** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

** **

**Washington,D.C.  20549**

** **

**FORM10-Q**

** **

**ý**QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934

 

**FOR THEQUARTERLY PERIOD ENDED March 31, 2005**

 

**OR**

 

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

 

**FOR THETRANSITION PERIOD FROM              TO              .**

 

**Commissionfile number:  000-51120**

 

**HilandPartners, LP**

**(Exact name of Registrant as specified in its charter)**

** **
| **DELAWARE**                                                                | ** ** | **71-0972724**                         |
|-----------------------------------------------------------------------------|------------|----------------------------------------|
| (State or  other jurisdiction of  incorporation or organization)            |       | (I.R.S.  Employer  Identification No.) |
|                                                                        |       |                                   |
| **205 West Maple, Suite 1100  Enid, Oklahoma**                              | ** ** | **73701**                              |
| (Address of  principal executive offices)                                   |       | (Zip code)                             |
|                                                                        |       |                                   |
| Registrant’s  telephone number including area code **(580)  242-6040** |

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.  Yes  ý    No  o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Act).  Yes  o    No  ý

 

**The number of the registrant’soutstanding equity units at May 6, 2005 was 2,720,000 common units, 4,080,000subordinated units and a 2% general partnership interest.**

 

 

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**HILANDPARTNERS, LP**

**INDEX**

** **
| **PART I. FINANCIAL  INFORMATION**                                                                       | **3**      |
|----------------------------------------------------------------------------------------------------------|------------|
| **DESCRIPTION OF BUSINESS**                                                                              | **3**      |
| **Item 1. Financial  Statements (Unaudited, except December 31, 2004 Balance Sheet)**               | **5**      |
| **Consolidated Balance Sheets**                                                                          | **5**      |
| **Consolidated  Combined Statements of Operations**                                                      | **6**      |
| **Consolidated  Combined Statements of Cash Flows**                                                      | **7**      |
| **Consolidated  Combined Statements of Owners’ Equity**                                             | **8**      |
| **Notes  to Consolidated Combined Financial Statements**                                                 | **9**      |
| **Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations** | **25**     |
| **Item  3. Quantitative and Qualitative Disclosures About Market Risks**                                 | **33**     |
| **Item 4. Controls and Procedures**                                                                      | **33**     |
| **PART II. OTHER INFORMATION**                                                                           | **34**     |
| **Item 1. Legal Proceedings**                                                                            | **34**     |
| **Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds**                                 | **34**     |
| **Item 3.  Defaults Upon Senior Securities**                                                             | **34**     |
| **Item  4. Submission of Matters to a Vote of Security Holders**                                         | **34**     |
| **Item 5. Other Information**                                                                            | **34**     |
| **Item 6. Exhibits**                                                                                     | **34**     |
| **SIGNATURES**                                                                                           | **36**     |
| **Certification of CEO under Section 302**                                                          | ** ** |
| **Certification of CFO under Section 302**                                                          | ** ** |
| **Certification of CEO under Section 906**                                                          | ** ** |
| **Certification of CFO under Section 906**                                                          | ** ** |

 

i

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**CautionaryStatement About Forward-Looking Statements**

 

This Quarterly Report on Form 10-Q includes certain “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933 and Section 21E of the Securities Exchange Act of 1934.  These statements include statements regardingour plans, goals, beliefs or current expectations. Statements using words suchas “anticipate,” “believe,” “intend,” “project,” “plan,” “continue,” “estimate,”“forecast,” “may,” “will,” or similar expressions help identify forward-lookingstatements.  Although we believe suchforward-looking statements are based on reasonable assumptions and currentexpectations and projections about future events, no assurance can be giventhat every objective will be reached.

 

Actual results may differ materially from any resultsprojected, forecasted, estimated or expressed in forward-looking statements sincemany of the factors that determine these results are subject to uncertaintiesand risks, difficult to predict, and beyond management’s control.  Such factors include:

 

•      the generaleconomic conditions in the United States of America as well as the generaleconomic conditions and currencies in foreign countries;

 

•      the continuedability to find and contract for new sources of natural gas supply;

 

•      the amount ofnatural gas transported on our gathering systems;

 

•      the level ofthroughput in our natural gas processing and treating facilities;

 

•      the fees wecharge and the margins realized for our services;

 

•      the prices andmarket demand for, and the relationship between, natural gas and NGLs;

 

•      energy pricesgenerally;

 

•      the level ofdomestic oil and natural gas production;

 

•      theavailability of imported oil and natural gas;

 

•      actions takenby foreign oil and gas producing nations;

 

•      the politicaland economic stability of petroleum producing nations;

 

•      the weather inour operating areas;

 

•      the extent ofgovernmental regulation and taxation;

 

•      hazards oroperating risks incidental to the transporting, treating and processing ofnatural gas and NGLs that may not be fully covered by insurance;

 

•      competitionfrom other midstream companies;

 

•      loss of keypersonnel;

 

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

 

•      changes in lawsand regulations to which we are subject, including tax, environmental,transportation and employment regulations;

 

•      the costs andeffects of legal and administrative proceedings;

 

•      the ability tosuccessfully identify and consummate strategic acquisitions at purchase pricesthat are accretive to the our financial results; and

 

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

 

These factors are not necessarily all of the importantfactors that could cause actual results to differ materially from thoseexpressed in any of our forward-looking statements.  Our future results will depend upon variousother risks and uncertainties,

 

1

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including, but notlimited to those described under “Item 2. Management’s Discussion and Analysisof Financial Condition and Results of Operations.”  Other unknown or unpredictable factors alsocould have material adverse effects on our future results.  You should not put undue reliance on anyforward-looking statements.

 

All forward-looking statements attributable to us arequalified in their entirety by this cautionary 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.

 

2

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# **PART I. FINANCIAL INFORMATION**

# ** **

# **DESCRIPTIONOF BUSINESS**

# ** **

The financial statements presented in thisForm 10-Q present the financial position and results of Continental Gas, Inc.(Predecessor) for periods presented through February 14, 2005.  The financial results of Continental Gas,Inc. pre-dates the commencement of operations of the Registrant, HilandPartners, LP and subsequent transactions described below.

 

The financial statements for the three-monthperiod ended March 31, 2005 also include the results of operations ofHiland Partners, LP for the period from February 15, 2005, the date HilandPartners, LP commenced operations.  Thebalance sheet as of March 31, 2005 presents solely the consolidatedfinancial position of Hiland Partners, LP.

 

Hiland Partners, LP is a Delaware limitedpartnership formed in October 2004 to own and operate the assets that havehistorically been owned and operated by Continental Gas, Inc. and HilandPartners, LLC.  In connection with our initialpublic offering described below, the former owners of Continental Gas, Inc. andHiland Partners, LLC and certain of our affiliates, including our generalpartner, contributed to us all of the assets and operations of Continental Gas,Inc., other than a portion of its working capital assets, and substantially allof the assets and operations of Hiland Partners, LLC, other than a portion ofits working capital assets and the assets related to the Bakken gatheringsystem, in exchange for an aggregate of 720,000 common units and 4,080,000subordinated units, a 2% general partner interest in us and all of ourincentive distribution rights, which entitle the general partner to increasingpercentages of the cash we distribute in excess of $0.495 per unit per quarter.Harold Hamm and members of our management own a 100% managing member interestin Hiland Partners GP, LLC, our general partner.

 

Continental Gas, Inc. historically has ownedall of our natural gas gathering, processing, treating and fractionation assetsother than our Worland gathering system. Prior to July 21, 2004, Continental Gas, Inc. was owned byContinental Resources, Inc., an independent exploration and development companyowned by Harold Hamm, the Chairman of the Board of Directors of our generalpartner and the Harold Hamm DST and the Harold Hamm HJ Trusts, which are trustsestablished for the benefit of Harold Hamm’s children and which we refer toherein as the “Hamm Trusts.”  On July 21,2004, Continental Resources, Inc. completed the transfer of Continental Gas,Inc. to Harold Hamm and the Hamm Trusts. Hiland Partners, LLC historically owned our Worland gathering system,our compression services assets and the Bakken gathering system.  Hiland Partners, LLC is owned by the HammTrusts and an entity owned by Randy Moeder, our President and Chief ExecutiveOfficer and a director of our general partner.

 

On October 22, 2004, we filed aregistration statement on Form S-1 with the United States Securities andExchange Commission (the “SEC”) relating to a proposed underwritten initialpublic offering of limited partnership units in Hiland Partners, LP.

 

On February 9, 2005, the SEC declaredour registration statement on Form S-1 effective and we priced 2,000,000 commonunits for the initial public offering at a price of $22.50 per unit.  On February 10, 2005, our common unitsbegan trading on the Nasdaq National Market under the symbol “HLND”.  On February 15, 2005, we closed ourinitial public offering of 2,300,000 common units, which included a 300,000unit over-allotment option that was exercised by the underwriters.  Total proceeds from the sale of the unitswere $48.1 million, net of $3.6 million of underwriting commissions.  The proceeds of the public offering were usedto: (i) repay approximately $22.9 million of outstanding indebtedness, (ii) paythe remaining $2.2 million of expenses associated with the offering and therelated formation transactions, (iii) make a distribution of approximately $3.9million to the former owners of Hiland Partners, LLC in reimbursement ofcertain capitalized expenditures related to the assets of Hiland Partners, LLCthat were contributed to us, (iv) pay $0.6 million of deferred debt issuancecosts related to the credit facility, (v) replenish approximately $12.2 millionof working capital and (vi) redeem an aggregate of 300,000 common units from anaffiliate of Harold Hamm and the Hamm Trusts for $6.3 million.

 

Concurrently with the closing of our initialpublic offering, we established a $55.0 million credit facility through ouroperating company, Hiland Operating, LLC, with MidFirst Bank, a federallychartered savings association located in Oklahoma City, Oklahoma, asadministrative agent and a lender, with an option to increase the amount to$90.0 million under certain conditions. As of May 6, 2005, we had no indebtedness outstanding under the creditfacility.

 

In reviewing the financial statementsdiscussed herein, you should be aware of the following:

 

•      The assets ofContinental Gas, Inc. transferred to us are recorded at historical cost as itis considered a reorganization of entities under common control.  The acquisition of the assets of HilandPartners, LLC was accounted for as a purchase and, as a result, these assetsare recorded at their fair value at the time of purchase, which occurredconcurrent with the closing of our initial public offering.

 

3

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•      The financialstatement for the three-month period ended March 31, 2005 for HilandPartners, LP includes the results of operations of the assets acquired fromHiland Partners, LLC only from February 15, 2005, the date HilandPartners, LP commenced operations and acquired the assets.

 

•      Prior to ourformation, Hiland Partners, LLC owned our Horse Creek air compression facilityand our Cedar Hills water injection facility. In 2002, Hiland Partners, LLC entered into a five-year lease agreementwith Continental Resources, Inc., pursuant to which Hiland Partners, LLC leasedthe facilities to Continental Resources, Inc. Continental Resources, Inc. used its own personnel to operate thefacilities, and Hiland Partners, LLC made no operational decisions.  In connection with our formation and ourinitial public offering, we entered into a four-year services agreement withContinental Resources, Inc., effective as of January 28, 2005, thatreplaced the existing lease.  Under theservices agreement, we own and operate the facilities and provide aircompression and water injection services to Continental Resources, Inc. for afee.  As part of the new agreement, thepersonnel at Continental Resources, Inc. that operated the facilities are nowemployed by us.  Under the new servicesagreement, we will receive a fixed payment of approximately $4.8 million peryear as compared to $3.8 million under the prior lease agreement.  In connection with the new servicesarrangement, we will incur approximately $1.0 million per year in additionaloperating costs.

 

See “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” for further discussion of theinitial public offering and related transactions and agreements.

 

**References in thisquarterly report on Form 10-Q to “we,” “our,” “us,” or similar terms refer toHiland Partners, LP and its operating subsidiaries after giving effect to theformation transactions described above.**

 

4

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**Item 1.Financial Statements**

 

**HILANDPARTNERS, LP**

**CONTINENTAL GAS, INC. (PREDECESSOR)**

**Consolidated Balance Sheets**

 
| ** **                                                                                             | ** ** | **Hiland Partners, LP  March 31, 2005** | ** ** | **Continental Gas, Inc.  (Predecessor)  December 31, 2004** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                                                                             | ** ** | **(Unaudited)**                              | ** ** | ** **                                                       | ** ** |
| ** **                                                                                             | ** ** | **(in thousands, except unit  amounts)**     | ** ** |
| **ASSETS**                                                                                             |       |                                         |       |                                                             |       |
| **Current  Assets:**                                                                                   |       |                                         |       |                                                             |       |
| Cash and  cash equivalent                                                                              |       | $                                            | 3,202      |                                                             | $          | 217 |   |
| Accounts  receivable:                                                                                  |       |                                         |       |                                                             |       |
| Trade                                                                                                  |       | 10,527                                       |       | 9,663                                                            |       |
| Affiliates                                                                                             |       | 909                                          |       | 758                                                              |       |
|                                                                                                   |       | 11,436                                       |       | 10,421                                                           |       |
| Inventories                                                                                            |       | 153                                          |       | 153                                                              |       |
| Other  current assets                                                                                  |       | 311                                          |       | 118                                                              |       |
| Total  current assets                                                                                  |       | 15,102                                       |       | 10,909                                                           |       |
| Property and  equipment, net                                                                           |       | 67,622                                       |       | 37,075                                                           |       |
| Intangible  assets, net                                                                                |       | 26,465                                       |       | —                                                           |       |
| Other  assets, net                                                                                     |       | 797                                          |       | 1,191                                                            |       |
| **Total  assets**                                                                                      |       | $                                            | 109,986    |                                                             | $          | 49,175 |   |
|                                                                                                   |       |                                         |       |                                                             |       |
| **LIABILITIES  AND PARTNERS’ EQUITY**                                                             |       |                                         |       |                                                             |       |
| **Current  liabilities:**                                                                              |       |                                         |       |                                                             |       |
| Accounts  payable                                                                                      |       | $                                            | 6,104      |                                                             | $          | 5,649 |   |
| Accounts  payable - affiliates                                                                         |       | 2,698                                        |       | 2,998                                                            |       |
| Accrued  liabilities                                                                                   |       | 703                                          |       | 327                                                              |       |
| Current  maturities of long-term debt                                                                  |       | —                                       |       | 2,429                                                            |       |
| Total  current liabilities                                                                             |       | 9,505                                        |       | 11,403                                                           |       |
| Commitment  and contingencies                                                                          |       | —                                       |       | —                                                           |       |
| Long-term  debt, net of current maturities                                                             |       | —                                       |       | 12,643                                                           |       |
| Asset  retirement obligation                                                                           |       | 1,024                                        |       | 619                                                              |       |
| **Owners’  equity:**                                                                              |       |                                         |       |                                                             |       |
| Predecessor  stockholders’ equity                                                                 |       | —                                       |       | 24,510                                                           |       |
| Common  unitholders (2,720,000 units issued and outstanding March 31, 2005)                       |       | 47,854                                       |       | —                                                           |       |
| Subordinated  unitholders (4,080,000 units issued and outstanding at March 31, 2005)              |       | 49,791                                       |       | —                                                           |       |
| General  partner interest (2% interest with 138,776 equivalent units outstanding March 31,  2005) |       | 1,812                                        |       | —                                                           |       |
| **Total  owners’ equity**                                                                         |       | 99,457                                       |       | 24,510                                                           |       |
| **Total  liabilities and owners’ equity**                                                         |       | $                                            | 109,986    |                                                             | $          | 49,175 |   |

