**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

| **o****  QUARTERLY REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                                           |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                         |
| **FOR THE  QUARTERLY PERIOD ENDED June 30, 2007**                                                                                                                                                  |
| ** **                                                                                                                                                                                         |
| **OR**                                                                                                                                                                                             |
| ** **                                                                                                                                                                                         |
| **o****  TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**                                                                          |
| ** **                                                                                                                                                                                         |
| **FOR THE  TRANSITION PERIOD  FROM             TO             ** |
| ** **                                                                                                                                                                                         |
| **Commission  file number:  000-51120**                                                                                                                                                       |

 

**HilandHoldings GP, LP**

(Exact name ofRegistrant as specified in its charter)

| **DELAWARE**                              |   | **76-0828238**       |
|-------------------------------------------|--------|----------------------|
| (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’stelephone number including area code**  (580)242-6040**

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 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 x     No o

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

| Large accelerated  filer o |   | Accelerated  filer o |   | Non-accelerated  filer x |
|---------------------------------|--------|---------------------------|--------|-------------------------------|

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Act).  Yes o   No x

The number of theregistrant’s outstanding equity units at August 3, 2007 was 21,600,000 commonunits.

 

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**HILANDHOLDINGSGP, LP**

**INDEX**
| **PART I. FINANCIAL INFORMATION**                                                                    |
|------------------------------------------------------------------------------------------------------|
| Item 1. Financial Statements (Unaudited, except  December 31, 2006 Balance Sheet)                    |
| Consolidated Balance Sheets                                                                          |
| Consolidated  Statements of Operations                                                               |
| Consolidated  Statements of Cash Flows                                                               |
| Consolidated  Statement of Changes in Owners’ Equity and Comprehensive Income                   |
| 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  1A. Risk Factors                                                                               |
| 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                                                               |

 

1

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**HILANDHOLDINGS GP, LP**

**Consolidated Balance Sheets**
| ** **                                                    | ** ** | **June 30,**                                           | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                    | ** ** | **2007**                                                    | ** ** | **2006**              | ** ** |
| ** **                                                    | ** ** | **(unaudited)**                                             | ** ** | ** **            | ** ** |
| ** **                                                    | ** ** | **(in thousands, except unit amounts)** | ** ** |
| **ASSETS**                                                    | ** ** | ** **                                                  | ** ** | ** **            | ** ** |
| **Current assets:**                                           | ** ** | ** **                                                  | ** ** | ** **            | ** ** |
| Cash and cash  equivalents                                    |       | $                                                           | 9,992      |                  | $          | 10,569 |   |
| Accounts receivable:                                          |       |                                                        |       |                  |       |
| Trade                                                         |       | 25,411                                                      |       | 23,702                |       |
| Affiliates                                                    |       | 939                                                         |       | 1,284                 |       |
|                                                          |       | 26,350                                                      |       | 24,986                |       |
| Fair value of  derivative assets                              |       | 3,760                                                       |       | 4,707                 |       |
| Other current assets                                          |       | 1,177                                                       |       | 945                   |       |
| Total current assets                                          |       | 41,279                                                      |       | 41,207                |       |
|                                                          |       |                                                        |       |                  |       |
| Property and equipment,  net                                  |       | 289,521                                                     |       | 257,003               |       |
| Intangibles, net                                              |       | 50,016                                                      |       | 53,094                |       |
| Fair value of  derivative assets                              |       | 938                                                         |       | 1,955                 |       |
| Other assets, net                                             |       | 1,863                                                       |       | 1,939                 |       |
| **Total assets**                                              |       | $                                                           | 383,617    |                  | $          | 355,198 |   |
|                                                          |       |                                                        |       |                  |       |
| **LIABILITIES AND OWNERS’ EQUITY**                       | ** ** | ** **                                                  | ** ** | ** **            | ** ** |
| **Current liabilities:**                                      | ** ** | ** **                                                  | ** ** | ** **            | ** ** |
| Accounts payable                                              |       | $                                                           | 27,701     |                  | $          | 19,161 |   |
| Accounts  payable—affiliates                             |       | 4,975                                                       |       | 4,412                 |       |
| Fair value of  derivative liabilities                         |       | 2,455                                                       |       | 1,902                 |       |
| Accrued liabilities                                           |       | 1,464                                                       |       | 1,459                 |       |
| Total current  liabilities                                    |       | 36,595                                                      |       | 26,934                |       |
|                                                          |       |                                                        |       |                  |       |
| Commitments and  contingencies (Note 7)                       |       |                                                        |       |                  |       |
| Long-term debt                                                |       | 177,919                                                     |       | 147,318               |       |
| Fair value of  derivative liabilities                         |       | 387                                                         |       | 291                   |       |
| Asset retirement  obligation                                  |       | 2,695                                                       |       | 2,196                 |       |
| Minority interests                                            |       | 133,163                                                     |       | 137,302               |       |
|                                                          |       |                                                        |       |                  |       |
| **Owners’ equity**                                       | ** ** | ** **                                                  | ** ** | ** **            | ** ** |
| Common unitholders  (21,600,000 units issued and outstanding) |       | 31,919                                                      |       | 38,590                |       |
| Accumulated other  comprehensive income                       |       | 939                                                         |       | 2,567                 |       |
| **Total owners’ equity**                                 |       | 32,858                                                      |       | 41,157                |       |
|                                                          |       |                                                        |       |                  |       |
| **Total liabilities and owners’ equity**                 |       | $                                                           | 383,617    |                  | $          | 355,198 |   |

 

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

2

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**HILANDHOLDINGS GP, LP**

**Consolidated Statements of Operations**

**Forthe Three and Six Months Ended (Unaudited)**
| ** **                                                                  | ** ** | **Three Months Ended**                                     | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                  | ** ** | **June 30,**                                                    | ** ** | **June 30,**              | ** ** |
| ** **                                                                  | ** ** | **2007**                                                             | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                                  | ** ** | ** **                                                           | ** ** | **Predecessor**                | ** ** | ** ** | ** ** | **Predecessor** | ** ** |
| ** **                                                                  | ** ** | **(in thousands, except per unit amounts)** | ** ** |
| **Revenues:**                                                               | ** ** | ** **                                                           | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Midstream  operations                                                       |       |                                                                 |       |                           |       |   |   |   |   |
| Third parties                                                               |       | $                                                                    | 64,664     |                           | $          | 50,583 |   | $ | 123,523 |   | $ | 101,469 |   |
| Affiliates                                                                  |       | 747                                                                  |       | 951                            |       | 1,736 |   | 2,269 |   |
| Compression  services, affiliate                                            |       | 1,205                                                                |       | 1,205                          |       | 2,410 |   | 2,410 |   |
| Total revenues                                                              |       | 66,616                                                               |       | 52,739                         |       | 127,669 |   | 106,148 |   |
|                                                                        |       |                                                                 |       |                           |       |   |   |   |   |
| **Operating  costs and expenses:**                                          | ** ** | ** **                                                           | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Midstream  purchases (exclusive of items shown separately below)            |       | 34,908                                                               |       | 24,752                         |       | 66,789 |   | 51,909 |   |
| Midstream  purchases -affiliate (exclusive of items shown separately below) |       | 13,008                                                               |       | 12,069                         |       | 24,742 |   | 26,447 |   |
| Operations and  maintenance                                                 |       | 4,980                                                                |       | 3,998                          |       | 9,950 |   | 6,571 |   |
| Depreciation,  amortization and accretion                                   |       | 7,326                                                                |       | 5,657                          |       | 14,352 |   | 9,794 |   |
| General and  administrative expenses                                        |       | 2,285                                                                |       | 1,259                          |       | 4,330 |   | 2,298 |   |
| Total operating  costs and expenses                                         |       | 62,507                                                               |       | 47,735                         |       | 120,163 |   | 97,019 |   |
| Operating income                                                            |       | 4,109                                                                |       | 5,004                          |       | 7,506 |   | 9,129 |   |
|                                                                        |       |                                                                 |       |                           |       |   |   |   |   |
| **Other  income (expense):**                                                | ** ** | ** **                                                           | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest and  other income                                                  |       | 93                                                                   |       | 79                             |       | 219 |   | 154 |   |
| Amortization of  deferred loan costs                                        |       | (110                                                                 | )          | (110                           | )          | (220 | ) | (233 | ) |
| Interest expense                                                            |       | (2,314                                                               | )          | (1,727                         | )          | (4,405 | ) | (2,262 | ) |
| Other income  (expense), net                                                |       | (2,331                                                               | )          | (1,758                         | )          | (4,406 | ) | (2,341 | ) |
|                                                                        |       |                                                                 |       |                           |       |   |   |   |   |
| **Income  before minority interest in income of Hiland Partners, LP**       |       | 1,778                                                                |       | 3,246                          |       | 3,100 |   | 6,788 |   |
| Minority  interest in income of Hiland Partners, LP                         |       | (639                                                                 | )          | (3,062                         | )          | (1,213 | ) | (6,226 | ) |
| **Limited  partners’ interest in net income**                          |       | $                                                                    | 1,139      |                           | $          | 184 |   | $ | 1,887 |   | $ | 562 |   |
| ** **                                                                  | ** ** | ** **                                                           | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net  income per limited partners’ unit - basic**                     |       | $                                                                    | 0.05       |                           |       |   | $ | 0.09 |   |   |   |
| ** **                                                                  |       |                                                                 |       |                           |       |   |   |   |   |
| **Net  income per limited partners’ unit - diluted**                   |       | $                                                                    | 0.05       |                           |       |   | $ | 0.09 |   |   |   |
| ** **                                                                  | ** ** | ** **                                                           | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Weighted  average limited partners’ units outstanding - basic**      |       | 21,600                                                               |       |                           |       | 21,600 |   |   |   |
| ** **                                                                  |       |                                                                 |       |                           |       |   |   |   |   |
| **Weighted average limited  partners’ units outstanding - diluted**    |       | 21,606                                                               |       |                           |       | 21,606 |   |   |   |

 

