** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

** **

**FORM10-Q**

** **

**ý** QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIESEXCHANGE ACT OF 1934

** **

**FORTHE QUARTERLY PERIOD ENDED September 30, 2005**

** **

**OR**

 

**o** TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

** **

**FORTHE TRANSITION PERIOD FROM                 TO                 **

 

**Commission file number:  000-51120**

** **

**HilandPartners, LP**(Exact nameof Registrant as specified in its charter)

** **

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

 

Registrant’s telephone number including areacode **(580) 242-6040**

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes ý No  o

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined in Rule12b-2 of the Exchange Act).  Yes o No  ý

 

Indicate by acheck mark whether the registrant is a shell company (as defined in rule 12b-2of the Exchange Act).  Yes o No  ý

 

**The number of the registrant’soutstanding equity units at November 3, 2005 was 2,728,000 common units, 4,080,000subordinated units and a 2% general partnership interest.**

** **

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** **

**HILAND PARTNERS, LP**

**INDEX**

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

 

2

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**HILAND PARTNERS, LP**

**Consolidated Balance Sheets**

 
| ** **                                                                                    | ** ** | **Hiland**                              | ** ** | ** **            | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------|------------|
| ** **                                                                                    | ** ** | **Partners, LP**                        | ** ** | **Predecessor**       | ** ** |
| ** **                                                                                    | ** ** | **September 30, 2005**                  | ** ** | **December 31, 2004** | ** ** |
| ** **                                                                                    | ** ** | **(Unaudited)**                         | ** ** | **(Audited)**         | ** ** |
| ** **                                                                                    | ** ** | **(in thousands, except unit amounts)** | ** ** |
| **ASSETS**                                                                                    |       |                                    |       |                  |       |
| **Current assets:**                                                                           |       |                                    |       |                  |       |
| Cash and cash equivalents                                                                     |       | $                                       | 6,816      |                  | $          | 217 |   |
| Accounts receivable:                                                                          |       |                                    |       |                  |       |
| Trade                                                                                         |       | 18,601                                  |       | 9,663                 |       |
| Affiliates                                                                                    |       | 1,107                                   |       | 758                   |       |
|                                                                                          |       | 19,708                                  |       | 10,421                |       |
| Inventories                                                                                   |       | 153                                     |       | 153                   |       |
| Other current assets                                                                          |       | 347                                     |       | 118                   |       |
| Total current assets                                                                          |       | 27,024                                  |       | 10,909                |       |
|                                                                                          |       |                                    |       |                  |       |
| Property and equipment, net                                                                   |       | 116,239                                 |       | 37,075                |       |
| Intangibles, net                                                                              |       | 42,281                                  |       | —                |       |
| Other assets, net                                                                             |       | 1,007                                   |       | 1,191                 |       |
|                                                                                          |       |                                    |       |                  |       |
| **Total assets**                                                                              |       | $                                       | 186,551    |                  | $          | 49,175 |   |
|                                                                                          |       |                                    |       |                  |       |
| **LIABILITIES AND OWNERS’ EQUITY**                                                       | ** ** | ** **                              | ** ** | ** **            | ** ** |
| **Current liabilities:**                                                                      |       |                                    |       |                  |       |
| Accounts payable                                                                              |       | $                                       | 11,719     |                  | $          | 5,649 |   |
| Accounts payable-affiliates                                                                   |       | 7,660                                   |       | 2,998                 |       |
| Accrued liabilities                                                                           |       | 943                                     |       | 327                   |       |
| Current maturities of long-term debt                                                          |       | —                                  |       | 2,429                 |       |
| Total current liabilities                                                                     |       | 20,322                                  |       | 11,403                |       |
| Commitments and contingencies                                                                 |       |                                    |       |                  |       |
| Long-term debt, net of current maturities                                                     |       | 93,700                                  |       | 12,643                |       |
| Asset retirement obligation                                                                   |       | 1,042                                   |       | 619                   |       |
|                                                                                          |       |                                    |       |                  |       |
| **Owners’ equity**                                                                       |       |                                    |       |                  |       |
| Predecessor stockholders’ equity                                                         |       | —                                  |       | 24,510                |       |
| Common unitholders (2,728,000 units issued and outstanding at  September 30, 2005)       |       | 45,585                                  |       | —                |       |
| Subordinated unitholders (4,080,000 units issued and outstanding at  September 30, 2005) |       | 25,186                                  |       | —                |       |
| General partner interest                                                                      |       | 1,040                                   |       | —                |       |
| Unearned compensation                                                                         |       | (324                                    | )          | —                |       |
| **Total owners’ equity**                                                                 |       | 71,487                                  |       | 24,510                |       |
|                                                                                          |       |                                    |       |                  |       |
| **Total liabilities and owners’ equity**                                                 |       | $                                       | 186,551    |                  | $          | 49,175 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

3

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**HILAND PARTNERS, LP**

**Consolidated Statements of Operations**

**(Unaudited)**

 
| ** **                                                                  | ** ** | **Three Months Ended**                  | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------|------------|
| ** **                                                                  | ** ** | **September 30,**                       | ** ** | **September 30,**     | ** ** |
| ** **                                                                  | ** ** | **Hiland**                              | ** ** | ** **            | ** ** | **Hiland** | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | **Partners,**                           | ** ** | ** **            | ** ** | **Partners,** | ** ** | ** ** | ** ** |
| ** **                                                                  | ** ** | **LP**                                  | ** ** | **Predecessor**       | ** ** | **LP** | ** ** | **Predecessor** | ** ** |
| ** **                                                                  | ** ** | **2005**                                | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                  | ** ** | **(in thousands except per unit data)** | ** ** |
| **Revenues:**                                                               |       |                                    |       |                  |       |   |   |   |   |
| Midstream operations                                                        |       |                                    |       |                  |       |   |   |   |   |
| Third parties                                                               |       | $                                       | 39,608     |                  | $          | 24,661 |   | $ | 91,780 |   | $ | 67,952 |   |
| Affiliates                                                                  |       | 1,112                                   |       | 726                   |       | 3,514 |   | 2,334 |   |
| Compression services, affiliate                                             |       | 1,205                                   |       | —                |       | 3,012 |   | — |   |
| Total revenues                                                              |       | 41,925                                  |       | 25,387                |       | 98,306 |   | 70,286 |   |
|                                                                        |       |                                    |       |                  |       |   |   |   |   |
| **Operating costs and expenses:**                                           |       |                                    |       |                  |       |   |   |   |   |
| Midstream purchases (exclusive of items shown separately below)             |       | 21,713                                  |       | 14,850                |       | 50,750 |   | 39,525 |   |
| Midstream purchases -affiliate (exclusive of items shown separately  below) |       | 11,600                                  |       | 6,674                 |       | 26,798 |   | 20,321 |   |
| Operations and maintenance                                                  |       | 1,897                                   |       | 1,395                 |       | 5,083 |   | 3,624 |   |
| Depreciation, amortization and accretion                                    |       | 2,912                                   |       | 1,193                 |       | 6,924 |   | 3,003 |   |
| Gain on sale of assets                                                      |       | —                                  |       | (15                   | )          | — |   | (15 | ) |
| General and administrative                                                  |       | 521                                     |       | 201                   |       | 1,539 |   | 680 |   |
| Total operating costs and expenses                                          |       | 38,643                                  |       | 24,298                |       | 91,094 |   | 67,138 |   |
| Operating income                                                            |       | 3,282                                   |       | 1,089                 |       | 7,212 |   | 3,148 |   |
|                                                                        |       |                                    |       |                  |       |   |   |   |   |
| **Other income (expense):**                                                 |       |                                    |       |                  |       |   |   |   |   |
| Interest and other income                                                   |       | 70                                      |       | 7                     |       | 112 |   | 23 |   |
| Amortization of deferred loan costs                                         |       | (83                                     | )          | (25                   | )          | (360 | ) | (76 | ) |
| Interest expense                                                            |       | (585                                    | )          | (173                  | )          | (766 | ) | (508 | ) |
| Net other income (expense)                                                  |       | (598                                    | )          | (191                  | )          | (1,014 | ) | (561 | ) |
|                                                                        |       |                                    |       |                  |       |   |   |   |   |
| **Income from continuing operations**                                       |       | 2,684                                   |       | 898                   |       | 6,198 |   | 2,587 |   |
| **Discontinued operations, net**                                            |       | —                                  |       | (52                   | )          | — |   | 34 |   |
|                                                                        |       |                                    |       |                  |       |   |   |   |   |
| **Net income**                                                              |       | 2,684                                   |       | $                     | 846        |   | 6,198 |   | $ | 2,621 |   |
|                                                                        |       |                                    |       |                  |       |   |   |   |   |
| Less income attributable to predecessor                                     |       | —                                  |       |                  |       | 493 |   |   |   |
| Less general partner interest in net income                                 |       | 67                                      |       |                  |       | 128 |   |   |   |
| **Limited partners’ interest in net income**                           |       | $                                       | 2,617      |                  |       |   | $ | 5,577 |   |   |   |
|                                                                        |       |                                    |       |                  |       |   |   |   |   |
| **Net income per limited partners’ unit — basic**                 |       | $                                       | 0.38       |                  |       |   | $ | 0.82 |   |   |   |
|                                                                        |       |                                    |       |                  |       |   |   |   |   |
| **Net income per limited partners’ unit — diluted**               |       | $                                       | 0.38       |                  |       |   | $ | 0.82 |   |   |   |
|                                                                        |       |                                    |       |                  |       |   |   |   |   |
| **Weighted average limited partners’ units  outstanding -basic**       |       | 6,800                                   |       |                  |       | 6,800 |   |   |   |
|                                                                        |       |                                    |       |                  |       |   |   |   |   |
| **Weighted average limited partners’ units  outstanding -diluted**     |       | 6,844                                   |       |                  |       | 6,830 |   |   |   |

 

The accompanying notes are an integral partof these financial statements.

 

4

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**HILAND PARTNERS, LP**

**Consolidated Statements of Cash Flows**

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

 
| ** **                                                                         | ** ** | **Hiland**             | ** ** | ** **             | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **Partners, LP**       | ** ** | **Predecessor**        | ** ** |
| ** **                                                                         | ** ** | **September 30, 2005** | ** ** | **September 30, 2004** | ** ** |
| ** **                                                                         | ** ** | **(in  thousands)**    | ** ** |
| **Cash flows from operating activities:**                                          |       |                   |       |                   |       |
| Net income                                                                         |       | $                      | 6,198      |                   | $          | 2,621 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                   |       |                   |       |
| Depreciation and amortization                                                      |       | 6,898                  |       | 3,052                  |       |
| Change in asset retirement obligation                                              |       | 26                     |       | 18                     |       |
| Amortization of deferred loan cost                                                 |       | 360                    |       | 76                     |       |
| Gain on sale of assets                                                             |       | —                 |       | (15                    | )          |
| (Increase) decrease in current assets:                                             |       |                   |       |                   |       |
| Accounts receivable                                                                |       | (14,413                | )          | 218                    |       |
| Accounts receivable - affiliates                                                   |       | (153                   | )          | 223                    |       |
| Inventories                                                                        |       | —                 |       | 122                    |       |
| Other current assets                                                               |       | (163                   | )          | (9                     | )          |
| Increase (decrease) in current liabilities:                                        |       |                   |       |                   |       |
| Accounts payable                                                                   |       | (938                   | )          | 642                    |       |
| Accounts payable-affiliates                                                        |       | 2,658                  |       | (85                    | )          |
| Accrued liabilities                                                                |       | 427                    |       | 48                     |       |
| **Net cash provided by operating activities**                                      |       | 900                    |       | 6,911                  |       |
|                                                                               |       |                   |       |                   |       |
| **Cash flows from investing activities:**                                          |       |                   |       |                   |       |
| Additions to property and equipment                                                |       | (2,770                 | )          | (4,876                 | )          |
| Acquisition of net assets of Hiland Partners, LLC, less cash received              |       | (62,440                | )          | —                 |       |
| Proceeds from disposals of property and equipment                                  |       | —                 |       | 9                      |       |
| **Net cash used in investing activities**                                          |       | (65,210                | )          | (4,867                 | )          |
|                                                                               |       |                   |       |                   |       |
| **Cash flows from financing activities:**                                          |       |                   |       |                   |       |
| Proceeds from public offering - net of underwriting commissions                    |       | 48,128                 |       | —                 |       |
| Redemption of common units                                                         |       | (6,278                 | )          | —                 |       |
| Distributions to organizers                                                        |       | (3,851                 | )          | —                 |       |
| Cash not contributed by organizers                                                 |       | (869                   | )          | —                 |       |
| Proceeds from long-term borrowings                                                 |       | 93,700                 |       | —                 |       |
| Payments on long-term borrowings                                                   |       | (23,951                | )          | (1,821                 | )          |
| Increase in deferred offering cost                                                 |       | —                 |       | (431                   | )          |
| Debt issuance costs                                                                |       | (1,189                 | )          | (5                     | )          |
| Payment of offering costs                                                          |       | (2,249                 | )          | —                 |       |
| Cash distribution to controlling member for net assets of Hiland  Partners, LLC    |       | (27,768                | )          | —                 |       |
| Contribution by general partner                                                    |       | 6                      |       | —                 |       |
| Cash distribution to unitholders                                                   |       | (4,770                 | )          | —                 |       |
| **Net cash provided by (used in) financing  activities**                           |       | 70,909                 |       | (2,257                 | )          |
|                                                                               |       |                   |       |                   |       |
| Increase (decrease) for the period                                                 |       | 6,599                  |       | (213                   | )          |
| Beginning of period                                                                |       | 217                    |       | 496                    |       |
| **End of period**                                                                  |       | $                      | 6,816      |                   | $          | 283 |   |
|                                                                               |       |                   |       |                   |       |
| Supplementary information                                                          |       |                   |       |                   |       |
| Cash paid for interest                                                             |       | $                      | 367        |                   | $          | 602 |   |

 

The accompanying notes are an integral partof these financial statements.

