**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

**x**** QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**FORTHE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008**

 

**OR**

 

**o**** TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**FORTHE TRANSITION PERIOD FROM                TO                **

 

**Commissionfile number:  000-51120**

 

**HilandPartners, LP**

(Exact name ofRegistrant as specified in its charter)

 

| **DELAWARE**                              | ** ** | **71-0972724**       |
|-------------------------------------------|------------|----------------------|
| (State or other  jurisdiction of          |       | (I.R.S. Employer     |
| incorporation or  organization)           |       | Identification  No.) |
| ** **                                | ** ** | ** **           |
| **205  West Maple, Suite 1100**      |       |                 |
| **Enid,  Oklahoma**                       | ** ** | **73701**            |
| (Address of  principal executive offices) |       | (Zip Code)           |

 

**(580)242-6040**

(Registrant’stelephone number, 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.   x  Yes   o  No

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

| Large  accelerated filer o | Non-accelerated  filer o    | Accelerated  filer x | Smaller  reporting company o |
|----------------------------|-----------------------------|----------------------|------------------------------|
|                       | (Do  not check if a smaller |                 |                         |
|                       | reporting  company)         |                 |                         |

 

Indicate by a check markwhether the registrant is a shell company (as defined in rule 12b-2 of theExchange Act).  oYes  x No

 

The number of theregistrant’s outstanding equity units as of November 5, 2008 was 6,282,335common units, 3,060,000 subordinated units and a 2% general partnershipinterest.

 

 

 

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**HILANDPARTNERS, LP**

 

**INDEX**

 
| **PART I.  FINANCIAL INFORMATION**                                                             | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|
| Item 1. Financial  Statements (Unaudited, except December 31, 2007 Balance Sheet)              |       |
| Consolidated Balance  Sheets                                                                        | 3          |
| Consolidated Statements  of Operations                                                              | 4          |
| Consolidated Statements  of Cash Flows                                                              | 5          |
| Consolidated Statement  of Changes in Partners’ Equity and Comprehensive Income                | 6          |
| Condensed Notes to  Consolidated Financial Statements                                               | 7          |
| Item 2. Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 22         |
| Item 3. Quantitative  and Qualitative Disclosures About Market Risks                                | 35         |
| Item 4. Controls and  Procedures                                                                    | 37         |
| **PART II.  OTHER INFORMATION**                                                                | 37         |
| Item 1. Legal  Proceedings                                                                          | 37         |
| Item 1A. Risk Factors                                                                               | 37         |
| Item 2. Unregistered  Sales of Equity Securities and Use of Proceeds                                | 38         |
| Item 3. Defaults Upon  Senior Securities                                                            | 38         |
| Item 4. Submission of  Matters to a Vote of Security Holders                                        | 38         |
| Item 5. Other Information                                                                           | 39         |
| Item 6. Exhibits                                                                                    | 39         |
| SIGNATURES                                                                                          | 41         |
| Certification of CEO  under Section 302                                                        |       |
| Certification of CFO  under Section 302                                                        |       |
| Certification of CEO  under Section 906                                                        |       |
| Certification of CFO  under Section 906                                                        |       |

 

2

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**HILAND PARTNERS, LP**

**Consolidated Balance Sheets**

 
| ** **                                                                                                                                            | ** ** | **September 30,**                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                            | ** ** | **2008**                                                    | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                            | ** ** | **(unaudited)**                                             | ** ** | ** **            | ** ** |
| ** **                                                                                                                                            | ** ** | **(in thousands, except unit amounts)** | ** ** |
| **ASSETS**                                                                                                                                            |       |                                                        |       |                  |       |
| **Current  assets:**                                                                                                                                  |       |                                                        |       |                  |       |
| Cash and cash  equivalents                                                                                                                            |       | $                                                           | 12,147     |                  | $          | 10,497 |   |
| Accounts  receivable:                                                                                                                                 |       |                                                        |       |                  |       |
| Trade - net of  allowance for doubtful accounts of $304 in 2008                                                                                       |       | 41,573                                                      |       | 31,841                |       |
| Affiliates                                                                                                                                            |       | 5,325                                                       |       | 1,479                 |       |
|                                                                                                                                                  |       | 46,898                                                      |       | 33,320                |       |
| Fair value of  derivative assets                                                                                                                      |       | 4,521                                                       |       | 2,718                 |       |
| Other current  assets                                                                                                                                 |       | 2,614                                                       |       | 1,155                 |       |
| Total current  assets                                                                                                                                 |       | 66,180                                                      |       | 47,690                |       |
|                                                                                                                                                  |       |                                                        |       |                  |       |
| Property and  equipment, net                                                                                                                          |       | 333,900                                                     |       | 319,320               |       |
| Intangibles, net                                                                                                                                      |       | 37,007                                                      |       | 41,102                |       |
| Fair value of  derivative assets                                                                                                                      |       | 4,991                                                       |       | 418                   |       |
| Other assets,  net                                                                                                                                    |       | 1,953                                                       |       | 1,943                 |       |
|                                                                                                                                                  |       |                                                        |       |                  |       |
| **Total  assets**                                                                                                                                     |       | $                                                           | 444,031    |                  | $          | 410,473 |   |
|                                                                                                                                                  |       |                                                        |       |                  |       |
| **LIABILITIES  AND PARTNERS’ EQUITY**                                                                                                            | ** ** | ** **                                                  | ** ** | ** **            | ** ** |
| **Current  liabilities:**                                                                                                                             |       |                                                        |       |                  |       |
| Accounts payable                                                                                                                                      |       | $                                                           | 22,576     |                  | $          | 24,709 |   |
| Accounts  payable-affiliates                                                                                                                          |       | 8,315                                                       |       | 7,880                 |       |
| Fair value of  derivative liabilities                                                                                                                 |       | 1,626                                                       |       | 8,238                 |       |
| Accrued  liabilities and other                                                                                                                        |       | 3,419                                                       |       | 2,075                 |       |
| Total current  liabilities                                                                                                                            |       | 35,936                                                      |       | 42,902                |       |
|                                                                                                                                                  |       |                                                        |       |                  |       |
| Commitments and  contingencies (Note 8)                                                                                                               |       |                                                        |       |                  |       |
| Long-term debt                                                                                                                                        |       | 266,633                                                     |       | 226,104               |       |
| Fair value of  derivative liabilities                                                                                                                 |       | —                                                      |       | 141                   |       |
| Asset retirement  obligation                                                                                                                          |       | 2,417                                                       |       | 2,159                 |       |
|                                                                                                                                                  |       |                                                        |       |                  |       |
| **Partners’  equity**                                                                                                                            |       |                                                        |       |                  |       |
| Limited  partners’ interest:                                                                                                                     |       |                                                        |       |                  |       |
| Common  unitholders (6,282,335 and 5,214,323 units issued and outstanding at  September 30, 2008 and December 31, 2007, respectively)       |       | 125,914                                                     |       | 130,066               |       |
| Subordinated  unitholders (3,060,000 and 4,080,000 units issued and outstanding at  September 30, 2008 and December 31, 2007, respectively) |       | 4,792                                                       |       | 10,774                |       |
| General partner  interest                                                                                                                             |       | 4,625                                                       |       | 4,056                 |       |
| Accumulated  other comprehensive income (loss)                                                                                                        |       | 3,714                                                       |       | (5,729                | )          |
| **Total  partners’ equity**                                                                                                                      |       | 139,045                                                     |       | 139,167               |       |
|                                                                                                                                                  |       |                                                        |       |                  |       |
| **Total  liabilities and partners’ equity**                                                                                                      |       | $                                                           | 444,031    |                  | $          | 410,473 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

3

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**HILANDPARTNERS, LP**

**ConsolidatedStatements of Operations**

**Forthe Three and Nine Months Ended (Unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended September 30,**             | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2008**                                                             | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                   | ** ** | **(In thousands, except per unit amounts)** | ** ** |
| **Revenues:**                                                                | ** ** | ** **                                                           | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Midstream  operations                                                        |       |                                                                 |       |                                                    |       |   |   |   |   |
| Third parties                                                                |       | $                                                                    | 107,158    |                                                    | $          | 65,777 |   | $ | 308,625 |   | $ | 189,301 |   |
| Affiliates                                                                   |       | 7,390                                                                |       | 654                                                     |       | 10,433 |   | 2,390 |   |
| Compression  services, affiliate                                             |       | 1,205                                                                |       | 1,205                                                   |       | 3,615 |   | 3,615 |   |
| Total revenues                                                               |       | 115,753                                                              |       | 67,636                                                  |       | 322,673 |   | 195,306 |   |
|                                                                         |       |                                                                 |       |                                                    |       |   |   |   |   |
| **Operating  costs and expenses:**                                           |       |                                                                 |       |                                                    |       |   |   |   |   |
| Midstream  purchases (exclusive of items shown separately below)             |       | 45,616                                                               |       | 31,267                                                  |       | 139,258 |   | 98,056 |   |
| Midstream  purchases - affiliate (exclusive of items shown separately below) |       | 36,279                                                               |       | 14,522                                                  |       | 99,328 |   | 39,264 |   |
| Operations and  maintenance                                                  |       | 7,881                                                                |       | 6,157                                                   |       | 22,201 |   | 16,108 |   |
| Depreciation,  amortization and accretion                                    |       | 9,554                                                                |       | 7,583                                                   |       | 27,652 |   | 21,362 |   |
| Bad debt                                                                     |       | (7,799                                                               | )          | —                                                  |       | 304 |   | — |   |
| General and  administrative expenses                                         |       | 2,259                                                                |       | 1,715                                                   |       | 6,423 |   | 5,108 |   |
| Total operating  costs and expenses                                          |       | 93,790                                                               |       | 61,244                                                  |       | 295,166 |   | 179,898 |   |
| Operating income                                                             |       | 21,963                                                               |       | 6,392                                                   |       | 27,507 |   | 15,408 |   |
|                                                                         |       |                                                                 |       |                                                    |       |   |   |   |   |
| **Other  income (expense):**                                                 |       |                                                                 |       |                                                    |       |   |   |   |   |
| Interest and  other income                                                   |       | 96                                                                   |       | 102                                                     |       | 267 |   | 314 |   |
| Amortization of  deferred loan costs                                         |       | (147                                                                 | )          | (114                                                    | )          | (426 | ) | (290 | ) |
| Interest expense                                                             |       | (3,271                                                               | )          | (3,126                                                  | )          | (9,888 | ) | (7,519 | ) |
| Other income  (expense), net                                                 |       | (3,322                                                               | )          | (3,138                                                  | )          | (10,047 | ) | (7,495 | ) |
|                                                                         |       |                                                                 |       |                                                    |       |   |   |   |   |
| **Net  income**                                                              |       | 18,641                                                               |       | 3,254                                                   |       | 17,460 |   | 7,913 |   |
| Less general  partner interest in net income                                 |       | 2,641                                                                |       | 1,199                                                   |       | 6,513 |   | 2,976 |   |
| **Limited  partners’ interest in net income**                           |       | $                                                                    | 16,000     |                                                    | $          | 2,055 |   | $ | 10,947 |   | $ | 4,937 |   |
|                                                                         |       |                                                                 |       |                                                    |       |   |   |   |   |
| **Net  income per limited partners’ unit – basic**                 |       | $                                                                    | 1.71       |                                                    | $          | 0.22 |   | $ | 1.17 |   | $ | 0.53 |   |
|                                                                         |       |                                                                 |       |                                                    |       |   |   |   |   |
| **Net  income per limited partners’ unit – diluted**               |       | $                                                                    | 1.71       |                                                    | $          | 0.22 |   | $ | 1.17 |   | $ | 0.53 |   |
|                                                                         |       |                                                                 |       |                                                    |       |   |   |   |   |
| **Weighted  average limited partners’ units outstanding -basic**        |       | 9,339                                                                |       | 9,281                                                   |       | 9,323 |   | 9,276 |   |
|                                                                         |       |                                                                 |       |                                                    |       |   |   |   |   |
| **Weighted  average limited partners’ units outstanding -diluted**      |       | 9,365                                                                |       | 9,322                                                   |       | 9,364 |   | 9,316 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

4

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**HILANDPARTNERS, LP**

**ConsolidatedStatements of Cash Flows**

**Forthe Nine Months Ended (Unaudited)**

 
| ** **                                                                         | ** ** | **September 30,**  | ** ** | **September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **2008**                | ** ** | **2007**               | ** ** |
| ** **                                                                         | ** ** | **(in thousands)** | ** ** |
| **Cash  flows from operating activities:**                                         |       |                    |       |                   |       |
| Net income                                                                         |       | $                       | 17,460     |                   | $          | 7,913 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                    |       |                   |       |
| Depreciation and  amortization                                                     |       | 27,550                  |       | 21,281                 |       |
| Accretion of  asset retirement obligation                                          |       | 102                     |       | 81                     |       |
| Amortization of  deferred loan cost                                                |       | 426                     |       | 290                    |       |
| Gain on  derivative transactions                                                   |       | (3,685                  | )          | (510                   | )          |
| Unit based compensation                                                            |       | 1,159                   |       | 589                    |       |
| Bad debt                                                                           |       | 304                     |       | —                 |       |
| Gain on sale of  assets                                                            |       | (12                     | )          | —                 |       |
| Increase in  other assets                                                          |       | (72                     | )          | —                 |       |
| (Increase)  decrease in current assets:                                            |       |                    |       |                   |       |
| Accounts  receivable - trade                                                       |       | (10,036                 | )          | 489                    |       |
| Accounts  receivable - affiliates                                                  |       | (3,846                  | )          | 139                    |       |
| Other current  assets                                                              |       | (1,459                  | )          | 111                    |       |
| Increase  (decrease) in current liabilities:                                       |       |                    |       |                   |       |
| Accounts payable                                                                   |       | (2,856                  | )          | (2,438                 | )          |
| Accounts  payable-affiliates                                                       |       | 435                     |       | 610                    |       |
| Accrued  liabilities                                                               |       | 1,241                   |       | 572                    |       |
| **Net  cash provided by operating activities**                                     |       | 26,711                  |       | 29,127                 |       |
|                                                                               |       |                    |       |                   |       |
| **Cash  flows from investing activities:**                                         |       |                    |       |                   |       |
| Additions to  property and equipment                                               |       | (37,164                 | )          | (61,940                | )          |
| Proceeds from  disposals of property and equipment                                 |       | 18                      |       | —                 |       |
| **Net  cash used in investing activities**                                         |       | (37,146                 | )          | (61,940                | )          |
|                                                                               |       |                    |       |                   |       |
| **Cash  flows from financing activities:**                                         |       |                    |       |                   |       |
| Proceeds from  long-term borrowings                                                |       | 41,000                  |       | 54,000                 |       |
| Increase in  deferred offering cost                                                |       | (7                      | )          | (157                   | )          |
| Debt issuance  costs                                                               |       | (355                    | )          | (494                   | )          |
| Proceeds from  unit options exercise                                               |       | 1,052                   |       | 1,045                  |       |
| General partner  contribution for issuance of restricted common units              |       | 5                       |       | 6                      |       |
| Proceeds from  conversion of vested phantom units                                  |       | 2                       |       | —                 |       |
| Redemption of  vested phantom units                                                |       | (35                     | )          | —                 |       |
| Payments on  capital lease obligations                                             |       | (369                    | )          | (178                   | )          |
| Cash  distributions to unitholders                                                 |       | (29,208                 | )          | (22,950                | )          |
| **Net  cash provided by financing activities**                                     |       | 12,085                  |       | 31,272                 |       |
|                                                                               |       |                    |       |                   |       |
| Increase  (decrease) for the period                                                |       | 1,650                   |       | (1,541                 | )          |
| Beginning of  period                                                               |       | 10,497                  |       | 10,386                 |       |
| **End of  period**                                                                 |       | $                       | 12,147     |                   | $          | 8,845 |   |
|                                                                               |       |                    |       |                   |       |
| Supplementary  information                                                         |       |                    |       |                   |       |
| Cash paid for  interest, net of amounts capitalized                                |       | $                       | 9,707      |                   | $          | 7,470 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

5

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**HILANDPARTNERS, LP**

**ConsolidatedStatement of Changes in Partners’ Equity and Comprehensive Income**

**Forthe Nine Months Ended September 30, 2008 (Unaudited)**

 
| ** **                                                                           | ** ** | **Common**                              | ** ** | **Subordinated** | ** ** | ** **   | ** ** | **Accumulated**        | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|------------------|------------|--------------|------------|------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                                           | ** ** | **Limited**                             | ** ** | **Limited**      | ** ** | **General**  | ** ** | **Other**              | ** ** | ** ** | ** ** | **Total**         | ** ** |
| ** **                                                                           | ** ** | **Partner**                             | ** ** | **Partner**      | ** ** | **Partner**  | ** ** | **Comprehensive**      | ** ** | ** ** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                           | ** ** | **Interest**                            | ** ** | **Interest**     | ** ** | **Interest** | ** ** | **Income (loss)** | ** ** | **Total**  | ** ** | **Income**        | ** ** |
| ** **                                                                           | ** ** | **(in thousands, except unit amounts)** | ** ** |
|                                                                                 |       |                                    |       |             |       |         |       |                   |       |       |       |              |       |
| **Balance,  January 1, 2008**                                                   |       | $                                       | 130,066    |             | $          | 10,774       |       | $                      | 4,056      |       | $          | (5,729            | )          | $ | 139,167 |   |   |   |
|                                                                                 |       |                                    |       |             |       |         |       |                   |       |       |       |              |       |
| Proceeds from  40,705 unit options exercise                                          |       | 1,031                                   |       | —           |       | 21           |       | —                 |       | 1,052      |       |              |       |
|                                                                                 |       |                                    |       |             |       |         |       |                   |       |       |       |              |       |
| Conversion of  1,020,000 subordinated units to common units                          |       | —                                  |       | —           |       | —       |       | —                 |       | —     |       |              |       |
|                                                                                 |       |                                    |       |             |       |         |       |                   |       |       |       |              |       |
| Issuance of  1,807 common units from 1,807 vested phantom units                      |       | —                                  |       | —           |       | 2            |       | —                 |       | 2          |       |              |       |
|                                                                                 |       |                                    |       |             |       |         |       |                   |       |       |       |              |       |
| Redemption of  693 vested phantom units                                              |       | (35                                     | )          | —           |       | —       |       | —                 |       | (35        | )          |              |       |
|                                                                                 |       |                                    |       |             |       |         |       |                   |       |       |       |              |       |
| Issuance of  6,000 restricted common units                                           |       | —                                  |       | —           |       | 5            |       | —                 |       | 5          |       |              |       |
|                                                                                 |       |                                    |       |             |       |         |       |                   |       |       |       |              |       |
| Periodic cash  distributions                                                         |       | (13,977                                 | )          | (9,259           | )          | (5,972       | )          | —                 |       | (29,208    | )          |              |       |
|                                                                                 |       |                                    |       |             |       |         |       |                   |       |       |       |              |       |
| Unit based  compensation                                                             |       | 1,159                                   |       | —           |       | —       |       | —                 |       | 1,159      |       |              |       |
|                                                                                 |       |                                    |       |             |       |         |       |                   |       |       |       |              |       |
| Other  comprehensive losses reclassified to income on closed derivative transactions |       | —                                  |       | —           |       | —       |       | 6,478                  |       | 6,478      |       | $                 | 6,478      |   |
|                                                                                 |       |                                    |       |             |       |         |       |                   |       |       |       |              |       |
| Change in fair  value of derivatives                                                 |       | —                                  |       | —           |       | —       |       | 2,965                  |       | 2,965      |       | 2,965             |       |
|                                                                                 |       |                                    |       |             |       |         |       |                   |       |       |       |              |       |
| Net income                                                                           |       | 7,670                                   |       | 3,277            |       | 6,513        |       | —                 |       | 17,460     |       | 17,460            |       |
|                                                                                 |       |                                    |       |             |       |         |       |                   |       |       |       |              |       |
| Comprehensive  income                                                                |       |                                    |       |             |       |         |       |                   |       |       |       | $                 | 26,903     |   |
|                                                                                 |       |                                    |       |             |       |         |       |                   |       |       |       |              |       |
| **Balance,  September 30, 2008**                                                |       | $                                       | 125,914    |             | $          | 4,792        |       | $                      | 4,625      |       | $          | 3,714             |       | $ | 139,045 |   |   |   |

 

The accompanying notes are an integral part of this consolidatedfinancial statement.

 

6

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**HILANDPARTNERS, LP**

**CONDENSEDNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

**THREE ANDNINE MONTHS ENDED SEPTEMBER 30, 2008 and 2007**

**(inthousands, except unit information or unless otherwise noted)**

 

**Note 1: Organization, Basis of Presentation and Principles of Consolidation**

 

HilandPartners, LP, a Delaware limited partnership (“we,” “us,” “our,” “HPLP” or“the Partnership”), was formed in October 2004 to acquire and operatecertain midstream natural gas plants, gathering systems and compression andwater injection assets located in the states of Oklahoma, North Dakota,Wyoming, Texas and Mississippi that were previously owned by Continental Gas, Inc.,our predecessor (“Predecessor” or “CGI”) and Hiland Partners, LLC. Wecommenced operations on February 15, 2005, and concurrently with thecompletion of our initial public offering, CGI contributed a substantialportion of its net assets to us. The transfer of ownership of net assets fromCGI to us represented a reorganization of entities under common control and wasrecorded at historical cost. CGI was formed in 1990 as a wholly ownedsubsidiary of Continental Resources, Inc. (“CLR”).

 

CGI operated in onesegment, midstream, which involved the purchasing, gathering, compressing,dehydrating, treating, processing and marketing of natural gas andfractionating and marketing of natural gas liquids, or NGLs. CGI historicallyhas owned all of our natural gas gathering, processing, treating andfractionation assets other than our Worland, Bakken and Woodford Shalegathering systems. Hiland Partners, LLC historically owned our Worlandgathering system and our compression services assets, which we acquired on February 15,2005, and our Bakken gathering system. Since our initial public offering, wehave operated in midstream and compression services segments. On September 26,2005, we acquired Hiland Partners, LLC, which at such time owned theBakken gathering system, for $92.7 million, $35.0 million of whichwas used to retire outstanding Hiland Partners, LLC indebtedness. On May 1,2006, we acquired the Kinta Area gathering assets from Enogex Gas Gathering,L.L.C., consisting of certain eastern Oklahoma gas gathering assets, for $96.4million. We financed this acquisition with $61.2 million of borrowings from ourcredit facility and $35.0 million of proceeds from the issuance to HilandPartners GP, LLC, our general partner, of 761,714 common units and 15,545general partner equivalent units, both at $45.03 per unit.  We began construction of the Woodford Shale gatheringsystem in the first quarter of 2007.  Asof September 30, 2008, we have invested approximately $39.8 million in thegathering system.

 

The unaudited financialstatements for the three and nine months ended September 30, 2008 and 2007included herein have been prepared pursuant to the rules and regulationsof the United States Securities and Exchange Commission (the “SEC”). Theinterim financial statements reflect all adjustments, which in the opinion ofour management, are necessary for a fair presentation of our results for theinterim periods. Such adjustments are considered to be of a normal recurringnature. Results of operations for the three and nine months ended September 30,2008 are not necessarily indicative of the results of operations that will berealized for the year ending December 31, 2008.  The accompanyingconsolidated financial statements and notes thereto should be read inconjunction with the consolidated financial statements and notes theretoincluded in our Form 10-K for the fiscal year ended December 31,2007.