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

3

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**HILANDHOLDINGS GP, LP**

**Consolidated Statements of Cash Flows**

**Forthe Six Months Ended (Unaudited)**
| ** **                                                                         | ** ** | **June 30,**       | ** ** | **June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------|------------|
| ** **                                                                         | ** ** | **2007**                | ** ** | **2006**          | ** ** |
| ** **                                                                         | ** ** | ** **              | ** ** | **Predecessor**   | ** ** |
| ** **                                                                         | ** ** | **(in thousands)** | ** ** |
| **Cash  flows from operating activities:**                                         | ** ** | ** **              | ** ** | ** **        | ** ** |
| Net income                                                                         |       | $                       | 1,887      |              | $          | 562 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                    |       |              |       |
| Depreciation and  amortization                                                     |       | 14,299                  |       | 9,768             |       |
| Accretion of  asset retirement obligation                                          |       | 53                      |       | 26                |       |
| Amortization of  deferred loan cost                                                |       | 220                     |       | 233               |       |
| Gain on  derivative transactions                                                   |       | (171                    | )          | (164              | )          |
| Unit based  compensation                                                           |       | 756                     |       | 234               |       |
| Minority  interest in income of Hiland Partners, LP                                |       | 1,213                   |       | 6,226             |       |
| (Increase)  decrease in current assets:                                            |       |                    |       |              |       |
| Accounts  receivable—trade                                                    |       | (1,709                  | )          | 5,777             |       |
| Accounts  receivable—affiliates                                               |       | 345                     |       | 585               |       |
| Other current  assets                                                              |       | (232                    | )          | (173              | )          |
| Increase  (decrease) in current liabilities:                                       |       |                    |       |              |       |
| Accounts  payable—trade                                                       |       | 1,962                   |       | 5,523             |       |
| Accounts  payable—affiliates                                                  |       | 563                     |       | (2,168            | )          |
| Accrued  liabilities                                                               |       | 5                       |       | 478               |       |
| **Net  cash provided by operating activities**                                     |       | 19,191                  |       | 26,907            |       |
| ** **                                                                         | ** ** | ** **              | ** ** | ** **        | ** ** |
| **Cash  flows from investing activities:**                                         | ** ** | ** **              | ** ** | ** **        | ** ** |
| Additions to  property and equipment                                               |       | (36,715                 | )          | (33,659           | )          |
| Payments for  businesses acquired, less cash received                              |       | —                  |       | (96,400           | )          |
| Proceeds from  disposals of property and equipment                                 |       | —                  |       | 16                |       |
| **Net  cash used in investing activities**                                         |       | (36,715                 | )          | (130,043          | )          |
| ** **                                                                         | ** ** | ** **              | ** ** | ** **        | ** ** |
| **Cash  flows from financing activities:**                                         | ** ** | ** **              | ** ** | ** **        | ** ** |
| Proceeds from  long-term borrowings                                                |       | 30,601                  |       | 116,780           |       |
| Debt issuance  costs                                                               |       | (2                      | )          | (986              | )          |
| Offering costs                                                                     |       | (142                    | )          | (320              | )          |
| Capital Contributions                                                              |       | —                  |       | 491               |       |
| Proceeds from  Hiland Partners, LP unit options exercise                      |       | 1,024                   |       | 972               |       |
| Minority  interest cash distribution to unitholders of Hiland Partners, LP         |       | (5,565                  | )          | (10,785           | )          |
| Cash  distribution to members of Hiland Partners GP, LLC                           |       | —                  |       | (685              | )          |
| Cash distribution  to unitholders                                                  |       | (8,969                  | )          | —            |       |
| **Net  cash provided by financing activities**                                     |       | 16,947                  |       | 105,467           |       |
|                                                                               |       |                    |       |              |       |
| Increase  (decrease) for the period                                                |       | (577                    | )          | 2,331             |       |
| Beginning of  period                                                               |       | 10,569                  |       | 6,318             |       |
| **End of  period**                                                                 |       | $                       | 9,992      |              | $          | 8,649 |   |
|                                                                               |       |                    |       |              |       |
| Supplementary  information                                                         |       |                    |       |              |       |
| Cash paid for interest,  net of amounts capitalized                                |       | $                       | 4,397      |              | $          | 1,112 |   |

 

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

4

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| **Non-cash  investing and financing activities:**                                                                                                                                                                                       | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
|                                                                                                                                                                                                                                    |       |       |       |
| May 10, 2006  purchase of limited partner common units of Hiland Partners, LP in excess of  proportionate historical financial cost basis of Hiland Partners, LP  allocated to property and equipment and intangible assets as follows: |       |       |       |
|                                                                                                                                                                                                                                    |       |       |       |
| Property and  equipment                                                                                                                                                                                                                 |       | $          | 4,488      |   |
| Customer contracts                                                                                                                                                                                                                      |       | 6,980      |       |
| Excess of cost over  proportionate equity interest                                                                                                                                                                                      |       | $          | 11,468     |   |

 

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

5

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**HilandHoldings GP, LP**

**Consolidated Statement of Changes in Owners’ Equity andComprehensive Income**

**Forthe Six Months Ended June 30, 2007 (Unaudited)**
| ** **                                                                           | ** ** | **Common  Units**       | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Total** | ** ** | **Total  Comprehensive  Income** | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------------------------|------------|-----------|------------|----------------------------------|------------|
| ** **                                                                           | ** ** | **(in thousands)** | ** ** |
|                                                                                 |       |                    |       |                                          |       |      |       |                             |       |
| **Balance,  January 1, 2007**                                                   |       | $                       | 38,590     |                                          | $          | 2,567     |       | $                                | 41,157     |   |   |   |
|                                                                                 |       |                    |       |                                          |       |      |       |                             |       |
| Periodic cash  distributions                                                         |       | (8,969                  | )          | —                                        |       | (8,969    | )          |                             |       |
|                                                                                 |       |                    |       |                                          |       |      |       |                             |       |
| Unit based  compensation                                                             |       | 411                     |       | —                                        |       | 411       |       |                             |       |
|                                                                                 |       |                    |       |                                          |       |      |       |                             |       |
| Other  comprehensive income reclassified to income on closed derivative transactions |       | —                  |       | (835                                          | )          | (835      | )          | $                                | (835       | ) |
|                                                                                 |       |                    |       |                                          |       |      |       |                             |       |
| Change in fair  value of derivatives                                                 |       | —                  |       | (793                                          | )          | (793      | )          | (793                             | )          |
|                                                                                 |       |                    |       |                                          |       |      |       |                             |       |
| Net income                                                                           |       | 1,887                   |       | —                                        |       | 1,887     |       | 1,887                            |       |
|                                                                                 |       |                    |       |                                          |       |      |       |                             |       |
| Comprehensive  income                                                                |       |                    |       |                                          |       |      |       | $                                | 259        |   |
|                                                                                 |       |                    |       |                                          |       |      |       |                             |       |
| **Balance June 30, 2007**                                                            |       | $                       | 31,919     |                                          | $          | 939       |       | $                                | 32,858     |   |   |   |

 

The accompanyingnotes are an integral part of this consolidated financial statement.

6

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**HILANDHOLDINGS GP, LP**

**CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

**THREEAND SIX MONTHS ENDED JUNE 30, 2007 AND 2006**

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

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

Unless the contextrequires otherwise, references to “we,” “our,” “us,” “Hiland Holdings” or “thePartnership” are intended to mean the consolidated business and operations ofHiland Holdings GP, LP. References to “Hiland Partners” are intended to meanthe consolidated business and operations of Hiland Partners, LP and itssubsidiaries.

Hiland HoldingsGP, LP, a Delaware limited partnership, was formed in May 2006 to ownHiland Partners GP, LLC, the general partner of Hiland Partners, LP and certainother common and subordinated units in Hiland Partners. Hiland Partners GP, LLCwas formed in October 2004 to hold the 2% general partner ownershipinterest in Hiland Partners and serve as its general partner. Hiland PartnersGP, LLC manages the operations of Hiland Partners. In connection with theclosing of our initial public offering, all of the membership interests inHiland Partners GP, LLC were contributed to us. Hiland Partners GP, LLCconstitutes our predecessor.

Our generalpartner, Hiland Partners GP Holdings, LLC manages our operations andactivities, including, among other things, paying our expenses and establishingthe quarterly cash distribution levels for our common units and reserves thatour general partner determines, in good faith, are necessary or appropriate toprovide for the conduct of our business, to comply with applicable law, any ofour debt instruments or other agreements or to provide for future distributionsto our unitholders for any one or more of the upcoming four quarters.

Hiland Partners, aDelaware limited partnership, was formed in October 2004 to acquire andoperate certain midstream natural gas plants, gathering systems and compressionand water injection assets located in the states of Oklahoma, North Dakota,Wyoming, Texas and Mississippi that were previously owned by ContinentalGas, Inc. and Hiland Partners, LLC. Hiland Partners commencedoperations on February 15, 2005, and concurrently with the completion ofits initial public offering, Continental Gas, Inc. contributed asubstantial portion of its net assets to Hiland Partners. The transfer ofownership of net assets from Continental Gas, Inc. to Hiland Partnersrepresented a reorganization of entities under common control and was recordedat historical cost. Continental Gas, Inc. was formed in 1990 as a whollyowned subsidiary of Continental Resources, Inc.

ContinentalGas, Inc. operated in one segment, midstream, which involved thegathering, compressing, dehydrating, treating, and processing of natural gasand fractionating natural gas liquids, or NGLs. Continental Gas, Inc.historically has owned all of Hiland Partners’ natural gas gathering,processing, treating and fractionation assets other than the Worland and Bakkengathering systems. Hiland Partners, LLC historically owned the Worlandgathering system and compression services assets, which Hiland Partnersacquired on February 15, 2005, and the Bakken gathering system. Since itsinitial public offering, Hiland Partners has operated in midstream andcompression services segments. On September 26, 2005, Hiland Partnersacquired Hiland Partners, LLC, which at such time owned the Bakken gatheringsystem, for $92.7 million, $35.0 million of which was used to retireoutstanding Hiland Partners, LLC indebtedness. On May 1, 2006, HilandPartners acquired the Kinta Area gathering assets from Enogex GasGathering, L.L.C., consisting of certain eastern Oklahoma gas gatheringassets, for $96.4 million.  Hiland Partners financed this acquisition with$61.2 million of borrowings from its credit facility and $35.0 million ofproceeds from the issuance to Hiland Partners GP, LLC, its general partner, of761,714 common units and 15,545 general partner equivalent units, both at$45.03 per unit.

