during theyear ended December 31, 2004, using an estimated average term of the leases of25 years.  Accretion expense for thethree months ended March 31, 2005 was less than $0.1 million.  At March 31, 2005, the asset retirementobligation was $0.4 million.

 

Inaccordance with SFAS No. 143, the Partnership has identified certain assetsthat have an indeterminate life, and thus a future retirement obligation is notdeterminable.  These assets includecertain pipelines and processing plants. A liability for these asset retirement obligations will be recorded whena fair value is determinable.

 

Theasset retirement obligation associated with the Partnership’s remainingfacilities was insignificant and was not recognized in the financialstatements.

 

InOctober 2003, the Board of Directors of the Company’s general partner approveda plan to shut down the Partnership’s existing Cobb processing facility andconstruct a replacement facility. Construction of the new facility wascompleted in the first quarter of 2005.  During the fourth quarter of2003, the Partnership estimated the amount of the asset retirement obligation associatedwith the decommissioning and dismantlement of the old Cobb facility to be $0.5million and, accordingly, the Partnership recorded a related currentliability.  The Partnership expects tocomplete the decompressing and dismantelment of the old Cobb facility in thefourth quarter of 2005.  At March 31,2005, the asset retirement obligation was $0.5 million.

 

AtMarch 31, 2005 and 2004, there were no assets legally restricted for purposesof settling asset retirement obligations.

 

Thefollowing is a reconciliation of the Company’s asset retirement obligationactivity for the three months ended March 31, 2005 (in thousands):

 
| Asset retirement obligation as of December 31, 2004 |   | $      | 892    | ** ** |
|-----------------------------------------------------|--------|--------|--------|------------|
| Accretion                                           |   | 9      |   |
| Asset retirement obligation  as of March 31, 2005   |   | $      | 901    |       |
|                                                |   |   |   |
| Current                                             |   | $      | 450    |       |
| Long-term                                           |   | 451    |   |
| Asset  retirement obligation                        |   | $      | 901    |       |

 

16

----

 

**10.****  Property, Plant and Equipment**

 

Property,plant and equipment consists of:

 
| ** **                                     | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|--------------------|------------|------------------|------------|
| ** **                                     | ** ** | **2005**           | ** ** | **2004**         | ** ** |
| ** **                                     | ** ** | **(in thousands)** | ** ** |
| Property, plant and  equipment:                |       |               |       |             |       |
| Gas gathering facilities                       |       | $                  | 179,771    |             | $          | 160,763 |   |
| Gas processing plants                          |       | 58,499             |       | 56,239           |       |
| Fractionation and storage facilities           |       | 22,721             |       | 22,112           |       |
| Natural gas pipelines                          |       | 38,167             |       | 38,167           |       |
| Crude oil pipelines                            |       | 19,447             |       | 18,499           |       |
| NGL transportation facilities                  |       | 4,381              |       | 4,381            |       |
| Land, buildings and other equipment            |       | 9,683              |       | 9,418            |       |
| Furniture, office equipment and other          |       | 3,985              |       | 4,113            |       |
| Construction in progress                       |       | 21,202             |       | 28,944           |       |
|                                           |       | 357,856            |       | 342,636          |       |
| Less: Accumulated depreciation                 |       | (63,976            | )          | (59,443          | )          |
|  Total property, plant and equipment, net |       | $                  | 293,880    |             | $          | 283,193 |   |

 

Forthe three months ended March 31, 2005 and 2004, we capitalized interest onconstruction in progress, including amortization of deferred financing costs,of $0.6 million and less than $0.1 million, respectively.

 

**11.  Dividends to Shareholders**

 

OnApril 28, 2005, the Company’s Boardof Directors declared a quarterly cash dividend of $0.10 per share, an increase of $0.075 per share from the same period of2004, payable on May 23, 2005 to the stockholders of record as of the closeof business on May 16, 2005.  The ex-dividenddate was May 12, 2005.   The Board continues to support its objective ofmaintaining a regular quarterly dividend, but cautions that any such futuredeclaration will be dependent upon the Company’s financial performance.

 

**12.  SegmentInformation**

 

Ouroperations are classified into two reportable segments:

 

(1)   MarkWest Energy Partners—The Partnership is engaged inthe gathering, processing and transmission of natural gas; the transportation,fractionation and storage of natural gas liquids; and the gathering andtransportation of crude oil.

(2)   MarkWest Hydrocarbon Standalone—The Standalone Companysells its equity and third-party NGLs, purchases third-party natural gas andsells its equity and third-party natural gas. Since February 2004, the Standalone Company is also engaged in thewholesale marketing of propane. MarkWest Hydrocarbon Standalone operates MarkWestEnergy Partners, a publicly-traded limited partnership.

 

Theaccounting policies the Company applies in the preparation of business segmentinformation are generally the same as those described in Note 2 to theConsolidated Financial Statements in our December 31, 2004, Annual Report onForm 10-K, except that certain items below the “Income before non-controllinginterest in net income of consolidated subsidiary and income taxes” line arenot allocated to business segments as they are not considered by management inits evaluation of business unit performance.

 

Thetable below presents information about income before non-controlling interestin net income of consolidated subsidiary and income taxes for the reportedsegments for the three months ended March 31, 2005 and 2004. Selling, general and administrative expenses areallocated to the segments based on direct expenses incurred 

 

17

----

 

by the segments or allocatedbased on****the percent of time that employeesdevote to the segment in accordance with the Partnership’s services agreementwith the Company.****

 

18

----

 
| ** **                                                                                               | ** ** | **MarkWest  Hydrocarbon  Standalone** | ** ** | **MarkWest  Energy  Partners** | ** ** | **Eliminating  Entries** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------|------------|--------------------------|------------|-----------|------------|
| ** **                                                                                               | ** ** | **(in thousands)**                    | ** ** |
| **Three Months Ended March 31,  2005:**                                                                  |       |                                  |       |                           |       |                     |       |      |       |
| Revenues                                                                                                 |       | $                                     | 64,521     |                           | $          | 89,637                   |       | $         | (15,805    | ) | $ | 138,353 |   |
| Purchased product costs                                                                                  |       | 53,821                                |       | 60,785                         |       | (9,907                   | )          | 104,699   |       |
| Facility expenses                                                                                        |       | 5,827                                 |       | 9,331                          |       | (5,898                   | )          | 9,260     |       |
| Selling, general and administrative  expenses                                                            |       | 3,463                                 |       | 4,639                          |       | —                   |       | 8,102     |       |
| Depreciation                                                                                             |       | 415                                   |       | 4,326                          |       | —                   |       | 4,741     |       |
| Amortization of intangible  assets                                                                       |       | —                                |       | 2,095                          |       | —                   |       | 2,095     |       |
| Accretion of asset retirement  and sublease obligations                                                  |       | —                                |       | 10                             |       | —                   |       | 10        |       |
| Income from operations                                                                                   |       | 995                                   |       | 8,451                          |       | —                   |       | 9,446     |       |
|                                                                                                     |       |                                  |       |                           |       |                     |       |      |       |
| Interest income                                                                                          |       | 182                                   |       | 67                             |       | —                   |       | 249       |       |
| Interest expense                                                                                         |       | (30                                   | )          | (3,674                         | )          | —                   |       | (3,704    | )          |
| Amortization of deferred financing costs (a component of interest  expense)                              |       | (61                                   | )          | (475                           | )          | —                   |       | (536      | )          |
| Dividend income                                                                                          |       | 92                                    |       | —                         |       | —                   |       | 92        |       |
| Other income (expense)                                                                                   |       | 191                                   |       | (104                           | )          | —                   |       | 87        |       |
| Income before non-controlling interest in net income of consolidated  subsidiary and income taxes        |       | $                                     | 1,369      |                           | $          | 4,265                    |       | $         | —     |   | $ | 5,634 |   |
| **March 31, 2005:**                                                                                      |       |                                  |       |                           |       |                     |       |      |       |
| Cash, cash equivalents and  restricted cash                                                              |       | $                                     | 21,364     |                           | $          | 15,184                   |       | $         | —     |   | $ | 36,548 |   |
| Marketable securities                                                                                    |       | 20,544                                |       | —                         |       | —                   |       | 20,544    |       |
| Current  assets                                                                                          |       | 64,915                                |       | 51,231                         |       | —                   |       | 116,146   |       |
| Current  liabilities                                                                                     |       | 17,840                                |       | 54,611                         |       | —                   |       | 72,451    |       |
| Total assets                                                                                             |       | 70,541                                |       | 557,828                        |       | —                   |       | 628,369   |       |
| Total debt                                                                                               |       | —                                |       | 265,000                        |       | —                   |       | 265,000   |       |
|                                                                                                     |       |                                  |       |                           |       |                     |       |      |       |
| **Three Months Ended March 31,  2004:**                                                                  |       |                                  |       |                           |       |                     |       |      |       |
| Revenues                                                                                                 |       | $                                     | 44,392     |                           | $          | 63,825                   |       | $         | (14,517    | ) | $ | 93,700 |   |
| Purchased product costs                                                                                  |       | 35,851                                |       | 47,853                         |       | (8,216                   | )          | 75,488    |       |
| Facility expenses                                                                                        |       | 6,097                                 |       | 6,290                          |       | (6,301                   | )          | 6,086     |       |
| Selling, general and  administrative expenses                                                            |       | 2,416                                 |       | 2,898                          |       | —                   |       | 5,314     |       |
| Depreciation                                                                                             |       | 383                                   |       | 3,145                          |       | —                   |       | 3,528     |       |
| Amortization of intangible  assets                                                                       |       | —                                |       | 34                             |       | —                   |       | 34        |       |
| Income (loss) from operations                                                                            |       | (355                                  | )          | 3,605                          |       | —                   |       | 3,250     |       |
|                                                                                                     |       |                                  |       |                           |       |                     |       |      |       |
| Interest income                                                                                          |       | 128                                   |       | 7                              |       | —                   |       | 135       |       |
| Interest expense                                                                                         |       | (1                                    | )          | (1,129                         | )          | —                   |       | (1,130    | )          |
| Amortization of deferred financing cost (a component of interest  expense)                               |       | 1                                     |       | (308                           | )          | —                   |       | (307      | )          |
| Other income (expense)                                                                                   |       | 39                                    |       | (14                            | )          | —                   |       | 25        |       |
| Income (loss) before non-controlling interest in net income of  consolidated subsidiary and income taxes |       | $                                     | (188       | )                              | $          | 2,161                    |       | $         | —     |   | $ | 1,973 |   |
| **March 31, 2004:**                                                                                      |       |                                  |       |                           |       |                     |       |      |       |
| Cash, cash equivalents and  restricted cash                                                              |       | $                                     | 37,899     |                           | $          | 11,216                   |       | $         | —     |   | $ | 49,115 |   |
| Marketable  securities                                                                                   |       | 4,430                                 |       | —                         |       | —                   |       | 4,430     |       |
| Current  assets                                                                                          |       | 55,920                                |       | 27,610                         |       | —                   |       | 83,530    |       |
| Current  liabilities                                                                                     |       | 14,360                                |       | 23,512                         |       | —                   |       | 37,872    |       |
| Total assets                                                                                             |       | 59,759                                |       | 214,992                        |       | —                   |       | 274,751   |       |
| Total debt                                                                                               |       | —                                |       | 84,200                         |       | —                   |       | 84,200    |       |

 

19

----

 

**13.  Commitments and Contingencies**

 

*Legal*

 

TheCompany and several of its affiliates were served earlier this year with twolawsuits presently under the jurisdiction of the U.S. District Court for theEastern District of Kentucky, Pikeville Division, and in early November 2005,were served with an additional lawsuit filed in Floyd County Circuit Court,Kentucky, adding five new claimants, essentially alleging the same facts andclaims as the earlier two suits.  Thesesuits are for third-party claims of property and personal injury damagessustained as a consequence of a NGL pipeline leak and an ensuing explosion andfire that occurred on November 8, 2004 from a natural gas pipeline, owned by anunrelated business entity, and leased and operated by the Partnership’ssubsidiary, MarkWest Energy Appalachia, LLC. The pipeline transports NGLs from the Maytown gas processing plant tothe Partnership’s Siloam fractionator. An ignition and fire from the leakedvapors resulted in property damage to five homes and injuries to some of theresidents.  The cause of the pipelinesplit, resulting leak, explosion, and fire is being investigated by thepipeline owner, the U.S. Department of Transportation, Office of PipelineSafety (“OPS”), and the Partnership.

 

TheCompany and the Partnership have timely notified their general liabilityinsurance carriers of the incident and of the filed Kentucky actions and arecoordinating the defense of these third-party lawsuits with the insurers.  At this time, the Company and the Partnershipbelieve that they have adequate general liability insurance coverage forthird-party property damage and personal injury liability resulting from theincident.  To date, the Company and thePartnership have settled with several of the claimants for third-party propertydamage claims (damage to residences and personal property) related to thisincident, in addition to reaching settlement for some of the personal injuryclaims related to the pipeline explosion and fire.  These settlements have been paid for orreimbursed under the Partnership’s general liability insurance.  As a result, the Company has not provided fora loss contingency.

