**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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Form 10-Q

**x        Quarterly report pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934**

**Forthe quarterly period ended June 30, 2005**

**OR**

**o        Transition report pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934**

**Commissionfile number:  001-32329**

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Copano Energy, L.L.C.

(Exact Name of Registrantas Specified in Its Charter)

| **Delaware**                                                     | **51-0411678**                        |
|------------------------------------------------------------------|---------------------------------------|
| (State or Other  Jurisdiction of  Incorporation or Organization) | (I.R.S. Employer  Identification No.) |

 

**2727 Allen Parkway, Suite 1200Houston, Texas 77019**

(Address of PrincipalExecutive Offices)

**(713) 621-9547**

(Registrant’s TelephoneNumber, Including Area Code)

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes  x   No  o

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act). Yes  o   No  x

Therewere 8,541,828 common units of Copano Energy, L.L.C. outstanding at August 12, 2005.Copano Energy, L.L.C.’s common units trade on The NASDAQ National Market underthe symbol “CPNO.”

 

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**TABLE OF CONTENTS**
|         | ** **                                                                                                             | **Page** |
|---------|------------------------------------------------------------------------------------------------------------------------|----------|
|    | **PART  I—FINANCIAL INFORMATION**                                                                                 |     |   |
| Item 1. | Financial  Statements                                                                                                  | 3        |   |
|    | Unaudited  Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004                                       | 3        |   |
|    | Unaudited  Consolidated Statements of Operations for the Three and Six Months Ended June 30,  2005 and 2004  | 4        |   |
|    | Unaudited  Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2005  and 2004       | 5        |   |
|    | Unaudited  Consolidated Statement of Members’ Capital for the Six Months Ended June 30, 2005       | 6        |   |
|    | Notes  to Unaudited Consolidated Financial Statements                                                                  | 7        |   |
| Item 2. | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                            | 27       |   |
| Item 3. | Quantitative  and Qualitative Disclosures About Market Risk                                                            | 45       |   |
| Item 4. | Controls  and Procedures                                                                                               | 46       |   |
|    | **PART  II—OTHER INFORMATION**                                                                                    |     |   |
| Item 1. | Legal  Proceedings                                                                                                     | 47       |   |
| Item 4. | Submission  of Matters to a Vote of Security Holders                                                                   | 47       |   |
| Item 6. | Exhibits                                                                                                               | 47       |   |

 

2

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**Item 1.**                        FinancialStatements.

**COPANOENERGY, L.L.C. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(Unaudited)**
| ** **                                                                                                                                           | ** ** | **June 30,**                         | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                           | ** ** | **2005**                                  | ** ** | **2004**              | ** ** |
| ** **                                                                                                                                           | ** ** | **(in thousands, except ** | ** ** |
| ** **                                                                                                                                           | ** ** | **unit information)**                | ** ** |
| **ASSETS**                                                                                                                                           |       |                                      |       |                  |       |   |   |
| Current assets:                                                                                                                                      |       |                                      |       |                  |       |   |   |
| Cash and  cash equivalents                                                                                                                           |       | $                                         | 10,210     |                  |       | $ | 7,015 |   |   |
| Escrow  cash                                                                                                                                         |       | 1,008                                     |       |                  | 1,000      |   |   |
| Accounts  receivable, net                                                                                                                            |       | 28,490                                    |       |                  | 37,045     |   |   |
| Accounts  receivable from affiliates                                                                                                                 |       | 650                                       |       |                  | 1,141      |   |   |
| Prepayments  and other current assets                                                                                                                |       | 489                                       |       |                  | 1,300      |   |   |
| Total  current assets                                                                                                                                |       | 40,847                                    |       |                  | 47,501     |   |   |
| Property, plant and equipment, net                                                                                                                   |       | 119,094                                   |       |                  | 119,683    |   |   |
| Intangible assets, net                                                                                                                               |       | 4,342                                     |       |                  | 4,469      |   |   |
| Investment in unconsolidated affiliate                                                                                                               |       | 4,797                                     |       |                  | 4,371      |   |   |
| Other assets, net                                                                                                                                    |       | 8,682                                     |       |                  | 2,375      |   |   |
| Total  assets                                                                                                                                        |       | $                                         | 177,762    |                  |       | $ | 178,399 |   |   |
| **LIABILITIES AND MEMBERS’  CAPITAL**                                                                                                           |       |                                      |       |                  |       |   |   |
| Current liabilities:                                                                                                                                 |       |                                      |       |                  |       |   |   |
| Accounts  payable                                                                                                                                    |       | $                                         | 28,134     |                  |       | $ | 36,960 |   |   |
| Accounts  payable to affiliates                                                                                                                      |       | 138                                       |       |                  | 127        |   |   |
| Note  payable                                                                                                                                        |       | 88                                        |       |                  | 350        |   |   |
| Other  current liabilities                                                                                                                           |       | 7,768                                     |       |                  | 777        |   |   |
| Total  current liabilities                                                                                                                           |       | 36,128                                    |       |                  | 38,214     |   |   |
| Long-term debt                                                                                                                                       |       | 53,000                                    |       |                  | 57,000     |   |   |
| Other noncurrent liabilities                                                                                                                         |       | 786                                       |       |                  | 829        |   |   |
| Commitments and contingencies (Note 8)                                                                                                               |       |                                      |       |                  |       |   |   |
| Members’ capital:                                                                                                                               |       |                                      |       |                  |       |   |   |
| Common  units, no par value, 7,083,372 and 7,056,252 units issued and outstanding as  of June 30, 2005 and December 31, 2004, respectively |       | 95,109                                    |       |                  | 94,325     |   |   |
| Subordinated  units, no par value, 3,519,126 units outstanding as of  June 30, 2005 and December 31, 2004, respectively               |       | 10,379                                    |       |                  | 10,379     |   |   |
| Paid-in  capital                                                                                                                                     |       | 1,424                                     |       |                  | —     |   |   |
| Accumulated  deficit                                                                                                                                 |       | (18,084                                   | )          |                  | (21,927    | ) |   |
| Deferred  compensation                                                                                                                               |       | (980                                      | )          |                  | (421       | ) |   |
|                                                                                                                                                 |       | 87,848                                    |       |                  | 82,356     |   |   |
| Total liabilities and members’ capital                                                                                                          |       | $                                         | 177,762    |                  |       | $ | 178,399 |   |   |

 

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

3

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF OPERATIONS(Unaudited)**
| ** **                                                             | ** ** | **Three Months**                                           | ** ** | **Six Months**          | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                             | ** ** | **Ended June 30,**                                    | ** ** | **Ended June 30,** | ** ** |
| ** **                                                             | ** ** | **2005**                                                        | ** ** | **2004**                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                             | ** ** | **(in thousands, except unit information)** | ** ** |
| Revenue:                                                               |       |                                                            |       |                         |       |   |   |   |   |
| Natural gas sales(1)                                                   |       | $                                                               | 58,871     |                         | $          | 61,376 |   | $ | 137,013 |   | $ | 123,264 |   |
| Natural gas sales—affiliates                                      |       | 38                                                              |       | 429                          |       | 38 |   | 429 |   |
| Natural gas liquids sales                                              |       | 47,294                                                          |       | 36,807                       |       | 92,896 |   | 67,267 |   |
| Transportation, compression and processing fees                        |       | 2,303                                                           |       | 1,361                        |       | 4,462 |   | 4,752 |   |
| Transportation, compression and processing  fees—affiliates  |       | 6                                                               |       | 24                           |       | 17 |   | 41 |   |
| Other                                                                  |       | 610                                                             |       | 376                          |       | 1,546 |   | 766 |   |
| Total revenue                                                          |       | 109,122                                                         |       | 100,373                      |       | 235,972 |   | 196,519 |   |
| Costs and expenses:                                                    |       |                                                            |       |                         |       |   |   |   |   |
| Cost of natural gas and natural gas liquids(2)                         |       | 93,853                                                          |       | 89,578                       |       | 205,124 |   | 174,802 |   |
| Cost of natural gas and natural gas  liquids—affiliates           |       | 337                                                             |       | 555                          |       | 767 |   | 1,288 |   |
| Transportation                                                         |       | 498                                                             |       | 355                          |       | 961 |   | 683 |   |
| Transportation—affiliates                                         |       | 127                                                             |       | 110                          |       | 262 |   | 201 |   |
| Operations and maintenance                                             |       | 3,006                                                           |       | 3,010                        |       | 5,977 |   | 5,969 |   |
| Depreciation and amortization                                          |       | 1,873                                                           |       | 1,644                        |       | 3,665 |   | 3,246 |   |
| General and administrative                                             |       | 3,095                                                           |       | 1,772                        |       | 6,530 |   | 3,498 |   |
| Taxes other than income                                                |       | 195                                                             |       | 251                          |       | 392 |   | 501 |   |
| Equity in (earnings) loss from unconsolidated  affiliate               |       | (261                                                            | )          | 91                           |       | (486 | ) | (168 | ) |
| Total costs and expenses                                               |       | 102,723                                                         |       | 97,366                       |       | 223,192 |   | 190,020 |   |
| Operating income                                                       |       | 6,399                                                           |       | 3,007                        |       | 12,780 |   | 6,499 |   |
| Other income  (expense):                                               |       |                                                            |       |                         |       |   |   |   |   |
| Interest and other income                                              |       | 84                                                              |       | 16                           |       | 151 |   | 23 |   |
| Interest and other financing costs                                     |       | (967                                                            | )          | (3,615                       | )          | (1,990 | ) | (7,734 | ) |
| Net income (loss)                                                      |       | $                                                               | 5,516      |                         | $          | (592 | ) | $ | 10,941 |   | $ | (1,212 | ) |
| Basic net income (loss) per equivalent unit                            |       | $                                                               | 0.52       |                         | $          | (0.42 | ) | $ | 1.04 |   | $ | (0.85 | ) |
| Basic weighted average number of equivalent units                      |       | 10,557                                                          |       | 1,426                        |       | 10,557 |   | 1,426 |   |
| Diluted net income (loss) per equivalent unit                          |       | $                                                               | 0.52       |                         | $          | (0.42 | ) | $ | 1.03 |   | $ | (0.85 | ) |
| Diluted weighted average number of equivalent units                    |       | 10,630                                                          |       | 1,426                        |       | 10,620 |   | 1,426 |   |

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| (1)Includes  sales related to purchases/sales with the same counterparty:     |   | $ | 6,614 |   | $ | — |   | $ | 27,021 |   | $ | — |   |
|-------------------------------------------------------------------------------|--------|---|-------|--------|---|--------|--------|---|--------|--------|---|--------|--------|
| (2)Includes  purchases related to purchases/sales with the same counterparty: |   | $ | 6,911 |   | $ | — |   | $ | 27,364 |   | $ | — |   |

 

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

4

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF CASH FLOWS(Unaudited)**
| ** **                                                                                | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                                      | ** ** | **2004** | ** ** |
| ** **                                                                                | ** ** | **(in thousands)**                       | ** ** |
| Cash Flows From Operating Activities:                                                     |       |                                          |       |   |   |
| Net income (loss)                                                                         |       | $                                             | 10,941     |   | $ | (1,212 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                          |       |   |   |
| Depreciation and  amortization                                                            |       | 3,665                                         |       | 3,246 |   |
| Amortization of debt  issue costs                                                         |       | 329                                           |       | 738 |   |
| Equity in earnings from  unconsolidated affiliate                                         |       | (486                                          | )          | (168 | ) |
| Payment-in-kind  interest on subordinated debt                                            |       | —                                        |       | 814 |   |
| Payment-in-kind  interest to preferred unitholders                                        |       | —                                        |       | 3,584 |   |
| Accretion of preferred  unitholders warrant value                                         |       | —                                        |       | 821 |   |
| Accretion of subsidiary  warrant value                                                    |       | —                                        |       | 33 |   |
| Deferred compensation                                                                     |       | 225                                           |       | 40 |   |
| Deferred rent                                                                             |       | (30                                           | )          | (30 | ) |
| Deferred revenue                                                                          |       | (12                                           | )          | — |   |
| (Increase) decrease in:                                                                   |       |                                          |       |   |   |
| Accounts receivable                                                                       |       | 8,555                                         |       | (7,756 | ) |
| Accounts receivable from  affiliates                                                      |       | 551                                           |       | (547 | ) |
| Prepayments and other  current assets                                                     |       | 549                                           |       | 626 |   |
| Increase (decrease) in:                                                                   |       |                                          |       |   |   |
| Accounts payable                                                                          |       | (9,333                                        | )          | 3,285 |   |
| Accounts payable to  affiliates                                                           |       | 11                                            |       | (297 | ) |
| Other current  liabilities                                                                |       | 1,029                                         |       | 348 |   |
| Net cash provided by  operating activities                                                |       | 15,994                                        |       | 3,525 |   |
| Cash Flows From Investing Activities:                                                     |       |                                          |       |   |   |
| Additions to property,  plant and equipment and intangible assets                         |       | (2,021                                        | )          | (4,128 | ) |
| Acquisitions of  property, plant and equipment                                            |       | (493                                          | )          | — |   |
| Other                                                                                     |       | (304                                          | )          | — |   |
| Net cash used in  investing activities                                                    |       | (2,818                                        | )          | (4,128 | ) |
| Cash Flows From Financing Activities:                                                     |       |                                          |       |   |   |
| Repayments of long-term  debt                                                             |       | (4,000                                        | )          | (11,300 | ) |
| Proceeds from long-term  debt                                                             |       | —                                        |       | 31,000 |   |
| Escrow cash                                                                               |       | (8                                            | )          | 1,001 |   |
| Repayment of  subordinated debt                                                           |       | —                                        |       | (15,199 | ) |
| Repayments of other long-term  obligations                                                |       | —                                        |       | (19 | ) |
| Deferred financing costs                                                                  |       | (287                                          | )          | (1,541 | ) |
| Distributions to unitholders                                                              |       | (7,098                                        | )          | — |   |
| Capital contributions  from Pre-Offering Investors                                        |       | 1,424                                         |       | — |   |
| Deferred offering costs                                                                   |       | (12                                           | )          | (1,643 | ) |
| Net cash (used in)  provided by financing activities                                      |       | (9,981                                        | )          | 2,299 |   |
| Net increase in cash and  cash equivalents                                                |       | 3,195                                         |       | 1,696 |   |
| Cash and cash  equivalents, beginning of year                                             |       | 7,015                                         |       | 4,607 |   |
| Cash and cash equivalents, end of period                                                  |       | $                                             | 10,210     |   | $ | 6,303 |   |

 

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

5

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIESCONSOLIDATED STATEMENTOF MEMBERS’ CAPITAL(Unaudited)**
| ** **                                         | ** ** | **Common**              | ** ** | **Subordinated** | ** ** | ** **        | ** ** | **Accumulated**  | ** ** | ** **  | ** ** | ** **    | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|------------------|------------|-------------------|------------|------------------|------------|-------------|------------|---------------|------------|
| ** **                                         | ** ** | **Number**              | ** ** | **Common**       | ** ** | **Number**        | ** ** | **Subordinated** | ** ** | **Paid-in** | ** ** | **Earnings**  | ** ** | **Deferred** | ** ** | ** ** | ** ** |
| ** **                                         | ** ** | **of Units**       | ** ** | **Units**        | ** ** | **of Units** | ** ** | **Units**        | ** ** | **Capital** | ** ** | **(Deficit)** | ** ** | **Compensation** | ** ** | **Total** | ** ** |
| ** **                                         | ** ** | **(in thousands)** | ** ** |
| **Balance,  December 31, 2004**               |       |                    | 7,056      |             |       | $                 | 94,325     |             |       | 3,519       |       |          |       | $ | 10,379 |   |   | $ | — |   |   | $ | (21,927 | ) |   |   | $ | (421 | ) |   | $ | 82,356 |   |
| Capital  contributions from Pre-Offering Investors |       |                    | —     |             |       | —            |       |             | —     |        |       |          | —     |   |   | 1,424 |   |   | — |   |   |   | — |   |   | 1,424 |   |
| Distributions to  unitholders                      |       |                    | —     |             |       | —            |       |             | —     |        |       |          | —     |   |   | — |   |   | (7,098 | ) |   |   | — |   |   | (7,098 | ) |
| Issuance of  restricted units                      |       |                    | 27         |             |       | 784               |       |             | —     |        |       |          | —     |   |   | — |   |   | — |   |   |   | (784 | ) |   | — |   |
| Stock-based  compensation                          |       |                    | —     |             |       | —            |       |             | —     |        |       |          | —     |   |   | — |   |   | — |   |   |   | 225 |   |   | 225 |   |
| Net income                                         |       |                    | —     |             |       | —            |       |             | —     |        |       |          | —     |   |   | — |   |   | 10,941 |   |   |   | — |   |   | 10,941 |   |
| **Balance,  June 30, 2005**                   |       |                    | 7,083      |             |       | $                 | 95,109     |             |       | 3,519       |       |          |       | $ | 10,379 |   |   | $ | 1,424 |   |   | $ | (18,084 | ) |   |   | $ | (980 | ) |   | $ | 87,848 |   |

 

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

6

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

**Note 1—Organization and Basis of Presentation**

*Organization*

Copano Energy, L.L.C. (“CE”), a Delaware limitedliability company, was formed in August 2001 as Copano Energy Holdings,L.L.C. (“CEH”) to acquire entities owning businesses operating under the Copanoname since 1992. To simplify its corporate structure, on July 27, 2004,CEH caused the merger of Copano Energy, L.L.C., a then wholly ownedsubsidiary of CEH, with and into CEH, with CEH being the surviving entity. Inconnection with the merger, CEH changed its name to Copano Energy, L.L.C. OnAugust 1, 2005, a subsidiary of CE acquired ScissorTail Energy, LLC (“ScissorTail”)as discussed in Note 11. Unless otherwise noted, discussions in Note 1 donot reflect the ScissorTail acquisition.

CE, through its wholly owned subsidiaries, providesmidstream energy services, including gathering, transportation, treating,processing and conditioning services in the South Texas and Texas Gulf Coastregions and, as of August 1, 2005, Central and Eastern Oklahoma (see Note11) (CE and its subsidiaries collectively are referred to as the “Company”).

The Company’s natural gas pipelines collect naturalgas from designated points near producing wells and transport these volumes tothird-party pipelines, the Company’s gas processing plant, utilities andindustrial consumers. Natural gas shipped to the Company’s gas processingplant, either on the Company’s pipelines or third-party pipelines, istreated to remove contaminants, conditioned or processed into mixed natural gasliquids (“NGL”) and then fractionated or separated into select component NGLproducts, including ethane, propane, butane and natural gasoline mix andstabilized condensate. The Company also owns and operates an NGL productspipeline extending from the Company’s gas processing plant to the Houston area.The Company refers to its natural gas pipeline operating subsidiariescollectively as “Copano Pipelines” and to its processing and related activitiesoperating subsidiaries collectively as “Copano Processing.”

On November 15, 2004,the Company completed its initial public offering (the “Offering”) of 5,750,000common units, inclusive of 750,000 common units that were issued as a result ofthe underwriters’ exercise of their over-allotment option. The common unitsissued in the Offering were sold at $20.00 per common unit and the net proceedsfrom the Offering were used (i) to redeem CE’s redeemable preferred unitsfrom certain of the Company’s investors existing prior to the Offering (the “Pre-OfferingInvestors”), (ii) to reduce existing indebtedness under the CPG CreditAgreement (as defined herein), (iii) to reduce existing indebtedness underthe term loan entered into in 2001, (iv) to pay other obligations, (v) topay expenses of the Offering and (vi) to redeem common units, on a prorata basis, from certain Pre-Offering Investors.

*Basis ofPresentation and Principles of Consolidation*

The accompanying unaudited consolidated financialstatements and related notes include the assets, liabilities and results of operationsof the Company for each of the periods presented. Although CE, through certainsubsidiaries, owns a 62.5% equity investment in Webb/Duval Gatherers (“WDG”), aTexas general partnership, the Company accounts for the investment using theequity method of accounting because the minority general partners havesubstantive participating rights with respect to the management of WDG. Allsignificant intercompany accounts and transactions are eliminated in theconsolidated financial statements.