 

***Principles of Consolidation***

 

The consolidatedfinancial statements include our accounts and those of our subsidiaries. Allsignificant intercompany transactions and balances have been eliminated.

 

***Use of Estimates***

 

The preparation offinancial statements in accordance with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the amounts reported in the financial statementsand accompanying notes. Actual results could differ from those estimates.

 

***Fair Value of Financial Instruments***

 

Our financialinstruments, which require fair value disclosure, consist primarily of cash andcash equivalents, accounts receivable, financial derivatives, accounts payableand long-term debt. The carrying value of cash and cash equivalents, accountsreceivable and accounts payable are considered to be representative of theirrespective fair values, due to the short maturity of these instruments.Derivative instruments are reported in the accompanying consolidated financialstatements at fair value in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 133, “Accounting for Derivative Instruments andHedging Activities,” as amended (“SFAS 133”). Fair value of our derivativeinstruments is determined based on management estimates through utilization ofmarket data including forecasted forward natural gas and NGL prices as afunction of forward New York Mercantile Exchange (“NYMEX”) natural gas andlight crude prices. The fair value of long-term debt approximates its carryingvalue due to the variable interest rate feature of such debt.

 

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***Commodity Risk Management***

 

We engage in price riskmanagement activities in order to minimize the risk from market fluctuation inthe prices of natural gas and NGLs. To qualify as an accounting hedge, theprice movements in the commodity derivatives must be highly correlated with theunderlying hedged commodity. Gains and losses related to commodity derivativesthat qualify as accounting hedges are recognized in income when the underlyinghedged physical transaction closes and are included in the consolidatedstatements of operations as revenues from midstream operations. Gains andlosses related to commodity derivatives that are not designated as accountinghedges or do not qualify as accounting hedges are recognized in incomeimmediately and are included in revenues from midstream operations in theconsolidated statement of operations.

 

SFAS 133 establishesaccounting and reporting standards for derivative instruments, includingcertain derivative instruments embedded in other contracts, and for hedgingactivities. SFAS 133 requires that an entity recognize all derivatives aseither assets or liabilities in the statement of financial position and measurethose instruments at fair value. However, if a derivative does qualify forhedge accounting, depending on the nature of the hedge, changes in fair valuecan be offset against the change in fair value of the hedged item throughearnings or recognized in other comprehensive income until such time as thehedged item is recognized in earnings. To qualify for cash flow hedgeaccounting, the cash flows from the hedging instrument must be highly effectivein offsetting changes in cash flows due to changes in the underlying item beinghedged. In addition, all hedging relationships must be designated, documentedand reassessed periodically. SFAS 133 also provides that normal purchases andnormal sales contracts are not subject to the statement. Normal purchases andnormal sales are contracts that provide for the purchase or sale of somethingother than a financial instrument or a derivative instrument that will bedelivered in quantities expected to be used or sold by the reporting entityover a reasonable period in the normal course of business. Our fixed pricephysical forward natural gas sales contract in which we have contracted to sellnatural gas quantities at a fixed price is designated as a normal sale. Thisforward sales contract expires on December 31, 2008.

 

Currently, our derivativefinancial instruments that qualify for hedge accounting are designated as cashflow hedges. The cash flow hedge instruments hedge the exposure of variabilityin expected future cash flows that is attributable to a particular risk. Theeffective portion of the gain or loss on these derivative instruments isrecorded in accumulated other comprehensive income (loss) in partners’ equityand reclassified into earnings in the same period in which the hedgedtransaction closes. The asset or liability related to the derivativeinstruments is recorded on the balance sheet as fair value of derivative assetsor liabilities. Any ineffective portion of the gain or loss is recognized inearnings immediately.

 

***Comprehensive Income***

 

Comprehensive incomeincludes net income and other comprehensive income, which includes, but is notlimited to, changes in the fair value of derivative financial instruments. Pursuantto SFAS 133, for derivatives qualifying as accounting hedges, the effectiveportion of changes in fair value is recognized in partners’ equity asaccumulated other comprehensive income (loss) and reclassified to earnings whenthe underlying hedged physical transaction closes.  Our comprehensiveincome for the three and nine months ended September 30, 2008 and 2007 ispresented in the table below:

 
| ** **                                             | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net income                                             |       | $                                                        | 18,641     |                                                    | $          | 3,254 |   | $ | 17,460 |   | $ | 7,913 |   |
| Closed  derivative transactions reclassified to income |       | 1,395                                                    |       | (854                                                    | )          | 6,478 |   | (2,309 | ) |
| Change in fair  value of derivatives                   |       | 13,219                                                   |       | (26                                                     | )          | 2,965 |   | (1,356 | ) |
| Comprehensive  income                                  |       | $                                                        | 33,255     |                                                    | $          | 2,374 |   | $ | 26,903 |   | $ | 4,248 |   |

 

***Net Income per Limited Partners’ Unit***

 

Net income per limitedpartners’ unit is computed based on the weighted-average number of common andsubordinated units outstanding during the period. The computation of dilutednet income per limited partner unit further assumes the dilutive effect of unitoptions and restricted and phantom units. Net income per limited partners’ unitis computed by dividing net income applicable to limited partners, afterdeducting the general partner’s 2% interest and incentive distributions, byboth the basic and diluted weighted-average number of limited partnership unitsoutstanding.

 

***Recent Accounting Pronouncements***

 

On April 25, 2008,the Financial Accounting Standards Board (“FASB”) FASB issued Staff Position No. FAS142-3, “Determination of the UsefulLife of Intangible Assets” (“FSP 142-3”).  FSP 142-3 amends the factors that an entityshould consider in developing renewal or extension assumptions used indetermining the useful life of recognized intangible assets under FASBStatement No. 142 (“SFAS 142”), “Goodwilland Other Intangible Assets”. In determining the useful life of anacquired intangible asset, FSP 142-3 removes the requirement from SFAS 142 foran entity to consider whether renewal of the intangible asset requiressignificant costs or material modifications to the related arrangement. FSP142-3 also replaces the previous useful life assessment

 

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criteria with arequirement that an entity considers its own experience in renewing similararrangements. If the entity has no relevant experience, it would considermarket participant assumptions regarding renewal.  FSP 142-3 will beeffective as of January 1, 2009 and will apply only to intangible assets acquiredafter that date. Retroactive application to previously acquired intangibleassets is prohibited.  The adoption of FSP 142-3 is not expected to have amaterial impact on our financial position, results of operations or cash flows.

 

On March 19, 2008,the FASB issued SFAS No. 161, “Disclosures about Derivative Instrumentsand Hedging Activities”, an amendment of SFAS 133 (“SFAS 161”). SFAS 161 isintended to improve transparency in financial reporting by requiring enhanceddisclosures of an entity’s derivative instruments and hedging activities andtheir effects on the entity’s financial position, financial performance, andcash flows. SFAS 161 is effective prospectively for financial statements issuedfor fiscal years and interim periods beginning after November 15, 2008,with early application encouraged. SFAS 161 encourages, but does not require,comparative disclosures for periods prior to its initial adoption. SFAS 161amends the current qualitative and quantitative disclosure requirements for derivativeinstruments and hedging activities set forth in SFAS 133 and generallyincreases the level of aggregation/disaggregation that will be required in anentity’s financial statements. We are currently reviewing SFAS 161 to determinethe effect it will have on our financial statements and disclosures therein.

 

On March 12, 2008,the Emerging Issues Task Force (“EITF”) reached consensus opinion on EITF Issue07-4, “Application of the two-class method under FASB Statement No. 128,Earnings per Share, to Master Limited Partnerships” (“EITF 07-4”), which theFASB ratified at its March 26, 2008 meeting. EITF 07-4 requires thecalculation of a Master Limited Partnership’s (“MLPs”) net earnings per limitedpartner unit for each period presented according to distributions declared andparticipation rights in undistributed earnings as if all of the earnings forthat period had been distributed. In periods with undistributed earnings abovespecified levels, the calculation per the two-class method results in an increasedallocation of such undistributed earnings to the general partner and a dilutionof earnings to the limited partners. EITF 07-4 is effective for fiscal yearsbeginning after December 15, 2008, and is to be applied retrospectively toall periods presented. Early application is not permitted. We will apply therequirements of EITF 07-4 as it pertains to MLPs upon its adoption during thequarter ended March 31, 2009 and do not expect a significant impact whenadopted.

 

In December 2007,the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”).SFAS 141(R) amends and replaces SFAS 141, but retains the fundamentalrequirements in SFAS 141 that the purchase method of accounting be used for allbusiness combinations and an acquirer be identified for each businesscombination. SFAS 141(R) provides for how the acquirer recognizes andmeasures the identifiable assets acquired, liabilities assumed and anynon-controlling interest in the acquiree. SFAS 141(R) provides forhow the acquirer recognizes and measures the goodwill acquired in the businesscombination or a gain from a bargain purchase. SFAS 141(R) also determineswhat information to disclose to enable users to be able to evaluate the natureand financial effects of the business combination. The provisions ofSFAS 141(R) apply prospectively to business combinations for whichthe acquisition date is on or after the beginning of the first annual reportingperiod beginning on or after December 15, 2008 and do not allow earlyadoption. We are evaluating the new requirements of SFAS 141(R) and theimpact it will have on business combinations completed in 2009 and thereafter.

 

 In December 2007, the FASB issued SFAS No. 160,“Noncontrolling Interests in Consolidated Financial Statements — an amendmentof ARB No. 51” (“SFAS 160”). SFAS 160 establishes accounting and reportingstandards that require the ownership interests in subsidiaries held by partiesother than the parent (minority interest) be clearly identified, labeled andpresented in the consolidated balance sheet within equity, but separate fromthe parent’s equity. SFAS 160 requires the equity amount of consolidated netincome attributable to the parent and to the noncontrolling interest be clearlyidentified and presented on the face of the consolidated income statement andthat changes in a parent’s ownership interest while the parent retains itscontrolling financial interest in its subsidiary be accounted for consistentlyand similarly as equity transactions. Consolidated net income and comprehensiveincome will be determined without deducting minority interest; however,earnings-per-share information will continue to be calculated on the basis ofthe net income attributable to the parent’s shareholders. Additionally, SFAS160 establishes a single method for accounting for changes in a parent’sownership interest in a subsidiary that does not result in deconsolidation andthat the parent recognize a gain or loss in net income when a subsidiary isdeconsolidated. SFAS 160 is effective for fiscal years beginning on or after December 15,2008. Early adoption is not permitted. We do not expect SFAS 160 will have amaterial impact on our financial position, results of operations or cash flows.

 

 In February 2007, the FASB issued SFAS No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS159”). SFAS 159 expands opportunities to use fair value measurement infinancial reporting and permits entities to choose to measure many financialinstruments and certain other items at fair value. SFAS 159 is effective forfiscal years beginning after November 15, 2007. SFAS 159 was adopted by useffective January 1, 2008, at which time no financial assets orliabilities, not previously required to be recorded at fair value by other authoritativeliterature, were designated to be recorded at fair value. As such, the adoptionof SFAS 159 did not have any impact on our financial position, results ofoperations or cash flows.

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”).  SFAS 157 defines fair value as the price thatwould be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants at the measurement date,establishes a framework for measuring fair value in generally acceptedaccounting principles (“GAAP”) such as fair value hierarchy used to classifythe source of information used in fair value measurements (i.e., market basedor non-market

 

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based) and expandsdisclosure about fair value measurements based on their level in thehierarchy.  SFAS 157 applies toderivatives and other financial instruments, which SFAS 133 requires bemeasured at fair value at initial recognition and for all subsequent periods.SFAS 157 establishes a fair value hierarchy which requires an entity tomaximize the use of observable inputs and minimize the use of unobservableinputs when measuring fair value. SFAS 157’s hierarchy defines three levels ofinputs that may be used to measure fair value. Level 1 refers to assets thathave observable market prices, level 2 assets do not have an “observable price”but do have inputs that are based on such prices in which components haveobservable data points and level 3 refers to assets in which one or more of theinputs do not have observable prices and calibrated model parameters, valuationtechniques or management’s assumptions are used to derive the fair value. SFAS157 is effective for financial statements issued for fiscal years beginningafter November 15, 2007 and interim periods within those fiscal years. Weelected to implement SFAS 157 prospectively in the first quarter of 2008 withthe one-year deferral permitted by FASB Staff Position (FSP) 157-2 fornonfinancial assets and nonfinancial liabilities measured at fair value, exceptthose that are recognized or disclosed on a recurring basis (at leastannually). The deferral applies to nonfinancial assets and liabilities measuredat fair value in a business combination; impaired properties, plants andequipment; intangible assets and goodwill; and initial recognition of assetretirement obligations and restructuring costs for which we use fair value. Wedo not expect any significant impact to our consolidated financial statementswhen we implement SFAS 157 for these assets and liabilities. See Note 5 “FairValue Measurements of Financial Instruments.”

 

**Note 2:  Property and Equipment and AssetRetirement Obligations**

 

Propertyand equipment consisted of the following for the periods indicated:

 

| ** **                                       | ** ** | **As of**         | ** ** | **As of**        | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                       | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Land                                             |       | $                      | 298        |                  | $          | 295 |   |
| Construction in  progress                        |       | 8,940                  |       | 12,030                |       |
| Midstream  pipeline, plants and compressors      |       | 392,277                |       | 352,003               |       |
| Compression and  water injection equipment       |       | 19,373                 |       | 19,258                |       |
| Other                                            |       | 4,558                  |       | 3,958                 |       |
|                                             |       | 425,446                |       | 387,544               |       |
| Less:  accumulated depreciation and amortization |       | 91,546                 |       | 68,224                |       |
|                                             |       | $                      | 333,900    |                  | $          | 319,320 |   |

 

During the three and ninemonths ended September 30, 2008, we capitalized interest of $5 and $160,respectively.  We capitalized $828 and$2,281 interest during the three and nine months ended September 30, 2007,respectively.

 

In accordance with SFAS No. 143,“Accounting for Asset Retirement Obligations” (“SFAS 143”), we have recordedthe fair value of liabilities for asset retirement obligations in the periodsin which they are incurred and corresponding increases in the carrying amountsof the related long-lived assets. The asset retirement costs are subsequentlyallocated to expense using a systematic and rational method and the liabilitiesare accreted to measure the change in liability due to the passage of time. Theprovisions of SFAS 143 primarily apply to dismantlement and site restoration ofcertain of our plants and pipelines. We have evaluated our asset retirementobligations as of September 30, 2008 and have determined that revisions inthe carrying values are not necessary at this time.

 

The following tablesummarizes our activity related to asset retirement obligations for the indicatedperiod:

 

| Asset retirement  obligation, January 1, 2008    |   | $   | 2,159  |   |
|-------------------------------------------------------|--------|-----|--------|--------|
| Add: additions  on leased locations                   |   | 156 |   |
| Add: accretion  expense                               |   | 102 |   |
| Asset retirement  obligation, September 30, 2008 |   | $   | 2,417  |   |
|                                                       |        |     |        |        |  |

 

**Note 3:   Intangible Assets**

 

Intangible assets consistof the acquired value of customer relationships and existing contracts to sellnatural gas and other NGLs and compression contracts, which do not havesignificant residual value. The customer relationships and the contracts arebeing amortized over their estimated lives of ten years. We review intangibleassets for impairment whenever events or circumstances indicate that thecarrying amounts may not be recoverable. If such a review should indicate thatthe carrying amount of intangible assets is not recoverable, we reduce thecarrying amount of such assets to fair value based on the discounted probablecash flows of the intangible assets. No impairments of intangible assets wererecorded during the three and nine months ended September 30, 2008 or 2007.

 

Intangible assetsconsisted of the following for the periods indicated:

 

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| ** **                     | ** ** | **As of**         | ** ** | **As of**        | ** ** |
|--------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                     | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Gas sales  contracts           |       | $                      | 25,585     |                  | $          | 25,585 |   |
| Compression  contracts         |       | 18,515                 |       | 18,515                |       |
| Customer  relationships        |       | 10,492                 |       | 10,492                |       |
|                           |       | 54,592                 |       | 54,592                |       |
| Less accumulated  amortization |       | 17,585                 |       | 13,490                |       |
| Intangible  assets, net        |       | $                      | 37,007     |                  | $          | 41,102 |   |

 

During each of the threemonths ended September 30, 2008 and 2007, we recorded $1,365 ofamortization expense.  During each of thenine months ended September 30, 2008 and 2007, we recorded $4,095 ofamortization expense.  Estimatedaggregate amortization expense for the remainder of 2008 is $1,365 and $5,459for each of the four succeeding fiscal years from 2009 through 2012 and a totalof $13,806 for all years thereafter.

 

**Note 4:  Derivatives**

 

We have entered intocertain derivative contracts that are classified as cash flow hedges inaccordance with SFAS 133 and relate to forecasted sales and purchases in 2008,2009 and a mark-to-market cash flow derivative which relates to forecastedsales in 2010. The 2010 hedge does not qualify for cash flow hedge accounting.We entered into these financial swap instruments to hedge forecasted naturalgas sales or purchases and NGL sales against the variability in expected futurecash flows attributable to changes in commodity prices. Under these contractualswap agreements with our counterparty, we receive a fixed price and pay afloating price or we pay a fixed price and receive a floating price based oncertain indices for the relevant contract period as the underlying natural gasis sold or purchased or NGL is sold.

 

We formally document allrelationships between hedging instruments and the items being hedged, includingour risk management objective and strategy for undertaking the hedgingtransactions. This includes matching the natural gas and NGL futures, the “soldfixed for floating price” or “buy fixed for floating price” contracts, to theforecasted transactions. We assess, both at the inception of the hedge and onan ongoing basis, whether the derivatives are highly effective in offsettingchanges in the fair value of hedged items. Highly effective is deemed to be acorrelation range from 80% to 125% of the change in cash flows of thederivative in offsetting the cash flows of the hedged transaction. If it isdetermined that a derivative is not highly effective as a hedge or it hasceased to be a highly effective hedge, due to the loss of correlation betweenchanges in natural gas or NGL reference prices under a hedging instrument andactual natural gas or NGL prices, we will discontinue hedge accounting for thederivative and subsequent changes in fair value for the derivative will berecognized immediately into earnings. We assess effectiveness using regressionanalysis and measure ineffectiveness using the dollar offset method.

 

Derivatives are recordedon our consolidated balance sheet as assets or liabilities at fair value. Forderivatives qualifying as hedges, the effective portion of changes in fairvalue are recognized in partners’ equity as accumulated other comprehensiveincome (loss) and reclassified to earnings when the underlying hedged physicaltransaction closes. Changes in fair value of non-qualifying derivatives and theineffective portion of qualifying derivatives are recognized in earnings asthey occur. Actual amounts that will be reclassified will vary as a result offuture changes in prices. Hedge ineffectiveness is recorded in income while thehedge contract is open and may increase or decrease until settlement of thecontract. Realized cash gains and losses on closed/settled instruments andhedge ineffectiveness are reflected in the contract month being hedged as anadjustment to our midstream revenue.

 

On May 27, 2008, weentered into a financial swap instrument related to forecasted natural gassales in 2010 whereby we receive a fixed price and pay a floating price basedon NYMEX Henry Hub pricing for the relevant contract period as the underlyingnatural gas is sold. This financial swap instrument does not qualify for hedgeaccounting as there is inadequate correlation between NYMEX Henry Hub naturalgas prices and actual prices received for the natural gas sold. It ismanagement’s intent to swap a fixed and pay a floating Colorado Interstate Gas(“CIG”) basis differential to the contract NYMEX price in a future period.  Until, and if, this hedge positionqualifies for hedge accounting treatment, increases or decreases in the fairvalue of the derivative will be recorded directly to midstream revenues asgains or losses.

 

Presented in the tablebelow is information related to our derivatives for the indicated periods:

 

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| ** **                                                                                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                          | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                                                          | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net gains  (losses) on closed/settled transactions reclassified from accumulated other comprehensive  income (loss) |       | $                                | (1,395     | )                               | $          | 854 |   | $ | (6,478 | ) | $ | 2,309 |   |
| Increases  (decreases) in fair values of open derivatives recorded to accumulated other comprehensive income (loss) |       | $                                | 13,218     |                            | $          | (26 | ) | $ | 2,965 |   | $ | (1,356 | ) |
| Unrealized  non-cash gains on ineffective portions of qualifying derivative transactions                            |       | $                                | 133        |                            | $          | 33 |   | $ | 128 |   | $ | 24 |   |
| Unrealized  non-cash gains on non-qualifying derivatives                                                            |       | $                                | 5,487      |                            | $          | 305 |   | $ | 3,557 |   | $ | 486 |   |

 

At September 30,2008, our accumulated other comprehensive income related to qualifyingderivatives was $3,714. Of this amount, we anticipate $2,744 will bereclassified to earnings during the next twelve months and $970 will bereclassified to earnings in subsequent periods.

 

The fair value ofderivative assets and liabilities are as follows for the indicated periods:

 

| ** **                                        | ** ** | **As of**         | ** ** | **As of**        | ** ** |
|---------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                        | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Fair value of  derivative assets - current        |       | $                      | 4,521      |                  | $          | 2,718 |   |
| Fair value of  derivative assets - long term      |       | 4,991                  |       | 418                   |       |
| Fair value of  derivative liabilities - current   |       | (1,626                 | )          | (8,238                | )          |
| Fair value of  derivative liabilities - long term |       | —                 |       | (141                  | )          |
| Net fair value  of derivatives                    |       | $                      | 7,886      |                  | $          | (5,243 | ) |

 

The terms of ourderivative contracts currently extend as far as December 2010. Ourcounterparties to our derivative contracts are BP Energy Company and Bank ofOklahoma, N.A. Set forth below is the summarized notional amount and terms ofall instruments held for price risk management purposes at September 30,2008.