 

Pursuantto OPS regulation mandates and to a Corrective Action Order issued by the OPSimmediately after the incident, pipeline and valve integrity evaluation,testing, and repair efforts were required and conducted on the affectedpipeline segment before service could be resumed.  Partial return to service of the affectedpipeline occurred in October 2005.  TheCompany and the Partnership have filed an independent action against theirAll-Risk Property and Business Interruption insurance carriers as a result oftheir refusal to honor their insurance coverage obligation for providing theCompany and the Partnership insurance payments for certain expenses.  These expenses related to the Partnership’sinternal expenses and costs incurred for damage to, and loss of use of, thepipeline, equipment, products, the extra transportation costs incurred fortransporting the liquids while the pipeline was out of service, the reducedvolumes of liquids that could be processed, and the costs of complying with theOPS Corrective Action Order (hydrostatic testing, repair/replacement and otherpipeline integrity assurance measures). These expenses and costs have been expensed as incurred and anypotential recovery from the All-Risks Property and Business Interruptioninsurance carriers will be treated as “other income” if they are received.  The Company has not provided for a receivablerelated to these claims because of the uncertainty as to whether and how muchthe Partnership will ultimately recover under the All-Risks Property andBusiness Interruption insurance policies. The Company and the Partnership have also asserted that the costsassociated with such testing, replacement and repair are also subject to anequitable sharing arrangement with the owner of the pipeline, pursuant to theterms of the pipeline lease agreement.

 

TheCompany has also been involved in a lawsuit captioned *Ross Bros. Construction v. MarkWest Hydrocarbon, Inc.,*(U.S. District Court Eastern District of Kentucky, Ashland Division, Civ.Action No. 01-CV-205).  This lawsuitinvolved the construction of the Siloam, Kentucky plant and a dispute as to themonetary value of additional work beyond the contract’s lump sum priceperformed by the contractor.  Thislawsuit involved a claim of approximately $0.7 million in extra costs.  The Company was recently granted SummaryJudgment on its defense asserting accord and satisfaction.  In August 2005, Plaintiffs filed an appeal ofthe Summary Judgment to the U.S. Court of Appeals for the 6thCircuit.  The Company believes that whileit is not able to predict the ultimate outcome of this matter, based on theCourt’s discussion on the grant of the summary judgment and denial of RossBrothers’ 

 

20

----

 

motion for reconsideration, it is probable that theCompany will prevail in the appeal. As a result, the Company has not providedfor a loss contingency.

 

TheCompany has also been involved in an arbitration proceeding captioned*Kevin Stowe and Scott Daves v. MarkWest Hydrocarbon, Inc.,*Arbitration, Denver, Colorado, 2005. Claimants filed an arbitration proceeding against the Company seekingfurther payments out of a dispute and settlement over interests in certainnatural gas wells in Colorado.  TheCompany had transferred, via a purchase and sale agreement, any liability forany payments out of the settlement it had reached with claimants to athird-party in the sale of certain of the Company’s oil and gas propertyinterests.  The Company has been incommunication with the third-party purchaser ,and the third-party purchaser hasadmitted it has those liabilities under the purchase and sale agreement, andthe Company does not believe there are material liabilities associated withthis claim.  As a result, the Company hasnot provided for a loss contingency.

 

In September 2005, a lawsuit was served on the Partnership’s subsidiary,MarkWest Pinnacle, L.P., filed in the District Court of Midland, Texas, 285thJudicial District, alleging breach of contract, fraud and breach of impliedduty of good faith with respect to a dispute on volumes of gas purchased by thePartnership under a gas purchase agreement. Under the gas purchase agreement, MarkWest Energy Partners paid thePlaintiff based on volumes of gas measured at the wellhead (deliverypoint).  Plaintiff claims that it isentitled to a prorated portion of any system gain, that is to be paid for moregas than it actually sold and delivered to the Partnership.  MarkWest Energy Partners has filed an Answerto the Complaint, denying Plaintiff’s allegations and has asserted acounter-claim for declaratory judgment on the contract terms as being clear andunambiguous as to payment being limited to those volumes measured at thewellhead, that Plaintiff’s claims are without merit, and that the Partnershipalso may have overpaid Plaintiff based on, among other things, the wet versusdry Btu measurements.  Discovery has notyet begun and, at this time, the Partnership is not able to predict theultimate outcome of this matter.  As aresult, the Partnership has not provided for a loss contingency.

 

Inthe ordinary course of business, the Company is a party to various other legalactions.  In the opinion of management,none of these actions, either individually or in the aggregate, will have amaterial adverse effect on the Company’s financial condition, liquidity, orresults of operations.

 

*Lease Obligations*

 

The Company has various non-cancelable operating leaseagreements for equipment and office space expiring at various times throughfiscal 2015. The Company’s minimum future lease payments under these operatingleases as of March 31, 2005 are as follows (in thousands):

 
| 2005                |   | $     | 3,317  |   |
|---------------------|--------|-------|--------|--------|
| 2006                |   | 3,345 |   |
| 2007                |   | 2,043 |   |
| 2008                |   | 1,459 |   |
| 2009                |   | 1,377 |   |
| 2010 and thereafter |   | 826   |   |
| Total               |   | $     | 12,367 |   |

## ** **

TheCompany also has a commitment to purchase equipment of $3.6 million at March31, 2005.

 

**14.****          Subsequent Event – Javelina**

 

On November 1, 2005, MarkWest Energy Partners completed the acquisitionof 100% of the interests in the Javelina gas processing and fractionationfacility, and related pipeline facilities located in Corpus Christi, Texas,from El Paso Corporation, Kerr-McGee Corporation, and Valero Energy Corporationfor approximately $355.0 million (the “Javelina Acquisition”) plus workingcapital of approximately $45.0 million.

 

21

----

 

The gas processing facility was constructed in 1989 to process off-gasfrom six refineries in the Corpus Christi area, recovering up to 28,000 barrelsper day of natural gas liquids, as well as hydrogen.  The Javelina facility currently processes 125to 130 MMcf/d of inlet gas.

 

MarkWest Energy Partners financed the Javelina acquisition throughborrowing under its amended and restated credit agreement as more thoroughlydiscussed in Note 15 below.  The amendedand restated credit agreement provided for a $100.0 million revolving creditfacility and a $400.0 million term loan. In addition to financing the acquisition, proceeds were used to retirethe outstanding debt and provide for future liquidity requirements of thePartnership.  The loans mature on October31, 2006.  The Partnership intends torefinance the debt incurred to complete the Javelina acquisition, as well asits growth capital projects, with a combination of private and public equityand long-term debt over the next several months.  Permanent capital will be issued in amountsdesigned to bring the Partnership’s capital structure in line with its statedgoal of less than 50% debt.

 

On November 9, 2005, the Partnership completed a private placement of1,644,065 common units.  The units wereissued at a purchase price of $44.21 per unit, raising approximately $74.0million, including the general partner’s contribution.  Proceeds from the equity placement were usedto reduce borrowing under the revolver and to reduce the size of the term loan.

 

**15.****         Subsequent Event –Debt**

 

In October 2004, the Company entered into a $25.0 million senior creditfacility with a term of one year.  The$25.0 million revolving facility has a variable interest rate based on the baserate, which is equal to the higher of a) the Federal Funds Rate plus 1⁄2 of 1%,and b) the rate of interest in effect for such day as publicly announced fromtime to time by the Administrative Agent as its prime rate, plus the applicablerate, which is based on a utilization percentage.  In October and November 2005, the Companyentered into the first and second amendment to the credit agreement.  The first amendment extended the term of theoriginal agreement to November 15, 2005. The second amendment reduced the lending amount from $25.0 million to$16.0 million, of which $6.0 million of availability is committed to a letterof credit, leaving $10.0 million available for revolving loans.  The second amendment also extended the termof the revolving credit to December 30, 2005. If the revolving credit is converted into a term loan, the term will beextended to December 29, 2006.

 

In connection with the credit facility, the Company is subject to anumber of restrictions on its business, including restrictions on its abilityto grant liens on assets; merge, consolidate or sell assets; incurindebtedness; make acquisitions; engage in other businesses; enter intooperating leases; enter into certain swap contracts; engage in transactionswith affiliates; make dispositions; make restricted payments, distributions andredemptions and other usual and customary covenants.  As of March 31, 2005, the Company had nooutstanding borrowings from the credit facility.  At November 15, 2005, the Company had aborrowing capacity of $10.0 million.  Thecredit facility also contains covenants requiring the Company to maintain aminimum net worth of $40.0 million plus 50% of proceeds of equity issued subsequentto October 25, 2004.

 

***MarkWest Energy Partners***

 

OnNovember 1, 2005, the Partnership entered into the fourth amended and restatedcredit agreement (“Partnership Credit Facility”), which provides for a maximumlending limit of  $500.0 million for aterm of one year.  The credit facilityincludes a revolving facility of $100.0 million and a $400.0 million termloan.  The credit facility is guaranteedby the Partnership and all of the Partnership’s subsidiaries and iscollateralized by substantially all of the Partnership’s assets and those ofits subsidiaries.  The borrowings underthe credit facility bear interest at a variable interest rate plus basis pointsthat correspond to the ratio of the Partnership’s Consolidated Senior Debt (asdefined in the Partnership Credit Facility) to Consolidated EBITDA (as definedin the Partnership Credit Facility), ranging from 1.25% to 2.00% for Base Rateloans, and 2.25% to 3.00% for Eurodollar Rate loans.  The basis points will increase by 0.25% inMay 2006 and August 2006, for a total increase of 0.50%.  Borrowings under the Partnership Credit Facilitywere used to finance, in part, the Javelina acquisition discussed in Note 14above.

 

22

----

 

Under the provisions of the Partnership CreditFacility, the Partnership is subject to a number of restrictions on itsbusiness, including restrictions on its ability to grant liens on assets; makeor own certain investments; enter into any swap contracts other than in theordinary course of business; merge, consolidate or sell assets; incur indebtedness(other than subordinated indebtedness); make distributions on equity investments;declare or make, directly or indirectly, any restricted payments.

 

The Partnership Credit Facility also contains covenantsrequiring the Partnership to maintain:

 

•      a ratio of not less than 2.00 to 1.00 ofconsolidated EBITDA to consolidated interest expense for any fiscal quarter-endthrough and including March 31, 2006 and 3.00 to 1.00 for any fiscal quarter-endthereafter;

•      a ratio of not more than 7.00 to 1.00 of totalconsolidated debt to consolidated EBITDA for any fiscal quarter-end through andincluding March 31, 2006 and 5.00 to 1.00 for any fiscal quarter-end thereafter;

•      a ratio of not more than 5.00 to 1.00 ofConsolidated senior debt to consolidated EBITDA for any fiscal quarter-endthrough and including March 31, 2006 and 3.50 to 1.00 for any fiscalquarter-end thereafter; and

•      a minimum net worth of $200.0 million plus 50%of proceeds from partnership interests.

 

These covenants are used to calculate the available borrowing capacityon a quarterly basis.  The Partnershipincurs a commitment fee on the unused portion of the credit facility at 50.0basis points based upon the ratio of Consolidated Senior Debt (as defined inthe Partnership Credit Facility) to Consolidated EBITDA (as defined in thePartnership Credit Facility).  The PartnershipCredit Facility matures on October 31, 2006. At that time, the Partnership Credit Facility terminates and alloutstanding amounts thereunder are due and payable.

 

23

----

 

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

 

##### **Management’sDiscussion and Analysis (“MD&A”) contains statements that areforward-looking**.  These statements are based on currentexpectations and assumptions that are subject to risks and uncertainties.  Actual results could differ materially fromthose expressed or implied in the forward-looking statements.

##### ** **

##### **Management Overview of theQuarter Ended March 31, 2005**

 

TheCompany reported net income of $1.5 million, or $0.14 per diluted sharefor the three months ended March 31, 2005, compared to net income of$0.7 million, or $0.07 per diluted share for the first quarter of 2004.

 

***MarkWest HydrocarbonStandalone Results***

 

Income from continuing operations before non-controllinginterest in net income of consolidated subsidiary and income taxes was $1.4million for the three months ended March 31, 2005, compared to a loss fromcontinuing operations before non-controlling interest in net income ofconsolidated subsidiary and income taxes of $0.2 million for the correspondingquarter of 2004.  The increase isprimarily due to a decrease in hedge losses realized in the firstquarter of 2005 of $0.3 million compared to $2.2 million in the first quarterof 2004.  The loss in 2004 was the resultof an unfavorable hedging program that settled in April 2004.  This was offsetin part by an increase in selling, general and administrative expenses as aresult of additional compensation expense of $0.8 million recognized under theCompany’s Participation Plan and the 1996 Stock Incentive Plan and 1996Non-employee Director Stock Option Plan.

 

MarkWestHydrocarbon’s Standalone primary source of growth is from the marketing ofnatural gas and NGLs, as well as quarterly distributions received from MarkWestEnergy Partners.  The Company owns 89% ofthe general partner of MarkWest Energy Partners.  The general partner of MarkWest EnergyPartners owns the 2% general partner interest and all of the incentivedistribution rights.  The incentivedistribution rights entitle the Company to receive an increasing percentage ofcash distributed by the Partnership as certain target distribution levels arereached.  For the three months endedMarch 31, 2005, the Company received $1.9 million in distributions for itssubordinated units, and the general partner received $1.0 million, including$0.8 million representing payments on incentive distribution rights.  For the three months ended March 31, 2004,the Company received $2.0 in distributions for its subordinated units, and thegeneral partner received $0.3 million, including $0.2 representing payments onincentive distribution rights.