7

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note1—Organization and Basis of Presentation (Continued)**

The accompanying consolidated financial statementshave been prepared without audit pursuant to the rules and regulations ofthe Securities and Exchange Commission. Accordingly, the statements reflect allnormal and recurring adjustments that are, in the opinion of management,necessary for a fair presentation of the results of operations for the interimperiods. Certain information and notes normally included in financialstatements prepared in accordance with generally accepted accounting principleshave been condensed or omitted pursuant to such rules and regulations. However,management believes that the disclosures are adequate to make the informationpresented not misleading. These interim financial statements should be read inconjunction with the audited consolidated financial statements and notesthereto contained in the Company’s Annual Report on Form 10-K for the yearended December 31, 2004.

Copano General Partners, Inc. (“CGP”) and CopanoEnergy Finance Corporation (“CEFC”), Delaware corporations and wholly ownedsubsidiaries of CE, are the only entities within the consolidated group subjectto federal income taxes. CGP’s operations primarily include its indirectownership of the managing general partner interest in certain of the CopanoPipelines entities and CEFC was formed in July 2005. As of December 31,2004, CGP had a net operating loss (“NOL”) carryforward of approximately$265,000, for which a valuation allowance has been recorded. During the sixmonths ended June 30, 2005, CGP utilized a significant portion of this NOLcarryforward. No income tax expense was recognized for the interim periodpresented and except for income allocated to CGP, income is taxable directly tothe members holding the membership interests in CE.

The number of common unitsoutstanding and per common unit amounts have been restated for the three andsix months ended June 30, 2004 to reflect the conversion or exchange ofpre-Offering common units into post-Offering common units immediately prior tothe completion of the Offering.

**Note 2—New Accounting Pronouncements**

*Share-Based Payment*

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 123 (revised 2004), or SFAS No. 123(R), “Share-Based Payment,”which establishes accounting standards for alltransactions in which an entity exchanges its equity instruments for goods orservices. SFAS No. 123(R) focuses primarily on accounting fortransactions with employees and carries forward without change to priorguidance for share-based payments for transactions with non-employees. SFAS No. 123(R) eliminatesthe intrinsic value measurement objective in Accounting Principles BoardOpinion (“APB”) No. 25 and generally requires the Company to measure thecost of employee services received in exchange for an award of equityinstruments based on the fair value of the award on thedate of the grant.

The standard requires grant date fair value to beestimated using either an option-pricing model that is consistent with theterms of the award or a market observed price, if such a price exists. Suchcost must be recognized over the period during which an employee is required toprovide services in exchange for the award (which is usually the vestingperiod). The standard also requires the Company to estimate the number ofinstruments that will ultimately be issued, rather than accounting forforfeitures as they occur. The Company is required to apply SFAS No. 123(R) toall equity awards granted, modified or settled by January 1, 2006. TheCompany is also required to use either the “modified prospective method” or the“modified retrospective method.” Under the modified prospective method, theCompany must recognize 

8

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note2—New Accounting Pronouncements (Continued)**

compensation cost for allawards granted after the Company adopts the standard and for the unvestedportion of previously granted awards that are outstanding on that date. Underthe modified retrospective method, the Company must restate previously issuedfinancial statements to recognize the amounts the Company previously calculatedand reported on a pro forma basis, as if the prior standard had been adopted. Underboth methods, the Company is permitted to use either a straight line or anaccelerated method to amortize the cost as an expense for awards with gradedvesting. The standard permits and encourages early adoption.

The Company has commencedthe analysis of the impact of SFAS No. 123(R), but has not yetdecided: (1) whether the Company will elect early adoption, (2) ifthe Company elects early adoption, at what date the Company would do so, (3) whetherthe Company will use the modified prospective method or elect to use themodified retrospective method and (4) whether the Company will elect touse straight line amortization or an accelerated method. Additionally, theCompany cannot predict with reasonable certainty the number of options thatwill be unvested and outstanding upon adoption. Accordingly, the Company cannotcurrently quantify with precision the effect that this standard would have onthe financial position or results of operations in the future, except that theCompany probably will recognize a greater expense for any awards that theCompany may grant in the future than the Company would recognize using thecurrent guidance. If the Company were to adopt SFAS No. 123(R) usingthe modified retrospective method, the Company’s net income would have beenapproximately $95,000 less than that reported for the six months ended June 30,2005 (Note 5).

*Exchanges ofNonmonetary Assets an amendment of APB No. 29*

In December 2004, theFASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets anamendment of APB Opinion No. 29.” This statement amends APB No. 29 toeliminate the exception for nonmonetary exchanges of similar productive assetsand replaces it with a general exception for exchanges of nonmonetary assetsthat do not have commercial substance. The statement specifies that anonmonetary exchange has commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange. Thisstatement is effective for nonmonetary asset exchanges occurring in fiscalperiods beginning after June 15, 2005. Earlier application is permittedfor nonmonetary asset exchanges occurring in fiscal periods beginning after thedate this statement is issued. Retroactive application is not permitted. Managementis analyzing the requirements of this new statement and believes that itsadoption will not have any significant impact on the Company’s financialposition, results of operations or cash flows.

*Accounting forConditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143*

In March 2005, the FASB issued FASBInterpretation No. (“FIN”) 47, “Accountingfor Conditional Asset Retirement Obligations, an interpretation of FASBStatement No. 143.” FIN 47 clarifies that the term,conditional asset retirement obligation as used in SFAS No. 143, “Accounting for Asset Retirement Obligations,”refers to a legal obligation to perform an asset retirement activity in whichthe timing and/or method of settlement are conditional upon a future event thatmay or may not be within the control of the entity. Even though uncertaintyabout the timing and/or method of settlement exists and may be conditional upona future event, the obligation to perform the asset retirement activity isunconditional. Accordingly, an entity is required to recognize a liability forthe fair value of a conditional asset retirement 

9

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note2—New Accounting Pronouncements (Continued)**

obligationif the fair value of the liability can be reasonably estimated. Uncertaintyabout the timing and/or method of settlement of a conditional asset retirementobligation should be factored into the measurement of the liability whensufficient information exists. The fair value of a liability for theconditional asset retirement obligation should be recognized when incurredgenerally upon acquisition, construction or development or through the normaloperation of the asset. SFAS No. 143 acknowledges that in some cases,sufficient information may not be available to reasonably estimate the fairvalue of an asset retirement obligation. FIN 47 also clarifies when anentity would have sufficient information to reasonably estimate the fair valueof an asset retirement obligation. FIN 47 is effective no later than theend of reporting periods ending after December 15, 2005. Retrospectiveapplication for interim financial information is permitted but is not required.Early adoption of FIN 47 is encouraged. Management of the Company iscurrently evaluating what impact FIN 47 will have on the Company’sconsolidated financial statements, but at this time, does not believe that theadoption of FIN 47 will have a significant impact on the Company’sfinancial position, results of operations or cash flows.

*Accounting Changesand Error Corrections*

In May 2005, the FASBissued SFAS No. 154, “Accounting Changes and Error Corrections.” SFAS No. 154requires companies to recognize changes in accounting principle, includingchanges required by a new accounting pronouncement when the pronouncement doesnot include specific transition provisions, retrospectively to prior periods’financial statements. SFAS No. 154 is effective for accountingchanges and corrections of errors made in fiscal years beginning after December 15,2005. The Company does not believe that the adoption of SFAS No. 154will have a material effect on its financial position or results of operations.

**Note 3—Intangible Assets**

Intangibleassets consist of rights-of-way, easements and an acquired customerrelationship, which the Company amortizes over the term of the agreement orestimated useful life. As of June 30, 2005 and December 31, 2004, theweighted average amortization period for the Company’s intangible assets was9.6 years and 10.1 years, respectively. Amortization expense was$110,000 and $109,000 for the three months ended June 30, 2005 and 2004,respectively. Amortization expense was $217,000 for each of the six monthsended June 30, 2005 and 2004. Estimated aggregate amortization expenseremaining for each of the succeeding fiscal years and thereafter isapproximately: *2005—*$217,000; *2006—*$425,000;*2007—*$385,000; *2008—*$318,000;*2009—*$250,000;and *thereafter—*$2,747,000.Intangible assets consisted of the following (in thousands):
| ** **                            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| Rights-of-way  and easements, at cost |       | $                 | 6,642      |                  |       | $ | 6,552 |   |   |
| Customer  relationship                |       | 725               |       |                  | 725        |   |   |
| Less accumulated  amortization        |       | (3,025            | )          |                  | (2,808     | ) |   |
| Intangible  assets, net               |       | $                 | 4,342      |                  |       | $ | 4,469 |   |   |

 

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note 4—Long-TermDebt**

Asummary of the Company’s debt follows (in thousands):
| ** **           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------|------------|-------------------|------------|-----------------------|------------|
| ** **           | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| Long-term debt:      |       |              |       |                  |       |   |   |
| CPG Credit Agreement |       | $                 | 45,000     |                  |       | $ | 48,000 |   |   |
| CHC Facility         |       | 8,000             |       |                  | 9,000      |   |   |
| Total                |       | $                 | 53,000     |                  |       | $ | 57,000 |   |   |

 

*CPG CreditAgreement*

Copano Pipelines Group, L.L.C. (“CPG”), a wholly ownedsubsidiary, and certain of Copano Pipelines’ operating subsidiaries have a$100.0 million revolving credit agreement (the “CPG Credit Agreement”),which matures on February 12, 2008. The balance outstanding under the CPGCredit Agreement totaled $45,000,000 and $48,000,000 as of June 30, 2005and December 31, 2004, respectively. Borrowings under this revolvingcredit facility are available for acquisitions, capital expenditures, workingcapital and general corporate purposes. This revolving credit facility does notprovide for the type of working capital borrowings that would be eligible,pursuant to the Company’s limited liability company agreement, to be consideredavailable cash or operating surplus distributable to the unitholders.

Management believes that CPG and its subsidiaries arein compliance with the financial covenants under the CPG Credit Agreement as ofJune 30, 2005. If an event of default exists under the credit agreement,the lenders will be able to accelerate the maturity of the credit agreement andexercise other rights and remedies.

The effective average interest rate on borrowingsunder the CPG Credit Agreement was 5.3% and 5.4% as of June 30, 2005 and December 31,2004, respectively. The quarterly commitment fee on the unused portion of thecredit facility was 0.375% and 0.5% at June 30, 2005 and December 31,2004, respectively. Interest and other financing costs related to the CPGCredit Agreement totaled $1,718,000 and $1,296,000 for the six months ended June 30,2005 and 2004, respectively. Costs incurred in connection with theestablishment of this facility and subsequent amendments are being amortizedover the remaining term of the CPG Credit Agreement, and as of June 30,2005 and December 31, 2004, the unamortized portion of debt issue coststotaled $1,520,000 and $1,736,000, respectively.

On August 1, 2005,this credit facility was paid in full and terminated using the proceeds fromthe new $350 million revolving credit facility discussed below. During thethree months ended September 30, 2005, the Company will take a $1,472,000charge for the write off of the remaining unamortized debt issuance costsrelated to the CPG Credit Agreement.

*CHC Facility*

Concurrent with the closing of the Offering, on November 15,2004, Copano Houston Central, L.L.C. (“CHC”), a wholly owned subsidiary, andcertain of its subsidiaries entered into a $12 million secured revolving creditfacility (the “CHC Facility”) with Comerica Bank due January 31, 2007. Thebalance outstanding under the CHC Facility totaled $8,000,000 and $9,000,000 asof June 30, 2005 and December 31, 2004, respectively. Borrowingsunder the CHC Facility are available to finance capital expenditures (includingconstruction and expansion projects) as well as to meet working capital 

11

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note4—Long-Term Debt (Continued)**

requirements of itsprocessing operations. The CHC Facility does not provide for the type ofworking capital borrowings that would be eligible, pursuant to the Company’s limitedliability company agreement, to be considered available cash or operatingsurplus distributable to the unitholders.

The effective average interest rate on borrowingsunder the CHC Facility was 5.7% and 4.8% as of June 30, 2005 and December 31,2004, respectively. The quarterly commitment fee on the unused portion of thecredit facility was 0.3% at June 30, 2005 and December 31, 2004. Interestand other financing costs related to the CHC Facility totaled $272,000 for thesix months ended June 30, 2005. Costs incurred in connection with theestablishment of this credit facility are being amortized over the term of theCHC Facility, and as of June 30, 2005 and December 31, 2004, theunamortized portion of debt issue costs totaled $143,000 and $188,000,respectively.

Management believes that CHC and its subsidiaries arein compliance with the covenants under the CHC Facility as of June 30,2005. If an event of default exists under the credit agreement, the lender willbe able to accelerate the maturity of the credit agreement and exercise otherrights and remedies.

On August 1, 2005,this credit facility was paid in full and terminated using the proceeds fromthe new $350 million revolving credit facility discussed below. During thethree months ended September 30, 2005, the Company will take a $136,000charge for the write off of the remaining unamortized debt issuance costsrelated to the CHC Facility.

*Credit Facility*

On August 1, 2005, CE entered into a new $350million senior secured revolving credit facility (the “Credit Facility”) withBank of America, N.A., as Administrative Agent, Banc of America Securities LLC,as Sole Lead Arranger and Sole Book Manager and a group of financialinstitutions. The Credit Facility matures on July 31, 2010.

On August 1, 2005, the Company borrowed $232.0million under the Credit Facility to: (i) partially finance theacquisition of ScissorTail discussed in Note 11 and (ii) to repay in fullindebtedness outstanding under the CPG Credit Agreement and the CHC Facility. Futureborrowings under the Credit Facility are available for acquisitions, capitalexpenditures, working capital and general corporate purposes. The CreditFacility does not provide for the type of working capital borrowings that wouldbe eligible, pursuant to the Company’s limited liability company agreement, tobe considered available cash distributable to unitholders. The Credit Facilityis available to be drawn on and repaid without restriction so long as theCompany is in compliance with the terms of the Credit Facility, includingcertain financial covenants.

The Credit Facility contains various covenants thatlimit CE and certain of its operating subsidiaries’ ability to grant certainliens; make certain loans and investments; make certain capital expendituresoutside the Company’s current lines of business or certain related lines ofbusiness; make distributions other than from available cash (as defined in theCompany’s limit liability company agreement); merge or consolidate with or intoa third party; or engage in certain asset dispositions, including a sale of allor substantially all of the Company’s assets. Additionally, the Credit Facilitylimits CE and certain of its operating subsidiaries’ ability to incur additionalindebtedness with certain exceptions, including under the Term Loan Facility(as discussed below), purchase money indebtedness and indebtedness related tocapital or synthetic leases not to exceed $5.0 million, unsecured indebtednessnot to exceed $5.0 million and unsecured indebtedness qualifying assubordinated debt.

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note4—Long-Term Debt (Continued)**

The Credit Facility also contains covenants, which,among other things, requires CE and certain of its subsidiaries, on aconsolidated basis, to maintain specified ratios or conditions as follows:

·       EBITDA(as defined) to interest expense of not less than 2.5 to 1.0 through September 30,2005, 2.75 to 1.0 from December 31, 2005 through June 30, 2006 and 3.0to 1.0 thereafter;

·       EBITDAminus maintenance capital expenditures to consolidated fixed charges of notless than 1.5 to 1.0 through September 30, 2005 and 1.75 to 1.0thereafter;

·       totaldebt to EBITDA of not more than 5.5 to 1.0 through September 30, 2005, 5.0to 1.0 from December 31, 2005 through June 30, 2006 and 4.75 to 1.0thereafter; and

·       totalsenior debt to EBITDA of not more than 3.75 to 1.0 through September 30,2005 and 3.5 to 1.0 thereafter.

The obligations under the Credit Facility are securedby first priority liens on substantially all of the Company’s assets andsubstantially all of the assets of the Company’s subsidiaries (other than WDG,Southern Dome, LLC (“Southern Dome”) and certain subsidiaries withinsignificant assets). Additionally, the obligations under the Credit Facilityare guaranteed by substantially all of CE’s subsidiaries (other than WDG,Southern Dome and certain subsidiaries with insignificant assets).

At the Company’s election, interest under the CreditFacility is determined by reference to (i) the British Bankers AssociationLIBOR rate, or LIBOR, plus an applicable margin between 1.75% and 2.75% perannum or (ii) the higher of the federal funds rate plus 0.5% or the primerate plus, in either case, an applicable margin between 0.25% and 1.25% perannum. Interest is payable quarterly for prime rate loans and at the applicablematurity date for LIBOR loans, except that if the interest period for a LIBORloan is six months, interest will be paid at the end of each three-monthperiod.

If an event ofdefault exists under the Credit Facility, the lenders will be able toaccelerate the maturity of the obligations outstanding under the CreditFacility and exercise other rights and remedies. Each of the following will bean event of default;

·       failureto pay any principal when due or any interest, fees or other amount withincertain grace periods;

·       failureto perform or otherwise comply with the covenants in the credit agreement orother loan documents, subject, in certain instances, to certain grace periods;

·       defaultby the Company on the payment of any other indebtedness in excess of $5.0million or any default in the performance of any obligation or condition withrespect to such indebtedness beyond the applicable grace period if the effectof the default is to permit or cause the acceleration of the indebtedness;

·       bankruptcyor insolvency events involving CE or its subsidiaries;

·       theentry of, and failure to pay, one or more adverse judgments in excess of $5.0million against which enforcement proceedings are brought or that are notstayed pending appeal; and

·       achange of control (as defined in the Credit Facility).

13

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note4—Long-Term Debt (Continued)**

*Term Loan Facility*

On August 1, 2005, CE entered into a $170 millionsenior unsecured term loan facility (the “Term Loan Facility”) with Banc ofAmerica Bridge LLC, as the Lender and Banc of America Securities LLC, as SoleLead Arranger and Sole Book Manager. The proceeds from the Term Loan Facilitywere used to pay a portion of the purchase price of the acquisition ofScissorTail.

The Term Loan Facility matures on August 1, 2006.Any outstanding term loans on August 1, 2006 (the “Conversion Date”) willbe automatically converted into new term loans with a six year term (the “RolloverLoans”) subject to satisfaction of certain conditions. On and after theConversion Date, the Lenders (as defined in the Term Loan Facility) holding atleast $42.5 million of the Rollover Loans may elect to exchange their RolloverLoans for exchange notes, which will be governed by the Exchange Note Indenture(as defined in the Term Loan Facility). The obligations under the Term LoanFacility are general unsecured obligations of CE and certain of itssubsidiaries.

The Term Loan Facility contains customary restrictivecovenants pertaining to management and operations of CE and its subsidiaries,which are substantially similar to those contained in the Credit Facility. TheTerm Loan Facility also includes the same financial covenants as thosecontained in the Credit Facility except that the required interest expense andconsolidated fixed charge coverage ratios have been set at 0.5 to 1.0 lower andthe permitted total debt and total senior debt to EBITDA ratios have been set0.5 to 1.0 higher. Generally, amounts outstanding under the Term Loan Facilitywill bear interest at a base rate being the greater of (i) three-monthLIBOR plus an applicable margin initially equal to 5% per annum or (ii) 8.5%per year; provided that the rates and margins increase by 0.5% per quarterwhile the Term Loan Facility remains outstanding subject to a cap of 11%(subject to certain additional interest rate increases in certaincircumstances). In addition, the Term Loan Facility contains covenants thatobligate CE to use commercially reasonable efforts to refinance the Term LoanFacility as promptly as practicable and, within certain time periods, toprepare the Exchange Note Indenture and to register the related exchange noteswith the Securities and Exchange Commission.

The Term Loan Facilityalso includes events of default substantially similar to those contained in theCredit Facility. If an event of default under the Term Loan Facility shalloccur and be continuing, the principal amount outstanding thereunder, togetherwith all accrued unpaid interest and other amounts owed thereunder, may bedeclared immediately due and payable.

**Note 5—Members’ Capital and Distributions**

*Common Units andSubordinated Units*

As of June 30, 2005, 10,602,498 units wereoutstanding, comprised of 7,083,372 common units and 3,519,126 subordinatedunits. Pre-Offering Investors and their assignees owned an aggregate of1,288,252 common units, employees and board members owned an aggregate 45,120restricted common units and the public owned an aggregate of 5,750,000 commonunits. Pre-Offering Investors and their assignees owned all of the outstandingsubordinated units.

