##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2007
 OR
 o
    
    TRANSITION REPORT PURSUANT OT SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 Commission File No. 001-33016
 
 EAGLE ROCK ENERGY PARTNERS, L.P.
 (Exact Name of Registrant as Specified in Its Charter)
 Delaware
    
    68-0629883(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification Number)
 16701 Greenspoint Park Drive, Suite 200
Houston, Texas 77060
 (281) 408-1200
 
 þ o
  o o þ
 o þ




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##### 



EAGLE ROCK ENERGY PARTNERS, L.P.
 TABLE OF CONTENTS
 PagePART I. FINANCIAL INFORMATION
    
    
    1Item 1. Financial Statements
    
    
    1Condensed
Consolidated Balance Sheets as of March 31, 2007 and December 31, 2006 (unaudited)
    
    
    1Condensed
Consolidated Statements of Operations for the three months ended March 31, 2007 and 2006 (unaudited)
    
    
    2Condensed
Consolidated Statements of Cash Flows for the three months ended March 31, 2007 and 2006 (unaudited)
    
    
    3Condensed
Consolidated Statements of Members Equity for the three months ended March 31, 2007 (unaudited)
    
    
    4Notes to the Condensed
Consolidated Financial Statements (unaudited)
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    19Cautionary Note Regarding Forward-Looking Statements
    
    
    20Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    33Item 4. Controls and Procedures
    
    
    34PART II. OTHER INFORMATION
    
    
    35Item 1. Legal Proceedings
    
    
    35Item 1A. Risk Factors
    
    
    35Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    36Item 3. Defaults Upon Senior Securities
    
    
    37Item 4. Submission of Matters to a Vote of Security Holders
    
    
    37Item 5. Other Information
    
    
    37Item 6. Exhibits
    
    
    37Certification Pursuant to Section 302Certification Pursuant to Section 302Certification Pursuant to Section 906Certification Pursuant to Section 906
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PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 EAGLE ROCK ENERGY PARTNERS, L.P.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (unaudited)
 March 31,
    
    
    December 31,($ in thousands)
    
    2007
    
    
    2006ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    2,059
    
    
    $
    10,581Accounts receivable
    
    
    44,567
    
    
    
    43,567Risk management assets
    
    
    5,629
    
    
    
    13,837Prepayments and other current assets
    
    
    2,122
    
    
    
    2,679Total current assets
    
    
    54,377
    
    
    
    70,664PROPERTY, PLANT AND EQUIPMENT  Net
    
    
    569,147
    
    
    
    554,063INTANGIBLE ASSETS  Net
    
    
    127,069
    
    
    
    130,001RISK MANAGEMENT ASSETS
    
    
    14,768
    
    
    
    17,373OTHER ASSETS
    
    
    7,459
    
    
    
    7,800TOTAL
    
    $
    772,820
    
    
    $
    779,901LIABILITIES AND MEMBERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    60,813
    
    
    $
    49,558Accrued liabilities
    
    
    13,640
    
    
    
    7,996Risk management liabilities
    
    
    2,639
    
    
    
    1,005Total current liabilities
    
    
    77,092
    
    
    
    58,559LONG-TERM DEBT
    
    
    405,731
    
    
    
    405,731ASSET RETIREMENT OBLIGATIONS
    
    
    1,905
    
    
    
    1,819DEFERRED STATE TAX LIABILITY
    
    
    1,393
    
    
    
    1,229RISK MANAGEMENT LIABILITIES
    
    
    20,383
    
    
    
    20,576COMMITMENTS AND CONTINGENCIES (Note 11)MEMBERS EQUITY (DEFICIT):Common Unit Holders(1)
    
    
    104,402
    
    
    
    116,283Subordinated Unitholders(2)
    
    
    162,999
    
    
    
    176,248General Partner
    
    
    (1,085
    )
    
    
    (544
    )Total members equity
    
    
    266,316
    
    
    
    291,987TOTAL
    
    $
    772,820
    
    
    $
    779,901
 
 (1)
    
    20,691,495 units were issued and outstanding for March 31, 2007 and December 31, 2006. These
numbers do not include 115,150 units and 122,450, respectively, issued to employees as of
March 31, 2007 and December 31, 2006, respectively, under the 2006 Long-Term Incentive Plan
and which are subject to vesting requirements.(2)
    
    20,691,495 units were issued and outstanding for March 31, 2007 and December 31, 2006.  1




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EAGLE ROCK ENERGY PARTNERS, L.P.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (unaudited)
 Three MonthsEnded March 31,($ in thousands except per share data)
    
    2007
    
    
    2006REVENUE:Natural gas liquids sales
    
    $
    51,695
    
    
    $
    46,704Natural gas sales
    
    
    48,272
    
    
    
    53,281Condensate
    
    
    10,154
    
    
    
    14,202Gathering, compression and processing fees
    
    
    4,283
    
    
    