 

5

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**HILAND PARTNERS, LP**

**Consolidated Statement of Owners’ Equity**

**(Unaudited)**

 
| ** **                                                                      | ** ** | ** **         | ** ** | ** ** | ** ** | ** **       | ** ** | **General**  | ** ** | ** **       | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------|------------|------------|------------|------------------|------------|--------------|------------|------------------|------------|------------|------------|
| ** **                                                                      | ** ** | ** **         | ** ** | **Common** | ** ** | **Subordinated** | ** ** | **Partner**  | ** ** | **Unearned**     | ** ** | ** ** | ** ** |
| ** **                                                                      | ** ** | **Predecessor**    | ** ** | **Units**  | ** ** | **Units**        | ** ** | **Interest** | ** ** | **Compensation** | ** ** | **Total**  | ** ** |
| ** **                                                                      | ** ** | **(in thousands)** | ** ** |
|                                                                            |       |               |       |       |       |             |       |         |       |             |       |       |       |
| Balance, December 31, 2004                                                 |       | $                  | 24,510     |       | $          | —           |       | $            | —     |             | $          | —     |       | $ | — |   | $ | 24,510 |   |
|                                                                            |       |               |       |       |       |             |       |         |       |             |       |       |       |
| Assets not contributed to Hiland Partners, LP                                   |       | (9,972             | )          | —     |       | —           |       | —       |       | —           |       | (9,972     | )          |
|                                                                            |       |               |       |       |       |             |       |         |       |             |       |       |       |
| Net income from January 1, 2005 through February 14, 2005                  |       | 493                |       | —     |       | —           |       | —       |       | —           |       | 493        |       |
|                                                                            |       |               |       |       |       |             |       |         |       |             |       |       |       |
| Allocation of net parent investment to unitholders                              |       | (15,031            | )          | 2,191      |       | 12,418           |       | 422          |       | —           |       | —     |       |
|                                                                            |       |               |       |       |       |             |       |         |       |             |       |       |       |
| Contribution of certain net assets 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 at organization                                                   |       | —             |       | (362       | )          | (3,489           | )          | —       |       | —           |       | (3,851     | )          |
|                                                                            |       |               |       |       |       |             |       |         |       |             |       |       |       |
| Cash distribution to controlling member for net assets of Hiland  Partners, LLC |       | —             |       | (2,507     | )          | (24,473          | )          | (788         | )          | —           |       | (27,768    | )          |
|                                                                            |       |               |       |       |       |             |       |         |       |             |       |       |       |
| Contribution by general partner                                                 |       | —             |       | —     |       | —           |       | 6            |       | —           |       | 6          |       |
|                                                                            |       |               |       |       |       |             |       |         |       |             |       |       |       |
| Periodic cash distributions                                                     |       | —             |       | (1,870     | )          | (2,805           | )          | (95          | )          | —           |       | (4,770     | )          |
|                                                                            |       |               |       |       |       |             |       |         |       |             |       |       |       |
| Issuance of restricted units                                                    |       | —             |       | 324        |       | —           |       | —       |       | (324             | )          | —     |       |
|                                                                            |       |               |       |       |       |             |       |         |       |             |       |       |       |
| Net income from February 15, 2005 through September 30,  2005         |       | —             |       | 2,232      |       | 3,345            |       | 128          |       | —           |       | 5,705      |       |
|                                                                            |       |               |       |       |       |             |       |         |       |             |       |       |       |
| Balance, September 30, 2005                                                |       | $                  | —     |       | $          | 45,585           |       | $            | 25,186     |             | $          | 1,040      |       | $ | (324 | ) | $ | 71,487 |   |

 

The accompanying notes are an integral partof these financial statements.

 

6

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**HILANDPARTNERS, LP**

CONDENSED NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS (UNAUDITED)

THREE AND NINE MONTHSENDED SEPTEMBER 30, 2005 AND 2004

(in thousands, exceptunit information or unless otherwise noted)

 

**Note 1:  Organization, Basis of Presentation andPrinciples of Consolidation**

 

                HilandPartners, LP, a Delaware limited partnership, was formed in October 2004 toacquire and operate certain of the midstream natural gas plants, gatheringsystems and compression and water injection assets previously owned by Continental Gas, Inc. and Hiland Partners, LLC.  References inthis quarterly report on Form 10-Q to “we,” “our,” “us,” or similar terms referto Hiland Partners, LP and our operating subsidiaries after giving effect tothe formation transactions described above.

 

Continental Gas, Inc. historically has owned all of ournatural gas gathering, processing, treating and fractionation assets other thanour Worland gathering system and our Bakken gathering system.  Prior toJuly 21, 2004, Continental Gas, Inc. was owned by Continental Resources,Inc., an independent exploration and development company owned by Harold Hamm,the Chairman of the Board of Directors of our general partner, and the HaroldHamm DST and the Harold Hamm HJ Trusts, which are trusts established for thebenefit of Harold Hamm’s children and which we refer to herein as the “HammTrusts.”  On July 21, 2004, Continental Resources, Inc. completed thetransfer of Continental Gas, Inc. to Harold Hamm and the Hamm Trusts. Hiland Partners, LLC historically owned our Worland gathering system, ourcompression services assets and our Bakken gathering system.  HilandPartners, LLC was owned by Harold Hamm, the Hamm Trusts and Equity FinancialServices, Inc., an entity owned by Randy Moeder, our President and ChiefExecutive Officer and a director of our general partner.

 

                In October 2004, we filed a registration statement on Form S-1with the Securities and Exchange Commission, relating to our proposed initialpublic offering.  On February 15, 2005,we closed our offering and (a) substantially all of Continental Gas, Inc.’sassets and liabilities were transferred via conversion to our wholly ownedsubsidiary, Continental Gas Operating, LP, (b) substantially all of HilandPartners, LLC’s assets less the Bakken gathering system were transferred to ourwholly owned subsidiary, Hiland Energy Partners, LLC, and (c) all of theinterests in these two operating entities were transferred to Hiland Partners,LP.  Harold Hamm and members of ourmanagement own a 100% managing member interest in Hiland Partners GP, LLC, ourgeneral partner.

 

Concurrentlywith the closing of our initial public offering, we established a $55.0 millioncredit facility through our operating company, Hiland Operating, LLC, withMidFirst Bank, a federally chartered savings association located in OklahomaCity, Oklahoma, as administrative agent and a lender, with an option toincrease the amount to $90.0 million under certain conditions.

 

On September26, 2005, we acquired Hiland Partners, LLC for $92.7 million in cash,$35.0 million of which was used to retire outstanding Hiland Partners, LLCindebtedness.  Concurrently with theacquisition, we amended our senior secured revolving credit facility toincrease our borrowing capacity under the facility from $55.0 million to$125.0 million, consisting of a $117.5 million acquisition facilityand a $7.5 million working capital facility.  As of November 3, 2005, we had $93.7 millionindebtedness outstanding under the credit facility.

 

The financial statementsfor the three and nine months ended September 30, 2005 and 2004 included hereinhave been prepared without audit, pursuant to the rules and regulations of theUnited States Securities and Exchange Commission (the “SEC”).  Our consolidated statements of operations,cash flows and owners’ equity include the accounts of our predecessorContinental Gas, Inc. through February 14, 2005 and our accounts for the periodfrom February 15, 2005 through September 30, 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 our Form 10-K for the year ended December 31, 2004.

 

The interim financialstatements reflect all adjustments, which are in the opinion of our management,necessary for a fair presentation of our results for the interim periods.  Such adjustments are considered to be of anormal recurring nature.  Results ofoperations for the three and nine months ended September 30, 2005 are notnecessarily indicative of the results of operations that will be realized forthe year ending December 31, 2005.  The preparation of financial statements in accordancewith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the amountsreported in the financial statements and accompanying notes.  Actual results could differ from thoseestimates.

 

The consolidatedfinancial statements include our accounts and those of our subsidiaries.  All significant intercompany transactions andbalances have been eliminated. The consolidated financial statements include thenet assets and operations of assets owned by Continental Gas, Inc. and HilandPartners, LLC that were contributed to us concurrently 

 

7

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with the completion ofour initial public offering and also include the net assets and operations of Hiland Partners, LLCacquired effective September 1, 2005.

 

In accordancewith Statement of Financial Accounting Standards (SFAS) No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” we evaluate ourlong-lived assets of identifiable business activities for impairment whenevents or changes in circumstances indicate, in management’s judgment, that thecarrying value of such assets may not be recoverable.  The determination of whether impairment hasoccurred is based on our management’s estimate of undiscounted future cashflows attributable 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 for eachreporting period or when related events or circumstances change.

 

Intangible assets consistof the acquired value of existing contracts to sell natural gas and natural gasliquids (NGLs) and compression contracts, which do not have a significantresidual value.  The contracts are being amortized over ten years. The deferred loan costs are being amortized over the life of the creditfacility.

 

***Restricted Units***

 

                We began issuing restrictedcommon units in August 2005.  The totalvalue of restricted units granted is recorded as unearned compensation inowners’ equity based on the fair market value of the units on the date ofgrant. This value is amortized over a four year vesting period from the date ofgrant.

 

***Share-BasedCompensation***

 

                Weapply Accounting Principles Board Opinion No. 25 and relatedinterpretations in accounting for our share-based compensation awards.Accordingly, no compensation cost has been recognized for unit options grantedin the accompanying consolidated financial statements. We had granted no unitoptions until adoption of our incentive unit option plan on February 15,2005. The following pro forma data is calculated as if compensation cost forour share-based compensation awards was determined based upon the fairvalue at the grant date consistent with the methodology prescribed under SFASNo. 123.

 

 
| ** **                                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                  | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                  | ** ** | **2005**               | ** ** | **2005**               | ** ** |
| Net income as reported                                      |       | $                      | 2,684      |                   | $          | 6,198 |   |
| Share based compensation adjustment                         |       | (289                   | )          | (739                   | )          |
| Pro forma net income                                        |       | 2,395                  |       | 5,459                  |       |
| Less income attributable to predecessor                     |       | —                 |       | 493                    |       |
| Less general partner interest                               |       | 60                     |       | 111                    |       |
| Limited partner’s interest in pro forma net income     |       | $                      | 2,335      |                   | $          | 4,855 |   |
| Net income per limited partner unit as reported, basic      |       | $                      | 0.38       |                   | $          | 0.82 |   |
| Net income per limited partner unit as reported, diluted    |       | $                      | 0.38       |                   | $          | 0.82 |   |
| Adjustment, basic                                           |       | $                      | (0.04      | )                      | $          | (0.11 | ) |
| Adjustment, diluted                                         |       | $                      | (0.04      | )                      | $          | (0.11 | ) |
| Proforma net income per limited partner unit, basic         |       | $                      | 0.34       |                   | $          | 0.71 |   |
| Proforma net income per limited partner unit, diluted       |       | $                      | 0.34       |                   | $          | 0.71 |   |
| Weighted average limited partner units outstanding, basic   |       | 6,800,000              |       | 6,800,000              |       |
| Weighted average limited partner units outstanding, diluted |       | 6,844,000              |       | 6,830,000              |       |

 

 

                Therewere 23,000 options granted during the third quarter.  As of September 30, 2005, there were166,000 options outstanding with a weighted-average exercise price of $24.53per unit and a weighted-average grant date fair value of $12.43 per unit.  As of September 30, 2005, no options wereexercisable.  The fair value of eachoption granted was estimated on the date of grant using the American Binomialoption pricing model with the following weighted average assumptions used forgrants in 2005: risk-free interest rates of 4.5 percent; 5.2 percentdividend yield; no assumed forfeitures; expected lives of 6.0 years; andvolatility of 29.7 percent. The pro forma amounts above are not likely tobe representative of future years because there is no assurance that additionalawards will be made each year.

 

8

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**Note 2:Acquisition of Hiland Partners, LLC**

 

                OnSeptember 26, 2005, we completed our acquisition of Hiland Partners, LLC, anOklahoma limited liability company, for approximately $92.7 million incash, $35.0 million of which was used to retire outstanding HilandPartners, LLC indebtedness. The effective date of the acquisition was September1, 2005.  Hiland Partners, LLC’sprincipal asset was the Bakken gathering system located in Richland County,Montana.  The Bakken gathering systemconsists of approximately 256 miles of gas gathering pipeline, a natural gasprocessing plant, two compressor stations, which are comprised of threecompressors with an aggregate of approximately 4,434 horsepower, and onefractionation facility.  The Bakkenprocessing plant and a portion of the gathering system became operational onNovember 8, 2004.

 

To facilitate the closing of the acquisition, we amendedour senior secured revolving credit facility to increase our borrowing capacityunder the facility from $55.0 million to $125.0 million, consistingof a $117.5 million acquisition facility and a $7.5 million workingcapital facility. The credit facility’s maturity date remained the same,February 15, 2008.  The current interestrate ranges from LIBOR plus 150 to 275 basis points depending on leveragecoverage.  We used a portion of thisincreased capacity to fund the acquisition.