14

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note 5—Members’Capital and Distributions (Continued)**

Pursuant to the Company’s limited liability companyagreement, the Pre-Offering Investors have agreed to reimburse the Company forgeneral and administrative expenses in excess of stated levels (subject tocertain limitations) for a period of three years beginning on January 1,2005. Specifically, to the extent general and administrative expenses exceedcertain levels, the portion of the general and administrative expensesultimately funded by the Company (subject to certain adjustments andexclusions) will be limited, or capped. For the year ended December 31,2005, the “cap” limits the Company’s general and administrative expenseobligations to $1.5 million per quarter (subject to certain adjustments andexclusions). During this three-year period, the quarterly limitation on generaland administrative expenses will be increased by 10% of the amount by whichEBITDA (as defined) for any quarter exceeds $5.4 million. On May 12, 2005,Pre-Offering Investors made capital contributions to the Company in theaggregate amount of $1,424,000 as a reimbursement of excess general andadministrative expenses for the three months ended March 31, 2005. On August 12, 2005,Pre-Offering Investors made capital contributions to the Company in theaggregate amount of $1,150,000 as a reimbursement of excess general andadministrative expense for the three months ended June 30, 2005. ThePre-Offering Investors used escrowed funds that the Company had distributed tothem prior to the Offering to make these contributions.

On August 1, 2005,the Company issued 1,372,458 common units in a private equity placement tocertain institutional investors for an aggregate consideration of $39.5 millionto partially fund the ScissorTail acquisition and related costs (Note 11). Holdersof these common units are entitled to piggy back and demand registration rightsas described in the Registration Rights Agreement filed as an exhibit to thisQuarterly Report on Form 10-Q.

*Class B Units*

On August 1, 2005,the Company issued 4,830,758 Class B units in a private equity placementto certain institutional investors for an aggregate consideration of $135.5million to partially fund the ScissorTail acquisition and related costs (Note11). Pursuant to the terms of the Class B units, the holders of the Class Bunits are entitled to quarterly distributions equal to 110% of the quarterlydistribution per unit to be received by the common units, which is applicableunless and until the existing unitholders approve the conversion of the Class Bunits into common units, have no voting rights other than required by law andare subordinated to the common units on dissolution and liquidation. CE hasagreed to hold a special meeting of its unitholders to consider the conversionas soon as feasible but no later than 180 days following the closing of theScissorTail acquisition. Holders of Class B units are entitled to piggyback and demand registration rights with respect to the common units underlyingthe Class B units as described in the Registration Rights Agreement filedas an exhibit to this Quarterly Report on Form 10-Q.

*Restricted Units*

Restricted units are awarded under the Company’slong-term incentive plan and are common units that vest over a period of timeand that during such time are subject to forfeiture. In addition, restrictedunits will vest upon a change in control of CE, unless provided otherwise bythe Compensation Committee of the Company’s Board of Directors. Distributionsmade on restricted units may be subjected to the same vesting provisions as therestricted units. The restricted units are intended to serve as a means ofincentive compensation for performance and not primarily as an opportunity toparticipate in the equity 

15

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note 5—Members’Capital and Distributions (Continued)**

appreciation of the commonunits. Therefore, plan participants will not pay any consideration for thecommon units they receive and CE will receive no remuneration for the units.

During the six monthsended June 30, 2005, CE awarded 27,120 restricted common units toemployees with an aggregate intrinsic value of $784,000. Of these restrictedunit grants, 15,400 vest in equal one-third annual installments commencing onthe first anniversary of the grant date, 11,720 vest in equal one-fourth annualinstallments commencing on the first anniversary of the grant date and all ofthese restricted units vest upon a change of control, death, disability or, incertain circumstances, retirement. The aggregate intrinsic value of the unitsis amortized into general and administrative expense over the respectivevesting periods. The Company recognized non-cash compensation expense of$142,000 and $225,000 related to the amortization of restricted unitsoutstanding during the three and six months ended June 30, 2005,respectively.

*Distributions*

The holders of the common and subordinated units areentitled to participate in distributions. The common units have the right toreceive a minimum quarterly distribution of $0.40 per unit, plus any arrearageson the common units, before any distribution is made to the holders of thesubordinated units. Subordinated units do not accrue distribution arrearages. Afterthe expiration of the subordination period as defined in the Company’s limitedliability company agreement, common units will no longer be entitled toarrearages.

On January 18, 2005, the Board of Directorsdeclared an adjusted cash distribution for the partial quarterly period fromthe closing of the Offering on November 15, 2004 through December 31,2004 of $0.20 per unit for all outstanding common and subordinated units. Thedistribution totaling $2,115,000 was paid on February 14, 2005 to holdersof record at the close of business on February 1, 2005.

On April 15, 2005 and pursuant to the provisionsof the Company’s limited liability company agreement, the Board of Directorsdeclared and the Company paid a cash distribution of $533,000 to certainPre-Offering Investors for reimbursement of their respective tax obligationsattributable to their ownership interest in the Company for the period from January 1,2004 through November 14, 2004, the day prior to the closing of theOffering.

On April 18, 2005, the Board of Directorsdeclared a cash distribution for the three months ended March 31, 2005 of$0.42 per unit for all outstanding common and subordinated units. Thedistribution totaling $4,450,000 was paid on May 13, 2005 to holders ofrecord at the close of business on May 2, 2005.

On July 15, 2005 theBoard of Directors declared a cash distribution for the three months ended June 30,2005 of $0.45 per unit for all outstanding common and subordinated units. Thedistribution totaling $7,819,000 will be paid on August 15, 2005 toholders of record at the close of business on August 1, 2005 and willinclude 1,372,458 common units issued in connection with the closing of theacquisition of ScissorTail (discussed in Note 11). This distribution amountalso includes a concurrent quarterly distribution of $0.495 per unit withrespect to 4,830,758 Class B units issued in connection with the closingof the ScissorTail acquisition discussed in Note 11. Pursuant to the terms ofthe Class B units, the holders of these units are entitled to quarterlydistributions equal to 110% of the quarterly distribution per unit to bereceived by the common units, which is applicable unless and until the existingunitholders approve the conversion of the Class B units into common units.CE has agreed to hold a special meeting of 

16

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note 5—Members’Capital and Distributions (Continued)**

itsunitholders to consider the conversion as soon as feasible but no later than180 days following the closing of the ScissorTail acquisition.

*Unit Options*

Unit options are granted under the Company’s long-termincentive plan and have an exercise price that may not be less than the fairmarket value of the underlying units on the date of grant. In general, unitoptions granted will become exercisable over a period determined by theCompensation Committee. In addition, unit options will become exercisable upona change in control of CE, unless provided otherwise by the CompensationCommittee.

During the six months ended June 30, 2005, CEgranted 98,380 unit options to purchase an equal number of common units at anaverage of $28.97 per unit to officers and certain employees. These unitoptions will vest in five equal annual installments commencing with the firstanniversary of the grant date or will become exercisable upon a change ofcontrol, death or disability. Outstanding options have remaining contractuallives of approximately 10 years at June 30, 2005.

Asummary of the unit option activity for the six months ended June 30, 2005is provided below:
| ** **                                     | ** ** | **Number of   Units   underlying   Options** | ** ** | **Weighted   Average   Exercise   Price** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Outstanding at  beginning of period            |       |                                                             | 200,000    |                                                     |       |   | $ | 20.00 |   |   |
| Granted                                        |       |                                                             | 98,380     |                                                     |       |   | 28.97 |   |   |
| Exercised                                      |       |                                                             | —     |                                                     |       |   | — |   |   |
| Forfeited                                      |       |                                                             | (8,870     | )                                                        |       |   | 22.24 |   |   |
| Outstanding at  end of period                  |       |                                                             | 289,510    |                                                     |       |   | $ | 22.98 |   |   |
| Exercisable at end of period                   |       |                                                             | 3,400      |                                                     |       |   | $ | 20.00 |   |   |
| Weighted average  fair value of option granted |       |                                                             |       |                                                     |       |   | $ | 2.19 |   |   |

 

*Accounting forStock-Based Compensation*

The Company uses the intrinsic value methodestablished by APB No. 25, “Accountingfor Stock Issued to Employees” to value unit options issued to employeesunder the Company’s long-term incentive plan adopted on November 15, 2004.In accordance with APB No. 25 for fixed unit options, compensation isrecorded to the extent the fair value of the unit exceeds the exercise price ofthe option at the measurement date. Compensation costs for fixed awards withpro rata vesting are recognized on a straight-line basis over the vestingperiod. For the six months ended June 30, 2005, the cost of thisstock-based compensation program had no impact on the Company’s net income, asall options granted had an exercise price equal to the market value of theunderlying common unit on the date of grant.

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note 5—Members’Capital and Distributions (Continued)**

If compensation expenserelated to the issuance of the options had been determined by applying the fairvalue method prescribed in SFAS No. 123, the Company’s net income (loss)and net income (loss) per equivalent unit would have approximated the pro formaamounts below (in thousands):
| ** **                                                                          | ** ** | **Three Months Ended June 30,**                                                      | ** ** | **Six Months Ended June 30,**                                                        | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                          | ** ** | **        2005        ** | ** ** | **        2004        ** | ** ** | **       2005       ** | ** ** | **      2004       ** | ** ** |
| Net income  (loss), as reported                                                     |       |                                                                                                     | $          | 5,516                                                                                                    |       |   |   | $ | (592 | ) |   |   | $ | 10,941 |   |   |   | $ | (1,212 | ) |   |
| Less: Stock-based  employee compensation expense determined under fair value method |       |                                                                                                     | (57        | )                                                                                                        |       |   | — |   |   |   | (95 | ) |   |   | — |   |   |
| Pro forma net  income (loss)                                                        |       |                                                                                                     | $          | 5,459                                                                                                    |       |   |   | $ | (592 | ) |   |   | $ | 10,846 |   |   |   | $ | (1,212 | ) |   |
| Net income (loss)  per equivalent unit:                                             |       |                                                                                                     |       |                                                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic—as reported                                                              |       |                                                                                                     | $          | 0.52                                                                                                     |       |   |   | $ | (0.42 | ) |   |   | $ | 1.04 |   |   |   | $ | (0.85 | ) |   |
| Basic—pro forma                                                                |       |                                                                                                     | $          | 0.52                                                                                                     |       |   |   | $ | (0.42 | ) |   |   | $ | 1.03 |   |   |   | $ | (0.85 | ) |   |
| Diluted—as reported                                                            |       |                                                                                                     | $          | 0.52                                                                                                     |       |   |   | $ | (0.42 | ) |   |   | $ | 1.03 |   |   |   | $ | (0.85 | ) |   |
| Diluted—pro forma                                                              |       |                                                                                                     | $          | 0.51                                                                                                     |       |   |   | $ | (0.42 | ) |   |   | $ | 1.02 |   |   |   | $ | (0.85 | ) |   |

 

The effects of applying SFAS No. 123 in this proforma disclosure are not indicative of future amounts.

The fair value of eachunit option granted is estimated on the date of grant using the Black-Scholesoption-pricing model with the following assumptions for 2005 (no options weregranted during the six months ended June 30, 2004): weighted averageexercise price of $28.97, expected volatility rate of 25.22%, risk-freeinterest rate of 4% and expected life of seven years. The Black-Scholesweighted average fair value of options granted in 2005 was $3.70 per unit.

**Note 6—Net Income (Loss)Per Unit**

Basic net income (loss) per equivalent unit excludesdilution and is computed by dividing net income (loss) attributable to thecommon unitholders by the weighted average number of equivalent unitsoutstanding during the period. Dilutive net income (loss) per equivalent unitreflects potential dilution and is computed by dividing net income (loss)attributable to the common unitholders by the weighted average number ofequivalent units outstanding during the period increased by the number ofadditional units that would have been outstanding if the dilutive potentialunits had been exercised.

18

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note 6—Net Income (Loss)Per Unit (Continued)**

Basicnet income (loss) per equivalent unit is calculated as follows (in thousands,except per unit amounts). For periods prior to the Offering, equivalent unitswere calculated using the weighted average of pre-Offering common units andcommon special units adjusted by a conversion or exchange factor to reflect theexchange of pre-Offering common units and common special units forpost-Offering common units immediately prior to completion of the Offering.
| ** **                                          | ** ** | **Three Months**        | ** ** | **Six Months**          | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                          | ** ** | **Ended June 30,** | ** ** | **Ended June 30,** | ** ** |
| ** **                                          | ** ** | **2005**                     | ** ** | **2004**                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income (loss)  available—basic and diluted |       | $                            | 5,516      |                         | $          | (592 | ) | $ | 10,941 |   | $ | (1,212 | ) |
| Basic weighted average equivalent units             |       | 10,557                       |       | 1,426                        |       | 10,557 |   | 1,426 |   |
| Dilutive weighted  average equivalent units         |       | 10,630                       |       | 1,426                        |       | 10,620 |   | 1,426 |   |
| Basic net income (loss) per equivalent unit         |       | $                            | 0.52       |                         | $          | (0.42 | ) | $ | 1.04 |   | $ | (0.85 | ) |
| Diluted* net income  (loss) per equivalent unit     |       | $                            | 0.52       |                         | $          | (0.42 | ) | $ | 1.03 |   | $ | (0.85 | ) |

----

*       CEhad 69,809 and 62,772 potentially dilutive employee unit options outstandingduring the three and six months ended June 30, 2005, respectively, and2,746 and 0 potentially dilutive restricted units outstanding during the threeand six months ended June 30, 2005, respectively. The 3,750,000potentially dilutive warrants previously held by pre-Offering preferredunitholders and a subsidiary warrant that was repurchased in November 2004that were outstanding during the three and six months ended June 30, 2004were excluded from the dilutive loss per equivalent unit calculation because toinclude these equity securities would have been anti-dilutive since the Companyreported a net loss for the three and six months ended June 30, 2004.

Net loss per unit for thethree and six months ended June 30, 2004 has not been presented forpre-Offering junior units and junior special units as such units were notentitled to share in earnings for this period.

**Note 7—Related Party Transactions**

*Operations Services*

Through December 31, 2004, the Company did notdirectly employ any persons to manage or operate its business other thancertain Delaware-based officers. With respect to the Texas operatingsubsidiaries of the Company, Copano/Operations, Inc. (“Copano Operations”),an entity controlled by John R. Eckel, Jr., Chairman of the Board ofDirectors and Chief Executive Officer of the Company, provided management,operations and administrative support services for the Company. The Companyreimbursed Copano Operations for all direct and indirect costs of theseservices. Copano Operations charged these subsidiaries, without markup, basedupon total monthly expenses incurred by Copano Operations less (i) a fixedallocation to reflect expenses incurred by Copano Operations for the benefit ofcertain entities controlled by Mr. Eckel and (ii) any costs to becharged directly to an entity for which Copano Operations performed services. Managementbelieves that this methodology was reasonable. Effective January 1, 2005and pursuant to a general and administrative services agreement with CopanoOperations, Copano Operations transferred responsibility to CPNO Services,L.P., an indirect wholly owned subsidiary of CE, for a significant portion ofthe services, including its employment of certain employees on the Company’s 

19

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note7—Related Party Transactions (Continued)**

behalf, that CopanoOperations had previously provided to the Company. Under the general andadministrative services agreement, the Company continues to reimburse CopanoOperations for all direct and indirect costs of the services provided to theCompany by Copano Operations using the same methodology as utilized prior to January 1,2005. Management believes that this methodology is reasonable. For the threemonths ended June 30, 2005 and 2004, the Company reimbursed CopanoOperations $755,000 and $4,017,000, respectively, for administrative andoperating costs, including payroll and benefits expense for both field andadministrative personnel of the Company. For the six months ended June 30,2005 and 2004, the Company reimbursed Copano Operations $1,533,000 and$7,319,000, respectively, for administrative and operating costs, includingpayroll and benefits expense for both field and administrative personnel of theCompany. These costs are included in operations and maintenance expenses andgeneral and administrative expenses on the consolidated statements ofoperations. As of June 30, 2005, amounts payable by the Company to CopanoOperations were $64,000.

Management estimates thatthese expenses on a stand-alone basis (that is, the cost that would have beenincurred by the Company to conduct current operations if the Company hadobtained these services from an unaffiliated entity) would not be significantlydifferent from the amounts recorded in the Company’s consolidated financialstatements for each of the three and six months ended June 30, 2005 and2004.

*Natural GasTransactions*

During the three months ended June 30, 2005 and2004, the Company purchased natural gas from affiliated companies of Mr. Eckeltotaling $265,000 and $384,000, respectively, and provided gathering andcompression services to affiliated entities of Mr. Eckel totaling $6,000and $24,000, respectively. During the six months ended June 30, 2005 and2004, the Company purchased natural gas from affiliated companies of Mr. Eckeltotaling $526,000 and $764,000, respectively, and provided gathering andcompression services to affiliated entities of Mr. Eckel totaling $17,000and $41,000, respectively. Additionally, affiliated companies of Mr. Eckelreimbursed the Company $24,000 and $15,000 for the three months ended June 30,2005 and 2004, respectively, and $43,000 and $24,000 for the six months ended June 30,2005 and 2004, respectively, in gas lift costs which are reflected as areduction of operations and maintenance expense in the consolidated statementsof operations. Management believes these purchases and sales were on terms noless favorable than those that could have been achieved with an unaffiliatedentity. As of June 30, 2005, amounts payable by the Company to affiliatedcompanies of Mr. Eckel, other than Copano Operations, totaled $74,000.

Natural gas sales to WDGtotaled $38,000 for the three and six months ended June 30, 2005 and$429,000 for the three and six months ended June 30, 2004. Natural gaspurchases and transportation costs from WDG totaled $199,000 and $281,000 forthe three months ended June 30, 2005 and 2004, respectively. Natural gaspurchases and transportation costs from WDG totaled $503,000 and $725,000 forthe six months ended June 30, 2005 and 2004, respectively. Well connectionfees paid to WDG totaled $67,000 for the three and six months ended June 30,2005. Additionally, as operator of WDG, a subsidiary of CE charges WDG amonthly administrative fee of $16,000 and has made advances to WDG for capitalexpenditures. As of June 30, 2005, the Company’s net receivable from WDGtotaled $650,000.

20

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note7—Related Party Transactions (Continued)**

*Other*

A subsidiary of MerrillCorporation (“Merrill”), an affiliate of Credit Suisse First Boston PrivateEquity which held an interest in the Company as of June 30, 2005, providedthe Company with printing and distribution services in connection with theOffering and continues to provide assistance with printing and on-going publicfilings. For the six months ended June 30, 2005 and 2004, the Companyincurred $63,000 and $0, respectively, of printing, distribution and filingcosts from Merrill. Management believes that the Company obtained theseservices on terms no less favorable than those that could have been achievedwith an unaffiliated entity.

**Note 8—Commitments and Contingencies**

*Commitments*

For the three months ended June 30, 2005 and2004, rental expense for office space, leased vehicles and leased compressorsand related field equipment used in the Company’s operations totaled $251,000and $465,000, respectively. For the six months ended June 30, 2005 and2004, rental expense for office space, leased vehicles and leased compressorsand related field equipment used in the Company’s operations totaled $482,000and $972,000, respectively.

The Company has both fixedand variable quantity contractual commitments arising in the ordinary course ofits natural gas marketing activities. At June 30, 2005, the Company hadfixed contractual commitments to purchase 518,785 million British thermal units(“MMBtu”) of natural gas in July 2005. As of June 30, 2005, theCompany had fixed contractual commitments to sell 2,597,800 MMBtu of naturalgas in July 2005. All of these contracts are based on index-related marketpricing. Using index-related market prices as of June 30, 2005, totalcommitments to purchase natural gas related to such agreements equaled$3,520,000 and the total commitment to sell natural gas under such agreementsequaled $17,487,000. The Company’s commitments to purchase variable quantitiesof natural gas at index-based prices range from contract periods extending fromone month to the life of the dedicated production. During June 2005,natural gas volumes purchased under such contracts equaled 3,973,554 MMBtu. TheCompany’s commitments to sell variable quantities of natural gas at index-basedprices range from contract periods extending from one month to 2012. During June 2005,natural gas volumes sold under such contracts equaled 227,642 MMBtu.