 

***MarkWest EnergyPartners Results***

 

The increase in the first quarter income fromcontinuing operations before non-controlling interest in net income ofconsolidated subsidiary and income taxes of $2.1 million over the comparableperiod in 2004 is primarily attributable to the contribution of the East Texassystem acquisition from July 2004.  Thisacquisition increased operating income by approximately $5.3 million comparedto the three months ended March 31, 2004. Operating income before selling, general, and administrative expensesfrom MarkWest Energy Partners’ Oklahoma segment also increased by $2.7 millionas a result of higher volumes and processing margins.  This was offset somewhat by an increase ininterest expense and amortization of deferred financing costs of $2.7 milliondue to an increase in debt levels and financing costs, resulting from the Partnership’s2004 acquisitions.  MarkWest EnergyPartners was also impacted by a decrease in operating income contributed by itsAppalachia and Michigan segments, primarily as a result of reduced volumes aswell as an increase in transportation costs and pipeline testing, repair andimprovements costs incurred as a result of the November 2004 pipeline failureand resulting fire and explosion that occurred on a section of one of thePartnership’s leased pipelines in Appalachia. Testing and repair of the Appalachia pipeline commenced in the firstquarter of 2005 and will continue through the fourth quarter of 2005.  The Partnership’s current estimate is thatthe full cost of pipeline testing, repair and improvements will beapproximately $5.5 million, of which approximately $1.3 million will becapitalized.  Through September 30, 2005,the Partnership has incurred pipeline testing, refurbishment and replacementcosts of approximately $5.1 million, of which $1.3 million has beencapitalized.  First quarter testing andrepair costs incurred were $0.2 million, and second quarter costs wereapproximately $1.5 million.  Increasedtransportation costs have been approximately $0.6 million per quarter.  The Partnership is seeking recovery under itsbusiness interruption insurance and has asserted that the costs associated

 

24

----

 

with suchtesting, repairs and improvements are subject to a sharing arrangement with theowner of the pipeline pursuant to the terms of the pipeline lease agreement. Theseexpenses and costs have been expensed as incurred and any potential recoveryfrom the All-Risks Property and Business Interruption insurance carriers willbe treated as “other income” if they are received.

 

Selling, general and administrative expenses alsoincreased by $2.8 million over the comparable period in 2004 as a result ofcosts of Sarbanes-Oxley implementation and additional compensation of $0.7million expense recognized under the Company’s Participation Plan.

 

On March 31, 2005, MarkWest Energy Partners acquired a50% non-operating membership interest in Starfish Pipeline Company, LLC, froman affiliate of Enterprise Products Partners, L.P. for $41.7 million.  Starfish owns the FERC-regulated Stingraynatural gas pipeline and the unregulated Triton natural gas gathering systemand West Cameron dehydration facility, all located in the Gulf of Mexico andSouthwestern Louisiana.  The acquisitionwas financed through the Partnership’s existing credit facility.

 

***Cash Dividend***

 

OnApril 28, 2005, our Board ofDirectors declared a quarterly cash dividend of $0.10 per share, an increase of $0.075 per share from the same period of2004, payable on May 23, 2005 to the stockholders of record as of the closeof business on May 16, 2005.  The ex-dividenddate is May 12, 2005.   The Board continues to support its objective ofmaintaining a regular quarterly dividend, but cautions that any such futuredeclaration will be dependent upon our financial performance.

 

## **Our Business**

 

We were founded in 1988 as a partnership and later incorporated inDelaware.  We completed our initialpublic offering in 1996.

 

We are an energy company primarily focused on increasing shareholdervalue by growing MarkWest Energy Partners, our consolidated subsidiary and a publicly-tradedmaster limited partnership engaged in the gathering, processing andtransmission of natural gas; the transportation, fractionation and storage ofnatural gas liquids; and the gathering and transportation of crude oil. We alsomarket natural gas and natural gas liquids (NGLs). We discontinued ourexploration and production activities in 2003.

 

Ourassets consist primarily of partnership interests in MarkWest EnergyPartners.  As of March 31, 2005, our partnershipinterests consisted of the following:

 

•      2,469,496 subordinated units, representing a 23%limited partner interest in the Partnership; and

•      An 89% ownership interest in MarkWest Energy GP,L.L.C., the general partner of the Partnership, which owns a 2% general partnerinterest and all of the incentive distribution rights in the Partnership.

 

To better understand ourbusiness and the results of operations discussed below, it is important to havean understanding of three factors:

 

•      The nature of our relationship with MarkWestEnergy Partners;

•      The nature of the contracts from which we deriveour revenues and from which MarkWest Energy Partners derives its revenues; and

•      The lack of comparability within our results ofoperations across periods because of MarkWest Energy Partners’ significant andrecent acquisition activity.

 

25

----

 

***Our Relationshipwith MarkWest Energy Partners***

 

We spun off the majority of ourthen-existing natural gas gathering and processing and NGL transportation,fractionation and storage assets into MarkWest Energy Partners in May 2002,just before the Partnership completed its initial public offering. At the timeof its formation and initial public offering, we entered into four contractswith MarkWest Energy Partners whereby MarkWest Energy Partners providesmidstream services in Appalachia for a fee. Additionally, MarkWest EnergyPartners receives 100% of all fee and percent-of-proceeds consideration for thefirst 10 MMcf/d that it gathers and processes in Michigan. MarkWest Hydrocarbonretains a 70% net profits interest in the gathering and processing incomeearned on quarterly pipeline throughput in excess of 10 MMcf/d. In accordancewith generally accepted accounting principles, MarkWest Energy Partners’financial results are included in our condensed consolidated financialstatements.  All intercompany accountsand transactions are eliminated during consolidation. You should read Note 12to our Condensed Consolidated Financial Statements, appearing earlier in thisForm 10-Q, for further information regarding our two business segments: (i)MarkWest Energy Partners and (ii) MarkWest Hydrocarbon Standalone.

 

As a result of our contracts with MarkWest Energy Partners mentionedabove, we accounted for 18% of the Partnership’s revenues and 23% of its netoperating margin (a non-GAAP financial measure) for the three months endedMarch 31, 2005. This represents a decrease from the year ended December 31,2004, during which MarkWest Hydrocarbon Standalone accounted for 20% of thePartnership’s revenues and 33% of its net operating margin (a non-GAAP financialmeasure).  We expect to account for lessof MarkWest Energy Partners’ business in the future as it continues to acquireassets and increase its customer and business diversification.

 

Also,at the time of the initial public offering, we entered into an OmnibusAgreement with MarkWest Energy Partners and related parties that governpotential competition and indemnification obligations among the parties.

 

Throughour majority ownership in the Partnership’s general partner, we control andoperate MarkWest Energy Partners. Our employees are responsible for conductingthe Partnership’s business and operating its assets pursuant to a ServicesAgreement, which was formalized effective January 1, 2004. We receive $5,000annually from MarkWest Energy Partners for services provided under the ServicesAgreement. We also are reimbursed for any reasonable costs incurred in the operationof the Partnership.

 

***Our Contracts***

 

Excludingthe revenues and net operating margin (a non-GAAP financial measure) derivedfrom MarkWest Energy Partners, we generate the majority of our revenues and netoperating margin (a non-GAAP financial measure) from the marketing of NGLs and,to a lesser extent, natural gas. As compensation for providing processingservices to our Appalachian producers (we have since outsourced these servicesto MarkWest Energy Partners as discussed below), we earn a fee and receivetitle to the NGLs produced. In return, we are required to replace, in drynatural gas, the Btu value of the NGLs extracted. This Btu replacementobligation is referred to in the industry as a “keep-whole” arrangement. Inkeep-whole arrangements, our principal cost is the replacement of the Btusextracted from the gas stream in the form of NGLs or consumed as fuel duringprocessing with dry gas of an equivalent Btu content. The spread between theNGL product sales price and the purchase price of natural gas with anequivalent Btu content is called the “frac spread.” Generally, the frac spreadand, consequently, the net operating margins, (non-GAAP financial measure) arepositive under these contracts. In the event natural gas becomes more expensiveon a Btu equivalent basis than NGL products, the cost of keeping the producer “whole”results in operating losses.

 

Atthe closing of MarkWest Energy Partners’ initial public offering on May 24,2002, we outsourced our midstream services to the Partnership. Pursuant to theterms of the operating agreements, we retained all the benefits and associatedrisks of our keep-whole contracts with producers. Our NGL and gas marketingoperations were retained by us and not contributed to MarkWest Energy Partners.

 

Ourkeep-whole contracts expose us to commodity price risk, both on the sales side(of NGLs) and on the purchase side (of natural gas), which may increase thevolatility of our marketing results and cash flows. We attempt 

 

26

----

 

to mitigate our commodity price risk through ourhedging program.  You should read Item 3,“Quantitative and Qualitative Disclosures about Market Risk” for furtherdetails about our commodity price risk management program.

 

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

 

ThePartnership generates the majority of its revenues and net operating marginfrom 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 the following five different types ofcontracts.

 

•      *Fee-based contracts.*  Underfee-based contracts, the Partnership receives a fee or fees for one or more ofthe following services: gathering, processing, and transmission of natural gas,transportation, fractionation and storage of NGLs, and gathering andtransportation of crude oil. The revenue MarkWest Energy Partners earns fromthese contracts is generally directly related to the volume of natural gas, NGLsor crude oil that flows through its systems and facilities and is not directlydependent on commodity prices. In certain cases, the Partnership’s contractsprovide for minimum annual payments. To the extent a sustained decline incommodity prices results in a decline in volumes, however, the Partnership’srevenues from these contracts would be reduced.

 

•      *Percent-of-proceeds contracts.*  Underpercent-of-proceeds contracts, MarkWest Energy Partners generally gathers andprocesses natural gas on behalf of producers, sells the resulting residue gasand NGLs at market prices and remits to producers an agreed-upon percentage ofthe proceeds based on an index price. In other cases, instead of remitting cashpayments to the producer, the Partnership delivers an agreed-upon percentage ofthe residue gas and NGLs to the producer and sells the volumes it keeps tothird parties at market prices. Under these types of contracts, MarkWest EnergyPartners’ revenues and net operating margins increase as natural gas prices andNGL prices increase, and its revenues and net operating margins decrease asnatural gas prices and NGL prices decrease.

 

•      *Percent-of-index contracts.*  Underpercent-of-index contracts, the Partnership generally purchases natural gas ateither (1) a percentage discount to a specified index price, (2) aspecified index price less a fixed amount or (3) a percentage discount toa specified index price less an additional fixed amount. MarkWest EnergyPartners then gathers and delivers the natural gas to pipelines where itresells the natural gas at the index price, or at a different percentagediscount to the index price. With respect to (1) and (3) above, the netoperating margins the Partnership realizes under the arrangements decrease inperiods of low natural gas prices because these net operating margins are basedon a percentage of the index price. Conversely, MarkWest Energy Partners’ netoperating margins increase during periods of high natural gas prices.

 

•      *Keep-whole contracts.*  Underkeep-whole contracts, the Partnership gathers natural gas from the producer,processes the natural gas and sells the resulting NGLs to third parties atmarket prices. Because the extraction of the NGLs from the natural gas duringprocessing reduces the Btu content of the natural gas, MarkWest Energy Partnersmust either purchase natural gas at market prices for return to producers ormake cash payment to the producers equal to the value of this natural gas.Accordingly, under these arrangements, the Partnership’s revenues and netoperating margins increase as the price of NGLs increases relative to the priceof natural gas, and its revenues and net operating margins decrease as theprice of natural gas increases relative to the price of NGLs.

 

•      *Other Gathering Arrangements. *Under these contracts, the Partnerships gather volumes under contractswith fee arrangements, which are unique to each system.  These contracts typically contain one or moreof the following revenue components:

 

•      *Fixed gathering andcompression fees. *Typically, gathering and compression fees arecomprised of a fixed-fee portion in which producers pay a fixed rate per unitto transport their natural gas through the gathering system.  Under the majority of these arrangements,fees are adjusted annually based on the Consumer Price Index.

 

27

----

 

•      *Settlement margin. *Typically, the terms of the Partnership’s gathering arrangements specifythat they are allowed to retain a fixed percentage of the volume gathered tocover the compression fuel charges and deemed line losses.  To the extent the gathering system isoperated more efficiently than specified per contract allowance, thePartnership is entitled to retain the difference for its own account.

 

•      *Condensate sales. *During the gathering process, thermodynamic forces contribute to changesin operating conditions of the natural gas flowing through the pipelineinfrastructure.  As a result, hydrocarbondew points are reached, causing condensation of hydrocarbons in thehigh-pressure pipelines.  The Partnershipsells 100% of the condensate collected in the system at a monthly crude-oilindex-based price and it retains the proceeds.

 

In its current areas of operations, MarkWest EnergyPartners has a combination of contract types and a limited number of keep-wholearrangements.  In many cases, thePartnership provides services under contracts that contain a combination ofmore than one of the arrangements described above.  The terms of the Partnership’s contracts varybased on gas quality conditions, the competitive environment at the time thecontracts are signed, and customer requirements.  The Partnership’s contract mix and,accordingly, our exposure to natural gas and NGL prices, may change as a resultof changes in producer preferences, the Partnership’s expansion in regionswhere some types of contracts are more common, and other market factors.  Any change in mix will impact our financialresults.

 

                At March 31, 2005, MarkWest Energy Partners’ primaryexposure to keep-whole contracts was limited to its Arapaho (Oklahoma)processing plant and its East Texas processing contracts.  At the Arapaho plant inlet, the Btu contentof the natural gas meets the downstream pipeline specification; however, thePartnership has the option of extracting NGLs when the processing marginenvironment is favorable.  In addition,approximately half, as measured in volumes, of the related gas gatheringcontracts include additional fees to cover plant operating costs, fuel costsand shrinkage costs in a low-processing-margin environment.  Because of the Partnership’s ability tooperate the plant in several recovery modes, including turning it off, coupledwith the additional fees provided for in the gas gathering contracts, thePartnership’s overall keep-whole contract exposure is limited to a portion ofthe operating costs of the plant.  InEast Texas, approximately 18%****ofthe inlet volume is processed pursuant to keep-whole contracts.