    2,201Loss on risk management instruments
    
    
    (7,642
    )
    
    
    (20,070
    )Total revenue
    
    
    106,762
    
    
    
    96,318COSTS AND EXPENSES:Cost of natural gas and natural gas liquids
    
    
    90,636
    
    
    
    91,991Operations and maintenance
    
    
    7,923
    
    
    
    5,682General and administrative
    
    
    4,923
    
    
    
    2,453Other
    
    
    1,711
    
    
    
    Depreciation and amortization
    
    
    11,630
    
    
    
    9,214Total costs and expenses
    
    
    116,823
    
    
    
    109,340OPERATING LOSS
    
    
    (10,061
    )
    
    
    (13,022
    )OTHER (EXPENSE) INCOME:Interest and other income
    
    
    124
    
    
    
    40Interest and other expense
    
    
    (9,567
    )
    
    
    (2,535
    )Total other (expense) income
    
    
    (9,443
    )
    
    
    (2,495
    )STATE INCOME TAX PROVISION
    
    
    164
    
    
    
    NET LOSS
    
    $
    (19,668
    )
    
    $
    (15,517
    )NET LOSS PER COMMON UNIT -
BASIC AND DILUTED:Net lossCommon units
    
    $
    (0.28
    )
    
    $
    (0.63
    )Subordinated units
    
    
    (0.64
    )
    
    
    (0.63
    )General partner units
    
    
    (0.64
    )
    
    
    (0.63
    )Basic and Diluted (units in thousands)Common units
    
    
    20,691
    
    
    
    23,027Subordinated units
    
    
    20,691
    
    
    
    1,342General partner units
    
    
    845
    
    
    
    263
  2




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EAGLE ROCK ENERGY PARTNERS, L.P.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (unaudited)
 Three MonthsEnded March 31,($ in thousands)
    
    2007
    
    
    2006CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
    
    $
    (19,668
    )
    
    $
    (15,517
    )Adjustments to reconcile net loss to net cash provided by operating activities:Depreciation and amortization
    
    
    11,630
    
    
    
    9,214Amortization of debt issuance costs
    
    
    416
    
    
    
    229Reclassifying financing derivative settlements
    
    
    (100
    )
    
    
    (811
    )Equity-based compensation expense
    
    
    173
    
    
    
    Other
    
    
    120
    
    
    
    17Changes in assets and liabilities  net of acquisitions:Accounts receivable
    
    
    (1,000
    )
    
    
    (4,002
    )Prepayments and other current assets
    
    
    557
    
    
    
    306Risk management activities
    
    
    12,254
    
    
    
    15,905Accounts payable
    
    
    4,252
    
    
    
    (3,265
    )Accrued liabilities
    
    
    5,623
    
    
    
    2,056Other assets
    
    
    (76
    )
    
    
    761Net cash provided by operating activities
    
    
    14,181
    
    
    
    4,893CASH FLOWS FROM INVESTING ACTIVITIES:Additions to property, plant and equipment
    
    
    (16,145
    )
    
    
    (6,218
    )Acquisitions
    
    
    
    
    
    
    (75,654
    )Escrow cash
    
    
    
    
    
    
    7,643Purchase of intangible assets
    
    
    (513
    )
    
    
    (717
    )Net cash used in investing activities
    
    
    (16,658
    )
    
    
    (74,946
    )CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from revolver
    
    
    (9,000
    )
    
    
    Repayment of revolver
    
    
    9,000
    
    
    
    Repayment of long-term debt
    
    
    
    
    
    
    (1,320
    )Payment of debt issuance costs
    
    
    
    
    
    
    (431
    )Proceeds from derivative contracts
    
    
    100
    
    
    
    811Payment of deferred offering costs
    
    
    
    
    
    
    (1,452
    )Contribution by members
    
    
    
    
    
    
    98,390Distributions to members and affiliates
    
    
    (6,145
    )
    
    
    Net cash (used in) provided by financing activities
    
    
    (6,045
    )
    
    
    95,998NET CHANGE IN CASH AND CASH EQUIVALENTS
    
    
    (8,522
    )
    
    
    25,945CASH AND CASH EQUIVALENTS  Beginning of period
    
    
    10,581
    
    
    
    19,372CASH AND CASH EQUIVALENTS  End of period
    
    $
    2,059
    
    
    $
    45,317Interest paid  net of amounts capitalized
    
    $
    7,925
    
    
    $
    9,467Investments in property, plant and equipment not paid
    
    $
    6,943
    
    
    $
    
  3




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EAGLE ROCK ENERGY PARTNERS, L.P.
 