** **

**The accompanying notes are an integral part of thesefinancial statements.**

** **

**5**

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** **

**HILAND PARTNERS, LP**

**CONTINENTAL GAS, INC. (PREDECESSOR)**

**ConsolidatedCombined Statements of Operations**

**For the Three Months Ended (Unaudited)**

 
| ** **                                                              | ** ** | **Hiland  Partners, LP  March 31,**  | ** ** | **Continental Gas, Inc.  (Predecessor)  March 31,** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                              | ** ** | **2005**                                  | ** ** | **2004**                                                 | ** ** |
| ** **                                                              | ** ** | **(in thousands, except per unit  data)** | ** ** |
| **Revenues:**                                                           |       |                                      |       |                                                     |       |
| Midstream  operations                                                   |       |                                      |       |                                                     |       |
| Third  parties                                                          |       | $                                         | 24,191     |                                                     | $          | 20,235 |   |
| Affiliates                                                              |       | 984                                       |       | 815                                                      |       |
| Compression  services, affiliate                                        |       | 603                                       | ** ** | **—**                                               | ** ** |
| Total  revenues                                                         |       | 25,778                                    |       | 21,050                                                   |       |
|                                                                    |       |                                      |       |                                                     |       |
| **Operating  costs and expenses:**                                      |       |                                      |       |                                                     |       |
| Midstream  purchases (exclusive of items shown below)                   |       | 13,860                                    |       | 10,827                                                   |       |
| Midstream  purchases - affiliate (exclusive of items shown below)       |       | 6,343                                     |       | 6,983                                                    |       |
| Operations  and maintenance                                             |       | 1,577                                     |       | 1,196                                                    |       |
| Depreciation,  amortization and accretion                               |       | 1,677                                     |       | 847                                                      |       |
| General and  administrative                                             |       | 353                                       |       | 264                                                      |       |
| Total  operating costs and expenses                                     |       | 23,810                                    |       | 20,117                                                   |       |
| Operating  income                                                       |       | 1,968                                     |       | 933                                                      |       |
|                                                                    |       |                                      |       |                                                     |       |
| **Other  income (expense):**                                            |       |                                      |       |                                                     |       |
| Interest and  other income                                              |       | 7                                         |       | 13                                                       |       |
| Amortization  of deferred loan costs                                    |       | (205                                      | )          | (25                                                      | )          |
| Interest  expense                                                       |       | (134                                      | )          | (169                                                     | )          |
| Total other  income (expense)                                           |       | (332                                      | )          | (181                                                     | )          |
|                                                                    |       |                                      |       |                                                     |       |
| **Income  from continuing operations**                                  |       | 1,636                                     |       | 752                                                      |       |
| **Discontinued  operations, net**                                       | ** ** | **—**                                |       | 15                                                       |       |
|                                                                    |       |                                      |       |                                                     |       |
| **Net  Income**                                                         |       | 1,636                                     |       | $                                                        | 767        |   |
| ** **                                                              | ** ** | ** **                                | ** ** | ** **                                               | ** ** |
| Less income  attributable to predecessor                                |       | 493                                       |       |                                                     |       |
| Less general  partner interest in net income                            |       | 23                                        |       |                                                     |       |
| **Limited  partners’ interest in net income**                      |       | $                                         | 1,120      |                                                     |       |   |
|                                                                    |       |                                      |       |                                                     |       |
| **Net  income per limited partners’ unit – basic**            |       | $                                         | 0.16       |                                                     |       |   |
|                                                                    |       |                                      |       |                                                     |       |
| **Net  income per limited partners’ unit – diluted**          |       | $                                         | 0.16       |                                                     |       |   |
|                                                                    |       |                                      |       |                                                     |       |
| **Weighted  average limited partners’ units outstanding -basic**   |       | 6,800                                     |       |                                                     |       |
|                                                                    |       |                                      |       |                                                     |       |
| **Weighted  average limited partners’ units outstanding -diluted** |       | 6,840                                     |       |                                                     |       |

 

Theaccompanying notes are an integral part of these financial statements.

 

6

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**HILAND PARTNERS, LP**

**CONTINENTAL GAS, INC. (PREDCESSOR)**

**ConsolidatedCombined Statements of Cash Flows**

**For the Three Months Ended (Unaudited)**

 
| ** **                                                                                                 | ** ** | **Hiland Partners, LP  March 31,** | ** ** | **Continental Gas, Inc.  (Predecessor)  March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2005**                                | ** ** | **2004**                                                 | ** ** |
| ** **                                                                                                 | ** ** | **(in thousands)**                      | ** ** |
| **Cash  flows from operating activities:**                                                                 |       |                                    |       |                                                     |       |
| Net income                                                                                                 |       | $                                       | 1,636      |                                                     | $          | 767 |   |
| Adjustments  to reconcile net income to net cash provided by (used in) operating  activities:              |       |                                    |       |                                                     |       |
| Depreciation  and amortization                                                                             |       | 1,669                                   |       | 847                                                      |       |
| Change in  asset retirement obligation                                                                     |       | 8                                       |       | 13                                                       |       |
| Amortization  of deferred loan cost                                                                        |       | 205                                     |       | 25                                                       |       |
| Change in  current assets and current liabilities net of effects of the Hiland Partners,  LLC acquisition: |       |                                    |       |                                                     |       |
| (Increase)  decrease in current assets:                                                                    |       |                                    |       |                                                     |       |
| Accounts  receivable                                                                                       |       | (9,849                                  | )          | 1,122                                                    |       |
| Account  receivable – affiliates                                                                      |       | (151                                    | )          | 12                                                       |       |
| Inventories                                                                                                |       | —                                  |       | 122                                                      |       |
| Other  current assets                                                                                      |       | (147                                    | )          | —                                                   |       |
| Increase  (decrease) in current liabilities:                                                               |       |                                    |       |                                                     |       |
| Accounts  payable                                                                                          |       | (221                                    | )          | 365                                                      |       |
| Accounts  payable – affiliates                                                                        |       | (300                                    | )          | (94                                                      | )          |
| Accrued  liabilities                                                                                       |       | 311                                     |       | (150                                                     | )          |
| **Net cash  provided by (used in) operating activities**                                                   |       | (6,839                                  | )          | 3,029                                                    |       |
| **Cash  flows from investing activities:**                                                                 |       |                                    |       |                                                     |       |
| Additions to  property and equipment                                                                       |       | (281                                    | )          | (1,328                                                   | )          |
| **Net cash  used for investing activities**                                                                |       | (281                                    | )          | (1,328                                                   | )          |
| **Cash  flows from financing activities:**                                                                 |       |                                    |       |                                                     |       |
| Proceeds  from public offering -net                                                                        |       | 48,128                                  |       | —                                                   |       |
| Redemption  of common units                                                                                |       | (6,278                                  | )          | —                                                   |       |
| Distribution  to organizers                                                                                |       | (3,851                                  | )          | —                                                   |       |
| Cash not  contributed by organizers                                                                        |       | (869                                    | )          | **—**                                               | ** ** |
| Payment on  long-term borrowings                                                                           |       | (23,951                                 | )          | (607                                                     | )          |
| Debt  issuance costs                                                                                       |       | (825                                    | )          | (7                                                       | )          |
| Payment of  offering costs                                                                                 |       | (2,249                                  | )          | —                                                   |       |
| **Net cash  provided (used by) financing activities**                                                      |       | 10,105                                  |       | (614                                                     | )          |
|                                                                                                       |       |                                    |       |                                                     |       |
| Increase  (decrease) for the period                                                                        |       | 2,985                                   |       | 1,087                                                    |       |
| Beginning of  period                                                                                       |       | 217                                     |       | 496                                                      |       |
| **End of  period**                                                                                         |       | $                                       | 3,202      |                                                     | $          | 1,583 |   |
|                                                                                                       |       |                                    |       |                                                     |       |
| Supplementary  information:                                                                                |       |                                    |       |                                                     |       |
| Cash paid  for interest                                                                                    |       | $                                       | 153        |                                                     | $          | 170 |   |

 

See Note 4 fornon-cash business combination transactions.

 

Theaccompanying notes are an integral part of these financial statements.

 

7

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**HILAND PARTNERS, LP**

**CONTINENTAL GAS, INC. (PREDECESSOR)**

**ConsolidatedCombined Statement of Partners’ Equity**

**(Unaudited)**

 
| ** **                                                               | ** ** | **Hiland Partners, LP**                   | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                               | ** ** | **Continental  Gas, Inc.  (Predecessor)** | ** ** | **Common  Units** | ** ** | **Subordinated  Units** | ** ** | **General  Partner  Interest** | ** ** | **Total** | ** ** |
| ** **                                                               | ** ** | **(in thousands)**                        | ** ** |
|                                                                     |       |                                      |       |   |   |   |   |   |   |   |   |
| Balance December 31,  2004                                          |       | $                                         | 24,510     | ** ** | **$** | **—** | ** ** | **$** | **—** | ** ** | **$** | **—** |   | $ | 24,510 |   |
|                                                                     |       |                                      |       |   |   |   |   |   |   |   |   |
| Assets and  liabilities not contributed to Hiland Partners, LP           |       | (9,972                                    | )          | **—** | ** ** | **—** | ** ** | **—** |   | (9,972 | ) |
|                                                                     |       |                                      |       |   |   |   |   |   |   |   |   |
| Net income  through February 14, 2005                               |       | 493                                       | ** ** | **—** | ** ** | **—** | ** ** | **—** |   | 493 |   |
|                                                                     |       |                                      |       |   |   |   |   |   |   |   |   |
| Allocation  of net parent investment to unitholders                      |       | (15,031                                   | )          | 2,191 |   | 12,418 |   | 422 | ** ** | **—** | ** ** |
|                                                                     |       |                                      |       |   |   |   |   |   | ** ** | ** ** | ** ** |
| Contribution  of Hiland Partners, LLC by owners                     | ** ** | **—**                                |       | 7,092 |   | 40,190 |   | 1,367 |   | 48,649 |   |
|                                                                     | ** ** | ** **                                |       |   |   |   |   |   |   |   |   |
| Proceeds  from initial public offering, net of underwriter discount | ** ** | **—**                                |       | 48,128 | ** ** | **—** | ** ** | **—** |   | 48,128 |   |
|                                                                     | ** ** | ** **                                |       |   | ** ** | ** ** | ** ** | ** ** |   |   |   |
| Offering  costs                                                          |       |                                      |       | (3,365 | ) | **—** |   | **—** |   | (3,365 | ) |
|                                                                     |       |                                      |       | ** ** | ** ** | ** ** |   |   |   |   |   |
| Redemption  of Common Units from Organizers                         | ** ** | **—**                                |       | (6,278 | ) | **—** | ** ** | **—** |   | (6,278 | ) |
|                                                                     | ** ** | ** **                                |       |   |   | ** ** | ** ** | ** ** |   |   |   |
| Distributions                                                            | ** ** | **—**                                |       | (362 | ) | (3,489 | ) | **—** |   | (3,851 | ) |
|                                                                     | ** ** | ** **                                |       |   |   |   |   | ** ** |   |   |   |
| Net income  from February 15, 2005 through March 31, 2005 | ** ** | **—**                                |       | 448 |   | 672 |   | 23 |   | 1,143 |   |
|                                                                     | ** ** | ** **                                |       |   |   |   |   |   |   |   |   |
| Balance March 31,  2005                                             | ** ** | **$**                                     | **—** |   | $ | 47,854 |   | $ | 49,791 |   | $ | 1,812 |   | $ | 99,457 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

8

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**HILANDPARTNERS, LP**

**CONTINENTALGAS, INC. (PREDECESSOR)**

NOTES TO CONSOLIDATED COMBINED FINANCIAL STATEMENTS (UNAUDITED)

AS OF AND FOR THE THREE MONTHSENDED MARCH, 2004, AND 2005

 

**(inthousands, except unit amounts and per unit amounts or unless otherwise noted)**

 

**Note 1: Description of Business and Summary of Significant Accounting Policies**

 

***Interim Financial Statements***

 

The financial statements for the three months ended March 31,2004 and 2005 included herein have been prepared without audit, pursuant to therules and regulation of the United States Securities and Exchange Commission(the “SEC”).  The statements ofoperations, cash flow and partners’ equity include the accounts of ContinentalGas, Inc. (“CGI”) through February 14, 2005 and Hiland Partners, LP ( the “Partnership”)for the period from February 15, 2005 to March 31, 2005.  The accompanying condensed consolidatedfinancial statements and related notes should be read in conjunction with theaudited financial statements of Continental Gas, Inc. (Predecessor) and HilandPartners, LLC, and notes thereto, for the year ended December 31, 2004 aspresented in the Partnership’s  Form 10-Kfor the year ended December 31, 2004.

 

The interim financial statements reflect alladjustments, which are in the opinion of management, necessary for a fairpresentation of our results for the interim periods to the extent permitted byGAAP.  Such adjustments are considered tobe of a normal recurring nature.  Resultsof operations for the three months ended March 31, 2005 are notnecessarily indicative of the results of operations that will be realized forthe year ending December 31, 2005.

 

***Principles of Consolidation***

 

The consolidated financial statements includeour accounts and those of our subsidiaries. All significant intercompanytransactions and balances have been eliminated. In addition, the consolidatedfinancial statements include the financial position and results of operationsof assets owned by CGI or Hiland Partners, LLC that were contributed to thePartnership concurrently with the completion of our initial public offering.

 

***Description ofBusiness***

 

Hiland Partners, LP was formed in October,2004 to acquire and operate certain of the midstream natural gas plants,gathering systems, and compression and water injection assets previously ownedby CGI and Hiland Partners, LLC.

 

CGI was formed in 1990 as a wholly ownedsubsidiary of Continental Resources, Inc. (“CRI”). CGI operates in onebusiness, midstream, which is the gathering, compressing, dehydrating,treating, and processing of natural gas and fractionating natural gas liquids,or NGLs. CGI connects the wells of natural gas producers in its market areas toits gathering systems, treats natural gas to remove impurities, processesnatural gas for the removal of NGLs and sells the resulting products to avariety of intermediate purchasers. CGI owns and operates three processingplants with associated compressor stations, fractionation facilities andapproximately 650 miles of gathering pipeline. These plants and associatedgathering systems are located in Oklahoma and North Dakota. CGI also owns threesmall gathering systems consisting of approximately 20 miles of pipeline andcompressor stations. These gathering systems are located in Texas, Mississippiand Oklahoma.

 

CGI had minor interests in producing oil andgas properties located primarily in North Dakota. The properties were acquiredover several years while CGI was a subsidiary of CRI. CGI does not to intend topursue the exploration for and development of oil and natural gas and,accordingly, conveyed its interest in these properties effective May 31,2004 to CRI. Therefore this activity is presented as discontinued operations.