*Guarantees*

In November 2002, the FASB issued FIN 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others.” In certain instances, thisinterpretation requires a guarantor to recognize, at the inception of aguarantee, a liability for the fair value of the obligation undertaken inissuing the guarantee.

From July 8, 2002 through April 1, 2004, theCompany guaranteed certain vehicle lease obligations of Copano Operations forvehicles operated for the benefit of certain of the Company’s operatingentities. Effective as of April 2, 2004, the vehicle leases weretransferred by Copano Operations to Copano Pipelines/Hebbronville, L.P. (“Hebbronville”),an indirect wholly owned subsidiary of CE. Hebbronville, as lessee, guaranteesthe lessor a minimum residual sales value upon the expiration of the lease andsale of the underlying vehicle under the transferred leases and certain othervehicle leases. Certain of the Copano

21

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note8—Commitments and Contingencies (Continued)**

Pipelines entities currently guarantee the leasepayment obligations, including the residual sales value under the transferredleases. As of June 30, 2005, certain subsidiaries of CE guaranteed$418,000 related to these lease payment obligations. As of June 30, 2005,aggregate guaranteed residual values for vehicles under these operating leaseswere as follows (in thousands):
| ** **             | ** ** | **2005** | ** ** | ** 2006 ** | ** ** | ** 2007 ** | ** ** | **2008** | ** ** | **Thereafter** | ** ** | **  Total  ** | ** ** |
|------------------------|------------|----------|------------|----------------------|------------|----------------------|------------|----------|------------|----------------|------------|-----------------------------------|------------|
| Lease residual  values |       | $        | 120        |                 |       | $                    | 36         |     |       |           | $          | 55                                |       |   | $ | 111 |   |   | $ | — |   |   |   | $ | 322 |   |   |
|                        |            |          |            |                      |            |                      |            |          |            |                |            |                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Effective April 12, 2003, the Company hasguaranteed certain telephone equipment lease obligations (approximately $18,000of lease payment obligations as of June 30, 2005) of Copano Operations. Priorto January 1, 2005, the use of this telephone equipment by the Company wasincluded in the support services provided by Copano Operations to the Company.See Note 7. The Company anticipates that the obligations under this lease willbe transferred to the Company.

Presently, neither the Company nor any of itssubsidiaries have any other types of guarantees outstanding that requireliability recognition under the provisions of FIN 45.

FIN 45also sets forth disclosure requirements for guarantees by a parent company onbehalf of its subsidiaries. CE or a subsidiary entity, from time to time, mayissue parent guarantees of commitments resulting from the ongoing activities ofsubsidiary entities. Additionally, a subsidiary entity may from time to timeissue a guarantee of commitments resulting from the ongoing activities ofanother subsidiary entity. The guarantees generally arise in connection with asubsidiary commodity purchase obligation, subsidiary lease commitments orsubsidiary bank debt. The nature of such guarantees is to guarantee theperformance of the subsidiary entities in meeting their respective underlyingobligations. Except for operating lease commitments, all such underlyingobligations are recorded on the books of the subsidiary entities and areincluded in the consolidated financial statements as obligations of thecombined entities. Accordingly, such obligations are not recorded again on thebooks of the parent. The parent would only be called upon to perform under theguarantee in the event of a payment default by the applicable subsidiaryentity. In satisfying such obligations, the parent would first look to theassets of the defaulting subsidiary entity. As of June 30, 2005, theapproximate amount of parental guaranteed obligations were as follows (inthousands):
| ** **           | ** ** | **2005** | ** ** | ** 2006 ** | ** ** | **2007** | ** ** | **2008** | ** ** | **Total** | ** ** |
|----------------------|------------|----------|------------|----------------------|------------|----------|------------|----------|------------|-----------|------------|
| Bank debt            |       | $        | —     |                 |       | $        | —     |     |       | $         | 8,000      |   | $ | 45,000 |   | $ | 53,000 |   |
| Commodity  purchases |       | 2,500    |       |                 | —     |     |       | —   |       | —    |       | 2,500 |   |
|                 |       | $        | 2,500      |                 |       | $        | —     |     |       | $         | 8,000      |   | $ | 45,000 |   | $ | 55,500 |   |

 

22

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note 8—Commitments andContingencies (Continued)**

As aresult of the acquisition of ScissorTail (Note 11), repaying and terminatingthe Company’s indebtedness outstanding as of June 30, 2005 (Note 4) andentering into the Credit Facility (Note 4) and the Term Loan Facility (Note 4),the approximate amount of parental guaranteed obligations as of August 1,2005 were as follows (in thousands):
| ** **          | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|---------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Bank debt           |       | $        | —     |     | $          | —   |       | $        | —     |           | $          | —    |       | $ | 402,000 |   | $ | 402,000 |   |
| Commodity purchases |       | 2,500    |       | —   |       | —   |       | —   |       | —         |       | 2,500     |       |
|                |       | $        | 2,500      |     | $          | —   |       | $        | —     |           | $          | —    |       | $ | 402,000 |   | $ | 404,500 |   |

 

*RegulatoryCompliance*

In the ordinary course ofbusiness, the Company is subject to various laws and regulations. In theopinion of management, compliance with existing laws and regulations will notmaterially affect the financial position of the Company.

*Litigation*

The Company is named as adefendant, from time to time, in litigation relating to its normal businessoperations. Management is not aware of any significant litigation, pending orthreatened, that would have a significant adverse effect on the Company’sfinancial position or results of operations.

**Note 9—Supplemental Disclosures to the Statements ofCash Flows**

*Cash paid during each of the periods presented (inthousands)*
| ** ** | ** ** | **Six Months**          | ** ** |
|------------|------------|------------------------------|------------|
| ** ** | ** ** | **Ended June 30,** | ** ** |
| ** ** | ** ** | **2005**                     | ** ** | **2004** | ** ** |
| Interest   |       | $                            | 1,555      |   | $ | 1,406 |   |
| Taxes      |       | —                       |       | — |   |
|            |            |                              |            |  |  |  |  |

 

*Supplemental disclosures of noncash investing andfinancing activities (in thousands)*
| ** **                                                    | ** ** | **Six Months**          | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                    | ** ** | **Ended June 30,** | ** ** |
| ** **                                                    | ** ** | **2005**                     | ** ** | **2004** | ** ** |
| Decrease in  equity in earnings from unconsolidated affiliate |       | $                            | 60         |   | $ | 60 |   |
| Decrease in  accounts receivable from affiliates              |       | (60                          | )          | (60 | ) |
| Decrease in  senior debt                                      |       | —                       |       | (395 | ) |
| Increase in  property, plant and equipment                    |       | (337                         | )          | (381 | ) |
| Increase in other  assets                                     |       | (6,133                       | )          | — |   |
| Increase in  accounts payable                                 |       | 508                          |       | — |   |
| Increase in other  current liabilities                        |       | 5,962                        |       | — |   |
| Increase in other  noncurrent liabilities                     |       | —                       |       | 776 |   |
|                                                               |            |                              |            |  |  |  |  |

 

23

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note 10—Segment Information**

Based on the Company’s approach to managing its assetsprior to the acquisition of ScissorTail on August 1, 2005, the Company believesits operations consist of two segments: (i) gathering, transportation andmarketing of natural gas (Copano Pipelines) and (ii) natural gas processing andrelated NGL transportation (Copano Processing). The Company currently reportsits operations, both internally and externally, using these two segments. TheCompany evaluates segment performance based on segment margin beforedepreciation and amortization. Through June 30, 2005, all of the Company’srevenue is derived from, and all of the Company assets and operations arelocated in, the South Texas and Texas Gulf Coast regions of the United States.Transactions between reportable segments are conducted on an arm’s lengthbasis.

24

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note 10—SegmentInformation (Continued)**

Summarized financialinformation concerning the Company’s reportable segments is shown in thefollowing table (in thousands):
| ** **                                       | ** ** | **Copano**    | ** ** | **Copano**     | ** ** | ** **                | ** ** | ** **       | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|---------------|------------|----------------|------------|---------------------------|------------|------------------|------------|------------|------------|
| ** **                                       | ** ** | **Pipelines** | ** ** | **Processing** | ** ** | ** Corporate ** | ** ** | **Eliminations** | ** ** | **Total**  | ** ** |
| ***Three  Months Ended June 30, 2005:***         |       |          |       |           |       |                      |       |             |       |       |       |   |   |   |   |   |   |
| Sales to external customers                      |       | $             | 62,163     |           |       | $                         | 46,959     |             |       |       | $          | — |   |   |   | $ | — |   |   | $ | 109,122 |   |
| Intersegment sales                               |       | 40,840        |       |           | 2,809      |                      |       |             | —     |       |       |   | (43,649 | ) |   | — |   |
| Interest expense and other financing costs       |       | 831           |       |           | 136        |                      |       |             | 166        |       |       |   | (166 | ) |   | 967 |   |
| Depreciation and amortization                    |       | 1,314         |       |           | 534        |                      |       |             | 25         |       |       |   | — |   |   | 1,873 |   |
| Equity in earnings from unconsolidated affiliate |       | (261          | )          |           | —     |                      |       |             | —     |       |       |   | — |   |   | (261 | ) |
| Segment profit (loss)                            |       | 2,921         |       |           | 3,924      |                      |       |             | (1,329     | )          |       |   | — |   |   | 5,516 |   |
| Capital expenditures                             |       | 1,595         |       |           | 127        |                      |       |             | 722        |       |       |   | — |   |   | 2,444 |   |
| ***Three  Months Ended June 30, 2004:***         |       |          |       |           |       |                      |       |             |       |       |       |   |   |   |   |   |   |
| Sales to external customers                      |       | $             | 63,435     |           |       | $                         | 36,938     |             |       |       | $          | — |   |   |   | $ | — |   |   | $ | 100,373 |   |
| Intersegment sales                               |       | 31,221        |       |           | 1,406      |                      |       |             | —     |       |       |   | (32,627 | ) |   | — |   |
| Interest expense and other financing costs       |       | 722           |       |           | 591        |                      |       |             | 2,302      |       |       |   | — |   |   | 3,615 |   |
| Depreciation and amortization                    |       | 1,152         |       |           | 461        |                      |       |             | 31         |       |       |   | — |   |   | 1,644 |   |
| Equity in loss from unconsolidated affiliate     |       | 91            |       |           | —     |                      |       |             | —     |       |       |   | — |   |   | 91 |   |
| Segment profit (loss)                            |       | 2,122         |       |           | (196       | )                         |       |             | (2,518     | )          |       |   | — |   |   | (592 | ) |
| Capital expenditures                             |       | 2,920         |       |           | 192        |                      |       |             | —     |       |       |   | — |   |   | 3,112 |   |
| ***Six  Months Ended June 30, 2005:***           |       |          |       |           |       |                      |       |             |       |       |       |   |   |   |   |   |   |
| Sales to external customers                      |       | $             | 143,847    |           |       | $                         | 92,125     |             |       |       | $          | — |   |   |   | $ | — |   |   | $ | 235,972 |   |
| Intersegment sales                               |       | 79,883        |       |           | 6,418      |                      |       |             | —     |       |       |   | (86,301 | ) |   | — |   |
| Interest expense and other financing costs       |       | 1,718         |       |           | 272        |                      |       |             | 330        |       |       |   | (330 | ) |   | 1,990 |   |
| Depreciation and amortization                    |       | 2,559         |       |           | 1,062      |                      |       |             | 44         |       |       |   | — |   |   | 3,665 |   |
| Equity in earnings from unconsolidated affiliate |       | (486          | )          |           | —     |                      |       |             | —     |       |       |   | — |   |   | (486 | ) |
| Segment profit (loss)                            |       | 6,380         |       |           | 7,683      |                      |       |             | (3,122     | )          |       |   | — |   |   | 10,941 |   |
| Segment assets                                   |       | 142,962       |       |           | 69,068     |                      |       |             | 5,776      |       |       |   | (40,044 | ) |   | 177,762 |   |
| Capital expenditures                             |       | 2,261         |       |           | 340        |                      |       |             | 916        |       |       |   | — |   |   | 3,517 |   |
| ***Six  Months Ended June 30, 2004:***           |       |          |       |           |       |                      |       |             |       |       |       |   |   |   |   |   |   |
| Sales to external customers                      |       | $             | 129,389    |           |       | $                         | 67,130     |             |       |       | $          | — |   |   |   | $ | — |   |   | $ | 196,519 |   |
| Intersegment sales                               |       | 64,743        |       |           | 9,680      |                      |       |             | —     |       |       |   | (74,423 | ) |   | — |   |
| Interest expense and other financing costs       |       | 1,296         |       |           | 1,851      |                      |       |             | 4,587      |       |       |   | — |   |   | 7,734 |   |
| Depreciation and amortization                    |       | 2,286         |       |           | 927        |                      |       |             | 33         |       |       |   | — |   |   | 3,246 |   |
| Equity in earnings in consolidated affiliate     |       | (168          | )          |           | —     |                      |       |             | —     |       |       |   | — |   |   | (168 | ) |
| Segment profit (loss)                            |       | 5,284         |       |           | (1,478     | )                         |       |             | (5,018     | )          |       |   | — |   |   | (1,212 | ) |
| Capital  expenditures                            |       | 3,606         |       |           | 522        |                      |       |             | —     |       |       |   | — |   |   | 4,128 |   |

 

25

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**COPANO ENERGY, L.L.C. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**Note 11—Subsequent Events:**

*Acquisition ofScissorTail Energy, LLC*

On August 1, 2005, the Company acquired all of themembership interests in Tulsa-based ScissorTail for $495.6 million in cash,which reflected estimated net working capital adjustments. ScissorTail providesnatural gas midstream services in Central and Eastern Oklahoma and its assetsprimarily consist of approximately 3,200 miles of gathering pipelines and threeprocessing plants located in Oklahoma. In connection with the acquisition, theCompany, through ScissorTail, now operates and holds a majority interest inSouthern Dome in partnership with the prior ScissorTail ownership group.Southern Dome has been formed to engage in the midstream gas gathering andprocessing business and related operations in the Southern Dome prospect in theState of Oklahoma. In connection with this acquisition, the Company issued85,998 restricted units and 169,002 unit options to employees of ScissorTailsubject to a five-year vesting schedule.

The Companyfinanced the ScissorTail acquisition and related transactions and costs withproceeds from the following:

·       Borrowingsof approximately $179.0 million of the $232.0 million initially borrowed underthe Credit Facility discussed in Note 4;

·       Borrowingsof $170.0 million borrowed under the Term Loan Facility discussed in Note 4;and

·       Netproceeds from a $175.0 million private placement of equity to certaininstitutional investors discussed in Note 5.

An additional $53.0 million of borrowings under theCredit Facility were used to repay and terminate the CPG Credit Agreement andthe CHC Facility discussed in Note 4.

26

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**Item 2.        Management’sDiscussion and Analysis of Financial Condition and Results of Operations.**

*You should read thefollowing discussion of our financial condition and results of operations inconjunction with the unaudited consolidated financial statements and notesthereto included elsewhere in this report. References in this Item 2 to “CopanoEnergy, L.L.C.,” “we,” “our,” “us,” or like terms refer to Copano Energy,L.L.C. and its consolidated subsidiaries.*

*As generally used in the energy industry and in thisreport, the following terms have the following meanings:*
| *Bbls/d:*     | * * | *B**arrels per day*                                                                                                                       |
|---------------|----------|-------------------------------------------------------------------------------------------------------------------------------------------|
| *Btu:*        | * * | *British thermal units*                                                                                                                   |
| *MMBtu:*      | * * | *One million British thermal units*                                                                                                       |
| *MMBtu/d:*    | * * | *One million British thermal units per day*                                                                                               |
| *Mcf/d*       | * * | *One thousand cubic feet per day*                                                                                                         |
| *MMcf/d:*     | * * | *One million cubic feet per day*                                                                                                          |
| *NGLs:*       | * * | *Natural gas liquids, which consist primarily of  ethane, propane, isobutane, normal butane, natural gasoline and stabilized  condensate* |
| *throughput:* | * * | *The volume of product transported or passing  through a pipeline, plant, terminal or other facility*                                     |

 

***Overview***

We are a Delaware limited liability company formed in2001 to acquire entities operating under the Copano name since 1992 and toserve as a holding company for our operating subsidiaries. On November 15,2004, we completed our initial public offering of 5,750,000 common units at aprice of $20.00 per unit, inclusive of 750,000 common units which were issuedas a result of the underwriters’ exercise of their over-allotment option.Net proceeds from the sale of the units totaled $106.95 million. Unlessotherwise noted, discussions in this Item 2. “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” do not reflect theScissorTail acquisition which was completed on August 1, 2005.

We own networks of natural gas gathering andintrastate pipelines in the Texas Gulf Coast region. Our natural gas processingplant is the second largest in the Texas Gulf Coast region and the thirdlargest in Texas in terms of throughput capacity. The plant is locatedapproximately 100 miles southwest of Houston, Texas.

We manage ourbusiness and analyze and report our results of operations on a segment basis.Prior to the acquisition of ScissorTail, our operations are divided into twobusiness segments, Copano Pipelines and Copano Processing.

·  *Copano Pipelines*is engaged in the gathering and intrastate transmission of natural gas in areaswe refer to as the South Texas, Coastal Waters, Central Gulf Coast and UpperGulf Coast regions. Within this segment, we also provide certain relatedservices including compression, dehydration and marketing of natural gas. Forthe three months ended June 30, 2005 and 2004, this segment generatedapproximately 52% and 69%, respectively, of our total gross margin. For the sixmonths ended June 30, 2005 and 2004, this segment generated approximately 53%and 72%, respectively, of our total gross margin.

·  *Copano Processing*is engaged in natural gas processing, conditioning and treating and NGL fractionationand transportation through our Houston Central Processing Plant and SheridanNGL Pipeline. For the three months ended June 30, 2005 and 2004, thissegment generated approximately 48% and 31%, respectively, of our total grossmargin. For the six months ended June 30, 2005 and 2004, this segmentgenerated approximately 47% and 28%, respectively, of our total gross margin.

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Total gross margin is a non-GAAP financial measure.For a reconciliation of total gross margin to its most directly comparable GAAPmeasure, please read “—Non-GAAP Financial Measures.”

Our segment gross margins are determined primarily byfour interrelated variables: (1) the volume of natural gas gathered ortransported through our pipelines, (2) the volume of natural gas processed,conditioned or treated at our Houston Central Processing Plant, (3) the leveland relationship of natural gas and NGL prices and (4) our current contractportfolio. Because our profitability is a function of the difference betweenthe revenues we receive from our operations, including revenues from theproducts we sell, and the costs associated with conducting our operations,including the costs of products we purchase, increases or decreases in ourrevenues alone are not necessarily indicative of increases or decreases in ourprofitability. To a large extent, our contract portfolio and the pricingenvironment for natural gas and NGLs will dictate increases or decreases in ourprofitability. Our profitability is also dependent upon prices and marketdemand for natural gas and NGLs, which fluctuate with changes in market andeconomic conditions and other factors.

The margins we realizefrom a significant portion of the natural gas that we gather or transportthrough our pipeline systems decrease in periods of low natural gas pricesbecause our gross margins on such natural gas volumes are based on a percentageof the index price. The profitability of our processing operations is dependentupon the relationship between natural gas and NGL prices. When natural gas pricesare low relative to NGL prices, it is more profitable for us to process naturalgas than to condition it. Conversely, when natural gas prices are high relativeto NGL prices, processing is less profitable or unprofitable. During suchperiods, we have the flexibility to condition natural gas rather than fullyprocess it. Conditioning natural gas, however, is less profitable thanprocessing during periods when the value of recovered NGLs exceeds the value ofnatural gas required for plant fuel and to replace the reduced Btus that resultfrom processing the natural gas.