 

Management evaluates contractperformance on the basis of net operating margin (a non-GAAP financialmeasure), which is defined as income (loss) from operations, excluding facilitycost, selling, general and administrative expense, depreciation, amortization,impairments and accretion of asset retirement. These charges have been excluded for the purpose of enhancing theunderstanding by both management and investors of the underlying baselineoperating performance of our contractual arrangements, which management uses toevaluate our financial performance for purposes of planning and forecastingfuture periods.  Net operating margin (anon-GAAP financial measure) does not have any standardized definition andtherefore is unlikely to be comparable to similar measures presented by otherreporting companies.  Net operatingmargin (a non-GAAP financial measure) results should not be evaluated inisolation of, or as a substitute for, our financial results prepared inaccordance with United States GAAP.  Ourusage of net operating margin, and the underlying methodology in excludingcertain charges, is not necessarily an indication of the results of operationsthat may be expected in the future, or that we will not, in fact, incur suchcharges in future periods.

 

For the three months endedMarch 31, 2005, the Partnership generated the following percentages of itsrevenues and net operating margin from the following types of contracts:

 
| ** **           | ** ** | **Fee-Based** | ** ** | **Percent-of-  Proceeds(1)** | ** ** | **Percent-of-  Index(2)** | ** ** | **Keep-Whole(3)** | ** ** | **Total** | ** ** |
|----------------------|------------|---------------|------------|------------------------------|------------|---------------------------|------------|-------------------|------------|-----------|------------|
| Revenues             |       | 18            | %          | 13                           | %          | 30                        | %          | 39                | %          | 100       | %          |
| Net operating margin |       | 54            | %          | 5                            | %          | 31                        | %          | 10                | %          | 100       | %          |

 

----

(1)   Includes other types of contracts tied to NGLprices.

(2)   Includes other types of contracts tied tonatural gas prices.

(3)   Includes other types of contracts tied to bothNGL and natural gas prices.

 

28

----

 

Internal management uses theterm “net operating margin” (a non-GAAP measure) as a unit of performancemeasurement.  We calculate net operatingmargin (a non-GAAP financial measure) as the sum of income from operations,facility costs, selling, general and administrative costs, depreciation,amortization of intangible assets, impairments and accretion of assetretirement and sublease obligations.  Thefollowing is a reconciliation to the most comparable GAAP financial measure ofthis non-GAAP financial measure for the Company (in thousands):

 
| ** **                                            | ** ** | **March 31, 2005** | ** ** |
|-------------------------------------------------------|------------|--------------------|------------|
| Revenues                                              |       | $                  | 138,353    |   |
|                                                  |       |               |       |
| Purchased product costs                               |       | 104,699            |       |
|                                                  |       |               |       |
| Net operating margin                                  |       | $                  | 33,654     |   |
|                                                  |       |               |       |
| Facility expenses                                     |       | 9,260              |       |
| Selling, general and administrative expenses          |       | 8,102              |       |
| Depreciation                                          |       | 4,741              |       |
| Amortization of intangible assets                     |       | 2,095              |       |
| Accretion of asset retirement and sublease obligation |       | 10                 |       |
| Income from operations                                |       | $                  | 9,446      |   |

 

##### ***ItemsImpacting Comparability of Financial Results***

 

*Recent MarkWest Energy Partners Acquisition Activity*

 

In reading the discussion ofour historical results of operations, you should be aware of the impact ofMarkWest Energy Partners’ recent significant acquisitions, which impact thecomparability of our results of operations for the periods discussed.

 

ThroughMarch 31, 2005, the Partnership has completed seven acquisitions for anaggregate purchase price of approximately $396.1 million.  Four of these acquisitions occurred in 2003and are included in the results of operations for both the three months endingMarch 31, 2005 and 2004, respectively. These four acquisitions include:

 

•      The Pinnacle acquisition, which closed onMarch 28, 2003, for consideration of $39.9 million;

 

•      The Lubbock Pipeline acquisition (also known asthe Power-Tex Lateral pipeline), which closed September 2, 2003, forconsideration of $12.2 million;

 

•      The Western Oklahoma acquisition, which closedDecember 1, 2003, for consideration of $38.0 million; and

 

•      The Michigan Crude Pipeline acquisition, whichclosed December 18, 2003, for consideration of $21.3 million.

 

Twoacquisitions occurred after the first quarter of 2004.  Therefore, our historic results of operationsfor the three months ended March 31, 2004, do not reflect the impact of theseacquisitions.

 

•      The Hobbs Pipeline acquisition, which closed onApril 1, 2004, for consideration of $2.3 million; and

 

•      The East Texas acquisition, which closed on July30, 2004, for consideration of $240.7 million.

 

TheStarfish acquisition closed on March 31, 2005, for consideration of $41.7million.  As a result, the acquisitiondid not affect our results of operations in the first quarters of 2005 and2004.

 

29

----

 

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

 

***Operating Data***

*** ***
| ** **                                    | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **2005**                         | ** ** | **2004** | ** ** | **% Change** | ** ** |
|                                          |       |                             |       |   |   |   |   |
| Marketing                                     |       |                             |       |   |   |   |   |
| NGL product sales (gallons)                   |       | 52,164,000                       |       | 51,525,000 |   | 1 | % |
|                                          |       |                             |       |   |   |   |   |
| Wholesale                                     |       |                             |       |   |   |   |   |
| NGL product sales (gallons)(1)                |       | 19,672,332                       |       | 888,665 |   | 2,114 | % |
|                                          |       |                             |       |   |   |   |   |
| MarkWest Energy Partners                      |       |                             |       |   |   |   |   |
| ***Southwest:***                              |       |                             |       |   |   |   |   |
| *East Texas*(2)                               |       |                             |       |   |   |   |   |
| Gathering system throughput (Mcf/d)           |       | 287,000                          |       | NA |   | NA |   |
| NGL product sales                             |       | 27,612,000                       |       | NA |   | NA |   |
| *Oklahoma*                                    |       |                             |       |   |   |   |   |
| Foss Lake gathering system throughput (Mcf/d) |       | 67,000                           |       | 55,000 |   | 22 | % |
| Arapaho NGL product sales (gallons)           |       | 15,217,000                       |       | 10,459,000 |   | 45 | % |
| *Other*                                       |       |                             |       |   |   |   |   |
| Appleby gathering system throughput (Mcf/d)   |       | 28,000                           |       | 24,000 |   | 17 | % |
| Other gathering systems throughput (Mcf/d)    |       | 17,000                           |       | 18,000 |   | (6 | )% |
| Lateral throughput (Mcf/d) (3)                |       | 52,000                           |       | 61,000 |   | (15 | )% |
|                                          |       |                             |       |   |   |   |   |
| ***Appalachia:***                             |       |                             |       |   |   |   |   |
| Natural gas processed for a fee (Mcf/d)       |       | 210,000                          |       | 207,000 |   | 1 | % |
| NGLs fractionated for a fee (Gal/d)           |       | 462,000                          |       | 462,000 |   | 0 | % |
| NGL product sales (gallons)                   |       | 10,765,000                       |       | 10,926,000 |   | (1 | )% |
|                                          |       |                             |       |   |   |   |   |
| ***Michigan:***                               |       |                             |       |   |   |   |   |
| Natural gas volumes transported (Mcf/d) (4)   |       | 6,900                            |       | 13,900 |   | (50 | )% |
| NGL product sales (gallons)                   |       | 1,563,000                        |       | 2,714,000 |   | (42 | )% |
| Crude oil transported (Bbl/d)                 |       | 14,100                           |       | 14,600 |   | (3 | )% |

 

----

NA – Not applicable.

(1)   Represents sales from ourwholesale business.  Volumes are from theperiod since the Company started the line of business in February 2004.

(2)   We acquired our East TexasSystem in late July 2004.  Volumes arefor the period of time since acquiring the facility.

(3)   We acquired our Lubbockpipeline (a/k/a the Power-Tex lateral pipeline) in September 2003 and our Hobbslateral pipeline in April 2004.  TheLubbock and Hobbs pipelines are the only laterals we own that produce revenueon a per-unit-of-throughput basis.  Wereceive a flat fee from our other lateral pipelines and, consequently, thethroughput data from these lateral pipelines is excluded from this statistic.

(4)   Includes throughput fromthe Kenova, Cobb, and Boldman processing plants.

*** ***

***SegmentReporting***

 

TheCompany’s operations are classified into two reportable segments:

 

(1)   MarkWest Energy Partners—The Partnership is engaged inthe gathering, processing and transmission of natural gas, the transportation,fractionation and storage of natural gas liquids, and the gathering and transportationof crude oil.

(2)   MarkWest Hydrocarbon Standalone —The Standalone Companysells its equity and third-party NGLs, purchases third-party natural gas andsells its equity and third-party natural gas. Since February 2004, MarkWest Hydrocarbon Standalone

 

30

----

 

isalso engaged in the wholesale marketing of propane. MarkWest Hydrocarbon Standaloneoperates MarkWest Energy Partners, a publicly-traded limited partnership.

 

31

----

 

***Three Months Ended March 31, 2005 Compared to the ThreeMonths Ended March 31, 2004***

 
| ** **                                                                                               | ** ** | **MarkWest  Hydrocarbon  Standalone** | ** ** | **MarkWest  Energy  Partners** | ** ** | **Eliminating  Entries** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------|------------|--------------------------|------------|-----------|------------|
| ** **                                                                                               | ** ** | **(in thousands)**                    | ** ** |
| **Three Months Ended March 31, 2005:**                                                                   |       |                                  |       |                           |       |                     |       |      |       |
| Revenues                                                                                                 |       | $                                     | 64,521     |                           | $          | 89,637                   |       | $         | (15,805    | ) | $ | 138,353 |   |
| Purchased product costs                                                                                  |       | 53,821                                |       | 60,785                         |       | (9,907                   | )          | 104,699   |       |
| Facility expenses                                                                                        |       | 5,827                                 |       | 9,331                          |       | (5,898                   | )          | 9,260     |       |
| Selling, general and administrative expenses                                                             |       | 3,463                                 |       | 4,639                          |       | —                   |       | 8,102     |       |
| Depreciation                                                                                             |       | 415                                   |       | 4,326                          |       | —                   |       | 4,741     |       |
| Amortization of intangible assets                                                                        |       | —                                |       | 2,095                          |       | —                   |       | 2,095     |       |
|  Accretion of asset retirement  and sublease obligations                                            |       | —                                |       | 10                             |       | —                   |       | 10        |       |
| Income from operations                                                                                   |       | 995                                   |       | 8,451                          |       | —                   |       | 9,446     |       |
|                                                                                                     |       |                                  |       |                           |       |                     |       |      |       |
| Interest income                                                                                          |       | 182                                   |       | 67                             |       | —                   |       | 249       |       |
| Interest expense                                                                                         |       | (30                                   | )          | (3,674                         | )          | —                   |       | (3,704    | )          |
|  Amortization of deferred  financing costs (a component of interest expense)                        |       | (61                                   | )          | (475                           | )          | —                   |       | (536      | )          |
| Dividend income                                                                                          |       | 92                                    |       | —                         |       | —                   |       | 92        |       |
| Other income (expense)                                                                                   |       | 191                                   |       | (104                           | )          | —                   |       | 87        |       |
| Income before non-controlling interest in net income of consolidated  subsidiary and income taxes        |       | $                                     | 1,369      |                           | $          | 4,265                    |       | $         | —     |   | $ | 5,634 |   |
|                                                                                                     |       |                                  |       |                           |       |                     |       |      |       |
| **Three Months Ended March 31, 2004:**                                                                   |       |                                  |       |                           |       |                     |       |      |       |
| Revenues                                                                                                 |       | $                                     | 44,392     |                           | $          | 63,825                   |       | $         | (14,517    | ) | $ | 93,700 |   |
| Purchased product costs                                                                                  |       | 35,851                                |       | 47,853                         |       | (8,216                   | )          | 75,488    |       |
| Facility expenses                                                                                        |       | 6,097                                 |       | 6,290                          |       | (6,301                   | )          | 6,086     |       |
| Selling, general and administrative expenses                                                             |       | 2,416                                 |       | 2,898                          |       | —                   |       | 5,314     |       |
| Depreciation                                                                                             |       | 383                                   |       | 3,145                          |       | —                   |       | 3,528     |       |
| Amortization of intangible assets                                                                        |       | —                                |       | 34                             |       | —                   |       | 34        |       |
| Income (loss) from operations                                                                            |       | (355                                  | )          | 3,605                          |       | —                   |       | 3,250     |       |
|                                                                                                     |       |                                  |       |                           |       |                     |       |      |       |
| Interest income                                                                                          |       | 128                                   |       | 7                              |       | —                   |       | 135       |       |
| Interest expense                                                                                         |       | (1                                    | )          | (1,129                         | )          | —                   |       | (1,130    | )          |
| Amortization of deferred financing cost (a component of interest  expense)                               |       | 1                                     |       | (308                           | )          | —                   |       | (307      | )          |
| Other income (expense)                                                                                   |       | 39                                    |       | (14                            | )          | —                   |       | 25        |       |
| Income (loss) before non-controlling interest in net income of  consolidated subsidiary and income taxes |       | $                                     | (188       | )                              | $          | 2,161                    |       | $         | —     |   | $ | 1,973 |   |

 
| ** **                                                                                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                   | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                                                                                                                   | ** ** | **(in thousands)**               | ** ** |
| Income from continuing operations before non-controlling interest in  net income of consolidated subsidiary and income taxes |       | $                                | 5,634      |   | $ | 1,973 |   |
| Provision (benefit) for  income taxes                                                                                        |       | 770                              |       | (56 | ) |
| Non-controlling interest in  net income of consolidated subsidiary                                                           |       | (3,325                           | )          | (1,309 | ) |
| Net income                                                                                                                   |       | $                                | 1,539      |   | $ | 720 |   |

 

32

----

 

***MarkWest Hydrocarbon Standalone***

 

*Revenues.*  Revenues increased $20.1 million, or 45%, inthe first quarter of 2005 compared to 2004 primarily due to an increase in ourwholesale propane marketing business revenue of $14.6 million.  The commencement of the wholesale propanemarketing business began at the end of the first quarter of 2004.  The increase is also due to a decrease inhedge losses realized in the first quarter of 2005 of $0.3 million compared to$2.2 million in the first quarter of 2004. The loss in 2004 was the result of an unfavorable hedging program thatsettled in April 2004.  Revenue alsoincreased due to an increase in NGL product sale prices and volumes inAppalachia.