 

In July 2004, CRI sold all of the issuedand outstanding capital stock of CGI to the shareholders of CRI at fair value.The stock sale transaction was approved by all of the independent members ofthe Board of Directors of CRI, and the independent members of the Board ofDirectors were provided with an opinion as to the fairness of the stock saletransaction, from a financial point of view. CGI and CRI were previouslyreported as a consolidated entity.

 

As of the date of the closing of the publicoffering, CGI, through a series of steps, became Continental Gas Operating,LP.  This entity is a wholly-ownedsubsidiary of the Partnership.

 

Hiland Partners, LLC was formed in September 2000as an Oklahoma limited liability company. Hiland Partners, LLC operates in twobusinesses: midstream, which is the gathering, compressing, dehydrating,treating, processing and marketing of natural gas and

 

9

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fractionating NGLs; and compression, which is providing air compressionand water injection services for oil and gas secondary recovery operations thatare ongoing in North Dakota.

 

Hiland Partners, LLC connects the wells ofnatural gas producers in its market area to its gathering system, treatsnatural gas to remove impurities, processes natural gas for the removal of NGLsand sells the resulting products to a variety of intermediate purchasers.Hiland Partners, LLC owns and operates one processing plant with associatedcompressor stations, fractionation facilities and approximately 150 miles of gatheringpipeline. The plant and associated gathering system is located in Wyoming.Hiland Partners, LLC is in the process of constructing a processing plant andgathering system in Montana (the “Bakken gathering system”).

 

Hiland Partners, LLC leased several largecompressors to CRI, an affiliated entity. Certain Hiland Partners, LLC ownersalso own approximately 9% of CRI common stock. These compressors supplycompressed air and water for use in a secondary oil recovery project in NorthDakota for which CRI is the operator. Effective January 28, 2005, the agreements were revised into aservices agreement (see also Note 4).

 

Hiland Partners, LLC formed a subsidiary,Hiland Energy Partners, LLC, and conveyed all of its assets, other than itsassets related to the Bakken gathering system, to Hiland Energy Partners, LLC.As of the date of the closing of the public offering, Hiland Energy Partners,LLC, through a series of steps, became a wholly-owned subsidiary of thePartnership.

 

In October 2004, Hiland Partners, LPfiled a registration statement on Form S-1 with the Securities andExchange Commission, relating to its proposed initial public offering. On February 15,2005, the Partnership closed its offering and (a) substantially all of CGI’sassets and liabilities were transferred to Continental Gas Operating, LP, (b)substantially all of Hiland Partners, LLC’s assets less the Bakken gatheringsystem were transferred to Hiland Energy Partners, LLC, and (c) all of theinterests in these two operating entities were transferred to Hiland Partners,LP.

 

***Use of Estimates***

 

The preparation of financial statements inaccordance with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe amounts reported in the financial statements and accompanying notes. Actualresults could differ from those estimates.

 

***Cash and CashEquivalents***

 

The Partnership considers all highly liquidinvestments with maturity of three months or less at the time of purchase to becash equivalents.

 

***Accounts Receivable***

 

The majority of the accounts receivable aredue from independent companies in the oil and gas industry as well as theutility industry. Credit is extended based on evaluation of the customer’s financialcondition. In certain circumstances, collateral, such as letters of credit orguarantees, is required. Accounts receivable are due within 30 days andare stated at amounts due from customers. The Partnership has establishedvarious procedures to manage its credit exposure, including initial creditapprovals, credit limits and rights of offset. Credit losses are charged toincome when accounts are deemed uncollectible, determined on a case-by-casebasis when the Partnership believes the required payment of specific amountsowed is unlikely to occur. These losses historically have been minimal;therefore, an allowance for uncollectible accounts is not required.

 

***Inventories***

 

Inventories consist primarily of compressorsand associated equipment. Inventories are stated at the lower of cost orestimated net realizable value.

 

***Concentration andCredit Risk***

 

Financial instruments that potentiallysubject the Partnership to concentrations of credit risk consist principally ofcash and cash equivalents and receivables.

 

The Partnership places its cash and cashequivalents with high-quality institutions and in money market funds. ThePartnership derives its revenue from customers primarily in the natural gas andutility industries. These industry concentrations have the potential to impactthe Partnership’s overall exposure to credit risk, either positively ornegatively, in that the Partnership’s customers could be affected by similarchanges in economic, industry or other conditions. However, the Partnership believesthat the credit risk posed by this industry concentration is offset by thecreditworthiness of the Partnership’s customer base. The Partnership’sportfolio of accounts receivable is comprised primarily of mid-size to largedomestic corporate entities.

 

10

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***Fair Value ofFinancial Instruments***

 

The Partnership’s financial instruments,which require fair value disclosure, consist primarily of cash, accountsreceivable, accounts payable and bank debt. The carrying value of cash,accounts receivable and accounts payable are considered to be representative oftheir respective fair values, due to the short maturity of these instruments.The fair value of long-term debt approximates its carrying value based on theborrowing rates currently available to the Partnership for bank loans withsimilar terms and maturities.

 

***Intangibleand Other Assets***

 

Intangible assetsconsist of the acquired value of existing contracts to sell natural gas andother NGLs and compression contracts, which have a significant residualvalue.  The contracts are being amortizedover ten years.  The deferred loan costsare being amortized over the life of the credit facility.

 

The table below detailsthe gross carrying amount and accumulated amortization:

 
| ** **                                       | ** ** | **As of March 31,** | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|
| ** **                                       | ** ** | **2005**                 | ** ** | **2004** | ** ** |
|                                             |       |                     |       |   |   |
| Gas sales  contracts, gross                      |       | $                        | 8,285      | ** ** | **$** | **—** | ** ** |
| Compression  contracts, gross                    |       | 18,515                   | ** ** | **—** | ** ** |
| Total  intangibles, gross                        |       | 26,800                   |       | — |   |
|                                             |       |                     |       |   |   |
| Accumulated  amortization, gas sales contracts   |       | 104                      |       | — |   |
| Accumulated  amortization, compression contracts |       | 231                      |       | — |   |
| Total  accumulated amortization                  |       | 335                      |       | — |   |
| Net  intangible assets                           |       | $                        | 26,465     |   | $ | — |   |

 

Intangible amortizationfor the quarters ended March 31, 2004 and 2005, was $0 and $335,respectively. Deferred loan cost amortization for the quarters ended March 31,2004 and 2005, was $25 and $205, respectively.

 

***Long-Lived Assets***

 

In accordance with Statement of FinancialAccounting Standards (SFAS) No. 144, “*Accountingfor the Impairment or Disposal of Long-Lived Assets*,” thePartnership evaluates its long-lived assets of identifiable business activitiesfor impairment when events or changes in circumstances indicate, in management’sjudgment, that the carrying value of such assets may not be recoverable. Thedetermination of whether impairment has occurred is based on management’sestimate of undiscounted future cash flows attributable to the assets ascompared to the carrying value of the assets. If impairment has occurred, theamount of the impairment recognized is determined by estimating the fair valuefor the assets and recording a provision for loss if the carrying value isgreater than fair value. For assets identified to be disposed of in the future,the carrying value of these assets is compared to the estimated fair value lessthe cost to sell to determine if impairment is required. Until the assets aredisposed of, an estimate of the fair value is redetermined when related eventsor circumstances change.

 

When determining whether impairment of one ofthe Partnership’s long-lived assets has occurred, the Partnership must estimatethe undiscounted cash flows attributable to the asset or asset group. ThePartnership’s estimate of cash flows is based on assumptions regarding thevolume of reserves providing asset cash flow and future NGL product and naturalgas prices. The amount of reserves and drilling activity are dependent in parton natural 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 ingeneral economic conditions in regions in which the Partnership’s products arelocated;

•      theavailability and prices of NGL products and competing commodities;

•      theavailability and prices of raw natural gas supply;

•      the Partnership’sability to negotiate favorable marketing agreements;

•      the risks thatthird party oil and gas exploration and production activities will not occur orbe successful;

•      the Partnership’sdependence on certain significant customers and producers of natural gas; and

•      competitionfrom other midstream service providers and processors, including major energycompanies.

 

11

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Any significant variance in any of the aboveassumptions or factors could materially affect the Partnership’s cash flows,which could require the Partnership to record an impairment of an asset.

 

***Revenue Recognition***

 

Revenues for sales of natural gas and NGLsare recognized at the time all gathering and processing activities arecompleted, the product is delivered and title is transferred. Revenues forcompression services are recognized when the services under the agreement areperformed. Revenues from oil and gas production (discontinued operations) arerecorded in the month produced and title is transferred to the purchaser.

 

***Derivatives***

 

Statement of Financial Accounting Standards (“SFAS”)No. 133, “Accounting for Derivative Instruments and Hedging Activities,”as amended, establishes accounting and reporting standards for derivativeinstruments, including certain derivative instruments embedded in othercontracts, and for hedging activities. SFAS No. 133 requires that anentity recognize all derivatives as either assets or liabilities in the statementof financial position and measure those instruments at fair value. SFASNo. 133 provides that normal purchases and normal sales contracts are notsubject to the statement. Normal purchases and normal sales are contracts thatprovide for the purchase or sale of something other than a financial instrumentor derivative instrument that will be delivered in quantities expected to beused or sold by the reporting entity over a reasonable period in the normalcourse of business. The Partnership’s forward natural gas purchase and salescontracts qualify as normal purchases and sales. Substantially all forwardcontracts fall within a one-month to five-year term.

 

***Property andEquipment***

 

The Partnership’s property and equipment arecarried at cost. Depreciation and amortization of all equipment is determinedunder the straight-line method using various rates based on useful lives, 10 to22 years for pipeline and processing plants, and 3 to 10 years forcorporate and other assets. The cost of assets and related accumulateddepreciation is removed from the accounts when such assets are disposed of, andany related gains or losses are reflected in current earnings. Maintenance,repairs and minor replacements are expensed as incurred. Costs of replacementsconstituting improvement are capitalized.

 

***Environmental Costs***

 

Environmental costs are expensed if theyrelate to an existing condition caused by past operations and do not contributeto current or future revenue generation. Liabilities are recorded when siterestoration and environmental remediation and cleanup obligations are eitherknown or considered probable and can be reasonably estimated. Recoveries ofenvironmental costs through insurance, indemnification arrangements or othersources are included in other assets to the extent such recoveries areconsidered probable.

 

***Income Taxes***

 

The Partnership and its predecessor are notsubject to income taxes. Accordingly, there is no provision for income taxesincluded in the consolidated financial statements. Taxable income, gain, lossand deductions are allocated to the partners who are responsible for payment ofany income taxes thereon.

 

***Description of Equity Interest in the Partnership***

 

The common and subordinated units represent limitedpartner interests in the Partnership. The holders of units are entitled to participate in partnershipdistributions and exercise the rights and privileges available to limitedpartners under the partnership agreement of the Partnership.

 

The common units have the right to receive minimumquarterly distributions of $0.45 per unit, or $1.80 on an annualized basis,plus any arrearages on the common units, before any distribution is made to theholders of subordinated units.  Inaddition, if the aggregate ownership of common and subordinated units owned bypersons other than the general partner and its affiliates is less than 20%, thegeneral partner will have a right to call the common units at a price not lessthan the then-current market price of the common units.

 

The subordinated units generally receive quarterlycash distributions only when common units have received a minimum quarterlydistribution of $0.45 per unit for each quarter since the commencement ofoperations.  Subordinated units willconvert into common units on a one-for-one basis when the subordination periodends.  The subordination period will endwhen the Partnership meets financial tests specified in the partnershipagreement but generally cannot end before March 31, 2010.  The subordinated units have an early conversion-to-common-unitspotential of 25% of the subordinated units after March 31, 2008 andanother 25% after March 31, 2009, if certain distribution targets areachieved.

 

12

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The general partner is entitled to at least 2% ofall distributions made by the partnership. In addition, the general partner holds incentive distribution rights,which allow the general partner to receive a higher percentage of quarterlydistributions of available cash from operating surplus after the minimumquarterly distributions have been achieved, and as additional target levels aremet.  The higher percentages range from15% to 50%.  There were no distributionsduring the first quarter of 2005.

 

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

 

The computation of net income per limited partners’ unit isbased on the weighted-average number of common and subordinated unitsoutstanding during the period. Net income per unit applicable to limitedpartners is computed by dividing net income applicable to limited partners,after deducting the general partner’s 2% interest and incentive distributions,and after deducting net income attributable to the Predecessor (before February 15,2005), by the weighted-average number of limited partnership units outstanding.The following is a reconciliation of thelimited partner units used in the calculations of income per limited partnerunit and income per limited partner unit - assuming dilution:

 
| ** **                                                       | ** ** | **Income  Available to  Limited  Partners (Numerator)** | ** ** | **Limited  Partner Units  (Denominator)** | ** ** | **Per Unit  Amount** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------|------------|----------------------|------------|
| For the quarter ended March 31, 2005:                       |       |                                                    |       |                                      |       |                 |       |
| Income per limited partner unit -basic:                          |       |                                                    |       |                                      |       |                 |       |
| Income available to limited unitholders                          |       | $                                                       | 1,120      |                                      |       |                 |       | $ | 0.16 |   |
| Weighted average limited partner units  outstanding              |       |                                                    |       | 6,800,000                                 |       |                 |       |
| Income per limited partner unit – assuming  dilution:       |       |                                                    |       |                                      |       |                 |       |
| Unit Options                                                     |       |                                                    |       | 40,000                                    |       |                 |       |
| Income available to common unitholders plus  assumed conversions |       | $                                                       | 1,120      |                                      | 6,840,000  |                 | $          | 0.16 |   |
|                                                                  |            |                                                         |            |                                           |            |                      |            |  |  |  |

 

***Transportation andExchange Imbalances***

 

In the course of transporting natural gas andNGLs for others, the Partnership may receive for redelivery differentquantities of natural gas or NGLs than the quantities actually redelivered.These transactions result in transportation and exchange imbalance receivablesor payables that are recovered or repaid through the receipt or delivery ofnatural gas or NGLs in future periods, if not subject to cashout provisions.Imbalance receivables are included in accounts receivable and imbalancepayables are included in accounts payable on the balance sheets andmarked-to-market using current market prices in effect for the reporting periodof the outstanding imbalances. Changes in market value and the settlement ofany such imbalance at a price greater than or less than the recorded imbalanceresults in either an upward or downward adjustment, as appropriate, to the costof natural gas sold. As of March 31, 2004 and 2005, the Partnership had noimbalance receivables or payables.

 

***Segment reporting***

 

In accordance with SFAS No. 131, “Disclosures AboutSegments of an Enterprise and Related Information,” the Partnership’sreportable business segments have been identified based on the differences inthe products or services provided (see Note 11).

 

***Share-Based Compensation***

 

The Partnership appliesAccounting Principles Board Opinion No. 25 and related interpretations inaccounting for its share-based compensation awards.  Accordingly, no compensation cost has beenrecognized for unit options granted in the accompanying consolidated financialstatements.  The following pro forma datais calculated as if compensation cost for the Partnership’s share-basedcompensation awards (see also Note 10) was determined based upon the fair valueat the grant date consistent with the methodology prescribed under SFAS No.123.