***Recent Developments***

On August 1, 2005,we acquired all the membership interest in Tulsa-based ScissorTail for $495.6 millionin cash, which reflected estimated net working capital adjustments.ScissorTail’s assets primarily consist of approximately 3,200 miles ofgathering pipelines and three processing plants with current processingcapacity of approximately 100 Mcf/d located in Oklahoma. In connection with theacquisition, we, through ScissorTail, now operate and hold a majority interestin Southern Dome in partnership with the prior ScissorTail ownership group.Southern Dome was formed to engage in the midstream gas gathering andprocessing business and related operations in the Southern Dome prospect in theState of Oklahoma. We financed the ScissorTail acquisition and related costswith:

·  Borrowings of approximately $179.0 million ofthe $232.0 million initially borrowed under our new Credit Facility discussedin “—Liquidity and Capital Resources—Our Indebtedness”;

·  Borrowings of $170.0 million borrowed underthe Term Loan Facility discussed in “—Liquidity and Capital Resources—OurIndebtedness”; and

·  Netproceeds from a $175.0 million private placement of equity to certaininstitutional investors discussed in Note 5 of the unaudited consolidatedfinancial statements.

***How We Evaluate Our Operations***

We believe that investors benefit from having accessto the same financial measures that our management uses in evaluating ourperformance. Our management uses a variety of financial and operationalmeasurements to analyze our performance. These measurements include thefollowing: (1) throughput volumes, (2) segment gross margin, (3)operations and maintenance expenses, (4) general and administrative expenses,(5) EBITDA and (6) distributable cash flow.

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*Throughput Volumes.  *Throughput volumes associatedwith our business are an important part of our operational analysis. Wecontinually evaluate volumes on our pipelines to ensure that we have adequatethroughput to meet our financial objectives. It is important that we continuallyadd new volumes to our gathering systems to offset or exceed the normal declineof existing volumes that are attached to those systems. Our performance at theHouston Central Processing Plant is significantly influenced by both the volumeof natural gas coming into the plant and the NGL content of the natural gas. Inaddition, we monitor fuel consumption because it has a significant impact onthe gross margin realized from our processing or conditioning operations.Although we monitor fuel costs associated with our pipeline operations, thesecosts are frequently passed on to our producers.

*Segment Gross Margin.  *Wedefine segment gross margin as our revenue less cost of sales. Cost of salesincludes the following costs and expenses: cost of natural gas and NGLspurchased by us from third parties, cost of natural gas and NGLs purchased byus from affiliates, costs we pay third parties to transport our volumes andcosts we pay our affiliates to transport our volumes. We view segment grossmargin as an important performance measure of the core profitability of ouroperations. The segment gross margin data reflect the financial impact on ourcompany of our contract portfolio. With respect to our Copano Pipelinessegment, our management analyzes segment gross margin per unit of volumesgathered or transported. With respect to our Copano Processing segment, ourmanagement also analyzes segment gross margin per unit of natural gas processedor conditioned and the segment gross margin per unit of NGLs recovered. Oursegment gross margin is reviewed monthly for consistency and trend analysis.

To isolate and consistently track changes in commodityprice relationships and their impact on our processing segment’s results, wecalculate a hypothetical “standardized” processing margin. This processingmargin is based on a fixed set of assumptions, with respect to liquidscomposition and fuel consumption per recovered gallon, which we believe isgenerally reflective of our business. Because these assumptions are held stableover time, changes in underlying natural gas and NGL prices drive changes inthe standardized processing margin. Our financial results are not derived fromthis standardized processing margin and the standardized margin is not derivedfrom our financial results. However, we believe this calculation isrepresentative of our current operating commodity price environment and we usethis calculation to track commodity price relationships. Our results ofoperations may not necessarily correlate to the changes in our standardizedprocessing margin because of the impact of factors other than commodity pricessuch as volumes, changes in NGL composition, recovery rates and variablecontract terms. Our standardized processing margins averaged $0.10 per gallonduring the second quarter of 2005 compared to $0.02 per gallon during thesecond quarter of 2004. Our standardized processing margins averaged $0.12 pergallon during the six months ended June 30, 2005 compared to $0.05 per gallonduring the six months ended June 30, 2004. The average standardized processingmargin for the period from 1989 through June 30, 2005 is $0.09 per gallon.

*Operations and Maintenance Expenses.  *Operationsand maintenance expenses are costs associated with the operations of a specificasset. Direct labor, insurance, ad valorem taxes, repair and maintenance,utilities and contract services comprise the most significant portion ofoperations and maintenance expenses. These expenses remain relatively stableacross broad volume ranges and fluctuate slightly depending on the activitiesperformed during a specific period. A portion of our operations and maintenanceexpenses are incurred through Copano Operations, an affiliate of our company.Under the terms of our arrangement with Copano Operations, we will reimburseit, at cost, for the operations and maintenance expenses it incurs on ourbehalf. Effective January 1, 2005 and pursuant to our general andadministrative services agreement with Copano Operations, Copano Operationstransferred responsibility to us for a significant portion of the services,including certain operating and maintenance services, that it had previouslyprovided to us.

*General and Administrative Expenses.  *Ourgeneral and administrative expenses include the cost of employee and officercompensation and related benefits, office lease and expenses, professionalfees, 

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information technologyexpenses, as well as other expenses not directly associated with our fieldoperations. Substantially all of our general and administrative expenses wereincurred through Copano Operations, an affiliate of our company, throughDecember 31, 2004. Effective January 1, 2005 and pursuant to our general andadministrative services agreement with Copano Operations, Copano Operationstransferred responsibility to us for a significant portion of the services,including certain general and administrative services, that it had previouslyprovided to us.

Pursuantto our limited liability company agreement, our Pre-Offering Investors haveagreed to reimburse us for our general and administrative expenses in excess ofstated levels (subject to certain limitations) for a period of three yearsbeginning on January 1, 2005. Specifically, to the extent our general andadministrative expenses exceed the following levels, the portion of the generaland administrative expenses ultimately funded by us (subject to certainadjustments and exclusions) will be limited, or capped, as indicated:

| ** ** | **Year** | ** ** | ** ** | **General and Administrative Expense Limitations** | ** ** |
|------------|----------|------------|------------|------------------------------------------------------------------------|------------|
| 1          |     |       | $          | 1.50 million per  quarter                                              |       |   |
| 2          |     |       | $          | 1.65 million per  quarter                                              |       |   |
| 3          |     |       | $          | 1.80 million per quarter                                               |       |   |

 

During this three-year period, the quarterlylimitation on general and administrative expenses will be increased by 10% ofthe amount by which EBITDA (as defined below) for any quarter exceeds$5.4 million. Additionally, the cap may be extended beyond its initialthree-year term at the same or a higher level by the affirmative vote of atleast 95% of the common and subordinated units held by our Pre-OfferingInvestors or their assignees, voting together as a single class. We can provideno assurance as to any such extension, as such determination will be made inthe sole discretion of our Pre-Offering Investors. This cap on general andadministrative expenses excludes non-cash expenses as well as expenses we mayincur in connection with potential acquisitions and capital improvements.

Immediately prior to completion of the Offering, wedistributed to our Pre-Offering Investors $4 million. Our Pre-OfferingInvestors deposited these funds in escrow accounts to be used for the purposeof satisfying their respective general and administrative expense reimbursementobligation. If the escrow accounts are exhausted, any further reimbursementobligation will be limited to the amount of the distributions attributable tothe common and subordinated units owned by the Pre-Offering Investorsimmediately prior to our Offering. On May 12, 2005 and August 12, 2005,Pre-Offering Investors made capital contributions to us in the aggregateamounts of $1.4 million and $1.2 million as reimbursement of excess general andadministrative expenses for the three months ended March 31, 2005 and June 30,2005, respectively, using these escrowed funds.

*EBITDA.  *Wedefine EBITDA as net income (loss) plus interest expense, provision for incometaxes and depreciation and amortization expense. EBITDA is used as asupplemental financial measure by our management and by external users of ourfinancial statements such as investors, commercial banks, research analysts andothers, to assess:

·  the financial performance of our assetswithout regard to financing methods, capital structure or historical costbasis;

·  the ability of our assets to generate cashsufficient to pay interest costs and support our indebtedness;

·  our operating performance and return oncapital as compared to those of other companies in the midstream energy sector,without regard to financing or capital structure; and

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·  the viability of acquisitions and capitalexpenditure projects and the overall rates of return on alternative investmentopportunities.

EBITDA is also a financial measurement that, withcertain negotiated adjustments, is reported to our lenders and is used tocompute our financial covenants under our credit facilities. EBITDA should notbe considered an alternative to net income, operating income, cash flows fromoperating activities or any other measure of financial performance presented inaccordance with GAAP.

*Distributable Cash Flow:  *We define distributable cash flowas net income or loss plus: (1) depreciation and amortization expense;(2) cash distributions received from investments in unconsolidated affiliatesless equity in the earnings of such unconsolidated affiliates; (3) reimbursementsby our Pre-Offering Investors of certain general and administrative expenses inexcess of the “G&A Cap” defined in our limited liability company agreement;(4) the subtraction of maintenance capital expenditures; and (5) the additionof losses or subtraction of gains relating to other miscellaneous non-cashamounts affecting net income for the period. Maintenance capital expendituresrepresent capital expenditures employed to replace partially or fullydepreciated assets to maintain the existing operating capacity of our assetsand to extend their useful lives, or other capital expenditures that areincurred in maintaining existing system volumes and related cash flows.Distributable cash flow is a significant performance metric used by senior managementto compare basic cash flows generated by us (prior to the establishment of anyretained cash reserves by our board of directors) to the cash distributions weexpect to pay our unitholders. Using this metric, management can quicklycompute the coverage ratio of estimated cash flows to planned cashdistributions. Distributable cash flow is also an important non-GAAP financialmeasure for our unitholders since it serves as an indicator of our success inproviding a cash return on investment. Specifically, this financial measureindicates to investors whether or not we are generating cash flow at a levelthat can sustain or support an increase in our quarterly distribution rates.Distributable cash flow is also a quantitative standard used throughout theinvestment community with respect to publicly-traded partnerships andlimited liability companies because the value of a unit of such an entity isgenerally determined by the unit’s yield (which in turn is based on the amountof cash distributions the entity can pay to a unitholder).

***How We Manage Our Operations***

Our management team uses a variety of tools to manageour business. These tools include: (1) our processing and conditioning economicmodel; (2) flow and transaction monitoring systems; (3) producer activityevaluation and reporting; and (4) imbalance monitoring and control.

*Our Processing and Conditioning Economic Model.*   Weutilize a processing and conditioning economic model to determine whether weshould process or condition natural gas at our Houston Central ProcessingPlant. This model allows management to analyze whether current natural gas andNGL pricing supports operating our Houston Central Processing Plant atfull processing mode or whether it is economically more advantageous to operatethe plant in a conditioning mode.

*Flow and Transaction Monitoring Systems.  *We utilize proprietary systems thattrack commercial activity on each of our pipelines and monitor the flow ofnatural gas on our pipelines. For example, we designed and implemented softwarethat tracks each of our natural gas transactions, which allows us tocontinuously track volumes, pricing, imbalances and estimated revenues from ourpipeline assets. Additionally, we designed and installed a Supervisory Controland Data Acquisition (SCADA) system, which assists management in monitoring andoperating our pipeline systems. The SCADA system allows us to monitor ourassets at remote locations and respond to changes in pipeline operatingconditions from our corporate office.

*Producer Activity Evaluation and Reporting.  *We monitor the producer drillingand completion activity in our areas of operation to identifyanticipated changes in production and potential new well attachment 

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opportunities. Thecontinued attachment of natural gas production to our pipeline systems iscritical to our business and directly impacts our financial performance. Usinga third-party electronic reporting system, we receive daily reports of newdrilling permits and completion reports filed with the state regulatory agencythat governs these activities. Additionally, our field personnel report thelocations of new wells in their respective areas and anticipated changes inproduction volumes to supply representatives and operating personnel at ourcorporate office. These processes enhance our awareness of new well activity inour operating areas and allow us to be responsive to producers in connectingnew volumes of natural gas to our pipelines.

*Imbalance Monitoring and Control.  *Wecontinually monitor volumes received and volumes delivered on behalf of thirdparties to ensure we remain within acceptable imbalance limits during thecalendar month. We seek to reduce imbalances because of the inherent commodityprice risk that results when receipts and deliveries of natural gas are notbalanced concurrently. We have implemented “cash-out” provisions in many of ourtransportation agreements to reduce this commodity price risk. Cash-outprovisions require that any imbalance that exists between a third party and usat the end of a calendar month is settled in cash based upon a pre-determinedpricing formula. This provision ensures that imbalances under such contractsare not carried forward from month-to-month and revalued at higher or lowerprices.

***Our Growth Strategy***

Our growth strategy contemplates complementaryacquisitions of midstream assets in our operating areas as well as capitalexpenditures to enhance our ability to increase cash flows from our existingassets. We intend to pursue acquisitions and capital expenditure projects thatwe believe will allow us to capitalize on our existing infrastructure,personnel and relationships with producers and customers to provide midstreamservices. In the future, we intend to pursue selected acquisitions in newgeographic areas, including other areas of Texas, Louisiana, Oklahoma and theGulf of Mexico, to the extent they present growth opportunities similar tothose we are pursuing in our existing areas of operations. To successfullyexecute our growth strategy, we will require access to capital on competitiveterms. We intend to finance future acquisitions primarily by using the capacityavailable under our bank credit facilities and equity or debt offerings or acombination of both. For a more detailed discussion of our capital resources,please read “—Liquidity and Capital Resources.”

*Acquisition Analysis.  *In analyzing a particularacquisition we consider the operational, financial and strategic benefits ofthe transaction. Our analysis includes location of the assets, strategic fit ofthe asset in relation to our business strategy, expertise required to managethe asset, capital required to integrate and maintain the asset, and thecompetitive environment of the area where the assets are located. From afinancial perspective, we analyze the rate of return the assets will generateunder various case scenarios, comparative market parameters and the additiveearnings and cash flow capabilities of the assets.

*Capital Expenditure Analysis.  *Wemake capital expenditures either to maintain our assets or the supply ofnatural gas volumes to our assets or for expansion projects to increase ourgross margin. Maintenance capital expenditures are capital expendituresemployed to replace partially or fully depreciated assets to maintain theexisting operating capacity of our assets and to extend their useful lives, orother capital expenditures that are incurred in maintaining existing systemvolumes and related cash flows. Expansion capital expenditures representcapital expenditures made to expand or increase the efficiency of the existingoperating capacity of our assets. Expansion capital expenditures includeexpenditures that facilitate an increase in volumes within our operations,whether through construction or acquisition. Expenditures that reduce ouroperating costs will be considered expansion capital expenditures only if thereduction in operating expenses exceeds cost reductions typically resultingfrom routine maintenance. Our decisions whether to spend capital on expansionprojects are generally based on anticipated earnings, cash flow and rate ofreturn of the assets.

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***Forward-Looking Statements***

This reportcontains certain “forward-looking statements” within the meaning of the federalsecurities laws. All statements, other than statements of historical factincluded in this report, including, but not limited to, those under “—OurResults of Operations” and “—Liquidity and Capital Resources” areforward-looking statements. Statements included in this report that are nothistorical facts, that address activities, events or developments that weexpect or anticipate will or may occur in the future, including things such asplans for growth of the business, future capital expenditures, competitivestrengths, goals, references to future goals or intentions or other suchreferences are forward-looking statements. These statements can be identifiedby the use of forward-looking terminology including “may,” “believe,” “expect,”“anticipate,” “estimate,” “continue,” or similar words. These statements aremade by us based on our past experience and our perception of historicaltrends, current conditions and expected future developments as well as otherconsiderations we believe are appropriate under the circumstances. Whetheractual results and developments in the future will conform to our expectationsis subject to numerous risks and uncertainties, many of which are beyond ourcontrol. Therefore, actual outcomes and results could materially differ fromwhat is expressed, implied or forecast in these statements. Any differencescould be caused by a number of factors, including, but not limited to:

·  Our ability to successfully purchase andintegrate any future acquired assets or operations;

·  The volatility of prices and market demand fornatural gas and natural gas liquids;

·  Our ability to continue to obtain new sourcesof natural gas supply;

·  Our ability to retain our key producers;

·  Our ability to retain our key customers;

·  General economic conditions;

·  The effects of government regulations andpolicies; and

·  Other financial, operations and legal risksand uncertainties detailed from time to time in our filings with the Securitiesand Exchange Commission.

Cautionary statements identifying important factorsthat could cause actual results to differ materially from our expectations areset forth in this report, including without limitation in conjunction with theforward-looking statements that are referred to above. When consideringforward-looking statements, you should keep in mind the risk factors and othercautionary statements set forth in our Annual Report on Form 10-K for the yearended December 31, 2004, and in this report in “Management’s Discussion andAnalysis of Financial Condition and Results of Operations.” All forward-lookingstatements included in this report and all subsequent written or oralforward-looking statements attributable to us or persons acting on our behalfare expressly qualified in their entirety by these cautionary statements. Theforward-looking statements speak only as of the date made, other than asrequired by law, and we undertake no obligation to publicly update or reviseany forward-looking statements, whether as a result of new information, futureevents or otherwise.

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***Our Results of Operations***
| ** **                                                | ** ** | **Three Months  Ended June 30,** | ** ** | **Six Months  Ended June 30,** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                | ** ** | **2005**                                        | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                | ** ** | **($ in thousands)**                  | ** ** |
| Total gross  margin(1)                                    |       | $                                               | 14,307     |                                          | $          | 9,775 |   | $ | 28,858 |   | $ | 19,545 |   |
| Operations and  maintenance expenses                      |       | 3,006                                           |       | 3,010                                         |       | 5,977 |   | 5,969 |   |
| Depreciation and  amortization                            |       | 1,873                                           |       | 1,644                                         |       | 3,665 |   | 3,246 |   |
| General and  administrative expenses                      |       | 3,095                                           |       | 1,772                                         |       | 6,530 |   | 3,498 |   |
| Taxes other than  income                                  |       | 195                                             |       | 251                                           |       | 392 |   | 501 |   |
| Equity in  (earnings) loss from unconsolidated affiliates |       | (261                                            | )          | 91                                            |       | (486 | ) | (168 | ) |
| Operating income                                          |       | 6,399                                           |       | 3,007                                         |       | 12,780 |   | 6,499 |   |
| Interest and  other income                                |       | 84                                              |       | 16                                            |       | 151 |   | 23 |   |
| Interest and  other financing costs                       |       | (967                                            | )          | (3,615                                        | )          | (1,990 | ) | (7,734 | ) |
| Net income (loss)                                         |       | $                                               | 5,516      |                                          | $          | (592 | ) | $ | 10,941 |   | $ | (1,212 | ) |
| Segment gross margin:                                     |       |                                            |       |                                          |       |   |   |   |   |
| Pipelines(2)                                              |       | $                                               | 7,450      |                                          | $          | 6,776 |   | $ | 15,389 |   | $ | 14,033 |   |
| Processing                                                |       | 6,857                                           |       | 2,999                                         |       | 13,469 |   | 5,512 |   |
| Total gross margin(1)                                     |       | $                                               | 14,307     |                                          | $          | 9,775 |   | $ | 28,858 |   | $ | 19,545 |   |
| Segment gross  margin per unit:                           |       |                                            |       |                                          |       |   |   |   |   |
| Pipelines ($/MMBtu)(2)                                    |       | $                                               | 0.37       |                                          | $          | 0.34 |   | $ | 0.38 |   | $ | 0.33 |   |
| Processing:                                               |       |                                            |       |                                          |       |   |   |   |   |
| Inlet throughput ($/MMBtu)(3)                             |       | $                                               | 0.13       |                                          | $          | 0.06 |   | $ | 0.13 |   | $ | 0.05 |   |
| NGLs produced ($/Bbl)(3)                                  |       | $                                               | 4.88       |                                          | $          | 2.09 |   | $ | 4.69 |   | $ | 2.10 |   |
| Volumes:                                                  |       |                                            |       |                                          |       |   |   |   |   |
| Pipelines—throughput (MMBtu/d)(2)                    |       | 222,888                                         |       | 221,577                                       |       | 226,702 |   | 232,945 |   |
| Processing:                                               |       |                                            |       |                                          |       |   |   |   |   |
| Inlet throughput (MMBtu/d)                                |       | 560,150                                         |       | 596,629                                       |       | 564,658 |   | 571,520 |   |
| NGLs produced (Bbls/d)                                    |       | 15,436                                          |       | 15,765                                        |       | 15,854 |   | 14,455 |   |
| Maintenance capital expenditures                          |       | $                                               | 822        |                                          | $          | 395 |   | $ | 1,395 |   | $ | 1,108 |   |
| Expansion capital  expenditures                           |       | 1,622                                           |       | 2,717                                         |       | 2,122 |   | 3,020 |   |
| Total capital expenditures                                |       | $                                               | 2,444      |                                          | $          | 3,112 |   | $ | 3,517 |   | $ | 4,128 |   |
| Operations and  maintenance expenses:                     |       |                                            |       |                                          |       |   |   |   |   |
| Pipelines                                                 |       | $                                               | 1,322      |                                          | $          | 1,385 |   | $ | 2,634 |   | $ | 2,814 |   |
| Processing                                                |       | 1,684                                           |       | 1,625                                         |       | 3,343 |   | 3,155 |   |
| Total operations  and maintenance expenses                |       | $                                               | 3,006      |                                          | $          | 3,010 |   | $ | 5,977 |   | $ | 5,969 |   |

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(1)          Total gross margin is anon-GAAP financial measure. For a reconciliation of total gross margin to itsmost directly comparable GAAP measure, please read “—Non-GAAP FinancialMeasures.”