The unauditedfinancial statements for the three and six months ended June 30, 2007 and 2006included herein have been prepared in accordance with the instructions forinterim reporting as prescribed by the United States Securities and ExchangeCommission (the “SEC”). The interim financial statements reflect alladjustments, which are in the opinion of our management, necessary for a fairpresentation of our results for the interim periods. Such adjustments areconsidered to be of a normal recurring nature. Results of operations for thethree and six months ended June 30, 2007 are not necessarily indicative of theresults of operations that will be realized for the year ending December 31,2007.  The accompanying consolidated financial statements and notesthereto should be read in conjunction with the consolidated financialstatements and notes thereto included in our Form 10-K for the fiscal yearended December 31, 2006.

7

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***Principles ofConsolidation***

Because we own thegeneral partner of Hiland Partners, the consolidated financial statementsinclude our accounts, the accounts of Hiland Partners GP, LLC and the accountsof Hiland Partners and its subsidiaries. All significant intercompanytransactions and balances have been eliminated. The consolidated financialstatements include the assets of Hiland Partners GP, LLC that were contributedto us concurrently with the completion of our initial public offering onSeptember 25, 2006. Hiland Partners GP, LLC commenced operations onFebruary 15, 2005, therefore amounts presented in these consolidatedfinancial statements and accompanying notes for the period January 1, 2006to September 25, 2006 relate to the consolidated accounts of HilandPartners GP, LLC, Hiland Partners and its subsidiaries

***Use of Estimates***

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

***Fair Value ofFinancial Instruments***

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

***Commodity RiskManagement***

We engage in pricerisk management activities in order to minimize the risk from market fluctuationin the prices of natural gas and NGLs. To qualify as a hedge, the pricemovements in the commodity derivatives must be highly correlated with theunderlying hedged commodity. Gains and losses related to commodity derivativeswhich qualify as hedges are recognized in income when the underlying hedgedphysical transaction closes and are included in the consolidated statements ofoperations as revenues from midstream operations. Gains and losses related tocommodity derivatives that are not designated as hedges or do not qualify ashedges are recognized in income immediately, and are included in midstreamrevenues in the consolidated statement of operations.

SFAS No. 133,as amended, establishes accounting and reporting standards for derivativeinstruments, including certain derivative instruments embedded in othercontracts, and for hedging activities. SFAS No. 133 requires that anentity recognize all derivatives as either assets or liabilities in thestatement of financial position and measure those instruments at fair value.However, if a derivative does qualify for hedge accounting, depending on thenature of the hedge, changes in fair value can be offset against the change infair value of the hedged item through earnings or recognized in other comprehensiveincome until such time as the hedged item is recognized in earnings. To qualifyfor cash flow hedge accounting, the cash flows from the hedging instrument mustbe highly effective in offsetting changes in cash flows due to changes in theunderlying item being hedged. In addition, all hedging relationships must bedesignated, documented, and reassessed periodically. SFAS No. 133 alsoprovides that normal purchases and normal sales contracts are not subject tothe statement. Normal purchases and normal sales are contracts that provide forthe purchase or sale of something other than a financial instrument orderivative instrument that will be delivered in quantities expected to be usedor sold by the reporting entity over a reasonable period in the normal courseof business. Our fixed price physical forward natural gas purchase and salescontracts in which we have contracted to purchase or sale natural gasquantities at fixed prices are designated as normal purchases and sales.Substantially all forward contracts fall within a one to 24 month term.

Currently, ourderivative financial instruments that qualify for hedge accounting aredesignated as cash flow hedges. The cash flow hedge instruments hedge theexposure of variability in expected future cash flows that is attributable to aparticular risk. The effective portion of the gain or loss on these derivativeinstruments is recorded in accumulated other comprehensive income in owners’equity and reclassified into earnings in the same period in which the hedgedtransaction closes. The asset or liability related to the derivativeinstruments is recorded on the balance sheet as fair value of derivative assetsor liabilities. Any ineffective portion of the gain or loss is recognized inearnings immediately.

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***ComprehensiveIncome***

Comprehensiveincome includes net income and other comprehensive income, which includes, butis not limited to, changes in the fair value of derivative financialinstruments. Pursuant to SFAS No. 133, for derivatives qualifying ashedges, the effective portion of changes in fair value are recognized in owners’equity as accumulated other comprehensive income and reclassified to earningswhen the underlying hedged physical transaction closes, to the extent of ourinterest in Hiland Partners. Our comprehensive income for the three and sixmonths ended June 30, 2007 and 2006 is presented in the table below:
|                                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                             | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                             | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net income                                             |       | $                                | 1,139      |                           | $          | 184 |   | $ | 1,887 |   | $ | 562 |   |
| Closed  derivative transactions reclassified to income |       | (503                             | )          | (149                           | )          | (835 | ) | (149 | ) |
| Change in fair  value of derivatives                   |       | 39                               |       | 179                            |       | (793 | ) | 183 |   |
| Comprehensive Income                                   |       | $                                | 675        |                           | $          | 214 |   | $ | 259 |   | $ | 596 |   |

 

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

Net income perlimited partners’ unit is computed based on the weighted-average number ofcommon units outstanding during the period. The computation of diluted netincome per limited partner unit further assumes the dilutive effect ofrestricted unit awards. Net income per limited partners’ unit is computed bydividing net income applicable to limited partners by both the basic anddiluted weighted-average number of limited partnership units outstanding.

***Intangible Assets***

Intangible assetsconsist of the acquired value of customer relationships, existing contracts tosell natural gas and other NGLs and compression contracts, which do not havesignificant residual value. The customer relationships and the contracts arebeing amortized over their estimated lives of ten years. We review intangibleassets for impairment whenever events or circumstances indicate that thecarrying amounts may not be recoverable. If such a review should indicate thatthe carrying amount of intangible assets is not recoverable, we reduce thecarrying amount of such assets to fair value based on the discounted probablecash flows of the intangible assets. No impairments of intangible assets wererecorded as of June 30, 2007 or 2006. On May 1, 2006 Hiland Partnersacquired the Kinta Area gathering assets and recorded identifiable customerrelationships of $10,492. On May 10, 2006, Hiland Partners GP, LLCpurchased 761,714 common units and 15,545 general partner units of HilandPartners for $35.0 million. Hiland Partners GP, LLC recorded an additional$6,979 in contracts to sell natural gas for a portion of the amount that thepurchase price exceeded the proportionate interest in the underlying equity ofHiland Partners.

Intangible assetsconsisted of the following for the periods indicated:
|                                | ** ** | **As of**    | ** ** | **As of**        | ** ** |
|--------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| ** **                     | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| Gas sales  contracts           |       | $                 | 32,564     |                  | $          | 32,564 |   |
| Compression  contracts         |       | 18,515            |       | 18,515                |       |
| Customer  relationships        |       | 10,492            |       | 10,492                |       |
|                           |       | 61,571            |       | 61,571                |       |
| Less accumulated  amortization |       | 11,555            |       | 8,477                 |       |
| Intangible assets, net         |       | $                 | 50,016     |                  | $          | 53,094 |   |

 

During the three monthsended June 30, 2007 and 2006, we recorded amortization expense of $1,540 and$1,374, respectively and during the six months ended June 30, 2007 and 2006 we recordedamortization expense of $3,078 and $2,477, respectively. Estimated aggregateamortization expense for the remainder of 2007 is $3,079 and $6,157 for each ofthe four succeeding fiscal years from 2008 through 2011 and a total of $22,309for all years thereafter.

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***Accounting forAsset Retirement Obligations***

In accordance withSFAS No. 143, “Accounting for Asset Retirement Obligations,” we haverecorded the fair value of liabilities for asset retirement obligations in theperiods in which they are incurred and corresponding increases in the carryingamounts of the related long-lived assets. The asset retirement costs aresubsequently allocated to expense using a systematic and rational method andthe liabilities are accreted to measure the change in liability due to thepassage of time. The provisions of this standard primarily apply todismantlement and site restoration of certain of our plants and pipelines.During the six months ended June 30, 2007, we incurred asset retirementobligations on new and existing plant and compressor locations under lease. Wehave also evaluated existing asset retirement obligations and have maderevisions in the carrying values as of June 30, 2007.

The followingtable summarizes our activity related to asset retirement obligations for theindicated period:
| Asset retirement obligation,  January 1, 2007 |   | $    | 2,196  |   |
|----------------------------------------------------|--------|------|--------|--------|
| Add: additions  on leased locations                |   | 588  |   |
| Revisions of  prior estimates                      |   | (142 | )      |
| Add: accretion  expense                            |   | 53   |   |
| Asset retirement  obligation, June 30, 2007        |   | $    | 2,695  |   |

 

***Minority Interests***

The minorityinterest on our consolidated balance sheets as of June 30, 2007 and December31, 2006 reflects the outside ownership interest of Hiland Partners. Minorityinterest in income is calculated by multiplying the minority interest owners’proportionate ownership of limited partner units in Hiland Partners by thelimited partners’ allocation of Hiland Partners’ net income. Hiland Partners’net income is allocated to its limited partners and its general partner basedon the proportionate share of the contractually-determined cash distributionsfor the period, with adjustments made for incentive distributions specificallyallocated to its general partner. All amounts we have received from HilandPartners’ issuance and sale of limited partner units have been recorded asincreases to the minority interest balance on the consolidated balance sheet.

***Contributions toSubsidiary***

The Partnershipdirectly and indirectly owns all of the equity interests in Hiland Partners GP,LLC, the general partner of Hiland Partners. Hiland Partners GP, LLC may electto make contributions to Hiland Partners each time Hiland Partners issuescommon units in order to maintain its 2% general partner ownership in HilandPartners. Hiland Partners GP, LLC contributed to Hiland Partners $1 and $2 forthe three months ended June 30, 2007 and 2006, respectively and $21 and $20 forthe six months ended June 30, 2007 and 2006, respectively to maintain its 2%general partner ownership.