 

To the extent of our non-controlling ownership, the acquisitionwas accounted for using the purchase method of accounting under SFASNo. 141, “Business Combinations.” As of the date of our acquisition, Hiland Partners, LLC was an entitypartially owned by a controlling member of our general partner.  Accordingly, 49% of the Bakken gatheringsystem assets, for which estimated fair value was in excess of historicalbasis, have been recorded at historical cost and 51% of the Bakken gatheringsystem assets have been recorded at fair value. A cash distribution of $27.8 million made to the controlling member asreported in the statement of owners’ equity reflects the difference in thepurchase price paid to the controlling member of our general partner and hiscost basis in the net assets of Hiland Partners, LLC.  The fair value of the assets acquired hasalso been reduced by imputed interest expense from September 1, 2005, theeffective date of the acquisition, through the closing date, September 26,2005.  The following table presents theresulting allocation to the net assets acquired and liabilities assumed at theeffective date of acquisition:

 
| Cash and cash equivalents                                    |   | $      | 300    |   |
|--------------------------------------------------------------|--------|--------|--------|--------|
| Accounts receivable                                          |   | 3,708  |   |
| Other assets                                                 |   | 20     |   |
| Property, plant and  equipment                               |   | 49,643 |   |
| Customer contracts,  customer relationships and right of way |   | 17,589 |   |
| Total net assets acquired                                    |   | 71,260 |   |
| Accounts payable                                             |   | (6,217 | )      |
| Accrued liabilities                                          |   | (125   | )      |
| Total liabilities assumed                                    |   | (6,342 | )      |
| Net assets of Hiland  Partners, LLC                          |   | 64,918 |   |
| Imputed interest expense                                     |   | (289   | )      |
| Purchase price of net  assets of Hiland Partners, LLC        |   | $      | 64,629 |   |

 

**Note3:  Initial Public Offering**

 

On October 22, 2004, wefiled a Registration Statement on Form S-1 with the SEC relating to ourproposed initial public offering of limited partnership interests.  We were formed to own and operate the assetsthat have historically been owned and operated by Continental Gas, Inc. andHiland Partners, LLC.  On February 9,2005, we priced 2,000,000 common units for the public offering; and on February10, 2005, our common units began trading on the NASDAQ National Market underthe symbol “HLND”.  On February 15, 2005,we closed our initial public offering of 2,300,000 common units, which includeda 300,000 unit over-allotment option that was exercised by theunderwriters.  Proceeds from the sale ofthe units were $48.1 million, net of $3.6 million of underwriting commissions.

 

All of our initial assetswere contributed by the former owners of Continental Gas, Inc., HilandPartners, LLC, and certain of our affiliates, including our general partner, inexchange for an aggregate of 720,000 common units and 4,080,000 subordinatedunits, a 2% general partner interest in us and all of our incentivedistribution rights, which entitle the general partner to increasingpercentages of the cash we distribute in excess of $0.495 per unit per quarter.The assets of Continental 

 

9

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Gas, Inc. transferred tous are recorded at historical cost as it is considered to be a reorganizationof entities under common control and Continental Gas, Inc. is considered ouraccounting predecessor.   Inconsideration for the transfer, Harold Hamm and the Hamm Trusts received467,073 common units and 2,646,749 subordinated units of the Partnership.  Immediately following the closing of theoffering, 195,991 of the common units were redeemed for approximately $4.1million.

 

Thefollowing table presents the assets and liabilities of our predecessorimmediately prior to contributing assets to us, the predecessor’s assets andliabilities not contributed and the assets and liabilities that our predecessordid contribute to us.

 

**ContinentalGas, Inc. (Predecessor)**

**AssetsContributed to Hiland Partners, LP**

**As ofFebruary 15, 2005**

**(inthousands)**

 
| ** **                                | ** ** | **Continental Gas, Inc.** | ** ** | **Net Assets**  | ** ** | **Contributed to**      | ** ** |
|-------------------------------------------|------------|---------------------------|------------|-----------------|------------|-------------------------|------------|
| ** **                                | ** ** | **(Predecessor)**         | ** ** | **Not**         | ** ** | **Hiland Partners, LP** | ** ** |
| ** **                                | ** ** | **February 14, 2005**     | ** ** | **Contributed** | ** ** | **February 15, 2005**   | ** ** |
| **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 |   |

 

The contribution ofcertain assets of Hiland Partners, LLC was accounted for as a purchase and, asa result, these assets were recorded at their fair value at the time ofpurchase.  In consideration for thetransfer of assetsand liabilities of Hiland Partners, LLC, the Hamm Trusts received247,868 common units and 1,404,586 subordinated units of the Partnership.  Immediately following the closing of the offering,104,009 of the common units were redeemed for approximately $2.2 million.  Equity Financial Services, Inc. received5,059 common units and 28,665 subordinated units of the Partnership, none ofwhich were redeemed.

 

The following tablepresents the assets and liablilities of Hiland Partners, LLC as of February 14,2005, the assets excluded from the acquisition and the fair value of the assetscontributed on February 15, 2005.

 

10

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**Hiland Partners, LLC**

**AssetsContributed to Hiland Partners, LP**

**Asof February 15, 2005**

**(inthousands)**

 
| ** **                                | ** ** | ** **               | ** ** | **Net Assets**  | ** ** | **Contributed to**      | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|--------------------------|------------|-----------------|------------|-------------------------|------------|------------|------------|
| ** **                                | ** ** | **Hiland Partners, LLC** | ** ** | **Not**         | ** ** | **Hiland Partners, LP** | ** ** | **Fair**   | ** ** |
| ** **                                | ** ** | **February 14, 2005**    | ** ** | **Contributed** | ** ** | **February 15, 2005**   | ** ** | **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 |   |

 

As a part of thetransactions, Harold Hamm, the Hamm Trusts, Equity Financial Services, Inc.,Mr. Moeder, and Mr. Maples received an aggregate of 138,776 equivalent units ofour general partner, representing substantially all of the ownership of ouirgeneral partner and a 2% equity ownership of the Partnership.

 

We used the proceeds ofthe public offering to:  redeem anaggregate of 300,000 common units from Harold Hamm and the Hamm Trusts for $6.3million; repay $14.0 million in debt owed by Continental Gas, Inc. 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 in reimbursement ofcertain capitalized expenditures related to the assets of Hiland Partners, LLCthat were contributed to us; and replenish approximately $12.2 million ofworking capital.

 

In connection with theinitial public offering, we entered into a four-year agreement with ContinentalResources, Inc., an affiliate of Harold Hamm, under which they agreed to pay usan operating fee of approximately $400 per month for us to provide air andwater compression service for Continental Resources, Inc.’s secondary recoveryoperations in North Dakota.  We haverecorded $3.0 million of revenues from Continental Resources, Inc. under thecompression services agreement for the period from February 15, 2005 throughSeptember 30, 2005.

 

We also entered into anomnibus agreement with Continental Resources, Inc. that became effectiveFebruary 15, 2005 (the “Omnibus Agreement”) and determines the servicesContinental Resources, Inc. will provide to us and the liabilities from whichContinental Resources, Inc. will indemnify us. Under the agreement, Continental Resources, Inc. will charge us thelower of Continental Resources, Inc.’s cost or $50 per year for a two-yearperiod for certain general, administrative and information technologysupport.  Continental Resources, Inc.,Hiland Partners, LLC, and Continental Gas Holdings, Inc. agreed to indemnify usfor income tax liabilities arising from operations prior to the closing of theoffering and Continental Resources, Inc. agreed to indemnify us for liabilitiesassociated with oil and gas properties conveyed by Continental Gas, Inc. toContinental Resources, Inc. for a period of five years from the closing date ofthe offering.  In addition, Harold Hamm,Hiland Partners, LLC, and Continental Resources, Inc. agreed, with certainexceptions, not to engage in, whether by acquisition or otherwise, midstreamand NGL gathering and processing in the continental United States.  For a description of this agreement, pleaseread “Item 13.  Certain Relationships andRelated Party Transactions — Omnibus Agreement” of our Form 10-K for the fiscalyear ended December 31, 2004.

 

11

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 **Note 4:  Pro Forma Operations**

 

**             **The acquisition of Hiland Partners, LLC was effective September 1, 2005(at which time its principle asset was the Bakken gathering system) and theinitial acquisition of assets from Hiland Partners, LLCoccurred on February 15, 2005. Had the acquisitions been made effective January1, 2004, the operations of the assets acquired from Hiland Partners, LLC wouldhave been included in our consolidated financial statements for each subsequentperiod.  The following unaudited proforma financial information reflects consolidated results of our operations asif the initial acquisition of assets from Hiland Partners, LLC  and the Bakken gathering systemacquisition and the closing of our amended credit facility had occurred onJanuary 1, 2004.  The additional incomefrom acquired interests shown below includes adjustments for depreciation ofacquired property, plant and equipment, amortization of intangibles andinterest expense for the borrowing on our amended credit facility.  The pro forma financial information is notnecessarily indicative of the results of operations as it would have been hadthese transactions been effected on the assumed date.

** **
| ** **                                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                                  | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                  | ** ** | ** **             | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues as reported                                        |       | $                      | 41,925     |                  | $          | 25,387 |   | $ | 98,306 |   | $ | 70,286 |   |
| Revenues from Hiland Partners, LLC                          |       | 1,869                  |       | 3,183                 |       | 18,649 |   | 8,941 |   |
| Pro forma revenues                                          |       | $                      | 43,794     |                  | $          | 28,570 |   | $ | 116,955 |   | $ | 79,227 |   |
|                                                        |       |                   |       |                  |       |   |   |   |   |
| Net income as reported                                      |       | $                      | 2,684      |                  | $          | 846 |   | $ | 6,198 |   | $ | 2,621 |   |
| Additional expenses from acquired interests                 |       | (622                   | )          | (533                  | )          | (4,176 | ) | (1,860 | ) |
| Pro forma net income                                        |       | $                      | 2,062      |                  | $          | 313 |   | 2,022 |   | $ | 761 |   |
| Less income attributable to predecessor                     |       | —                 |       |                  |       | 493 |   |   |   |
| Less general partner interest in pro forma net income       |       | 52                     |       |                  |       | 41 |   |   |   |
| Limited partners’ interest in pro forma net income     |       | $                      | 2,010      |                  |       |   | $ | 1,488 |   |   |   |
| Pro forma net income per limited partner unit, basic        |       | $                      | 0.30       |                  |       |   | $ | 0.22 |   |   |   |
| Pro forma net income per limited partner unit, diluted      |       | $                      | 0.29       |                  |       |   | $ | 0.22 |   |   |   |
| Weighted average limited partner units outstanding, basic   |       | 6,800,000              |       |                  |       | 6,800,000 |   |   |   |
| Weighted average limited partner units outstanding, diluted |       | 6,844,000              |       |                  |       | 6,830,000 |   |   |   |

 

 

**Note 5: Net Income per Limited Partners’Unit**

 

The computation of net income per limited partners’ unitis based 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 Continental Gas, Inc. (ourpredecessor before February 15, 2005), by the weighted-average number oflimited partnership units outstanding. The following is a reconciliation of thelimited partner units used in the calculations of income per limited partnerunit — basic and income per limited partner unit — diluted assuming dilutionfor the quarter ended September 30, 2005 and for the nine months endedSeptember 30, 2005:

 

12

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| ** **                                                      | ** ** | **Income**       | ** ** | ** **        | ** ** | ** **   | ** ** |
|-----------------------------------------------------------------|------------|------------------|------------|-------------------|------------|--------------|------------|
| ** **                                                      | ** ** | **Available to** | ** ** | ** **        | ** ** | ** **   | ** ** |
| ** **                                                      | ** ** | **Limited**      | ** ** | **Limited**       | ** ** | ** **   | ** ** |
| ** **                                                      | ** ** | **Partners**     | ** ** | **Partner Units** | ** ** | **Per Unit** | ** ** |
| ** **                                                      | ** ** | **(Numerator)**  | ** ** | **(Denominator)** | ** ** | **Amount**   | ** ** |
| **For the three months ended September 30, 2005:**              |       |             |       |              |       |         |       |
| Income per limited partner unit -basic:                         |       |             |       |              |       |         |       |
| Income available to limited unitholders                         |       | $                | 2,617      |              |       |         | $          | 0.38 |   |
| Weighted average limited partner units outstanding              |       |             |       | 6,800,000         |       |         |       |
| Income per limited partner unit — diluted:                 |       |             |       |              |       |         |       |
| Unit Options                                                    |       |             |       | 44,000            |       |         |       |
| Income available to common unitholders plus assumed conversions |       | $                | 2,617      |              | 6,844,000  |         | $          | 0.38 |   |

 
| ** **                                                      | ** ** | **Income**       | ** ** | ** **        | ** ** | ** **   | ** ** |
|-----------------------------------------------------------------|------------|------------------|------------|-------------------|------------|--------------|------------|
| ** **                                                      | ** ** | **Available to** | ** ** | ** **        | ** ** | ** **   | ** ** |
| ** **                                                      | ** ** | **Limited**      | ** ** | **Limited**       | ** ** | ** **   | ** ** |
| ** **                                                      | ** ** | **Partners**     | ** ** | **Partner Units** | ** ** | **Per Unit** | ** ** |
| ** **                                                      | ** ** | **(Numerator)**  | ** ** | **(Denominator)** | ** ** | **Amount**   | ** ** |
| **For the nine months ended September 30, 2005:**               |       |             |       |              |       |         |       |
| Income per limited partner unit -basic:                         |       |             |       |              |       |         |       |
| Income available to limited unitholders                         |       | $                | 5,577      |              |       |         | $          | 0.82 |   |
| Weighted average limited partner units outstanding              |       |             |       | 6,800,000         |       |         |       |
| Income per limited partner unit — diluted:                 |       |             |       |              |       |         |       |
| Unit Options                                                    |       |             |       | 30,000            |       |         |       |
| Income available to common unitholders plus assumed conversions |       | $                | 5,577      |              | 6,830,000  |         | $          | 0.82 |   |

 

**Note 6: Distribution to Unitholders**

 

On April 25,2005, we announced our first regular cash distribution in 2005 of $0.225 perunit, based on the minimum quarterly cash distribution of $0.45 prorated forthe period since the initial public offering on February 15, 2005. Thedistribution to all common, subordinated and general partner units was paid May13, 2005, to all unitholders of record on May 5, 2005. The aggregate amount ofthe distribution was $1.6 million.