 

*Purchased Product Costs.*  Purchased product costsincreased $18.0 million, or 50%, in the first quarter of 2005 compared to 2004primarily due to costs from our wholesale propane marketing business introducedin February 2004 adding $14.6 million and an increase in product costs from ourAppalachian natural gas liquids business of $3.1 million as a result of anincrease in volume and an increase in price.

 

*Facility Expenses.*  Facility expenses decreased by approximately$0.3 million, or 4%, during the first quarter of 2005 compared to first quarter2004 primarily as a result of favorable fuel reimbursement at our Kenova, Cobband Boldman facilities.

 

*Selling,General and Administrative Expenses. *Selling,general and administrative expenses increased by $1.0 million, or 43%, as aresult of the increase in compensation expense attributed to the ParticipationPlan and the 1996 Stock Incentive Plan and 1996 Non-employeeDirector Stock Option Plan.

 

*Depreciation*.  The increase in depreciationexpense of less than $0.1 million, or 8%, was principally due to the increasein software and hardware additions associated with the upgrade of ourinformation technology infrastructure as well as the acceleration ofdepreciation of our facilities in Michigan to more closely match our decliningreserves.

 

*InterestIncome. *Interest income increasedduring 2005 relative to the same period in 2004, primarily due to an increasein interest earned on cash equivalents.

 

*Interest Expense.*  Interest expense increased by less than $0.1million primarily due to commitment fees related to the October 2004 creditfacility.

 

*Amortization of Deferred Financing Costs. *The Company amortized less than $0.1 million of deferred financing costsin the first quarter of 2005 related to debt issuance costs incurred from theOctober 2004 credit facility.  Theincrease in 2005 relative to the same period in 2004 is attributable to debt refinancingcompleted in the last half of 2004. Deferred financing costs are being amortized over the terms of therelated obligations, which approximates the effective interest method.

 

*Dividend Income. *Dividend income increased by approximately $0.1million as a result of the Company’s investments in master limited partnershipsbeginning in the first quarter of 2004. The Company began receiving distributions on the master limitedpartnerships in the second quarter of 2004.

 

***MarkWest Energy Partners***

 

*Revenues. *2005 first quarter revenues were higher thanour 2004 first quarter revenues primarily due to the Partnership’s East Texasacquisition that added $14.7 million to the Partnership’s 2005 revenue. Revenue also increased during the first threemonths of 2005 relative to the same time period in 2004 due to increased wellvolumes contracted to the gathering system, higher crude oil prices positivelyimpacting condensate sales and higher processing margins in western Oklahoma.

 

*Purchased Product Costs.*  Purchased product costs were higher in 2005by $12.9 million primarily as a result ofan increase in purchased volumes and price increases in western Oklahoma andAppalachia.  The remainder of theincrease is due to the Partnership’s late 2004 acquisition, which increased itspurchased product costs by $3.6 million.

 

33

----

 

*Facility Expenses. *Facility expenses increased approximately $3.0million during 2005 relative to the same period in 2004 primarily due to thePartnership’s 2004 acquisitions, which added $2.3 million.  The remainder of the increase is due to increased pipeline repair and maintenance costs,salary and utility expenses.

 

*Selling,*G*eneral and Administrative Expenses.*  Selling, general and administrative expensesincreased by $1.7 million during the first quarter of 2005 compared to 2004, primarilyas a result of the increase in compensation expense attributed to theParticipation Plan.

 

*Depreciation. *Depreciation expense increased during thefirst quarter of 2005 primarily due to the Partnership’s July 2004 East Texas systemacquisitions.

 

*Amortization of IntangibleAssets. *Amortization expenseincreased during 2005 primarily due to the East Texas System acquisition inJuly 2004.  On July 30, 2004,the Partnership completed the acquisition of American Central Eastern Texas’Carthage gathering system and gas processing assets located in East Texas forapproximately $240.7 million.  Of thetotal purchase price, $165.4 million was allocated to customer contracts, ofwhich $2.1 million was amortized during the first quarter of 2005.

 

*Accretion of Asset Retirement and Sublease Obligations. *Accretion of asset retirement and sublease obligations increased by lessthan $0.1 million as a result of the recording of an asset retirementobligation in the third quarter of 2004 for new land leases in East Texas thatrequire the Partnership to return the land to its original condition.

 

*Interest Income. *Interest income increasedduring the first quarter of 2005 relative to the same period in 2004, primarilydue to an increase in interest earned on cash equivalents.

 

*Interest Expense.*  Interest expense was $3.7 million for thethree months ended March 31, 2005, compared to $1.1 million for the threemonths ended March 31, 2004, an increase of $2.6 million, or 236%. The increasewas principally attributable to MarkWest Energy Partners’ increased outstandingdebt levels, a function of financing its 2004 acquisitions. In October 2004, the Partnership issued $225.0million in senior notes.

 

*Amortization of Deferred Financing Costs. *The Partnership amortized approximately $0.5 million of deferredfinancing costs related to debt issuance costs incurred to finance its 2004acquisitions.  The increase in the firstquarter of 2005 relative to the same period in 2004 is attributable to debtrefinancing completed in the last half of 2004, as well as an increase indeferred financing costs as a result of the increase in the Partnership’s debtlevel.  Deferred financing costs arebeing amortized over the terms of the related obligations, which approximatesthe effective interest method.

 

***Other***

 

*Income TaxProvision (Benefit). *Income tax provision increased $0.9 million forthe three months ended March 31, 2005, compared to the same period in 2004, dueprimarily to the increase in net income before taxes.  The Company bases the effective corporate taxrate for interim periods on the estimated annual effective corporate taxrate.  Income tax expense totaled $0.8million for the first three months of 2005 and an income tax benefit of $0.1million for the same period in 2004, resulting in effective income tax rates of33.4% and (8.4)% for each respective period.

 

*Non-controlling Interest in Net Income of ConsolidatedSubsidiary. *Non-controlling interest in net income ofconsolidated subsidiary increased by $2.0 million, or 154%, as a result of theincrease in earnings of MarkWest Energy Partners and an increase in ownershipof non-controlling interests commensurate with private placements and publicofferings to finance acquisitions.

 

34

----

 

**Liquidity and Capital Resources**

 

***MarkWestHydrocarbon***

 

Ourprimary source of liquidity to meet operating expenses and fund capitalexpenditures is cash flow from operations, principally from the marketing ofnatural gas and NGLs, and quarterly distributions received from MarkWest EnergyPartners.  Based on current volume, priceand expense assumption, we expect cash flow from operations and distributions fromthe Partnership to fund our operations and capital expenditures in 2005.  Most of our future capital expenditures arediscretionary in nature.  During 2005, wehave budgeted $0.8 million for capital expenditures, consisting principally ofcomputer hardware and software.

 

We had$6.4 million in unrestricted cash on hand and $20.5 million in marketablesecurities at March 31, 2005, exclusive of MarkWest Energy Partner’s $15.2million unrestricted cash on hand.  InNovember 2005, the Company entered into the second amendment to its creditfacility.  The amendment released theCompany from the $15.0 million restriction on cash.  Exclusive of MarkWest Energy Partner’s debt,we had no outstanding debt during the nine months ended September 30,2005.  On January 21, 2005, our Board ofDirectors announced that it declared a quarterly cash dividend of $0.075 pershare of our common stock.  The dividendwas paid on February 21, 2005, to the stockholders of record as of the close ofbusiness on February 9, 2005.  Wedisbursed $0.8 million to pay this dividend. On April 28, 2005, our Board of Directors announced that it declared aquarterly cash dividend of $0.10 per share of our common stock.  The dividend was paid on May 23, 2005, to thestockholders of record as of the close of business on May 16, 2005.  We disbursed $1.1 million to pay thisdividend.  On July 22, 2005, our Board ofDirectors announced that it declared a quarterly cash dividend of $0.10 pershare of our common stock.  The dividendwas paid on August 22, 2005 to the stockholders of record as of the close ofbusiness on August 15, 2005.  Wedisbursed $1.1 million to pay this dividend. On October 27, 2005, our Board of Directors announced that it declared aquarterly cash dividend of $0.125 per share of our common stock.  The dividend was paid on November 22, 2005 tothe stockholders of record as of the close of business on November 15,2005.  We disbursed approximately $1.4 millionto pay this dividend.

 

We own89% of the general partner of MarkWest Energy Partners.  The general partner of MarkWest EnergyPartners owns the 2% general partner interest and all of the incentivedistribution rights.  The incentivedistribution rights entitle us to receive an increasing percentage of cashdistributed by the Partnership as certain target distribution levels arereached.  Specifically, they entitle usto receive 13% of all cash distributed in a quarter after each unit hasreceived $0.55 for that quarter, 23% of all cash distributed after each unithas received $0.625 for that quarter and 48% of all cash distributed after eachunit has received $0.75 for that quarter. For the three months ended March 31, 2005, we received $1.9 million indistributions for our subordinated units, and the general partner received $1.0million, including $0.8 million representing payments on incentive distributionrights.  For the year ended December 31,2005, we expect to receive $7.9 million in distributions for our subordinatedand common units and we expect the general partner to receive $4.9 million.

 

Cashflows generated from our marketing operations are subject to volatility inenergy prices, especially prices for NGLs and natural gas.  Our cash flows are enhanced in periods whenthe prices received for NGLs are high relative to the price of natural gas wepurchase to satisfy our “keep-whole” contractual arrangements in Appalachia,and are reduced in periods when the prices received for NGLs are low relativeto the price of natural gas we purchase to satisfy such contractual arrangements.  Under “keep-whole” contracts, we retain andsell the NGLs produced in our processing operations for third-party producers,and then reimburse or “keep whole” the producers for the energy content of theNGLs removed through the re-delivery to the producers of an equivalent amount(on a Btu basis) of dry natural gas. Generally, the value of the NGLs extracted is greater than the cost ofreplacing those Btus with dry gas, resulting in positive operating marginsunder these contracts.  Periodically,when natural gas becomes more expensive, on a Btu equivalent basis, than NGLproducts, the cost of keeping the producer “whole” can result in operatinglosses.  We entered into several new andamended agreements in September 2004 with one of the largest Appalachiaproducers that allow us to significantly reduce our exposure to commodity pricerisk for approximately 25% of our keep-whole gas volumes.  Under these agreements, the Company islimited on the amount of costs it would have to pay to the producer in theevent natural gas becomes more expensive on a per btu basis than the relativeNGL product sales prices, thereby mitigating the risk of incurring operatinglosses.  In connection with theseagreements, we paid $3.3 million of consideration to the producer that is beingamortized as additional purchased product costs over the term of the contracts,October 1, 2004 through February 9, 2015.

 

35

----

 

*Debt*

 

In October 2004, the Company entered into a $25.0 million senior creditfacility with a term of one year.  The$25.0 million revolving facility has a variable interest rate based on the baserate, which is equal to the higher of a) the Federal Funds Rate plus 1⁄2 of 1%,and b) the rate of interest in effect for such day as publicly announced fromtime to time by the Administrative Agent as its prime rate, plus the applicablerate, which is based on a utilization percentage.  In October and November 2005, the Companyentered into the first and second amendment to the credit agreement.  The first amendment extended the term of theoriginal agreement to November 15, 2005. The second amendment reduced the lending amount from $25.0 million to$16.0 million, of which $6.0 million of availability is committed to a letterof credit, leaving $10.0 million available for revolving loans.  The second amendment also extended the termof the revolving credit to December 30, 2005. If the revolving credit is converted into a term loan, the term will beextended to December 29, 2006.

 

In connection with the credit facility, the Company is subject to anumber of restrictions on its business, including restrictions on its abilityto grant liens on assets; merge, consolidate or sell assets; incurindebtedness; make acquisitions; engage in other businesses; enter intooperating leases; enter into certain swap contracts; engage in transactionswith affiliates; make dispositions; make restricted payments, distributions andredemptions and other usual and customary covenants.  As of March 31, 2005, the Company had nooutstanding borrowings.  At November 15,2005, the Company had a borrowing capacity of $10.0 million.  The credit facility also contains covenants requiringthe Company to maintain a minimum net worth of $40.0 million plus 50% ofproceeds of equity issued subsequent to October 25, 2004.

 

*Liquidity Requirements*

 

We have spent$0.3 million for capital expenditures through September 30, 2005.  The Company has budgeted $0.2 million for thefourth quarter of 2005, consisting principally of computer hardware andsoftware.  We believe that cash on hand,cash received from quarterly distributions (including the incentivedistribution rights) from MarkWest Energy Partners, and projected cash generatedfrom our marketing operations will be sufficient to meet our working capitalrequirements and fund our required capital expenditures, if any, for the nexttwelve months.  Cash generated from ourmarketing operations will depend on our operating performance, which will beaffected by prevailing commodity prices and other factors, some of which arebeyond our control.