 

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| ** **                                                   | ** ** | **Quarters Ended March 31,** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                   | ** ** | **2005**                          | ** ** | **2004** | ** ** |
|                                                         |       |                              |       |   |   |
| Net income as reported                                       |       | $                                 | 1,636      |   | $ | 767 |   |
| Less income attributable to predecessor                      |       | 493                               |       |   |   |
| Net income (net of predecessor income)                       |       | 1,143                             |       |   |   |
| Less general partner interest                                |       | 23                                |       |   |   |
| Limited partner’s interest in net income                |       | 1,120                             |       |   |   |
| Adjustment (net of general partner’s  interest)         |       | (133                              | )          |   |   |
| Limited partner’s interest in proforma net  income      |       | $                                 | 987        |   |   |   |
| Net income per limited partner unit as  reported, basic      |       | $                                 | 0.16       |   |   |   |
| Net income per limited partner unit as  reported, diluted    |       | $                                 | 0.16       |   |   |   |
| Adjustment, basic                                            |       | $                                 | (0.01      | ) |   |   |
| Adjustment, diluted                                          |       | $                                 | (0.02      | ) |   |   |
| Proforma net income per limited partner  unit, basic         |       | $                                 | 0.15       |   |   |   |
| Proforma net income per limited partner  unit, diluted       |       | $                                 | 0.14       |   |   |   |
| Weighted average limited partner units  outstanding, basic   |       | 6,800,000                         |       |   |   |
| Weighted average limited partner units  outstanding, diluted |       | 6,840,000                         |       |   |   |
|                                                              |            |                                   |            |  |  |  |  |

 

The fair value of eachoption grant is estimated on the date of grant using the American Binomialoption pricing model with the following weighted average assumptions used forgrants in 2005, respectively: risk-free interest rates of 4.54 percent; 5.37percent dividend yield; no assumed forfeitures; expected lives of 6.0 years;and volatility of 31 percent.  The proforma amounts above are not likely to be representative of future years becausethere is no assurance that additional awards will be made each year.

 

***Asset RetirementObligations***

 

*SFAS No. 143, “Accounting for AssetRetirement Obligations”*

 

The Partnership records the fair value of aliability for an asset retirement obligation in the period in which it isincurred and a corresponding increase in the carrying amount of the relatedlong-lived asset. Subsequently, the asset retirement cost is allocated toexpense using a systematic and rational method and the liability is accreted tomeasure the change in liability due to the passage of time.

 

The following table summarizes CGI’s activitythrough February 14, 2005 and the Partnership’s activity from February 15,2005 through March 31, 2005 related to asset retirement obligations:

 
| Asset Retirement Obligation, January 1,  2005   |                                                                     | $      | 619    |   |
|------------------------------------------------------|--------------------------------------------------------------------------|--------|--------|--------|
| Plus:                                                | Asset Retirement Obligation accretion  expense to February 14, 2005 |   | 3      |   |
| Asset Retirement Obligation, February 14,  2005 |                                                                     | 622    |   |
| Plus:                                                | Asset Retirement Obligation acquired from  Hiland Partners, LLC          |   | 397    |   |
|                                                 | Asset Retirement Obligation accretion  expense to March 31, 2005    |   | 5      |   |
| Asset Retirement Obligation, March 31,  2005    |                                                                     | $      | 1,024  |   |

 

## ***Recent Accounting Pronouncements***

## ** **

## ***SFAS No.123R, “Share-Based Payment”***

## ** **

In October 1995, the FASB issued SFASNo. 123, “Share-Based Payments,” which was revised in December 2004(collectively, “FASB 123R”).  FASB 123Rrequires that the compensation cost relating to share-based paymenttransactions be recognized in financial statements.  That cost will be measured based on the fairvalue of the equity or liability instruments issued.  The effect of the standard will be to requireentities to measure the cost of employee services received in exchange forstock options based on the grant-date fair value of the award, and to recognizethe cost over the period the employee is required to provide services for theaward.

 

In accordance with SEC Release No. 33-8568,the Partnership will adopt SFAS 123R as of the first interim period beginningon or after January 1, 2006.  ThePartnership expects to apply the Statement using the permitted modifiedretrospective method beginning January 1, 2006. The Partnership is stillevaluating the impact of this statement on its financial statements.

 

None of the entities (the Partnership, CGI,or Hiland Partners, LLC) had issued any options prior to February 10,2005.

 

*SFAS No. 153 (“SFAS 153”), “Exchangesof Nonmonetary Assets-an amendment of APB Opinion No. 29.”*

 

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In December 2004, theFASB issued SFAS 153, which amends APB Opinion No. 29 by eliminating theexception to the fair-value principle for exchanges of similar productiveassets, which were accounted for under APB Opinion No. 29 based on the bookvalue of the asset surrendered with no gain or loss recognition. SFAS 153 alsoeliminates APB 29’s concept of culmination of an earnings process. Theamendment requires that an exchange of nonmonetary assets be accounted for atfair value if the exchange has commercial substance and fair value isdeterminable within reasonable limits. Commercial substance is assessed by comparingthe entity’s expected cash flows immediately before and after the exchange. Ifthe difference is significant, the transaction is considered to have commercialsubstance and should be recognized at fair value. SFAS 153 is effective fornonmonetary transactions occurring in fiscal periods beginning after June 15,2005. The impact of SFAS 153 will depend on the nature and extent of anyexchanges of nonmonetary assets after the effective date, but we do notcurrently expect SFAS 153 to have a material impact on our consolidated resultsof operations, cash flows or financial position.

 

*EITF Issue No. 03-13 (“EITF 03-13”),Applying the Conditions in Paragraph 42 of SFAS 144, Accounting for theImpairment or Disposal of Long-Lived Assets, in Determining Whether to ReportDiscontinued Operations.”*

 

In November 2004, theEITF reached a consensus with respect to evaluating whether the criteria inSFAS 144 has been met for classifying as a discontinued operation a componentof an entity that either has been disposed of or is classified as held forsale. To qualify as a discontinued operations, SFAS 144 requires that the cashflows of the disposed component be eliminated from the operations of theongoing entity and that the ongoing entity not have any significant continuinginvolvement in the operations of the disposed component after the disposaltransaction. The consensus in EITF 03-13 clarifies that the cash flows of theeliminated component are not considered to be eliminated if the continuing cashflows represent “direct” cash flows, as defined in the consensus. The consensusalso requires that the assessment of whether significant continuing involvementexists be made from the perspective of the disposed component. The assessmentshould consider whether (a) the continuing entity retains an interest in thedisposed component sufficient to enable it to exert significant influence overthe disposed component’s operating and financial policies or (b) the entity andthe disposed component are parties to a contract or agreement that gives riseto significant continuing involvement by the ongoing entity. The consensus isto be applied prospectively to a component of an entity that is either disposedor classified held for sale in fiscal periods beginning after December 15,2004. The impact of EITF 03-13 will depend on the nature and extent of anylong-lived assets disposed of or held for sale after the effective date, but wedo not currently expect EITF 03-13 to have a material impact on ourconsolidated results of operations, cash flows or financial position.

 

**Note 2: Property and Equipment**

 
| ** **                                       | ** ** | **As of  March 31,** | ** ** | **As of  December 31,** | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|------------------------------|------------|
| ** **                                       | ** ** | **2005**                  | ** ** | **2004**                     | ** ** |
| Land                                             |       | $                         | 225        |                         | $          | 127 |   |
| Pipelines  and plants                            |       | 66,853                    |       | 55,475                       |       |
| Compression  and water injection equipment       |       | 19,200                    |       | —                       |       |
| Other                                            |       | 3,415                     |       | 2,209                        |       |
|                                             |       | 89,693                    |       | 57,811                       |       |
| Less:  accumulated depreciation and amortization |       | 22,071                    |       | 20,736                       |       |
|                                             |       | $                         | 67,622     |                         | $          | 37,075 |   |

 

Depreciation and amortization charged toexpense, including discontinued operations, totaled $878 and $1,669 for thequarters ended March 31, 2004 and 2005, respectively.

 

**Note 3: Long-Term Debt**

 
| ** **             | ** ** | **As of  March 31,** | ** ** | **As of  December 31,** | ** ** |
|------------------------|------------|---------------------------|------------|------------------------------|------------|
| ** **             | ** ** | **2005 (b)**              | ** ** | **2004 (a)**                 | ** ** |
| Note payable  - bank   |       | $                         | —     |                         | $          | 15,072 |   |
| Less:  current portion |       | —                    |       | 2,429                        |       |
| Long-term  portion     |       | $                         | —     |                         | $          | 12,643 |   |

 

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(a)   Concurrently with the closingof the initial public offering, the debt was paid in full from offeringproceeds.

 

(b)   Concurrently with the closingof the initial public offering, the Partnership established a $55.0 millioncredit facility through its operating company that consists of:

•      a $47.5 millionsenior secured revolving credit facility to be used for funding acquisitionsand other capital expenditures, issuance of letters of credit, and general corporatepurposes (the “revolving acquisition facility”); and

•      a $7.5 millionsenior secured revolving credit facility to be used for working capital and tofund distributions (the “revolving working capital facility”).

 

The Partnership has the right, no more thanonce in each fiscal year, to increase the size of the revolving acquisitionfacility; provided that each such increase shall be at least $10.0 million andin no event may the amount of the revolving acquisition facility exceed $82.5million in the aggregate, and provided further that at the time of such requestno default has occurred or would result due to such increase and subject toadditional conditions set forth in the credit facility.  In addition, the revolving acquisitionfacility allows for the issuance of letters of credit of up to $5.0 million inthe aggregate.  The credit facilitymatures in February, 2008.

 

Indebtedness under the credit facility bearsinterest, at the Partnership’s option, at either (i) an Alternate Base Rateplus an applicable margin ranging from 50 to 175 basis points per annum or (ii)LIBOR plus an applicable margin ranging from 150 to 275 basis points per annumbased on our ratio of total debt to EBITDA, as defined.  The Alternate Base Rate is a rate per annumequal to the greatest of (a) the Prime Rate in effect on such date, (b) thebase CD rate in effect on such day plus 1.5% and (c) the Federal Fundseffective rate in effect on such day plus 1⁄2 of 1%.  An unused commitment fee ranging from 30 to50 basis points per annum based on our total debt to EBITDA is payable on theunused portion of the credit facility.

 

The credit facility prohibits us from makingdistributions to unitholders if any default or event of default, as defined inthe credit facility, has occurred and is continuing or would result from thedistribution.  In addition, the creditfacility contains various covenants that limit, among other things,  our ability to borrow, merge or disposeassets. The credit facility also contains covenants requiring the Partnershipto maintain EBITDA and interest coverage ratios and tangible net worth of atleast $55 million.

 

Upon occurrence of an event of default asdefined in the credit facility, the lenders may, among other things, be able toaccelerate the maturity of the credit facility and exercise other rights andremedies as set forth in the credit facility.

 

The credit facility limits distributions tounitholders to available cash as defined, and borrowings to fund suchdistributions are only permitted under the revolving working capitalfacility.  The revolving working capitalfacility is subject to an annual “clean-down” period of 15 consecutive days inwhich the amount outstanding under the revolving working capital facility isreduced to $0.

 

As of March 31, 2005, no amounts wereoutstanding under the credit facility.

 

**Note 4:  Initial Public Offeringof Hiland Partners, LP**

 

On October 22, 2004, a Registration Statementon Form S-1 was filed with the SEC relating to a proposed initial publicoffering of limited partnership interests in Hiland Partners, LP.  Hiland Partners, LP was formed to own andoperate the assets that have historically been owned and operated by CGI andHiland Partners, LLC.

 

On February 9, 2005, we priced 2,000,000 commonunits for the public offering; and on February 10, 2005, our common unitsbegan trading on the NASDAQ National Market under the symbol “HLND”.  On February 15, 2005, we closed ourinitial public offering of 2,300,000 common units, which included a 300,000unit over-allotment option that was exercised by the underwriters.  Total proceeds from the sale of the unitswere $48.1 million, net of $3.6 million of underwriting commissions.

 

All of our initial assets were contributed by theformer owners of CGI, Hiland Partners, LLC, and certain of our affiliates,including our general partner, in exchange for an aggregate of 720,000 commonunits and 4,080,000 subordinated units, a 2% general partner interest in us andall of our incentive distribution rights, which entitle the general partner toincreasing percentages of the cash we distribute in excess of $0.495 per unitper quarter. The assets of GCI transferred to the Partnership are recorded athistorical cost as it is considered to be a reorganization of entities undercommon control and CGI is considered the Partnership’s accounting predecessor.The acquisition of the assets of Hiland Partners, LLC was accounted for as apurchase and, as a result, these assets were recorded at their fair value atthe time of purchase.

 

16

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Thefollowing table presents the assets and liabilities of our predecessorimmediately prior to contributing assets to Hiland Partners, LP, and assets andliabilities contributed to Hiland Partners, LP, and the predecessor’s assetsand liabilities that were not contributed to Hiland Partners, LP.

 

Continental Gas, Inc. (Predecessor)As of February 14, 2005(in thousands)

 
| ** **                                | ** ** | **Continental Gas, Inc.  (Predecessor)  February 14, 2005** | ** ** | **Net Assets  Not  Contributed** | ** ** | **Contributed to  Hiland Partners, LP  15-Feb-05** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------------------------|------------|
| **ASSETS**                                |       |                                                        |       |                             |       |                                               |       |
| Current assets:                           |       |                                                        |       |                             |       |                                               |       |
| Cash and cash equivalents                 |       | $                                                           | 869        |                             | $          | 869                                                |       | $ | — |   |
| Accounts Receivable                       |       | 10,521                                                      |       | 9,101                            |       | 1,420                                              |       |
| Inventories                               |       | 153                                                         |       | —                           |       | 153                                                |       |
| Other current assets                      |       | 291                                                         |       | 2                                |       | 289                                                |       |
| Total Current Assets                      |       | 11,834                                                      |       | 9,972                            |       | 1,862                                              |       |
| Property and equipment, at cost, net      |       | 36,805                                                      |       | —                           |       | 36,805                                             |       |
| Other assets, net                         |       | 3,388                                                       |       | —                           |       | 3,388                                              |       |
| Total assets                              |       | 52,027                                                      |       | 9,972                            |       | 42,055                                             |       |
|                                      |       |                                                        |       |                             |       |                                               |       |
| **LIABILITIES**                           |       |                                                        |       |                             |       |                                               |       |
| Current liabilities:                      |       |                                                        |       |                             |       |                                               |       |
| Accounts payable                          |       | 11,703                                                      |       | —                           |       | 11,703                                             |       |
| Accrued liabilities                       |       | 700                                                         |       | —                           |       | 700                                                |       |
| Current maturities of long term debt      |       | 2,429                                                       |       | —                           |       | 2,429                                              |       |
| Total current liabilities                 |       | 14,832                                                      |       | —                           |       | 14,832                                             |       |
| Commitments and contingencies             |       | —                                                      |       | —                           |       | —                                             |       |
| Long term debt, net of current maturities |       | 11,570                                                      |       | —                           |       | 11,570                                             |       |
| Asset retirement obligation               |       | 622                                                         |       | —                           |       | 622                                                |       |
| Total liabilities                         |       | 27,024                                                      |       | —                           |       | 27,024                                             |       |
|                                      |       |                                                        |       |                             |       |                                               |       |
| **NET ASSETS**                            |       | $                                                           | 25,003     |                             | $          | 9,972                                              |       | $ | 15,031 |   |

 

 

In consideration for the transfer, Harold Hamm and the Hamm Trustsreceived 467,073 common units and 2,646,749 subordinated units of thePartnership.  Immediately following theclosing of the offering, 195,991 of the common units were redeemed forapproximately $4.1 million.