 

              On July 26, 2005, we announced a regular cashdistribution of $0.4625 per unit for the second quarter of 2005.  This represents an increase of $0.0125 perunit over our minimum quarterly distribution rate of $0.45.  The distribution to all common, subordinatedand general partner units was paid on August 12, 2005 to all unitholders ofrecord on August 5, 2005. The aggregate amount of the distribution was $3.2million.

 

              On October 25, 2005, we announced a regularcash distribution of $0.5125 per unit for the third quarter of 2005.  This represents an increase of $0.0625 perunit over our minimum quarterly distribution rate of $0.45 and an increase of$.05 per unit over our distribution made on August 12, 2005.  The distribution to all common, subordinatedand general partner units is to be paid on November 14, 2005 to all unitholdersof record on November 4, 2005. The aggregate amount of the distribution will be$3.5 million.  As provided for in ourPartnerhsip Agreetment, our general partner is entitled to receive increasingpercentages, up to a maximum of 50% of the cash distributed in excess of $0.495in any quarter as “incentive distributions.” This distribution of $0.5125 per unit exceeds the $0.495 per unit by$0.0175.  Accordingly, our generalpartner will receive an additional 15% of the excess, or $21.

 

**Note 7:  Long-Term Debt**

 

                OnFebruary 15, 2005, concurrently with the closing of our initial publicoffering, we entered into a three-year $55.0 million senior securedrevolving credit facility. MidFirst Bank, a federally chartered savingsassociation located in Oklahoma City, Oklahoma, is a lender and serves asadministrative agent under this facility. The credit facility consisted of a$47.5 million senior secured revolving credit facility to be used forfunding acquisitions and other capital expenditures, issuance of letters ofcredit and general corporate purposes (the “revolving acquisition facility”)and a $7.5 million senior secured revolving credit facility to be used forworking capital and to fund distributions (the “revolving working capitalfacility”).

 

                OnSeptember 26, 2005, concurrently with the acquisition of Hiland Partners, LLC,we amended our senior secured revolving credit facility to increase ourborrowing capacity under the facility from $55.0 million to$125.0 million, consisting of a $117.5 million acquisition facilityand a $7.5 million working capital facility. On September 26, 2005, we incurred$93.7 million 

 

13

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of indebtedness under the credit facility in connectionwith our acquisition of Hiland Partners, LLC. The credit facility will mature in February 2008. At that time, theagreement will terminate and all outstanding amounts thereunder will be due andpayable.

 

                Ourobligations under the credit facility are collateralized by substantially allof our assets and guaranteed by us and all of our subsidiaries, other than ouroperating company, which is the borrower under the credit facility. The creditfacility is non-recourse to our general partner.

 

                Indebtednessunder the credit facility will bear interest, at our option, at either(i) an Alternate Base Rate plus an applicable margin ranging from 50 to175 basis points per annum or (ii) LIBOR plus an applicable margin rangingfrom 150 to 275 basis points per annum based on our ratio of total debt toEBITDA as defined in our credit facility. The Alternate Base Rate is a rate perannum equal to the greatest of (a) the Prime Rate in effect on such day,(b) the base CD rate in effect on such day plus 1.50% and (c) theFederal Funds effective rate in effect on such day plus 1¤2 of 1%. 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 commitmentfee ranging from 30 to 50 basis points per annum based on our ratio of totaldebt to EBITDA will be payable on the unused portion of the credit facility.

 

                Thecredit facility imposes certain requirements, including: prohibition againstdistribution to unitholders if, before or after the distribution, a potentialdefault or an event of default as defined in the agreement would occur;limitations on our ability to incur debt, grant liens, make loans,acquisitions, and investments, change the nature of our business, enter amerger 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 ofdefault exists under the agreement, the lenders will be able to accelerate thematurity of the debt and exercise other rights and remedies. As ofSeptember 30, 2005, we were in compliance with all of the covenantsassociated with the credit facility.

 

**Note 8:  Restricted Units**

 

                During the quarter, we issued8,000 restricted common units to non-employee board members of our generalpartner.  We have recorded $324 as unearned compensation inowners’ equity based on the fair market value of the units on the date ofgrant.  The restricted units vest overa four year period from the date of issuance. Periodic distributions on the restricted units will be held in trust byour general partner until the units vest. As a result of the additional restricted common units issued our generalpartner contributed $6 to us to maintain its 2% ownership.  Equivalent general partner units increasedaccordingly.

 

**Note 9:  Commitments and Contingencies**

 

                We have executed fixed pricephysical forward sales contracts on approximately 50,000 MMBtu per month withweighted average fixed prices per MMBtu of $4.53, $4.47 and $4.49,respectively, for years 2005 through 2007. We also have fixed price physical forward sales contracts to sellapproximately 50,000 MMBtu of natural gas per month from October 2005 throughDecember 2006 with weighted average fixed prices per MMBtu of $9.52.  Such contracts qualify as normal sales underSFAS No. 133 and are therefore not marked to market as derivatives.

 

                Wemaintain a defined contribution retirement plan for our employees under whichwe make discretionary contributions to the plan based on a percentage ofeligible employees’ compensation. Through September 30, 2005 and 2004,contributions to the plan were 5.0% of eligible employees’ compensation.Expense for the three months ended September 30, 2005 and 2004 was $31 and $18,respectively.  Expense for the ninemonths ended September 30, 2005 and 2004 was $72 and $53, respectively.

 

                We participate jointly with otheraffiliated companies in a self-insurance pool (the “Pool”) covering health andworkers’ compensation claims made by employees up to the first $150 and $500,respectively, per claim. Any amounts paid above these are reinsured throughthird party providers. Premiums charged to us are based on estimated costs peremployee of the Pool. No additional premium assessments are anticipated forperiods prior to September 30, 2005. Property and general liability insuranceis maintained through third-party providers with a $100 deductible oneach policy.

 

                We are a party to various regulatoryproceedings and various other litigation that we believe will not have amaterially adverse impact on our financial condition, results of operations orcash flows.

 

                Theoperation of pipelines, plants and other facilities for gathering, compressing,treating, or processing natural gas, NGLs and other products is subject tostringent and complex laws and regulations pertaining to health, safety and theenvironment. Our management believes that compliance with federal, state orlocal environmental laws and regulations will not 

 

14

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have a material adverse effect on our business, financialposition or results of operations.

 

**Note 10:  Related Party Transactions**

 

                We sell natural gas and NGLs to affiliatedcompanies.   Sales of product totaled$1,112 and $726 for the quarters ended September 30, 2005 and 2004,respectively.  Sales of product were$3,514 and $2,334 for the nine month periods ended September 30, 2005 and 2004,respectively.  Compression revenues of$1,205 and $3,012 for the three and nine month periods ended September 30, 2005are to an affiliated company.  There wereno compression revenues in the similar periods in 2004.

 

                Wepurchase natural gas and NGLs from affiliated companies. Purchases of producttotaled $11,600 and $6,674 for the quarters ended September 30, 2005 and 2004,respectively.  Purchases of product were$26,798 and $20,321 for the nine month periods ended September 30, 2005 and2004, respectively.

 

                Weutilize unconsolidated affiliated companies to provide services to our plantsand pipelines and certain administrative costs. The total amount paid to thesecompanies was $15 and $45 during the quarters ended September 30, 2005 and2004, respectively.  Amounts paid in thenine months ended September 30, 2005 and 2004 were $74 and $127, respectively.

 

                Welease office space under operating leases directly or indirectly from anaffiliate. Rent expense for these leases totaled $19 and $13 for the quartersended September 30, 2005 and 2004, respectively, and $57 and $32 for the ninemonths ended September 30, 2005 and 2004, respectively.

 

                On September 26, 2005, wecompleted our acquisition of Hiland Partners, LLC for approximately $92.7 millionin cash, $35.0 million of which was used to retire outstanding HilandPartners, LLC indebtedness.  Hiland Partners, LLC was anentity partially owned by a controlling member of our general partner.  Included in accounts payable affiliates atSeptember 30, 2005, is $2,119 payable to the previous owners of HilandPartners, LLC as final settlement for the Bakken acquisition.

 

**Note 11:Business Segments**

 

                As a part of the transaction discussed in Note 3, weacquired an operating segment from Hiland Partners, LLC.  Continental Gas, Inc. (Precedessor) did nothave operating segments.  Our operations are classified into two reportable segments:

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

 

                (2)Compression, which is providing air compression and water injection servicesfor Continental Resources, Inc.’s oil and gas secondary recovery operationsthat are ongoing in North Dakota.

 

                Weevaluate the performance of our segments and allocate resources to them basedon operating income. Our operations are conducted in the United States.

 

                Midstreamassets totaled $150,649 at September 30, 2005. Assets attributable to compression operations totaled $35,902. Excludingthe Bakken acquisition, $2,757 of the total $2,770 capital expenditures for thenine months ended September 30, 2005 were related to the midstreamsegment.  The tables below presentinformation about operating income for the reportable segments for the quarterended September 30, 2005 and for the nine months ended September 30, 2005.

 
| ** **                                                      | ** ** | **Threee Months Ended September 30, 2005** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                      | ** ** | **Midstream**                              | ** ** | **Compression** | ** ** | **Total** | ** ** |
| Revenues                                                        |       | $                                          | 40,720     |   | $ | 1,205 |   | $ | 41,925 |   |
| Operating costs and expenses:                                   |       |                                       |       |   |   |   |   |
| Midstream purchases (exclusive of items shown separately below) |       | 33,313                                     |       | — |   | 33,313 |   |
| Operations and maintenance                                      |       | 1,744                                      |       | 153 |   | 1,897 |   |
| Depreciation and amortization                                   |       | 2,024                                      |       | 888 |   | 2,912 |   |
| General and administrative                                      |       | 507                                        |       | 14 |   | 521 |   |
| Total operating costs and expenses                              |       | 37,588                                     |       | 1,055 |   | 38,643 |   |
| Income from operations                                          |       | $                                          | 3,132      |   | $ | 150 |   | 3,282 |   |
| Other income (expense):                                         |       |                                       |       |   |   |   |   |
| Interest and other income                                       |       |                                       |       |   |   | 70 |   |
| Amortization of deferred loan costs                             |       |                                       |       |   |   | (83 | )  |
| Interest expense                                                |       |                                       |       |   |   | (585 | )  |
| Total other income (expense)                                    |       |                                       |       |   |   | (598 | )  |
| Net income                                                      |       |                                       |       |   |   | $ | 2,684 |   |

 

15

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| ** **                                                      | ** ** | **Nine Months Ended September 30, 2005** | ** ** |
|-----------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                      | ** ** | **Midstream**                            | ** ** | **Compression** | ** ** | **Total** | ** ** |
| Revenues                                                        |       | $                                        | 95,294     |   | $ | 3,012 |   | $ | 98,306 |   |
| Operating costs and expenses:                                   |       |                                     |       |   |   |   |   |
| Midstream purchases (exclusive of items shown separately below) |       | 77,548                                   |       | — |   | 77,548 |   |
| Operations and maintenance                                      |       | 4,712                                    |       | 371 |   | 5,083 |   |
| Depreciation and amortization                                   |       | 4,697                                    |       | 2,227 |   | 6,924 |   |
| General and administrative                                      |       | 1,492                                    |       | 47 |   | 1,539 |   |
| Total operating costs and expenses                              |       | 88,449                                   |       | 2,645 |   | 91,094 |   |
| Income from operations                                          |       | $                                        | 6,845      |   | $ | 367 |   | 7,212 |   |
| Other income (expense):                                         |       |                                     |       |   |   |   |   |
| Interest and other income                                       |       |                                     |       |   |   | 112 |   |
| Amortization of deferred loan costs                             |       |                                     |       |   |   | (360 | ) |
| Interest expense                                                |       |                                     |       |   |   | (766 | ) |
| Total other income (expense)                                    |       |                                     |       |   |   | (1,014 | ) |
| Net income                                                      |       |                                     |       |   |   | $ | 6,198 |   |

 

**Note 12:  Discontinued Operations**

 

Duringthe first quarter of 2004, Continental Gas, Inc. determined it would no longerpursue its interests in direct production of oil and gas. Amounts for oil andgas income and expense are presented in these statements as discontinued operations.Effective May 31, 2004, Continental Gas, Inc. transferred all itsinterests in its oil and gas properties to Continental Resources, Inc..  Net assets transferred consisted leaseholds,capitalized intangibles, lease and well equipment and asset retirement coststotaling $2,489 offset by accounts payable and asset retirement obligation of$348.