 

| ** **                                                 | ** ** | ** **  | ** ** | **Average**           | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------------|------------|-------------|------------|-----------------------|------------|---------------------|------------|
| ** **                                                 | ** ** | ** **  | ** ** | **Fixed**             | ** ** | **Asset**           | ** ** |
| **Description and Production Period**       | ** ** | **Volume**  | ** ** | **Price**             | ** ** | **(Liability)**     | ** ** |
| ** **                                                 | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**  | ** ** | ** **          | ** ** |
| Natural Gas -  Sold Fixed for Floating Price Swaps         |       |        |       |                  |       |                |       |   |   |
| October 2008  - September 2009                   |       | 2,097,000   |       | $                     | 7.42       |                | $          | 4,521 |   |
| October 2009  - December 2009                    |       | 534,000     |       | $                     | 7.30       |                | 1,016      |   |
| January 2010  - December 2010                    |       | 2,136,000   |       | $                     | 10.50      |                | 3,975      |   |
|                                                       |       |        |       |                  |       | $                   | 9,512      |   |
|                                                       |       |        |       |                  |       |                |       |
| ** **                                                 | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**  | ** ** | ** **          | ** ** |
| Natural Gas -  Buy Fixed for Floating Price Swaps          |       |        |       |                  |       |                |       |   |   |
| October 2008  - December 2008                    |       | 180,288     |       | $                     | 6.93       |                | $          | (396 | ) |
|                                                       |       |        |       |                  |       |                |       |
| ** **                                                 | ** ** | **(Bbls)**  | ** ** | **(per Gallon)** | ** ** | ** **          | ** ** |
| Natural Gas  Liquids - Sold Fixed for Floating Price Swaps |       |        |       |                  |       |                |       |   |   |
| October 2008  - December 2008                    |       | 110,442     |       | $                     | 1.31       |                | $          | (1,230 | ) |

 

**Note 5:  ****Fair ValueMeasurements of Financial Instruments**

 

We adopted SFAS No. 157,“Fair Value Measurements” (“SFAS 157”) beginning in the first quarter of 2008.SFAS 157 defines fair value as the price that would be received to sell anasset or paid to transfer a liability in an orderly transaction between marketparticipants at the measurement date, establishes a framework for measuringfair value in GAAP such as fair value hierarchy used to classify the source ofinformation used in fair value measurements (i.e., market based or non-marketbased) and expands disclosure about fair value measurements based on theirlevel in the hierarchy.  SFAS 157 appliesto derivatives and other financial instruments, which SFAS 133 requires bemeasured at fair value at initial recognition and for all subsequent periods.SFAS 157 establishes a fair value hierarchy which requires an entity tomaximize the use of observable inputs and minimize the use of unobservableinputs when measuring fair value. SFAS 157’s hierarchy defines three levels ofinputs that may be used to measure fair value. Level 1 refers to assets thathave observable market prices, level 2 assets do not have an “observable price”but do have inputs that are based on such prices in which components haveobservable data points and level 3 refers to assets in which one or more of theinputs do not have observable prices and calibrated model parameters, valuationtechniques or management’s assumptions are used to

 

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derive the fair value.

 

We use the fair valuemethodology outlined in SFAS 157 to value assets and liabilities for ouroutstanding fixed price cash flow swap derivative contracts. Valuations of ournatural gas and propane derivative contracts are based on published forwardprice curves for natural gas and propane and, as such, are defined as Level 2fair value hierarchy assets and liabilities. There are no published forwardprice curves for butanes or natural gasoline, and therefore, our butanes andnatural gasoline derivative contracts are defined as Level 3 fair valuehierarchy assets and liabilities. We value our butanes and natural gasolinederivative contracts based on calibrated model parameters relative to forwardpublished price curves for crude oil and comparative mark-to-market valuesreceived from our counterparty.  Thefollowing table represents the fair value hierarchy for our assets andliabilities at September 30, 2008:

 
| ** **                               | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|-----------|------------|
| Commodity -based  derivative assets      |       | $                | —     |             | $          | 9,512            |       | $         | —     |   | $ | 9,512 |   |
| Commodity -based  derivative liabilities |       | —           |       | (1,023           | )          | (603             | )          | (1,626    | )          |
| Total                                    |       | $                | —     |             | $          | 8,489            |       | $         | (603       | ) | $ | 7,886 |   |

 

Thefollowing table provides a summary of changes in the fair value of our Level 3commodity-based derivatives for the nine months ended September 30, 2008:

** **
| Balance,  January 1, 2008                    |   | $     | (4,489 | ) |
|---------------------------------------------------|--------|-------|--------|---|
| Cash settlements  from other comprehensive income |   | 4,850 |   |
| Net change in  other comprehensive income         |   | (964  | )      |
| Balance,  September 30, 2008                 |   | $     | (603   | ) |

 

**Note 6:  Long-TermDebt**

 
| ** **                                          | ** ** | **As of**         | ** ** | **As of**        | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                          | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Credit facility                                     |       | $                      | 262,064    |                  | $          | 221,064 |   |
| Capital lease  obligations                          |       | 5,216                  |       | 5,585                 |       |
|                                                |       | 267,280                |       | 226,649               |       |
| Less: current  portion of capital lease obligations |       | 647                    |       | 545                   |       |
| Long-term debt                                      |       | $                      | 266,633    |                  | $          | 226,104 |   |

 

*CreditFacility*. On February 6, 2008, we entered into a fourthamendment to our credit facility dated February 15, 2005. Pursuant to thefourth amendment, we have, among other things, increased our borrowing basefrom $250 million to $300 million and decreased the accordion feature in thefacility from $100 million to $50 million.  Our original credit facility dated February 15,2005 was first amended in September 2005, amended a second time in June 2006and amended a third time in July 2007.

 

The fourth amendmentincreases our borrowing capacity under our senior secured revolving creditfacility to $300 million such that the facility now consists of a $291 millionsenior secured revolving credit facility to be used for funding acquisitionsand other capital expenditures, issuance of letters of credit and generalcorporate purposes (the “Acquisition Facility”) and a $9.0 million seniorsecured revolving credit facility to be used for working capital and to funddistributions (the “Working Capital Facility”).

 

In addition, the fourthamendment provides for an accordion feature, which permits us, if certainconditions are met, to increase the size of the Acquisition Facility by up to$50 million and allows for the issuance of letters of credit of up to $15million in the aggregate.  The senior secured revolving credit facilityalso requires us to meet certain financial tests, including a maximumconsolidated funded debt to EBITDA ratio of 4.0:1.0 as of the last day of anyfiscal quarter; provided that in the event that the Partnership makes certainpermitted acquisitions or capital expenditures, this ratio may be increased to4.75:1.0 for the three fiscal quarters following the quarter in which suchacquisition or capital expenditure occurs; and a minimum interest coverageratio of 3.0:1.0. The credit facility will mature in May 2011. At thattime, the agreement will terminate and all outstanding amounts thereunder willbe due and payable.

 

Our obligations under thecredit facility are secured by substantially all of our assets and guaranteedby us, and all of our subsidiaries, other than our operating company, which isthe borrower under the credit facility.

 

Indebtedness under thecredit facility will bear interest, at our option, at either (i) anAlternate Base Rate plus an applicable margin ranging from 50 to 125 basispoints per annum or (ii) LIBOR plus an applicable margin ranging from 150to 225 basis points

 

13

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per annum based on ourratio of consolidated funded debt to EBITDA. The Alternate Base Rate is a rateper annum equal to the greatest of (a) the Prime Rate in effect on suchday, (b) the base CD rate in effect on such day plus 1.50% and (c) theFederal Funds effective rate in effect on such day plus 1/2 of 1%. We have elected for theindebtedness to bear interest at LIBOR plus the applicable margin. A letter ofcredit fee will be payable for the aggregate amount of letters of credit issuedunder the credit facility at a percentage per annum equal to 1.0%. An unusedcommitment fee ranging from 25 to 50 basis points per annum based on our ratioof consolidated funded debt to EBITDA will be payable on the unused portion ofthe credit facility. During any step-up period, the applicable margin withrespect to loans under the credit facility will be increased by 35 basis pointsper annum and the unused commitment fee will be increased by 12.5 basis pointsper annum. At September 30, 2008, the interest rate on outstandingborrowings from our credit facility was 4.76%.

 

The credit facilityprohibits us from making distributions to unitholders if any default or eventof default, as defined in the credit facility, has occurred and is continuingor would result from the distribution. In addition, the credit facilitycontains various covenants that limit, among other things, subject to certain exceptionsand negotiated “baskets,” our ability to incur indebtedness, grant liens, makecertain loans, acquisitions and investments, make any material changes to thenature of its business, amend its material agreements, including the OmnibusAgreement or enter into a merger, consolidation or sale of assets.

 

The credit facilitydefines EBITDA as our consolidated net income (loss), plus income tax expense,interest expense, depreciation, amortization and accretion expense,amortization of intangibles and organizational costs, non-cash unit basedcompensation expense, and adjustments for non-cash gains and losses onspecified derivative transactions and for other extraordinary or non-recurringitems.

 

Upon the occurrence of anevent of default as defined in the credit facility, the lenders may, amongother things, be able to accelerate the maturity of the credit facility andexercise other rights and remedies as set forth in the credit facility.

 

The credit facilitylimits distributions to our unitholders to available cash, as defined by theagreement, and borrowings to fund such distributions are only permitted underthe revolving working capital facility. The revolving working capital facilityis subject to an annual “clean-down” period of 15 consecutive days in which theamount outstanding under the revolving working capital facility is reduced tozero.

 

As of September 30,2008, we had $262.1 million outstanding under the credit facility and were incompliance with all of the financial covenants contained in the creditfacility.

 

*CapitalLease Obligations.* During the third quarter of 2007, weincurred two separate capital lease obligations at our Bakken and Badlandsgathering systems. Under the terms of a capital lease agreement for a railloading facility and an associated products pipeline at our Bakken gatheringsystem, we have agreed to repay a counterparty a predetermined amount over aperiod of eight years. Once fully paid, title to the leased assets willtransfer to us no later than the end of the eight-year period commencing fromthe inception date of the lease. We also incurred a capital lease obligation toa counterparty for the aid to construct several electric substations at ourBadlands gathering system which, by agreement, will be repaid in equal monthlyinstallments over a period of five years.

 

During the three and ninemonths ended September 30, 2008, we made principal payments of $134 and$369, respectively, on the above described capital lease obligations.  The current portion of the capital leaseobligations presented in the table above is included in accrued liabilities andother in the balance sheet.

 

**Note 7:  Share-Based Compensation**

 

Our general partner,Hiland Partners GP, LLC adopted the Hiland Partners, LP Long-Term IncentivePlan for its employees and directors of our general partner and employees ofits affiliates. The long-term incentive plan currently permits an aggregate of680,000 common units to be issued with respect to unit options, restrictedunits and phantom units granted under the plan. No more than 225,000 of the680,000 common units may be issued with respect to vested restricted or phantomunits. The plan is administered by the compensation committee of our generalpartner’s board of directors. The plan will continue in effect until theearliest of (i) a date determined by the board of directors of our generalpartner; (ii) the date common units are no longer available for payment ofawards under the plan; or (iii) the tenth anniversary of the plan.

 

Our general partner’s boardof directors or compensation committee may, in their discretion, terminate,suspend or discontinue the long-term incentive plan at any time with respect toany units for which a grant has not yet been made. Our general partner’s boardof directors or its compensation committee also has the right to alter or amendthe long-term incentive plan or any part of the plan from time to time,including increasing the number of units that may be granted, subject tounitholder approval if required by the exchange upon which the common units arelisted at that time. No change in any outstanding grant may be made, however,that would materially impair the rights of the participant without the consentof the participant. Under the unit option grant agreement, granted options ofcommon units vest and become exercisable in one-third increments on theanniversary of the grant date over three years.

 

14

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Vested options areexercisable within the option’s contractual life of ten years after the grantdate. Restricted common units granted vest and become exercisable in one-fourthincrements on the anniversary of the grant date over four years. A restricted unitis a common unit that is subject to forfeiture, and upon vesting, the granteereceives a common unit that is not subject to forfeiture. Distributions onunvested restricted common units are held in trust by our general partner untilthe units vest, at which time the distributions are distributed to the grantee.Granted phantom common units are generally more flexible than restricted unitsand vesting periods and distribution rights may vary with each grant. A phantomunit is a common unit that is subject to forfeiture and is not consideredissued until it vests. Upon vesting, holders of phantom units will receive (i) acommon unit that is not subject to forfeiture, cash in lieu of the delivery ofsuch unit equal to the fair market value of the unit on the vesting date, or acombination thereof, at the discretion of our general partner’s board ofdirectors and (ii) the distributions held in trust, if applicable, relatedto the vested units.

 

*PhantomUnits.*  On August 7,2008, we granted 7,500 phantom units to Mr. Kent C. Christopherson, ourChief Operating Officer, appointed on August 4, 2008, and on July 31,2008, we granted 3,000 phantom units to a key employee.  These phantom units vest over a four-yearperiod from the dates of issuance and distributions are held in trust by ourgeneral partner until such units vest.

 

The followingtable summarizes information about our phantom units for the nine months ended September 30,2008:

 

| ** **                        | ** ** | ** ** | ** ** | **Weighted**        | ** ** | ** **                  | ** ** |
|-----------------------------------|------------|------------|------------|---------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | ** ** | ** ** | **Average**         | ** ** | ** **                  | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Fair Value** | ** ** | **Fair Value At** | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **At Grant**   | ** ** | **Redemption**              | ** ** |
| ** **                        | ** ** | **Units**  | ** ** | **Date**            | ** ** | **Date**                    | ** ** |
| Unvested  January 1, 2008    |       | 42,825     |       | $                   | 50.12      |                        |       |   |
| Granted                           |       | 20,500     |       | $                   | 49.36      |                        |       |   |
| Vested and  converted             |       | (1,807     | )          | $                   | 54.50      |                        |       |   |
| Vested and  redeemed              |       | (693       | )          | $                   | 54.50      |                        | $          | 50.00 |   |
| Forfeited                         |       | (6,300     | )          | $                   | 48.80      |                        |       |   |
| Unvested  September 30, 2008 |       | 54,525     |       | $                   | 48.83      |                        |       |   |
|                                   |            |            |            |                     |            |                             |            |  |  |

 

During the three and ninemonths ended September 30, 2008, we incurred non-cash unit basedcompensation expense of $297 and $877, respectively, related to phantom units.During the three and nine months ended September 30, 2007, we incurred $73and $81, respectively, of non-cash unit based compensation expense related tophantom units. We will recognize additional expense of $1,698 over the nextfour years, and the additional expense is to be recognized over a weightedaverage period of 2.9 years.

 

*RestrictedUnits.*   As providedfor in the Long-Term Incentive Plan, each non-employee board member of ourgeneral partner on each anniversary date of the initial award is entitled toreceive an additional 1,000 restricted common units.  Accordingly, we issued a total of 6,000restricted units to our six non-employee board members of our general partnerduring the three and nine months ended September 30, 2008.  Alsoduring the three months ended September 30, 2008, a total of 5,500restricted units issued to the six non-employee board members of our generalpartner in 2005, 2006 and 2007 vested and were converted into commonunits.  The following table summarizesinformation about our restricted units for the nine months ended September 30,2008.

 

| ** **                             | ** ** | ** ** | ** ** | **Weighted**            | ** ** |
|----------------------------------------|------------|------------|------------|-------------------------|------------|
| ** **                             | ** ** | ** ** | ** ** | **Average**             | ** ** |
| ** **                             | ** ** | ** ** | ** ** | **Fair Value**     | ** ** |
| ** **                             | ** ** | ** ** | ** ** | **At Grant**       | ** ** |
| **Restricted Units**              | ** ** | **Units**  | ** ** | **Date ($ )** | ** ** |
| Non-vested at  January 1, 2008    |       | 19,375     |       | $                       | 46.57      |   |
| Granted                                |       | 6,000      |       | $                       | 43.97      |   |
| Vested                                 |       | (5,500     | )          | $                       | 44.78      |   |
| Forfeited or  expired                  |       | (375       | )          | $                       | 48.85      |   |
| Non-vested at  September 30, 2008 |       | 19,500     |       | $                       | 46.23      |   |

 

Non-cash unit basedcompensation expense related to the restricted units was $91 and $258 for thethree and nine months ended September 30, 2008, respectively, and was $137and $377 for the three and nine months ended September 30, 2007,respectively. As of September 30, 2008, there was $528 of totalunrecognized cost related to the unvested restricted units. This cost is to berecognized over a weighted average period of 2.7 years.

 

*UnitOptions.*   There havebeen no unit options granted since March 2006. In October 1995, TheFASB issued SFAS No. 123, “Share-Based Payment,” which was revised in December 2004(collectively, “SFAS 123R”). As a result of adopting SFAS 123R on the modified prospectivebasis beginning on January 1, 2006, during the three and nine months endedSeptember 30, 2008, we 

 

15

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incurred non-cashunit based compensation expense of $8 and $24, respectively, related to unitoptions that were awarded in both 2006 and 2005. During the three and ninemonths ended September 30, 2007, we expensed $34 and $131, respectively,related to the unit options.

 

The followingtable summarizes information about our common unit options for the nine monthsended September 30, 2008:

 

| ** **                              | ** ** | ** ** | ** ** | ** **         | ** ** | **Weighted-**         | ** ** | ** **         | ** ** |
|-----------------------------------------|------------|------------|------------|--------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                              | ** ** | ** ** | ** ** | **Weighted**       | ** ** | **Average**           | ** ** | ** **         | ** ** |
| ** **                              | ** ** | ** ** | ** ** | **Average**        | ** ** | **Remaining**         | ** ** | **Aggregate**      | ** ** |
| ** **                              | ** ** | ** ** | ** ** | **Exercise**       | ** ** | **Contractual**       | ** ** | **Intrinsic**      | ** ** |
| **Options**                             | ** ** | **Units**  | ** ** | **Price ($)** | ** ** | **Term (Years)** | ** ** | **Value ($)** | ** ** |
| Outstanding at  January 1, 2008    |       | 75,041     |       | $                  | 28.24      |                  |       |               |       |   |
| Granted                                 |       | —     |       |               |       |                  |       |               |       |
| Exercised                               |       | (40,705    | )          | $                  | 25.32      |                  |       |               | $          | 975 |   |
| Forfeited or  expired                   |       | (1,000     | )          | $                  | 40.11      |                  |       |               |       |   |
| Outstanding at  September 30, 2008 |       | 33,336     |       | $                  | 37.92      |                  | 7.3        |               | —     |   |
| Exercisable at  September 30, 2008 |       | 24,002     |       | $                  | 37.01      |                  | 7.1        |               | —     |   |
|                                         |            |            |            |                    |            |                       |            |                    |            |  |  |

 

**Note 8:  Commitmentsand Contingencies**

 

We have executed anatural gas fixed price physical forward sales contract on 100,000 MMBtu permonth for the remainder of 2008 with a fixed price of $8.43 per MMBtu.  This contract has been designated as a normalsale under SFAS 133 and is therefore not marked to market as a derivative.

 

We maintain a definedcontribution retirement plan for our employees under which we makediscretionary contributions to the plan based on a percentage of eligible employees’compensation. Contributions to the plan are 5.0% of eligible employees’compensation and resulted in expense for the three months ended September 30,2008 and 2007 of $83 and $64, respectively, and for the nine months ended September 30,2008 and 2007 was $238 and $190, respectively.

 

We maintain our healthand workers’ compensation insurance through third-party providers. Property andgeneral liability insurance is also maintained through third-party providerswith a $100 deductible on each policy.

 

The operation ofpipelines, plants and other facilities for gathering, compressing, treating, orprocessing natural gas, NGLs and other products is subject to stringent andcomplex laws and regulations pertaining to health, safety and the environment.Our management believes that compliance with federal, state and localenvironmental laws and regulations will not have a material adverse effect onour business, financial position or results of operations.

 

Although there are nosignificant regulatory proceedings in which we are currently involved,periodically we may be a party to regulatory proceedings. The results ofregulatory proceedings cannot be predicted with certainty; however, ourmanagement believes that we presently do not have material potential liabilityin connection with regulatory proceedings that would have a significantfinancial impact on our consolidated financial condition, results of operationsor cash flows.

 

We lease certainequipment, vehicles and facilities under operating leases, most of whichcontain annual renewal options. We also lease office space from a relatedentity. See Note 10 “Related Party Transactions.” Under these lease agreements,rent expense was $731 and $532, respectively, for the three months ended September 30,2008 and 2007 and $1,983 and $1,541 for the nine months ended September 30,2008 and 2007, respectively.

 

**Note 9:  SignificantCustomers and Suppliers**

 

All of our revenues aredomestic revenues. The following table presents our top midstream customers asa percent of total revenue for the periods indicated:

 

| ** ** | ** ** | **For the Three Months** | ** ** | **For the Nine Months** | ** ** |
|------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** ** | ** ** | **Ended September 30,**       | ** ** | **Ended September 30,**      | ** ** |
| ** ** | ** ** | **2008**                                | ** ** | **2007**                               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Customer 1 |       | 18                                      | %          | 7                                      | %          | 13 | % | 7 | % |
| Customer 2 |       | 14                                      | %          | 15                                     | %          | 10 | % | 12 | % |
| Customer 3 |       | 10                                      | %          | 9                                      | %          | 9 | % | 9 | % |
| Customer 4 |       | 7                                       | %          | 9                                      | %          | 12 | % | 20 | % |
| Customer 5 |       | 5                                       | %          | 19                                     | %          | 15 | % | 17 | % |

 

16

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All of our purchases arefrom domestic sources. The following table presents our top midstream suppliersas a percent of total midstream purchases for the periods indicated:

 

| ** **                       | ** ** | **For the Three Months** | ** ** | **For the Nine Months** | ** ** |
|----------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                       | ** ** | **Ended September 30,**       | ** ** | **Ended September 30,**      | ** ** |
| ** **                       | ** ** | **2008**                                | ** ** | **2007**                               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Supplier 1  (affiliated company) |       | 45                                      | %          | 32                                     | %          | 42 | % | 29 | % |
| Supplier 2                       |       | 17                                      | %          | 25                                     | %          | 18 | % | 26 | % |
| Supplier 3                       |       | 14                                      | %          | 13                                     | %          | 15 | % | 14 | % |

 

**Note 10:  RelatedParty Transactions**

 

We purchase natural gasand NGLs from affiliated companies. Purchases of product from affiliatestotaled $36,279 and $14,522 for the three months ended September 30, 2008and 2007, respectively, and totaled $99,328 and $39,264 for the nine monthsended September 30, 2008 and 2007, respectively. We also sell natural gasand NGLs to affiliated companies. Sales of product to affiliates totaled $7,390and $654 for the three months ended September 30, 2008 and 2007,respectively, and totaled $10,433 and $2,390 for the nine months ended September 30,2008 and 2007, respectively. Compression revenues from affiliates were $1,205and $3,615 for each of the three and nine months ended September 30, 2008and 2007, respectively.

 

Accountsreceivable-affiliates of $5,325 at September 30, 2008 include $5,183 fromone affiliate for midstream sales. Accounts receivable-affiliates of $1,479 at December 31,2007 include $1,090 from one affiliate for midstream sales.

 

Accountspayable-affiliates of $8,315 at September 30, 2008 include $7,671 due toone affiliate for midstream purchases. Accounts payable-affiliates of $7,880 atDecember 31, 2007 include $7,094 payable to the same affiliate formidstream purchases.

 

We utilize affiliatedcompanies to provide services to our plants and pipelines and certainadministrative services. The total expenditures to these companies were $157and $78 during the three months ended September 30, 2008 and 2007,respectively, and were $420 and $352 during the nine months ended September 30,2008 and 2007, respectively.

 

We lease office spaceunder operating leases directly or indirectly from an affiliate. Rent expenseassociated with these leases totaled $42 and $38 for the three months ended September 30,2008 and 2007, respectively, and totaled $117 and $105 for the nine monthsended September 30, 2008 and 2007, respectively.

 

**Note 11: Reportable Segments**

 

We have distinctoperating segments for which additional financial information must be reported.Our operations are classified into two reportable segments:

 

(1)   Midstream,which is the purchasing, gathering, compressing, dehydrating, treating,processing and marketing of natural gas and the fractionating and marketing ofNGLs.