 

17

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Thefollowing table presents the assets and liabilities of Hiland Partners, LLC asof February 14, 2005, the assets excluded from the acquisition, and the fairvalue of the assets acquired.

 

HilandPartners, LLCAs of February 14, 2005(in thousands)

 
| ** **                                | ** ** | **Hiland Partners, LLC  14-Feb-05** | ** ** | **Net Assets  Not  Contributed** | ** ** | **Assets  Contributed to  Hiland Partners, LP  15-Feb-05** | ** ** | **Fair  Value** | ** ** |
|-------------------------------------------|------------|-------------------------------------|------------|----------------------------------|------------|------------------------------------------------------------|------------|-----------------|------------|
| **ASSETS**                                |       |                                |       |                             |       |                                                       |       |            |       |
| Current assets:                           |       |                                |       |                             |       |                                                       |       |            |       |
| Cash and cash equivalents                 |       | $                                   | 964        |                             | $          | 964                                                        |       | $               | —     |   | $ | — |   |
| Accounts Receivable                       |       | 2,619                               |       | 2,503                            |       | 116                                                        |       | 116             |       |
| Other current assets                      |       | 56                                  |       | 10                               |       | 46                                                         |       | 46              |       |
| Total Current Assets                      |       | 3,639                               |       | 3,477                            |       | 162                                                        |       | 162             |       |
| Property and equipment, at cost, net      |       | 50,063                              |       | 29,858                           |       | 20,205                                                     |       | 31,600          |       |
| Intangible Assets                         |       | —                              |       | —                           |       | —                                                     |       | 26,800          |       |
| Other assets, net                         |       | 194                                 |       | 89                               |       | 105                                                        |       | 105             |       |
| Total assets                              |       | 53,896                              |       | 33,424                           |       | 20,472                                                     |       | 58,667          |       |
|                                      |       |                                |       |                             |       |                                                       |       |            |       |
| **LIABILITIES**                           |       |                                |       |                             |       |                                                       |       |            |       |
| Current liabilities:                      |       |                                |       |                             |       |                                                       |       |            |       |
| Accounts payable                          |       | 5,048                               |       | 4,372                            |       | 676                                                        |       | 676             |       |
| Accrued liabilities                       |       | 95                                  |       | 30                               |       | 65                                                         |       | 65              |       |
| Current maturities of long term debt      |       | 11,100                              |       | 2,221                            |       | 8,879                                                      |       | 8,879           |       |
| Total current liabilities                 |       | 16,243                              |       | 6,623                            |       | 9,620                                                      |       | 9,620           |       |
| Commitments and contingencies             |       | —                              |       | —                           |       | —                                                     |       | —          |       |
| Long term debt, net of current maturities |       | 24,253                              |       | 24,253                           |       | —                                                     |       | —          |       |
| Asset retirement obligation               |       | 398                                 |       | —                           |       | 398                                                        |       | 398             |       |
| Total liabilities                         |       | 40,894                              |       | 30,876                           |       | 10,018                                                     |       | 10,018          |       |
| **NET ASSETS**                            |       | $                                   | 13,002     |                             | $          | 2,548                                                      |       | $               | 10,454     |   | $ | 48,649 |   |

 

In consideration for the transfer:

 

a.  The Hamm Trusts received 247,868 common units and 1,404,586 subordinatedunits of the Partnership.  Immediatelyfollowing the closing of the offering, 104,009 of the common units wereredeemed for approximately $2.2 million.

 

b.  Equity Financial Services, Inc. received 5,059 common units and 28,665subordinated units of the Partnership, none of which were redeemed.

 

Asa part of the transactions, Harold Hamm, the Hamm Trusts, Equity FinancialServices, Inc., Mr. Moeder, and Mr. Maples received an aggregate of 138,776equivalent units of the General Partner, representing substantially all of theownership of the general partner and a 2% equity ownership of the Partnership.

 

Weused the proceeds of the public offering to: redeem an aggregate of 300,000 common units from Harold Hamm and theHamm Trusts for $6.3 million; repay $14.0 million in debt owed by CGI and $8.9million in debt acquired from Hiland Partners, LLC; pay the remaining $2.2million of expenses associated with the offering and formation transactions;pay $0.6 million of debt issuance costs related to the credit facility;distribute $3.9 million to the former owners of Hiland Partners, LLC inreimbursement of certain capitalized expenditures related to the assets ofHiland Partners, LLC that were contributed to the Partnership; and replenishapproximately $12.2 million of working capital.

 

Inconnection with this offering, we entered into a four-year agreement with CRI,an affiliate of Harold Hamm, under which they agreed to pay us an operating feeof approximately $402,000 per month for us to provide air and water compressionservice for CRI’s

 

18

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secondaryrecovery operations in North Dakota.  Wehave recorded $603,000 of revenues from CRI under the compression servicesagreement for the period from February 15, 2005 through March 31, 2005.

 

Wealso entered into an omnibus agreement with CRI that became effective February15, 2005 (the “Omnibus Agreement”) and determines the services CRI will provideto us and the liabilities from which CRI will indemnify us.  Under the agreement, CRI will charge us the lowerof CRI’s cost or $50,000 per year for a two-year period for certain general,administrative and information technology support.  Continental Resources, Inc., Hiland Partners,LLC, and Continental Gas Holdings, Inc. agreed to indemnify the Partnership forincome tax liabilities arising from operations prior to the closing of theoffering and Continental Resources, Inc. agreed to indemnify the Partnershipfor liabilities associated with oil and gas properties conveyed by ContinentalGas, Inc. to Continental Resources, Inc. for a period of five years from theclosing date of the offering.  Inaddition, Harold Hamm, Hiland Partners, LLC, and Continental Resources, Inc.agreed, with certain exceptions, not to engage in, whether by acquisition orotherwise, midstream and NGL gathering and processing in the continental UnitedStates.  In addition, Hiland Partners,LLC has granted the Partnership a two-year option to purchase its Bakken gasgathering system pursuant to the Omnibus Agreement.  For a description of this agreement, pleaseread “Item 13.  Certain Relationships andRelated Party Transactions – Omnibus Agreement” of the Partnership’s Form 10-Kfor the fiscal year ended December 31, 2004.

 

**Note 5:  Proforma Operations**

 

Theacquisition of assets from Hiland Partners, LLC discussed above occurred onFebruary 15, 2005. Had the acquisition been made effective January 1, 2004, theoperations of the assets acquired from Hiland Partners, LLC would have beenincluded in our consolidated financial statements for each subsequent periodwith the following pro forma impact on the consolidated combined statements ofoperations.

 
| ** **                                                   | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                   | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                                                   | ** ** | **(in thousands)**               | ** ** |
|                                                         |       |                             |       |   |   |
| Revenues as reported                                         |       | $                                | 25,778     |   | $ | 21,050 |   |
| Revenues from Hiland Partners, LLC                           |       | 1,318                            |       | 2,906 |   |
| Pro forma revenues                                           |       | $                                | 27,096     |   | $ | 23,956 |   |
|                                                         |       |                             |       |   |   |
| Net income as reported                                       |       | $                                | 1,636      |   | $ | 767 |   |
| Additional income from acquired interest                     |       | 377                              |       | 1,198 |   |
| Pro forma net income                                         |       | 2,013                            |       | $ | 1,965 |   |
| Less general partner interest in proforma  net income        |       | 40                               |       |   |   |
| Limited partners’ interest in proforma net  income      |       | $                                | 1,973      |   |   |   |
| Proforma net income per limited partner  unit, basic         |       | $                                | 0.29       |   |   |   |
| Proforma net income per limited partner  unit, diluted       |       | $                                | 0.29       |   |   |   |
| Weighted average limited partner units  outstanding, basic   |       | 6,800,000                        |       |   |   |
| Weighted average limited partner units  outstanding, diluted |       | 6,840,000                        |       |   |   |
|                                                         |       |                             |       |   |   |

 

**Note 6: Commitments and Contingencies**

 

The Partnership has executed fixed pricephysical forward sales contracts on approximately 50,000 MMBtu per monththrough December 2007 with weighted average fixed prices per MMBtu of$4.53, $4.47 and $4.49, respectively, for years 2005 through 2007. Suchcontracts qualify as normal sales under SFAS No. 133 and are therefore notmarked to market as derivatives.

 

The Partnership maintains a definedcontribution retirement plan for its employees under which it makesdiscretionary contributions to the plan based on a percentage of eligibleemployees’ compensation. Through March 31, 2004 and 2005, contributions to theplan were 5.0% of eligible employees’ compensation. Expense for the threemonths ended March 31, 2004 and 2005 was $16 and $25, respectively.

 

The Partnership and other affiliatedcompanies participate jointly in a self-insurance pool (the “Pool”) coveringhealth and workers’ compensation claims made by employees up to the first$150,000 and $500,000, respectively, per claim. Any amounts paid above theseare reinsured through third party providers. Premiums charged to the Partnershipare based on estimated costs per employee of the Pool. No additional premiumassessments are anticipated for periods prior to March 31, 2005. Property andgeneral liability insurance is maintained through third-party providers with a$100,000 deductible on each policy.

 

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The Partnership is a party to variousregulatory proceedings and various other litigation that it believes will nothave a materially adverse impact on the Partnership’s financial condition,results of operations or cash flows.

 

The operation of pipelines, plants and otherfacilities for gathering, compressing, treating, or processing natural gas,NGLs and other products is subject to stringent and complex laws andregulations pertaining to health, safety and the environment. Managementbelieves that compliance with federal, state or local environmental laws andregulations will not have a material adverse effect on the Partnership’sbusiness, financial position or results of operations.

 

**Note 7: Significant Customers and Suppliers**

 

All revenues are domestic revenues. Thefollowing table presents the Partnership’s top midstream customers as a percentof total revenue for the periods indicated:

 
| ** ** | ** ** | **For the Quarters Ended  March 31,** | ** ** |
|------------|------------|---------------------------------------|------------|
| ** ** | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Customer 1 |       | 32                                    | %          |   | 56 | % |   |
| Customer 2 |       | 24                                    | %          |   | 14 | % |   |
| Customer 3 |       | 3                                     | %          |   | 6 | % |   |
| Customer 4 |       | 11                                    | %          |   | 7 | % |   |
| Customer 5 |       | 10                                    | %          |   | — |   |

 

All purchases are from domestic sources. Thefollowing table presents the Partnership’s top midstream suppliers as a percentof total midstream purchases for the periods indicated:

 
| ** **                      | ** ** | **For the Quarters Ended  March 31,** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| ** **                      | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| Supplier 1 (affiliated company) |       | 30                                         | %          |   | 39 | % |   |
| Supplier 2                      |       | 16                                         | %          |   | 18 | % |   |
| Supplier 3                      |       | 34                                         | %          |   | 25 | % |   |

 

**Note 8: Related Party Transactions**

 

The Partnership purchases natural gas andNGLs from affiliated companies. Purchases of product totaled $6,983 and $6,343for the quarters ended March 31, 2004 and 2005, respectively.

 

The Partnership utilizes unconsolidatedaffiliated companies to provide services to its plants and pipelines andcertain administrative costs. The total amount paid to these companies was $46and $31 during the quarters ended March 31, 2004 and 2005, respectively.

 

The Partnership leases office space underoperating leases directly or indirectly from the principal unitholder. Rentexpense for these leases totaled $10 and $19 for the quarters ended March 31,2004 and 2005, respectively.

 

**Note 9: Discontinued Operations**

 

During the first quarter of 2004, CGIdetermined it would no longer pursue its interests in direct production of oiland gas. Amounts for oil and gas income and expense are presented in thesestatements as discontinued operations. Effective May 31, 2004, CGItransferred all its interests in its oil and gas properties to CRI.

 

20

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A summary of oil and gas operations for thequarters ended March 31 follows:

 
| ** **                    | ** ** | **Quarters Ended  March 31,** | ** ** |
|-------------------------------|------------|------------------------------------|------------|
| ** **                    | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| Revenues                      |       | $                                  | —     |   | $ | 137 |   |
| Expenses                      |       | —                             |       | 81 |   |
| Depreciation and amortization |       | —                             |       | 41 |   |
| Net income                    |       | $                                  | —     |   | $ | 15 |   |
| Net assets                    |       | $                                  | —     |   | $ | 2,241 |   |
| Associated liabilities        |       | $                                  | —     |   | $ | 235 |   |

 

CGI followed the “successful efforts” methodof accounting for its oil and gas properties. Under the successful effortsmethod, costs of acquiring undeveloped oil and gas leasehold acreage, includinglease bonuses, brokers’ fees and other related costs are capitalized.Provisions for impairment of undeveloped oil and gas leases are based onperiodic evaluations. Annual lease rentals and exploration expenses, includinggeological and geophysical expenses and exploratory dry hole costs, are chargedagainst income as incurred. Costs of drilling and equipping productive wells,including development dry holes and related production facilities, arecapitalized. Depreciation and depletion of oil and gas production equipment andproperties are determined under the unit-of-production method based onestimated proved recoverable oil and gas reserves.

 

**Note 10: Long Term Incentive Plan**

 

Our general partner adopted the HilandPartners, LP Long-Term Incentive Plan for employees and directors of ourgeneral partner and employees of its affiliates, who perform services for ourgeneral partner or its affiliates.  Thelong-term incentive plan currently permits an aggregate of 680,000 common unitsto be issued with respect to unit options, restricted units, and phantom unitsgranted under the plan.  No more than225,000 of the 680,000 common units may be issued with respect to vested restrictedor phantom units.  The Plan will beadministered by the compensation committee of our general partner’s board ofdirectors.  The plan will continue ineffect until the earliest of (i) the date determined by the board of directorsof our general partner; (ii) the date that common units are no longer availablefor payment of awards under the plan; or (iii) the tenth anniversary of theplan.

 

Our general partner’s board of directors orcompensation committee may, in their discretion, terminate, suspend ordiscontinue the long-term incentive plan at any time with respect to any unitsfor which a grant has not yet been made. Our general partner’s board of directors or its compensation committeealso has the right to alter or amend the long-term incentive plan or any partof the plan from time to time, including increasing the number of units thatmay be granted, subject to unitholder approval if required by the exchange uponwhich the common units are listed at that time. No change in any outstanding grant may be made, however, that would materiallyimpair the rights of the participant without the consent of the participant.