(2)          Excludes results andvolumes associated with our interest in Webb/Duval Gatherers. Gross volumestransported by Webb/Duval Gatherers were 125,358 MMBtu/d and 125,156MMBtu/d, net of intercompany volumes, for the three months ended June 30,2005 and 2004, respectively. Gross volumes transported by Webb/Duval Gathererswere 127,100 MMBtu/d and 119,135 MMBtu/d, net of intercompany volumes, forthe six months ended June 30, 2005 and 2004, respectively.

(3)          Represents the totalprocessing segment gross margin divided by the total inlet throughput or NGLsproduced, as appropriate.

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***Three Months Ended June 30, 2005 Compared withThree Months Ended June 30, 2004***

*Pipelines Segment Gross Margin.  *Pipelinessegment gross margin was $7.4 million for the three months ended June 30,2005 compared to $6.8 million for the three months ended June 30,2004, an increase of $0.6 million, or 9%. The increase was primarilyattributable to higher average natural gas prices during the three months endedJune 30, 2005 compared to the three months ended June 30, 2004,which resulted in an increase in margins associated with our index price-relatedgas purchase and transportation arrangements. During the second quarter of2005, the Houston Ship Channel, or HSC, natural gas index price averaged $6.57per MMBtu compared to $5.88 per MMBtu during the second quarter of 2004, anincrease of $0.69, or 12%. Additionally, a portion of the increase in grossmargin for our pipeline segment resulted from the acquisitions of our KarnesCounty Gathering System in September 2004 and our Runge Gathering Systemin December 2004.

*Processing Segment Gross Margin.  *Processingsegment gross margin was $6.9 million for the three months ended June 30,2005 compared to $3.0 million for the three months ended June 30,2004, an increase of $3.9 million, or 130%. For the three months ended June 30,2005, we experienced improvements of $4.7 million in our processingsegment gross margin as the result of increased plant utilization and animproved commodity price environment. For a discussion of the commodity priceenvironment, please read “—How We Evaluate Our Operations—Segment Gross Margin.”Our processing segment gross margin was further improved during the secondquarter of 2005 as compared to the second quarter of 2004 as a result ofincreased conditioning fee revenue of $0.4 million. This increasedprocessing segment gross margin was partially offset by an increase inprocessing upgrade payments of $1.2 million to natural gas suppliers,including our pipeline affiliates, during the second quarter of 2005 ascompared to the second quarter in 2004.

*Operations and Maintenance Expenses.  *Operationsand maintenance expenses totaled $3.0 million for each of the three monthsended June 30, 2005 and 2004. Lower compression rental expense of$0.2 million during the three months ended June 30, 2005 as a resultof our purchase of certain compression equipment in our South Texas Region thathad been leased by us during 2004 was offset by higher repair and maintenanceexpense totaling $0.1 million and increased salaries and benefits for ourfield employees of $0.1 million.

*Depreciation and Amortization.  *Depreciationand amortization totaled $1.9 million for the three months ended June 30,2005 compared with $1.6 million for the three months ended June 30,2004, an increase of $0.3 million, or 19%. This increase relates primarilyto additional depreciation and amortization associated with capitalexpenditures made after June 30, 2004, including the purchase ofcompression equipment in 2004, the purchase and modification of the KarnesCounty Gathering System during the third quarter of 2004 and modifications andenhancements made to the Runge Gathering System during the fourth quarter of2004.

*General and Administrative Expenses.  *Generaland administrative expenses totaled $3.1 million for the three monthsended June 30, 2005 compared with $1.8 million for the three monthsended June 30, 2004, an increase of $1.3 million, or 72%. Theincrease was primarily due to costs of being a public company including (i) costsassociated with accounting, legal, director compensation, investor relationsand insurance of $0.3 million, (ii) costs related to augmentedinfrastructure and hiring additional staff of $0.4 million, (iii) costsof preparing and processing tax K-1s to unitholders of $0.1 million (iv) costsof Sarbanes-Oxley readiness of $0.3 million and (v) non-cashcompensation expense related to the amortization of the intrinsic value ofrestricted units issued to employees and directors of $0.1 million. Additionally,we incurred $0.1 million related to growth and acquisition initiativesduring the three months ended June 30, 2005.

*InterestExpense.  *Interest and other financing costs totaled$1.0 million for the three months ended June 30, 2005 comparedwith $3.6 million for the three months ended June 30, 2004. Interestexpense 

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related to ourcredit facilities totaled $0.8 million and $0.6 million for the threemonths ended June 30, 2005 and 2004, respectively. Average borrowingsunder these credit facilities were $53.0 million and $69.8 millionwith average interest rates of 5.4% and 6.6% for the second quarter 2005 and2004, respectively. Amortization of debt issue costs totaled $0.2 millionfor each of the three months ended June 30, 2005 and 2004. Additionally,interest expense for the three months ended June 30, 2004 included$2.8 million of interest related to the payment-in-kind preferred unitsissued to certain Pre-Offering Investors that held the redeemable preferredunits, the accretion of the allocated warrant value associated with theredeemable preferred units and payment-in-kind interest under a term loanentered into in 2001. The decrease in interest expense is due primarily to ourredemption of the redeemable preferred units and the payment of the remainingbalance due under the term loan with the net proceeds from the initial publicoffering in November 2004.

***Six Months Ended June 30, 2005 Compared with SixMonths Ended June 30, 2004***

*Pipelines Segment Gross Margin.  *Pipelinessegment gross margin was $15.4 million for the six months ended June 30,2005 compared to $14.0 million for the six months ended June 30,2004, an increase of $1.4 million, or 10%. The increase was primarilyattributable to higher average natural gas prices during the six months ended June 30, 2005compared to the six months ended June 30, 2004, which resulted in anincrease in margins associated with our index price-related gas purchaseand transportation arrangements. During the six months ended June 30, 2005,the HSC natural gas index price averaged $6.20 per MMBtu compared to $5.60 perMMBtu during the six months ended June 30, 2004, an increase of $0.60, or11%. Additionally, a portion of the increase in gross margin for our pipelinesegment resulted from the acquisitions of our Karnes County Gathering System inSeptember 2004 and our Runge Gathering System in December 2004 andimproved contract terms.

*Processing Segment Gross Margin.  *Processingsegment gross margin was $13.5 million for the six months ended June 30,2005 compared to $5.5 million for the six months ended June 30, 2004,an increase of $8.0 million, or 145%. For the six months ended June 30,2005, we experienced improvements of $9.8 million in our processingsegment gross margin as the result of increased plant utilization and animproved commodity price environment. For a discussion of the commodity priceenvironment, please read “—How We Evaluate Our Operations—Segment Gross Margin.”Our processing segment gross margin was further improved during the six monthsended June 30, 2005 as compared to the six months ended June 30, 2004as a result of increased conditioning fee revenue of $0.9 million. Thisincreased processing segment gross margin was partially offset by an increasein processing upgrade payments of $2.7 million to natural gas suppliers,including our pipeline affiliates, during the six months ended June 30,2005 as compared to the six months ended June 30, 2004.

*Operations and Maintenance Expenses.  *Operationsand maintenance expenses totaled $6.0 million for each of the six monthsended June 30, 2005 and 2004. Lower compression rental expense of$0.5 million during the six months ended June 30, 2005 as a result ofour purchase of certain compression equipment in our South Texas Region thathad been leased by us during 2004 was offset by higher repair and maintenanceexpense totaling $0.3 million and increased salaries and benefits for ourfield employees of $0.2 million.

*Depreciation and Amortization.  *Depreciationand amortization totaled $3.7 million for the six months ended June 30,2005 compared with $3.2 million for the six months ended June 30,2004, an increase of $0.5 million, or 16%. This increase relates primarilyto additional depreciation and amortization associated with capitalexpenditures made after June 30, 2004, including the purchase ofcompression equipment in 2004, the purchase and modification of the KarnesCounty Gathering System during the third quarter of 2004 and modifications andenhancements made to the Runge Gathering System during the fourth quarter of2004.

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*General and Administrative Expenses.  *Generaland administrative expenses totaled $6.5 million for the six months ended June 30,2005 compared with $3.5 million for the six months ended June 30,2004, an increase of $3.0 million, or 86%. The increase was primarily dueto costs of being a public company including (i) costs associated withaccounting, legal, director compensation, investor relations and insurance of$1.1 million, (ii) costs related to augmented infrastructure andhiring additional staff of $0.8 million, (iii) costs of preparing andprocessing tax K-1s to unitholders of $0.4 million, (iv) costsassociated with Sarbanes-Oxley readiness of $0.3 million and (v) non-cashcompensation expense related to the amortization of the intrinsic value ofrestricted units issued to employees and directors of $0.2 million. Additionally,we incurred $0.2 million related to growth and acquisition initiativesduring the six months ended June 30, 2005.

*InterestExpense.  *Interest and other financing costs totaled$2.0 million for the six months ended June 30, 2005 comparedwith $7.7 million for the six months ended June 30, 2004. Interest expenserelated to our credit facilities totaled $1.7 million and$1.1 million for the six months ended June 30, 2005 and 2004,respectively. Average borrowings under these credit facilities were$55.0 million and $68.4 million with average interest rates of 5.4%and 6.6% for 2005 period and 2004 period, respectively. Amortization of debtissue costs totaled $0.3 million and $0.7 million for the six monthsended June 30, 2005 and 2004, respectively. Amortization of debt issuecost for the six months ended June 30, 2004 included a one-time charge of$0.3 million related to the early termination of the then outstanding CopanoProcessing credit facility. Additionally, interest expense for the six monthsended June 30, 2004 included $5.9 million of interest related to thepayment-in-kind preferred units issued to certain Pre-Offering Investors thatheld the redeemable preferred units, the accretion of the allocated warrant valueassociated with the redeemable preferred units and payment-in-kind interestunder a term loan entered into in 2001. The decrease in interest expense is dueprimarily to our redemption of the redeemable preferred units and the paymentof the remaining balance due under the term loan with the net proceeds from theOffering in November 2004.

***Impact of Inflation***

Inflation in the UnitedStates has been relatively low in recent years and did not have a materialimpact on our results of operations for the periods presented. Although theimpact of inflation has not been significant in recent years, it is still afactor in the United States economy and may increase the cost to acquire orreplace property, plant and equipment and may increase the cost of labor andsupplies, and capital available to us. To the extent permitted by competition,regulation and our existing agreements, we may pass along increased costs toour customers in the form of higher fees.

***Liquidity and Capital Resources***

Cash generated from operations, borrowings under ourcredit facilities and funds from equity and debt offerings are our primarysources of liquidity. We believe that funds from these sources should besufficient to meet both our short-term working capital requirements and our long-termcapital expenditure requirements. Our ability to pay distributions to ourunitholders, to fund planned capital expenditures and to make acquisitions willdepend upon our future operating performance, and more broadly, on theavailability of equity and debt financing, which will be affected by prevailingeconomic conditions in our industry and financial, business and other factors,some of which are beyond our control.

*Off-Balance Sheet Arrangements.  *Wehad no off-balance sheet arrangements as of June 30, 2005.

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*CapitalRequirements.  *The natural gas gathering, transmission,and processing businesses are capital-intensive, requiring significantinvestment to maintain and upgrade existing operations. Our capitalrequirements have consisted primarily of, and we anticipate will continue tobe:

·       maintenancecapital expenditures, which are capital expenditures made to replace partiallyor fully depreciated assets to maintain the existing operating capacity of ourassets and to extend their useful lives, or other capital expenditures that areincurred in maintaining existing system volumes and related cash flows; and

·       expansioncapital expenditures such as those to acquire additional assets to grow ourbusiness, to expand and upgrade gathering systems, transmission capacity,processing plants, and to construct or acquire new pipelines or processingplants.

Given our objective of growth through acquisitions, weanticipate that we will continue to invest significant amounts of capital togrow and acquire assets. We actively consider a variety of assets for potentialacquisitions. For a discussion of the primary factors we consider in decidingwhether to pursue a particular acquisition, please read “—Our Growth Strategy—AcquisitionAnalysis.”

During the six months ended June 30, 2005, ourtotal capital expenditures incurred of $3.5 million consisted of$2.1 million of expansion capital and $1.4 million of maintenancecapital. We funded our capital expenditures with funds from operations. Themajority of the expansion capital expenditures relates to completing theintegration of the Runge Gathering System and constructing wellinterconnections to attach volumes in new areas. We expect to fund futurecapital expenditures with funds generated from our operations, borrowings underour credit facilities and the issuance of additional equity or debt asappropriate given market conditions. We anticipate expending $3.0 millionto $4.0 million of maintenance capital over the next 12 months. ScissorTailmaintenance capital expenditures are also anticipated to be in this range overthe next 12 months.

*TotalContractual Cash Obligations.  *A summary of our totalcontractual cash obligations as of June 30, 2005 is as follows:
| ** **                          | ** ** | ** **              | ** ** | **Total**                              | ** ** | **Payment Due by Period** | ** ** |
|-------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|------------------------------------------|------------|
| **Type of Obligation**    | ** ** | ** **              | ** ** | **  Obligation  ** | ** ** | **2005**                                 | ** ** | **   2006/2007   ** | ** ** | **  2008/2009  ** | ** ** | **Thereafter** | ** ** |
| ** **                          | ** ** | **(In thousands)** | ** ** |
| Long-term  debt                     |       |                    | $          | 53,000                                 |       |                                     | $          | — |   |   | $ | 8,000 |   |   |   | $ | 45,000 |   |   |   | $ | — |   |   |
| Interest                            |       |                    | 7,001      |                                   |       | 1,438                                    |       |   | 5,287 |   |   |   | 276 |   |   |   | — |   |   |
| Operating Leases                    |       |                    | 2,468      |                                   |       | 359                                      |       |   | 1,052 |   |   |   | 713 |   |   |   | 344 |   |   |
| Total contractual  cash obligations |       |                    | $          | 62,469                                 |       |                                     | $          | 1,797 |   |   | $ | 14,339 |   |   |   | $ | 45,989 |   |   |   | $ | 344 |   |   |

 

Thefollowing table is a summary of our total contractual cash obligations as of August 1,2005 as a result of our acquisition of ScissorTail and related transactions:
| ** **                          | ** ** | ** **              | ** ** | **Total**      | ** ** | **Payment Due by Period** | ** ** |
|-------------------------------------|------------|-------------------------|------------|----------------|------------|------------------------------------------|------------|
| **Type of Obligation**    | ** ** | ** **              | ** ** | **Obligation** | ** ** | **2005**                                 | ** ** | ** 2006/2007 ** | ** ** | ** 2008/2009 ** | ** ** | **Thereafter** | ** ** |
| ** **                          | ** ** | **(In thousands)** | ** ** |
| Debt                                |       | $                       | 402,000    |           | $          | —                                   |       |   | $ | — |   |   |   | $ | — |   |   | $ | 402,000 |   |
| Interest                            |       | 157,426                 |       | 12,269         |       |                                     | 59,653     |   |   |   | 60,767 |   |   | 24,737 |   |
| Operating Leases                    |       | 2,468                   |       | 359            |       |                                     | 1,052      |   |   |   | 713 |   |   | 344 |   |
| Total contractual  cash obligations |       | $                       | 561,894    |           | $          | 12,628                                   |       |   | $ | 60,705 |   |   |   | $ | 61,480 |   |   | $ | 427,081 |   |

 

In addition to thecontractual obligations noted in the table above, we have both fixed andvariable quantity contracts to purchase natural gas, which were executed inconnection with our natural gas marketing activities. As of June 30, 2005,we had fixed contractual commitments to purchase 518,785 

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MMBtu ofnatural gas in July 2005. All of these contracts were based on index-relatedprices. Using these index-related prices at June 30, 2005, we hadtotal commitments to purchase $3.5 million of natural gas under suchagreements. Our contracts to purchase variable quantities of natural gas atindex-related prices range from one month to the life of the dedicatedproduction. During June 2005, we purchased 3,973,554 MMBtu of naturalgas under such contracts.

*CashFlows.  *The following summarizes our cash flows for thesix months ended June 30, 2005 and 2004.
| ** **                                           | ** ** | **Six Months  Ended June 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                           | ** ** | **2005**                                      | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                       | ** ** |
| Net cash provided by  operating activities           |       | $                                             | 15,994     |   | $ | 3,525 |   |
| Net cash used in  investing activities               |       | (2,818                                        | )          | (4,128 | ) |
| Net cash (used in)  provided by financing activities |       | (9,981                                        | )          | 2,299 |   |
| Net increase in cash and  cash equivalents           |       | 3,195                                         |       | 1,696 |   |
| Cash and cash  equivalents at beginning of period    |       | 7,015                                         |       | 4,607 |   |
| Cash and cash equivalents at end of period           |       | $                                             | 10,210     |   | $ | 6,303 |   |

 

*Operating:*
| ** **                                        | ** ** | **Six Months  Ended June 30,** | ** ** |
|---------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                        | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| Net income (loss)                                 |       | $                                        | 10,941     |   | $ | (1,212 | ) |
| Depreciation and  amortization                    |       | 3,994                                    |       | 3,984 |   |
| Equity in earnings from  unconsolidated affiliate |       | (486                                     | )          | (168 | ) |
| Deferred stock  compensation and other            |       | 183                                      |       | 10 |   |
| Non-cash interest  expense                        |       | —                                   |       | 5,252 |   |
| Cash provided by (used  in) working capital       |       | 1,362                                    |       | (4,341 | ) |
| Net cash provided by operating activities         |       | $                                        | 15,994     |   | $ | 3,525 |   |

 

The overall increase of $12.5million in operating cash flow for the six months ended June 30, 2005 comparedto the six months ended June 30, 2004 was primarily the result of an increasein net income of $12.1 million, a decrease in non-cash items of $5.3 millionand an increase in the changes in working capital components (exclusive of cashand cash equivalents) of $5.7 million. This increase in the changes in workingcapital components (exclusive of cash and cash equivalents) was primarily theresult of a decrease in accounts receivable of $17.3 million that was partiallyoffset by a decrease in accounts payable of $11.6 million.

We believe that we will continue to have adequateliquidity to fund future recurring operating and investing activities. Ourprimary cash requirements consist of normal operating expenses, capitalexpenditures to sustain existing operations and revenue generatingexpenditures, interest payments on our credit facilities, distributions to ourunitholders and acquisitions of new assets or businesses. Short-term cashrequirements, such as operating expenses, capital expenditures to sustainexisting operations and quarterly distributions to our unitholders, areexpected to be funded through operating cash flows. Long-term cash requirementsfor expansion projects and acquisitions are expected to be funded by severalsources, including cash flows from operating activities, borrowings under ourcredit facilities, and the issuance of additional equity and debt securities,as appropriate. Our ability to complete future debt and equity offerings andthe timing of any such offerings will depend on various factors, includingprevailing market conditions, interest rates, our financial condition and ourcredit rating at the time.