 

A summary of the oil and gas operations ofContinental Gas, Inc., our predecessor, for the periods indicated are shownbelow:

 
| ** **                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                    | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues                      |       | $                      | —     |                  | $          | (54 | ) | $ | — |   | $ | 265 |   |
| Expenses                      |       | —                 |       | 3                     |       | — |   | (164 | ) |
| Depreciation and amortization |       | —                 |       | (1                    | )          | — |   | (67 | ) |
| Net income (loss)             |       | $                      | —     |                  | $          | (52 | ) | $ | — |   | $ | 34 |   |

 

**Note 13:  Subsequent Events**

 

In October 2005, we executed swap contracts relating to a portion ofour residue gas sales from our Bakken gathering system for the fixed pricesnoted below. Under these swap contracts, we will either pay or receive thedifference between the fixed prices below and the Colorado Interstate Gas (CIG)index price.  As a result, we have hedgeda portion of our expected exposure to natural gas prices in 2006 and 2007 atthe Bakken gathering system.  Thefollowing table provides information about our financial derivativeinstruments:

** **
| ** **                   | ** ** | **Monthly** | ** ** | ** **    | ** ** |
|------------------------------|------------|-------------|------------|---------------|------------|
| ** **                   | ** ** | **Volume**  | ** ** | **Price**     | ** ** |
| **Natural Gas Swaps**        | ** ** | **(MMBtu)** | ** ** | **($/MMBtu)** | ** ** |
| May 2006 - December 2006     |       | 40,000      |       | $             | 8.78       |   |
| January 2007 - October  2007 |       | 40,000      |       | $             | 7.83       |   |

 

                On November 2, 2005, we filedwith the Securities and Exchange Commission a registration statement for anoffering of 1,600,000 common units.  Theunderwriters will have an option to purchase up to 240,000 additional units tocover over-allotments, if any.  We intendto use the net proceeds from the offering to repay a portion of the outstandingindebtedness incurred to fund our recent acquisition of the Bakken gatheringsystem.  The registration statement hasnot been declared effective by the SEC.

 

16

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                On November 8th,2005, we entered into a new 15-year definitive Gas Purchase Agreement withContinental Resources, Inc., an affiliate of our general partner, under whichwe will gather, treat and process additional natural gas, which is produced asa by-product of Continental Resource’s secondary oil recovery operations, inthe areas specified by the contract.  Inreturn, we will receive 50% of the proceeds attributable to residue gas andnatural gas liquids as well as certain fixed fees associated with gathering andtreating the natural gas.  In order tofulfill our obligations under the agreement, we intend to expand our Badlandsgas gathering system and processing plant located in Bowman County, NorthDakota.  This expansion project willinclude the construction of a 40 million cubic feet per day nitrogen rejectionplant ant the expansion of our existing Badlands field gatheringinfrastructure.  The expansion project,which is targeted for completion in the 4th quarter of 2006, isexpected to cost approximately $40.0 million, which we intend to fund using ourexisting bank credit facility.

 

17

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**HILANDPARTNERS, LP**

** **

** **

**Item 2. Management’s Discussion and Analysis of Financial Condition andResults of Operations**

** **

You should readthe following discussion in conjunction with our Financial Statements and notesthereto included elsewhere in this Quarterly Report on Form 10-Q.

 

**Cautionary Statement About Forward-Looking Statements**

 

ThisQuarterly Report on Form 10-Q includes certain “forward-looking statements”within the meaning of Section 27A of the Securities Act of 1933 andSection 21E of the Securities Exchange Act of 1934.  These statementsinclude statements regarding our plans, goals, beliefs or current expectations.Statements using words such as “anticipate,” “believe,” “intend,” “project,” “plan,”“continue,” “estimate,” “forecast,” “may,” “will,” or similar expressions helpidentify forward-looking statements.  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.

 

Ouractual results may differ materially from any results projected, forecasted,estimated or expressed in forward-looking statements since many of the factorsthat determine these results are subject to uncertainties and risks, difficultto 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 inlaws and 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 our financial results; and

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

 

Thesefactors are not necessarily all of the important factors that could cause ouractual results to differ materially from those expressed in any of ourforward-looking statements.  Our future results will depend upon variousother risks and uncertainties, including, but not limited to those describedabove.  Other unknown or unpredictable factors also could have materialadverse effects on our future results.  You should not place unduereliance on any forward-looking statements.

 

Allforward-looking statements attributable to us are qualified in their entiretyby 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.

** **

**18**

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** **

**OVERVIEW**

** **

        Weare a Delaware limited partnership formed in October 2004 to own andoperate the assets that have historically been owned and operated byContinental Gas, Inc. and Hiland Partners, LLC.

 

        ContinentalGas, Inc. historically has owned all of our natural gas gathering,processing, treating and fractionation assets other than our Worland and Bakkengathering systems. Hiland Partners, LLC historically has owned our Worlandgathering system, our compression services assets and the Bakken gatheringsystem. Continental Gas, Inc. is our predecessor for accounting purposes.As a result, our historical financial statements for periods prior to February15, 2005 are the financial statements of Continental Gas, Inc.

 

        Inconnection with our initial public offering, the former owners of ContinentalGas, Inc. and Hiland Partners, LLC and certain of our affiliates,including our general partner, contributed to us, all of the assets andoperations of Continental Gas, Inc., other than a portion of its workingcapital assets, and substantially all of the assets and operations of HilandPartners, LLC, other than a portion of its working capital assets and theassets related to the Bakken gathering system, in exchange for an aggregate of720,000 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.

 

        Wecompleted our initial public offering of 2,300,000 common units onFebruary 15, 2005, receiving net proceeds of $48.1 million. Theproceeds from the public offering were used to (1) pay remaining offeringcosts of $2.2 million and deferred debt issuance costs of$0.6 million, (2) pay outstanding indebtedness of $22.9 million,(3) redeem $6.3 million of common units from an affiliate of HaroldHamm and the Hamm Trusts, and (4) make a $3.9 million distribution to theprevious owners of Hiland Partners, LLC. We retained $12.2 million toreplenish working capital.

 

        EffectiveSeptember 1, 2005, we consummated the Bakken acquisition pursuant to whichwe acquired Hiland Partners, LLC, an Oklahoma limited liability company, forapproximately $92.7 million in cash,$35.0 million of which was used to retire outstanding Hiland Partners, LLCindebtedness. HilandPartners, LLC’s principal asset is the Bakken gathering system located ineastern Montana.

 

Weare engaged in gathering, compressing, dehydrating, treating, processing andmarketing natural gas, fractionating NGLs and providing air compression andwater injection services for oil and gas secondary recovery operations. Ouroperations are primarily located in the Mid-Continent and Rocky Mountainregions of the United States.

 

We manage ourbusiness and analyze and report our results of operations on a segmentbasis.  Our operations are divided intotwo business segments:

 

•                                                                                          *MidstreamSegment*, whichis engaged in gathering and processing of natural gas primarily in theMid-Continent and Rocky Mountain regions. Within this segment, we also provide certain related services forcompression, dehydrating, and treating of natural gas and the fractionation ofNGLs.  This segment generated approximately86% and 85% of our total segment margin for the quarter ended September 30,2005 and the nine months ended September 30, 2005, respectively.

 

•                                                                                          *CompressionSegment*, whichis engaged in providing air compression and water injection services for oiland gas secondary recovery operations that are ongoing in North Dakota.  For the three and nine month periods  ended September 30, 2005, this segmentgenerated approximately 14% and 15%, respectively, of our total segment margin.

 

Our midstream assets consist of eight naturalgas gathering systems with approximately 1,120 miles of gas gatheringpipelines, five natural gas processing plants, three natural gas treatingfacilities and three NGL fractionation facilities.  Our compression assets consist of two aircompression facilities and a water injection plant.

 

The financial statements and financialinformation for the three and nine month periods ended September 30, 2004reflect the operations of Continental Gas, Inc., our predecessor.  The financial statements and financialinformation for the three and nine month period ended September 30, 2005reflect the operations of our predecessor prior to February 15, 2005 and ouroperations from February 15, 2005, the date of our initial public offering.

 

19

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***HistoricalResults of Operations***

Our historical results of operations for theperiods presented may not be comparable, either from period to period or goingforward, for the reasons described below:

 

•                  The assets of Continental Gas,Inc. (Predecessor) were transferred to us at historical cost as it isconsidered a reorganization of entities under common control.  Accordingly, our historical financialstatements for the periods prior to February 15, 2005 are the financialstatements of Continental Gas, Inc.

 

•                  Our acquisition of certain netassets from Hiland Partners, LLC in connection with our initial public offeringwas accounted for as a purchase and, as a result, these assets are recorded attheir fair value at the time of purchase, which occurred concurrent with theclosing of our initial public offering on February 15, 2005.  Therefore, the results of operations from ourWorland gathering system and compression assets are only reflected fromFebruary 15, 2005, the date of our initial public offering.

 

•                  As stated above, prior to ourformation, Hiland Partners, LLC owned our Horse Creek air compression and ourCedar Hills water injection facility. These assets have historically been under a lease agreement withContinental Resources, Inc.  Inconnection with our formation and our initial public offering, we entered intoa four-year services agreement with Continental Resources, Inc., effective asof January 28, 2005, that replaced the existing lease.  Under the services agreement, we own andoperate the facilities and provide air compression and water injection servicesto Continental Resources, Inc. for a fee. As part of the new agreement, the personnel at Continental Resources,Inc. that operated the facilities are now employed by us.  Under the new services agreement, we receivea fixed payment of approximately $4.8 million per year as compared to $3.8million under the prior lease agreement. In connection with the new services arrangement, we expect to incurapproximately $1.0 million per year in additional operating costs.

 

•                  Our acquisition of HilandPartners, LLC on September 26, 2005 was accounted for as a purchase except asdescribed below.   As a result of 49% ofthe outstanding membership interests of Hiland Partners, LLC being partiallyowned by a controlling member of our general partner, 49% of the net assets ofHiland Partners. LLC, for which estimated fair value was in excess ofhistorical basis, have been recorded at historical cost and 51% of the assetshave been recorded at fair value.  Theresults of operations from our Bakken gathering system, the primary assetof  Hiland Partners, LLC at the time ofthis acquisition, are only reflected from September 1, 2005, our effectiveacquisition date.

 

**Results of Operations**

 

                Set forth in the table below isfinancial and operating data for our predecessor, Continental Gas, Inc., and usfor the periods indicated. Operations from our Worland gathering system andcompression assets contributed to us by Hiland Partners, LLC are reflected onlyfrom February 15, 2005, the date of our initial public offering.  Operations from our acquisition of the Bakkengathering system assets are reflected only from September 1, 2005.

 

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| ** **                                                      | ** ** | **Three Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| ** **                                                      | ** ** | **Hiland**                           | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **Partners, LP**                     | ** ** | **Predecessor (1)** | ** ** |
| ** **                                                      | ** ** | **(in thousands)**                   | ** ** |
| **Total Segment Margin Data:**                                  | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Midstream revenues                                              |       | $                                    | 40,720     |   | $ | 25,387 |   |
| Midstream purchases                                             |       | 33,313                               |       | 21,524 |   |
| Midstream segment margin                                        |       | 7,407                                |       | 3,863 |   |
| Compression revenues (2)                                        |       | 1,205                                |       | — |   |
| Total segment margin (3)                                        |       | $                                    | 8,612      |   | $ | 3,863 |   |
|                                                            |       |                                 |       |   |   |
| **Summary of Operations Data:**                                 | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Midstream revenues                                              |       | $                                    | 40,720     |   | $ | 25,387 |   |
| Compression revenues                                            |       | 1,205                                |       | — |   |
| Total revenues                                                  |       | 41,925                               |       | 25,387 |   |
|                                                            |       |                                 |       |   |   |
| Midstream purchases (exclusive of items shown separately below) |       | 33,313                               |       | 21,524 |   |
| Operations and maintenance                                      |       | 1,897                                |       | 1,395 |   |
| Depreciation, amortization and accretion                        |       | 2,912                                |       | 1,193 |   |
| Gain on sale of assets                                          |       | —                               |       | (15 | ) |
| General and administrative                                      |       | 521                                  |       | 201 |   |
| Total operating costs and expenses                              |       | 38,643                               |       | 24,298 |   |
| Operating income                                                |       | 3,282                                |       | 1,089 |   |
| Net other income (expense)                                      |       | (598                                 | )          | (191 | ) |
| Income from continuing operations                               |       | 2,684                                |       | 898 |   |
| Discontinued operations, net                                    |       | —                               |       | (52 | ) |
|                                                            |       |                                 |       |   |   |
| **Net income**                                                  |       | 2,684                                |       | 846 |   |
|                                                            |       |                                 |       |   |   |
| Add:                                                            |       |                                 |       |   |   |
| Depreciation, amortization and accretion                        |       | 2,912                                |       | 1,193 |   |
| Amortization of deferred loan costs                             |       | 83                                   |       | 25 |   |
| Interest expense                                                |       | 585                                  |       | 173 |   |
|                                                            |       |                                 |       |   |   |
| **EBITDA (4)**                                                  |       | $                                    | 6,264      |   | $ | 2,237 |   |
|                                                            |       |                                 |       |   |   |
| Operating Data:                                                 |       |                                 |       |   |   |
| Natural gas sales (MMBTU/d)                                     |       | 46,815                               |       | 42,885 |   |
| NGL sales (Bbls/d)                                              |       | 1,911                                |       | 1,186 |   |

 