***Share-Based Compensation***

***Hiland Holdings GP, LP Long Term Incentive Plan***

Hiland HoldingsGP, the general partner of Hiland Holdings, adopted the Hiland Holdings GP, LPLong-Term Incentive Plan for its employees and directors of its general partnerand employees of its affiliates. The long-term incentive plan consists of threecomponents: unit options, restricted units and phantom units. The long-termincentive plan limits the number of units that be delivered pursuant to awardsto 2,160,000 units. The plan is administered by our general partner’s board ofdirectors or its compensation committee. The plan will expire upon the first tooccur of its termination by the board of directors or the compensationcommittee, the date when no units remain available under the plan for awards orthe tenth anniversary of the date the plan is approved by our unitholders.Awards then outstanding will continue pursuant to the terms of their grants.

Our generalpartner’s board of directors or the compensation committee may terminate oramend the long-term incentive plan at any time with respect to any units forwhich a grant has not yet been made. Our board of directors and thecompensation committee of the board also have the right to alter or amend thelong-term incentive plan or any part of the plan from time to time, includingincreasing the number of units that may be granted subject to unitholderapproval as may be required by applicable law or stock exchange rules. However,no change in any outstanding grant may be made that would materially reduce thebenefits of the participant without the consent of the participant. Under theunit option grant agreement, granted options of common units will vest andbecome exercisable in one-third increments on the anniversary of the grant dateover three years. Vested options are exercisable within the option’scontractual life of ten years after the grant date.  Our restricted and phantom units vest inone-quarter increments on the anniversary of the grant date over four years.

InOctober 1995, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 123, “Share-Based Payment,” which was revised inDecember 2004 (“SFAS 123R”). SFAS 123R requires that the compensation costrelating to share-based payment transactions be recognized in the financialstatements and that cost be measured based on the fair value of the equity orliability instruments issued. We adopted SFAS 123R effectiveJanuary 1, 2006 and have used the permitted modified prospective method

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beginning as of the samedate.

No options wereissued or are outstanding for the three or six months ended June 30, 2007.

No phantom unitswere issued or are outstanding for three or six moths ended June 30, 2007.

We issued norestricted units during the three or six months ended June 30, 2007. As of June30, 2007 and December 31, 2006, we had 12,000 restricted common units with aweighted average fair value at grant date of $20.00 per restricted unitoutstanding. A restricted unit is a common unit that is subject to forfeiture.Upon vesting, the grantee receives a common unit that is not subject toforfeiture. The restricted units vest over a four-year period from the date ofissuance. Periodic distributions on the restricted units are held in trust byour general partner until the units vest. As provided for in the long-termincentive plan, each non-employee board member of Hiland Partners GP Holdings,LLC on each anniversary date of the initial reward is entitled to receive anadditional 1,000 restricted common units. As of June 30, 2007, none of therestricted units had vested. Compensation expense related to the 12,000restricted units issued is to be recognized over their respective four-yearvesting period on the graded vesting attribution method. During the three andsix months ended June 30, 2007, we recorded $32 and $63, respectively ofexpense related to the 12,000 restricted units issued and will expense another$161 over the next four years.

OnFebruary 15, 2005, Hiland Partners GP, LLC issued member basedcompensation awards with a fair value of $118 to two of its members, RandyMoeder, our former Chief Executive Officer, President and director of ourgeneral partner and Ken Maples, our Chief Financial Officer, VicePresident-Finance, Secretary and director of our general partner as compensationfor services to be rendered exclusively for Hiland Partners GP, LLC’s benefit.In connection with the closing of our initial public offering, theseClass B member interests were exchanged for a calculated number of ourClass B common units, which had equal fair value. The Class B common unitsvest over a three-year period from the date of issuance. The Class Bcommon units have substantially the same rights as the common units and, uponvesting, become convertible at the election of the holder into common units.Member based compensation expense related to the Class B common units was$93 and $8 for three months ended June 30, 2007 and 2006, respectively and $347and $16 for the six months ended June 30, 2007 and 2006, respectively.

On March 14, 2007,Mr. Moeder announced his intention to resign. In connection with Mr. Moeder’sresignation, we and our general partner entered into a retention agreement withMr. Moeder that allowed Mr. Moeder to continue his employment for a mutuallyagreeable period of time, but no longer than six months. Under the agreement,as long as Mr. Moeder continued his employment, a pro rata portion of his72,249 unvested Class B common units in us would vest. The Class B common unitsthat did not vest would be forfeited to Hiland Holdings and distributed prorata to Harold Hamm, The Harold Hamm DST Trust, The Harold Hamm HJ Trust andKen Maples. Accordingly, as required by SFAS 123R “Share-Based Payment,” asamended, on March 14, 2007 we recalculated the fair value of the remainingunvested Class B common units as a modification of the units awarded to Mr.Moeder on February 15, 2005. We used the American Binomial option pricing modeland recalculated the fair value of the unvested Class B common units at $30.32per unit.

On April 16, 2007,Mr. Moeder resigned and 11,877 of his 72,249 unvested Class B common unitsvested and converted to common units. As a result of the recalculated fairvalue of $30.32 per unit, we recorded an additional $343 of expense for theperiod from March 15, 2007 through April 16, 2007. On the same day, Mr. Moederforfeited the remaining 60,372 unvested Class B common units.

***Hiland Partners, LP Long Term Incentive Plan***

Hiland PartnersGP, LLC, the general partner of Hiland Partners adopted the Hiland Partners, LPLong-Term Incentive Plan for its employees and directors of its general partnerand employees of its affiliates. The long-term incentive plan currently permitsan aggregate of 680,000 of Hiland Partners common units to be issued withrespect to unit options, restricted units, and phantom units granted under theplan. No more than 225,000 of the 680,000 common units may be issued withrespect to vested restricted or phantom units. The plan is administered by thecompensation committee of Hiland Partners GP, LLC’s board ofdirectors. The plan will continue in effect until the earliest of(i) the date determined by the board of directors of the general partner;(ii) the date that common units are no longer available for payment ofawards under the plan; or (iii) the tenth anniversary of the plan.

Hiland PartnersGP, LLC’s board of directors or compensation committee may, in theirdiscretion, terminate, suspend or discontinue the long-term incentive plan atany time with respect to any units for which a grant has not yet been made.Hiland Partners GP, LLC’s board of directors or its compensation committee alsohas the right to alter or amend the long-term incentive plan or any part of theplan from time to time, including increasing the number of units that may begranted, subject to unitholder approval if required by the exchange upon whichthe common units are listed at that time. No change in any outstanding grantmay be made, however, that would materially impair the rights of theparticipant without the consent of the participant. Under the unit option grantagreement, granted options of common units will vest and become exercisable inone-third increments on the anniversary of the grant date over three years.Vested options are exercisable within the option’s contractual life of tenyears after the grant date. Restricted and phantom units vest in one-quarterincrements on the anniversary of the grant date over four years.

SFAS 123Rrequires that the compensation cost relating to share-based payment transactionsbe recognized in the financial statements and that cost be measured based onthe fair value of the equity or liability instruments issued. Hiland Partnersadopted

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SFAS 123R as ofJanuary 1, 2006 and applied SFAS 123R using the permitted modifiedprospective method beginning as of the same date. Hiland Partners expects nochange to its cash flow presentation from the adoption of SFAS 123R sinceno tax benefits are recognized by them as a pass through entity. HilandPartners’ compensation expense for these awards is recognized onthe graded vesting attribution method. Units to be issued under HilandPartners’ unit incentive plan may be from newly issued units. Prior to HilandPartners’ adoption of SFAS 123R on January 1, 2006, Hiland Partnersapplied Accounting Principles Board Opinion No. 25 and relatedinterpretations in accounting for their unit-based compensation awards.

On June 19, 2007,Hiland Partners granted 10,000 phantom units under its Long-Term Incentive Planto the new Chief Executive Officer, Joseph L. Griffin. A phantom unit is acommon unit that is subject to forfeiture and is not considered issued until itvests. Upon vesting, Mr. Griffin will receive a common unit that is not subjectto forfeiture, cash in lieu of the delivery of such unit equal to the fairmarket value of the unit on the vesting date, or a combination thereof, at thediscretion of Hiland Partners general partner’s board of directors. Similar torestricted units, the phantom units vest over a four-year period from the dateof issuance and distributions on the phantom units will be held in trust byHiland Partners general partner until the units vest. During the three monthsended June 30, 2007, Hiland Partners incurred compensation expense of $9related to the phantom units and will recognize additional expense of $536 overthe next four years.  Hiland Partners hadnot granted any phantom units prior to June 19, 2007.

Hiland Partnersdid not grant any unit options during the three months ended June 30, 2007 or2006. The fair value of each option granted during the six months ended June30, 2006 were estimated on the date of grant using the American Binomial optionpricing model that used expected volatility ranges from 16.1% to 20.2%, aweighted-average volatility of 18.0%, an expected dividend yield of 5.2% and arisk-free interest rate of 4.5%. Expected and weighted-average volatility wasbased on peer group volatility averages as determined on the option grantdates. Expected lives of 6.0 years are calculated by the simplified method asprescribed under SEC Staff Accounting Bulletin 107 and represented the periodof time that unit options granted are expected to be outstanding. The risk-freeinterest rate for periods within the contractual life of the option is based onthe U.S. Treasury yield in effect at the time of grant. The exercise price ofthe options granted equaled the market price of the units on the grant date.