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*Investing:  *Net cash used in investingactivities was $2.8 million for the six months ended June 30, 2005 comparedto $4.1 million for the six months ended June 30, 2004. Capital expendituresfor 2005 include costs related to our acquisition of two small pipelines,completing the integration of the Runge Gathering System, building wellinterconnections, constructing a monitoring and control system for our NGL lineand upgrading dehydration facilities at the inlet to the cryogenic portion ofour Houston Central Processing Plant. Capital expenditures in 2004 includeexpenditures for the acquisition of compression equipment and the developmentand installation of our SCADA system.

*Financing:  *Net cash used infinancing activities totaled $10.0 million during the six months ended June 30,2005 and included repayments under our credit facilities of $4.0 million,distributions to our unitholders of $7.1 million and deferred financing andoffering costs of $0.3 million offset by capital contributions of $1.4 millionfrom our Pre-Offering Investors. Net cash provided by financing activities of$2.3 million during the six months ended June 30, 2004 was primarilyattributable to our net borrowings, including the release of restricted cash,of $5.5 million in long-term debt offset by deferred financing costs of $1.5million and deferring Offering costs of $1.7 million.

*Cash Distributions and Reserves:  *Within45 days after the end of each quarter, we intend to pay quarterly in arrears(in February, May, August and November of each year), to the extent we havesufficient available cash from operating surplus as defined in our limitedliability company agreement, no less than the minimum quarterly distribution,or MQD, of $0.40 per unit (or $1.60 per year), to our common and subordinatedunitholders of record on the applicable record date. During the subordinationperiod, the common units will have the right to receive distributions ofavailable cash from operating surplus in an amount equal to the MQD of $0.40per quarter, plus any arrearages in the payment of the MQD on the common unitsfrom prior quarters, before any distributions of available cash from operatingsurplus may be made on the subordinated units. Additionally, for so long as ourClass B units remain outstanding, these units are entitled to a specialquarterly distribution equal to 110% of the per unit distribution received bythe common units.

Our available cash consists generally of all cash onhand at the end of the fiscal quarter, less retained cash reserves that ourboard determines are necessary to a) provide for the proper conduct of ourbusiness; b) comply with applicable law, any of our debt instruments, or otheragreements; or (c) provide funds for distributions to our unitholders for anyone or more of the next four quarters; plus all cash on hand for the quarterresulting from eligible working capital borrowings made after the end of thequarter on the date of determination of available cash. Operating surplusgenerally consists of cash on hand at closing, cash generated from operationsafter deducting related expenditures and other items, plus eligible workingcapital borrowings after the end of the quarter, plus $12.0 million, asadjusted for reserves. We have not established a credit facility that providesfor the type of working capital borrowings that would be eligible, pursuant toour limited liability company agreement, to be considered available cash oroperating surplus distributable to our unitholders.

Our board has broad discretion to establish cashreserves that it determines are necessary or appropriate to properly conductour business. These can include cash reserves for future capital andmaintenance expenditures, reserves to stabilize distributions of cash to theunitholders, reserves to reduce debt, or, as necessary, reserves to comply withthe terms of any of our agreements or obligations.

On February 14, 2005, we paid cash distributions of$2.1 million, or $0.20 per unit, which reflected a pro rata portion of our MQDfor the period from November 15, 2004 (the closing of the Offering) throughDecember 31, 2004. On May 13, 2005, we paid $4.4 million of cash distributions representing$0.42 per unit, or $1.68 per unit annualized, for the three months ended March31, 2005. On July 15, 2005, our board declared a cash distribution for thethree months ended June 30, 2005 of $0.45 per unit, or $1.80 per unitannualized, for all outstanding common and subordinated units. The distributiontotaling $7.8 million will be paid on August 15, 2005 to holders of record atthe close of business on August 1, 2005 and will include 

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1,372,458 common unitsissued in connection with the closing of the acquisition of ScissorTail. Thisdistribution amount also includes a concurrent quarterly distribution of $.0495per unit with respect to 4,830,758 Class B units issued in connection with theclosing of the ScissorTail acquisition. The Class B unit distributionrepresents a quarterly distribution equal to 110% per unit of the distributionto be received by the common units, which is applicable unless and until theexisting unitholders approve the conversion of the Class B units into commonunits.

The amount of availablecash from operating surplus needed to pay the current distribution of $0.45 perunit, or $1.80 per unit annualized, to our common and subordinated unitholders(including all common units issued in connection with the ScissorTail acquisitionand the special quarterly distribution to our Class B unitholders) is asfollows (in thousands):
| ** **         | ** ** | **One Quarter** | ** ** | **Four Quarters** | ** ** |
|--------------------|------------|----------------------|------------|------------------------|------------|
| Common units(1)    |       |                 | $          | 3,844                  |       |   |   | $ | 15,375 |   |   |
| Subordinated units |       |                 | 1,584      |                   |       |   | 6,335 |   |   |
| Class B units      |       |                 | 2,391      |                   |       |   | 9,565 |   |   |
| Total              |       |                 | $          | 7,819                  |       |   |   | $ | 31,275 |   |   |

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(1)   Includes restricted common units issued under our long-termincentive plan. Distributions made on restricted units issued to date aresubject to the same vesting provisions as the restricted units. As of August 1,2005, we had 131,118 outstanding restricted units, none of which have vested.Annual distributions related to these restricted units are less than $240,000.

***Our Indebtedness***

*CPG CreditAgreement*

As of June 30, 2005, CPGand certain of Copano Pipelines’ operating subsidiaries had a $100.0 millionrevolving credit agreement, which was to have matured on February 12, 2008. AtJune 30, 2005, $45.0 million was outstanding under this revolving creditfacility, bearing interest at a weighted average interest rate of 5.3%. Pleaseread Note 4 to the unaudited consolidated financial statements for additionalinformation about the CPG Credit Agreement. On August 1, 2005, indebtednessoutstanding under this credit facility was repaid in full and terminated usingthe proceeds from the Credit Facility discussed below and in Note 4 to theunaudited consolidated financial statements.

*CHC Facility*

In November 2004,concurrently with the closing of our Offering, CHC and the Copano Processingoperating subsidiaries established a $12.0 million revolving credit facility.At June 30, 2005, $8.0 million was outstanding under this revolving creditfacility, bearing interest at a weighted average interest rate of 5.7%. Pleaseread Note 4 to the unaudited consolidated financial statements for additionalinformation about the CHC Facility. On August 1, 2005, indebtedness outstandingunder this credit facility was repaid in full and terminated using the proceedsfrom the Credit Facility discussed below and in Note 4 to the unauditedconsolidated financial statements.

*New $350 MillionCredit Facility*

On August 1, 2005, we entered into a new $350 millionsenior secured revolving credit facility (the “Credit Facility”) with Bank ofAmerica, N.A., as Administrative Agent, Banc of America Securities LLC, as SoleLead Arranger and Sole Book Manager and a group of financial institutions. TheCredit Facility matures on July 31, 2010.

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On August 1, 2005, we borrowed $232.0 million underthe Credit Facility to: (i) partially finance the acquisition of ScissorTailand (ii) to repay in full indebtedness outstanding under the CPG Credit Agreementand the CHC Facility. Future borrowings under the Credit Facility are availablefor acquisitions, capital expenditures, working capital and general corporatepurposes. The Credit Facility does not provide for the type of working capitalborrowings that would be eligible, pursuant to our limited liability companyagreement, to be considered available cash distributable to our unitholders.The Credit Facility is available to be drawn on and repaid without restrictionso long as we are in compliance with the terms of the Credit Facility,including certain financial covenants.

The Credit Facility contains various covenants thatlimit our and certain of our operating subsidiaries’ ability to grant certainliens; make certain loans and investments; make certain capital expendituresoutside our current lines of business or certain related lines of business;make distributions other than from available cash (as defined in our limitliability company agreement); merge or consolidate with or into a third party;or engage in certain asset dispositions, including a sale of all orsubstantially all of our assets. Additionally, the Credit Facility limits ourand certain of our operating subsidiaries’ ability to incur additionalindebtedness with certain exceptions, including under the Term Loan Facility(as discussed below), purchase money indebtedness and indebtedness related tocapital or synthetic leases not to exceed $5.0 million, unsecured indebtednessnot to exceed $5.0 million and unsecured indebtedness qualifying assubordinated debt.

The Credit Facilityalso contains covenants, which, among other things, require us and certain ofour subsidiaries, on a consolidated basis, to maintain specified ratios orconditions as follows:

·  EBITDA (as defined) to interest expense of notless than 2.5 to 1.0 through September 30, 2005, 2.75 to 1.0 from December 31,2005 through June 30, 2006 and 3.0 to 1.0 thereafter;

·  EBITDA minus maintenance capital expendituresto consolidated fixed charges of not less than 1.5 to 1.0 through September 30,2005 and 1.75 to 1.0 thereafter;

·  total debt to EBITDA of not more than 5.5 to1.0 through September 30, 2005, 5.0 to 1.0 from December 31, 2005 through June30, 2006 and 4.75 to 1.0 thereafter; and

·  total senior debt to EBITDA of not more than3.75 to 1.0 through September 30, 2005 and 3.5 to 1.0 thereafter.

The obligations under the Credit Facility are securedby first priority liens on substantially all of our assets and substantiallyall of the assets of our subsidiaries (other than WDG, Southern Dome andcertain subsidiaries with insignificant assets). Additionally, the obligationsunder the Credit Facility are guaranteed by substantially all of oursubsidiaries (other than WDG, Southern Dome and certain subsidiaries withinsignificant assets).

At our election, interest under the Credit Facility isdetermined by reference to (i) the British Bankers Association LIBOR rate, orLIBOR, plus an applicable margin between 1.75% and 2.75% per annum or (ii) thehigher of the federal funds rate plus 0.5% or the prime rate plus, in eithercase, an applicable margin between 0.25% and 1.25% per annum. Interest is payablequarterly for prime rate loans and at the applicable maturity date for LIBORloans, except that if the interest period for a LIBOR loan is six months,interest will be paid at the end of each three-month period.

If an event ofdefault exists under the Credit Facility, the lenders will be able toaccelerate the maturity of the obligations outstanding under the CreditFacility and exercise other rights and remedies. Each of the following will bean event of default;

·  failure to pay any principal when due or anyinterest, fees or other amount within certain grace periods;

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·  failure to perform or otherwise comply withthe covenants in the credit agreement or other loan documents, subject, incertain instances, to certain grace periods;

·  default by us on the payment of any otherindebtedness in excess of $5.0 million, or any default in the performance ofany obligation or condition with respect to such indebtedness beyond theapplicable grace period if the effect of the default is to permit or cause theacceleration of the indebtedness;

·  bankruptcy or insolvency events involving usor our subsidiaries;

·  the entry of, and failure to pay, one or moreadverse judgments in excess of $5.0 million against which enforcementproceedings are brought or that are not stayed pending appeal; and

·  a changeof control (as defined in the Credit Facility).

*Term Loan Facility*

On August 1, 2005, we entered into a $170 millionsenior unsecured term loan facility (the “Term Loan Facility”) with Banc ofAmerica Bridge LLC, as the Lender and Banc of America Securities LLC, as SoleLead Arranger and Sole Book Manager. The proceeds from the Term Loan Facilitywere used to pay a portion of the purchase price of the acquisition ofScissorTail.

The Term Loan Facility matures on August 1, 2006. Anyoutstanding term loans on August 1, 2006 (the “Conversion Date”) will beautomatically converted into new term loans with a six year term (the “RolloverLoans”) subject to satisfaction of certain conditions. On and after theConversion Date, the Lenders (as defined in the Term Loan Facility) holding atleast $42.5 million of the Rollover Loans may elect to exchange their RolloverLoans for exchange notes, which will be governed by the Exchange Note Indenture(as defined in the Term Loan Facility). The obligations under the Term LoanFacility are general unsecured obligations of our company and certain of itssubsidiaries.

The Term Loan Facility contains customary restrictivecovenants pertaining to management and operations of our company and our subsidiaries,which are substantially similar to those contained in the Credit Facility. TheTerm Loan Facility also includes the same financial covenants as thosecontained in the Credit Facility except that the required interest expense andconsolidated fixed charge coverage ratios have been set at 0.5 to 1.0 lower andthe permitted total debt and total senior debt to EBITDA ratios have been set0.5 to 1.0 higher. Generally, amounts outstanding under the Term Loan Facilitywill bear interest at a base rate being the greater of (i) three-month LIBORplus an applicable margin initially equal to 5% per annum or (ii) 8.5% peryear; provided that the rates and margins increase by 0.5% per quarter whilethe Term Loan Facility remains outstanding subject to a cap of 11% (subject tocertain additional interest rate increases in certain circumstances). Inaddition, the Term Loan Facility contains covenants that obligate us to usecommercially reasonable efforts to refinance the Term Loan Facility as promptlyas practicable and, within certain time periods, to prepare the Exchange NoteIndenture and to register the related exchange notes with the Securities andExchange Commission.

The Term Loan Facilityalso includes events of default substantially similar to those contained in theCredit Facility. If an event of default under the Term Loan Facility shalloccur and be continuing, the principal amount outstanding thereunder, togetherwith all accrued unpaid interest and other amounts owed thereunder, may bedeclared immediately due and payable.

***Recent Accounting Pronouncements***

For information on newaccounting pronouncements, please read Note 2 to the unaudited consolidatedfinancial statements.

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***Critical Accounting Policies***

For a discussion of ourcritical accounting policies, which are related to revenue recognition,depreciation, amortization and impairment of long-lived assets and financialinstruments previously classified as equity and are now classified asliabilities and equity method of accounting, and which remain unchanged, pleaseread “Management’s Discussion and Analysis of Financial Condition and Resultsof Operation—Significant Accounting Policies and Estimates” in our Annualreport on Form 10-K for the year ended December 31, 2004.

***Non-GAAP Financial Measures***

Thefollowing table presents a reconciliation of the non-GAAP financial measures of(i) total gross margin (which consists of the sum of individual segment grossmargins) to the GAAP financial measure of operating income and (ii) EBITDA tothe GAAP financial measures of net income (loss) and cash flows from operatingactivities for each of the periods indicated (in thousands).
| ** **                                                         | ** ** | **Three Months  Ended June 30,** | ** ** | **Six Months  Ended June 30,** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                                        | ** ** | **2004**                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| Reconciliation of total  gross margin to operating income:         |       |                                            |       |                                          |       |   |   |   |   |
| Operating income                                                   |       | $                                               | 6,399      |                                          | $          | 3,007 |   | $ | 12,780 |   | $ | 6,499 |   |
| Add: Operations and maintenance expenses                           |       | 3,006                                           |       | 3,010                                         |       | 5,977 |   | 5,969 |   |
| Depreciation and amortization                                      |       | 1,873                                           |       | 1,644                                         |       | 3,665 |   | 3,246 |   |
| General and administrative expenses                                |       | 3,095                                           |       | 1,772                                         |       | 6,530 |   | 3,498 |   |
| Taxes other than income                                            |       | 195                                             |       | 251                                           |       | 392 |   | 501 |   |
| Equity in (earnings) loss from unconsolidated  affiliate           |       | (261                                            | )          | 91                                            |       | (486 | ) | (168 | ) |
| Total gross margin                                                 |       | $                                               | 14,307     |                                          | $          | 9,775 |   | $ | 28,858 |   | $ | 19,545 |   |
| Reconciliation of EBITDA  to net income:                           |       |                                            |       |                                          |       |   |   |   |   |
| Net income (loss)                                                  |       | $                                               | 5,516      |                                          | $          | (592 | ) | $ | 10,941 |   | $ | (1,212 | ) |
| Add: Depreciation and amortization                                 |       | 1,873                                           |       | 1,644                                         |       | 3,665 |   | 3,246 |   |
| Interest expense and other financing costs                         |       | 967                                             |       | 3,615                                         |       | 1,990 |   | 7,734 |   |
| EBITDA                                                             |       | $                                               | 8,356      |                                          | $          | 4,667 |   | $ | 16,596 |   | $ | 9,768 |   |
| Reconciliation of EBITDA  to cash flows from operating activities: |       |                                            |       |                                          |       |   |   |   |   |
| Cash flow from operating activities                                |       | $                                               | 5,103      |                                          | $          | 1,396 |   | $ | 15,994 |   | $ | 3,525 |   |
| Add: Cash paid for interest and other financing  costs             |       | 801                                             |       | 1,201                                         |       | 1,661 |   | 1,745 |   |
| Equity in earnings (loss) of unconsolidated  affiliate             |       | 261                                             |       | (91                                           | )          | 486 |   | 168 |   |
| Increase (decrease) in working capital and other                   |       | 2,191                                           |       | 2,161                                         |       | (1,545 | ) | 4,330 |   |
| EBITDA                                                             |       | $                                               | 8,356      |                                          | $          | 4,667 |   | $ | 16,596 |   | $ | 9,768 |   |

 

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**Item 3.        Quantitativeand Qualitative Disclosures About Market Risk.**

Market risk is the risk of loss arising from adversechanges in market rates and prices. The principal market risk to which we areexposed is commodity price risk for natural gas and NGLs. We also incur, to alesser extent, risks related to interest rate fluctuations. We do not engage incommodity energy trading activities.

*Interest Rate Risk.  *Duringthe quarter ended June 30, 2005, we were exposed to changes in interest ratesas a result of the indebtedness outstanding under our existing creditfacilities of $53.0 million, which had an average floating interest rate of5.4% as of June 30, 2005. On August 1, 2005, we used proceeds from our newCredit Facility to repay in full indebtedness outstanding under the twoexisting credit facilities as of June 30, 2005 and such credit facilities weresubsequently terminated. We also used proceeds from our Credit Facility andfrom our new Term Loan Facility to partially finance the acquisition ofScissorTail. Borrowings under our Credit Facility and our Term Loan Facility asof August 1, 2005 totaled $402.0 million with an average floating interest rateof 7%. Both the Credit Facility and the Term Loan Facility expose us to changesin interest rates. The impact of a 1% increase in interest rates on this amountof debt would result in an increase in interest expense and a correspondingdecrease in net income of approximately $4.0 million annually.

*Commodity Price Risks.  *Ourprofitability is affected by volatility in prevailing NGL and natural gasprices. Historically, changes in the prices of most NGL products have generallycorrelated with changes in the price of crude oil. NGL and natural gas pricesare volatile and are impacted by changes in the supply and demand for NGLs andnatural gas, as well as market uncertainty. The current mix of our contractualarrangements, together with our ability to condition natural gas during periodsof unfavorable processing margins, significantly reduces our exposure tonatural gas and NGL price volatility. Natural gas prices can also affect ourprofitability indirectly by influencing the level of drilling activity andrelated opportunities for our services. For the six months ended June 30, 2005,the impact on our gross margin of a $0.01 per gallon change (increase ordecrease) in NGL prices would result in a corresponding change of $1.0 millionto our gross margin and the impact on our gross margin of a $0.10 per MMBtuincrease (decrease) in the price of natural gas would result in a decrease(increase) of $0.9 million to our gross margin. Increases in natural gas pricesor reduced natural gas liquids prices could trigger favorable provisions underour processing agreement with Kinder Morgan Texas Pipeline, L.P., which isexpected to reduce our exposure to adverse processing margins. If processingmargins are negative, we can operate the plant in a conditioning mode such thatadditional price increases in natural gas would have an anticipated positiveimpact to our gross margin. We are currently evaluating the impact that theScissorTail acquisition will have on our commodity price sensitivity analysis;however, once the ScissorTail results are included in this sensitivity analysis,we expect the impact of the price sensitivities to change from the estimatesabove.

We engage in risk management activities that generallytake the form of commodity derivative instruments. These activities aregoverned by our Risk Management Policy, which prohibits speculativetransactions and limits the type, maturity, and notional amounts of derivativetransactions. The policy allows management to purchase crude oil and naturalgas liquids puts and certain natural gas put or call options in order to reduceour exposure to a substantial adverse change in the prices of thosecommodities. Our Risk Management Committee monitors and ensures compliance withour risk management policy and is comprised of senior level executives in theoperations, finance and legal departments. The Audit Committee of our Board ofDirectors monitors the implementation of the policy and we have engaged anindependent firm to provide additional oversight. Potential derivativetransactions are analyzed to evaluate their efficacy within our risk managementstrategy.