 CONDENSED CONSOLIDATED STATEMENTS OF MEMBERS EQUITY
 FOR THE THREE MONTH PERIOD ENDED MARCH 31, 2007
 (Unaudited)
 Number of
    
    
    
    
    
    
    Number ofGeneral
    
    
    Common
    
    
    Common
    
    
    Subordinated
    
    
    SubordinatedPartner
    
    
    Units
    
    
    Units
    
    
    Units
    
    
    Units
    
    
    Total($ in thousands, except unit amounts)BALANCE
December 31, 2006
    
    $
    (544
    )
    
    
    20,691,495
    
    
    $
    116,283
    
    
    
    20,691,495
    
    
    $
    176,248
    
    
    $
    291,987Net loss
    
    
    (544
    )
    
    
    
    
    
    
    (5,790
    )
    
    
    
    
    
    
    (13,334
    )
    
    
    (19,668
    )Distributions
    
    
    
    
    
    
    
    
    
    
    (6,176
    )
    
    
    
    
    
    
    
    
    
    
    (6,176
    )Restricted unit
expense
    
    
    3
    
    
    
    
    
    
    
    85
    
    
    
    
    
    
    
    85
    
    
    
    173BALANCE 
March 31, 2007
    
    $
    (1,085
    )
    
    
    20,691,495
    
    
    $
    104,402
    
    
    
    20,691,495
    
    
    $
    162,999
    
    
    $
    266,316
  4




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EAGLE ROCK ENERGY PARTNERS, L.P.
 
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 1. ORGANIZATION AND DESCRIPTION OF BUSINESS
 Organization
 Initial Public Offering
 Basis of Presentation and Principles of Consolidation
 Description of Business
 NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
  5




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Use of Estimates
 Reclassifications
 Interim
Condensed Disclosures
 Cash and Cash Equivalents
 Concentration and Credit Risk
  Certain Other Concentrations
 Property, Plant, and Equipment
 Pipelines and equipment
    
    20 yearsGas processing and equipment
    
    20 yearsOffice furniture and equipment
    
    5   years
  6




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Impairment of Long-Lived Assets
 
    
    significant adverse change in legal factors or in the business climate;
    
    a current-period operating or cash flow loss combined with a history of operating or
cash flow losses or a projection or forecast which demonstrates continuing losses
associated with the use of a long-lived asset;
    
    an accumulation of costs significantly in excess of the amount originally expected for
the acquisition or construction of a long-lived asset;
    
    significant adverse changes in the extent or manner in which an asset is used or in its physical condition;
    
    a significant change in the market value of an asset; or
    
    a current expectation that, more likely than not, an asset will be sold or otherwise
disposed of before the end of its estimated useful life.
  Intangible Assets
 March 31,
    
    
    December 31,($ in thousands)
    
    2007
    
    
    2006Rights-of-way and easements  at cost
    
    $
    68,000
    
    
    $
    66,801Less: accumulated amortization
    
    
    (4,355
    )
    
    
    (3,510
    )Contracts
    
    
    80,210
    
    
    
    80,210Less: accumulated amortization
    
    
    (16,786
    )
    
    
    (13,500
    )Net intangible assets
    
    $
    127,069
    
    
    $
    130,001
  Other Assets
 7




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Transportation and Exchange Imbalances
 Revenue Recognition
 
    
    sales of natural gas, NGLs and condensate;
    
    natural gas gathering, processing and transportation, from which Eagle Rock Energy
generates revenues primarily through the compression, gathering, treating, processing and
transportation of natural gas; and
    
    NGL transportation from which we generate revenues from transportation fees.
    Environmental Expenditures
 Income Taxes
 8




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Derivatives Accounting for
Derivative Instruments and Hedging Activities,
 NOTE 3. NEW ACCOUNTING PRONOUNCEMENTS
 Accounting for Certain Hybrid Financial Instruments Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities,
 Fair Value Measurements.
 The Fair Value Option for Financial Assets and
Financial Liabilities
  9




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Accounting for Purchases and Sales of Inventory with the Same
Counterparty
 Accounting for Uncertainty in Income
Taxes  an interpretation of FASB Statement No. 109
 NOTE 4. ACQUISITIONS
  ($ in thousands)Property, plant and equipment
    
    $
    89,054Intangibles
    
    
    7,992Other current liabilities
    
    
    (750
    )Asset retirement obligations
    
    
    (291
    )$
    96,005
   Quarter Ended($
in thousands)
    
    March 31, 2006Pro forma earnings data:Revenues
    
    $
    106,998Costs and expenses
    
    
    (119,645
    )Operating income
    
    
    12,647Other income (expense), net
    
    
    (2,495
    )Loss from continuing operations
    
    $
    (15,142
    )
 10




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NOTE 5. FIXED ASSETS AND ASSET RETIREMENT OBLIGATIONS
  March 31,
    
    
    December 31,($ in thousands)
    
    2007
    
    
    2006Land
    
    $
    853
    
    
    $
    853Plant
    
    
    82,082
    
    
    
    81,485Gathering and pipeline
    
    
    458,577
    
    
    
    433,779Equipment and machinery
    
    
    38,023
    
    
    