The followingtable summarizes information about outstanding options with respect to HilandPartners’ common units for the six months ended June 30, 2007:
| Options                              | ** ** | **Units** | ** ** | **Weighted  Average  Exercise  Price ($)** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value  ($)** | ** ** |
|--------------------------------------|------------|-----------|------------|-------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------|------------|
| Outstanding at  January 1, 2007 |       | 128,468   |       | $                                               | 28.24      |                                                 |       |                                 |       |   |
| Granted                              |       | —    |       | $                                               | —     |                                                 |       |                                 |       |   |
| Exercised                            |       | (42,362   | )          | $                                               | 22.50      |                                                 |       |                                 | $          | 1,394 |   |
| Forfeited or  expired                |       | (9,767    | )          | $                                               | 22.50      |                                                 |       |                                 |       |   |
| Outstanding at  June 30, 2007        |       | 76,339    |       | $                                               | 31.24      |                                                 | 8.2        |                                 | $          | 1,776 |   |
| Exercisable at June 30,  2007        |       | 12,671    |       | $                                               | 15.01      |                                                 | 8.4        |                                 | $          | 297 |   |

 

In connection withMr. Moeder’s resignation (see also Hiland Holdings GP, LP Long Term IncentivePlan above), on March 14, 2007, Mr. Moeder’s 10,666 unvested Hiland Partners’options to purchase Hiland Partners common units would vest pro rata as long asMr. Moeder continued his employment. Accordingly, as required by SFAS 123R “Share-BasedPayment,” as amended, on March 14, 2007, Hiland Partners recalculated the fairvalue of the remaining unvested options to purchase Hiland partners commonunits as a modification of the options awarded to Mr. Moeder on February 10,2005. The recalculated fair value of the options of $33.65 per unit, determinedby using the American Binomial option pricing model, equaled the differencebetween Hiland Partners’ closing price of $56.15 per unit on March 14, 2007 andthe Hiland Partners’ exercise price of $22.50 per unit granted to Mr. Moeder onFebruary 10, 2005.

On April 16, 2007,Mr. Moeder resigned and 1,899 of his 10,666 unvested Hiland Partners’ optionsto purchase Hiland Partners’ common units vested. As a result of therecalculated fair value of $33.65 per unit, Hiland Partners recorded anadditional $24 of expense for the period from March 15, 2007 through April 16,2007. On the same day, Mr. Moeder forfeited his remaining 8,767 unvested HilandPartners unit options. The forfeiture of Mr. Moeder’s 8,767 unvested unitoptions reduced compensation expense for the period from April 1, 2007 throughApril 16, 2007 by $16. On April 19, 2007, Mr. Moeder exercised his 1,899 vestedoptions to purchase Hiland Partners common units.

As a result ofadopting SFAS 123R on the modified prospective basis beginning onJanuary 1, 2006, during the three months ended June 30, 2007 and 2006,Hiland Partners expensed $39 and $92, respectively and during the six monthsended June 30, 2007 and 2006, Hiland Partners expensed $97 and $179,respectively all related to unit options that were awarded in both 2006 and2005.

Hiland Partnersissued no restricted units during the three or six months ended June 30, 2007. As of June 30, 2007 and December 31, 2006, Hiland Partners had 19,000restricted common units with a weighted average fair value at grant date of$44.12 per restricted

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unit outstanding. Arestricted unit is a common unit that is subject to forfeiture. The restrictedunits vest over a four-year period from the date of issuance. Periodicdistributions on the restricted units are held in trust by Hiland Partners GP,LLC until the units vest. Upon vesting, the grantee receives a common unit thatis not subject to forfeiture. Each non-employee board member of Hiland PartnersGP, LLC is entitled to receive an additional 1,000 restricted common units oneach anniversary date of the initial award.

Total compensationexpense related to phantom and restricted units was $129 and $19 for the threemonths ended June 30, 2007 and 2006, respectively and $248 and $39 for the sixmonths ended June 30, 2007 and 2006, respectively. As of June 30, 2007, therewas $1,067 of total unrecognized compensation cost related to Hiland Partners’unvested phantom and restricted units granted. This cost is to be recognizedover a weighted average period of 1.8 years.

***Recent AccountingPronouncements***

InFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value Optionfor Financial Assets and Financial Liabilities”. SFAS No. 159 expandsopportunities to use fair value measurement in financial reporting and permitsentities to choose to measure many financial instruments and certain otheritems at fair value. SFAS No. 159 is effective for fiscal years beginningafter November 15, 2007. We have not decided if we will choose to measureany eligible financial assets and liabilities at fair value.

InSeptember 2006, the FASB issued SFAS No. 157 “Fair ValueMeasurements.”  SFAS No. 157 defines fair value as the price thatwould be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants at the measurement date,establishes a framework for measuring fair value in generally accepted accountingprinciples (GAAP) such as fair value hierarchy used to classify the source ofinformation used in fair value measurements (i.e., market based or non-marketbased) and expands disclosure about fair value measurements based on theirlevel in the hierarchy. This Statement applies to derivatives and otherfinancial instruments, which Statement 133,*Accounting for Derivative Instruments and Hedging Activities*, asamended, requires be measured at fair value at initial recognition and for allsubsequent periods. This Statement is effective for financial statements issuedfor fiscal years beginning after November 15, 2007 and interim periodswithin those fiscal years. We will apply the provisions of the Statementprospectively in our first interim period in the fiscal year beginning onJanuary 1, 2008 and we do not expect a change in our methodologies of fairvalue measurements.

**Note 2: Initial Public Offering**

On May 26,2006, a Registration Statement on Form S-1 was filed with the SEC relatingto a proposed initial public offering of limited partnership interests inHiland Holdings. On September 13, 2006, the SEC declared our registrationstatement on Form S-1 effective. On September 19, 2006, we priced7,000,000 common units in connection with our initial public offering at aprice of $18.50 per unit. On September 20, 2006, our common units begantrading on the NASDAQ National Market under the symbol “HPGP.” OnSeptember 25, 2006, we closed our initial public offering of 8,050,000common units, which included 1,050,000 common units issued pursuant to anover-allotment option that was exercised by the underwriters. Total proceedsfrom the sale of the units were $139.6 million, net of $9.3 million ofunderwriting commissions.

In connection withthe closing of our initial public offering, all of the membership interests inHiland Partners GP, LLC (which owns the 2% general partner interest and all ofthe incentive distribution rights in Hiland Partners), 1,301,471 HilandPartners common units (including 761,714 Hiland Partners common unitspreviously owned by Hiland Partners GP, LLC) and 4,080,000 subordinated unitsof Hiland Partners were contributed to us, resulting in our ownership of a57.0% limited partner interest in Hiland Partners. Contributions of Hiland PartnersGP, LLC’s assets are reflected at their historical carrying basis because thecontributions are from a related party. As consideration for this contribution,substantially all of the net proceeds from our initial public offering, afterthe retirement of $36.0 million of outstanding debt and accrued interest ofHiland Partners GP, LLC, were distributed to Harold Hamm, The Harold Hamm DSTTrust, The Harold Hamm HJ Trust, Randy Moeder and Ken Maples (the “ContributingParties”) and 13,550,000 common units and Class B common units in us wereissued to the Contributing Parties.

**Note 3: Acquisition**

*KintaArea Gathering System*.   On May 1, 2006,Hiland Partners acquired certain gas gathering assets from Enogex GasGathering, L.L.C. for $96.4 million cash, including certain closing costs,financed with borrowings under its credit facility and an additional notepayable to a bank. We refer to these assets as the Kinta Area gathering assets.A determination was made by our management of the fair value of these assetsand liabilities primarily using current replacement cost for the acquired gasgathering assets and related equipment less estimated accumulated depreciationon such replacement costs and estimated discounted cash flows arising fromfuture renegotiated customer contracts. The acquired assets, which are locatedin the eastern Oklahoma Arkoma Basin, have approximately 672 wellhead receiptpoints and include five separate low pressure natural gas gathering systemsconsisting of 569 miles of natural gas gathering pipelines and 23 compressorunits capable of nearly 40,000 horsepower of compression. The natural gasgathering systems operate under contracts with producers that provide forservices under fixed-fee arrangements. Hiland Partners operates the Kinta Areagathering assets substantially differently than they were operated by theprevious owner. Since there was no sufficient continuity of the Kinta Areagathering assets’ operations prior to and after the acquisition, disclosure ofprior financial information would not be material to an understanding of futureoperations. Therefore, the acquisition has been recorded as a purchase ofassets and not a business, and no pro forma financial information is requiredto be presented.

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The followingtable presents the resulting allocation to the net assets acquired andliabilities assumed on May 1, 2006:
| Pipelines, including right  of ways  |   | $      | 56,175 |   |
|--------------------------------------|--------|--------|--------|--------|
| Compressors                          |   | 22,221 |   |
| Other equipment  and buildings       |   | 8,618  |   |
| Customer  relationships              |   | 10,492 |   |
|                                 |   | 97,506 |   |
| Asset retirement  obligation assumed |   | 1,106  |   |
| Net assets acquired                  |   | $      | 96,400 |   |

 

The Kinta Areagathering assets and operations are included in the consolidated financialstatements from May 1, 2006 forward.

**Note 4: Property andEquipment**
|                                                  | ** ** | **As of  June 30,  2007** | ** ** | **As of  December 31,  2006** | ** ** |
|--------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------------|------------|
| Land                                             |       | $                                   | 267        |                                    | $          | 255 |   |
| Construction in  progress                        |       | 63,036                              |       | 48,610                                  |       |
| Midstream pipeline,  plants and compressors      |       | 259,048                             |       | 230,645                                 |       |
| Compression and water  injection equipment       |       | 19,270                              |       | 19,270                                  |       |
| Other                                            |       | 3,403                               |       | 2,471                                   |       |
|                                             |       | 345,024                             |       | 301,251                                 |       |
| Less: accumulated  depreciation and amortization |       | 55,503                              |       | 44,248                                  |       |
|                                             |       | $                                   | 289,521    |                                    | $          | 257,003 |   |

 

On May 10,2006, Hiland Partners GP, LLC purchased 761,714 common units and 15,545 generalpartner units of Hiland Partners for $35.0 million. Hiland Partners GP,LLC recorded additional pipeline and processing plant cost of $4,488 for aportion of the amount that the unit purchase price exceeded the proportionateinterest in the underlying equity of Hiland Partners.

During the threeand six months ended June 30, 2007 we capitalized interest of $784 and $1,453,respectively. During the three and six months ended June 30, 2006 wecapitalized interest of $239 and $340, respectively.