As of June 30, 2005, we had no commodity derivativetransactions outstanding. In late July 2005, we entered into derivativetransactions for the purchase of West Texas Intermediate crude oil put optionswith a combined notional amount of 60,000 barrels per month for a term fromSeptember 2005 through 

45

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December 2007. Thecounterparties have investment grade ratings, as required by our riskmanagement policy. The derivatives are intended to hedge the risk of weakeningNGL prices with offsetting increases in the value of the puts based on thecorrelation between NGL prices and crude oil prices.

Our risk management policy requires derivativetransactions to take place either on the New York Mercantile Exchange (NYMEX)through a clearing member firm or with over the counter counterparties withinvestment grade ratings from both Moody’s and Standard & Poor’s.

*CreditRisk.  *Weare diligent in attempting to ensure that we provide credit to onlycredit-worthy customers. However, our purchase and resale of natural gasexposes us to significant credit risk, as the margin on any sale is generally avery small percentage of the total sale price. Therefore, a credit loss couldbe very large relative to our overall profitability.

**Item 4.        Controlsand Procedures.**

We carried out an evaluation under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, of the effectiveness of our disclosure controlsand procedures as of the end of the period covered by this report. Based on thevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures were effective to providereasonable assurance that information required to be disclosed in our reportsfiled or submitted under the Exchange Act is recorded, processed, summarizedand reported timely.

There have been no changes in our internal controlsover financial reporting (as defined in Rule 13(a)-15(f) under theExchange Act) that occurred during the three months ended June 30, 2005 thathave materially affected or are reasonably likely to materially affect ourinternal controls over financial reporting.

46

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**PART II—OTHER INFORMATION**

**Item 1.        LegalProceedings.**

We are named as adefendant, from time to time, in litigation relating to our normal businessoperations. Our management is not aware of any significant litigation, pendingor threatened, that would have a significant adverse effect on our financialposition or results of operations.

**Item 4.**     Submission of Matters to aVote of Security Holders.

We held our annual unitholders meeting on June 7,2005. A brief description of each proposal and the voting results follows:

Acompany proposal to elect eight directors to our Board of Directors to serveuntil the 2006 Annual Meeting of Unitholders.
| ** **               | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|--------------------------|------------|------------|------------|--------------|------------|
| John R.  Eckel, Jr. |       | 9,718,803  |       | 7,552        |       |
| Robert L. Cabes,  Jr     |       | 10,978,413 |       | 11,352       |       |
| James G. Crump           |       | 9,718,959  |       | 7,396        |       |
| Ernie L. Danner          |       | 9,719,003  |       | 7,352        |       |
| Scott A.  Griffiths      |       | 9,717,417  |       | 8,937        |       |
| Michael L.  Johnson      |       | 9,719,003  |       | 7,352        |       |
| T. William Porter  III   |       | 9,717,373  |       | 8,981        |       |
| William L. Thacker       |       | 9,717,418  |       | 8,937        |       |

 

Acompany proposal to ratify the appointment of Deloitte & Touche LLP asindependent auditors of Copano for the fiscal year ending December 31,2005.
| For         |   | 9,865,429 |   |
|-------------|--------|-----------|--------|
| Against     |   | 5,770     |   |
| Abstentions |   | 13,082    |   |

 

All eight nominateddirectors were elected and the appointment of the independent auditors wasratified.

**Item 6.**     Exhibits.

Exhibitsnot incorporated by reference to a prior filing are designated by an asterisk(*) and are filed herewith; all exhibits not so designated are incorporatedherein by reference to a prior filing as indicated.
| Number | ** ** | ** **                                                                                                                                                                                                                                                     | ** ** | **Description** |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 3.1    |       | Certificate of Formation  of Copano Energy Holdings, L.L.C. (now Copano Energy, L.L.C.) (incorporated  by reference to Exhibit 3.1 to Registration Statement on Form S-1  filed July 30, 2004).                                                 |
| 3.2    |       | Certificate of Amendment  to Certificate of Formation of Copano Energy Holdings, L.L.C. (now Copano  Energy, L.L.C.) (incorporated by reference to Exhibit 3.2 to  Registration Statement on Form S-1 filed July 30, 2004).                     |
| 3.3    |       | Second Amended and  Restated Limited Liability Company Agreement of Copano Energy, L.L.C.  (incorporated by reference to Exhibit 3.3 to Post-Effective Amendment  No. 1 to Registration Statement on Form S-1/A filed  December 15, 2004). |

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| 3.4* |   | Amendment No. 1 to  Second Amended and Restated Limited Liability Company Agreement of Copano  Energy, L.L.C.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
|------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1 |   | Amended and Restated  Credit Agreement dated February 13, 2004 among Copano Pipelines Group,  L.L.C., Copano Field Services/Copano Bay, L.P., Copano Field Services/Agua  Dulce, L.P., Copano Field Services/South Texas, L.P., Copano Field  Services/Upper Gulf Coast, L.P., Copano Field Services/Live Oak, L.P., Copano  Field Services/Central Gulf Coast, L.P., Copano Pipelines/South Texas, L.P.,  Copano Pipelines/Upper Gulf Coast, L.P., Copano Pipelines/Hebbronville, L.P.  and Copano Energy Services/Upper Gulf Coast, L.P., as the Borrowers, and  Fleet National Bank and the other Lenders named therein (incorporated by  reference to Exhibit 10.1 to Amendment No. 2 to Registration  Statement on Form S-1/A filed October 12, 2004).                                                |
| 10.2 |   | First Amendment to  Amended and Restated Credit Agreement dated as of March 15, 2004, among  Copano Pipelines Group, L.L.C., Copano Field Services/Copano Bay, L.P.,  Copano Field Services/Agua Dulce, L.P., Copano Field Services/South Texas,  L.P., Copano Field Services/Upper Gulf Coast, L.P., Copano Field  Services/Live Oak, L.P., Copano Field Services/Central Gulf Coast, L.P.,  Copano Pipelines/South Texas, L.P., Copano Pipelines/Upper Gulf Coast, L.P.,  Copano Pipelines/Hebbronville, L.P. and Copano Energy Services/Upper Gulf  Coast, L.P., as the Borrowers, and Fleet National Bank and the other Lenders  named therein (incorporated by reference to Exhibit 10.2 to Amendment  No. 2 to Registration Statement on Form S-1/A filed  October 12, 2004).                        |
| 10.3 |   | Second Amendment to  Amended and Restated Credit Agreement dated as of November 15, 2004,  among Copano Pipelines Group, L.L.C., Copano Field Services/ Copano Bay,  L.P., Copano Field Services/Agua Dulce, L.P., Copano Field Services/ South  Texas, L.P., Copano Field Services/Upper Gulf Coast, L.P., Copano Field  Services/Lice Oak, L.P., Copano Field Services/Central Gulf Coast, L.P.,  Copano Pipelines/South Texas, L.P., Copano Pipelines/Upper Gulf Coast, L.P.,  Copano Pipelines/Hebbronville, L.P., and Copano Energy Services/Upper Gulf  Coast, L.P., as the Borrowers, and Fleet National Bank and the other Lenders  named therein (incorporated by reference to Exhibit 10.3 to  Post-Effective Amendment No. 1 to Registration Statement on Form S-1/A  filed December 15, 2004). |
| 10.4 |   | Credit Agreement dated  as of November 15, 2004, by and among Copano Houston Central, L.L.C.,  Copano Processing, L.P. and Copano NGL Services, L.P. as the Borrowers and  Comerica Bank as the Lender (incorporated by reference to Exhibit 10.4  to Post-Effective Amendment No. 1 to Registration Statement on  Form S-1/A filed December 15, 2004).                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 10.5 |   | Form of  Copano Energy, L.L.C. Long-Term Incentive Plan (incorporated by reference to  Exhibit 10.5 to Amendment No. 3 to Registration Statement on  Form S-1/A filed October 26, 2004).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.6 |   | Stakeholders’ Agreement  dated July 30, 2004, by and among Copano Energy, L.L.C., Copano  Partners, L.P., R. Bruce Northcutt, Matthew J. Assiff, EnCap Energy Capital  Fund III, L.P., EnCap Energy Acquisition III-B, Inc., BOCP Energy  Partners, L.P., CEH Holdco, Inc., CEH Holdco II, Inc., DLJ Merchant  Banking Partners III, L.P., DLJ Offshore Partners III, C.V., DLJ Offshore  Partner III-1, C.V., DLJ Offshore Partners III-2, C.V., DLJ  Merchant Banking III, Inc., DLJ MB Partners III GmbH & Co,  KG, Millennium Partners II, L.P. and MBP III Plan Investors, L.P.  (incorporated by reference to Exhibit 10.6 to Registration Statement on  Form S-1 filed July 30, 2004).                                                                            |

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| 10.7† |   | Amended and Restated Gas  Processing Contract dated as of January 1, 2004, between Kinder Morgan  Texas Pipeline, L.P. and Copano Processing, L.P. (incorporated by reference  to Exhibit 10.7 to Amendment No. 6 to Registration Statement on  Form S-1/A filed November 5, 2004).                                                                                                                                   |
|------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.8       |   | Employment Agreement  between Copano/Operations, Inc., R. Bruce Northcutt and the Copano  Controlling Entities, dated April 9, 2003 (incorporated by reference to  Exhibit 10.8 to Amendment No. 2 to Registration Statement on  Form S-1/A filed October 12, 2004).                                                                                                                                             |
| 10.9       |   | First Amendment to  Employment Agreement between Copano/Operations, Inc., R. Bruce Northcutt  and the Copano Controlling Entities, dated July 30, 2004 (incorporated  by reference to Exhibit 10.9 to Amendment No. 2 to Registration  Statement on Form S-1/A filed October 12, 2004).                                                                                                                          |
| 10.10      |   | Assignment and  Assumption Agreement between Copano/Operations, Inc. and CPNO Services,  L.P. effective January 1, 2005 with respect to Employment Agreement  between Copano/Operations, Inc., R. Bruce Northcutt and the Copano  Controlling Entities, as amended (incorporated by reference to  Exhibit 10.10 to Annual Report on Form 10-K filed  March 31, 2005).                                            |
| 10.11      |   | Second Amendment to  Employment Agreement between CPNO Services, L.P., R. Bruce Northcutt and the  Copano Controlling Entities, effective March 1, 2005 (incorporated by  reference to Exhibit 10.11 to Annual Report on Form 10-K  filed March 31, 2005).                                                                                                                                                                 |
| 10.12      |   | Employment Agreement  between Copano/Operations, Inc. and James J. Gibson, III, dated as  of October 1, 2004 (incorporated by reference to Exhibit 10.11 to  Amendment No. 4 to Registration Statement on Form S-1/A filed  November 2, 2004).                                                                                                                                                              |
| 10.13      |   | Assignment and  Assumption Agreement between Copano/Operations, Inc. and CPNO Services,  L.P. effective January 1, 2005 with respect to Employment Agreement  between Copano/Operations, Inc. and James J. Gibson, III  (incorporated by reference to Exhibit 10.13 to Annual Report on  Form 10-K filed March 31, 2005).                                                                                   |
| 10.14      |   | First Amendment to  Employment Agreement between CPNO Services, L.P. and James J.  Gibson, III, effective March 1, 2005 (incorporated by reference to  Exhibit 10.14 to Annual Report on Form 10-K filed  March 31, 2005).                                                                                                                                                                                            |
| 10.15      |   | Lease Agreement dated  August 14, 2003 between Mateo Lueia and Copano Field Services/Agua  Dulce, L.P. (incorporated by reference to Exhibit 10.11 to Amendment  No. 2 to Registration Statement on Form S-1/A filed  October 12, 2004).                                                                                                                                                                              |
| 10.16      |   | Lease Agreement dated  January 22, 2003 between Copano/Operations, Inc., Copano  Processing, L.P., Copano Pipelines/Upper Gulf Coast, L.P., Copano  Pipelines/Hebbronville, L.P. and Copano Field Services/Central Gulf Coast,  L.P. and American General Life Insurance Company (incorporated by reference  to Exhibit 10.12 to Amendment No. 2 to Registration Statement on  Form S-1 filed October 12, 2004). |
| 10.17      |   | Lease Agreement dated as  of October 17, 2000, between Plow Realty Company of Texas and Texas Gas  Plants, L.P. (incorporated by reference to Exhibit 10.13 to Amendment  No. 2 to Registration Statement on Form S-1/A filed  October 12, 2004).                                                                                                                                                                     |
| 10.18      |   | Lease Agreement dated as  of December 3, 1964, between The Plow Realty Company of Texas and Shell  Oil Company (incorporated by reference to Exhibit 10.14 to Amendment  No. 2 to Registration Statement on Form S-1/A filed  October 12, 2004).                                                                                                                                                                      |

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| 10.19  |   | Lease Agreement dated as  of January 1, 1944, between The Plow Realty Company of Texas and Shell  Oil Company, Incorporated (incorporated by reference to Exhibit 10.15 to  Amendment No. 2 to Registration Statement on Form S-1/A filed  October 12, 2004).                                                                                                                                                                                                                                                            |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.20  |   | Form of Restricted  Unit Grant under the Copano Energy, L.L.C. Long-Term Incentive Plan  (Directors) (incorporated by reference to Exhibit 10.1 to Current Report  on Form 8-K filed December 15, 2004).                                                                                                                                                                                                                                                                                                                      |
| 10.21  |   | Form of Restricted  Unit Grant under the Copano Energy, L.L.C. Long-Term Incentive Plan  (Employees) (incorporated by reference to Exhibit 4.4 to Registration  Statement on Form S-8 filed February 11, 2005).                                                                                                                                                                                                                                                                                                               |
| 10.22  |   | Form of Unit Option  Grant under the Copano Energy, L.L.C. Long-Term Incentive Plan (incorporated  by reference to Exhibit 4.5 to Registration Statement on Form S-8  filed February 11, 2005).                                                                                                                                                                                                                                                                                                                               |
| 10.23  |   | Administrative and  Operating Services Agreement dated November 15, 2004, among  Copano/Operations, Inc. and Copano Energy, L.L.C., and the Copano  Operating Subsidiaries listed therein (incorporated by reference to  Exhibit 3.4 to Post-Effective Amendment No. 1 to Registration  Statement on Form S-1/A filed December 15, 2004).                                                                                                                                                                           |
| 10.24  |   | Copano Energy, L.L.C.  Management Incentive Compensation Plan (incorporated by reference to  Exhibit 10.1 to Current Report on Form 8-K filed  March 2, 2005).                                                                                                                                                                                                                                                                                                                                                                     |
| 10.25  |   | 2005 Administrative  Guidelines for the Copano Energy, L.L.C. Management Incentive Compensation  Plan (incorporated by reference to Exhibit 10.2 to Current Report on  Form 8-K filed March 2, 2005).                                                                                                                                                                                                                                                                                                                              |
| 10.26* |   | Membership Interest  Purchase Agreement by and among ScissorTail Energy, LLC, Hamilton ScissorTail  LLC, ScissorTail Holdings, LLC, Jay A. Precourt, Fredric C. Hamilton, Copano  Energy, L.L.C. and Copano Energy/Rocky Mountains and Mid-Continent, L.L.C.  dated as of June 20, 2005.                                                                                                                                                                                                                                                     |
| 10.27* |   | Class B Unit and  Common Unit Purchase Agreement dated as of June 17, 2005 by and among Copano  Energy, L.L.C. and Kayne Anderson MLP Investment Company, RCH Energy MLP Fund  LP, RCH Energy MLP Fund-A LP, Tortoise Energy Infrastructure Corporation,  Tortoise Energy Capital Corporation, Goldman, Sachs & Co., Energy  Income and Growth Fund, Fiduciary/Claymore MLP Opportunity Fund, Alerian  Opportunity Partners LP, Alerian Capital Partners LP, Strome HedgeCap, LP,  Strome Alpha, LP and Strome Family Foundation.   |
| 10.28* |   | Registration Rights  Agreement made and entered into as of August 1, 2005, by and among  Copano Energy, L.L.C. and Kayne Anderson MLP Investment Company, RCH Energy  MLP Fund LP, RCH Energy MLP Fund-A LP, Tortoise Energy Infrastructure  Corporation, Tortoise Energy Capital Corporation, Goldman, Sachs &  Co., Energy Income and Growth Fund, Fiduciary/Claymore MLP Opportunity Fund,  Alerian Opportunity Partners LP, Alerian Capital Partners LP, Strome MLP  Fund, L.P., Strome Alpha, LP and Strome Family Foundation. |
| 10.29* |   | Unitholder Voting  Agreement dated as of August 1, 2005 by and among Copano Partners Trust,  MBP III AIV, L.P., MBP Onapoc Holdings LLC, R. Bruce Northcutt and Matthew J.  Assiff.                                                                                                                                                                                                                                                                                                                                                          |
| 10.30* |   | Credit Agreement dated  as of August 1, 2005 among Copano Energy, L.L.C., as the Borrower, Bank  of America, N.A., as Administrative Agent and L/C Issuer, Comerica Bank and  U.S. Bank National Association, as Co-Syndication Agents, Bank of Scotland  and Fortis Capital Corp., as Co-Documentation Agents, and The Other Lenders  Party Hereto and Banc of America Securities LLC, as Sole Lead Arranger and  Sole Book Manager.                                                                                                        |

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| 10.31* |   | Bridge Loan Agreement dated  as of August 1, 2005 among Copano Energy, L.L.C., as the Borrower, Banc  of America Bridge LLC, as Administrative Agent and The Other Lenders Party  Hereto and Banc of America Securities LLC, as Sole Lead Arranger and Sole  Book Manager. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.32* |   | Employment Agreement  between CPNO Services, L.P. and John A. Raber dated as of August 1,  2005.                                                                                                                                                                           |
| 10.33* |   | Employment Agreement  between ScissorTail Energy, L.L.C. and Bruce Roderick dated as of  August 1, 2005.                                                                                                                                                                   |
| 10.34* |   | Employment Agreement  between ScissorTail Energy, L.L.C. and Sharon Robinson dated as of  August 1, 2005.                                                                                                                                                                  |
| 10.35* |   | Employment Agreement between  ScissorTail Energy, L.L.C. and Thomas Coleman dated as of August 1,  2005.                                                                                                                                                                   |
| 10.36* |   | Employment Agreement  between ScissorTail Energy, L.L.C. and Lee E. Fiegener dated as of  August 1, 2005.                                                                                                                                                                  |
| 10.37* |   | Form of Unit of  Options Grant under the Copano Energy, L.L.C. Long-Term Incentive Plan (ScissorTail  Energy, LLC Officers).                                                                                                                                               |
| 10.38* |   | Form of Restricted  Units Grant under the Copano Energy, L.L.C. Long-Term Incentive Plan (ScissorTail  Energy, LLC Officers).                                                                                                                                              |
| 21.1*  |   | List of Subsidiaries.                                                                                                                                                                                                                                                           |
| 31.1*  |   | Sarbanes-Oxley  Section 302 certification of John R. Eckel, Jr. (Chief Executive  Officer) for Copano Energy, L.L.C.                                                                                                                                                  |
| 31.2*  |   | Sarbanes-Oxley  Section 302 certification of Matthew J. Assiff (Chief Financial Officer)  for Copano Energy, L.L.C.                                                                                                                                                        |
| 32.1*  |   | Sarbanes-Oxley  Section 906 certification of John R. Eckel, Jr. (Chief Executive  Officer) for Copano Energy, L.L.C.                                                                                                                                                  |
| 32.2*  |   | Sarbanes-Oxley  Section 906 certification of Matthew J. Assiff (Chief Financial Officer)  for Copano Energy, L.L.C.                                                                                                                                                        |

----

*       Filedherewith.

†       Portionsof this exhibit have been omitted pursuant to a request for confidentialtreatment.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, in the City of Houston,State of Texas, on August 15, 2005.
|        | COPANO  ENERGY, L.L.C. |
|--------|------------------------|
|   | By:                    | /s/ JOHN R. ECKEL, JR. |
|   |                   | John R. Eckel, Jr. |
|   |                   | *Chairman of the Board and Chief Executive Officer* |
|   | By:                    | /s/ MATTHEW J. ASSIFF |
|   |                   | Matthew J. Assiff |
|   |                   | *Senior Vice President and Chief Financial Officer* |

 

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