    37,185Vehicles and transportation equipment
    
    
    2,799
    
    
    
    2,740Office equipment, furniture, and fixtures
    
    
    511
    
    
    
    511Computer equipment
    
    
    4,618
    
    
    
    4,623Corporate
    
    
    126
    
    
    
    126Linefill
    
    
    3,970
    
    
    
    3,923Construction in progress
    
    
    15,924
    
    
    
    19,677607,483
    
    
    
    584,902Less: accumulated depreciation and amortization
    
    
    (38,336
    )
    
    
    (30,839
    )Net fixed assets
    
    $
    569,147
    
    
    $
    554,063
  Asset Retirement Obligations Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No.
143 Accounting for Asset Retirement Obligations,
  ($ in thousands)Asset retirement obligations  December 31, 2006
    
    $
    1,819Additional liability on newly built assets
    
    
    49Accretion expense
    
    
    37Asset retirement obligations  March 31, 2007
    
    $
    1,905
 NOTE 6. LONG-TERM DEBT
  March 31,
    
    
    December 31,($ in thousands)
    
    2007
    
    
    2006Revolver
    
    $
    106,481
    
    
    $
    106,481Term loan
    
    
    299,250
    
    
    
    299,250Total debt
    
    
    405,731
    
    
    
    405,731Less: current portion
    
    
    
    
    
    
    Total long-term debt
    
    $
    405,731
    
    
    $
    405,731
  11




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
    
    Adjusted EBITDA (as defined) to interest expense of not less than 2.5 to 1.0; and
    
    Total consolidated funded debt to Adjusted EBITDA (as defined) of not more than 5.0 to
1.0 and 5.25 to 1.0 for the three quarters following a material acquisition.
    12




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Principal($ in thousands)
    
    Amount2007
    
    $
    02008
    
    
    02009
    
    
    02010
    
    
    02011
    
    
    405,731$
    405,731
  NOTE 7. MEMBERS EQUITY
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NOTE 8. RELATED PARTY TRANSACTIONS
      NOTE 9. FAIR VALUE OF FINANCIAL INSTRUMENTS
   NOTE 10. RISK MANAGEMENT ACTIVITIES
  ($ in thousands)Fair ValueRoll Forward
    
    Expiration
    
    Notional
    
    Fixed
    
    March 31,Effective Date
    
    Date
    
    Amount
    
    Rate
    
    200701/03/2006
    
    
    01/03/2011
    
    
    $
    100,000,000
    
    
    
    4.9500
    %
    
    $
    (264
    )01/03/2006
    
    
    01/03/2011
    
    
    
    100,000,000
    
    
    
    4.9625
    
    
    
    (213
    )01/03/2006
    
    
    01/03/2011
    
    
    
    50,000,000
    
    
    
    4.8800
    
    
    
    2101/03/2006
    
    
    01/03/2011
    
    
    
    50,000,000
    
    
    
    4.8800
    
    
    
    21
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
    
    Over-the-counter NGL puts, costless collar and swap transactions for the sale of Mont
Belvieu gas liquids with a combined notional amount of 530,000 Bbls per month for a term
from January 2006 through December 2010;
    
    Condensate puts and costless collar transactions for the sale of West Texas Intermediate
crude oil with a combined notional amount of 250,000 Bbls per month for a term from January
2006 through December 2010;
    
    Natural gas calls for the sale of Henry Hub natural gas with a notional amount of
200,000 MMBtu per month for a term from January 2006 through December 2007;
    
    Costless collar transactions for West Texas Intermediate crude oil with a combined
notional amount of 50,000 Bbls per month for a term of October through December 2006; and,
60,000 Bbls per month for a term of January 2007 through December 2007;
    
    Fixed swap agreements to hedge WTS-WTI basis differential in amount of 20,000 Bbls per
month for a term of October-December 2006; and, 20,000 Bbls per month for a term of January
through December 2007; and
    
    Natural gas fixed swap agreements to hedge short natural gas positions with a combined
notional amount of 100,000 MMBtu per month for the term of August 2006 through September
2006.
    15




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NOTE 11. COMMITMENTS AND CONTINGENT LIABILITIES
 Litigation
 Insurance
  Regulatory Compliance
 Environmental
 Other Commitments and Contingencies
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NOTE 12. SEGMENTS
   ($ in millions)
    
    
    
    
    
    Texas andThree months ended March 31, 2007
    
    Panhandle
    
    Louisiana
    
    Corporate
    
    TotalSales to external customers
    
    $
    94.9
    
    
    $
    19.5
    
    
    $
    (7.6
    )(a)
    
    $
    106.8Interest expense-net and other financing costs
    
    
    
    
    
    
    
    
    
    
    9.4
    
    
    
    9.4Depreciation and amortization
    
    
    9.8
    
    
    
    1.6
    
    
    
    0.2
    
    
    