**Note 5: Derivatives**

Hiland Partnershas entered into certain financial swap instruments that are classified as cashflow hedges in accordance with SFAS No. 133, as amended, and relate toforecasted sales in 2007, 2008 and 2009. Hiland Partners entered into theseinstruments to hedge forecasted natural gas and natural gas liquids (NGLs)sales or purchases against the variability in expected future cash flowsattributable to changes in commodity prices. Under all but one of thesecontractual swap agreements with Hiland Partners’ counterparties, HilandPartners receives a fixed price and pays a floating price based on certainindices for the relevant contract period as the underlying natural gas or NGLis sold. In one agreement, Hiland Partners pays a fixed price and receives a floatingprice based on certain indices for the relevant contract period as theunderlying natural gas is purchased. Hiland Partners has also entered into onefinancial swap instrument that currently does not qualify for hedge accountingas discussed below.

Hiland Partnersformally documents all relationships between hedging instruments and the itemsbeing hedged, including its risk management objective and strategy forundertaking the hedging transactions. This includes matching the natural gasand NGL futures, the “sold fixed for floating price” or “buy fixed for floatingprice” contracts, to the forecasted transactions. Hiland Partners assesses,both at the inception of the hedge and on an ongoing basis, whether thederivatives are highly effective in offsetting changes in the fair value ofhedged items. A derivative is deemed to be highly effective when changes in itscash flows correlate within a range of 80% to 125% to offsetting cash flows ofthe hedged transaction. If it is determined that a derivative is not highlyeffective as a hedge or it has ceased to be a highly effective hedge, due tothe loss of correlation between changes in natural gas or NGL reference pricesunder a hedging instrument and actual natural gas or NGL prices, HilandPartners will discontinue hedge accounting for the derivative and subsequentchanges in fair value for the derivative will be recognized immediately intoearnings. Hiland Partners assesses effectiveness using regression analysis andineffectiveness using the dollar offset method.

Derivatives arerecorded on our consolidated balance sheet as assets or liabilities at fairvalue. For derivatives qualifying as hedges, the effective portion of changesin fair value are recognized in owners’ equity as accumulated other comprehensiveincome and reclassified to earnings when the underlying hedged physicaltransaction closes. Changes in fair value of non-qualifying derivatives and theineffective portion of qualifying derivatives are recognized in earnings asthey occur. Actual amounts that will be reclassified will vary as a result offuture changes in prices. Hedge ineffectiveness is recognized as an adjustmentto midstream revenue while the hedge contract is open and may increase ordecrease until settlement of the contract. Realized cash gains and losses onclosed/settled instruments are reflected in the contract month being hedged asan adjustment to midstream revenues.

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On May 9, 2007,Hiland Partners entered into a financial swap instrument with BP Energy Companyrelated to forecasted sales in 2008 whereby we receive a fixed price and pay afloating price based on certain indices for the relevant contract period as theunderlying natural gas is sold. This financial swap instrument is classified asa cash flow hedge in accordance with SFAS No. 133, as amended.

On March 15, 2007Hiland Partners entered into two separate financial swap instruments with BPEnergy Company that relate to forecasted sales in 2009. In one instrumentHiland Partners receives a fixed price and pays a floating price based oncertain indices for the relevant contract period as the underlying natural gasis sold. This financial swap instrument is classified as a cash flow hedge inaccordance with SFAS No. 133, as amended. In the other instrument, currentlydesignated as an open trade, Hiland Partners receives a NYMEX index price lessa basis differential and pays a floating price based on certain indices for therelevant contract period as the underlying natural gas is sold. The open tradefinancial swap instrument has not been designated as a hedge. The forecastednon-cash unrealized gain on the open trade financial swap instrument has beenrecorded as an increase in midstream revenues in the current period.

During the threeand six months ended June 30, 2007, we reclassified net gains of $503 and $835on closed/settled hedge transactions to midstream revenues out of accumulatedother comprehensive income and also recorded $39 into accumulated othercomprehensive income for increase in fair value of open derivatives for thethree months ended June 30, 2007 and for the six months ended June 30, 2007, werecorded $793 out of accumulated other comprehensive income for the decrease infair value of open derivatives. Included in minority interest on the balance sheetis $1,156 of the changes in the net fair value of derivatives during the sixmonths ended June 30, 2007 attributable to minority interest. During the threeand six months ended June 30, 2007, Hiland Partners recorded a gain of $98 and$181, respectively on the non-qualifying open trade financial instrument andgains of $4 and $103, respectively on the ineffective portions of qualifyingopen derivative transactions. At June 30, 2007, our accumulated othercomprehensive income related to derivatives was $939. Of this amount weanticipate $744 will be reclassified to earnings during the next 12 months and$195 will be reclassified to earnings in subsequent periods.

During the threeand six months ended June 30, 2006, we reclassified net gains of $149 on closed/settledhedge transactions to midstream revenues out of accumulated other comprehensiveincome and also recorded $179 and $183, respectively into accumulated othercomprehensive income for the favorable change in fair value of openderivatives. For the same period, we recorded $549 to minority interest on theconsolidated balance sheet related to changes in the net fair value of openderivatives. Included in midstream revenues from third parties for the threeand six months ended June 30, 2006 is a realized non-cash gain of $82 and $164resulting from the ineffective portions of qualifying open derivativetransactions. At June 30, 2006 accumulated other comprehensive income relatedto derivatives was $55.

The fair value ofderivative assets and liabilities are as follows for the indicated periods:
|                                                      | ** ** | **As of  June 30,  2007** | ** ** | **As of  December 31,  2006** | ** ** |
|------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------------|------------|
| Fair value of  derivative assets—current        |       | $                                   | 3,760      |                                    | $          | 4,707 |   |
| Fair value of  derivative assets—long term      |       | 938                                 |       | 1,955                                   |       |
| Fair value of  derivative liabilities—current   |       | (2,455                              | )          | (1,902                                  | )          |
| Fair value of  derivative liabilities—long term |       | (387                                | )          | (291                                    | )          |
| Net fair value of  derivatives                       |       | $                                   | 1,856      |                                    | $          | 4,469 |   |

 

 The terms ofour derivative contracts currently extend out as far as December 2009. Thecounterparties to all derivative contracts are BP Energy Company and BPCorporation North America, Inc. Set forth below is the summarized notionalamount and terms of all instruments held for price risk management purposes atJune 30, 2007.

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| Description and Production Period                  | ** ** | **Volume**  | ** ** | **Average  Fixed Price** | ** ** | **Fair Value  Asset  (Liability)** | ** ** |
|-------------------------------------------------------------------|------------|-------------|------------|-------------------------------|------------|-----------------------------------------|------------|
|                                                              |       |        |       |                          |       |                                    |       |
| **Natural Gas—Sold Fixed for  Floating Price Swaps**         | ** ** | ** **  | ** ** | ** **                    | ** ** | ** **                              | ** ** |
| ** **                                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**               | ** ** | ** **                              | ** ** |
| July 2007 -  June 2008                                  |       | 1,800,000   |       | $                             | 7.92       |                                    | $          | 3,760 |   |
| July 2008-December 2008                                           |       | 990,000     |       | 7.84                          |       | 756                                     |       |
| January 2009 -  December 2009                           |       | 1,068,000   |       | $                             | 7.06       |                                    | (387       | ) |
|                                                              |       |        |       |                          |       | $                                       | 4,129      |   |
| ** **                                                        | ** ** | ** **  | ** ** | ** **                    | ** ** | ** **                              | ** ** |
| **Natural Gas - Sold Open for  Floating Price Swaps**             | ** ** | ** **  | ** ** | ** **                    | ** ** | ** **                              | ** ** |
| ** **                                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**               | ** ** | ** **                              | ** ** |
| January 2009 - December  2009                                     |       | 1,068,000   |       | $                             | 7.42       |                                    | $          | 182 |   |
|                                                              |       |        |       |                          |       |                                    |       |
| **Natural Gas—Buy Fixed for  Floating Price Swaps**          | ** ** | ** **  | ** ** | ** **                    | ** ** | ** **                              | ** ** |
| ** **                                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**               | ** ** | ** **                              | ** ** |
| July 2007 -  March 2008                                      |       | 450,000     |       | $                             | 8.87       |                                    | $          | (954 | ) |
|                                                              |       |        |       |                          |       |                                    |       |
| **Natural Gas Liquids—Sold Fixed  for Floating Price Swaps** | ** ** | ** **  | ** ** | ** **                    | ** ** | ** **                              | ** ** |
| ** **                                                        | ** ** | **(Bbls)**  | ** ** | **(per Gallon)**              | ** ** | ** **                              | ** ** |
| July 2007 - March 2008                                  |       | 114,489     |       | $                             | 1.13       |                                    | $          | (1,501 | ) |

 

**Note 6: Long-TermDebt**
|                                            | ** ** | **As of  June 30,  2007** | ** ** | **As of  December 31,  2006** | ** ** |
|--------------------------------------------|------------|-------------------------------------|------------|-----------------------------------------|------------|
| Hiland  Holdings-Revolving Credit Facility |       | $                                   | 355        |                                    | $          | 254 |   |
| Hiland  Partners-Revolving Credit Facility |       | 177,564                             |       | 147,064                                 |       |
| Long-Term Debt                             |       | $                                   | 177,919    |                                    | $          | 147,318 |   |

 

***Hiland Holdings***

OnSeptember 25, 2006, concurrently with the closing of our initial publicoffering, the Partnership entered into a three-year $25.0 million securedrevolving credit facility. The facility will permit us, if certain conditionsare met, to increase borrowing capacity by up to an additional $25.0 million.The facility is secured by all of our ownership interests in Hiland Partnersand its general partner, other than the 2% general partner interest and the incentivedistribution rights. The facility will mature on September 25, 2009 atwhich time all outstanding amounts thereunder become due and payable.

Indebtedness underthe facility bears interest, at our option, at either (i) an alternatebase rate plus an applicable margin ranging from 100 to 150 basis points perannum or (ii) LIBOR plus an applicable margin ranging from 200 to 250basis points per annum in each case based on our ratio of consolidated fundeddebt to EBITDA. The alternate base rate is equal to the greatest of(a) the prime rate in effect on such day, (b) the base CD rate ineffect on such day plus 1.50% and (c) the federal funds effective rate ineffect on such day plus   1 / 2   of 1%. A letter of credit fee willbe payable for the aggregate amount of letters of credit issued under thefacility at a percentage per annum equal to 2.0%. A commitment fee ranging from25 to 50 basis points per annum based on our ratio of consolidated funded debtto EBITDA will be payable on the average daily unused portion of the facilityfor the quarter most recently ended. At June 30, 2007, the interest rate onoutstanding borrowings from our credit facility was 7.32%.