 

***MarkWest EnergyPartners***

 

*Overview*

 

The Partnership’s primary source of liquidity to meetoperating expenses and fund capital expenditures (other than for largeracquisitions) is cash flow generated by operations.  The public and institutional markets havebeen the Partnership’s principal source of capital to finance a significantamount of its growth (including acquisitions). During the first quarter of 2005, the Partnership borrowed $40.0 millionfrom its credit facility to finance the acquisition of a 50% non-operatingmembership interest in Starfish Pipeline Co. LLC.  Starfish owns the FERC-regulated Stingraynatural gas pipeline and the unregulated Triton natural gas gathering systemand West Cameron dehydration facility, all located in the Gulf of Mexico andSouthwestern Louisiana.  During the ninemonths ended September 30, 2005, we spent $50.2 million on capitalexpenditures, primarily for the construction of a new processing plant andgathering systems in East Texas, to handle future contractual commitments.  On November 1, 2005, we acquired a 100%interest in the Javelina gas processing and fractionation facility in CorpusChristi, Texas for approximately $355.0 million.  We borrowed approximately $500.0 million,$355.0 million to finance Javelina, $45.0 million for working capitaladjustments and $100.0 million to retire long-term debt from the MarkWestEnergy Partner’s revolving credit facility. On November 1, 2005, the available borrowing capacity under the PartnershipCredit Facility was $43.0 million.

 

As of September 30, 2005, the Partnership has spent$50.2 million on capital expenditures, exclusive of any acquisitions.  As of September 30, 2005 the Partnership hasbudgeted $23.2 million for capital expenditures for the remainder of 2005,exclusive of any acquisitions, consisting of $22.6 million for expansioncapital and $0.6 million for sustaining capital.  Expansion capital includes expenditures madeto expand or increase the efficiency of the existing operating capacity of thePartnership’s assets, or facilitate an increase in volumes within operations,whether through construction or acquisition. Sustaining capital includes expenditures to replace partially or fullydepreciated assets in order to extend their useful lives.

 

36

----

 

*Equity*

 

OnNovember 9, 2005, the Partnership completed a private placement of 1,644,065common units.  The units were issued at apurchase price of $44.21 per unit, raising approximately $74.0 million,including the general partner’s contribution. This permanent capital was issued as a first step toward bringing thePartnership’s capital structure in line with the Partnership’s stated goal ofless than 50% debt.

 

Theinability of the Partnership to file its Annual Report on Form 10-K for theyear ended December 31, 2004 and its quarterly report on Form 10-Q for thequarterly period ending March 31, 2005 on time may impact the timing of the Partnership’sefforts to raise equity in the future. The Partnership no longer has the ability to incorporate by referenceinformation from its filings into a new registration statement for one yearfollowing the filing of its delinquent 2004 Form 10-K and its first quarter of2005 Form 10-Q on June 24, 2005, if the Partnership seeks to raise capitalthrough a public offering of registered debt or equity securities.  If the Partnership raises additional capitalthrough public debt or equity offerings, the Partnership will be required tofile a Form S-1 registration statement, the long form of registrationstatement.  The requirement to file aForm S-1 registration statement may affect the Partnership’s ability to accessthe capital markets on a timely basis and may increase the costs of doing so.

 

ThePartnership has the ability to issue an unlimited number of units to fundimmediately accretive acquisitions. Under the provisions of the Partnership Agreement, an immediatelyaccretive acquisition is one that, in the general partner’s good faithdetermination would have, if acquired by the Partnership as of the date that isone year prior to the first day of the quarter in which such acquisition isconsummated, resulted in an increase to the amount of operating surplusgenerated by the Partnership on a per-unit basis (for all outstanding units)with respect to each of the four most recently completed quarters (on a proforma basis) as compared to the actual amount of operating surplus generated bythe Partnership on a per-unit basis (for all outstanding units), excludingoperating surplus generated by the Partnership on a per-unit basis (for alloutstanding units), excluding operating surplus attributable to the acquisitionwith respect to each of such four most recently completed quarters.  For acquisitions that are not immediatelyaccretive, the Partnership has the ability to issue up to 1,207,500 commonunits without unitholder approval.

 

*Debt*

 

The Partnership’s $200.0million credit facility was established to fund capital expenditures and acquisitions,working capital requirements (including letters of credit) and distributions tounitholders. Advances to fund distributions to unitholders may not exceed $0.50per outstanding unit in any 12-consecutive-month period. To date there havebeen no advances to fund distributions to unitholders.  At September 30, 2005, the Partnership had borrowed$85.0 million, $40.0 million to finance its investment in Starfish in March2005 and $45.0 million to fund capital expenditures.  In November 2005, we amended and restated thePartnership’s credit facility, decreasing the maximum lending limit from $200.0million to $100.0 million and decreasing the term of the facility to one year,due October 31, 2006.  We also enteredinto a $400.0 million term loan due October 31, 2006.

 

Conditions of the Partnership’s credit facility mean weare subject to a number of restrictions on our business.  These include restrictions on our ability togrant liens on assets; make or own certain investments; enter into any swapcontracts other than in the ordinary course of business; merge, consolidate orsell assets; incur indebtedness (other than subordinated indebtedness); makeacquisitions; engage in other business; enter into capital or operating leases;engage in transactions with affiliates; make distributions on equity interests;declare or make, directly or indirectly any restricted payment and other usualand customary covenants.

 

The Partnership and its subsidiary, MarkWest EnergyFinance Corporation, also have $225.0 million in senior notes at a fixed rateof 6.875% outstanding at September 30, 2005. The notes mature on November 2, 2014. Subject to compliance with certain covenants, we may issue additionalnotes from time to time under the indenture pursuant to Rule 144A andRegulation S under the Securities Act of 1933. The proceeds from these notes were used to pay down the outstanding debtunder the Partnership’s credit facility in October 2004.

 

The indenture governing the senior notes limits theactivity of the Partnership and its restricted subsidiaries. 

 

37

----

 

The provisions of suchindenture places limits on the ability of the Partnership and its restrictedsubsidiaries to incur additional indebtedness; declare or pay dividends ordistributions or redeem, repurchase or retire equity interests or subordinatedindebtedness; make investments; incur liens; create any consensual limitationon the ability of the Partnership’s restricted subsidiaries to pay dividends,make loans or transfer property to the Partnership; engage in transactions withthe Partnership’s affiliates; sell assets, including equity interest of thePartnership’s subsidiaries; make any payment on or with respect to, or purchase,redeem, defease or otherwise acquire or retire for value any subordinatedobligation or guarantor subordination obligation (except principal and interestat maturity); and consolidate, merge or transfer assets.

 

The Partnership has agreed to file an exchange offerregistration statement, or under certain circumstances, a shelf registrationstatement, pursuant to a registration rights agreement relating to the 2004senior notes.  The Partnership failed tocomplete the exchange offer in the time provided by the subscription agreements(April 26, 2005) and, as a consequence, is incurring an interest rate penaltyof 0.5%, increasing 0.25% every 90 days thereafter up to 1%, until such time asthe exchange offer is completed.  ThePartnership is currently being charged an interest rate penalty of 1%.

 

*Liquidity Requirements*

 

As of September 30, 2050 the Partnership has budgeted$23.2 million for capital expenditures for the fourth quarter of 2005,exclusive of any acquisitions, consisting of $22.6 million for expansioncapital and $0.6 million for sustaining capital.  Expansion capital includes expenditures madeto expand or increase the efficiency of the existing operating capacity of thePartnership’s assets, or facilitate an increase in volumes within operations,whether through construction or acquisition. Sustaining capital includes expenditures to replace partially or fullydepreciated assets in order to extend their useful lives.

 

Webelieve that the Partnership’s available cash, cash provided by operatingactivities, and funds available under the Partnership’s credit facility will besufficient to fund the Partnership’s operating, interest and general andadministrative expenses, the Partnership’s capital expenditures budget,short-term contractual obligations and distribution payments at current levelsfor the foreseeable future.  However, thePartnership’s ability to finance additional acquisitions will likely requirethe issuance of additional common units, the expansion of the credit facility,additional debt financing or a combination thereof.  In the event that the Partnership desires orneeds to raise additional capital, we cannot guarantee that additional fundswill be available at times or on terms favorable to the Partnership, if at all.

 

The Partnership’s ability to pay distributions toits unitholders and to fund planned capital expenditures and to makeacquisitions will depend upon its future operating performance, which will beaffected by prevailing economic conditions in its industry and financial,business and other factors, some of which are beyond our control.

 

## ***Cash Flows***

## ** **

| ** **                                           | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | **(in thousands)**               | ** ** |
|                                                 |       |                             |       |   |   |
| Net cash provided by  operating activities           |       | $                                | 39,476     |   | $ | 17,373 |   |
| Net cash used in investing  activities               |       | $                                | (63,452    | ) | $ | (5,676 | ) |
| Net cash provided by (used  in) financing activities |       | $                                | 32,680     |   | $ | (4,726 | ) |

 

Netcash provided by operating activities was higher during the three months endedMarch 31, 2005 than during the three months ended March 31, 2004, primarily dueto increased activities as a result of the Partnership’s East Texasacquisition.  The increase is alsoattributable to higher processing margins and volumes from the Partnership’sOklahoma segment.

 

Netcash used in investing activities was higher during the three months endedMarch 31, 2005, than during the three months ended March 31, 2004, primarilydue to the Partnership’s March 31, 2005 acquisition of a 50% 

 

38

----

 

non-operating interest in Starfish forapproximately $41.7 million.  Inaddition, we used cash of $16.0 million for capital expenditures, primarily forthe construction of new processing plants and gathering systems in East Texasto handle the Partnership’s future contractual commitments and construction ofthe new Cobb replacement processing facility in Appalachia.  Net cash used in investing activities alsoincluded the purchase of $7.4 million of marketable securities.  Net cash used in investing activities duringthe three months ended March 31, 2004, was primarily due to the $4.3 millionincrease to marketable securities and the $1.6 million of capital expendituresfor existing facilities.

 

Netcash provided by financing activities during the three months ended March 31,2005 included net proceeds from the Partnership’s credit facility of $40.0million, offset in part by distributions to the Partnership’s unitholders,other than MarkWest Hydrocarbon and the general partner, of $6.4 million anddividends of $0.8 million.  Net cash usedin financing activities during the three months ended March 31, 2004, includednet proceeds from a secondary public offering of $44.1 million; of the netproceeds from the secondary offering, $42.0 million were used for the repaymentof long-term debt.  In addition, thePartnership distributed $3.0 million to unitholders other than MarkWestHydrocarbon and the general partner, and we paid a special dividend of $4.8million. Other financing activities included $1.0 million of proceeds from theexercise of stock options.

 

**Total Contractual Cash Obligations**

 

A summary of our total contractual cash obligations as of March 31,2005, is as follows, in thousands:

 
| ** **                         | ** ** | **Payment Due by Period** | ** ** |
|------------------------------------|------------|---------------------------|------------|
| **Type of  obligation**            | ** ** | **Total  obligation**     | ** ** | **Due in  2005** | ** ** | **Due in  2006-2007** | ** ** | **Due in  2008-2009** | ** ** | **Thereafter** | ** ** |
|                               |       |                      |       |   |   |   |   |   |   |   |   |
| Long-term debt (1)                 |       | $                         | 426,925    |   | $ | 13,852 |   | $ | 36,937 |   | $ | 76,370 |   | $ | 299,766 |   |
| Operating leases                   |       | 12,367                    |       | 3,317 |   | 5,388 |   | 2,836 |   | 826 |   |
| Purchase obligations               |       | 3,587                     |       | 3,587 |   | — |   | — |   | — |   |
| Total contractual cash obligations |       | $                         | 442,879    |   | $ | 20,756 |   | $ | 42,325 |   | $ | 79,206 |   | $ | 300,592 |   |

 

----

(1)   Includes interest on our 6.875% senior notesthrough 2014 of $148.2 million and interest on our 7.5% credit facility through2009 of $13.7 million

 

**Matters Impacting Future Results**

 

TheCompany and several of its affiliates were served earlier this year with twolawsuits presently under the jurisdiction of the U.S. District Court for theEastern District of Kentucky, Pikeville Division, and, in early November, wereserved with an additional lawsuit filed in Floyd County Circuit Court,Kentucky, adding five new claimants, but essentially alleging the same factsand claims as the earlier two suits. These suits are for third-party claims of property and personal injurydamages sustained as a consequence of a NGL pipeline leak and an ensuring explosionand fire that occurred on November 8, 2004 from a natural gas pipeline, ownedby an unrelated business entity, and leased and operated by the Partnership’ssubsidiary, MarkWest Energy Appalachia, LLC. The pipeline transports NGLs from the Maytown gas processing plant tothe Partnership’s Siloam fractionator. An ignition and fire from the leakedvapors resulted in property damage to five homes and injuries to some of theresidents.  The cause of the pipelinesplit, leak, and resulting explosion and fire is being investigated by thepipeline owner, the U.S. Department of Transportation, Office of PipelineSafety (“OPS”), and the Partnership.