 

(2)   Compression,which is providing air compression and water injection services for oil and gassecondary recovery operations that are ongoing in North Dakota.

 

These business segmentsreflect the way we manage our operations. Our operations are conducted in theUnited States. General and administrative costs, which consist of executivemanagement, accounting and finance, operations and engineering, marketing andbusiness development, are allocated to the individual segments based onrevenues.

 

Midstream assets totaled$417,914 at September 30, 2008. Assets attributable to compressionoperations totaled $26,117. All but $63 of the total capital expenditures of$38,043 for the nine months ended September 30, 2008 was attributable tomidstream operations. All but $16 of the total capital expenditures of $73,318for the nine months ended September 30, 2007 was attributable to midstreamoperations.

 

The tables below presentinformation for the reportable segments for the three and nine months ended September 30,2008 and 2007.

 

17

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| ** **                                                       | ** ** | **For the Three Months Ended September 30,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2008**                                                                   | ** ** | **2007** | ** ** |
| ** **                                                       | ** ** | **Midstream**                                                              | ** ** | **Compression** | ** ** | ** ** | ** ** | **Midstream** | ** ** | **Compression** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Segment**                                                                | ** ** | **Segment** | ** ** | **Total** | ** ** | **Segment** | ** ** | **Segment** | ** ** | **Total** | ** ** |
| Revenues                                                         |       | $                                                                          | 114,548    |   | $ | 1,205 |   | $ | 115,753 |   | $ | 66,431 |   | $ | 1,205 |   | $ | 67,636 |   |
| Operating costs  and expenses:                                   |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Midstream  purchases (exclusive of items shown separately below) |       | 81,895                                                                     |       | — |   | 81,895 |   | 45,789 |   | — |   | 45,789 |   |
| Operations and  maintenance                                      |       | 7,617                                                                      |       | 264 |   | 7,881 |   | 5,913 |   | 244 |   | 6,157 |   |
| Depreciation and  amortization                                   |       | 8,658                                                                      |       | 896 |   | 9,554 |   | 6,688 |   | 895 |   | 7,583 |   |
| Bad debt                                                         |       | (7,799                                                                     | )          | — |   | (7,799 | ) | — |   | — |   | — |   |
| General and  administrative expenses                             |       | 2,235                                                                      |       | 24 |   | 2,259 |   | 1,684 |   | 31 |   | 1,715 |   |
| Total operating  costs and expenses                              |       | 92,606                                                                     |       | 1,184 |   | 93,790 |   | 60,074 |   | 1,170 |   | 61,244 |   |
| Operating income                                                 |       | $                                                                          | 21,942     |   | $ | 21 |   | 21,963 |   | $ | 6,357 |   | $ | 35 |   | 6,392 |   |
| Other income  (expense):                                         |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest and  other income                                       |       |                                                                       |       |   |   | 96 |   |   |   |   |   | 102 |   |
| Amortization of  deferred loan costs                             |       |                                                                       |       |   |   | (147 | ) |   |   |   |   | (114 | ) |
| Interest expense                                                 |       |                                                                       |       |   |   | (3,271 | ) |   |   |   |   | (3,126 | ) |
| Total other  income (expense)                                    |       |                                                                       |       |   |   | (3,322 | ) |   |   |   |   | (3,138 | ) |
| Net income                                                       |       |                                                                       |       |   |   | $ | 18,641 |   |   |   |   |   | $ | 3,254 |   |

 
| ** **                                                       | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2008**                                                                  | ** ** | **2007** | ** ** |
| ** **                                                       | ** ** | **Midstream**                                                             | ** ** | **Compression** | ** ** | ** ** | ** ** | **Midstream** | ** ** | **Compression** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Segment**                                                               | ** ** | **Segment** | ** ** | **Total** | ** ** | **Segment** | ** ** | **Segment** | ** ** | **Total** | ** ** |
| Revenues                                                         |       | $                                                                         | 319,058    |   | $ | 3,615 |   | $ | 322,673 |   | $ | 191,691 |   | $ | 3,615 |   | $ | 195,306 |   |
| Operating costs  and expenses:                                   |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Midstream  purchases (exclusive of items shown separately below) |       | 238,586                                                                   |       | — |   | 238,586 |   | 137,320 |   | — |   | 137,320 |   |
| Operations and  maintenance                                      |       | 21,428                                                                    |       | 773 |   | 22,201 |   | 15,499 |   | 609 |   | 16,108 |   |
| Depreciation and  amortization                                   |       | 24,966                                                                    |       | 2,686 |   | 27,652 |   | 18,679 |   | 2,683 |   | 21,362 |   |
| Bad debt                                                         |       | 304                                                                       |       | — |   | 304 |   | — |   | — |   | — |   |
| General and  administrative expenses                             |       | 6,350                                                                     |       | 73 |   | 6,423 |   | 5,013 |   | 95 |   | 5,108 |   |
| Total operating  costs and expenses                              |       | 291,634                                                                   |       | 3,532 |   | 295,166 |   | 176,511 |   | 3,387 |   | 179,898 |   |
| Operating income                                                 |       | $                                                                         | 27,424     |   | $ | 83 |   | 27,507 |   | $ | 15,180 |   | $ | 228 |   | 15,408 |   |
| Other income  (expense):                                         |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Interest and  other income                                       |       |                                                                      |       |   |   | 267 |   |   |   |   |   | 314 |   |
| Amortization of  deferred loan costs                             |       |                                                                      |       |   |   | (426 | ) |   |   |   |   | (290 | ) |
| Interest expense                                                 |       |                                                                      |       |   |   | (9,888 | ) |   |   |   |   | (7,519 | ) |
| Total other income  (expense)                                    |       |                                                                      |       |   |   | (10,047 | ) |   |   |   |   | (7,495 | ) |
| Net income                                                       |       |                                                                      |       |   |   | $ | 17,460 |   |   |   |   |   | $ | 7,913 |   |

 

**Note 12: Net Income per Limited Partners’ Unit**

 

The computation of netincome per limited partners’ unit is based on the weighted-average number ofcommon and subordinated units outstanding during the period. The computation ofdiluted net income per limited partner unit further assumes the dilutive effectof unit options and restricted and phantom units. Net income per unitapplicable to limited partners is computed by dividing net income applicable tolimited partners, after deducting the general partner’s 2% interest andincentive distributions by the weighted-average number of limited partnershipunits outstanding. The following is a reconciliation of the limited partnerunits used in the calculations of income per limited partner unit—basic andincome per limited partner unit—diluted assuming dilution for the three andnine months ended September 30, 2008 and 2007:

 

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| ** **                                                                                   | ** ** | **For the Three Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2008**                                                                   | ** ** | **2007** | ** ** |
| ** **                                                                                   | ** ** | **Income**                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** | **Income** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | **Available to**                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | **Available to** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | **Limited**                                                                | ** ** | **Limited** | ** ** | ** ** | ** ** | **Limited** | ** ** | **Limited** | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | **Partners**                                                               | ** ** | **Partner Units** | ** ** | **Per Unit** | ** ** | **Partners** | ** ** | **Partner Units** | ** ** | **Per Unit** | ** ** |
| ** **                                                                                   | ** ** | **(Numerator)**                                                            | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** | **(Numerator)** | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| Income per  limited partner unit -basic:                                                     |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Income available  to limited partners                                                        |       | $                                                                          | 16,000     |   |   |   | $ | 1.71 |   | $ | 2,055 |   |   |   | $ | 0.22 |   |
| Weighted average  limited partner units outstanding                                          |       |                                                                       |       | 9,339,000 |   |   |   |   |   | 9,281,000 |   |   |   |
| Income per  limited partner unit - diluted: Unit Options, restricted and phantom units  |       |                                                                       |       | 26,000 |   |   |   |   |   | 41,000 |   |   |   |
| Income available  to limited partners plus assumed conversions                               |       | $                                                                          | 16,000     |   | 9,365,000 |   | $ | 1.71 |   | $ | 2,055 |   | 9,322,000 |   | $ | 0.22 |   |

 
| ** **                                                                                   | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| ** **                                                                                   | ** ** | **Income**                                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Income** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | **Available to**                                 | ** ** | ** ** | ** ** | ** ** | ** ** | **Available to** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | **Limited**                                      | ** ** | **Limited** | ** ** | ** ** | ** ** | **Limited** | ** ** | **Limited** | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | **Partners**                                     | ** ** | **Partner Units** | ** ** | **Per Unit** | ** ** | **Partners** | ** ** | **Partner Units** | ** ** | **Per Unit** | ** ** |
| ** **                                                                                   | ** ** | **(Numerator)**                                  | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** | **(Numerator)** | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| Income per  limited partner unit -basic:                                                     |       |                                             |       |   |   |   |   |   |   |   |   |   |   |
| Income available  to limited partners                                                        |       | $                                                | 10,947     |   |   |   | $ | 1.17 |   | $ | 4,937 |   |   |   | $ | 0.53 |   |
| Weighted average  limited partner units outstanding                                          |       |                                             |       | 9,323,000 |   |   |   |   |   | 9,276,000 |   |   |   |
| Income per  limited partner unit - diluted: Unit Options, restricted and phantom units  |       |                                             |       | 41,000 |   |   |   |   |   | 40,000 |   |   |   |
| Income available  to limited partners plus assumed conversions                               |       | $                                                | 10,947     |   | 9,364,000 |   | $ | 1.17 |   | $ | 4,937 |   | 9,316,000 |   | $ | 0.53 |   |

 

**Note13:   Partners’ Equity and Cash Distributions**

 

Our unitholders (limitedpartners) have only limited voting rights on matters affecting our operationsand activities and, therefore, limited ability to influence our management’sdecisions regarding our business. Unitholders did not select our generalpartner or elect the board of directors of our general partner and effectivelyhave no right to select our general partner or elect its board of directors inthe future. Unitholders’ voting rights are further restricted by ourpartnership agreement provision providing that any units held by a person thatowns 20% or more of any class of units then outstanding, other than the generalpartner, its affiliates, their transferees and persons who acquired such unitswith the prior approval of the board of directors of our general partner,cannot be voted on any matter. In addition, our partnership agreement containsprovisions limiting the ability of our unitholders to call meetings or toacquire information about our operations, as well as other provisions limitinga unitholders’ ability to influence the manner or direction of our management.

 

Our partnership agreementrequires that we distribute all of our cash on hand at the end of each quarter,less reserves established at our general partner’s discretion. We refer to thisas “available cash.” The amount of available cash may be greater than or lessthan the minimum quarterly distributions. In general, we will pay any cashdistribution made each quarter in the following manner:

 

·          first, 98% to the commonunits and 2% to our general partner, until each common unit has received aminimum quarterly distribution of $0.45 plus any arrearages from priorquarters;

 

·          second, 98% to thesubordinated units and 2% to our general partner, until each subordinated unithas received a minimum quarterly distribution of $0.45; and

 

·          third, 98% to all unitspro rata, and 2% to our general partner, until each unit has received adistribution of $0.495.

 

If cash distributions perunit exceed $0.495 in any quarter, our general partner will receive increasingpercentages, up to a maximum of 50% of the cash we distribute in excess of thatamount. We refer to these distributions as “incentive distributions.”

 

The distributions on thesubordinated units may be reduced or eliminated if necessary to ensure thecommon units receive their minimum quarterly distribution. Subordinated unitsdo not accrue arrearages. The subordination period will end with respect tocertain portions of the subordinated units once we meet certain financialtests, but will not end with respect to all subordinated units before March 31,2010. These financial tests require us to have earned and paid the minimumquarterly distribution on all of our outstanding units for three consecutivefour-quarter periods. When the subordination period ends, all remainingsubordinated units will convert into common units on a one-for-one basis andthe common units will no longer be entitled to arrearages. Following ourdistribution on 

 

19

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May 14, 2008, thesefinancial tests were met for the immediate preceding three consecutive four-quarterperiods, and accordingly, 25%, or 1,020,000, of the subordinated units wereconverted to common units on May 19, 2008.

 

Presented below are cashdistributions to common and subordinated unitholders, including amounts toaffiliate owners and regular and incentive distributions to our general partnerpaid by us from January 1, 2007 forward (in thousands, except per unitamounts):

 

| **Date Cash** | ** ** | **Per Unit Cash** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **               | ** ** | ** **          | ** ** | ** **       | ** ** |
|--------------------|------------|-----------------------------|------------|------------|------------|------------------|------------|--------------------------|------------|---------------------|------------|------------------|------------|
| **Distribution**   | ** ** | **Distribution**            | ** ** | **Common** | ** ** | **Subordinated** | ** ** | **General Partner** | ** ** | **Total Cash** | ** ** |
| **Paid**           | ** ** | **Amount**                  | ** ** | **Units**  | ** ** | **Units**        | ** ** | **Regular**              | ** ** | **Incentive**       | ** ** | **Distribution** | ** ** |
| 02/14/07           |       | $                           | 0.7125     |       | $          | 3,694            |       | $                        | 2,907      |                | $          | 150              |       | $ | 749 |   | $ | 7,500 |   |
| 05/15/07           |       | 0.7125                      |       | 3,724      |       | 2,907            |       | 151                      |       | 752                 |       | 7,534            |       |
| 08/14/07           |       | 0.7325                      |       | 3,837      |       | 2,989            |       | 158                      |       | 932                 |       | 7,916            |       |
| 11/14/07           |       | 0.7550                      |       | 3,959      |       | 3,080            |       | 167                      |       | 1,134               |       | 8,340            |       |
| 02/14/08           |       | 0.7950                      |       | 4,169      |       | 3,243            |       | 182                      |       | 1,492               |       | 9,086            |       |
| 05/14/08           |       | 0.8275                      |       | 4,364      |       | 3,376            |       | 194                      |       | 1,789               |       | 9,723            |       |
| 08/14/08           |       | 0.8625                      |       | 5,444      |       | 2,640            |       | 208                      |       | 2,107               |       | 10,399           |       |
| 11/14/08 (a)       |       | 0.8800                      |       | 5,574      |       | 2,693            |       | 215                      |       | 2,268               |       | 10,750           |       |
|               |       | $                           | 6.2775     |       | $          | 34,765           |       | $                        | 23,835     |                | $          | 1,425            |       | $ | 11,223 |   | $ | 71,248 |   |

 

----

(a)             This cashdistribution was announced on October 24, 2008 and will be paid on November 14,2008 to all unitholders of record as of November 4, 2008.

 

**Note14:   Subsequent Event**

 

OnJuly 22, 2008, SemGroup, L.P. and certain subsidiaries filed voluntarypetitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code.  Affiliates of SemGroup, L.P. purchase ournatural gas liquids and condensate, primarily at our Bakken and Badlands plantsand gathering systems.  During the secondquarter 2008, we increased our allowance for doubtful accounts and bad debtexpense by $8.1 million for related product sales through June 30, 2008.On October 20, 2008, the United States Bankruptcy Court for the Districtof Delaware entered an order approving the assumption of a Natural Gas LiquidsMarketing Agreement (the “SemStream Agreement”) between SemStream, L.P., anaffiliate of SemGroup, L.P., and us relating to the sale of natural gas liquidsand condensate at our Bakken and Badlands plants and gathering systems. As aresult of the assumption, and in accordance with the order, on October 21,2008, SemStream paid $12.1 million to us, representing amounts owed to us fromSemStream for June and July 2008 product sales under the SemStreamAgreement. The assumption of the SemStream Agreement restores us and SemStream,L.P. to our pre-bankruptcy contractual relationship.

 

Our third quarter results of operations reflect a reversal of $7.8million of the $8.1 million allowance for doubtful accounts and bad debtexpense previously recorded on our income statement in the second quarter of2008. After receipt of the October 21 payment, our total pre-petitioncredit exposure to SemGroup, related to condensate sales to SemCrude, LLC, andoutside of the SemStream Agreement, is approximately $0.3 million, which wehave reserved as of September 30, 2008.

 

On October 7, 2008,we entered into a floating-to-fixedinterest rate swap agreement with an investment grade counterpartywhereby we pay a monthly fixed interest rate of 2.245% and receive a monthlyvariable rate based on the one month posted LIBOR interest rate on a notionalamount of $100.0 million.  This swapagreement is effective on January 2, 2009 and terminates on January 1,2010.

 

20

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**CautionaryStatement About Forward-Looking Statements**

 

This Report on Form 10-Qincludes certain “forward-looking statements” within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934.  These statements include statements regarding our plans,goals, beliefs or current expectations. Statements using words such as “anticipate,”“believe,” “intend,” “project,” “plan,” “continue,” “estimate,” “forecast,” “may,”“will” or similar expressions help identify forward-looking statements. Although we believe such forward-looking statements are based on reasonableassumptions and current expectations and projections about future events, noassurance can be given that every objective will be reached.

 

Our actual results maydiffer materially from any results projected, forecasted, estimated orexpressed in forward-looking statements since many of the factors thatdetermine these results are subject to uncertainties and risks, difficult topredict, and beyond management’s control.  Such factors include:

 

·                  theability to pay distributions to our unitholders;

 

·                  thegeneral economic conditions in the United States of America as well as thegeneral economic conditions and currencies in foreign countries;

 

·                  thecontinued ability to find and contract for new sources of natural gas supply;

 

·                  theamount of natural gas transported on our gathering systems;

 

·                  thelevel of throughput in our natural gas processing and treating facilities;

 

·                  thefees we charge and the margins realized for our services;

 

·                  theprices and market demand for, and the relationship between, natural gas andNGLs;

 

·                  energyprices generally;

 

·                  thelevel of domestic oil and natural gas production;

 

·                  theavailability of imported oil and natural gas;

 

·                  actionstaken by foreign oil and gas producing nations;

 

·                  thepolitical and economic stability of petroleum producing nations;

 

·                  theweather in our operating areas;

 

·                  theextent of governmental regulation and taxation;

 

·                  hazardsor operating risks incidental to the transporting, treating and processing ofnatural gas and NGLs that may not be fully covered by insurance;

 

·                  competitionfrom other midstream companies;

 

·                  lossof key personnel;

 

·                  theability to comply with the financial covenants contained in our creditfacility;

 

·                  theavailability and cost of capital and our ability to access certain capitalsources;

 

·                  changesin laws and regulations to which we are subject, including tax, environmental,transportation and employment regulations;

 

·                  thecosts and effects of legal and administrative proceedings;

 

·                  theability to successfully identify and consummate strategic acquisitions atpurchase prices that are accretive to our financial results;

 

·                  risksassociated with the construction of new pipelines and treating and processingfacilities or additions to our existing pipelines and facilities.

 

21

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·      because of the natural decline in production from existing wells, oursuccess depends on our ability to obtain new supplies of natural gas, whichinvolves factors beyond our control. Any decrease in supplies of natural gas inour areas of operation could adversely affect our business and operatingresults;

 

·      the completion ofsignificant, unbudgeted expansion projects may require debt and/or equityfinancing which may not be available to us on acceptable terms, or at all;

 

·      increases in interest ratescould increase our borrowing costs, adversely impact our unit price and ourability to issue additional equity, which could have an adverse effect on ourcash flows and our ability to fund our growth; and

 

·      our cash flow is affected by thevolatility of natural gas and NGL product prices, which could adversely affectour ability to make distributions to unitholders.

 

These factors are notnecessarily all of the important factors that could cause our actual results todiffer materially from those expressed in any of our forward-lookingstatements.  Our future results will depend upon various other risks anduncertainties, including, but not limited to those described above.  Otherunknown or unpredictable factors also could have material adverse effects onour future results.  You should not place undue reliance on anyforward-looking statements.

 

All forward-lookingstatements attributable to us are qualified in their entirety by thiscautionary statement.   We undertake no duty to update ourforward-looking statements to reflect the impact of events or circumstancesafter the date of the forward-looking statements.

 

**Item2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

**DISRUPTION TO FUNCTIONINGOF CAPITAL MARKETS**

 

Multiple events during2008 involving numerous financial institutions have effectively restrictedcurrent liquidity within the capital markets throughout the United States andaround the world. Despite efforts by treasury and banking regulators in theUnited States, Europe and other nations around the world to provide liquidityto the financial sector, capital markets currently remain constrained. Weexpect that our ability to raise debt and equity at prices that are similar toofferings in recent years to be limited over the next three to six months andpossibly longer should capital markets remain constrained.

 

In the weeks followingthe third quarter, our unit price declined to a closing low of $18.00 on October 10,2008. Since that date our unit price recovered partially to a level of $[  .] on November 7, 2008. We currentlyintend to move forward with our planned internal growth projects, and in thenear-term we will focus on maintaining sufficient liquidity to fund our growthprograms, see “Liquidity and Capital Resources.” Maintaining adequate liquiditymay involve the issuance of debt and/or equity at less attractive terms.

 

**OVERVIEW**

 

We are engaged inpurchasing, gathering, compressing, dehydrating, treating, processing andmarketing of natural gas, fractionating and marketing of NGLs and providing aircompression and water injection services for oil and gas secondary recoveryoperations. Our operations are primarily located in the Mid-Continent and RockyMountain regions of the United States.

 

We manage our businessand analyze and report our results of operations on a segment basis. Ouroperations are divided into two business segments:

 

·    *Midstream Segment,* which is engagedin purchasing, gathering, compressing, dehydrating, treating, processing andmarketing of natural gas and the fractionating and marketing of NGLs. Themidstream segment generated 96.4% and 94.5% of our total segment margin for thethree months ended September 30, 2008 and 2007, respectively, and 95.7%and 93.8% of our total segment margin for the nine months ended September 30,2008 and 2007, respectively.

 

·    *Compression Segment,* which is engagedin providing air compression and water injection services for oil and gassecondary recovery operations that are ongoing in North Dakota. The compressionsegment generated 3.6% and 5.5% of our total segment margin for the threemonths ended September 30, 2008 and 2007, respectively, and 4.3% and 6.2%of our total segment margin for the nine months ended September 30, 2008and 2007, respectively.

 

Our midstream assetscurrently consist of 14 natural gas gathering systems with approximately 2,087miles of gas gathering pipelines, five natural gas processing plants, sevennatural gas treating facilities and three NGL fractionation facilities. Ourcompression assets consist of two air compression facilities and a waterinjection plant.

 

Our results of operationsare determined primarily by five interrelated variables: (1) the volume ofnatural gas gathered through our pipelines; (2) the volume of natural gasprocessed; (3) the volume of NGLs fractionated; (4) the level andrelationship of natural gas and NGL prices; and (5) 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, the pricingenvironment for natural gas and NGLs 

 

22

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and the price of NGLsrelative to natural gas prices 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.

 

**Recent Events**

 

*DistributionIncrease.  *On October 24,2008, we declared a cash distribution for the third quarter of 2008. Thisdeclared quarterly distribution on ourcommon and subordinated units increased to $0.88 per unit (an annualized rateof $3.52 per unit) from our most recent distribution of $0.8625 per unit (anannualized rate of $3.45 per unit). This represents a 2.0% increase over theprior quarter and a 16.6% increase over the distribution for the same quarterof the prior year. The distribution will be paid on November 14, 2008 tounitholders of record on November 4, 2008. Under our partnershipagreement, generally, our general partner is entitled to 15% of the amount wedistribute to each unitholder in excess of $0.495 per unit per quarter up to$0.5625 per unit per quarter, 25% of the amount we distribute to eachunitholder in excess of $0.5625 per unit per quarter up to $0.675 per unit perquarter and 50% of the excess over $0.675 per unit per quarter.