21

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| ** **                                                      | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                                      | ** ** | **Hiland**                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **Partners,**                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **LP (5)**                          | ** ** | **Predecessor (1)** | ** ** | **Total (6)** | ** ** | **Predecessor (1)** | ** ** |
| ** **                                                      | ** ** | **(in thousands)**                  | ** ** |
| **Total Segment Margin Data:**                                  | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Midstream revenues                                              |       | $                                   | 83,481     |   | $ | 11,813 |   | $ | 95,294 |   | $ | 70,286 |   |
| Midstream purchases                                             |       | 67,801                              |       | 9,747 |   | 77,548 |   | 59,846 |   |
| Midstream segment margin                                        |       | 15,680                              |       | 2,066 |   | 17,746 |   | 10,440 |   |
| Compression revenues (2)                                        |       | 3,012                               |       | — |   | 3,012 |   | — |   |
| Total segment margin (3)                                        |       | $                                   | 18,692     |   | $ | 2,066 |   | $ | 20,758 |   | $ | 10,440 |   |
|                                                            |       |                                |       |   |   |   |   |   |   |
| **Summary of Operations Data:**                                 | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Midstream revenues                                              |       | $                                   | 83,481     |   | $ | 11,813 |   | $ | 95,294 |   | $ | 70,286 |   |
| Compression revenues                                            |       | 3,012                               |       | — |   | 3,012 |   | — |   |
| Total revenues                                                  |       | 86,493                              |       | 11,813 |   | 98,306 |   | 70,286 |   |
|                                                            |       |                                |       |   |   |   |   |   |   |
| Midstream purchases (exclusive of items shown separately below) |       | 67,801                              |       | 9,747 |   | 77,548 |   | 59,846 |   |
| Operations and maintenance                                      |       | 4,303                               |       | 780 |   | 5,083 |   | 3,624 |   |
| Depreciation, amortization and accretion                        |       | 6,412                               |       | 512 |   | 6,924 |   | 3,003 |   |
| Gain on sale of assets                                          |       | —                              |       | — |   | — |   | (15 | ) |
| General and administrative                                      |       | 1,373                               |       | 166 |   | 1,539 |   | 680 |   |
| Total operating costs and expenses                              |       | 79,889                              |       | 11,205 |   | 91,094 |   | 67,138 |   |
| Operating income                                                |       | 6,604                               |       | 608 |   | 7,212 |   | 3,148 |   |
| Net other income (expense)                                      |       | (899                                | )          | (115 | ) | (1,014 | ) | (561 | ) |
| Income from continuing operations                               |       | 5,705                               |       | 493 |   | 6,198 |   | 2,587 |   |
| Discontinued operations, net                                    |       | —                              |       | — |   | — |   | 34 |   |
|                                                            |       |                                |       |   |   |   |   |   |   |
| **Net income**                                                  |       | 5,705                               |       | 493 |   | 6,198 |   | 2,621 |   |
|                                                            |       |                                |       |   |   |   |   |   |   |
| Add:                                                            |       |                                |       |   |   |   |   |   |   |
| Depreciation, amortization and accretion                        |       | 6,412                               |       | 512 |   | 6,924 |   | 3,003 |   |
| Amortization of deferred loan costs                             |       | 347                                 |       | 13 |   | 360 |   | 76 |   |
| Interest expense                                                |       | 658                                 |       | 108 |   | 766 |   | 508 |   |
|                                                            |       |                                |       |   |   |   |   |   |   |
| **EBITDA (4)**                                                  |       | $                                   | 13,122     |   | $ | 1,126 |   | $ | 14,248 |   | $ | 6,208 |   |
|                                                            |       |                                |       |   |   |   |   |   |   |
| Operating Data:                                                 |       |                                |       |   |   |   |   |   |   |
| Natural gas sales (MMBTU/d)                                     |       | 44,226                              |       | 37,052 |   | 43,044 |   | 40,730 |   |
| NGL sales (Bbls/d)                                              |       | 1,631                               |       | 1,206 |   | 1,561 |   | 1,095 |   |

----

(1)           Amounts presented in the Predecessorcolumns include only the operations of Continental Gas, Inc. for the periodprior to our initial public offering on February 15, 2005.

 

(2)           Compression revenues and compressionsegment margin are the same. There are no compression purchases associated withthe compression segment.

 

(3)           Reconciliation of total segment marginto operating income:

 

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| ** **                               | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------------|------------|--------------------------------------|------------|
| ** **                               | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **Hiland**                           | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Partners, LP**                     | ** ** | **Predecessor (1)** | ** ** |
| ** **                               | ** ** | **(in thousands)**                   | ** ** | ** ** | ** ** |
| Operating income                         |       | $                                    | 3,282      |   | $ | 1,089 |   |
| Add:                                     |       |                                 |       |   |   |
| Operations and maintenance               |       | 1,897                                |       | 1,395 |   |
| Depreciation, amortization and accretion |       | 2,912                                |       | 1,193 |   |
| Gain on sale of assets                   |       | —                               |       | (15 | ) |
| General and administrative               |       | 521                                  |       | 201 |   |
| Total segment margin                     |       | $                                    | 8,612      |   | $ | 3,863 |   |

 

 
| ** **                               | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------|------------|-------------------------------------|------------|
| ** **                               | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **Hiland**                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Partners, LP (5)**                | ** ** | **Predecessor (1)** | ** ** | **Total (6)** | ** ** | **Predecessor (1)** | ** ** |
| ** **                               | ** ** | **(in thousands)**                  | ** ** |
| Operating income                         |       | $                                   | 6,604      |   | $ | 608 |   | $ | 7,212 |   | $ | 3,148 |   |
| Add:                                     |       |                                |       |   |   |   |   |   |   |
| Operations and maintenance               |       | 4,303                               |       | 780 |   | 5,083 |   | 3,624 |   |
| Depreciation, amortization and accretion |       | 6,412                               |       | 512 |   | 6,924 |   | 3,003 |   |
| Gain on sale of assets                   |       | —                              |       | — |   | — |   | (15 | ) |
| General and administrative               |       | 1,373                               |       | 166 |   | 1,539 |   | 680 |   |
| Total segment margin                     |       | $                                   | 18,692     |   | $ | 2,066 |   | $ | 20,758 |   | $ | 10,440 |   |

 

We view totalsegment margin, a non-GAAP financial measure, as an important performancemeasure of the core profitability of our operations. We review total segmentmargin monthly for a consistency and trend analysis. We define midstreamsegment margin as midstream revenue less midstream purchases. Midstreampurchases include the following costs and expenses: cost of natural gas andNGLs purchased by us from third parties, cost of natural gas and NGLs purchasedby us from affiliates, and the cost of crude oil purchased by us from thirdparties. We define compression segment margin as the revenue derived from ourcompression segment.

 

(4)           We define EBITDA, a non-GAAP financialmeasure, as net income plus interest expense, provisions for income taxes anddepreciation, amortization and accretion expense. EBITDA is used as asupplemental financial measure by our management and by external users of ourfinancial statements such as investors, commercial banks, research analysts andothers to assess: (1) the financial performance of our assets without regard tofinancial methods, capital structure or historical cost basis; (2) the abilityof our assets to generate cash sufficient to pay interest costs and support ourindebtedness; (3) our operating performance and return on capital as comparedto those of other companies in the midstream energy sector, without refard tofinancing or structure; and (4) the viability of acquisitions and capitalexpenditure projects and the overall rates of return on alternative investmentopportunities. EBITDA is also a financial measurement that, with certainnegotiated adjustments, is reported to our banks and is used as a gauge forcompliance with our financial covenants under our credit facility.  EBITDA should not be considered analternative to net income, operating income, cash flows from operatingactivities or any other measure of financial performance presented inaccordance with GAAP.  Our EBITDA may notbe comparable to EBITDA of similarly titled measures of other entities, asother entities may not calculate EBITDA in the same manner as we do.

 

(5)           Amountspresented in the Hiland Partners, LP column include only the activity for theperiod beginning on February 15, 2005. These amounts include the operations of the Worland gathering system andcompression assets acquired from Hiland 

 

23

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Partners, LLC at the completion of our initial public offeringand the operations of the Bakken gathering system assets acquired effectiveSeptember 1, 2005.

 

(6)            Total income and expense items included in ourConsolidated Statements of Operations and our predecessor are included in thisForm 10-Q for the stated period.

 

**Basisof Presentation**

 

WE ARE REQUIRED TOPRESENT, DISCUSS AND ANALYZE THE FINANCIAL CONDITION AND RESULTS OF OPERATIONSFOR THE THREE MONTH AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND OURFINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE MONTH AND NINEMONTH PERIODS ENDED SEPTEMBER 30, 2005, WHICH INCLUDES THE RESULTS OFOPERATIONS FOR THE WORLAND GATHERING SYSTEM AND COMPRESSION ASSETS ACQUIREDFROM HILAND PARTNERS, LLC ON FEBRUARY 15, 2005 AND THE RESULTS OF OPERATIONS FORTHE BAKKEN GATHERING SYSTEM ASSETS ACQUIRED AS OF SEPTEMBER 1, 2005.

 

 

**ThreeMonths Ended September 30, 2005 Compared with Three Months Ended September 30,2004**

 

***Revenues.***  Our revenues (midstream and compression) were$41.9 million for the three months ended September 30, 2005 compared to $25.4million for the three months ended September 30, 2004, an increase of $16.5million, or 65.1%.  This increase wasprimarily attributable to (1) higher average realized natural gas prices andNGL sales prices, (2) increased volumes attributable to the contribution of theWorland gathering system by Hiland Partners, LLC on February 15, 2005 (3)increased revenues from compression assets contributed by Hiland Partners, LLCon February 15, 2005 and (4) increased volumes attributable to the acquisitionof the Bakken gathering system effective September 1, 2005.

 

Ourmidstream revenues were $40.7 million for the three months ended September 30,2005 compared to $25.4 million for the three months ended September 30, 2004, anincrease of $15.3 million, or 60.4%.  Ofthis increase, $11.1 million was attributable to higher average realizednatural gas prices and NGL sales prices and $4.2 million was attributable tohigher residue natural gas and NGL sales volumes. The volume increase isprimarily attributable to the contribution of the Worland gathering system fromHiland Partners, LLC on February 15, 2005 and the acquisition of the Bakkengathering system effective September 1, 2005.

 

Naturalgas sales volumes were 46,815 MMBtu per day, or MMBtu/d, for the three monthsended September 30, 2005 compared to 42,885 MMBtu/d for the three months endedSeptember 30, 2004, an increase of 3,930 MMBtu/d, or 9.2%.  Our NGL sales volumes were 1,911 Bbls perday, or Bbls/d, for the three months ended September 30, 2005 compared to 1,186Bbls/d for the three months ended September 30, 2004, an increase of 725Bbls/d, or 61.1%.  These increases involumes are primarily associated with the acquisition of the Worland gatheringsystem from Hiland Partners, LLC on February 15, 2005 and the acquisition ofthe Bakken gathering system from Hiland Partners, LLC effective September 1,2005.

 

Ouraverage realized natural gas sales prices were $7.28 per MMBtu for the threemonths ended September 30, 2005 compared to $5.24 per MMBtu for the threemonths ended September 30, 2004, an increase of $2.04 per MMBtu, or 38.9%.  In addition, average realized NGL salesprices were $1.08 per gallon for the three months ended September 30, 2005compared to $0.81 per gallon for the three months ended September 30, 2004, anincrease of $0.27 per gallon or 33.3%. The change in our average realized natural gas and NGL sales prices wasprimarily a result of higher index prices due to a tightening of supply anddemand fundamentals for energy, which caused crude oil and natural gas pricesto rise during the three months ended September 30, 2005 compared to the threemonths ended September 30, 2004.

 

Ourcompression revenues were $1.2 million for the three months ended September 30,2005.  The compression assets wereacquired from Hiland Partners, LLC on February 15, 2005.  Continental Gas, Inc., our predecessor, didnot have a compression segment, therefore, there were no compression revenuesreported for the three months ended September 30, 2004.

 

***Midstream Purchases.***  Our midstream purchases were $33.3 millionfor the three months ended September 30, 2005 compared to $21.5 million for thethree months ended September 30, 2004, an increase of $11.8 million, or 54.8%.  This increase is primarily attributable tohigher average realized natural gas prices and NGL sales prices, thecontribution of the Worland gathering system from Hiland Partners, LLC onFebruary 15, 2005 and the acquisition of the Bakken gathering system effectiveSeptember 1, 2005.

 

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***Operations and Maintenance.***  Our operations and maintenance expensetotaled $1.9 million for the three months ended September 30, 2005 comparedwith $1.4 million for the three months ended September 30, 2004, an increase of$0.5 million, or 36.0%.  This increase isprimarily attributable to the contribution of the Worland gathering system andthe compression assets from Hiland Partners, LLC on February 15, 2005 and theacquisition of the Bakken gathering system effective September 1, 2005.

 

***Depreciation, Amortization andAccretion.***  Ourdepreciation, amortization and accretion expense totaled $2.9 million for thethree months ended September 30, 2005 compared with $1.2 million for the threemonths ended September 30, 2004, an increase of $1.7 million, or 144.1 %.  This increase is primarily attributable tothe contribution of the Worland gathering system and the compression assetsfrom Hiland Partners, LLC on February 15, 2005 and the acquisition of theBakken gathering system effective September 1, 2005.

 

***General and Administrative.***  Our general and administrative expensetotaled $0.5 million for the three months ended September 30, 2005 comparedwith $0.2 million for the three months ended September 30, 2004, an increase of$0.3 million, or 159.2%.  The increase isprimarily attributable to adding staff as a result of our growth and theadditional costs of being a public company.

 

***Other Income (Expense).******* Our other income (expense) totaled($0.6) million for the three months ended September 30, 2005 compared with($0.2) million for the three months ended September 30, 2004, a increase inexpense of $0.4 million, or 213.1%.  Theincrease is primarily attributable to additional interest expense andamortization of deferred debt issuance costs associated with our creditfacility relating to the acquisition of the Bakken gathering system effectiveSeptember 1, 2005.

 

**NineMonths Ended September 30, 2005 Compared with Nine Months Ended September 30,2004**

 

***Revenues.***  Our total revenues (midstream andcompression) were $98.3 million for the nine months ended September 30, 2005compared to $70.3 million for the nine months ended September 30, 2004, anincrease of $28.0 million, or 39.9%. This increase was primarily attributable to (1) higher average realizednatural gas prices and NGL sales prices, (2) increased volumes attributable tothe contribution of the Worland gathering system by Hiland Partners, LLC onFebruary 15, 2005 to us, (3) increased revenues from compression assetscontributed by Hiland Partners, LLC on February 15, 2005 to us and (4)increased volumes attributable to the acquisition of the Bakken gatheringsystem effective September 1, 2005.