The facilitycontains several covenants that, among other things, require the maintenance oftwo financial performance ratios, restrict the payment of distributions tounitholders, and require financial reports to be submitted periodically to thefinancial institutions. The credit facility also contains covenants requiring amaximum consolidated funded debt to EBITDA ratio of 3.0:1.0 for the four fiscalquarters most recently ended and a minimum interest coverage ratio of 3.0:1.0.

The amount we mayborrow under the facility is limited to the lesser of: (i) 50% of the sumof the value of the Hiland Partners common and subordinated units and certainother assets held by us and certain of our subsidiaries at the end of eachfiscal quarter and (ii) the maximum available amount of the facility(currently $25.0 million).

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The facilityprohibits us from making distributions to unitholders if any default or eventof default, as defined in the credit facility, has occurred and is continuingor would result from the distribution. In addition, the facility containsvarious covenants that limit, among other things, subject to certain exceptionsand negotiated “baskets,” our ability to incur indebtedness, grant liens, enterinto agreements restricting our ability to grant liens on our assets or amendthe facility, make certain loans, acquisitions and investments or enter into amerger, consolidation or sale of assets.

The facilitylimits distributions to our unitholders to our available cash, as defined inour partnership agreement. Restricted payments under the facility are subjectto an annual “clean-down” period of 15 consecutive days in which the amountoutstanding that relates to funding the restricted payments under the facilitymust be reduced to zero.

As of June 30,2007, we had $0.4 million outstanding under this credit facility and werein compliance with our financial covenants.

***Hiland Partners***

On July 13, 2007,Hiland Partners entered into a third amendment to its credit agreement dated asof February 15, 2005. Pursuant to the amendment, Hiland Partners may, amongother things, increase its borrowing base from $200 million to $250 million anddecrease the accordion feature in the facility from $150 million to $100million.

The amendmentincreased Hiland Partners borrowing capacity under its senior secured revolvingcredit facility to $250 million such that the facility now consists of a $241million senior secured revolving credit facility to be used for fundingacquisitions and other capital expenditures, issuance of letters of credit andgeneral corporate purposes (the “Acquisition Facility”) and a $9.0 millionsenior secured revolving credit facility to be used for working capital and tofund distribution (the “Working Capital Facility”).

In addition, theamendment provides for an accordion feature, which permits Hiland Partners ifcertain conditions are met, to increase the size of the Acquisition Facility byup to $100 million and allows for the issuance of letters of credit of up to$15 million in the aggregate.  The senior secured revolving creditfacility also requires Hiland Partners to meet certain financial tests,including a maximum consolidated funded debt to EBITDA ratio of 4.0:1.0 as ofthe last day of any fiscal quarter; provided that in the event that thePartnership makes certain permitted acquisitions or capital expenditures, thisratio may be increased to 4.75:1.0 for the three fiscal quarters following thequarter in which such acquisition or capital expenditure occurs; and a minimuminterest coverage ratio of 3.0:1.0.

On June 8,2006, Hiland Partners entered into a second amendment to their credit facilityto, among other things, increase its borrowing base from February 15, 2005original borrowing base of $55.0 million, first amended on September 26, 2005to $125.0 million, to $200 million and revise certain covenants. Thecredit facility will mature in May 2011. At that time, the agreement willterminate and all outstanding amounts thereunder will be due and payable.

Hiland Partners’obligations under the credit facility are secured by substantially all of itsassets and guaranteed by Hiland Partners, and all of its subsidiaries, otherthan Hiland Operating, LLC its operating company, which is the borrower underthe credit facility.

Indebtedness underthe credit facility will bear interest, at Hiland Partners’ option, at either(i) an alternate base rate plus an applicable margin ranging from 50 to125 basis points per annum or (ii) LIBOR plus an applicable margin rangingfrom 150 to 225 basis points per annum based on our ratio of consolidatedfunded debt to EBITDA. The Alternate Base Rate is a rate per annum equal to thegreatest of (a) the Prime Rate in effect on such day, (b) the base CDrate in effect on such day plus 1.50% and (c) the Federal Funds effectiverate in effect on such day plus 1⁄2 of 1%. A letter of credit fee will be payablefor the aggregate amount of letters of credit issued under the credit facilityat a percentage per annum equal to 1.0%. An unused commitment fee ranging from25 to 50 basis points per annum based on our ratio of consolidated funded debtto EBITDA will be payable on the unused portion of the credit facility. Duringany step-up period, the applicable margin with respect to loans under thecredit facility will be increased by 35 basis points per annum and the unusedcommitment fee will be increased by 12.5 basis points per annum. At June 30,2007, the interest rate on outstanding borrowings from Hiland Partners’ creditfacility was 7.32%.

The creditfacility prohibits Hiland Partners from making distributions to unitholders ifany default or event of default, as defined in the credit facility, hasoccurred and is continuing or would result from the distribution. In addition,the credit facility contains various covenants that limit, among other things,subject to certain exceptions and negotiated “baskets,” our ability to incurindebtedness, grant liens, make certain loans, acquisitions and investments,make any material changes to the nature of its business, amend its materialagreements, including its Omnibus Agreement, which contains non-compete andindemnity provisions with affiliates, or enter into a merger, consolidation orsale of assets.

The creditfacility also contains covenants requiring Hiland Partners to maintain amaximum consolidated funded debt to EBITDA ratio of 4.0:1.0, provided that inthe event Hiland Partners makes certain permitted acquisitions or capitalexpenditures, the credit facility allows this ratio to increase to 4.75:1.0 forthe following three fiscal quarters (a “step-up period”) and a minimum interestcoverage ratio of 3.0:1.0.

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The creditfacility defines EBITDA as Hiland Partners’ consolidated net income, plusincome tax expense, interest expense, depreciation and amortization expense,amortization of intangibles and organizational costs, non-cash unit basedcompensation expense, and adjustments for non-cash gains and losses onspecified derivative transactions and for other extraordinary items.

Upon theoccurrence of an event of default as defined in the credit facility, thelenders may, among other things, be able to accelerate the maturity of thecredit facility and exercise other rights and remedies as set forth in thecredit facility.

The creditfacility limits distributions to Hiland Partners’ unitholders to availablecash, as defined by the agreement, 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 June 30,2007, Hiland Partners had $177.6 million outstanding under this creditfacility and was in compliance with its financial covenants.

***Hiland Partners GP, LLC***

On May 1,2006, Hiland Partners GP, LLC entered into an unsecured credit agreement underwhich it borrowed $35.0 million to purchase 761,714 common units and 15,545general partner units from Hiland Partners. The loan was guaranteed by allHiland Partners GP, LLC’s members and matured and was paid in full upon thecompletion of our initial public offering on September 25, 2006. HilandPartners GP, LLC’s board of directors, as well as the conflicts committee ofits board of directors, consisting of independent directors, approved thetransaction.

**Note 7: Commitments andContingencies**

Hiland Partnershas executed various natural gas fixed price physical forward sales contractson approximately 115,000 MMBtu per month for 2007 and 100,000 MMBtu per monthfor 2008 with fixed prices ranging from $4.49 to $9.13 per MMBtu in 2007 and$8.43 per MMBtu in 2008. These contracts have been designated as normal salesunder SFAS No. 133 and are therefore not marked to market as derivatives.A summary of the fixed price physical forward sales contracts is presented inthe table below:
| Production Period               | ** ** | **(MMBtu)** | ** ** | **Average  Fixed Price  (per MMBtu)** | ** ** |
|--------------------------------------|------------|-------------|------------|-------------------------------------------------|------------|
|                                 |       |        |       |                                            |       |
| July 2007 -  June 2008          |       | 1,290,000   |       | $                                               | 7.62       |   |
| July 2008 -  December 2008 |       | 600,000     |       | $                                               | 8.43       |   |

 

We maintain adefined contribution retirement plan for our employees under which we makediscretionary contributions to the plan based on a percentage of eligibleemployees’ compensation. Contributions to the plan are 5.0% of eligibleemployees’ compensation and resulted in expense for the three months ended June30, 2007 and 2006 of $64 and $46, respectively and expense for the six monthsended June 30, 2007 and 2006 of $127 and $87, respectively.

Prior to January1, 2007, we jointly participated with other affiliated companies in aself-insurance pool (the “Pool”) covering health and workers’ compensationclaims made by employees up to the first $150 and $500, respectively, perclaim. Any amounts paid above these were reinsured through third partyproviders. Premiums charged to us were based on estimated costs per employee ofthe Pool. Effective January 1, 2007, we obtained our own health and workers’compensation insurance through third-party providers Property and generalliability insurance is also maintained through third-party providers with a$100 deductible on each policy.

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

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

Hiland Partnersleases office space from a related entity (Please read Note 9). Hiland Partnersleases certain facilities, vehicles and equipment under operating leases, mostof which contain annual renewal options. Under these lease agreements, rentexpense was $495 and $182, for the three months ended June 30, 2007 and 2006,respectively and $1,009 and $356 for the six months ended June 30, 2007 and2006, respectively.

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OnNovember 8, 2005, Hiland Partners entered into a new 15-year definitivegas purchase agreement with Continental Resources, Inc. under which HilandPartners will gather, treat and process additional natural gas, which isproduced as a by-product of Continental Resources, Inc.’s secondary oilrecovery operations, in the areas specified by the contract. In order tofulfill the obligations under the agreement, Hiland Partners is expanding itsBadlands gas gathering system and processing plant located in Bowman County,North Dakota. This expansion project includes the construction of a40,000 Mcf/d nitrogen rejection plant and the expansion of the existingBadlands field gathering infrastructure. The expansion project, which beganoperations in the third quarter 2007, was initially expected to reach a totalcost of approximately $49.5 million. As of June 30, 2007, Hiland Partnershas invested $52.1 million in the expansion project and believe the totalinvestment will not exceed $56.0 million. Hiland Partners is currently fundingthis expansion project using its existing bank credit facility.