 

*Significant Trade Account Receivable.*  On July 22, 2008, SemGroup, L.P. andcertain subsidiaries filed voluntary petitions for reorganization under Chapter11 of the U.S. Bankruptcy Code. Affiliates of SemGroup, L.P. purchase our natural gas liquids andcondensate, primarily at our Bakken and Badlands plants and gatheringsystems.  During the second quarter 2008,we increased our allowance for doubtful accounts and bad debt expense by $8.1million for related  product sales throughJune 30, 2008. On October 20, 2008, the United States BankruptcyCourt for the District of Delaware entered an order approving the assumption ofa Natural Gas Liquids Marketing Agreement (the “SemStream Agreement”) betweenSemStream, L.P., an affiliate of SemGroup, L.P., and us relating to the sale ofnatural gas liquids and condensate at our Bakken and Badlands plants andgathering systems. As a result of the assumption, and in accordance with theorder, on October 21, 2008, SemStream paid $12.1 million to us,representing amounts owed to us from SemStream for June and July 2008product sales under the SemStream Agreement. The assumption of the SemStreamAgreement restores us and SemStream, L.P. to our pre-bankruptcy contractualrelationship.

 

Our third quarter results of operations reflect a reversal of $7.8million of the $8.1 million allowance for doubtful accounts and bad debtexpense previously recorded on our statement of operations in the secondquarter of 2008. After receipt of the October 21 payment, our totalpre-petition credit exposure to SemGroup, related to condensate sales toSemCrude, LLC, and outside of the SemStream Agreement, is approximately $0.3million, which we have reserved as of September 30, 2008.

 

*FinancialHedge Agreement. *On October 7,2008, we entered into a floating-to-fixedinterest rate swap agreement with an investment grade counterpartywhereby we pay a monthly fixed interest rate of 2.245% and receive a monthlyvariable rate based on the one month posted LIBOR interest rate on a notionalamount of $100.0 million.  The swapagreement is effective January 2, 2009 and terminates on January 1,2010.

 

*OrganicGrowth Projects.* During the second quarter 2008, we enteredinto an agreement with CLR to construct and operate gathering pipelines,processing plants and related facilities in the Bakken Shale play innorthwestern North Dakota in which CLR has dedicated approximately 129,000gross acres to us. The initial term of the agreement is for 10 years and grantsus the right to process natural gas, share in the sales proceeds of the naturalgas liquids and residue gas and receive certain fixed fees for treating thenatural gas. We plan to make an initial capital investment of approximately$10.0 million by the end of 2008 with additional investments of up to $17.0million over the next three years to build processing and treating facilitiesand install field gathering, compression and associated equipment.  As of September 30, 2008, we haveinitially invested $0.4 million in the project. The expected startup of the initial phase of the project should occur nolater than the second quarter of 2009.

 

During the third quarterof 2008, we invested approximately $10.4 million to expand our Woodford Shalegathering system’s throughput capacity to approximately 65,000 Mcf/d.

 

**HistoricalResults of Operations**

 

Our historical results ofoperations for the periods presented may not be comparable, either from periodto period or going forward due to increased volumes and associated operating expensesat our Badlands gathering system as a result of the construction of ournitrogen rejection plant which became operational in August 2007 andvolumes and operating expenses at our Woodford Shale gathering system whichcommenced operation in April 2007.

 

**OurResults of Operations**

 

Set forth in the tablesbelow are certain financial and operating data for the periods indicated.

 

23

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| ** **                                                       | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2008**                                                 | ** ** | **2007** | ** ** |
| ** **                                                       | ** ** | **(in thousands)**                                  | ** ** |
| **Total  Segment Margin Data:**                                  |       |                                                     |       |   |   |
| Midstream  revenues                                              |       | $                                                        | 114,548    |   | $ | 66,431 |   |
| Midstream  purchases                                             |       | 81,895                                                   |       | 45,789 |   |
| Midstream  segment margin                                        |       | 32,653                                                   |       | 20,642 |   |
| Compression  revenues (1)                                        |       | 1,205                                                    |       | 1,205 |   |
| Total segment  margin (2)                                        |       | $                                                        | 33,858     |   | $ | 21,847 |   |
|                                                             |       |                                                     |       |   |   |
| **Summary  of Operations Data:**                                 | ** ** | ** **                                               | ** ** | ** ** | ** ** |
| Midstream  revenues                                              |       | $                                                        | 114,548    |   | $ | 66,431 |   |
| Compression  revenues                                            |       | 1,205                                                    |       | 1,205 |   |
| Total revenues                                                   |       | 115,753                                                  |       | 67,636 |   |
|                                                             |       |                                                     |       |   |   |
| Midstream  purchases (exclusive of items shown separately below) |       | 81,895                                                   |       | 45,789 |   |
| Operations and  maintenance                                      |       | 7,881                                                    |       | 6,157 |   |
| Depreciation,  amortization and accretion                        |       | 9,554                                                    |       | 7,583 |   |
| Bad debt                                                         |       | (7,799                                                   | )          | — |   |
| General and  administrative                                      |       | 2,259                                                    |       | 1,715 |   |
| Total operating  costs and expenses                              |       | 93,790                                                   |       | 61,244 |   |
| Operating income                                                 |       | 21,963                                                   |       | 6,392 |   |
| Other income  (expense)                                          |       | (3,322                                                   | )          | (3,138 | ) |
| **Net  income**                                                  |       | 18,641                                                   |       | 3,254 |   |
|                                                             |       |                                                     |       |   |   |
| Add:                                                             |       |                                                     |       |   |   |
| Depreciation,  amortization and accretion                        |       | 9,554                                                    |       | 7,583 |   |
| Amortization of  deferred loan costs                             |       | 147                                                      |       | 114 |   |
| Interest expense                                                 |       | 3,271                                                    |       | 3,126 |   |
| **EBITDA  (3)**                                                  |       | $                                                        | 31,613     |   | $ | 14,077 |   |
|                                                             |       |                                                     |       |   |   |
| Operating Data:                                                  |       |                                                     |       |   |   |
| Inlet natural  gas (Mcf/d)                                       |       | 261,345                                                  |       | 219,544 |   |
| Natural gas  sales (MMBtu/d)                                     |       | 95,889                                                   |       | 84,281 |   |
| NGL sales  (Bbls/d)                                              |       | 6,036                                                    |       | 4,721 |   |

 

| ** **                                                       | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                       | ** ** | **2008**                                 | ** ** | **2007** | ** ** |
| ** **                                                       | ** ** | **(in thousands)**                       | ** ** |
| **Total  Segment Margin Data:**                                  |       |                                     |       |   |   |
| Midstream  revenues                                              |       | $                                        | 319,058    |   | $ | 191,691 |   |
| Midstream  purchases                                             |       | 238,586                                  |       | 137,320 |   |
| Midstream  segment margin                                        |       | 80,472                                   |       | 54,371 |   |
| Compression  revenues (1)                                        |       | 3,615                                    |       | 3,615 |   |
| Total segment  margin (2)                                        |       | $                                        | 84,087     |   | $ | 57,986 |   |
|                                                             |       |                                     |       |   |   |
| **Summary  of Operations Data:**                                 | ** ** | ** **                               | ** ** | ** ** | ** ** |
| Midstream  revenues                                              |       | $                                        | 319,058    |   | $ | 191,691 |   |
| Compression  revenues                                            |       | 3,615                                    |       | 3,615 |   |
| Total revenues                                                   |       | 322,673                                  |       | 195,306 |   |
|                                                             |       |                                     |       |   |   |
| Midstream  purchases (exclusive of items shown separately below) |       | 238,586                                  |       | 137,320 |   |
| Operations and  maintenance                                      |       | 22,201                                   |       | 16,108 |   |
| Depreciation,  amortization and accretion                        |       | 27,652                                   |       | 21,362 |   |
| Bad debt                                                         |       | 304                                      |       | — |   |
| General and  administrative                                      |       | 6,423                                    |       | 5,108 |   |
| Total operating  costs and expenses                              |       | 295,166                                  |       | 179,898 |   |
| Operating income                                                 |       | 27,507                                   |       | 15,408 |   |
| Other income  (expense)                                          |       | (10,047                                  | )          | (7,495 | ) |
| **Net  income**                                                  |       | 17,460                                   |       | 7,913 |   |
|                                                             |       |                                     |       |   |   |
| Add:                                                             |       |                                     |       |   |   |
| Depreciation,  amortization and accretion                        |       | 27,652                                   |       | 21,362 |   |
| Amortization of  deferred loan costs                             |       | 426                                      |       | 290 |   |
| Interest expense                                                 |       | 9,888                                    |       | 7,519 |   |
| **EBITDA  (3)**                                                  |       | $                                        | 55,426     |   | $ | 37,084 |   |
|                                                             |       |                                     |       |   |   |
| Operating Data:                                                  |       |                                     |       |   |   |
| Inlet natural  gas (Mcf/d)                                       |       | 245,098                                  |       | 210,878 |   |
| Natural gas  sales (MMBtu/d)                                     |       | 89,615                                   |       | 78,998 |   |
| NGL sales  (Bbls/d)                                              |       | 5,763                                    |       | 4,340 |   |

 

24

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----

(1) Compressionrevenues and compression segment margin are the same. There are no compressionpurchases associated with the compression segment.

 

(2) Reconciliationof total segment margin to operating income:

 

| ** **                                                      | ** ** | **Three Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2008**                                                 | ** ** | **2007** | ** ** |
| ** **                                                      | ** ** | **(in thousands)**                                  | ** ** |
| **Reconciliation  of Total Segment Margin to Operating Income** |       |                                                     |       |   |   |
| Operating income                                                |       | $                                                        | 21,963     |   | $ | 6,392 |   |
| Add:                                                            |       |                                                     |       |   |   |
| Operations and  maintenance expenses                            |       | 7,881                                                    |       | 6,157 |   |
| Depreciation,  amortization and accretion                       |       | 9,554                                                    |       | 7,583 |   |
| Bad debt                                                        |       | (7,799                                                   | )          | — |   |
| General and  administrative expenses                            |       | 2,259                                                    |       | 1,715 |   |
| Total segment  margin                                           |       | $                                                        | 33,858     |   | $ | 21,847 |   |

 

| ** **                                                      | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| ** **                                                      | ** ** | **(in thousands)**                                 | ** ** |
| **Reconciliation  of Total Segment Margin to Operating Income** |       |                                                    |       |   |   |
| Operating income                                                |       | $                                                       | 27,507     |   | $ | 15,408 |   |
| Add:                                                            |       |                                                    |       |   |   |
| Operations and  maintenance expenses                            |       | 22,201                                                  |       | 16,108 |   |
| Depreciation,  amortization and accretion                       |       | 27,652                                                  |       | 21,362 |   |
| Bad debt                                                        |       | 304                                                     |       | — |   |
| General and  administrative expenses                            |       | 6,423                                                   |       | 5,108 |   |
| Total segment  margin                                           |       | $                                                       | 84,087     |   | $ | 57,986 |   |

 

We view totalsegment margin, a non-GAAP financial measure, as an important performancemeasure of the core profitability of our operations because it is directlyrelated to our volumes and commodity price changes. We review total segmentmargin monthly for a consistency and trend analysis. We define midstreamsegment margin as midstream revenue less midstream purchases. Midstreampurchases include the following costs and expenses: cost of natural gas andNGLs purchased by us from third parties, cost 

 

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of natural gas andNGLs purchased by us from affiliates, and the cost of crude oil purchased by usfrom third parties. We define compression segment margin as the revenue derivedfrom our compression segment. Our total segment margin may not be comparable tosimilarly titled measures of other companies as other companies may notcalculate total segment margin in the same manner.

 

(3) We defineEBITDA, a non-GAAP financial measure, as net income (loss) plus interestexpense, provisions for income taxes and depreciation, amortization andaccretion expense. EBITDA is used as a supplemental financial measure by ourmanagement and by external users of our financial statements such as investors,commercial banks, research analysts and others to assess: (1) thefinancial performance of our assets without regard to financial methods,capital structure or historical cost basis; (2) the ability of our assetsto generate cash sufficient to pay interest costs and support our indebtedness;(3) our operating performance and return on capital as compared to thoseof other companies in the midstream energy sector, without regard to financingor structure; and (4) the viability of acquisitions and capitalexpenditure projects and the overall rates of return on alternative investmentopportunities. EBITDA is also a financial measurement that, with certainnegotiated adjustments, is reported to our banks and is used as a gauge forcompliance with our financial covenants under our credit facility. EBITDAshould not be considered an alternative to net income (loss), operating income,cash flows from operating activities or any other measure of financial performancepresented in accordance with GAAP.  Our EBITDA may not be comparable toEBITDA of similarly titled measures of other entities, as other entities maynot calculate EBITDA in the same manner as we do.

 

**ThreeMonths Ended September 30, 2008 Compared with Three Months Ended September 30,2007**

 

***Revenues.***  Total revenues(midstream and compression) were $115.7 million for the three months ended September 30,2008 compared to $67.6 million for the three months ended September 30,2007, an increase of $48.1 million, or 71.1%.  This $48.1 million increasewas primarily due to: (i) increased natural gas sales volumes of 15,830MMBtu/day (MMBtu per day) and increased NGL sales volumes of 609 Bbls/day (Bblsper day) related to the Woodford Shale gathering system, (ii) increasedNGL sales volumes of 646 Bbls/day attributable to the expanded Badlandsgathering system, including the nitrogen rejection plant, which commencedoperation in August 2007 and (iii) significantly higher averagerealized natural gas and NGL sales prices for the three months ended September 30,2008 as compared to the same period in 2007, resulting in increased revenuesfor nearly all of our gathering systems.  Revenues from compression assetswere the same for both periods.

 

Midstream revenues were$114.5 million for the three months ended September 30, 2008 compared to$66.4 million for the three months ended September 30, 2007, an increaseof $48.1 million, or 72.4%. Of this $48.1 million increase in midstreamrevenues, approximately $13.3 million was attributable to revenues fromincreased natural gas and NGL sales volumes at our Woodford Shale, Badlands,Bakken and Matli gathering systems and approximately $34.8 million wasattributable to significantly higher average realized natural gas and NGL salesprices for the three months ended September 30, 2008 as compared to thesame period in 2007, resulting in increased revenues for all of our gatheringsystems.

 

Inlet natural gas was261,345 Mcf/d (Mcf per day) for the three months ended September 30, 2008compared to 219,544 Mcf/d for the three months ended September 30, 2007,an increase of 41,801 Mcf/d, or 19.0%. This increase is primarily attributable to volume growth at our WoodfordShale and Badlands gathering systems offset by volume declines at our EagleChief and Worland gathering systems.

 

Natural gas sales volumeswere 95,889 MMBtu/d for the three months ended September 30, 2008 comparedto 84,281 MMBtu/d for the three months ended September 30, 2007, anincrease of 11,608 MMBtu/d, or 13.8%.  This 11,608 MMBtu/d net increase innatural gas sales volumes was attributable to increased natural gas salesvolumes at our Woodford Shale, Bakken and Matli gathering systems offset byreduced natural gas sales volumes at our Eagle Chief, Worland and Kintagathering systems.

 

NGL sales volumes were6,036 Bbls/d for the three months ended September 30, 2008 compared to4,721 Bbls/d for the three months ended September 30, 2007, a net increaseof 1,315 Bbls/d, or 27.9%.  This net increase is primarily attributable tovolume growth at our Woodford Shale and Badlands gathering systems.

 

Average realized naturalgas sales prices were $7.57 per MMBtu for the three months ended September 30,2008 compared to $5.20 per MMBtu for the three months ended September 30,2007, an increase of $2.37 per MMBtu, or 45.6%.  Average realized NGLsales prices were $1.55 per gallon for the three months ended September 30,2008 compared to $1.16 per gallon for the three months ended September 30,2007, an increase of $0.39 per gallon or 33.6%.  The increase in ouraverage realized natural gas and NGL sales prices was primarily a result ofsignificantly higher index prices for natural gas and posted prices for NGLsduring the three months ended September 30, 2008 compared to the threemonths ended September 30, 2007.

 

Cash received from ourcounterparty on cash flow swap contracts for natural gas derivativetransactions that closed during the three months ended September 30, 2008totaled $1.1 million compared to $1.5 million for the three months ended September 30,2007.  The $1.1 million gain for the three months ended September 30,2008 increased averaged realized natural gas prices to $7.57 per MMBtu from$7.44 per MMBtu, an increase of $0.13 per MMBtu.  The $1.5 million gain for the three monthsended September 30, 2007 increased averaged realized natural gas prices to$5.20 per MMBtu from $5.00 per MMBtu, an increase of $0.20 per MMBtu. Cash paidto our counterparty on cash flow swap contracts for NGL derivative transactionsthat closed during the three months ended September 30, 2008 totaled $2.5million compared to $0.6 million for the three months ended September 30,2007.

 

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The $2.5 million loss forthe three months ended September 30, 2008 reduced averaged realized NGLprices to $1.55 per gallon from $1.65 per gallon, a decrease of $0.10 pergallon. The $0.6 million loss for the three months ended September 30,2007 reduced averaged realized NGL prices to $1.16 per gallon from $1.18 pergallon, a decrease of $0.02 per gallon.

 

Compression revenues were$1.2 million for the each of the three months ended September 30, 2008 and2007.

 

***Midstream Purchases.***  Midstreampurchases were $81.9 million for the three months ended September 30, 2008compared to $45.8 million for the three months ended September 30, 2007,an increase of $36.1 million, or 78.9%.  The $36.1 million increase isprimarily due to volume growth at the Woodford Shale gathering system, theexpanded Badlands gathering system, including the nitrogen rejection plant,which commenced operation in August 2007 and higher natural gas and NGLpurchase prices, resulting in increased midstream purchases for all of ourgathering systems.

 

***Midstream Segment Margin .***  Midstreamsegment margin was $32.6 million for the three months ended September 30,2008 compared to $20.6 million for the three months ended September 30,2007, an increase of $12.0 million, or 58.2%. The increase is primarily due to favorable gross processing spreads,significantly higher average realized natural gas and NGL prices, volume growthat the Woodford Shale gathering system and volume growth at the expandedBadlands gathering system, including the nitrogen rejection plant, whichcommenced operations in August 2007. As a percent of midstream revenues, midstream segment margin was 28.5%and 31.1% for the three months ended September 30, 2008 and 2007,respectively, a reduction of 2.6%.  Thisreduction is attributable to net losses on closed/settled derivativetransactions and unrealized non-cash losses on derivative transactions for thethree months ended September 30, 2008 totaling $1.3 million, after beingoffset by an unrealized non-cash gain of $5.6 million related to anon-qualifying mark-to-market cash flow derivative for forecasted sales in2010, compared to net gains of $0.9 million on closed/settled derivativetransactions and unrealized non-cash gains on derivative transactions for thethree months ended September 30, 2007.

 

***Operations and Maintenance.*** Operations and maintenance expense totaled $7.9 million for the three monthsended September 30, 2008 compared with $6.2 million for the three monthsended September 30, 2007, an increase of $1.7 million, or 28.0%. Of thisincrease, $1.2 million was attributable to increased operations and maintenanceat the expanded Badlands gathering system and $0.4 million was attributable toincreased operations and maintenance at the Woodford Shale gathering system.

 

***Depreciation, Amortization and Accretion.*** Depreciation, amortization and accretion expense totaled $9.6 million for thethree months ended September 30, 2008 compared with $7.6 million for thethree months ended September 30, 2007, an increase of $2.0 million, or26.0 %.  Of this increase, $0.6 million was attributable to increaseddepreciation on the expanded Badlands gathering system, $0.7 million wasattributable to the Woodford Shale gathering system and $0.3 million wasattributable to increased depreciation on the Bakken gathering system.

 

***Bad Debt.***  During the threemonths ended September 30, 2008, we recorded a reversal of anuncollectible trade accounts receivable of $7.8 million related to a receivablefrom a significant customer in which we had previously reserved an allowancefor uncollectible accounts of $8.1 million during the second quarter of 2008.Accordingly, we have decreased our reserve for uncollectible accounts to $0.3million, which represents the remaining potential exposure to this significantcustomer. We had no bad debts for the three months ended September 30,2007.

 

***General and Administrative.*** General and administrative expense totaled $2.3 million for the three monthsended September 30, 2008 compared with $1.7 million for the three monthsended September 30, 2007, an increase of $0.5 million, or 31.7 %. Salariesexpense increased by $0.5 million as a result of increased non-cash unit basedcompensation and increased staffing during the three months ended September 30,2008 as compared to the three months ended September 30, 2007.

 

***Other Income (Expense).*** Otherincome (expense) totaled $(3.3) million for the three months ended September 30,2008 compared with $(3.1) million for the three months ended September 30,2007, an increase in expense of $0.2 million.  The increase is primarilyattributable to additional interest expense from borrowings on our creditfacility to fund expansions at the Badlands gathering system, Woodford Shalegathering system, and the Kinta gathering systems, after being offset by lowerinterest rates incurred during the three months ended September 30, 2008compared to interest rates incurred during the three months ended September 30,2007.

 

**NineMonths Ended September 30, 2008 Compared with Nine Months Ended September 30,2007**

 

***Revenues.***  Total revenues(midstream and compression) were $322.7 million for the nine months ended September 30,2008 compared to $195.3 million for the nine months ended September 30,2007, an increase of $127.4 million, or 65.2%.  This $127.4 millionincrease was primarily due to: (i) increased natural gas sales volumes of14,052 MMBtu/day (MMBtu per day) and increased NGL sales volumes of 901Bbls/day (Bbls per day) related to the Woodford Shale gathering system whichcommenced operation in April 2007, (ii) increased NGL sales volumesof 467 Bbls/day attributable to the expanded Badlands gathering system,including the nitrogen rejection plant, which commenced operation in August 2007and (iii) significantly higher average realized natural gas and NGL salesprices for the nine months ended September 30, 2008 as compared to thesame period in 2007, resulting in increased 

 

27

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revenue at all of ourgathering systems.  Revenues from compression assets were the same forboth periods.

 

Midstream revenues were$319.1 million for the nine months ended September 30, 2008 compared to$191.7 million for the nine months ended September 30, 2007, an increaseof $127.4 million, or 66.4%. Of this $127.4 million increase in midstream revenues,approximately $37.1 million was attributable to revenues from increased naturalgas and NGL sales volumes at the Woodford Shale, Badlands, Bakken and Matligathering systems and approximately $90.3 million was attributable tosignificantly higher average realized natural gas and NGL sales prices for thenine months ended September 30, 2008 as compared to the same period in2007, resulting in increased revenues for all of our gathering systems.

 

Inlet natural gas was245,098 Mcf/d (Mcf per day) for the nine months ended September 30, 2008compared to 210,878 Mcf/d for the nine months ended September 30, 2007, anincrease of 34,220 Mcf/d, or 16.2%.  Thisincrease is primarily attributable to volume growth at our Woodford Shale andBadlands gathering systems offset by volume declines at our Eagle Chief andKinta gathering systems.