 

The Company and the Partnershiphave timely notified their general liability insurance carriers of the incidentand of the filed Kentucky actions and is coordinating the defense of thesethird-party lawsuits with the insurers. At this time, the Company and the Partnership believe that they have adequategeneral liability insurance coverage for third-party property damage andpersonal injury liability resulting from the incident.  To date, the Company and the Partnership havesettled with several of the claimants for third-party property damage claims(damage to residences and personal property) related to this incident, inaddition to reaching settlement for some of the personal injury claims relatedto the pipeline explosion and fire. These settlements have been paid for or reimbursed under the Partnership’sgeneral liability insurance.  As aresult, the Company has not provided for a loss contingency.

 

39

----

 

Pursuant to OPS regulationmandates and to a Corrective Action Order issued by the OPS immediately afterthe incident, pipeline and valve integrity evaluation, testing and repairefforts were required and conducted on the affected pipeline segment beforeservice could be resumed.  Partial returnto service of the affected pipeline was resumed in October 2005.  The Company and the Partnership have filed anindependent action against their All-Risk Property and Business Interruptioninsurance carriers as a result of their refusal to honor their insurance coverageobligation for providing the Company and the Partnership insurance payments forcertain expenses.  These expenses relatedto the Partnership’s internal expenses and costs incurred for damage to, andloss of use of, the pipeline, equipment, products, the extra transportationcosts incurred for transporting the liquids while the pipeline was out of service,the reduced volumes of liquids that could be processed, and the costs ofcomplying with the OPS Corrective Action Order (hydrostatic testing,repair/replacement and other pipeline integrity assurance measures).  These expenses and costs have been expensedas incurred and any potential recovery from the All-Risks Property and BusinessInterruption insurance carriers will be treated as “other income” if and whenthey are received.  The Partnership hasnot provided for a receivable related to these claims because of theuncertainty as to whether and how much the Partnership will ultimately recoverunder the All-Risks Property and Business Interruption insurance policies.  In addition to the property and businesslosses and interruption costs, through September 30, 2005, the Partnershiphas incurred pipeline testing, refurbishment and replacements costs ofapproximately $5.1 million, of which $1.3 million has been capitalized. ThePartnership’s current estimate is that the full cost of pipeline testing,repair and improvements will be approximately $5.5 million.  The Company and the Partnership have alsoasserted that the costs associated with such testing, replacement and repairare subject to an equal sharing arrangement with the owner of the pipeline, pursuantto the terms of the pipeline lease agreement.

 

TheCompany has also been involved in a lawsuit captioned *Ross Bros. Construction v. MarkWest Hydrocarbon, Inc.*,(U.S. District Court Eastern District of Kentucky, Ashland Division, Civ.Action No. 01-CV-205).  This lawsuitinvolved the construction of the Siloam Kentucky plant and a dispute as to themonetary value of additional work beyond the contract’s lump sum priceperformed by the contractor.  Thislawsuit involved a claim of approximately $0.7 million in extra costs.  The Company was recently granted SummaryJudgment on its defense asserting accord and satisfaction.  In August 2005, Plaintiffs filed an appeal ofthe Summary Judgment to the U.S. Court of Appeals for the 6th Circuit.  The Company believes that while it is notable to predict the ultimate outcome of this matter, based on the Court’sdiscussion on the grant of the summary judgment and denial of Ross Brothers’motion for reconsideration, it is probable that the Company will prevail in theappeal. As a result, the Company has not provided for a loss contingency.

 

TheCompany has also been involved in an arbitration proceeding captioned *Kevin Stowe and Scott Daves v. MarkWest Hydrocarbon,Inc*., Arbitration, Denver, Colorado, 2005.  Claimants filed an arbitration proceedingagainst the Company seeking further payments out of a dispute and settlementover interests in certain wells in Colorado. The Company had transferred, via a purchase and sale agreement, anyliability for any payments out of the settlement it had reached with claimantsto a third-party in the sale of certain of the Company’s oil and gas propertyinterests.  The Company has been incommunication with the third-party purchaser, and the third-party purchaser hasadmitted it has those liabilities under the purchase and sale agreement, andthe Company does not believe there are material liabilities associated withthis claim.  As a result, the Company hasnot provided for a loss contingency.

 

InSeptember 2005, a lawsuit was served on the Partnership’s subsidiary, MarkWestPinnacle, L.P., filed in the District court of Midland, Texas, 285th JudicialDistrict, alleging breach of contract, fraud and breach of implied duty of goodfaith with respect to a dispute on volumes of gas purchased by the Partnershipunder a gas purchase agreement.  Underthe gas purchase agreement, MarkWest Energy Partners paid the Plaintiff basedon volumes of gas measured at the wellhead (delivery point).  Plaintiff claims that it is entitled to aprorated portion of any system gain, i.e., that is to be paid for more gas thanit actually sold and delivered to the Partnership.  MarkWest Energy Partners has filed an Answerto the Complaint, denying Plaintiff’s allegations and has asserted acounter-claim for declaratory judgment on the contract terms as being clear andunambiguous as to payment being limited to those volumes measured at thewellhead, that Plaintiff’s claims are without merit, and that the Partnershipalso may have overpaid Plaintiff based on, among other things, the wet versusdry Btu measurements.  Discovery has notyet begun, and at this time, the Partnership is not able to predict theultimate outcome of this matter.  As aresult, the Partnership has not provided for a loss contingency.

 

Inresponse to a shipper inquiry regarding the Partnership’s Michigan CrudePipeline, and following FERC-

 

40

----

 

requested rate structure discussions with theshippers, FERC recently requested that we file a tariff.   The Partnership is currently inFERC-sponsored discussions with all shippers regarding a proposed tariff ratestructure filing, and are attempting to resolve any issues they may have.  The Partnership has determined that itscurrent and proposed rate structures are well below rates that would be allowedunder FERC’s cost-of-service rate-making structure.  However, the Partnership cannot predict atthis time whether FERC jurisdiction and a tariff filing will adversely affectits Michigan Crude Pipeline results of operations.

 

The Partnership has a 50%non-operating ownership interest in Starfish Pipeline Company (“Starfish”).  In connection with the impact of HurricaneRita on the Starfish operations, based on our continuing discussions with theoperator and other 50% owner of Starfish, Enbridge Offshore (Gas Transmission)L.L.C. (“Enbridge”), the Partnership has been informed that initial onsite andaerial inspections indicated no material damage to the offshore platformfacilities and that pipe integrity was not compromised.  Sonar inspection of underwater pipe to assesssediment support and cover is pending. No major structural damage appears to have occurred at the onshoreStarfish dehydration and compressor facilities. However, due to flooding, the electrical, control equipment and officebuildings require repairs, which Enbridge believes can be completed by year-end2005.  Starfish operations have beensubstantially curtailed since shortly before Hurricane Rita hit the Gulf Coastin September 2005, and until such repairs are completed, Starfish is not ableto return to normal operations and this will have a continuing impact onoperating income.  Based on thispreliminary information and without further update on the situation fromEnbridge, we are unable to further estimate the ultimate impact of HurricaneRita to 2005 net income, but we expect that the effect will be material.  Our evaluation is subject to a number offactors, including ongoing assessments, disclosures by operators ofinterconnecting production and processing facilities, and discussions withinsurance carriers for insurance recovery for damages and businessinterruption.

 

Under the terms of certain gathering contracts in thePartnership’s East Texas systems, the Partnership is required to buy gas fromproducer customers based on a specific index price.  The Partnership’s typical process has been tosell its best estimate of the production at the same index price near the endof the prior month.  Due to unexpectedvolatility and a corresponding lack of liquidity in the gas trading market atthe end of October 2005, the Partnership was unable to sell all of itsrequirements at the same index price.  Asa result, the Partnership was not able to sell approximately 16,600 Mmbtu/dayof gas from its Appleby and East Texas assets for November 2005.  During the month of November, the Partnershipsold the gas at a different index price, which was lower than the index purchase price for the month.  The Partnership cannot currently predict theexact financial impact until the middle of December 2005, but based on itscurrent estimate of volume and price, the Partnership expects a negative impactto operating income from operations of approximately $2.5 million from theAppleby and East Texas operations.  ThePartnership has implemented additional controls and procedures to mitigate asimilar exposure going forward.  ThePartnership has sold 90% of its forecasted volumes through March 2006 at indexprice.  The Partnership has alsoestablished firm guidelines to sell the remainder of forecast volumes earlierin the preceding month to reduce the risk of encountering unexpected marketconditions that preclude these types of index sales.

 

Under the terms of the keep whole agreements in thePartnership’s Western Oklahoma System, the Partnership purchases gas to replacethe shrink and fuel requirements under those arrangements.  The Partnership then sells the natural gasliquids processed at the Foss Lake plant. The continued strong pricing environment for natural gas liquids coupledwith the decline in mid-continental natural gas prices in November, thatcontributed to the negative impact to operations in East Texas and Appleby,resulted in higher than expected margins in the Partnership’s Western OklahomaSystem of approximately $1.0 million.

 

**Recent Accounting Pronouncements**

 

In December 2004, the FASBissued SFAS No. 123 (revised 2004), *Share-BasedPayment*(“SFAS 123(R)”).  Thisstatement addresses the accounting for share-based payment transactions inwhich an enterprise receives employee services in exchange for (a) equityinstruments of the enterprise, or (b) liabilities that are based on the fairvalue of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. SFAS No. 123(R) requires an entity to recognize the grant-datefair-value of stock options and other equity-based compensation issued toemployees in the income statement.  Therevised Statement generally requires that an entity account for those transactionsusing the 

 

41

----

 

fair-value-based method, and eliminates theintrinsic value method of accounting in APB Opinion No. 25, *Accounting for Stock Issues to Employees*,which was permitted under SFAS No. 123 as originally issued.  The revised Statement required entities todisclose information about the nature of the share-based payment transactionsand the effects of those transactions on the financial statements.  SFAS 123(R) is effective for public companiesfor the first fiscal year beginning after December 15, 2005.  All public companies must use either themodified prospective or the modified retrospective transition method.  We have not yet evaluated the impact of theadoption of this pronouncement, which must be adopted in the first quarter ofcalendar year 2006.  On March 29, 2005,the SEC staff issued Staff Accounting Bulletin (“SAB”) No. 107, *Share-Based Payment* to express the viewsof the staff regarding the interaction between SFAS No. 123(R) and certain SECrules and regulations and to provide the staff’s views regarding the valuationof share-based payment arrangements for public companies.  The Company will take into consideration theadditional guidance provided by SAB 107 in connection with the implementationof SFAS No. 123(R).  We have not yetevaluated the impact of the adoption of this pronouncement, which must beadopted in the first quarter of calendar year 2006.

 

InMarch 2005, the FASB issued FASB Interpretation (FIN) No. 47, *Accounting for Conditional Asset RetirementObligations*, which clarifies the accounting for conditional assetretirement obligations as used in SFAS No. 142, *Accounting for Asset Retirement Obligations*.  A conditional asset retirement obligation isan unconditional legal obligation to perform an asset retirement activity inwhich the timing and (or) method of settlement are conditional on a futureevent that may or may not be within the control of the entity.   An entity is required to recognize aliability for the fair value of a conditional asset retirement obligation underSFAS No. 143 if the fair value of the liability can be reasonablyestimated.  FIN 47 permits, but does notrequire, restatement of interim financial information.  The provisions of FIN 47 are effective forreporting periods ending after December 15, 2005.  The Company has not yet assessed the impactof adopting FIN 47 on its consolidated financial statements.

 

InMay 2005, the FASB issued SFAS No. 154, *Accounting Changes and Error Corrections—a replacement of APB OpinionNo. 20 and FASB Statement No. 3* SFAS No. 154 replacesAccounting**Principles BoardOpinion No. 20, *Accounting Changes*,and SFAS No. 3, *Reporting AccountingChanges in Interim Financial Statements*, and changes therequirements for the accounting for and reporting of a**change in accounting principle. Thisstatement applies to all voluntary changes in accounting principle**and also applies to changes required byan accounting pronouncement in the unusual instance that the**pronouncement does not include specifictransition provisions. The statement is effective for accounting**changes and corrections of errors made infiscal years beginning after December 15, 2005. The**Company will adopt the provisions of SFASNo. 154 beginning in calendar year 2006. Management**believes that the adoption of theprovisions of SFAS No. 154 will not have a material impact on the**Company’s consolidated financialstatements.

 

**Forward-Looking Information**

 

Statements included in this Management’s Discussion andAnalysis that are not historical facts are forward-looking statements withinthe meaning of Section 27A of the Securities Act of 1933, as amended, and Section21E of the Securities and Exchange Act of 1934, as amended.  We use words such as “may,” “believe,” “estimate,”“expect,” “plan,” “intend,” “project,” “anticipate,” and similar expressions toidentify forward-looking statements.

 

These forward-looking statements are made based uponmanagement’s current plans, expectations, estimates, assumptions and beliefsconcerning future events impacting us and therefore involve a number of risksand 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.

 

Important factors could cause our actual results ofoperations or our actual financial condition to differ include, but are notnecessarily limited to:

 

•      Ourexpectations regarding MarkWest Energy Partners, L.P.

•      Ourability to grow MarkWest Energy Partners, L.P. and successfully integrate itsacquisitions.

•      MarkWestEnergy Partners, L.P.’s ability to obtain natural gas supply for its gatheringand processing services.

•      ThePartnership’s substantial debt and other financial obligations that couldimpact our financial condition.

 

42

----

 

•      Theavailability of NGLs for the Partnership’s transportation, fractionation andstorage services.

•      Ourability to amend certain producer contracts.

•      Ourexpectations regarding natural gas and NGL product prices.

•      Ourefforts to increase fee-based contract volumes.

•      Ourability to manage our commodity price risk.

•      Ourability to maximize the value of our NGL output.

•      Theadequacy of our general public liability, property, and business interruptioninsurance.