 

Ourmidstream revenues were $95.3 million for the nine months ended September 30,2005 compared to $70.3 million for the nine months ended September 30, 2004, anincrease of $25.0 million, or 35.6%.  Ofthis increase, $19.8 million was attributable to higher average realizednatural gas prices and NGL sales prices and $5.2 million was attributable tohigher residue natural gas and NGL sales volumes. The volume increase isprimarily attributable to the contribution of the Worland gathering system fromHiland Partners, LLC on February 15, 2005 and the acquisition of the Bakkengathering system effective September 1, 2005.

 

Our natural gas sales volumes were 43,044 MMBtu/d for thenine months ended September 30, 2005 compared to 40,730 MMBtu/d for the ninemonths ended September 30, 2004, an increase of 2,314 MMBtu/d, or 5.7%.  Our NGL sales volumes were 1,561 Bbls/d forthe nine months ended September 30, 2005 compared to 1,095 Bbls/d for the ninemonths ended September 30, 2004, an increase of 466 Bbls/d, or 42.6%.  These increases in volumes are primarilyassociated with the contribution of the Worland gathering system from HilandPartners, LLC on February 15, 2005 and theacquisition of the Bakken gathering system from Hiland Partners, LLC effectiveSeptember 1, 2005.

 

Ouraverage realized natural gas sales prices were $6.35 per MMBtu for the ninemonths ended September 30, 2005 compared to $5.24 per MMBtu for the nine monthsended September 30, 2004, an increase of $1.11 per MMBtu, or 21.2%.  In addition, average realized NGL salesprices were $0.96 per gallon for the nine months ended September 30, 2005compared to $0.71 per gallon for the nine months ended September 30, 2004, anincrease of $0.25 per gallon or 35.2%. The change in our average realized natural gas and NGL sales prices wasprimarily a result of higher index prices due to a tightening of supply anddemand fundamentals for energy, which caused crude oil and natural gas pricesto rise during the nine months ended September 30, 2005 compared to the ninemonths ended September 30, 2004.

 

Ourcompression revenues were $3.0 million for the nine months ended September 30,2005.  The compression assets were contributedby Hiland Partners, LLC on February 15, 2005. Continental Gas, Inc., our predecessor, did not have a compressionsegment, therefore, there were no compression revenues reported for the ninemonths ended September 30, 2004.

 

25

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***Midstream Purchases.***  Our midstream purchases were $77.5 millionfor the nine months ended September 30, 2005 compared to $59.8 million for thenine months ended September 30, 2004, an increase of $17.7 million, or29.6%.  This increase is primarilyattributable to higher average realized natural gas prices and NGL salesprices, the contribution of the Worland gathering system from Hiland Partners,LLC on February 15, 2005 and the acquisition of the Bakken gathering systemeffective September 1, 2005.

 

***Operations and Maintenance.***  Our operations and maintenance expensetotaled $5.1 million for the nine months ended September 30, 2005 compared with$3.6 million for the nine months ended September 30, 2004, an increase of $1.5million, or 40.3%.  This increase isprimarily attributable to the contribution of the Worland gathering system andthe compression assets from Hiland Partners, LLC on February 15, 2005 and theacquisition of the Bakken gathering system from Hiland Partners, LLC effectiveSeptember 1, 2005.

 

***Depreciation, Amortization andAccretion.***  Ourdepreciation, amortization and accretion expense totaled $6.9 million for thenine months ended September 30, 2005 compared with $3.0 million for the ninemonths ended September 30, 2004, an increase of $3.9 million, or 130.6 %.  This increase is primarily attributable tothe contribution of the Worland gathering system and the compression assetsfrom Hiland Partners, LLC on February 15, 2005 and the acquisition of theBakken gathering system effective September 1, 2005.

 

***General and Administrative.***  Our general and administrative expensetotaled $1.5 million for the nine months ended September 30, 2005 compared with$0.7 million for the nine months ended September 30, 2004, an increase of $0.8million, or 126.3%.  The increase isprimarily attributable to adding staff as a result of our growth and theadditional costs of being a public company.

 

***Other Income (Expense****). *Our other income (expense)totaled ($1.0) million for the nine months ended September 30, 2005 comparedwith ($0.6) million for the  nine monthsended September 30, 2004, a increase in expense of $0.4 million, or 80.7%.  The increase is primarily attributable toadditional interest expense and amortization of deferred debt issuance costsassociated with our credit facility relating to the acquisition of the Bakkengathering system effective September 1, 2005.

 

 

**LIQUIDITY AND CAPITAL RESOURCES**

# *** ***

# ***Overview***

 

Wecompleted our initial public offering of 2,300,000 common units on February 15,2005, realizing proceeds of $48.1 million, net of $3.6 million of underwritingcommissions.

 

On April 25,2005, we announced our first regular cash distribution in 2005 of $0.225 perunit, based on the minimum quarterly cash distribution of $0.45 prorated forthe period since the initial public offering on February 15, 2005. Thedistribution to all common, subordinated and general partner units was paid May13, 2005, to all unitholders of record on May 5, 2005. The aggregate amount ofthe distribution was $1.6 million.

 

              On July 26, 2005, we announced a regular cashdistribution of $0.4625 per unit for the second quarter of 2005.  This represents an increase of $0.0125 perunit over our minimum quarterly distribution rate of $0.45.  The distribution to all common, subordinatedand general partner units was paid on August 12, 2005 to all unitholders ofrecord on August 5, 2005. The aggregate amount of the distribution was $3.2million.

 

OnSeptember 26, 2005, we borrowed $93.7 million under our $125.0 million amendedcredit facility in connection with the purchase of Hiland Partners, LLC.

 

                On October 25, 2005, we announceda regular cash distribution of $0.5125 per unit for the third quarter of2005.  This represents an increase of$0.0625 per unit over our minimum quarterly distribution rate of $0.45 and anincrease of $.05 per unit over our distribution made on August 12, 2005.  The distribution to all common, subordinatedand general partner units is to be paid on November 14, 2005 to all unitholdersof record on November 4, 2005. The aggregate amount of the distribution will be$3.5 million.  Under our partnership agreement,generally our general partner is entitled to 15% of the amount we distribute toeach unitholder in excess of $0.495 per unit per quarter up to $0.5625 per unitper quarter, and 25% of the amount we distribute to each unitholder in excessof $0.5625 per unit per quarter up to $0.675 per unit per quarter.

 

26

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                On November 2, 2005, we filedwith the Securities and Exchange Commission a registration statement for anoffering of 1,600,000 common units.  Theunderwriters will have an option to purchase up to 240,000 additional units tocover over-allotments, if any.  We intendto use the net proceeds from the offering to repay a portion of the outstandingindebtedness incurred to fund our recent acquisition of the Bakken gatheringsystem.  The registration statement hasnot been declared effective by the SEC.

 

Webelieve our current cash balances, future internally-generated funds and fundsavailable under our credit facility will provide sufficient resources to meetour working capital liquidity needs for the foreseeable future.

 

 

# ***Cash Flows fromOperating Activities***

 

Our cash flows fromoperating activities decreased by $6.0 million to $0.9 million for the ninemonths ended September 30, 2005 from $6.9 million for the nine months endedSeptember 30, 2004.  Working capitalitems, exclusive of cash, decreased cash flows by $13.7 million to $(12.6)million during the first nine months ended September 30, 2005 from $1.1 millionfor the nine months ended September 30, 2004, primarily as a result ofreplenishing our accounts receivable after the closing of the initial publicoffering, increased accounts receivable as a result of higher realized pricesfor natural gas and NGLs and additional accounts receivable generated frommidstream sales from the Bakken gathering system.  In connection with our formation, the $9.1million accounts receivables of Continental Gas, Inc. was retained by theformer owners of Continental Gas, Inc. Net income for the nine months ended September 30, 2005 was $6.2million, an increase of $3.6 million from a net income of $2.6 million for thenine months ended September 30, 2004. Our non-cash expenses increased $4.2 million in the first nine months of2005 compared with the same period in 2004.

 

# ***Cash Flows Used forInvesting Activities***

 

Our cash flows used forinvesting activities, which represent investments in property and equipment,increased by $60.3 million to $65.2 million for the nine months ended September30, 2005 from $4.9 million for the nine months ended September 30, 2004.  Our acquisition of the Bakken gatheringsystem assets totaled approximately $62.4 million.

 

# ***Cash Flows fromFinancing Activities***

 

Our cash flows fromfinancing activities increased to $70.9 million for the nine months endedSeptember 30, 2005 from $(2.3) million for the nine months ended September 30,2004. We completed our initial public offering of 2,300,000 common units onFebruary 15, 2005, receiving net proceeds of $48.1 million. The proceeds fromthe public offering were used to (1) pay remaining offering costs of $2.2million and deferred debt issuance costs of $0.6 million, (2) pay outstandingindebtedness of $22.9 million, (3) redeem $6.3 million of common units from anaffiliate of Harold Hamm and the Hamm Trusts, and (4) make a $3.9 milliondistribution to the previous owners of Hiland Partners, LLC.  We retained $12.2 million to replenishworking capital.  During the period fromJanuary 1, 2005 to February 14, 2005, Continental Gas, Inc. repaid $1.1 millionof its outstanding indebtedness.  OnSeptember 26, 2005, we borrowed $93.7 million under our amended credit facilityin connection with our acquisition of Hiland Partners, LLC and incurred anadditional $0.3 million in debt issuance costs by amending our creditfacility.  In addition, our cash flowsfrom financing activities for the nine months ended September 30, 2005 reflecta $27.8 million distribution, for accounting purposes, to the controllingmember of our general partner in connection with the acquisition of HilandPartners, LLC.  The controlling member ofour general partner owned 49% of Hiland Partners, LLC.  The $27.8 million distribution presented inour statement of cash flows reflects the difference in the purchase price paidto the controlling member of our general partner and his cost bais in the netassets of Hiland Partner, LLC.  During the third quarter our general partnercontributed $6,000 to maintain its 2% interest in the Partnership as a resultof our issuance of 8,000 restricted common units to non-employee board membersof our general partner.  From February 15, 2005 through September30, 2005, we distributed $4.8 million to our unitholders.

 

# ***Capital Requirements***

 

Our midstreamenergy business is capital intensive, requiring significant investment tomaintain and upgrade existing operations. Our capital requirements have consisted primarily of, and we anticipatewill continue to be:

 

•                                                                                          maintenance capitalexpenditures, which are capital expenditures made to replace partially or fullydepreciated assets to maintain the existing operating capacity of our assetsand to extend their useful lives, or other capital expenditures that areincurred in maintaining existing system volumes and related cash flows; and

 

27

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•                                                                                          expansion capital expendituressuch as those to acquire additional assets to grow our business, to expand andupgrade gathering systems, processing plants, treating facilities andfractionation facilities and to construct or acquire similar systems orfacilities.

 

We believe thatcash generated from the operations of our business will be sufficient to meetanticipated maintenance capital expenditures, which we have budgeted $2.0million for in 2005.  We anticipate thatexpansion capital expenditures will be funded through long-term borrowings orother debt financings and/or equity capital offerings.  See “Credit Facility” below for informationrelated to our credit agreement.

 

***Badlands Expansion Project***

 

                On November 8, 2005, we enteredinto a new 15-year definitive Gas Purchase Agreement with ContinentalResources, Inc. under which we will gather, treat and process additionalnatural gas, which is produced as a by-product of Continental Resources’secondary oil recovery operations, in the areas specified by the contract.  In order to fulfill our obligations under theagreement, we intend to expand our Badlands gas gathering system and processingplant located in Bowman County, North Dakota. This expansion project will include the construction of a 40,000 Mcf/dnitrogen rejection plant and the expansion of our existing Badlands fieldgathering infrastructure.  The expansionproject, which is targeted for completion in the 4th quarter of2006, is expected to cost approximately $40.0 million, which we intend to fundusing our existing bank credit facility. Moreover, we expect to spend an additional $9.5 million in 2007 toexpand the system.

 

***Off-Balance Sheet Arrangements.***

 

Wehad no off-balance sheet arrangements as of September 30, 2005.

*** ***

***Credit Facility***

 

                Concurrently with the closing of ourinitial public offering, we entered into a three-year $55.0 million seniorsecured revolving credit facility. MidFirst Bank, a federally chartered savingsassociation located in Oklahoma City, Oklahoma, is a lender and serves asadministrative agent under this facility. On September 26, 2005,concurrently with the closing of the Bakken acquisition, we amended thisfacility to increase our borrowing capacity under the facility to $125.0 million.The facility currently consists of:

 

*•** *a $117.5 million seniorsecured revolving credit facility to be used for funding acquisitions and othercapital expenditures, issuance of letters of credit and general corporatepurposes (the “revolving acquisition facility”); and

 

*•** *a $7.5 million seniorsecured revolving credit facility to be used for working capital and to funddistributions (the “revolving working capital facility”).

 

                 In addition, the revolvingacquisition facility allows for the issuance of letters of credit of up to$5.0 million in the aggregate. The credit facility will mature inFebruary 2008. At that time, the agreement will terminate and alloutstanding amounts thereunder will be due and payable.

 

                 Our obligations under the credit facility aresecured by substantially all of our assets and guaranteed by us and all of oursubsidiaries, other than our operating company, which is the borrower under thecredit facility. The credit facility is non-recourse to our general partner.