 

Natural gas sales volumeswere 89,615 MMBtu/d for the nine months ended September 30, 2008 comparedto 78,998 MMBtu/d for the nine months ended September 30, 2007, anincrease of 10,617 MMBtu/d, or 13.4%.  This 10,617 MMBtu/d net increase innatural gas sales volumes was attributable to increased natural gas salesvolumes at our Woodford Shale, Bakken and Matli gathering systems offset byreduced natural gas sales volumes at our Eagle Chief and Kinta gatheringsystems.

 

NGL sales volumes were5,763 Bbls/d for the nine months ended September 30, 2008 compared to4,340 Bbls/d for the nine months ended September 30, 2007, a net increaseof 1,423 Bbls/d, or 32.8%.  This net increase is primarily attributable tovolume growth at our Woodford Shale and Badlands gathering systems.

 

Average realized naturalgas sales prices were $8.00 per MMBtu for the nine months ended September 30,2008 compared to $5.78 per MMBtu for the nine months ended September 30,2007, an increase of $2.22 per MMBtu, or 38.4%.  Average realized NGLsales prices were $1.53 per gallon for the nine months ended September 30,2008 compared to $1.07 per gallon for the nine months ended September 30,2007, an increase of $0.46 per gallon or 43.0%.  The increase in ouraverage realized natural gas and NGL sales prices was primarily a result ofsignificantly higher index prices for natural gas and posted prices for NGLsduring the nine months ended September 30, 2008 compared to the ninemonths ended September 30, 2007.

 

Cash received from ourcounterparty on cash flow swap contracts for natural gas derivativetransactions that closed during the nine months ended September 30, 2008totaled $1.4 million compared to $3.5 million for the nine months ended September 30,2007.  The $1.4 million gain for the nine months ended September 30,2008 increased averaged realized natural gas prices to $8.00 per MMBtu from$7.95 per MMBtu, an increase of $0.05 per MMBtu.  The $3.5 million gain for the nine monthsended September 30, 2007 increased averaged realized natural gas prices to$5.78 per MMBtu from $5.62 per MMBtu, an increase of $0.16 per MMBtu.  Cash paid to our counterparty on cash flowswap contracts for NGL derivative transactions that closed during the ninemonths ended September 30, 2008 totaled $7.9 million compared to $1.1million for the nine months ended September 30, 2007.   The $7.8million loss for the nine months ended September 30, 2008 reduced averagedrealized NGL prices to $1.53 per gallon from $1.64 per gallon, a decrease of$0.11 per gallon. The $1.1 million loss for the nine months ended September 30,2007 reduced averaged realized NGL prices to $1.07 per gallon from $1.09 pergallon, a decrease of $0.02 per gallon.

 

Compression revenues were$3.6 million for the each of the nine months ended September 30, 2008 and2007.

 

***Midstream Purchases.***  Midstreampurchases were $238.6 million for the nine months ended September 30, 2008compared to $137.3 million for the nine months ended September 30, 2007,an increase of $101.3 million, or 73.7%.  The $101.3 million increase isprimarily due to volume growth at the Woodford Shale gathering system whichcommenced operation in April 2007, the expanded Badlands gathering system,including the nitrogen rejection plant, which commenced operation in August 2007and higher natural gas and NGL purchase prices, resulting in increasedmidstream purchases for all of our gathering systems.

 

***Midstream Segment Margin .*** Midstream segment margin was $80.5 million for the nine months ended September 30,2008 compared to $54.4 million for the nine months ended September 30,2007, an increase of $26.1 million, or 48.0%. The increase is primarily due to favorable gross processing spreads,significantly higher average realized natural gas and NGL prices, volume growthat the Woodford Shale gathering system which commenced operation in April 2007and volume growth at the expanded Badlands gathering system, including thenitrogen rejection plant, which commenced operations in August 2007. As apercent of midstream revenues, midstream segment margin was 25.2% and 28.4% forthe nine months ended September 30, 2008 and 2007, respectively, areduction of 3.1%.  This reduction isattributable to net losses on closed/settled derivative transactions andunrealized non-cash losses on derivative transactions for the nine months endedSeptember 30, 2008 totaling $6.4 million, after being offset by anunrealized non-cash gain of $3.6 million related to a non-qualifyingmark-to-market cash flow derivative for forecasted sales in 2010, compared tonet gains of $2.4 million on closed/settled derivative transactions andunrealized non-cash gains on derivative transactions for the nine months ended September 30,2007. The increase in midstream segment margin was offset by approximately $2.3million of forgone margin as a result of the Badlands nitrogen rejection plantbeing temporarily taken out of service due to equipment failure during the ninemonths ended September 30, 2008.

 

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***Operations and Maintenance.*** Operations and maintenance expense totaled $22.2 million for the nine monthsended September 30, 2008 compared with $16.1 million for the nine monthsended September 30, 2007, an increase of $6.1 million, or 37.8%. Of thisincrease, $3.6 million was attributable to increased operations and maintenanceat the expanded Badlands gathering system and $2.2 million was attributable toincreased operations and maintenance at the Eagle Chief, Matli and WoodfordShale gathering systems.

 

***Depreciation, Amortization and Accretion.*** Depreciation, amortization and accretion expense totaled $27.7 million for thenine months ended September 30, 2008 compared with $21.4 million for thenine months ended September 30, 2007, an increase of $6.3 million, or 29.4%.  Of this increase, $2.2 million was attributable to increaseddepreciation on the expanded Badlands gathering system, $1.7 million wasattributable to the Woodford Shale gathering system and $1.1 million wasattributable to increased depreciation on the Bakken gathering system.

 

***General and Administrative.*** General and administrative expense totaled $6.4 million for the nine monthsended September 30, 2008 compared with $5.1 million for the nine monthsended September 30, 2007, an increase of $1.3 million, or 25.7%. Salariesincreased $1.4 million in the nine months ended September 30, 2008 ascompared to the nine months ended September 30, 2007 due to increasednon-cash unit based compensation and increased staffing during the nine monthsended September 30, 2008 as compared to the nine months ended September 30,2007.

 

***Other Income (Expense).*** Otherincome (expense) totaled $(10.0) million for the nine months ended September 30,2008 compared with $(7.5) million for the nine months ended September 30,2007, an increase in expense of $2.5 million.  The increase is primarilyattributable to additional interest expense from borrowings on our creditfacility to fund expansions at the Badlands gathering system, the WoodfordShale gathering system, and the Kinta gathering systems, after being offset bylower interest rates incurred during the nine months ended September 30,2008 compared to interest rates incurred during the nine months ended September 30,2007.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

***Disruption to Functioning of Capital Markets***

 

Multiple events during2008 involving numerous financial institutions have effectively restrictedcurrent liquidity within the capital markets throughout the United States andaround the world. Despite efforts by treasury and banking regulators in theUnited States, Europe and other nations around the world to provide liquidityto the financial sector, capital markets currently remain constrained. Weexpect that our ability to issue debt and equity at prices that are similar toofferings in recent years will be limited over the next three to six months andpossibly longer should capital markets remain constrained. Although we intendto move forward with our planned internal growth projects, we may revise thetiming and scope of these projects as necessary to adapt to existing economicconditions and the benefits expected to accrue to our unitholders from ourexpansion activities may be muted by substantial cost of capital increasesduring this period.

 

***Overview***

 

Cash generated fromoperations, borrowings under our credit facility and funds from private andpublic equity and debt offerings have historically been our primary sources ofliquidity. We believe that funds from these sources should be sufficient tomeet both our short-term working capital requirements and our long-term capitalexpenditure requirements. Our ability to pay distributions to our unitholders,to fund planned capital expenditures and to make acquisitions depends upon ourfuture operating performance and, more broadly, on the availability of equityand debt financing, which will be affected by prevailing economic conditions inour industry and financial, business and other factors, many of which arebeyond our control.

 

***Cash Flows from Operating Activities***

 

Our cash flows fromoperating activities decreased by $2.4 million to $26.7 million for the ninemonths ended September 30, 2008 from $29.1 million for the nine monthsended September 30, 2007.  During the nine months ended September 30,2008 we received cash flows from customers of approximately $303.9 millionattributable to increased natural gas and NGLs volumes and significantly higheraverage realized natural gas and NGL sales prices, had cash payments to oursuppliers and employees of approximately $267.5 million and payment of interestexpense of $9.7 million, net of amounts capitalized, resulting in cash receivedfrom operating activities of $26.7 million. During the same nine month periodin 2007, we received cash flows from customers of approximately $195.8 millionattributable to increased volumes of natural gas and NGLs decreased by lowernatural gas and NGL sales prices, had cash payments to our suppliers andemployees of approximately $159.3 million and payment of interest expense of $7.4million, net of amounts capitalized, resulting in cash received from ouroperating activities of $29.1 million.

 

Changes in cash receiptsand payments are primarily due to the timing of collections at the end of ourreporting periods. We collect and pay large receivables and payables at the endof each calendar month. The timing of these payments and receipts may vary by aday or two between month-end periods and cause fluctuations in cash received orpaid. Working capital items, exclusive of cash, 

 

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used $16.5 million ofcash flows from operating activities during the nine months ended September 30,2008 and used $0.5 million to cash flows from operating activities during thenine months ended September 30, 2007.

 

Net income for the ninemonths ended September 30, 2008 was $17.5 million, an increase of $9.6million from a net income of $7.9 million for the nine months ended September 30,2007.  Depreciation and amortization increased by $6.3 million to $27.6million for the nine months ended September 30, 2008 from $21.3 millionfor the nine months ended September 30, 2007.  Bad debt expense was $0.3 million for thenine months ended September 30, 2008 compared to zero for the nine monthsended September 30, 2007.

 

***Cash Flows Used for Investing Activities***

 

Our cash flows used forinvesting activities, which represent investments in property and equipment,decreased by $24.8 million to $37.1 million for the nine months ended September 30,2008 from $61.9 million for the nine months ended September 30, 2007primarily due to reduced capital investing in the nine months ended September 30,2008 related to the Badlands nitrogen rejection plant which was underconstruction during the first nine months of 2007.

 

***Cash Flows from Financing Activities***

 

Our cash flows fromfinancing activities decreased to $12.1 million for the nine months ended September 30,2008 from $31.3 million for the nine months ended September 30, 2007, adecrease of $19.2 million. During the nine months ended September 30,2008, we borrowed $41.0 million under our credit facility to fund internalexpansion projects, received capital contributions of $1.1 million as a resultof issuing common units due to the exercise of vested unit options, distributed$29.2 million to our unitholders, incurred debt issuance costs of $0.4 millionassociated with the fourth amendment to our credit facility amended in February 2008and made $0.4 million payments on capital lease obligations.

 

During the nine monthsended September 30, 2007, we borrowed $54.0 million under our creditfacility to fund internal expansion projects, received capital contributions of$1.0 million as a result of issuing common units due to the exercise of vestedunit options, distributed $23.0 million to unitholders, incurred offering costsof $0.2 million associated with our S-3/A registration statement filed with theSEC on January 23, 2007 and paid debt issuance costs of $0.5 millionassociated with our third amendment to our credit facility in July 2007.

 

***Capital Requirements***

 

Our midstream energybusiness is capital intensive, requiring significant investment to maintain andupgrade existing operations.  Our capital requirements have consistedprimarily of, and we anticipate will continue to be:

 

·  maintenance capital expenditures, which are capital expenditures made toreplace partially or fully depreciated assets to maintain the existingoperating capacity of our assets and to extend their useful lives, or othercapital expenditures that are incurred in maintaining existing system volumesand related cash flows; and

 

·  expansion capital expenditures such as those to acquire additional assets togrow our business, to expand and upgrade gathering systems, processing plants,treating facilities and fractionation facilities and to construct or acquiresimilar systems or facilities.

 

We believe that cashgenerated from the operations of our business will be sufficient to meetanticipated maintenance capital expenditures for the next twelve months. Givenour objective of growth through acquisitions and expansions, we anticipate thatwe will continue to invest significant amounts of capital to grow and acquireassets. We actively consider a variety of assets for potential acquisitions. Weanticipate that expansion capital expenditures will be funded through long-termborrowings or other debt financings and/or equity offerings.  See “CreditFacility” below for information related to our credit agreement.

 

***North Dakota Bakken***

 

We plan to make aninitial capital investment of approximately $10.0 million by the end of 2008with additional investments of up to $17.0 million over the next three years tobuild gas processing and treating facilities and install field gathering,compression and associated equipment at the Bakken Shale play in northwesternNorth Dakota in which CLR has dedicated approximately 129,000 gross acres tous. As of September 30, 2008, we have initially invested $0.4 million inthe project. The expected startup of the initial phase of the project shouldoccur no later than the second quarter of 2009.

 

***Woodford Shale***

 

We are continuing toexpand the Woodford Shale gathering system located in the Woodford Shalereservoir area in the Arkoma Basin of southeastern Oklahoma. The gatheringsystem is being designed to provide low-pressure and highly reliable gathering,compression and dehydration services. During the third quarter of 2008, weinvested approximately $10.4 million to expand our 

 

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Woodford Shale gathering system to provide takeaway capacityin excess of approximately 65,000 Mcf/d, at 17,400 horsepower of compression.As of September 30, 2008, we have invested a total of $39.8 million inthis internal expansion project.

 

***Financial Derivatives and Commodity Hedges***

 

We have entered intocertain financial derivative instruments that are classified as cash flowhedges in accordance with SFAS 133 and relate to forecasted sales in 2008 and2009, and a non-qualifying mark-to-market cash flow derivative that relates toforecasted sales in 2010. We entered into these instruments to hedge theforecasted natural gas and natural gas liquid sales or purchases against thevariability in expected future cash flows attributable to changes in market prices.The swap instruments are contractual agreements between counterparties toexchange obligations of money as the underlying natural gas or natural gasliquids are sold or purchased. Under these swap agreements, we either receiveor pay a monthly net settlement that is determined by the difference between afixed price and a floating price based on certain indices for the relevantcontract period for the agreed upon volumes.

 

The following tableprovides information about these financial derivative instruments for theperiods indicated:

 

| ** **                                                 | ** ** | ** **  | ** ** | **Average**           | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------------|------------|-------------|------------|-----------------------|------------|---------------------|------------|
| ** **                                                 | ** ** | ** **  | ** ** | **Fixed**             | ** ** | **Asset**           | ** ** |
| **Description and Production Period**       | ** ** | **Volume**  | ** ** | **Price**             | ** ** | **(Liability)**     | ** ** |
| ** **                                                 | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**  | ** ** | ** **          | ** ** |
| Natural Gas -  Sold Fixed for Floating Price Swaps         |       |        |       |                  |       |                |       |   |   |
| October 2008  - September 2009                   |       | 2,097,000   |       | $                     | 7.42       |                | $          | 4,521 |   |
| October 2009  - December 2009                    |       | 534,000     |       | $                     | 7.30       |                | 1,016      |   |
| January 2010  - December 2010                    |       | 2,136,000   |       | $                     | 10.50      |                | 3,975      |   |
|                                                       |       |        |       |                  |       | $                   | 9,512      |   |
|                                                       |       |        |       |                  |       |                |       |
| ** **                                                 | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**  | ** ** | ** **          | ** ** |
| Natural Gas -  Buy Fixed for Floating Price Swaps          |       |        |       |                  |       |                |       |   |   |
| October 2008  - December 2008                    |       | 180,288     |       | $                     | 6.93       |                | $          | (396 | ) |
|                                                       |       |        |       |                  |       |                |       |
| ** **                                                 | ** ** | **(Bbls)**  | ** ** | **(per Gallon)** | ** ** | ** **          | ** ** |
| Natural Gas  Liquids - Sold Fixed for Floating Price Swaps |       |        |       |                  |       |                |       |   |   |
| October 2008  - December 2008                    |       | 110,442     |       | $                     | 1.31       |                | $          | (1,230 | ) |

 

In addition to thederivative instruments noted in the table above, we have executed one naturalgas fixed price physical forward sales contract on 100,000 MMBtu per month witha fixed price of $8.43 per MMBtu for the remainder of 2008.  This contracthas been designated as normal sales under SFAS 133 and is therefore not markedto market as a derivative.

 

***Off-Balance Sheet Arrangements***

 

We had no significantoff-balance sheet arrangements as of September 30, 2008.

 

***AvailableCredit***

 

Credit markets in theUnited States and around the world remain constrained due to a lack ofliquidity and confidence in a number of financial institutions. Investorscontinue to seek perceived safe investments in securities of the United Statesgovernment rather than corporate issues. We may at times experience difficultyaccessing the long-term credit markets due to prevailing market conditions.Additionally, existing constraints in the credit markets may increase the rateswe are charged for utilizing these markets. Notwithstanding the continuingweakness in the United States credit markets, we expect that our availableliquidity is sufficient to meet our operating and capital requirements into2009 and for the foreseeable future.

 

***Credit Facility***

 

On February 6, 2008,we entered into a fourth amendment to our credit facility dated February 15,2005. Pursuant to the fourth amendment, we have, among other things, increasedour borrowing base from $250 million to $300 million and decreased theaccordion feature in the facility from $100 million to $50 million.  Our original credit facility dated February 15,2005 was first amended in September 2005, amended a second time in June 2006and amended a third time in July 2007.

 

The fourth amendmentincreases our borrowing capacity under our senior secured revolving creditfacility to $300 million such that the facility now consists of a $291 millionsenior secured revolving credit facility to be used for funding acquisitionsand other capital expenditures, issuance of letters of credit and general corporatepurposes (the “Acquisition Facility”) and a $9.0 million senior securedrevolving credit facility to be used for working capital and to funddistributions (the “Working Capital Facility”).

 

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In addition, the fourthamendment provides for an accordion feature, which permits us, if certainconditions are met, to increase the size of the Acquisition Facility by up to$50 million and allows for the issuance of letters of credit of up to $15million in the aggregate.  The senior secured revolving credit facilityalso requires us to meet certain financial tests, including a maximumconsolidated funded debt to EBITDA ratio of 4.0:1.0 as of the last day of anyfiscal quarter; provided that in the event that the Partnership makes certainpermitted acquisitions or capital expenditures, this ratio may be increased to4.75:1.0 for the three fiscal quarters following the quarter in which suchacquisition or capital expenditure occurs; and a minimum interest coverageratio of 3.0:1.0. The credit facility will mature in May 2011. At thattime, the agreement will terminate and all outstanding amounts thereunder willbe due and payable.

 

Our obligations under thecredit facility are secured by substantially all of our assets and guaranteedby us, and all of our subsidiaries, other than our operating company, which isthe borrower under the credit facility.

 

Indebtedness under thecredit facility will bear interest, at our option, at either: (i) anAlternate Base Rate plus an applicable margin ranging from 50 to 125 basispoints per annum or (ii) LIBOR plus an applicable margin ranging from 150to 225 basis points per annum based on our ratio of consolidated funded debt toEBITDA. The Alternate Base Rate is a rate per annum equal to the greatest of: (a) thePrime Rate in effect on such day, (b) the base CD rate in effect on suchday plus 1.50% and (c) the Federal Funds effective rate in effect on suchday plus 1/2of 1%. We have elected for the indebtedness to bear interest at LIBOR plus theapplicable margin. A letter of credit fee will be payable for the aggregateamount of letters of credit issued under the credit facility at a percentageper annum equal to 1.0%. An unused commitment fee ranging from 25 to 50 basispoints per annum based on our ratio of consolidated funded debt to EBITDA willbe payable on the unused portion of the credit facility. During any step-upperiod, the applicable margin with respect to loans under the credit facilitywill be increased by 35 basis points per annum and the unused commitment feewill be increased by 12.5 basis points per annum. At September 30, 2008,the interest rate on outstanding borrowings from our credit facility was 4.76%

 

The credit facilityprohibits us from making distributions to unitholders if any default or eventof default, as defined in the credit facility, has occurred and is continuingor would result from the distribution. In addition, the credit facilitycontains various covenants that limit, among other things, subject to certainexceptions and negotiated “baskets,” our ability to incur indebtedness, grantliens, make certain loans, acquisitions and investments, make any materialchanges to the nature of its business, amend its material agreements, includingthe Omnibus Agreement or enter into a merger, consolidation or sale of assets.

 

The credit facilitydefines EBITDA as our consolidated net income, plus income tax expense,interest expense, depreciation, amortization and accretion expense,amortization of intangibles and organizational costs, non-cash unit basedcompensation expense, and adjustments for non-cash gains and losses onspecified derivative transactions and for other extraordinary or non-recurringitems.

 

Upon the occurrence of anevent of default as defined in the credit facility, the lenders may, amongother things, be able to accelerate the maturity of the credit facility andexercise other rights and remedies as set forth in the credit facility.

 

The credit facilitylimits distributions to our unitholders to available cash, as defined by theagreement, and borrowings to fund such distributions are only permitted underthe revolving working capital facility. The revolving working capital facilityis subject to an annual “clean-down” period of 15 consecutive days in which theamount outstanding under the revolving working capital facility is reduced tozero.

 

As of September 30,2008, we had $262.1 million outstanding under the credit facility and werein compliance with its financial covenants.

 

***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.

 

***Recent Accounting Pronouncements***

 

On April 25, 2008,the Financial Accounting Standards Board (“FASB”) FASB issued Staff Position No. FAS142-3, “Determination of the UsefulLife of Intangible Assets” (“FSP 142-3”).  FSP 142-3 amends the factors that an entityshould consider in developing renewal or extension assumptions used in determiningthe useful life of recognized intangible assets under FASB Statement No. 142(“SFAS 142”), “Goodwill and OtherIntangible Assets.” In determining the useful life of an acquiredintangible asset, FSP 142-3 removes the requirement from SFAS 142 for an entityto consider whether renewal of the intangible asset requires significant costsor material modifications to the related arrangement. FSP 142-3 also replacesthe previous useful life assessment criteria with a requirement that an entityconsiders its own experience in renewing similar arrangements. If the entityhas no relevant experience, it would consider market participant assumptionsregarding renewal.  FSP 142-3 will be effective as of January 1, 2009and will apply only to intangible assets acquired after that date. Retroactiveapplication to previously acquired intangible assets is 

 

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prohibited.  Theadoption of FSP 142-3 is not expected to have a material impact on ourfinancial position, results of operations or cash flows.

 

On March 19, 2008,the FASB issued SFAS No. 161, “Disclosures about Derivative Instrumentsand Hedging Activities,” an amendment of SFAS 133 (“SFAS 161”). SFAS 161 isintended to improve transparency in financial reporting by requiring enhanceddisclosures of an entity’s derivative instruments and hedging activities andtheir effects on the entity’s financial position, financial performance, andcash flows. SFAS 161 is effective prospectively for financial statements issuedfor fiscal years and interim periods beginning after November 15, 2008,with early application encouraged. SFAS 161 encourages, but does not require,comparative disclosures for periods prior to its initial adoption. SFAS 161amends the current qualitative and quantitative disclosure requirements forderivative instruments and hedging activities set forth in SFAS 133 andgenerally increases the level of aggregation/disaggregation that will berequired in an entity’s financial statements. We are currently reviewing SFAS161 to determine the effect it will have on our financial statements anddisclosures therein.