    11.6Segment profit (loss)(b)
    
    
    19.2
    
    
    
    4.5
    
    
    
    (7.6
    )
    
    
    16.1Capital expenditures
    
    
    8.8
    
    
    
    13.6
    
    
    
    1.1
    
    
    
    23.5Segment assets
    
    
    574.0
    
    
    
    160.4
    
    
    
    38.4
    
    
    
    772.8
 ($ in millions)
    
    
    
    
    
    Texas andThree months ended March 31, 2006
    
    Panhandle
    
    Louisiana
    
    Corporate
    
    TotalSales to external customers
    
    $
    106.5
    
    
    $
    9.9
    
    
    $
    (20.1
    )
    
    $
    96.3Interest expense-net and other financing costs
    
    
    
    
    
    
    
    
    
    
    2.5
    
    
    
    2.5Depreciation and amortization
    
    
    8.1
    
    
    
    0.8
    
    
    
    0.3
    
    
    
    9.2Segment profit (loss)(b)
    
    
    22.0
    
    
    
    1.7
    
    
    
    (19.3
    )
    
    
    4.4Capital expenditures
    
    
    2.1
    
    
    
    2.7
    
    
    
    1.4
    
    
    
    6.2Segment assets
    
    
    570.7
    
    
    
    105.7
    
    
    
    101.1
    
    
    
    777.5
 
 (a)
    
    Represents results of our derivatives activity.(b)
    
    Segment profit (loss) is defined as sales to external customers minus cost of natural gas and
natural gas liquids and other cost of sales. Sales to external customers for the corporate
column include the impact of the risk management activities.  Three Months
    
    
    Three MonthsEnded
    
    
    EndedMarch 31,
    
    
    March 31,($ in millions)
    
    2007
    
    
    2006Segment profit
    
    $
    16.1
    
    
    $
    4.4Operations and maintenance
    
    
    (7.9
    )
    
    
    (5.7
    )General and administrative
    
    
    (4.9
    )
    
    
    (2.4
    )Depreciation and amortization
    
    
    (11.6
    )
    
    
    (9.2
    )Other expense
    
    
    (1.7
    )
    
    
    Interest expense, net
    
    
    (9.5
    )
    
    
    (2.6
    )State income tax provision
    
    
    (0.2
    )
    
    
    Net loss
    
    $
    (19.7
    )
    
    $
    (15.5
    )
 NOTE 13. INCOME TAXES
  17




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NOTE 14. EQUITY-BASED COMPENSATION
   Number of
    
    Weighted AverageRestricted
    
    Grant - Date FairUnits
    
    ValueOutstanding at December 31, 2006
    
    
    122,450
    
    
    $
    18.75Granted
    
    
    Vested
    
    
    Forfeitures
    
    
    (7,300
    )
    
    $
    18.75Outstanding at March 31, 2007
    
    
    115,150
    
    
    $
    18.75
   NOTE 15. SUBSEQUENT EVENTS
  18




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Overview
  
    
    our Texas Panhandle Systems from ONEOK Texas Field Services, L.P.;
    
    our Brookeland processing plant and system and Masters Creek system from Duke Energy
Field Services, L.P. and Swift Energy Corporation;
    
    our pro-rata undivided interests in the Indian Springs processing plant and Camp Ruby
gathering system, both of which are operated by an affiliate of Enterprise Products
Partners, L.P.; and
    
    Midstream Gas Services, L.P.
  19




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Cautionary Note Regarding Forward-Looking Statements
  20




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Our Operations
   
    
    Fee-Based Arrangements.Under these arrangements, we generally are paid a fixed cash
fee for performing the gathering and processing service. This fee is directly related to
the volume of natural gas that flows through our systems and is not directly dependent on
commodity prices. A sustained decline, however, in commodity prices could result in a
decline in volumes and, thus, a decrease in our fee revenues. These arrangements provide
stable cash flows, but minimal, if any, upside in higher commodity price environments. As
of March 31, 2007, these arrangements accounted for approximately 11% of our natural gas
volumes.
    
    Percent-of-Proceeds Arrangements.Under these arrangements, we generally gather raw
natural gas from producers at the wellhead, transport the gas through our gathering system,
process the gas and sell the processed gas and/or NGLs at prices based on published index
prices. These arrangements provide upside in high commodity price environments, but result
in lower margins in low commodity price environments. We regard the margin from this type
of arrangement, that is, the sale proceeds less amounts remitted to the producers, as an
important analytical measure of these arrangements. The price paid to producers is based on
an agreed percentage of one of the following: (1) the actual sale proceeds; (2) the
proceeds based on an index price; or (3) the proceeds from the sale of processed gas or
NGLs or both. We refer to contracts in which we share only in specified percentages of the
proceeds from the sale of NGLs and in which the producer receives 100% of the proceeds from
natural gas sales, as percent-of-liquids arrangements. Under percent-of-proceeds
arrangements, our margin correlates directly with the prices of natural gas and NGLs and
under percent-of-liquids arrangements, our margin correlates directly with the prices of
NGLs (although there is often a fee-based component to both of these forms of contracts in
addition to the commodity sensitive component). As of March 31, 2007, these arrangements
accounted for about 77% of our natural gas volumes. Approximately 76% of the
percent-of-proceeds volumes as of March 31, 2007 also have fee components.
    