•      Ourability to comply with environmental and governmental regulations.

•      Our riskof being delisted by the American Stock Exchange.

 

#### **Many of suchfactors are beyond our ability to control or predict.  Investors are cautioned not to put unduereliance on forward-looking statements.**

 

43

----

 

#### **Item3.  Quantitative and QualitativeDisclosures about Market Risk**

 

Marketrisk includes the risk of loss arising from adverse changes in market rates andprices.  We face market risk fromcommodity price changes and to a lesser extent interest rate changes.

 

***Commodity Price Risk***

 

Throughour consolidated subsidiary, MarkWest Energy Partners, we are engaged in thegathering, processing and transmission of natural gas, the transportation,fractionation and storage of NGLs and the gathering and transportation of crudeoil.  We also market natural gas and NGLproducts.  Our products are commoditiesthat are subject to price risk resulting from material changes in response tofluctuations in supply and demand, general economic conditions and other marketconditions, such as weather patterns, over which we have no control.

 

Ourprimary risk management objective is to manage volatility in our cashflows.  A committee, which includesmembers of senior management of the general partner, oversees all of ourhedging activity.

 

Wemay utilize a combination of fixed-price forward contracts, fixed-for-floatingprice swaps and options on the over-the-counter (“OTC”) market.  The Partnership may also enter into futurescontracts traded on the New York Mercantile Exchange (“NYMEX”).  Swaps and futures contracts allow us toprotect our margins because corresponding losses or gains on the financialinstruments are generally offset by gains or losses in our physical positions.

 

Weenter into OTC swaps with financial institutions and other energy companycounterparties.  We conduct a standardcredit review on counterparties and have agreements containing collateralrequirements where deemed necessary.  Weuse standardized swap agreements that allow for offset of positive and negativeexposures.  We are subject to margindeposit requirements under OTC agreements (with non-bank counterparties) andNYMEX positions.

 

Theuse of financial instruments may expose us to the risk of financial loss incertain circumstances, including instances when (i) NGLs do not trade athistorical levels relative to crude oil, (ii) sales volumes are less thanexpected requiring market purchases to meet commitments, or (iii) our OTCcounterparties fail to purchase or deliver the contracted quantities of naturalgas, NGLs or crude oil or otherwise fail to perform.  To the extent that we engage in hedgingactivities, we may be prevented from realizing the benefits of favorable pricechanges in the physical market.  However,we are similarly insulated against unfavorable changes in such prices.

 

*Commodity Risk Management Position*

 

Asof March 31, 2005, we have entered into derivative instruments designed tomanage the price risk of forecasted NGL and natural gas sales in 2005, asfollows:

 
| **MarkWest Hydrocarbon, Inc.**     | ** ** | ** ** | ** ** |
|------------------------------------|------------|------------|------------|
| NGL swaps:                         |       |       |       |
| NGL gallons                        |       | 6,248,340  |       |
| NGL sales price per gallon         |       | $          | 1.23       |   |
|                               |       |       |       |
| **MarkWest Energy Partners, L.P.** |       |       |       |
| Natural gas swaps:                 |       |       |       |
| Natural gas MMBtu                  |       | 46,000     |       |
| Natural gas sales price per  MMBtu |       | $          | 4.26       |   |

 

Aspart of an ongoing comprehensive hedge plan designed to manage risk andstabilize future cash flows, during October, 2005, the Partnership entered intothe following additional hedges that settle monthly through December 31,2006:

 

44

----

 

 
| **Costless Collars:**        | ** ** | **Period** | ** ** | **Floor** | ** ** | **Cap** | ** ** |
|------------------------------|------------|------------|------------|-----------|------------|---------|------------|
| Crude Oil — 500 Bbl/d   |       | 2006       |       | $         | 57.00      |    | $          | 67.00 |   |
| Crude Oil — 250 Bbl/d   |       | 2006       |       | $         | 57.00      |    | $          | 67.00 |   |
| Crude Oil — 205 Bbl/d   |       | 2006       |       | $         | 57.00      |    | $          | 65.10 |   |
|                         |       |       |       |      |       |    |       |
| Propane  — 10,000 Gal/d |       | 2006       |       | $         | 0.97       |    | $          | 1.15 |   |

 
| **Swaps**                  | ** ** | ** ** | ** ** | **Fixed Price** | ** ** | ** ** | ** ** |
|----------------------------|------------|------------|------------|-----------------|------------|------------|------------|
| Crude Oil — 250 Bbl/d |       | 2006       |       | $               | 62.00      |       |       |   |
| Crude Oil — 185 Bbl/d |       | 2006       |       | $               | 61.00      |       |       |   |

 

Whilewe expect these hedges to provide economic stability against the impact ofchanging commodity prices on our physical positions: for accounting purposes,we will not designate these derivatives as cash flow hedges and will not applyhedge accounting.  We will expand ourdisclosure around the resulting mark-to-market impacts.

 

##### ***Interest Rate Risk***

 

MarkWestEnergy Partners is exposed to changes in variable interest rates payable on$40.0 million of borrowings under its credit facility as of March 31, 2005,primarily as a result of its floating interest rates under this facility.  As of March 31, 2005, floating-rate debtcomprised 15% of total outstanding debt. The Partnership may make use of interest rate swap agreements in thefuture to adjust the ratio of fixed and floating rates in the debt portfolio.

 

45

----

 

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

 

***DisclosureControls and Procedures***

 

In connection with thepreparation of this quarterly report on Form 10-Q, our senior management, withparticipation of our Chief Executive Officer, Chief Financial Officer and ChiefAccounting Officer evaluated the effectiveness of the design and operation ofour disclosure controls and procedures as of March 31, 2005 pursuant to Rule13a-15 under the Securities Exchange Act of 1934.  Based upon that evaluation, our ChiefExecutive Officer, Chief Financial Officer and Chief Accounting Officerconcluded that as of March 31, 2005, as a result of the material weaknesses inour internal control over financial reporting discussed below, our disclosurecontrols and procedures were ineffective to provide reasonable assurance thatinformation required to be disclosed by us in reports that we file or submitunder the Securities Exchange Act of 1934 (the “Act”), is recorded, processed,summarized and reported, within the time periods specified in the SEC’s rulesand forms and to ensure that information required to be disclosed by us in thereports that we file under the Act is accumulated and communicated tomanagement, including our certifying officers, as appropriate, to allow timelydecisions regarding required disclosures.

 

Through the date of thefiling of this Form 10-Q, we have adopted remedial measures to address the deficienciesin our internal controls that existed on March 31, 2005.  In addition, we have applied compensatingprocedures and processes as necessary to ensure the reliability of ourfinancial reporting.  Such additionalprocedures include detailed management review of account reconciliations forall accounts in all business units, multiple level management review ofaccounting treatment for significant non-routine transaction and additionalreview at the Southwest Business Unit by Corporate personnel.  Accordingly, management believes, based onits knowledge, that (i) this report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstance under which they were made, not misleadingwith respect to the period covered by this report, and (ii) the financialstatements, and other financial information included in this report, fairlypresent in all material respects our financial condition, results of operationsand cash flows as of, and for, the periods presented in this report.

 

***Changes in InternalControl over Financial Reporting***

 

During the period covered by this quarterly reporton Form 10-Q, there were no changes in our internal control over financialreporting that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

***Material Weaknessesin Internal Control Over Financial Reporting***

 

As ofDecember 31, 2004, senior management concluded that we did not maintaineffective internal control over financial reporting due to a number of materialweaknesses.  All of the materialweaknesses discussed below were originally identified in management’sassessment of internal control that was conducted as of December 31, 2004.

 

Based onour evaluation, senior management has concluded that, as of March 31, 2005, wedid not maintain effective internal control over financial reporting due to thefollowing material weaknesses:

 

*Ineffective Control Environment* – Our control environmentdid not sufficiently promote effective internal control over financialreporting throughout our management structure, and this material weakness was acontributing factor in the development of other material weaknesses describedbelow.  Principal contributing factors includedthe lack of adequate personnel with sufficient expertise to perform accountingfunctions necessary to ensure preparation of financial statements in accordancewith generally accepted accounting principles, and a lack of adequate policiesand procedures to enable the timely preparation of reliable financialstatements, as described more fully below.

 

To date, we have taken the following steps to remediatethis material weakness:

 

46

----

 

•      We have hired a ChiefAccounting Officer with public company accounting and reporting technicalexpertise.

 

•      We have hired additionalaccounting staff to supplement our existing technical accounting resources.

 

•      We have hired a VicePresident of Compliance to coordinate our internal audit and internal controlcompliance efforts.

 

•      We have implemented aninternal audit outsourcing and technical consultation arrangement with aprofessional accounting and consulting firm.

 

•      We have conductedentity-level risk assessment, established an internal audit plan, and we havebegun to execute that plan.

 

*Insufficient technicalaccounting expertise, inadequate policies and procedures related to accountingmatters, and inadequate management review in the financial reporting process* – We did not have sufficienttechnical accounting expertise to address, or adequate policies and proceduresassociated with complex accounting matters. In addition, we did not maintain policies and procedures to ensureadequate management review of information supporting our financial statements.

 

To date, we have taken the following steps to remediatethis material weakness:

 

•      We have hired a ChiefAccounting Officer with public company accounting and reporting technicalexpertise.

 

•      We have hired additionalaccounting staff to supplement our existing technical accounting resources.

 

•      We have hired a VicePresident of Compliance to coordinate our internal audit and internal controlcompliance efforts.

 

•      We have implemented aninternal audit outsourcing and technical consultation arrangement with aprofessional accounting and consulting firm.

 

•      We have conductedentity-level risk assessment, established an internal audit plan, and have begunto execute that plan.

 

*Inadequate personnel, processes,and controls at our Southwest Business Unit* – We did not have adequatepersonnel, policies, and procedures at our Southwest Business Unit to enabletimely preparation of reliable financial information for that business unit.

 

To date, we have taken the following steps to remediatethis material weakness:

 

•      We have formalized themonthly account reconciliation process for all balance sheet accounts.  We have also implemented a formal review ofthese reconciliations by our business unit accounting management.

 

•      We have instituted a quarterly corporate reviewof all account reconciliations by the corporate accounting staff andmanagement.

 

•      We have provided specific training for our SouthwestBusiness Unit accountants on our accounting systems.

 

47

----

 

•      We initiated the process of consistentlycomparing each month’s accrual to the actual results in an effort to furtherrefine our estimation process.

 

•      We have systematized the data gathering functionfor the accounts payable invoices received after period end.  This accrual is now reviewed monthly bycorporate accounting staff.

 

*Inadequately designed controls and procedures overproperty, plant and equipment* – We did not have adequately designed policies and procedures to ensurethat costs associated with activities related to our facilities were properlyaccounted for as a capital expenditure or as a maintenance expense.  This material weakness in internal controlover financial reporting resulted in a material misstatement of property, plantand equipment, and in facilities expenses.

 

Todate, we have taken the following steps to remediate this material weakness:

 

•      We capitalize interest on major constructionprojects.  The financial reporting teamin our corporate office has assumed the responsibility for calculating andrecording capitalized interest related to major construction projects.

 

•      A periodic review meeting is now held by ourBusiness Unit Managers to review issues with active, open constructionprojects.  The fixed asset accountant andall operational managers are present for these meetings.

 

PlannedRemediation of Internal Control Weaknesses

 

Goingforward, we expect to implement the following additional measures to strengthenour internal control processes:

 

•      We are implementing additional entity-levelcontrols, including a robust disclosure review process and additional technicalaccounting reviews.

 

•      We are continuing our implementation processesof our new risk management and derivative transaction reporting software.

 

•      We will conduct in-depth training for allpersons with coding responsibilities to ensure clear and consistentunderstanding of capitalization policies.

 

•      Through our annual certification of the designand operating effectiveness of our internal controls, we are identifying andremediating specific control gaps.

 

Our Audit Committee has been and expects to remain,actively involved in the remediation planning and implementation.  The Company is fully committed to remediatingour material weaknesses in internal control over financial reporting, and webelieve that we are taking the steps that will properly address these issues during2005.  However, the remediation of thedesign of the deficient controls and the associated testing efforts are not complete,and further remediation may be required.

 

48

----

 

**PART II—OTHER INFORMATION**

 

##### **Item 1.  LegalProceedings**

 

Referenceis made to Note 13 of our Condensed Consolidated Financial Statements in Item 1of this Form 10-Q.

 

**Item 6.  Exhibits**

 
| 31.1   |   | Certification  of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange  Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.   |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                              |
| 31.2   |   | Certification  of the Chief Accounting Officer pursuant to Rule 13a-14(a) of the Securities  Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|   |   |                                                                                                                                                                              |
| 31.3   |   | Certification  of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange  Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.   |
|   |   |                                                                                                                                                                              |
| 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 Accounting 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 Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                          |

 

49

----

 

**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:  December 9, 2005 |   | /s/  Nancy K. Masten       |   |
|                         |   | Nancy  K. Masten           |
|                         |   | Chief  Accounting Officer  |
|                         |   |                       |

 

50

----

 
| **Exhibit  Number** | ** ** | **Exhibit Index**                                                                                                                                                                 |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                              |
| 31.1                |       | Certification  of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities  Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.  |
|                |       |                                                                                                                                                                              |
| 31.2                |       | Certification  of the Chief Accounting Officer pursuant to Rule 13a-14(a) of the Securities  Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|                |       |                                                                                                                                                                              |
| 31.3                |       | Certification  of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities  Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.  |
|                |       |                                                                                                                                                                              |
| 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 Accounting 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 Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                          |

 

51

----