 

On March 12, 2008,the Emerging Issues Task Force (“EITF”) reached consensus opinion on EITF Issue07-4, “Application of the two-class method under FASB Statement No. 128,Earnings per Share, to Master Limited Partnerships” (“EITF 07-4”), which theFASB ratified at its March 26, 2008 meeting. EITF 07-4 requires thecalculation of a Master Limited Partnership’s (“MLPs”) net earnings per limitedpartner unit for each period presented according to distributions declared andparticipation rights in undistributed earnings as if all of the earnings forthat period had been distributed. In periods with undistributed earnings abovespecified levels, the calculation per the two-class method results in anincreased allocation of such undistributed earnings to the general partner anda dilution of earnings to the limited partners. EITF 07-4 is effective forfiscal years beginning after December 15, 2008, and is to be appliedretrospectively to all periods presented. Early application is not permitted.We will apply the requirements of EITF 07-4 as it pertains to MLPs upon itsadoption during the quarter ended March 31, 2009 and do not expect asignificant impact when adopted.

 

In December 2007,the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141(R)”).SFAS 141(R) amends and replaces SFAS 141, but retains the fundamentalrequirements in SFAS 141 that the purchase method of accounting be used for allbusiness combinations and an acquirer be identified for each businesscombination. SFAS 141(R) provides for how the acquirer recognizes andmeasures the identifiable assets acquired, liabilities assumed and anynon-controlling interest in the acquiree. SFAS 141(R) provides forhow the acquirer recognizes and measures the goodwill acquired in the businesscombination or a gain from a bargain purchase. SFAS 141(R) also determineswhat information to disclose to enable users to be able to evaluate the natureand financial effects of the business combination. The provisions ofSFAS 141(R) apply prospectively to business combinations for whichthe acquisition date is on or after the beginning of the first annual reportingperiod beginning on or after December 15, 2008 and do not allow earlyadoption. We are evaluating the new requirements of SFAS 141(R) and theimpact it will have on business combinations completed in 2009 and thereafter.

 

In December 2007,the FASB issued SFAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements — an amendment of ARB No. 51” (“SFAS 160”). SFAS 160establishes accounting and reporting standards that require the ownershipinterests in subsidiaries held by parties other than the parent (minorityinterest) be clearly identified, labeled and presented in the consolidatedbalance sheet within equity, but separate from the parent’s equity. SFAS 160requires the equity amount of consolidated net income attributable to theparent and to the noncontrolling interest be clearly identified and presentedon the face of the consolidated income statement and that changes in a parent’sownership interest while the parent retains its controlling financial interestin its subsidiary be accounted for consistently and similarly as equitytransactions. Consolidated net income and comprehensive income will bedetermined without deducting minority interest; however, earnings-per-shareinformation will continue to be calculated on the basis of the net incomeattributable to the parent’s shareholders. Additionally, SFAS 160 establishes asingle method for accounting for changes in a parent’s ownership interest in asubsidiary that does not result in deconsolidation and that the parentrecognize a gain or loss in net income when a subsidiary is deconsolidated.SFAS 160 is effective for fiscal years beginning on or after December 15,2008. Early adoption is not permitted. We do not expect SFAS 160 will have amaterial impact on our financial position, results of operations or cash flows.

 

 In February 2007, the FASB issued SFAS No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS159”). SFAS 159 expands opportunities to use fair value measurement infinancial reporting and permits entities to choose to measure many financialinstruments and certain other items at fair value. SFAS 159 is effective forfiscal years beginning after November 15, 2007. SFAS 159 was adopted by useffective January 1, 2008, at which time no financial assets orliabilities, not previously required to be recorded at fair value by otherauthoritative literature, were designated to be recorded at fair value. Assuch, the adoption of SFAS 159 did not have any impact on our financialposition, results of operations or cash flows.

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”).  SFAS 157 defines fair value as the price thatwould be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants at the measurement date,establishes a framework for measuring fair value in generally acceptedaccounting principles (“GAAP”) such as fair value hierarchy used to classifythe source of information used in fair value measurements (i.e., market basedor non-market based) and expands disclosure about fair value measurements basedon their level in the hierarchy.  SFAS157 applies to derivatives and other financial instruments, which SFAS 133requires be measured at fair value at initial recognition and for all subsequent

 

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periods. SFAS 157establishes a fair value hierarchy which requires an entity to maximize the useof observable inputs and minimize the use of unobservable inputs when measuringfair value. SFAS 157’s hierarchy defines three levels of inputs that may beused to measure fair value. Level 1 refers to assets that have observablemarket prices, level 2 assets do not have an “observable price” but do haveinputs that are based on such prices in which components have observable datapoints and level 3 refers to assets in which one or more of the inputs do nothave observable prices and calibrated model parameters, valuation techniques ormanagement’s assumptions are used to derive the fair value. SFAS 157 iseffective for financial statements issued for fiscal years beginning after November 15,2007 and interim periods within those fiscal years. We elected to implementSFAS 157 prospectively in the first quarter of 2008 with the one-year deferralpermitted by FASB Staff Position (FSP) 157-2 for nonfinancial assets andnonfinancial liabilities measured at fair value, except those that arerecognized or disclosed on a recurring basis (at least annually). The deferralapplies to nonfinancial assets and liabilities measured at fair value in abusiness combination; impaired properties, plants and equipment; intangibleassets and goodwill; and initial recognition of asset retirement obligationsand restructuring costs for which we use fair value. We do not expect anysignificant impact to our consolidated financial statements when we implementSFAS 157 for these assets and liabilities.

 

**SignificantAccounting Policies and Estimates**

 

*Revenue Recognition.*    Revenues for sales ofnatural gas and NGLs product sales are recognized at the time the product isdelivered and title is transferred. Revenues for compression servicesare recognized when the services under the agreement are performed.

 

*Depreciation and Amortization.* Depreciation of all equipment is determined under the straight-linemethod using various rates based on useful lives, 10 to 22 years forpipeline and processing plants, and 3 to 10 years for corporate and otherassets. The cost of assets and related accumulated depreciation is removed fromthe accounts when such assets are disposed of, and any related gains or lossesare reflected in current earnings. Maintenance, repairs and minor replacementsare expensed as incurred. Costs of replacements constituting improvement arecapitalized. Intangible assets consist of the acquired value of existingcontracts to sell natural gas and other NGLs, compression contracts andidentifiable customer relationships, which do not have significant residualvalue. The contracts are being amortized over their estimated lives of tenyears.

 

*Derivatives.*    We utilize derivative financial instruments toreduce commodity price risks. We do not hold or issue derivative financialinstruments for trading purposes. Statement of Financial Accounting Standards (“SFAS”)No. 133, “Accounting for Derivative Instruments and Hedging Activities”,which was amended in June 2000 by SFAS 138 and in May 2003 by SFAS149, establishes accounting and reporting standards for derivative instrumentsand hedging activities. It requires that an entity recognize all derivatives aseither assets or liabilities in the statement of financial condition andmeasure those instruments at fair value. Derivatives that are not designated ashedges are adjusted to fair value through income. If the derivative is designatedas a hedge, depending upon the nature of the hedge, changes in the fair valueof the derivatives are either offset against the fair value of assets,liabilities or firm commitments through income, or recognized in othercomprehensive income until the hedged item is recognized in income. Theineffective portion of a derivative’s change in fair value is immediatelyrecognized into income. If a derivative no longer qualifies for hedgeaccounting the amounts in accumulated other comprehensive income will beimmediately charged to operations.

 

*Asset Retirement Obligations.*    SFAS No. 143, “Accountingfor Asset Retirement Obligations” (“SFAS 143”), requires entities to record thefair value of a liability for an asset retirement obligation in the period inwhich it is incurred and a corresponding increase in the carrying amount of therelated long-lived asset. Subsequently, the asset retirement cost is allocatedto expense using a systematic and rational method and the liability is accretedto measure the change in liability due to the passage of time. The primaryimpact of SFAS 143 relates to our estimated costs for primarily dismantling andsite restoration of leased compression facility locations. Estimating futureasset retirement obligations requires us to make estimates and judgmentsregarding timing, existence of a liability, as well as what constitutesadequate restoration. We use the present value of estimated cash flows relatedto our asset retirement obligation to determine the fair value, generally asestimated by third party consultants. The present value calculation requires usto make numerous assumptions and judgments, including the ultimate costs ofdismantling and site restoration, inflation factors, credit adjusted discountrates, timing of settlement and changes in the legal, regulatory, environmentaland political environments. To the extent future revisions to these assumptionsimpact the present value of the existing asset retirement obligation liability,a corresponding adjustment will be required to the related asset. We believethe estimates and judgments reflected in our financial statements arereasonable but are necessarily subject to the uncertainties we have justdescribed. Accordingly, any significant variance in any of the aboveassumptions or factors could materially affect our cash flows.

 

*Impairment of Long-Lived Assets.*    In accordance withSFAS No. 144, “Accounting for the Impairment or Disposal of Long-LivedAssets,” we evaluate our long-lived assets, including intangible assets, ofidentifiable business activities for impairment when events or changes incircumstances indicate, in management’s judgment, that the carrying value ofsuch assets may not be recoverable. The determination of whether impairment hasoccurred is based on management’s estimate of undiscounted future cash flowsattributable to the assets as compared to the carrying value of the assets. Ifimpairment has occurred, the amount of the impairment recognized is determinedby estimating the fair value for the assets and recording a provision for lossif the carrying value is greater than fair value. For assets identified to bedisposed of in the future, the carrying value of these assets is compared tothe estimated fair value less the cost to sell to determine if impairment isrequired. Until the assets are disposed of, an estimate of the fair value is 

 

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re-determinedwhen related events or circumstances change.

 

Whendetermining whether impairment of one of our long-lived assets has occurred, wemust estimate the undiscounted cash flows attributable to the asset or assetgroup. Our estimate of cash flows is based on assumptions regarding the volumeof reserves providing asset cash flow and future NGL product and natural gasprices. The amount of reserves and drilling activity are dependent in part onnatural gas prices. Projections of reserves and future commodity prices areinherently subjective and contingent upon a number of variable factors,including, but not limited to:

 

·* *changes in general economic conditions inregions in which the Partnership’s products are located;

 

·* *the availability and prices of NGL productsand competing commodities;

 

·* *the availability and prices of raw natural gassupply;

 

·* *our ability to negotiate favorable marketingagreements;

 

·* *the risks that third party oil and gasexploration and production activities will not occur or be successful;

 

·* *our dependence on certain significantcustomers and producers of natural gas; and

 

·* *competition from other midstream serviceproviders and processors, including major energy companies.

 

Anysignificant variance in any of the above assumptions or factors couldmaterially affect our cash flows, which could require us to record animpairment of an asset.

 

*ShareBased Compensation.*  InOctober 1995, the FASB issued SFAS No. 123, “Share-Based Payment,”which was revised in December 2004 (“SFAS 123R”).  SFAS 123R requires that the compensation costrelating to share-based payment transactions be recognized in the financialstatements and that cost be measured based on the fair value of the equity orliability instruments issued.

 

We estimate the fairvalue of each unit option granted on the date of grant using the AmericanBinomial option-pricing model. In estimating the fair value of each option, weuse our peer group volatility averages as determined on the option grant dates. We calculate expected lives of the options under the simplified method asprescribed by the SEC Staff Accounting Bulletin 107 and have used a risk freeinterest rate based on the applicable U.S. Treasury yield in effect at the timeof grant. We estimate the fair value of each restricted unit and phantom unitgranted on the date of grant based on the unit closing price on that same date. Our compensation expense for these awards is recognized on the gradedvesting attribution method. Units to be issued under our unit incentive planmay be from newly issued units.

 

**Item3. Quantitative and Qualitative Disclosures about Market Risk**

 

Market risk is the riskof loss arising from adverse changes in market rates and prices.  Theprincipal market risk to which we are exposed is commodity price risk fornatural gas and NGLs.  We also incur, to a lesser extent, risks related tointerest rate fluctuations.  We do not engage in commodity energy tradingactivities.

 

***Commodity Price Risks. *** Ourprofitability is affected by volatility in prevailing NGL and natural gasprices.  Historically, changes in the prices of most NGL products havegenerally correlated with changes in the price of crude oil.  NGL andnatural gas prices are volatile and are impacted by changes in the supply anddemand for NGLs and natural gas, as well as market uncertainty.  Our cashflow is affected by the volatility of natural gas and NGL product prices, whichcould adversely affect our ability to make distributions to unitholders.  To illustrate the impact of changes in pricesfor natural gas and NGLs on our operating results, we have provided the tablebelow, which reflects, for the three months ended September 30, 2008, theimpact on our midstream segment margin of a $0.01 per gallon change (increaseor decrease) in NGL prices coupled with a $0.10 per MMBtu change (increase ordecrease) in the price of natural gas.

 

| ** **                    | ** ** | ** ** | ** ** | **Natural Gas Price Change ($/MMBtu)** | ** ** |
|-------------------------------|------------|------------|------------|------------------------------------------------------------|------------|
| ** **                    | ** ** | ** ** | ** ** | **2008**                                                   | ** ** | **2007** | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **$0.10**                                                  | ** ** | **$(0.10)** | ** ** | **$0.10** | ** ** | **$(0.10)** | ** ** |
| **NGL  Price Change ($/gal)** |       | $          | 0.01       |                                                       | $          | 130,000 |   | $ | 156,000 |   | $ | 461,000 |   | $ | 109,000 |   |
|                          |       | $          | (0.01      | )                                                          | $          | (159,000 | ) | $ | (134,000 | ) | $ | (111,000 | ) | $ | (464,000 | ) |

 

The increase in commodityexposure is the result of increased natural gas and NGL product volumes in thethree months ended September 30, 2008 compared to the three months ended September 30,2007. The magnitude of the impact on total segment margin of changes in naturalgas and NGL prices presented may not be representative of the magnitude of theimpact on total segment margin for different commodity prices or contractportfolios.  Natural gas prices can also affect our profitabilityindirectly by influencing the level of drilling activity and relatedopportunities for our services.

 

We manage this commodityprice exposure through an integrated strategy that includes management of ourcontract portfolio, optimization of our assets and the use of derivativecontracts. As a result of these derivative swap contracts, we have hedged aportion of our expected exposure to natural gas prices and natural gas liquidsprices in 2008, 2009 and 2010. We continually monitor our 

 

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hedging and contractportfolio and expect to continue to adjust our hedge position as conditionswarrant. The following table provides information about our derivativeinstruments for the periods indicated:

 

| ** **                                                 | ** ** | ** **  | ** ** | **Average**           | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------------|------------|-------------|------------|-----------------------|------------|---------------------|------------|
| ** **                                                 | ** ** | ** **  | ** ** | **Fixed**             | ** ** | **Asset**           | ** ** |
| **Description and Production Period**       | ** ** | **Volume**  | ** ** | **Price**             | ** ** | **(Liability)**     | ** ** |
| ** **                                                 | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**  | ** ** | ** **          | ** ** |
| Natural Gas -  Sold Fixed for Floating Price Swaps         |       |        |       |                  |       |                |       |   |   |
| October 2008  - September 2009                   |       | 2,097,000   |       | $                     | 7.42       |                | $          | 4,521 |   |
| October 2009  - December 2009                    |       | 534,000     |       | $                     | 7.30       |                | 1,016      |   |
| January 2010  - December 2010                    |       | 2,136,000   |       | $                     | 10.50      |                | 3,975      |   |
|                                                       |       |        |       |                  |       | $                   | 9,512      |   |
|                                                       |       |        |       |                  |       |                |       |
| ** **                                                 | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**  | ** ** | ** **          | ** ** |
| Natural Gas -  Buy Fixed for Floating Price Swaps          |       |        |       |                  |       |                |       |   |   |
| October 2008  - December 2008                    |       | 180,288     |       | $                     | 6.93       |                | $          | (396 | ) |
|                                                       |       |        |       |                  |       |                |       |
| ** **                                                 | ** ** | **(Bbls)**  | ** ** | **(per Gallon)** | ** ** | ** **          | ** ** |
| Natural Gas  Liquids - Sold Fixed for Floating Price Swaps |       |        |       |                  |       |                |       |   |   |
| October 2008  - December 2008                    |       | 110,442     |       | $                     | 1.31       |                | $          | (1,230 | ) |

 

In addition to thederivative instruments noted in the table above, we have executed one naturalgas fixed price physical forward sales contract on 100,000 MMBtu per month witha fixed price of $8.43 per MMBtu for the remainder of 2008.  This contracthas been designated as normal sales under SFAS No. 133 and is thereforenot marked to market as a derivative.

 

***Interest Rate Risk*.**   Wehave elected for the indebtedness to bear interest at LIBOR plus the applicablemargin.  We are exposed to changes in theLIBOR rate as a result of our credit facility, which is subject to floating interestrates.  As of September 30, 2008, we had approximately $262.1 millionof indebtedness outstanding under our credit facility. The impact of a 100basis point increase in interest rates on the amount of current debt would, forthe remainder of 2008, result in an increase in annualized interest expense anda corresponding decrease in annualized net income of approximately $2.6million. On October 7, 2008, we entered into a floating-to-fixed interest rate swap agreement with an investmentgrade counterparty whereby we pay a monthly fixed interest rate of 2.245% andreceive a monthly variable rate based on the one month posted LIBOR interestrate on a notional amount of $100.0 million. This swap agreement is effective on January 2, 2009 and terminateson January 1, 2010.

 

***Credit Risk*.**  Counterparties pursuant to the terms of their contractual obligations expose usto potential losses as a result of nonperformance.  Our five largestcustomers for the three months ended September 30, 2008, accounted forapproximately 18%, 14%, 10%, 7% and 5%, respectively, of our revenues. Consequently, changes within one or more of these companies operations have thepotential to impact, both positively and negatively, our credit exposure andmake us subject to risks of loss resulting from nonpayment or nonperformance bythese or any of our other customers. Any material nonpayment or nonperformanceby our key customers could materially and adversely affect our business,financial condition or results of operations and reduce our ability to make distributionsto our unitholders. Furthermore, some of our customers may be highly leveragedand subject to their own operating and regulatory risks, which increases therisk that they may default on their obligations to us. Our counterparties for our derivative instruments as of September 30,2008 are BP Energy Company and Bank ofOklahoma, N.A.

 

OnJuly 22, 2008, SemGroup, L.P. and certain subsidiaries filed voluntarypetitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code.  Affiliates of SemGroup, L.P. purchase ournatural gas liquids and condensate, primarily at our Bakken and Badlands plantsand gathering systems.  During the secondquarter 2008, we increased our allowance for doubtful accounts and bad debtexpense by $8.1 million for related product sales through June 30, 2008. On October 20, 2008, theUnited States Bankruptcy Court for the District of Delaware entered an orderapproving the assumption of a Natural Gas Liquids Marketing Agreement (the “SemStreamAgreement”) between SemStream, L.P., an affiliate of SemGroup, L.P., and usrelating to the sale of natural gas liquids and condensate at our Bakken andBadlands plants and gathering systems. As a result of the assumption, and inaccordance with the order, on October 21, 2008, SemStream paid $12.1million to us, representing amounts owed to us from SemStream for June andJuly 2008 product sales under the SemStream Agreement. The assumption ofthe SemStream Agreement restores us and SemStream, L.P. to our pre-bankruptcycontractual relationship.

 

Our third quarter results of operations reflect a reversal of $7.8million of the $8.1 million allowance for doubtful accounts and bad debtexpense previously recorded on our income statement in the second quarter of2008. After receipt of the October 21 payment, our total pre-petitioncredit exposure to SemGroup, related to condensate sales to SemCrude, LLC, andoutside of the SemStream Agreement, is approximately $0.3 million, which wehave reserved as of September 30, 2008.

 

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**Item4. Controls and Procedures**

 

**Evaluationof Disclosure Controls and Procedures**

 

(a) Evaluation ofdisclosure controls and procedures.

 

As required by Rule 13a-15(b) under theSecurities Exchange Act of 1934, as amended, we have evaluated, under thesupervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, the effectivenessof the design and operation of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act)as of the end of the period covered by this Quarterly Report on Form 10-Q.Based upon that evaluation, our principal executive officer and principalfinancial officer concluded that our disclosure controls and procedures wereeffective as of September 30, 2008, to ensure that information isaccumulated and communicated to our management, including our principalexecutive officer and principal financial officer, as appropriate, to allowtimely decisions regarding required disclosure and is recorded, processed,summarized and reported within the time periods specified in the rules andforms of the SEC.

 

(b) Changes ininternal control over financial reporting.

 

During the three months ended September 30, 2008,there were no changes in our system of internal control over financialreporting (as defined in Rules 13a-15(f) and 15d-15(f) under theExchange Act) that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**PART II.OTHER INFORMATION**

 

**Item 1.Legal Proceedings**

 

Although there are nosignificant regulatory proceedings in which we are currently involved,periodically we may be a party to regulatory proceedings. The results of regulatoryproceedings cannot be predicted with certainty; however, our managementbelieves that we presently do not have material potential liability inconnection with regulatory proceedings that would have a significant financialimpact on our consolidated financial condition, results of operations or cashflows.

 

**Item 1A.Risk Factors**

 

In addition to the otherinformation set forth in this report, you should carefully consider the factorsdiscussed in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-Kfor the year ended December 31, 2007, which could materially affect ourbusiness, financial condition or future results. The risks described in ourAnnual Report on Form 10-K are not the only risks facing our Company.Additional risks and uncertainties not currently known to us or that wecurrently deem to be immaterial also may materially adversely affect ourbusiness, financial condition and/ or operating results.

 

***Becauseof the natural decline in production from existing wells, our success dependson our ability to obtain new supplies of natural gas, which involves factorsbeyond our control.  Any decrease insupplies of natural gas in our areas of operation could adversely affect ourbusiness and operating results.***

 

Our gathering systems andprocessing plants are dependent on the level of production from oil and naturalgas wells that supply our systems with natural gas and from which productionwill naturally decline over time.  As aresult, our cash flows associated with these wells will also decline overtime.  In order to maintain or increasethroughput volume levels on our gathering systems and the asset utilizationrates at our natural gas processing plants, we must continually obtain newsupplies.  The primary factors affectingour ability to obtain new supplies of natural gas and attract new customers toour assets are: the level of successful drilling activity near our gatheringsystems and our ability to compete with other gathering and processingcompanies for volumes from successful new wells.

 

The level of natural gasdrilling activity is dependent on economic and business factors beyond ourcontrol.  The primary factors thatimpacts drilling decisions are crude oil and natural gas prices.  Sustained declines in crude oil and naturalgas prices could result in decreases in exploration and development activitiesin the fields served by our assets, which would lead to reduced utilization ofthese assets. 

 

In addition, producersmay decrease their activity levels due to the current deterioration in thecredit markets.  Many of our customersfinance their activities through cash flow from operations, the incurrence ofdebt or the issuance of equity.  Recently, there has been a significant decline in the credit markets andthe availability of credit. Additionally, many of our customers’ equity values have substantiallydeclined.  The combination of a reductionof cash flow resulting from declines in commodity prices, a reduction inborrowing bases under reserve-based credit facilities and the lack ofavailability of debt or equity financing may result in a significant reductionin our customers’ spending.  For example,a number of our customers have announced reduced capital expenditure budgets forthe remainder of 2008 and 2009.   