    Keep-Whole Arrangements.Under these arrangements, we process raw natural gas to
extract NGLs and pay to the producer the full thermal equivalent volume of raw natural gas
received from the producer in the form of either processed gas or its cash equivalent. We
are generally entitled to retain the processed NGLs and to sell them for our account.
Accordingly, our margin is a function of the difference between the value of the NGLs
produced and the cost of the processed gas used to replace the thermal equivalent value of
those NGLs. The profitability of these arrangements is subject not only to the commodity
price risk of natural gas and NGLs, but also to the price of natural gas relative to NGL
prices. These arrangements can provide large profit margins in favorable commodity price
environments, but also can be subject to losses if the cost of natural gas exceeds the
value of its thermal equivalent of NGLs. Many of our keep-whole contracts include
provisions that reduce our commodity price exposure, including (1) conditioning floors that
require the keep-whole contract to convert to a fee-based arrangement if the NGLs have a
lower value than their thermal equivalent in natural gas, (2) embedded discounts to the
applicable natural gas index price under which we may reimburse the producer an amount in
cash for the thermal equivalent volume of raw natural gas acquired from the producer, or
(3) fixed cash fees for ancillary services, such as gathering, treating and compressing. As of March 31,
2007, these arrangements accounted for about 12% of our natural gas volumes. Approximately 80%
of these keep-whole
 21




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arrangements have fee components.
   ONEOK Hydrocarbon.
 Chesapeake Energy Marketing.
 Anadarko E&P.
 Ergon Energy Partners, L.P.
 Cimarex Energy Marketing.
 22




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How We Evaluate Our Operations
  Volumes.
 Margins.
 Risk Management.
 Operating Expenses.
 Adjusted EBITDA.
 23




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General Trends and Outlook
  Natural Gas Supply, Demand and Outlook.
   Impact of Interest Rates and Inflation.
  Formation and Acquisitions
  24




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Acquisition of Camp Ruby Gathering System and Indian Spring Processing Plant and Expansion of System
   Acquisition of Panhandle Assets
   Acquisition of Brookeland Assets
   Acquisition of MGS
  25




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Critical Accounting Policies and Estimates
  EAGLE ROCK ENERGY PARTNERS, L.P.
 RESULTS OF OPERATIONS
  Three MonthsEnded March 31,($ in thousands)
    
    2007
    
    
    2006Sales of natural gas, NGLS and condensate
    
    $
    110,121
    
    
    $
    114,187Compression, gathering and processing
    
    
    4,283
    
    
    
    2,201Gain/(loss) on realized risk management instrument
    
    
    2,999
    
    
    
    811Gain/(loss) on unrealized risk management instrument
    
    
    (10,641
    )
    
    
    (20,881
    )Total operating revenue
    
    
    106,762
    
    
    
    96,318Purchase of natural gas and NGLs
    
    
    90,636
    
    
    
    91,991Segment profit(a)
    
    
    16,126
    
    
    
    4,327Operating and maintenance expense
    
    
    7,923
    
    
    
    5,682General and administrative expense
    
    
    4,923
    
    
    
    2,453Other expense
    
    
    1,711
    
    
    
    Depreciation and amortization
    
    
    11,630
    
    
    
    9,214Interest-net including realized risk
management instrument
    
    
    7,832
    
    
    
    7,470Unrealized risk management interest related
instrument
    
    
    1,611
    
    
    
    (4,975
    )State income tax provision
    
    
    164
    
    
    
    Net loss
    
    $
    (19,668
    )
    
    $
    (15,517
    )Adjusted EBITDA(b)
    
    $
    14,093
    
    
    $
    17,112
 
 (a)
    
    Defined as operating revenues minus the cost of natural gas and NGLs and other cost of sales.
Operating revenues include both realized and unrealized risk management activities.(b)
    
    Defined as net income (loss) plus income tax, interest-net, depreciation and amortization
expense, separation costs, other non-cash operating expenses less non realized revenues risk
management loss (gain) activities and less net income from discontinued operations. The prior
year legal arbitration settlement recorded in Other expense for March 31, 2007 quarter has
also been added back to net income (loss). 26




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Three MonthsEnded March 31,($ in thousands)
    
    2007
    
    
    2006Segment profit:
    
    $
    16,126
    
    
    $
    4,327Less:Operations and maintenance
    
    
    7,923
    
    
    
    5,682General and administrative
    
    
    4,923
    
    
    