 

                Indebtedness under the credit facilitywill bear interest, at our 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 pointsper annum based on our ratio of total debt to EBITDA. The Alternate Base Rateis a rate per annum equal to the greatest of (a) the Prime Rate in effecton such day, (b) the base CD rate in effect on such day plus 1.50% and (c) theFederal Funds effective rate in effect on such day plus 1/2 of 1%. A letter ofcredit fee will be payable for the aggregate amount of letters of credit issuedunder the credit facility at a percentage per annum equal to 1.0%. An unusedcommitment fee ranging from 30 to 50 basis points per annum based on our ratioof total debt to EBITDA will be payable on the unused portion of the creditfacility.

 

                The credit facility prohibits us frommaking distributions to unitholders if any default or event of default, asdefined in the credit facility, has occurred and is continuing or would resultfrom the distribution. In addition, the credit facility 

 

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containsvarious covenants that limit, among other things, subject to certain exceptionsand negotiated “baskets,” our ability to:

 

•       incur indebtedness;

 

•       grant liens;

 

•       make certain loans,acquisitions and investments;

 

•       make any material changes tothe nature of our business;

 

•       amend our material agreements,including the Omnibus Agreement; or

 

•       enter into a merger,consolidation or sale of assets.

 

                The credit facility also containscovenants requiring us to maintain:

 

•       a maximum total debt toEBITDA ratio of 4.5:1.0 for the fiscal quarter ended September 30, 2005and the fiscal quarter ending December 31, 2005; thereafter a maximumtotal debt to EBITDA ratio of 4.0:1.0;

 

•       a minimum interest coverageratio of 3.0:1.0; and

 

•       minimum tangible net worth of$15.0 million for the fiscal quarter ended September 30, 2005 and thefiscal quarter ending December 31, 2005; thereafter a minimum tangible networth of $40.0 million.

 

                Upon the occurrence of an event ofdefault under the credit facility, the lenders may, among other things, be ableto accelerate the maturity of the credit facility and exercise other rights andremedies as set forth in the credit facility. Each of the following will be anevent of default:

 

•       failure to pay any principalwhen due or any interest, fees or other amount within 3 business days of whendue;

 

•       failure of any representationor warranty to be true and correct in all material respects;

 

•       failure to perform orotherwise comply with the covenants in the credit facility or other loandocuments, in certain cases subject to certain grace periods;

 

•       default by us or any of oursubsidiaries on the payment of any other indebtedness in excess of$1.0 million, or any default in the performance of any obligation orcondition with respect to such indebtedness beyond the applicable grace periodif the effect of the default is to permit or cause the acceleration of theindebtedness;

 

•       **bankruptcy or insolvency events involving us, our general partner or oursubsidiaries;

 

•       material default by any partyto any material agreement, which is not cured within the time period specifiedin the material agreement for cure, that is reasonably expected to have amaterial adverse effect;

 

•       the entry, and failure to payor contest in good faith, of one or more adverse judgments in an aggregateamount of $500,000 or more in excess of third party insurance coverage;

 

•       a change of control (asdefined in the credit facility); and

 

•       invalidity of any loandocumentation.

 

                The credit facility limits distributionsto our unitholders to Available Cash, and borrowings to fund such distributionsare only permitted under the revolving working capital facility. The revolvingworking capital facility is subject to an annual “clean-down” period of 15consecutive days in which the amount outstanding under the revolving workingcapital facility is reduced to zero.

 

                As of September 30, 2005, we had$93.7 million outstanding under the credit facility, substantially all of whichwas incurred to fund 

 

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theBakken acquisition.

 

***Impact of Inflation***

 

Inflation inthe United States has been relatively low in recent years and did not have amaterial impact on our results of operations for the periods presented.

 

**Recent Accounting Pronouncements**

 

**In October 1995, the FASBissued SFAS No. 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 and that cost will bemeasured based on the fair value of the equity or liability instrumentsissued.  The effect of the standard willbe to require entities to measure the cost of employee services received inexchange for stock or unit options based on the grant-date fair value of theaward, and to recognize the cost over the period the employee is required toprovide services for the award.  Inaccordance with SEC Release No. 33-8568, we will adopt SFAS 123R as of thefirst interim period beginning on or after January 1, 2006.  We expect to apply the statement using thepermitted modified prospective method, presenting all interim periods of theyear of adoption, beginning January 1, 2006. We had 166,000 options outstanding as of September 30, 2005.**

 

** **Significant Accounting Policiesand Estimates

 

The selectionand application of accounting policies is an important process that hasdeveloped as our business activities have evolved and as the accounting ruleshave developed.  Accounting rulesgenerally do not involve a selection among alternatives, but involve theimplementation and interpretation of existing rules, and the use of judgmentapplied to the specific set of circumstances existing in our business.  We make every effort to properly comply withall applicable rules on or before their adoption, and we believe the properimplementation and consistent application of the accounting rules arecritical.  For further details on ouraccounting policies, you should read Note 1 of the accompanying Notes toFinancial Statements.

 

***Asset Retirement Obligations*****.**   SFAS No. 143, “Accounting for AssetRetirement Obligations,” requires entities to record the fair value of aliability for an asset retirement obligation in the period in which it is incurredand a corresponding increase in the carrying amount of the related long-livedasset.  Subsequently, the assetretirement cost is allocated to expense using a systematic and rational methodand the liability is accreted to measure the change in liability due to thepassage of time.  The primary impact ofthis standard relates to our estimated costs for dismantling and siterestoration 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 of Long-Lived Assets*****.**   In accordance with SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” we evaluate ourlong-lived assets of identifiable business activities for impairment whenevents or changes in circumstances indicate, in management’s judgment, that thecarrying 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.

 

Whendetermining whether impairment of one of our long-lived assets has occurred, wemust estimate the undiscounted cash flows attributable to the asset or assetgroup.  Our estimate of cash flows isbased on assumptions regarding the volume of natural gas reserves providingasset cash flow and future NGL product and natural gas prices.  The amount of reserves and drilling activityare dependent in part on natural gas prices. Projections of reserves and future commodity prices are inherentlysubjective and contingent upon a number of variable factors, including, but notlimited to:

 

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•          changes in general economicconditions in regions in which our products are located;

 

•          the availability and prices ofNGL products and competing commodities;

 

•          the availability and prices ofraw natural gas supply;

 

•          our ability to negotiatefavorable marketing agreements;

 

•           the risks that third party oil and gas exploration andproduction activities will not occur or be successful;

 

•          our dependence on certainsignificant customers and producers of natural gas; and

 

•          competition from other midstream service providers,processors, including major energy companies.

 

Any significantvariance in any of the above assumptions or factors could materially affect ourcash flows, which could require us to record an impairment of an asset.  No impairment charges were recognized duringeach of the three or nine months ended September 30, 2005 and 2004.

 

***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 are performed.

 

*               ****Derivatives****.*    We utilize derivative financialinstruments to reduce commodity price risks. We do not hold or issue derivativefinancial instruments for trading purposes. Statement of Financial AccountingStandards (or SFAS) No. 133, Accounting for Derivative Instruments andHedging Activities, which was amended in June 2000 by SFAS No. 138 and inMay 2003 by SFAS No. 149, establishes accounting and reporting standardsfor derivative instruments and hedging activities. It requires that an entityrecognize all derivatives as either assets or liabilities in the statement offinancial condition and measure those instruments at fair value. Derivativesthat are not designated as hedges are adjusted to fair value through income. Ifthe derivative is designated as a hedge, depending upon the nature of thehedge, changes in the fair value of the derivatives are either offset againstthe fair value of assets, liabilities or firm commitments through income, orrecognized in other comprehensive income until the hedged item is recognized inincome. The ineffective portion of a derivative’s change in fair value isimmediately recognized into income. If a derivative no longer qualifies forhedge accounting the amounts in accumulated other comprehensive income will beimmediately charged to operations.

 

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

 

Market risk isthe risk of loss arising from adverse changes in market rates and prices.  The principal market risk to which we areexposed is commodity price risk for natural gas and NGLs.  We also incur, to a lesser extent, risksrelated to interest rate fluctuations. We do not engage in commodity energy trading activities.

 

***Commodity PriceRisks.***  Our profitabilityis affected by volatility in prevailing NGL and natural gas prices.  Historically, changes in the prices of mostNGL products have generally correlated with changes in the price of crudeoil.  NGL and natural gas prices arevolatile and are impacted by changes in the supply and demand for NGLs andnatural gas, as well as market uncertainty. To illustrate the impact of changes in prices for natural gas and NGLs onour operating results, we have provided below, a matrix that reflects, for thenine months ended September 30, 2005, the impact on our gross margin of a $0.01per gallon change (increase or decrease) in NGL prices coupled with a $0.10 perMMBtu change (increase or decrease) in the price of natural gas.  The magnitude of the impact on total segmentmargin of changes in natural gas and NGL prices presented may not berepresentative of the magnitude of the impact on total segment margin fordifferent commodity prices or contract portfolios.  Natural gas prices can also affect ourprofitability indirectly by influencing the level of drilling activity andrelated opportunities for our services.  

 
| ** **         | ** ** | ** ** | ** ** | **Natural Gas Price Change ($/MMBtu)** | ** ** |
|--------------------|------------|------------|------------|----------------------------------------|------------|
|               |       |       |       |                                   |       |   |   |
|               |       |       |       | $                                      | 0.10       |   | $ | (0.10 | ) |
|               |       |       |       |                                   |       |   |   |
| **NGL Price**      |       | $          | 0.01       |                                   | $          | 196,000 |   | $ | 83,000 |   |
| **Change ($/gal)** |       | $          | (0.01      | )                                      | $          | (1,000 | ) | $ | (111,000 | ) |

 

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                 We manage this commodity priceexposure through an integrated strategy that includes management of ourcontract portfolio, optimization of our assets and the use of derivativecontracts. In October 2005, we executed swap contracts relating to aportion of our residue gas sales from our Bakken gathering system that settleagainst natural gas market prices. As a result, we have hedged a portion of ourexpected exposure to natural gas prices in 2006 and 2007 at the Bakkengathering system. We continually monitor our hedging and contract portfolio andexpect to continue to adjust our hedge position as conditions warrant.

 

                The following table provides informationabout our financial derivative instruments:

 
| ** **                   | ** ** | **Monthly** | ** ** | ** **    | ** ** |
|------------------------------|------------|-------------|------------|---------------|------------|
| ** **                   | ** ** | **Volume**  | ** ** | **Price**     | ** ** |
| **Natural Gas Swaps**        | ** ** | **(MMBtu)** | ** ** | **($/MMBtu)** | ** ** |
| May 2006 - December 2006     |       | 40,000      |       | $             | 8.78       |   |
| January 2007 - October  2007 |       | 40,000      |       | $             | 7.83       |   |

 

***Interest Rate Risk*****.**   We are exposed to changes in interest ratesas a result of our credit facility, which has floating interest rates.  As of September 30, 2005, we hadapproximately $93.7 million of indebtedness outstanding under our credit facility.  The impact of a 100 basis point increase ininterest rates on this amount of debt would result in an increase in interestexpense, and a corresponding decrease in net income of approximately $0.9million annually.

 

***Credit Risk*****.**   Counterparties pursuant to the terms oftheir contractual obligations expose us to potential losses as a result ofnonperformance.  OGE Energy Resources,Inc., and BP Energy Company were our largest customers for the nine monthsended September 30, 2005, accounting for approximately 24.6% and 18.9%,respectively, of our revenues. Consequently, changes within one or both of these companies operationshave the potential to impact, both positively and negatively, our creditexposure.

 

**Item 4.    Controlsand Procedures**

 

**Evaluationof Disclosure Controls and Procedures**

 

(a)           Evaluation of disclosure controls andprocedures.

 

Our principal executive officer and principal financialofficer have evaluated, as required by Rule 13a-15(b) under the SecuritiesExchange Act of 1934 (the “Exchange Act”), our disclosure controls andprocedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of theperiod covered by this quarterly report on Form 10-Q.   Based on that evaluation, the principalexecutive officer and principal financial officer concluded that the design andoperation of our disclosure controls and procedures are effective in ensuringthat information we are required to disclose in the reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in the Securities and Exchange Commission’srules and forms.

 

(b)           Changesin internal control over financial reporting.

 

There have been no changes in our internal control overfinancial reporting (as defined in Rule 13a-15(f) under the Exchange Act)that occurred during our last fiscal quarter that have materially affected orare reasonably likely to materially affect our internal controlover financialreporting.

 

 

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**PART II.OTHER INFORMATION**

 

**Item 1.Legal Proceedings**

 

Weare a party to various legal and regulatory proceedings, none of which webelieve will have a material adverse impact on our financial condition, resultsof operations or cash flows.

 

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

 

None.

 

**Item 3. Defaults Upon Senior Securities**

 

None.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

 

None.

 

**Item 5.Other Matters**

 

None.

 

**Item 6.Exhibits**

 
| **Exhibit****Number** | ** ** | ** ** | ** ** | **Description**                                                                                                                                                                                                                                                                              | ** ** |
|-----------------------|------------|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 2.1                   |       | —     |       | Acquisition  Agreement by and among Hiland Operating, LLC, Hiland Partners, LLC and  the members of Hiland Partners, LLC dated as of September 1, 2005  (incorporated by reference to Exhibit 2.1 of Registrant’s Form 8-K  filed on September 12, 2005). |       |
| 10.12                 |       | —     |       | First  Amendment, dated as of September 26, 2005 to Credit Agreement dated as of  February 15, 2005 among Hiland Operating, LLC and the lenders thereto  (incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed on  September 12, 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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**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized in the city of Enid,Oklahoma, on the 14th day of November, 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 |

 

**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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