 

*Restricted Units and Phantom Units.*  A restricted unit is a common unit that issubject to forfeiture.  Upon vesting, thegrantee receives a common unit that is not subject to forfeiture.  A phantom unit is a notional unit thatentitles the grantee to receive a common unit upon the vesting of the phantomunit or, in the discretion of the compensation committee, cash equivalent tothe value of a common unit.  Thecompensation committee may make grants of restricted units and phantom unitsunder the plan to employees and directors containing such terms as thecompensation committee shall determine under the plan, including the periodover which restricted units and phantom units granted will vest.  The committee may, in its discretion, baseits determination on the grantee’s period of service or upon the achievement ofspecified financial objectives.  Inaddition, the restricted and phantom units will vest upon a change of controlof us or our general partner, subject to additional or contrary provisions inthe award agreement.

 

If a grantee’s employment or membership onthe board of directors terminates for any reason, the grantee’s restrictedunits and phantom units will be automatically forfeited unless, and to theextent, the compensation committee provides otherwise or unless otherwiseprovided in a written employment agreement between the grantee and our generalpartner or its affiliates.  Common unitsto be delivered with respect to these awards may be common units acquired byour general partner directly from us or any other person or any combination ofthe foregoing.  Our general partner willbe entitled to reimbursement by us for the cost incurred in acquiring commonunits.  If we issue new common units withrespect to these awards, the total number of common units outstanding willincrease.

 

Distributions on restricted units may besubject to the same vesting requirements as the restricted units, in thecompensation committee’s discretion.  Thecompensation committee, in its discretion, may also grant tandem distributionequivalent rights with respect to phantom units.  These are rights that entitle the grantee toreceive cash equal to the cash distributions made on the common units.

 

21

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We intend for the restricted units andphantom units under the plan to serve as a means of incentive compensation forperformance and not primarily as an opportunity to participate in the equityappreciation of the common units. Therefore, plan participants will not pay any consideration for thecommon units they receive, and we will receive no remuneration for the units.

 

There were no restricted units or phantomunits outstanding on March 31, 2005.

 

*Unit Options.*  The long-term incentive plan permits thegrant of options covering common units. The compensation committee may make grants under that plan to employeesand directors containing such terms as the committee shall determine.  Except in the case of substitute optionsgranted to new employees or directors in connection with a merger,consolidation or acquisition, unit options may not have an exercise price thatis less than the fair market value of the units on the date of grant.  In addition, unit options granted will becomeexercisable upon a change in control of us or the operating company.  Unless otherwise provided in an awardagreement, unit options may be exercised only by the participant during hislifetime or by the person to whom the participant’s right will pass by will orthe laws or descent and distribution.

 

If a grantee’s employment or membership onthe board of directors terminates for any reason, the grantee’s unvestedoptions will be automatically forfeited unless, and to the extent, thecompensation committee provides otherwise or unless otherwise provided in awritten employment agreement or the option agreement between the grantee andour general partner or its affiliates. If the exercise of an option is to be settled in common units ratherthan cash, the general partner will acquire common units in the open market ordirectly from us or any other person or use common units already owned by ourgeneral partner or any combination of the foregoing.  The general partner will be entitled toreimbursement by us for the difference between the cost incurred by it inacquiring these common units and the proceeds it receives from a grantee at thetime of exercise.  Thus, the cost of the unitoptions above the proceeds from grantees will be borne by us.  If we issue new common units upon exercise ofthe unit options, the total number of common units outstanding will increase,and our general partner will pay us the proceeds it received from the granteeupon exercise of the unit option.  Theplan has been designed to furnish additional compensation to employees anddirectors and align their economic interests with those of common unitholders.

 

*Unit Option Grant Agreement.*  At the time of our initial public offering,we granted options to purchase an aggregate of 143,000 common units toemployees, officers and directors of our general partner.  The options have an exercise price equal tothe initial public offering price.  Underthe unit option grant agreement, the options will vest and may be exercised inone third increments on the anniversary of the grant date over a period ofthree years.  In addition, the unitoptions will vest and become exercisable, subject to certain conditions, uponthe occurrence of any of the following:

•      the granteebecomes disabled;

•      the granteedies;

•      the grantee’semployment is terminated for other than cause; and

•      upon a changeof control of the Partnership.

 

The following table summarizes the Company’semployee unit option activity for the quarters ended March 31, 2005, and 2004:

 
| ** **                                | ** ** | **Quarter  Ended  March 31,  2005** | ** ** | **Exercise  Price** | ** ** | **Quarter  Ended  March 31,  2004** | ** ** | **Exercise  Price** | ** ** |
|-------------------------------------------|------------|-------------------------------------|------------|---------------------|------------|-------------------------------------|------------|---------------------|------------|
| Options outstanding  beginning of quarter |       | —                              |       | NA                  |       | —                              |       | NA                  |       |
|                                      |       |                                |       |                |       |                                |       |                |       |
| Options issued during  the quarter        |       | 143,000                             |       | $                   | 22.50      |                                | —     |                | NA         |   |
|                                      |       |                                |       |                |       |                                |       |                |       |
| Options exercised during  the quarter     |       | —                              |       | NA                  |       | —                              |       | NA                  |       |
|                                      |       |                                |       |                |       |                                |       |                |       |
| Option cancelled during  the quarter      |       | —                              |       | NA                  |       | —                              |       | NA                  |       |
|                                      |       |                                |       |                |       |                                |       |                |       |
| Options expired during  the quarter.      |       | —                              |       | —              |       | —                              |       | NA                  |       |
|                                      |       |                                |       |                |       |                                |       |                |       |
| Options outstanding, end  of quarter      |       | 143,000                             |       | $                   | 22.50      |                                | —     |                | NA         |   |

 

The weighted average grant-date fair value ofoptions granted during 2005 was $12.53 per unit.

 

22

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A summary of our outstanding options as ofMarch 31, 2005 is as follows:

 
| ** **         | ** ** | **Options  Outstanding**            | ** ** | **Options  Exercisable**         | ** ** |
|--------------------|------------|-------------------------------------|------------|----------------------------------|------------|
| **Exercise Price** | ** ** | **Number  Outstanding  at 3/31/05** | ** ** | **Remaining  Contractual  Life** | ** ** | **Remaining  Estimated  Actual Life** | ** ** | **Number  Exercisable  at 3/31/05** | ** ** | **Exercise  Price** | ** ** |
| $                  | 22.50      |                                | 143,000    |                             | 9.88 yrs   |   | 5.27 yrs |   | — |   | $ | 22.50 |   |
|                    |            |                                     |            |                                  |            |  |  |  |  |  |  |  |  |

 

**Note 11: Business Segments**

 

As a part ofthe transaction discussed in Note 4, Hiland Partners, LP acquired an operatingsegment from Hiland Partners, LLC.  CGI(Precedessor) did not have operating segments.

 

Hiland Partners, LP’s operations areclassified into two reportable segments:

 

(1) Midstream, which is the gathering,compressing, dehydrating, treating and processing of natural gas andfractionating NGLs.

 

(2) Compression, which is providing aircompression and water injection services for CRI’s oil and gas secondary recoveryoperations that are ongoing in North Dakota.

 

Hiland Partners, LP evaluates the performanceof its segments and allocates resources to them based on operating income.Hiland Partners, LP’s operations are conducted in the United States.

 

***Quarter ended March31, 2005***

 

The table below presents information aboutoperating income for the reportable segments for the quarter ended March 31,2005.

 
| ** **                                                       | ** ** | **Midstream** | ** ** | **Compression** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------|------------|---------------|------------|-----------------|------------|-----------|------------|
| Revenues                                                         |       | $             | 25,175     |            | $          | 603       |       | $ | 25,778 |   |
| Operating costs and expenses:                                    |       |          |       |            |       |      |       |
| Midstream purchases (exclusive of items  shown separately below) |       | 20,203        |       | —          |       | 20,203    |       |
| Operations and maintenance                                       |       | 1,524         |       | 53              |       | 1,577     |       |
| Depreciation and amortization                                    |       | 1,379         |       | 298             |       | 1,677     |       |
| General and administrative                                       |       | 337           |       | 16              |       | 353       |       |
| Total operating costs and expenses                               |       | 23,443        |       | 367             |       | 23,810    |       |
| Income from operations                                           |       | $             | 1,732      |            | $          | 236       |       | 1,968 |   |
| Other income (expense):                                          |       |          |       |            |       |      |       |
| Interest and other income                                        |       |          |       |            |       | 7         |       |
| Amortization of deferred loan costs                              |       |          |       |            |       | (205      | )          |
| Interest expense                                                 |       |          |       |            |       | (134      | )          |
| Total other income (expense)                                     |       |          |       |            |       | (332      | )          |
| Net income                                                       |       |          |       |            |       | $         | 1,636      |   |
| Total assets                                                     |       | $             | 72,167     |            | $          | 37,819    |       | $ | 109,986 |   |
| Capital expenditures                                             |       | $             | 281        |            | $          | —    |       | $ | 281 |   |

 

23

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**Note 12: Distribution to Unitholders**

 

On April 25, 2005, we announced our first regular cashdistribution for the first quarter of 2005 of $0.225 per unit, based on theminimum quarterly cash distribution of $0.45 prorated for the period since theinitial public offering on February 15, 2005. The distribution is payable onall common, subordinated and general partner units and will be paid May 13,2005, to all unitholders of record on May 5, 2005. The aggregate amount of thedistribution will be $1.6 million.

 

24

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**HILAND PARTNERS, LP**

** **

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

** **

You should read the following discussion inconjunction with our Financial Statements and notes thereto included elsewherein this quarterly report on Form 10-Q.

 

**OVERVIEW**

** **

Hiland Partners, LP is a Delaware limited partnershipformed in October 2004 to own and operate the assets that have historicallybeen owned and operated by Continental Gas, Inc. and Hiland Partners, LLC.

 

In connection with our initial public offering, theformer owners of Continental Gas, Inc. and Hiland Partners, LLC and certain ofour affiliates, including our general partner, contributed to us, all of theassets and operations of Continental Gas, Inc., other than a portion of itsworking capital assets, and substantially all of the assets and operations ofHiland Partners, LLC, other than a portion of its working capital assets andthe assets related to the Bakken gathering system, in exchange for an aggregateof 720,000 common units and 4,080,000 subordinated units, a 2% general partnerinterest in us and all of our incentive distribution rights, which entitle thegeneral partner to increasing percentages of the cash we distribute in excessof $0.495 per unit per quarter.

 

Continental Gas, Inc. historically has owned all ofour natural gas gathering, processing, treating and fractionation assets otherthan our Worland gathering system. Hiland Partners, LLC historically has owned our Worland gatheringsystem, our compression services assets and the Bakken gathering system. TheBakken gathering system was not contributed to the Partnership.

 

On February 9, 2005, the SEC declared our registrationstatement on Form S-1 effective and we priced 2,000,000 common units for theinitial public offering at a price of $22.50 per unit.  On February 10, 2005, our common units begantrading on the Nasdaq National Market under the symbol “HLND.”  On February 15, 2005, we closed our initialpublic offering of 2,300,000 common units, which included a 300,000 unitover-allotment option that was exercised by the underwriters.  Total proceeds from the sale of the unitswere $48.1 million, net of $3.6 million of underwriting commissions.  See “Liquidity and Capital Resources” belowfor further discussion of the proceeds.

 

We are engaged in gathering, compressing, dehydrating,treating, processing and marketing natural gas, fractionating NGLs andproviding air compression and water injection services for oil and gassecondary recovery operations.  Ouroperations are primarily located in the Mid-Continent and Rocky Mountainregions of the United States.

 

We manage our business and analyze and report ourresults of operations on a segment basis.  Our operations are divided into two businesssegments:

 

•      *Midstream Segment*, which is engaged ingathering and processing of natural gas primarily in the Mid-Continent andRocky Mountain regions.  Within thissegment, we also provide certain related services for compression, dehydrating,and treating of natural gas and the fractionation of NGLs.  For the three months ended March 31, 2005,this segment generated approximately 89.2% of our total segment margin.

 

•      *Compression Segment*, which is engaged inproviding air compression and water injection services for oil and gassecondary recovery operations that are ongoing in North Dakota.  For the three months ended March 31, 2005,this segment generated approximately 10.8% of our total segment margin.

 

Our midstreamassets consist of seven natural gas gathering systems with approximately 825miles of gas gathering pipelines, four natural gas processing plants, threenatural gas treating facilities and two NGL fractionation facilities.  Our compression assets consist of two aircompression facilities and a water injection plant.

 

The financialstatements and financial information for the three month period ended March 31,2004 reflect the operations of Continental Gas, Inc., the predecessor to HilandPartners, LP.  The financial statementsand financial information for the three month period ended March 31, 2005reflect the operations of the predecessor prior to February 15, 2005 andoperations of Hiland Partners, LP from February 15, 2005 upon completion of ourinitial public offering.

 

25

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***Historical Results of Operations***

 

Our historicalresults of operations for the periods presented may not be comparable, eitherfrom period to period or going forward, for the reasons described below:

 

•      Theassets of Continental Gas, Inc. (Predecessor) were transferred to us athistorical cost as it is considered a reorganization of entities under commoncontrol.

 

•      Theacquisition of the assets of Hiland Partners, LLC was accounted for as apurchase and, as a result, these assets are recorded at their fair value at thetime of purchase, which occurred concurrent with the closing of our initialpublic offering on February 15, 2005. Therefore, the results of operations from our Worland gathering systemand compression assets are only reflected from February 15, 2005, the dateHiland Partners, LP commenced operations.

 

•      Asstated above, prior to our formation, Hiland Partners, LLC owned our HorseCreek air compression and our Cedar Hills water injection facility.  These assets have historically been under alease agreement with Continental Resources, Inc.  In connection with our formation and ourinitial public offering, we entered into a four-year services agreement withContinental Resources, Inc., effective as of January 28, 2005, that replacedthe existing lease.  Under the servicesagreement, we own and operate the facilities and provide air compression andwater injection services to Continental Resources, Inc. for a fee.  As part of the new agreement, the personnelat Continental Resources, Inc. that operated the facilities are now employed byus.  Under the new services agreement, wewill receive a fixed payment of approximately $4.8 million per year as comparedto $3.8 million under the prior lease agreement.  In connection with the new servicesarrangement, we expect to incur approximately $1.0 million per year inadditional operating costs.

 

•      Pursuant to anoption agreement contained in an omnibus agreement we entered into with HilandPartners, LLC and Harold Hamm and his affiliates in connection with our initialpublic offering, Hiland Partners, LLC granted us an exclusive two-year optionto purchase its Bakken gathering system at fair market value at the time ofpurchase.  The Bakken gathering systemconsisted of approximately 135 miles of gas gathering pipeline as of December31, 2004 and is located in eastern Montana. Upon completion of construction, we expect the Bakken gathering systemto consist of 200 miles of natural gas gathering pipeline, a processing plant,two compressor stations, which are comprised of three units with an aggregateof approximately 4,434 horsepower, and one fractionation facility.  The Bakken processing plant and a portion ofthe gathering system became operational on November 8, 2004 and total plantthroughput on March 31, 2005 was 6,630 Mcf. The gathering system has an initial capacity of approximately 20,000Mcf/d.