    2,453Depreciation and amortization
    
    
    11,630
    
    
    
    9,214Interest-net including realized risk management instrument
    
    
    7,832
    
    
    
    7,470Unrealized risk management interest related instrument
    
    
    1,611
    
    
    
    (4,975
    )Other expense
    
    
    1,711
    
    
    
    State income tax provision
    
    
    164
    
    
    
    Net loss
    
    $
    (19,668
    )
    
    $
    (15,517
    )
  Three MonthsEnded March 31,($ in thousands)
    
    2007
    
    
    2006Adjusted EBITDA:
    
    $
    14,093
    
    
    $
    17,112Less:State income tax provision
    
    
    164
    
    
    
    Interest-net including realized risk
management instrument
    
    
    7,832
    
    
    
    7,470Unrealized risk management interest
related instrument
    
    
    1,611
    
    
    
    (4,975
    )Depreciation and amortization
    
    
    11,630
    
    
    
    9,214Equity-based compensation expense
    
    
    172
    
    
    
    Other expense
    
    
    1,711
    
    
    
    39Plus:Risk management instruments-unrealized
    
    
    (10,641
    )
    
    
    (20,881
    )Net loss
    
    $
    (19,668
    )
    
    $
    (15,517
    )
 Three Months Ended March 31, 2007 Compared with Three Months Ended March 31, 2006
    27




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28




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Other Matters
 Wildfires in Texas Panhandle.
 Environmental.
 Liquidity and Capital Resources
   
    
    cash generated from operations;
    
    borrowings under our credit facilities;
    
    debt offerings; and
    
    issuance of additional partnership units.
  Cash Flows
  
    
    the acquisition of the midstream assets in the Texas Panhandle on December 1, 2005 for
approximately $531.0 million, which was financed through an additional equity contribution
of $133.0 million and debt of $400.0 million, not including $27.5 million in risk
management costs related to option premiums financed entirely with equity contributions
from NGP;
    
    the acquisition of the Brookeland gathering and processing facility and related assets
on March 31, 2006 and April 7, 2006 for approximately $95.8 million, which we financed
entirely with equity; and
 29




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##### Table of Contents




    
    the acquisition of all of the partnership interests in Midstream Gas Services, L.P. on
June 2, 2006 for approximately $25.0 million which we paid with $4.7 million in cash and
$21.3 million in Eagle Rock Pipeline, L.P. units.
 Working Capital (Deficit).
  
    
    cash balances decreased overall by $8.5 million and was impacted from the results of
operations, timing of capital expenditures payments, financing activities including our
debt activities as well as members equity distributions;
    
    trade accounts receivable increased by $1.0 million primarily as a result of timing of
collections;
    
    risk management net working capital balance decreased by a net $9.8 million as a result
of the changes in the mark-to-market unrealized positions and fair value changing of the
option premiums;
    
    prepayments and other current assets decreased by $0.5 million primarily from the
property and liability prepaid insurance balances;
    
    accounts payable increased by $11.2 million from December 31, 2006 primarily as a
result of activities and timing of payments, including capital expenditures activities; and
    
    accrued liabilities increase of $5.8 million primarily reflects an accrual for an
unanticipated legal award and unbilled expenditures related primarily to capital
expenditures.
 Cash Flows Three Months 2007 Compared to Three Months 2006
 Cash Flows from Operating Activities .
 Cash Flows Used in Investing Activities .
 Cash Flows Provided by (Used in) Financing Activities .
 Capital Requirements
  
    
    growth capital expenditures, which are made to acquire additional assets to increase
our business, to expand and upgrade existing systems and facilities or to construct or
acquire similar systems or facilities; or
 30




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##### Table of Contents




    
    maintenance capital expenditures, which are made to replace partially or fully
depreciated assets, to meet regulatory requirements, to maintain the existing operating
capacity of our assets and extend their useful lives or well attachments costs to maintain
existing system volumes and related cash flows.
    Amended and Restated Credit Agreement
    31




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
    
    an interest coverage ratio (the ratio of our consolidated Adjusted EBITDA to our
consolidated interest expense, in each case as defined in the credit agreement) of not less
than 2.5 to 1.0, determined as of the last day of each quarter for the four quarter period
ending on the date of determination; and a leverage ratio (the ratio of our consolidated
indebtedness to our consolidated Adjusted EBITDA, in each case as defined in the credit
agreement) of not more than 5.0 to 1.0 (or, on a temporary basis for not more than three
consecutive quarters following the consummation of certain acquisitions, not more than 5.25
to 1.0).
   Off-Balance Sheet Obligations.
 Debt Covenants.
 Total Contractual Cash Obligations.
 ($ in millions)
    
    Payments Due by PeriodContractual Obligations
    
    Total
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010-2011
    
    
    ThereafterLong-term debt (including interest)(1)
    