 

Other factors that impactproduction decisions include producers’ capital budget limitations, the abilityof producers to obtain necessary drilling and other governmental permits andregulatory changes.  Because of thesefactors, even if additional crude oil or natural gas reserves were discoveredin areas served by our assets, producers may choose not to develop thosereserves.  If we were not able to obtainnew supplies of natural gas to replace the natural decline in volumes fromexisting wells due to reductions in drilling activity or competition,through-put volumes on our pipelines and the utilization rates of ourprocessing facilities would decline, which could have a material adverse effecton our business, results of operations and financial condition.

 

***Completionof significant, unbudgeted expansion projects may require debt and/or equityfinancing which may not be available to us on acceptable terms, or at all.***

 

We plan to fund ourexpansion capital expenditures, including any future expansions we mayundertake, with proceeds from sales of our debt and equity securities andborrowings under our revolving credit facility; however, we cannot be certainthat we will be able to issue our debt and equity securities on terms or in theproportions that we expect, or at all, and we may be unable to refinance ourrevolving credit facility when it expires.  In addition, we may be unable to obtain adequate funding under ourcurrent revolving credit facility because our lending counterparties may beunwilling or unable to meet their funding obligations.

 

Global financial marketsand economic conditions have been, and continue to be, disrupted and volatile.The debt and equity capital markets have been exceedingly distressed. Theseissues, along with significant write-offs in the financial services sector, there-pricing of credit risk and the current weak economic conditions have made,and will likely continue to make, it difficult to obtain funding.

 

          The cost of raising money in the debt and equity capitalmarkets has increased substantially while the availability of funds from thosemarkets generally has diminished significantly. Also, as a result of concernsabout the stability of financial markets generally and the solvency ofcounterparties specifically, the cost of obtaining money from the creditmarkets generally has increased as many lenders and institutional investorshave increased interest rates, enacted tighter lending standards, refused torefinance existing debt at maturity at all or on terms similar to our currentdebt and reduced and, in some cases, ceased to provide funding to borrowers.

 

37

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A significant increase inour indebtedness, or an increase in our indebtedness that is proportionatelygreater than our issuances of equity, as well as the credit market and debt andequity capital market conditions discussed above could negatively impact ourability to remain in compliance with the financial covenants under ourrevolving credit agreement which could have a material adverse effect on ourfinancial condition, results of operations and cash flows. If we are unable tofinance our expansion projects as expected, we could be required to seekalternative financing, the terms of which may not be attractive to us, or torevise or cancel our expansion plans.

 

***Increasesin interest rates could increase our borrowing costs, adversely impact our unitprice and our ability to issue additional equity, which could have an adverseeffect on our cash flows and our ability to fund our growth.***

 

Due to the recentvolatility and decline in the credit markets, the interest rate on our creditfacility could increase, which would reduce our cash flows.  In addition, interest rates on future creditfacilities and debt offerings could be higher than current levels, causing ourfinancing costs to increase accordingly. As with other yield-oriented securities, the market price for our unitswill be affected by the level of our cash distributions and implieddistribution yield.  The distributionyield is often used by investors to compare and rank yield-oriented securitiesfor investment decision-making purposes. Therefore, changes in interest rates, either positive or negative, mayaffect the yield requirements of investors who invest in our units, and arising interest rate environment could have an adverse effect on our unit priceand our ability to issue additional equity in order to make acquisitions, toreduce debt or for other purposes.

 

***Ourcash flow is affected by the volatility of natural gas and NGL product prices,which could adversely affect our ability to make distributions to unitholders.***

 

We are subject tosignificant risks due to frequent and often substantial fluctuations incommodity prices. In the past, the prices of natural gas and NGLs have beenextremely volatile, and we expect this volatility to continue. The markets andprices for natural gas and NGLs depend upon factors beyond our control. Thesefactors include demand for oil, natural gas and NGLs, which fluctuate withchanges in market and economic conditions and other factors, including:

 

·  theimpact of weather on the demand for oil and natural gas;

 

·  the levelof domestic oil and natural gas production;

 

·  theavailability of imported oil and natural gas;

 

·  actionstaken by foreign oil and gas producing nations;

 

·  theavailability of local, intrastate and interstate transportation systems;

 

·  theavailability and marketing of competitive fuels;

 

·  theimpact of energy conservation efforts; and

 

·  theextent of governmental regulation and taxation.

 

We operate under twotypes of contractual arrangements under which our total segment margin isexposed to increases and decreases in the price of natural gas and NGLs:percentage-of-proceeds and percentage-of-index arrangements. Underpercentage-of-proceeds arrangements, we generally purchase natural gas fromproducers for an agreed percentage of proceeds or upon an index related price,and then sell the resulting residue gas and NGLs or NGL products at indexrelated prices. Under percentage-of-index arrangements, we purchase natural gasfrom producers at a fixed percentage of the index price for the natural gasthey produce and subsequently sell the residue gas and NGLs or NGL products atmarket prices. Under both of these types of contracts our revenues and totalsegment margin increase or decrease, whichever is applicable, as the price ofnatural gas and NGLs fluctuates. 

 

**Item 2.Unregistered Sales of Equity Securities and Use of Proceeds**

 

None.

 

**Item 3.Defaults Upon Senior Securities**

 

None.

 

**Item4.  Submission of Matters to a Vote of Security Holders**

 

None.

 

38

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**Item 5.Other Information**

 

None.

 

**Item 6.Exhibits**

** **
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|--------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                | —     | Certificate of Limited  Partnership of Hiland Partners, LP. (incorporated by reference to  Exhibit 3.1 of Registrant’s Registration Statement on Form S-1  (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                                                      |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3.2                | —     | First Amended and  Restated Limited Partnership Agreement of Hiland Partners, LP (incorporated  by reference to exhibit 3.2 of Registrant’s annual report on Form 10-K  filed on March 30, 2005).                                                                                                                                                                                                                                                                                                                                                                            |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3.3                | —     | Certificate of  Formation of Hiland Partners GP, LLC (incorporated by reference to  Exhibit 3.3 of Registrant’s Registration Statement on Form S-1  (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                                                             |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3.4                | —     | Second Amended and  Restated Limited Liability Company Agreement of Hiland Partners GP, LLC  (incorporated by reference to exhibit 10.2 of Registrant’s Form 8-K  filed on September 29, 2006).                                                                                                                                                                                                                                                                                                                                                                              |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.1                | —     | Certificate of Limited  Partnership of Hiland Partners, LP. (incorporated by reference to  Exhibit 3.1 of Registrant’s Registration Statement on Form S-1  (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                                                      |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.2                | —     | First Amended and  Restated Limited Partnership Agreement of Hiland Partners, LP (incorporated  by reference to exhibit 3.2 of Registrant’s annual report on Form 10-K  filed on March 30, 2005).                                                                                                                                                                                                                                                                                                                                                                            |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.3                | —     | Certificate of  Formation of Hiland Partners GP, LLC (incorporated by reference to  Exhibit 3.3 of Registrant’s Registration Statement on Form S-1  (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                                                             |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.4                | —     | Second Amended and  Restated Limited Liability Company Agreement of Hiland Partners GP, LLC  (incorporated by reference to exhibit 10.2 of Registrant’s Form 8-K  filed on September 29, 2006).                                                                                                                                                                                                                                                                                                                                                                              |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.1               | —     | Credit Agreement dated  as of February 15, 2005 among Hiland Operating, LLC and MidFirst Bank  (incorporated by reference to exhibit 10.1 of Registrant’s annual report on  Form 10-K filed on March 30, 2005).                                                                                                                                                                                                                                                                                                                                                         |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.2*              | —     | Hiland Partners, LP  Long-Term Incentive Plan (incorporated by reference to Exhibit 10.2 of  Registrant’s Registration Statement on Form S-1 (File  No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                                                                   |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.3               | —     | Compression Services  Agreement, effective as of January 28, 2005, by and among Hiland  Partners, LP and Continental Resources, Inc. (incorporated by reference  to exhibit 10.3 of Registrant’s annual report on Form 10-K filed on  March 30, 2005).                                                                                                                                                                                                                                                                                                             |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| †10.4         | —     | Gas Purchase Contract  between Continental Resources, Inc. and Continental Gas, Inc.  (incorporated by reference to Exhibit 10.4 of Registrant’s Registration  Statement on Form S-1 (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                  |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| †10.5         | —     | Gas Purchase Contract  Chesapeake Energy Marketing, Inc. and Continental Gas, Inc.  (incorporated by reference to Exhibit 10.5 of Registrant’s Registration  Statement on Form S-1 (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                    |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| †10.6         | —     | Gas Purchase Contract  between Magic Circle Energy Corporation and Magic Circle Gas (incorporated by  reference to Exhibit 10.6 of Registrant’s Registration Statement on  Form S-1 (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                             |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| †10.7         | —     | Gas Purchase Contract  between Range Resources Corporation and Continental Gas, Inc.  (incorporated by reference to Exhibit 10.7 of Registrant’s Registration  Statement on Form S-1 (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                       |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.8               | —     | Contribution,  Conveyance and Assumption Agreement among Hiland Partners, LP, Hiland  Operating, LLC, Hiland GP, LLC, Hiland LP, LLC, Continental Gas, Inc.,  Hiland Partners GP, LLC, Hiland Partners, LLC, Continental Gas  Holdings, Inc., Hiland Energy Partners, LLC, Harold Hamm, Harold Hamm HJ  Trust, Harold Hamm DST Trust, Equity Financial Services, Inc., Randy  Moeder, and Ken Maples effective as of February 15, 2005 (incorporated  by reference to exhibit 10.8 of Registrant’s annual report on Form 10-K  filed on March 30, 2005). |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.9*              | —     | Form of Unit  Option Grant (incorporated by reference to Exhibit 10.9 of Registrant’s  Registration Statement on Form S-1 (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                                                                                  |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.10              | —     | Omnibus Agreement among  Continental Resources, Inc., Hiland Partners, LLC, Harold Hamm, Hiland  Partners GP, LLC, Continental Gas Holdings, Inc., and Hiland Partners,  LP effective as of February 15, 2005 (incorporated by reference to  exhibit 10.11 of Registrant’s annual report on Form 10-K filed on  March 30, 2005).                                                                                                                                                                                                                              |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.11*             | —     | Director’s Compensation  Summary (incorporated by reference to exhibit 10.11 of Registrant’s annual  report on Form 10-K filed on March 30, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                      |
|               |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.12*             | —     | Form of Restricted  Unit Grant Agreement (incorporated by reference to exhibit 10.1 of  Registrant’s Form 8-K filed on November 14, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                              |

 

39

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| 10.13  | — | First Amendment, dated  as of September 26, 2005 to Credit Agreement dated as of February 15,  2005 among Hiland Operating, LLC and the lenders thereto (incorporated by  reference to exhibit 10.1 of Registrant’s Form 8-K filed on  September 29, 2005).                                         |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.14  | — | Gas Purchase Agreement  among Hiland Partners, LP and Continental Resources, Inc. dated  November 8, 2005 (incorporated by reference to exhibit 10.1 of  Registrants form 8-K filed on November 10, 2005).                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.15  | — | Unit Purchase Agreement  dated May 1, 2006 by and between Hiland Partners, LP and Hiland Partners  GP, LLC (incorporated by reference to exhibit 10.1 of Registrants form 8-K  filed on May 3, 2006).                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.16  | — | Asset Purchase  Agreement dated March 30, 2006 by and between Hiland Operating, LLC and  Enogex Gas Gathering, L.L.C. (incorporated by reference to exhibit 10.2 of  Registrants form 8-K filed on May 3, 2006).                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.17  | — | Second Amendment, dated  as of June 8, 2006, to Credit Agreement dated as of February 15,  2005 among Hiland Operating, LLC and the lenders thereto (incorporated by  reference to exhibit 10.1 of Registrants form 8-K filed on June 13,  2006).                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.18  | — | Non-Competition  Agreement dated September 25, 2006 (2006 by and among Hiland Partners,  LP, Hiland Holdings GP, LP and Hiland Partners GP Holdings, LLC (incorporated  by reference to exhibit 10.1 of Registrants form 8-K filed on  September 29, 2006).                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.19  | — | Retention Agreement,  dated as of March 14, 2007, by and among Randy Moeder, Hiland Partners  GP, LLC, Hiland Partners GP Holdings, LLC and the other parties listed on the  signature page thereto. (incorporated by reference to exhibit 10.1 of  Registrant’s Form 8-K filed on March 15, 2007). |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.20  | — | Third Amendment, dated  as of July 13, 2007, to Credit Agreement dated as of February 15,  2005 among Hiland Operating, LLC and the lenders thereto (incorporated by  reference to exhibit 10.1 of Registrant’s Form 8-K filed on  July 18, 2007).                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.21  | — | Form of Phantom  Unit Grant Agreement (incorporated by reference to exhibit 10.1 of  Registrant’s Form 8-K filed on November 13, 2007).                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.22  | — | Fourth Amendment, dated  as of February 6, 2008, to Credit Agreement dated as of  February 15, 2005 among Hiland Operating, LLC and the lenders thereto  (incorporated by reference to exhibit 10.1 of Registrant’s Form 8-K  filed on February 12, 2008).                                          |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 19.1   | — | Code of Ethics for  Chief Executive Officer and Senior Finance Officers (incorporated by  reference to exhibit 19.1 of Registrant’s annual report on Form 10-K  filed on March 30, 2005).                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 31.1   | — | Certification of Chief  Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 31.2   | — | Certification of Chief  Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 32.1   | — | Certification of Chief  Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 32.2   | — | Certification of Chief  Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                          |

 

----

†      **Portions of this exhibit have been omitted pursuant toa request for confidential treatment**.

 

*******      Constitutes management contracts or compensatoryplans or arrangements.**

 

40

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized in Enid, Oklahoma, on this 10th dayof November, 2008.

 
|            | **HILAND  PARTNERS, LP** |
|------------|--------------------------|
|       |                     |
| ** ** | **By:**                  | **Hiland  Partners GP, LLC, its general partner** |
| ** ** | ** **               |
| ** ** | By:                      | /s/ Joseph L. Griffin |
|       |                     | Joseph L. Griffin |
|       |                     | *Chief Executive Officer, President  and Director**(principal executive officer)* |
|       |                     | * * |
|       | By:                      | /s/ Matthew S. Harrison |
|       |                     | Matthew S. Harrison |
|       |                     | *Chief Financial Officer, Vice President-Finance,  Secretary and Director**(principal financial and accounting officer)* |
|            |                          |  |  |

 

41

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**Exhibit Index**

 
| 3.1        | — | Certificate of Limited  Partnership of Hiland Partners, LP. (incorporated by reference to  Exhibit 3.1 of Registrant’s Registration Statement on Form S-1  (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                                                      |
|------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3.2        | — | First Amended and  Restated Limited Partnership Agreement of Hiland Partners, LP (incorporated  by reference to exhibit 3.2 of Registrant’s annual report on Form 10-K  filed on March 30, 2005).                                                                                                                                                                                                                                                                                                                                                                            |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3.3        | — | Certificate of  Formation of Hiland Partners GP, LLC (incorporated by reference to  Exhibit 3.3 of Registrant’s Registration Statement on Form S-1  (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                                                             |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 3.4        | — | Second Amended and  Restated Limited Liability Company Agreement of Hiland Partners GP, LLC  (incorporated by reference to exhibit 10.2 of Registrant’s Form 8-K  filed on September 29, 2006).                                                                                                                                                                                                                                                                                                                                                                              |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.1        | — | Certificate of Limited  Partnership of Hiland Partners, LP. (incorporated by reference to  Exhibit 3.1 of Registrant’s Registration Statement on Form S-1  (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                                                      |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.2        | — | First Amended and  Restated Limited Partnership Agreement of Hiland Partners, LP (incorporated  by reference to exhibit 3.2 of Registrant’s annual report on Form 10-K  filed on March 30, 2005).                                                                                                                                                                                                                                                                                                                                                                            |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.3        | — | Certificate of  Formation of Hiland Partners GP, LLC (incorporated by reference to  Exhibit 3.3 of Registrant’s Registration Statement on Form S-1  (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                                                             |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 4.4        | — | Second Amended and  Restated Limited Liability Company Agreement of Hiland Partners GP, LLC  (incorporated by reference to exhibit 10.2 of Registrant’s Form 8-K  filed on September 29, 2006).                                                                                                                                                                                                                                                                                                                                                                              |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.1       | — | Credit Agreement dated  as of February 15, 2005 among Hiland Operating, LLC and MidFirst Bank  (incorporated by reference to exhibit 10.1 of Registrant’s annual report on  Form 10-K filed on March 30, 2005).                                                                                                                                                                                                                                                                                                                                                         |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.2*      | — | Hiland Partners, LP  Long-Term Incentive Plan (incorporated by reference to Exhibit 10.2 of  Registrant’s Registration Statement on Form S-1 (File  No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                                                                   |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.3       | — | Compression Services  Agreement, effective as of January 28, 2005, by and among Hiland  Partners, LP and Continental Resources, Inc. (incorporated by reference  to exhibit 10.3 of Registrant’s annual report on Form 10-K filed on  March 30, 2005).                                                                                                                                                                                                                                                                                                             |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| †10.4 | — | Gas Purchase Contract  between Continental Resources, Inc. and Continental Gas, Inc.  (incorporated by reference to Exhibit 10.4 of Registrant’s Registration  Statement on Form S-1 (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                  |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| †10.5 | — | Gas Purchase Contract  Chesapeake Energy Marketing, Inc. and Continental Gas, Inc.  (incorporated by reference to Exhibit 10.5 of Registrant’s Registration  Statement on Form S-1 (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                    |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| †10.6 | — | Gas Purchase Contract  between Magic Circle Energy Corporation and Magic Circle Gas (incorporated by  reference to Exhibit 10.6 of Registrant’s Registration Statement on  Form S-1 (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                             |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| †10.7 | — | Gas Purchase Contract  between Range Resources Corporation and Continental Gas, Inc.  (incorporated by reference to Exhibit 10.7 of Registrant’s Registration  Statement on Form S-1 (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                       |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.8       | — | Contribution,  Conveyance and Assumption Agreement among Hiland Partners, LP, Hiland  Operating, LLC, Hiland GP, LLC, Hiland LP, LLC, Continental Gas, Inc.,  Hiland Partners GP, LLC, Hiland Partners, LLC, Continental Gas  Holdings, Inc., Hiland Energy Partners, LLC, Harold Hamm, Harold Hamm HJ  Trust, Harold Hamm DST Trust, Equity Financial Services, Inc., Randy  Moeder, and Ken Maples effective as of February 15, 2005 (incorporated  by reference to exhibit 10.8 of Registrant’s annual report on Form 10-K  filed on March 30, 2005). |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.9*      | — | Form of Unit  Option Grant (incorporated by reference to Exhibit 10.9 of Registrant’s  Registration Statement on Form S-1 (File No. 333-119908)).                                                                                                                                                                                                                                                                                                                                                                                                                  |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.10      | — | Omnibus Agreement among  Continental Resources, Inc., Hiland Partners, LLC, Harold Hamm, Hiland  Partners GP, LLC, Continental Gas Holdings, Inc., and Hiland Partners,  LP effective as of February 15, 2005 (incorporated by reference to  exhibit 10.11 of Registrant’s annual report on Form 10-K filed on  March 30, 2005).                                                                                                                                                                                                                              |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.11*     | — | Director’s Compensation  Summary (incorporated by reference to exhibit 10.11 of Registrant’s annual  report on Form 10-K filed on March 30, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                      |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.12*     | — | Form of Restricted  Unit Grant Agreement (incorporated by reference to exhibit 10.1 of  Registrant’s Form 8-K filed on November 14, 2005).                                                                                                                                                                                                                                                                                                                                                                                                                              |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.13      | — | First Amendment, dated  as of September 26, 2005 to Credit Agreement dated as of  February 15, 2005 among Hiland Operating, LLC and the lenders thereto  (incorporated by reference to exhibit 10.1 of Registrant’s Form 8-K  filed on September 29, 2005).                                                                                                                                                                                                                                                                                                        |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.14      | — | Gas Purchase Agreement  among Hiland Partners, LP and Continental Resources, Inc. dated  November 8, 2005 (incorporated by reference to exhibit 10.1 of  Registrants form 8-K filed on November 10, 2005).                                                                                                                                                                                                                                                                                                                                                                   |

 

42

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| 10.15  | — | Unit Purchase Agreement  dated May 1, 2006 by and between Hiland Partners, LP and Hiland Partners  GP, LLC (incorporated by reference to exhibit 10.1 of Registrants form 8-K  filed on May 3, 2006).                                                                                                              |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.16  | — | Asset Purchase  Agreement dated March 30, 2006 by and between Hiland Operating, LLC and  Enogex Gas Gathering, L.L.C. (incorporated by reference to exhibit 10.2 of  Registrants form 8-K filed on May 3, 2006).                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.17  | — | Second Amendment, dated  as of June 8, 2006, to Credit Agreement dated as of February 15,  2005 among Hiland Operating, LLC and the lenders thereto (incorporated by  reference to exhibit 10.1 of Registrants form 8-K filed on June 13,  2006).                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.18  | — | Non-Competition  Agreement dated September 25, 2006 (2006 by and among Hiland Partners,  LP, Hiland Holdings GP, LP and Hiland Partners GP Holdings, LLC (incorporated  by reference to exhibit 10.1 of Registrants form 8-K filed on  September 29, 2006).                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.19  | — | Retention Agreement,  dated as of March 14, 2007, by and among Randy Moeder, Hiland Partners  GP, LLC, Hiland Partners GP Holdings, LLC and the other parties listed on the  signature page thereto. (incorporated by reference to exhibit 10.1 of  Registrant’s Form 8-K filed on March 15, 2007). |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.20  | — | Third Amendment, dated  as of July 13, 2007, to Credit Agreement dated as of February 15,  2005 among Hiland Operating, LLC and the lenders thereto (incorporated by  reference to exhibit 10.1 of Registrant’s Form 8-K filed on  July 18, 2007).                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.21  | — | Form of Phantom  Unit Grant Agreement (incorporated by reference to exhibit 10.1 of  Registrant’s Form 8-K filed on November 13, 2007).                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 10.22  | — | Fourth Amendment, dated  as of February 6, 2008, to Credit Agreement dated as of  February 15, 2005 among Hiland Operating, LLC and the lenders thereto  (incorporated by reference to exhibit 10.1 of Registrant’s Form 8-K  filed on February 12, 2008).                                          |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 19.1   | — | Code of Ethics for  Chief Executive Officer and Senior Finance Officers (incorporated by  reference to exhibit 19.1 of Registrant’s annual report on Form 10-K  filed on March 30, 2005).                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 31.1   | — | Certification of Chief  Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 31.2   | — | Certification of Chief  Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 32.1   | — | Certification of Chief  Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                         |
| 32.2   | — | Certification of Chief  Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                          |

 

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†      **Portions of this exhibit have been omitted pursuant toa request for confidential treatment**.

 

*******      Constitutes management contracts or compensatoryplans or arrangements.**

 

43

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