 

26

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**Other Financial and Operating Data(Unaudited)**

 

**Results of Operations**

 

Set forth in the table below is financial andoperating data for Continental Gas, Inc. (predecessor) and Hiland Partners, LPfor the periods indicated. Operations from our Worland gathering system andcompression assets acquired from Hiland Partners, LLC are reflected only fromFebruary 15, 2005, the date Hiland Partners, LP commenced operations.

 
| ** **                                                       | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                       | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                                                       | ** ** | **Hiland  Partners, LP (1)**     | ** ** | **Continental  Gas, Inc.  (Predecessor) (2)** | ** ** | **Total (3)** | ** ** | **Continental  Gas, Inc.  (Predecessor)** | ** ** |
| ** **                                                       | ** ** | **(in thousands)**               | ** ** |
|                                                             |       |                             |       |   |   |   |   |   |   |
| **Total Segment Margin Data:**                                   |       |                             |       |   |   |   |   |   |   |
| Midstream revenues                                               |       | $                                | 13,362     |   | $ | 11,813 |   | $ | 25,175 |   | $ | 21,050 |   |
| Midstream purchases                                              |       | 10,456                           |       | 9,747 |   | 20,203 |   | 17,810 |   |
| Midstream segment margin                                         |       | 2,906                            |       | 2,066 |   | 4,972 |   | 3,240 |   |
| Compression revenues (4)                                         |       | 603                              |       | — |   | 603 |   | — |   |
| Total segment margin (5)                                         |       | $                                | 3,509      |   | $ | 2,066 |   | $ | 5,575 |   | $ | 3,240 |   |
|                                                             |       |                             |       |   |   |   |   |   |   |
| **Summary of Operations Data:**                                  |       |                             |       |   |   |   |   |   |   |
| Midstream revenues                                               |       | $                                | 13,362     |   | $ | 11,813 |   | $ | 25,175 |   | $ | 21,050 |   |
| Compression revenues                                             |       | 603                              |       | — |   | 603 |   | — |   |
| Total revenues                                                   |       | 13,965                           |       | 11,813 |   | 25,778 |   | 21,050 |   |
| Operating costs and expenses                                     |       |                             |       |   |   |   |   |   |   |
| Midstream purchases (exclusive of items  shown separately below) |       | 10,456                           |       | 9,747 |   | 20,203 |   | 17,810 |   |
| Operations and maintenance                                       |       | 797                              |       | 780 |   | 1,577 |   | 1,196 |   |
| Depreciation, amortization and accretion                         |       | 1,165                            |       | 512 |   | 1,677 |   | 847 |   |
| General and administrative                                       |       | 187                              |       | 166 |   | 353 |   | 264 |   |
| Total operating costs and expenses                               |       | 12,605                           |       | 11,205 |   | 23,810 |   | 20,117 |   |
| Operating income                                                 |       | 1,360                            |       | 608 |   | 1,968 |   | 933 |   |
| Other income (expense)                                           |       | (217                             | )          | (115 | ) | (332 | ) | (181 | ) |
| Income from continuing operations                                |       | 1,143                            |       | 493 |   | 1,636 |   | 752 |   |
| Discontinued operations, net                                     |       | —                           |       | — |   | — |   | 15 |   |
|                                                             |       |                             |       |   |   |   |   |   |   |
| **Net income**                                                   |       | 1,143                            |       | 493 |   | 1,636 |   | 767 |   |
|                                                             |       |                             |       |   |   |   |   |   |   |
| Add:                                                             |       |                             |       |   |   |   |   |   |   |
| Depreciation, amortization and accretion                         |       | 1,165                            |       | 512 |   | 1,677 |   | 847 |   |
| Amortization of deferred loan costs                              |       | 192                              |       | 13 |   | 205 |   | 25 |   |
| Interest expense                                                 |       | 26                               |       | 108 |   | 134 |   | 169 |   |
|                                                             |       |                             |       |   |   |   |   |   |   |
| **EBITDA (6)**                                                   |       | $                                | 2,526      |   | $ | 1,126 |   | $ | 3,652 |   | $ | 1,808 |   |
|                                                             |       |                             |       |   |   |   |   |   |   |
| Operating Data:                                                  |       |                             |       |   |   |   |   |   |   |
| Natural gas sales (MMBTU/d)                                      |       | 41,794                           |       | 37,052 |   | 39,423 |   | 38,232 |   |
| NGL sales (Bbls/d)                                               |       | 1,428                            |       | 1,206 |   | 1,317 |   | 938 |   |

 

27

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(1)   Amountspresented in the Hiland Partners, LP column include only the activity for theperiod beginning on the formation date February 15, 2005. Amounts include theoperations of the assets acquired from Hiland Partners, LLC at closing of theinitial public offering (Worland gathering system and compression assets).

 

(2)   Amountspresented in the Predecessor column include only the activity of CGI for theperiod prior to the formation of Hiland Partners, LP on February 15, 2005.

 

(3)   Totalincome and expense items included in the Consolidated Combined Statements ofOperations of Hiland Partners, LP and its predecessor are included in this Form10-Q for the stated period.

 

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

 

(5)   Reconciliationof total segment margin to operating income:

 
| ** **                               | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **Hiland  Partners, LP**         | ** ** | **Continental   Gas, Inc.  (Predecessor)** | ** ** | **Total** | ** ** | **Continental  Gas, Inc.  (Predecessor)** | ** ** |
|                                     |       |                             |       |   |   |   |   |   |   |
| Operating income                         |       | $                                | 1,360      |   | $ | 608 |   | $ | 1,968 |   | $ | 933 |   |
| Add:                                     |       |                             |       |   |   |   |   |   |   |
| Operations and maintenance               |       | 797                              |       | 780 |   | 1,577 |   | 1,196 |   |
| Depreciation, amortization and accretion |       | 1,165                            |       | 512 |   | 1,677 |   | 847 |   |
| General and administrative               |       | 187                              |       | 166 |   | 353 |   | 264 |   |
| Total segment margin                     |       | $                                | 3,509      |   | $ | 2,066 |   | $ | 5,575 |   | $ | 3,240 |   |

 

We view total segment margin, a non-GAAP financialmeasure, as an important performance measure of the core profitability of ouroperations. We review total segment margin monthly for a consistency and trendanalysis. We define midstream segment margin as midstream revenue lessmidstream purchases. Midstream purchases include the following costs andexpenses: cost of natural gas and NGLs purchased by us from third parties, costof natural gas and NGLs purchased by us from affiliates, and cost of crude oilpurchased by us from third parties. Our compression segment margin will equalthe fee we will earn under our Compression Services Agreement with ContinentalResources, Inc. for providing air compression and water injection services. Thefee that we will earn under this agreement will be fixed as long as ourfacilities meet specified availability requirements, regardless of ContinentalResources, Inc.’s utilization. As a result, our compression segment margin willbe dependent on our ability to meet their utilization levels.

 

(6)   Wedefine EBITDA, a non-GAAP financial measure, as net income plus interestexpense, provisions for income taxes and depreciation, amortization and accretionexpense. EBITDA is used as a supplemental financial measure by our managementand by external users of our financial statements such as investors, commercialbanks, research analysts and others to access: (1) the financial performance ofour assets without regard to financial methods, capital structure or historicalcost basis; (2) the ability of our assets to generate cash sufficient to payinterest costs and support our indebtedness; (3) our operating performance and returnon capital 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 facilities.

 

28

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**Basis of Presentation**

 

WE ARE REQUIRED TO PRESENT, DISCUSS AND ANALYZE THE FINANCIAL CONDITIONAND RESULTS OF OPERATIONS OF CONTINENTAL GAS, INC., PREDECESSOR, FOR THE THREEMONTH PERIOD ENDED MARCH 31, 2004 AND THE FINANCIAL CONDITION AND RESULTS OFOPERATIONS OF HILAND PARTNERS, LP FOR THE THREE MONTH PERIOD ENDED MARCH 31,2005, WHICH INCLUDES THE RESULTS OF OPERATIONS FOR THE ASSETS ACQUIRED FROMHILAND PARTNERS, LLC (WORLAND GATHERING SYSTEM AND COMPRESSION ASSETS) FROMFEBRUARY 15, 2005 (45 DAYS FOR THE PERIOD).

 

**Three Months Ended March 31, 2005 Compared with Three Months EndedMarch 31, 2004**

 

***Revenues.***  Total revenues (midstream and compression)were $25.8 million for the three months ended March 31, 2005 compared to $21.1million for the three months ended March 31, 2004, an increase of $4.7 million,or 22.5%.  Of this increase, $2.4 millionwas attributable to higher average realized natural gas prices and NGL salesprices and $1.5 million was attributable to higher residue and NGL salesvolumes. The volume increase was primarily attributable to the acquisition ofthe Worland gathering system from Hiland Partners, LLC on February 15,2005.  See Basis of Presentation.

 

Midstream revenues were $25.2 million for thethree months ended March 31, 2005 compared to $21.1 million for the threemonths ended March 31, 2004, an increase of $4.1 million, or 19.6%.  This increase is primarily attributable tohigher average realized natural gas prices and NGL sales prices and increasedvolumes associated with the acquisition of the Worland gathering system fromHiland Partners, LLC on February 15, 2005. See Basis of Presentation.

 

Natural gas sales volumes were 39,423 MMBtu/dfor the three months ended March 31, 2005 compared to 38,232 MMBtu/d for thethree months ended March 31, 2004, an increase of 1,191 MMBtu/d, or 3.1%.  NGL sales volumes were 1,317 Bbls/d for thethree months ended March 31, 2005 compared to 938 Bbls/d for the three monthsended March 31, 2004, an increase of 379 Bbls/d, or 40.4%.  The increase in volumes is primarilyassociated with the acquisition of the Worland gathering system from HilandPartners, LLC on February 15, 2005.  SeeBasis of Presentation.

 

Average realized natural gas sales priceswere $5.56 per MMBtu for the three months ended March 31, 2005 compared to$5.18 per MMBtu for the three months ended March 31, 2004, an increase of $0.38per MMBtu, or 7.3%.  In addition, averagerealized NGL sales prices were $0.84 per gallon for the three months endedMarch 31, 2005 compared to $0.63 per gallon for the three months ended March31, 2004, an increase of $0.21 per gallon or 33.3%.  The change in our average realized naturalgas and NGL sales prices was primarily a result of higher index prices.  The change in index prices was primarily aresult of a tightening of supply and demand fundamentals for energy, whichcaused crude oil and natural gas prices to rise during the three months endedMarch 31, 2005 compared to the three months ended March 31, 2004.

 

Compression revenues were $0.6 million forthe three months ended March 31, 2005. The compression assets were acquired from Hiland Partners, LLC onFebruary 15, 2005, the date Hiland Partners, LP commenced operations.  Continental Gas, Inc., our predecessor, didnot have a compression segment, therefore, there were no compression revenuesreported for the three months ended March 31, 2004. See Basis of Presentation.

 

***MidstreamPurchases.*** Midstream purchases were $20.2 million for the three months ended March31, 2005 compared to $17.8 million for the three months ended March 31, 2004,an increase of $2.4 million, or 13.4%. This increase is primarily attributable to higher average realizednatural gas prices and NGL sales prices and increased volumes associated withthe acquisition of the Worland gathering system from Hiland Partners, LLC onFebruary 15, 2005.  See Basis of Presentation.

 

***Operationsand Maintenance.*** Operations and maintenance totaled $1.6 million for the three monthsended March 31, 2005 compared with $1.2 million for the three months endedMarch 31, 2004, an increase of $0.4 million, or 31.9%.  This increase is primarily attributable tothe acquisition of the Worland gathering system and the compression assets fromHiland Partners, LLC on February 15, 2005. See Basis of Presentation.

 

***Depreciation,Amortization and Accretion.***  Depreciation, amortization and accretiontotaled $1.7 million for the three months ended March 31, 2005 compared with$0.8 million for the three months ended March 31, 2004, an increase of $0.9million, or 98.0%.  This increase isprimarily attributable to the acquisition of the Worland gathering system andthe compression assets from Hiland Partners, LLC on February 15, 2005.  See Basis of Presentation.

 

***Generaland Administrative.***  General and administrative totaled $0.4million for the three months ended March 31, 2005 compared with $0.3 millionfor the three months ended March 31, 2004, an increase of $0.1 million, or33.7%.  The increase is primarilyattributable to adding staff as a result of our growth and in preparation ofour public offering.

 

29

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*** ***

***OtherIncome (Expense).*** Other income (expense) totaled ($0.3) millionfor the three months ended March 31, 2005 compared with ($0.2) million for thethree months ended March 31, 2004, an increase in expense of $0.1 million, or83.4%.  The increase is primarilyattributable to increased amortization of deferred debt issuance costsassociated with our new credit facility. As of May 2, 2005, we had no indebtedness outstanding under the newcredit facility.

 

**LIQUIDITY ANDCAPITAL RESOURCES**

** **

# ***Overview***

# ** **

We completed our initial public offering of 2,300,000 common units ofHiland Partners, LP on February 15, 2005, realizing proceeds of $48.1 million,net of $3.6 million of underwriting commissions.  The proceeds of the public offering were usedto: (i) repay approximately $22.9 million of outstanding indebtedness, (ii) paythe remaining $2.2 million of expenses associated with the offering and therelated formation transactions, (iii) make a distribution of approximately $3.9million to the former owners of Hiland Partners, LLC in reimbursement ofcertain capitalized expenditures related to the assets of Hiland Partners, LLCthat were contributed to us, (iv) pay $0.8 million of deferred debt issuancecosts related to the credit facility, (v) replenish approximately $12.0 millionof working capital and (vi) redeem an aggregate of 300,000 common units from anaffiliate of Harold Hamm and the Hamm Trusts for $6.3 million.

 

We now have $55 million available and unused under our creditagreement.  We believe our current cashbalances, future internally-generated funds and funds available under ourcredit agreement will provide sufficient resources to meet our working capitalliquidity needs for the foreseeable future.

 

On April 25, 2005, we announced our first regular cash distribution forthe first quarter of 2005 of $0.225 per unit, based on the minimum quarterlycash distribution of $0.45 prorated for the period since the initial publicoffering on February 15, 2005.  The distributionis payable on all common, subordinated and general partner units and will bepaid May 13, 2005, to all unitholders of record May 5, 2005.  The aggregate amount of the distribution willbe $1.6 million.

 

# ***Cash Flows from Operating Activities***

# ** **

Cashflows from operating activities decreased by $9.8 million to ($6.8) million forthe three months ended March 31, 2005 from $3.0 million for the three monthsended March 31, 2004.  Working capitalitems, exclusive of cash, decreased cash flows by $9.7 million during the firstthree months of 2005, primarily as a result of rebuilding our accountsreceivable after the closing of the initial public offering.  Receivables not contributed from CGI totaled$9.1 million.  Net income for the threemonths ended March 31, 2005 was $1.6 million, an increase of $0.8 million froma net income of $0.8 million for the three months ended March 31, 2004.  The non-cash items of depreciation,amortization, accretion, and deferred loan costs increased $1.0 million in thefirst three months of 2005 compared with the same period in 2004.