    $
    554.8
    
    
    $
    31.1
    
    
    $
    31.1
    
    
    $
    31.1
    
    
    $
    461.5
    
    
    $
    0.0Operating leases
    
    
    4.4
    
    
    
    0.7
    
    
    
    0.7
    
    
    
    0.7
    
    
    
    0.3
    
    
    
    2.0Purchase obligations(2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total contractual obligations
    
    $
    559.2
    
    
    $
    31.8
    
    
    $
    31.8
    
    
    $
    31.8
    
    
    $
    461.8
    
    
    $
    2.0
 
 (1)
    
    Assumes our fixed swapped average interest rate of 4.92% plus the
applicable margin under our  Amended and Restated Credit Agreement,
which remains constant in all periods.(2)
    
    Excludes physical and financial purchases of natural gas, NGLs, and
other energy commodities due to the nature of both the price and
volume components of such purchases, which vary on a daily or monthly
basis. Additionally, we do not have contractual commitments for fixed
price and/or fixed quantities of any material amount. Recent Accounting Pronouncements
 Accounting for Certain Hybrid Financial Instruments Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities
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##### Table of Contents



Fair Value Measurements.
 The Fair Value Option for Financial Assets and
Financial Liabilities
 Accounting for Uncertainty in
Income Taxes  an interpretation of FASB Statement No. 109
 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Risk and Accounting Policies
  Commodity Price Risk
   33




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Item 4. Controls and Procedures.
 Disclosure Controls
   Internal Control over Financial Reporting
   34




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##### Table of Contents



PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings.
   
 Item 1A. Risk Factors.
 Limited partner interests are inherently different from capital stock of a corporation,
although many of the business risks to which we are subject are similar to those that would be
faced by a corporation engaged in similar businesses.
 If any of the following risks were actually to occur, our business, financial condition or
results of operations could be materially adversely affected. In that case, we might not be able to
pay the minimum quarterly distribution on our common units and the trading price of our common
units could decline.
 The following risks should be read in conjunction with other risk factors disclosed under Item
1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2006. The
following risks are included in this report because of our recently completed Montierra
Acquisition, described in Note 15 to our Unaudited Consolidated Financial Statements included with
this report, pursuant to which transaction we acquired interests in oil and natural gas properties.
 Risks Related to Our Business
  Eagle Rock may experience difficulties in integrating Montierras business and could fail to
realize potential benefits of the acquisition.
  
    
    Geographically separated organizations and possible differences in corporate
cultures and management philosophies;
    
    Significant demands on management resources, which may distract managements
attention from day-to-day business;
    
    Differences in the disclosure systems, accounting systems, and accounting
controls and procedures of the two companies, which may interfere with the ability of Eagle
Rock to make timely and accurate public disclosure;
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##### Table of Contents




    
    The demands of managing new lines of business acquired from Montierra in the
acquisition.
  The returns on Montierras oil and gas investments are subject to fluctuation as a result of
changes in oil and natural gas prices.
  
    
    Political conditions or hostilities in oil and natural gas producing regions;
    
    Weather conditions or force majeure events;
    
    Delays or cancellations of crude oil and natural gas drilling and production activities;
    
    Levels of supply of and demand for oil and natural gas;
    
    U.S. and worldwide economic conditions;
    
    The price and availability of alternative fuels; and
    
    Energy conservation and environmental measures.
  Risks associated with the production, gathering, transportation and sale of oil and natural gas
could adversely affect returns.
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
  36




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##### Table of Contents



Item 3. Defaults Upon Senior Securities.
  
 Item 4. Submission of Matters to a Vote of Security Holders.
  
 Item 5. Other Information.
  
 Item 6. Exhibits.
 31.1
    
    Certification by Joseph A. Mills pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification by Richard W. FitzGerald pursuant to Section 302 of the Sarbanes-Oxley Act of
200232.1
    
    Certification by Joseph A. Mills pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
and 18 U.S.C. Section 135032.2
    
    Certification by Richard W. FitzGerald pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 and 18 U.S.C. Section 1350
 37




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##### Table of Contents



SIGNATURES
   EAGLE ROCK ENERGY PARTNERS, L.P.By: EAGLE ROCK ENERGY GP, L.P., its general partnerBy: EAGLE ROCK ENERGY G&P, LLC, its general partner/s/ Richard W. FitzGeraldRichard W. FitzGeraldSenior Vice President, Chief Financial Officer and Treasurer(Duly Authorized and Principal Financial Officer)
 38




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EAGLE ROCK ENERGY PARTNERS, L.P.
EXHIBIT INDEX
 31.1
    
    Certification by Joseph A. Mills pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification by Richard W. FitzGerald pursuant to Section 302 of the Sarbanes-Oxley Act of
200232.1
    
    Certification by Joseph A. Mills pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
and 18 U.S.C. Section 135032.2
    
    Certification by Richard W. FitzGerald pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 and 18 U.S.C. Section 1350