 

# ***Cash Flows Used for InvestingActivities***

# ** **

Cashflows used for investing activities decreased to $0.3 million for the threemonths ended March 31, 2005 from $1.3 million for the three months ended March31, 2004.  These amounts representedinvestments in property and equipment for both periods.

 

# ***Cash Flows from Financing Activities***

# ** **

Wecompleted our initial public offering of 2,300,000 on February 15, 2005,receiving net proceeds of $48.1 million. The proceeds from the public offering were used to (1) pay remainingoffering costs of $2.2 million and deferred debt issuance costs of $0.6million, (2) repay debt of $22.9 million owed to banks, (3) redeem $6.3 millionof common units from an affiliate of Harold Hamm and the Hamm Trusts, and (4)make a $3.9 million distribution to the previous owners of Hiland Partners,LLC.  We retained $12.2 million toreplenish working capital.

 

Duringthe period from January 1, 2005 to February 14, 2005, CGI paid $1.1 million onits bank debt.

 

# ***Capital Requirements***

# ** **

The midstream energy business is capital intensive,requiring significant investment to maintain and upgrade existingoperations.  Our capital requirementshave consisted primarily of, and we anticipate will continue to be:

 

30

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

 

•      expansioncapital expenditures such as those to acquire additional assets to grow ourbusiness, to expand and upgrade gathering systems, processing plants, treatingfacilities and fractionation facilities and to construct or acquire similarsystems or facilities.

 

We believe that cash generated from the operations ofour business will be sufficient to meet anticipated maintenance capitalexpenditures, which we have budgeted $2.0 million for in 2005.  We anticipate that expansion capitalexpenditures will be funded through long-term borrowings or other debtfinancings and/or equity capital offerings. See “Credit Facility” below for information related to the creditagreement we entered into in February 2005.

 

***Credit Facility***

 

Concurrently with the closing of our initial publicoffering, we entered into a three-year $55.0 million senior secured revolvingcredit facility.  MidFirst Bank, afederally chartered savings association located in Oklahoma City, Oklahoma, isa lender and serves as administrative agent under this facility.  As of May 6, 2005, we had no indebtednessoutstanding under the credit facility. The credit facility consists of:

 

•      a$47.5 million senior secured revolving credit facility to be used for fundingacquisitions and other capital expenditures, issuance of letters of credit andgeneral corporate purposes (the “revolving acquisition facility”); and

 

•      a$7.5 million senior secured revolving credit facility to be used for workingcapital and to fund distributions (the “revolving working capital facility”).

 

We have the right, no more than once in each fiscalyear, to increase the size of the revolving acquisition facility; provided thateach such increase shall be at least $10.0 million and in no event may theamount of the revolving acquisition facility exceed $82.5 million in theaggregate, and provided further that at the time of such request no default hasoccurred or would result due to such increase and subject to additionalconditions set forth in the credit facility. In addition, the revolving acquisition facility allows for the issuanceof letters of credit of up to $5.0 million in the aggregate.  The credit facility will mature in February2008.  At that time, the agreement willterminate and all outstanding amounts thereunder will be due and payable.

 

Our obligations under the credit facility are securedby substantially all of our assets and guaranteed by us and all of our subsidiaries,other than our operating company, which is the borrower under the creditfacility.  The credit facility isnon-recourse to our general partner.

 

Indebtedness under the credit facility will bearinterest, at our option, at either (i) an Alternate Base Rate plus anapplicable margin ranging from 50 to 175 basis points per annum or (ii) LIBORplus an applicable margin ranging from 150 to 275 basis points per annum basedon our ratio of total debt to EBITDA. The Alternate Base Rate is a rate per annum equal to the greatest of (a)the Prime 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 such dayplus 1⁄2 of 1%.  A letter of credit feewill be payable for the aggregate amount of letters of credit issued under thecredit facility at a percentage per annum equal to 1.0%.  An unused commitment fee ranging from 30 to50 basis points per annum based on our ratio of total debt to EBITDA will bepayable on the unused portion of the credit facility.

 

The credit facility imposes certain requirements,including: prohibition against distribution to Unitholders if, before or afterthe distribution, a potential default or an event of default as defined in theagreement would occur; limitations on our ability to incur debt, grant liens,make loans, acquisitions, and investments, change the nature of our business,enter a merger or consolidation, or sell assets, amend material agreements; andcovenants that require maintenance of certain levels of tangible net worth,EBITDA to interest expense ratio, and debt to EBITDA ratio.  If an event of default exists under theagreement, the lenders will be able to accelerate the maturity of the debt andexercise other rights and remedies.

 

***Impact of Inflation***

 

Inflation in the United States has been relatively lowin recent years and did not have a material impact on our results of operationsfor the periods presented.

 

**RecentAccounting Pronouncements**

** **

**In October 1995, the FASB issued SFAS No. 123“Share-Based Payments” which was revised in December 2004 (collectively, “FASB123R”).  FASB 123R requires that thecompensation cost relating to share-based payment transactions be recognized infinancial statements and that cost will be measured based on the fair value ofthe equity or liability instruments issued. The effect of the standard will be to require entities to measure thecost of employee services received in exchange for stock or unit options based**

 

31

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**on the grant-date fair value of the award,and to recognize the cost over the period the employee is required to provideservices for the award.  In accordancewith SEC Release No. 33-8568, we will adopt SFAS 123R as of the first interimperiod beginning on or after January 1, 2006. We expect to apply the statement using the permitted modifiedretrospective method, presenting all interim periods of the year of adoption,beginning January 1, 2006.  We had143,000 options outstanding as of March 31, 2005.**

** **

**SignificantAccounting Policies and Estimates**

** **

The selection and application of accounting policiesis an important process that has developed as our business activities haveevolved and as the accounting rules have developed.  Accounting rules generally do not involve aselection among alternatives, but involve the implementation and interpretationof existing rules, and the use of judgment applied to the specific set ofcircumstances existing in our business. We make every effort to properly comply with all applicable rules on orbefore their adoption, and we believe the proper implementation and consistentapplication of the accounting rules are critical.  For further details on our accounting policies,you should read Note 1 of the accompanying Notes to Financial Statements.

 

***Asset RetirementObligations*.**   SFASNo. 143 “Accounting for Asset Retirement Obligations” requires entities torecord the fair value of a liability for an asset retirement obligation in theperiod in which it is incurred and a corresponding increase in the carryingamount of the related long-lived asset. Subsequently, the asset retirement cost is allocated to expense using asystematic and rational method and the liability is accreted to measure thechange in liability due to the passage of time. The primary impact of this standard relates to our estimated costs fordismantling and site restoration of certain of our plants and pipelines.  Estimating future asset retirementobligations requires us to make estimates and judgments regarding timing,existence of a liability, as well as what constitutes adequaterestoration.  We use the present value ofestimated cash flows related to our asset retirement obligation to determinethe fair value, generally as estimated by third party consultants.  The present value calculation requires us tomake 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 theextent future revisions to these assumptions impact the present value of theexisting asset retirement obligation liability, a corresponding adjustment willbe required to the related asset.  Webelieve the estimates and judgments reflected in our financial statements arereasonable but are necessarily subject to the uncertainties we have justdescribed.  Accordingly, any significantvariance in any of the above assumptions or factors could materially affect ourcash flows.

 

***Impairment ofLong-Lived Assets*.**  In accordance with Statement of Financial Accounting Standards (SFAS)No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets,we evaluate our long-lived assets of identifiable business activities forimpairment when events or changes in circumstances indicate, in management’sjudgment, that the carrying value of such 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 theassets.  If impairment has occurred, theamount of the impairment recognized is determined by estimating the fair valuefor the assets and recording a provision for loss if the carrying value isgreater than fair value.  For assetsidentified to be disposed of in the future, the carrying value of these assetsis compared to the estimated fair value less the cost to sell to determine ifimpairment is required.  Until the assetsare disposed of, an estimate of the fair value is re-determined when relatedevents or circumstances change.

 

When determining whether impairment of one of ourlong-lived assets has occurred, we must estimate the undiscounted cash flowsattributable to the asset or asset group. 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 drillingactivity are dependent in part on natural gas prices.  Projections of reserves and future commodityprices are inherently subjective and contingent upon a number of variablefactors, including, but not limited to:

 

•      changesin general economic conditions in regions in which our products are located;

 

•      theavailability and prices of NGL products and competing commodities;

 

•      theavailability and prices of raw natural gas supply;

 

•      ourability to negotiate favorable marketing agreements;

 

•      therisks that third party oil and gas exploration and production activities willnot occur or be successful;

 

•      ourdependence on certain significant customers and producers of natural gas; and

 

•      competitionfrom other midstream service providers, processors, including major energycompanies.

 

Any significant variance in any of the aboveassumptions or factors could materially affect our cash flows, which couldrequire us to record an impairment of an asset.

 

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No impairment charges were recognized during each ofthe three months ended March 31, 2004 and 2005.

 

***Revenue Recognition*.**   Revenues for sales of natural gas and NGLsproduct sales are recognized at the time the product is delivered and title istransferred.  Revenues for compressionservices are recognized when the services under the agreement areperformed.  Revenues from oil and gasproduction (discontinued operations) are recorded in the month produced andtitle is transferred to the purchaser.

 

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

** **

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

 

***CommodityPrice Risks.***  Our profitability is affected by volatilityin prevailing NGL and natural gas prices. Historically, changes in the prices of most NGL products have generallycorrelated with changes in the price of crude oil.  NGL and natural gas prices are volatile andare impacted by changes in the supply and demand for NGLs and natural gas, aswell as market uncertainty.  For thethree months ended March 31, 2005, a $0.10 per MMBtu increase in the price ofnatural gas combined with a $0.01 per gallon increase in NGL prices would haveincreased our total segment margin by $30,429, whereas a $0.10 per MMBtudecrease in the price of natural gas offset by a $0.01 per gallon increase inNGL prices would have increased our total segment margin by $29,759.  In addition, for the three months ended March31, 2005, a $0.10 per MMBtu increase in the price of natural gas offset by a$0.01 per gallon decrease in NGL prices would have decreased our total segmentmargin by $20,760, whereas a $0.10 per MMBtu decrease in the price of naturalgas combined with a $0.01 per gallon decrease in NGL prices would havedecreased our total segment margin by $21,763. The magnitude of the impact on total segment margin of changes innatural gas and NGL prices presented may not be representative of the magnitudeof the impact on total segment margin for different commodity prices orcontract portfolios.  Natural gas pricescan also affect our profitability indirectly by influencing the level ofdrilling activity and related opportunities for our services.

** **

***Interest Rate Risk*.**   We are exposed to changes in interest ratesas a result of our credit facility, which has floating interest rates.  We had no indebtedness outstanding under ourcredit facility at May 6, 2005.

 

***Credit Risk*.**   Counterparties pursuant to the terms oftheir contractual obligations expose us to potential losses as a result of nonperformance.  BP Energy Company and OGE Energy Resources,Inc. were our largest customers for the three months ended March 31, 2005,accounting for approximately 31.1% and 23.6%, respectively, of our revenues.  Consequently, changes within BP Energy Company’sor OGE Energy Resources, Inc.’s operations have the potential to impact, bothpositively and negatively, our credit exposure.

 

**Item 4.**    Controlsand Procedures

** **

**Evaluation ofDisclosure Controls and Procedures**

** **

(a)   Evaluationof disclosure controls and procedures.

 

Our principal executiveofficer and principal financial officer have evaluated, as required byRule 13a-15(b) under the Securities Exchange Act of 1934 (the “ExchangeAct”), our disclosure controls and procedures (as defined in Exchange Act Rule13a-15(e)) as of the end of the period covered by this quarterly report onForm 10-Q.   Based on thatevaluation, the principal executive officer and principal financial officerconcluded that the design and operation of our disclosure controls and proceduresare effective in ensuring that information we are required to disclose in thereports that we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms.

 

(b)   Changes ininternal control over financial reporting.

 

There have been nochanges in our internal control over financial reporting (as defined inRule 13a-15(f) under the Exchange Act) that occurred during our lastfiscal quarter that have materially affected or are reasonably likely tomaterially affect our internal control over financial reporting.

 

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** **

**PART II. OTHER INFORMATION**

 

**Item 1. Legal proceedings**

 

We are a party to various legal and regulatoryproceedings, none of which we believe will have a material adverse impact onour financial condition, results of operations or cash flows.

 

**Item 2.Unregistered Sales of equity Securities**

 

None.

 

**Item 3.Defaults Upon Senior Securities**

 

None.

 

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

 

None.

 

**Item 5. Other Matters**

 

None.

 

**Item 6. Exhibits**

 
| **Exhibit  Number** | ** ** | ** ** | ** ** | **Description**                                                                                                                                                                                                                                                                                          |
|---------------------|------------|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | —     |       | Certificate  of Limited Partnership of Hiland Partners, LP. (incorporated by referenced 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 Registrants Annual Report on Form 10-K for the  fiscal year ended December 31, 2004, filed with the SEC 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                 |       | —     |       | Amended  and Restated Limited Liability Company Agreement of Hiland Partners GP,  LLC(incorporated by reference to Registrants Annual Report on Form 10-K for  the fiscal year ended December 31, 2004, filed with the SEC on March 30, 2005)                                                            |
|                |       |       |       |                                                                                                                                                                                                                                                                                                     |
| 10.1                |       | —     |       | Credit  Agreement dated as of February 15, 2005 among Hiland Operating, LLC and  MidFirst Bank (incorporated by reference to Registrants Annual Report on Form  10-K for the fiscal year ended December 31, 2004, filed with the SEC 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 Registrants Annual Report on Form 10-K for the fiscal year ended  December 31, 2004, filed with the SEC 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                                                                                                       |

 

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|   |   |   |   | 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 Registrants Annual  Report on Form 10-K for the fiscal year ended December 31, 2004, filed with  the SEC 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 Registrants Annual Report on Form 10-K for the fiscal year  ended December 31, 2004, filed with the SEC on March 30, 2005)                             |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                               |
| 10.11* |   | — |   | Director’s  Compensation Summary (incorporated by reference to Registrants Annual Report  on Form 10-K for the fiscal year ended December 31, 2004, filed with the SEC  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 exhibithave been omitted pursuant to a request for confidential treatment**.

 

******* ****Constitutes managementcontracts or compensatory plans or arrangements.**

 

35

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**SIGNATURES**

** **

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized in thecity of Enid, Oklahoma, on the 13th day of May, 2005.

 
|   | **HILAND PARTNERS, LP**                               |
|--------|-------------------------------------------------------|
|   |                                                  |
|   | **By: Hiland Partners GP, LLC, its general  partner** |
|   |                                                  |
|   |                                                  |
|   | By:                                                   | /s/ Randy Moeder |   |
|   |                                                  | Randy Moeder |
|   |                                                  | Chief Executive Officer, President and  Director |
|   |                                                  |
|   |                                                  |
|   | By:                                                   | /s/ Ken Maples |   |
|   |                                                  | Ken Maples |
|   |                                                  | Chief Financial Officer, Vice President–Finance, |
|   |                                                  | Secretary and Director |

 

36

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**Exhibit Index**

 
| 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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