**Note 8: SignificantCustomers and Suppliers**

All of HilandPartners’ revenues are domestic revenues. The following table presents HilandPartners’ top midstream customers as a percent of total revenue for the periodsindicated:
|            | ** ** | **For the Three  Months Ended  June 30,** | ** ** | **For the Six  Months Ended  June 30,** | ** ** |
|------------|------------|---------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** ** | ** ** | **2007**                                                      | ** ** | **2006**                                                    | ** ** | **2007** | ** ** | **2006** | ** ** |
| Customer 1 |       | 21                                                            | %          | 21                                                          | %          | 25 | % | 20 | % |
| Customer 2 |       | 16                                                            | %          | 14                                                          | %          | 15 | % | 14 | % |
| Customer 3 |       | 11                                                            | %          | 15                                                          | %          | 14 | % | 16 | % |
| Customer 4 |       | 11                                                            | %          | 2                                                           | %          | 10 | % | 2 | % |
| Customer 5 |       | 10                                                            | %          | 11                                                          | %          | 6 | % | 11 | % |

 

All of HilandPartners’ purchases are from domestic sources. The following table presentsHiland Partners’ top midstream suppliers as a percent of total midstreampurchases for the periods indicated:
|                                  | ** ** | **For the Three  Months Ended  June 30,** | ** ** | **For the Six  Months Ended  June 30,** | ** ** |
|----------------------------------|------------|---------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                       | ** ** | **2007**                                                      | ** ** | **2006**                                                    | ** ** | **2007** | ** ** | **2006** | ** ** |
| Supplier 1  (affiliated company) |       | 27                                                            | %          | 33                                                          | %          | 27 | % | 34 | % |
| Supplier 2                       |       | 27                                                            | %          | 24                                                          | %          | 26 | % | 24 | % |
| Supplier 3                       |       | 13                                                            | %          | 13                                                          | %          | 14 | % | 14 | % |

 

**Note 9: Related PartyTransactions**

Hiland Partnerspurchases natural gas and NGLs from affiliated companies. Purchases of productfrom affiliates totaled $13.0 million and $12.1 million for the threemonths ended June 30, 2007 and 2006, respectively. Purchases of product fromaffiliates totaled $24.7 million and $26.4 million for the six monthsended June 30, 2007 and 2006, respectively. Hiland Partners also sells naturalgas and NGLs to affiliated companies. Sales of product to affiliates totaled$0.7 million and $1.0 million for the three months ended June 30, 2007 and2006, respectively. Sales of product to affiliates totaled $1.7 million and $2.3 millionfor the six months ended June 30, 2007 and 2006, respectively. Compressionrevenues from affiliates were $1.2 million for each of the three months endedJune 30, 2007 and 2006 and $2.4 million for each of the six months ended June30, 2007 and 2006.

Accountsreceivable-affiliates of $939 at June 30, 2007 include $859 from one affiliatefor midstream sales. Accounts receivable-affiliates of $1,284 atDecember 31, 2006, include $1,260 from one affiliate for midstream sales.

Accountspayable-affiliates of $4,975 at June 30, 2007 include $4,457 due to oneaffiliate for midstream purchases. Accounts payable-affiliates of $4,412 atDecember 31, 2006 include $3,819 payable to the same affiliate formidstream purchases

Hiland Partnersutilizes affiliated companies to provide services to its plants and pipelinesand certain administrative services. The total amount paid to these companieswas $180 and $57 during the three months ended June 30, 2007 and 2006,respectively. Amounts paid to these companies during the six months endedJune 30, 2007 and 2006 totaled $274 and $111, respectively.

Hiland Partnersleases office space under operating leases directly or indirectly from anaffiliate. Rents paid associated with these leases totaled $70 and $40 for thethree months ended June 30, 2007 and 2006, respectively. Rents paid associatedwith these leases totaled $102 and $65 for the six months ended June 30, 2007and 2006, respectively.

**Note 10: Reportable Segments**

Hiland Partnershas distinct operating segments for which additional financial information mustbe reported Hiland Partners’ operations are classified into two reportablesegments:

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(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 services forContinental Resources, Inc.’s oil and gas secondary recovery operationsthat are ongoing in North Dakota.

These segmentsreflect the way Hiland Partners manages its operations. Hiland Partners’operations are conducted in the United States. General and administrativecosts, which consist of executive management, accounting and finance,operations and engineering, marketing and business development, are allocatedto the individual segments based on revenues.

Midstream assetstotaled $354,005 at June 30, 2007. Assets attributable to compressionoperations totaled $29,612. All but $16 of the total capital expenditures of$43,294 for the six months ended June 30, 2007 was attributable to midstreamoperations.

The tables belowpresent information for the reportable segments for the three and six monthsended June 30, 2007 and 2006.
| ** **                                                       | ** ** | **For the Three Months Ended June 30,** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2007**                                                              | ** ** | **2006** | ** ** |
| ** **                                                       | ** ** | **Midstream**                                                         | ** ** | **Compression** | ** ** | **Total** | ** ** | **Midstream** | ** ** | **Compression** | ** ** | **Total** | ** ** |
| Revenues                                                         |       | $                                                                     | 65,411     |   | $ | 1,205 |   | $ | 66,616 |   | $ | 51,534 |   | $ | 1,205 |   | $ | 52,739 |   |
| Operating costs and  expenses:                                   |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Midstream purchases  (exclusive of items shown separately below) |       | 47,916                                                                |       | — |   | 47,916 |   | 36,821 |   | — |   | 36,821 |   |
| Operations and  maintenance                                      |       | 4,783                                                                 |       | 197 |   | 4,980 |   | 3,757 |   | 241 |   | 3,998 |   |
| Depreciation and  amortization                                   |       | 6,431                                                                 |       | 895 |   | 7,326 |   | 4,764 |   | 893 |   | 5,657 |   |
| General and  administrative expenses                             |       | 2,244                                                                 |       | 41 |   | 2,285 |   | 1,230 |   | 29 |   | 1,259 |   |
| Total operating costs  and expenses                              |       | 61,374                                                                |       | 1,133 |   | 62,507 |   | 46,572 |   | 1,163 |   | 47,735 |   |
| Operating income                                                 |       | $                                                                     | 4,037      |   | $ | 72 |   | 4,109 |   | $ | 4,962 |   | $ | 42 |   | 5,004 |   |
| Other income (expense):                                          |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Interest and other  income                                       |       |                                                                  |       |   |   | 93 |   |   |   |   |   | 79 |   |
| Amortization of  deferred loan costs                             |       |                                                                  |       |   |   | (110 | ) |   |   |   |   | (110 | ) |
| Interest expense                                                 |       |                                                                  |       |   |   | (2,314 | ) |   |   |   |   | (1,727 | ) |
| Minority interest in  income of Hiland Partners, LP              |       |                                                                  |       |   |   | (639 | ) |   |   |   |   | (3,062 | ) |
| Net income                                                       |       |                                                                  |       |   |   | $ | 1,139 |   |   |   |   |   | $ | 184 |   |

 
| ** **                                                       | ** ** | **For the Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2007**                                                            | ** ** | **2006** | ** ** |
| ** **                                                       | ** ** | **Midstream**                                                       | ** ** | **Compression** | ** ** | **Total** | ** ** | **Midstream** | ** ** | **Compression** | ** ** | **Total** | ** ** |
| Revenues                                                         |       | $                                                                   | 125,259    |   | $ | 2,410 |   | $ | 127,669 |   | $ | 103,738 |   | $ | 2,410 |   | $ | 106,148 |   |
| Operating costs and  expenses:                                   |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Midstream purchases  (exclusive of items shown separately below) |       | 91,531                                                              |       | — |   | 91,531 |   | 78,356 |   | — |   | 78,356 |   |
| Operations and maintenance                                       |       | 9,585                                                               |       | 365 |   | 9,950 |   | 6,142 |   | 429 |   | 6,571 |   |
| Depreciation and  amortization                                   |       | 12,563                                                              |       | 1,789 |   | 14,352 |   | 8,008 |   | 1,786 |   | 9,794 |   |
| General and  administrative expenses                             |       | 4,248                                                               |       | 82 |   | 4,330 |   | 2,246 |   | 52 |   | 2,298 |   |
| Total operating costs  and expenses                              |       | 117,927                                                             |       | 2,236 |   | 120,163 |   | 94,752 |   | 2,267 |   | 97,019 |   |
| Operating income                                                 |       | $                                                                   | 7,332      |   | $ | 174 |   | 7,506 |   | $ | 8,986 |   | $ | 143 |   | 9,129 |   |
| Other income (expense):                                          |       |                                                                |       |   |   |   |   |   |   |   |   |   |   |
| Interest and other  income                                       |       |                                                                |       |   |   | 219 |   |   |   |   |   | 154 |   |
| Amortization of  deferred loan costs                             |       |                                                                |       |   |   | (220 | ) |   |   |   |   | (233 | ) |
| Interest expense                                                 |       |                                                                |       |   |   | (4,405 | ) |   |   |   |   | (2,262 | ) |
| Minority interest in  income of Hiland Partners, LP              |       |                                                                |       |   |   | (1,213 | ) |   |   |   |   | (6,226 | ) |
| Net income                                                       |       |                                                                |       |   |   | $ | 1,887 |   |   |   |   |   | $ | 562 |   |

 

20

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**Note 11: Net Income perLimited Partners’ Unit**

The computation of basic net income per limitedpartner unit is based on the weighted-average number of common unitsoutstanding during the period. The computation of diluted earnings per unitfurther assumes the dilutive effect of restricted units. Net income per unitapplicable to limited partners is computed by dividing net income applicable tolimited partners by the weighted-average number of limited partnership unitsoutstanding. The following is a reconciliation of the limited partner unitsused in the calculations of income per limited partner unit—basic and incomeper limited partner unit—diluted assuming dilution for the three and six monthsended June 30, 2007:
| ** **                                          | ** ** | **For the Three Months  Ended June 30,** | ** ** | **For the Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2007**                                                                    | ** ** | **2007**                                                            | ** ** |
| ** **                                          | ** ** | **Income  Availableto  Limite  Partners  (Numerator)**                      | ** ** | **Limited  Partner Units  (Denominator)**                      | ** ** | **Per Unit  Amount** | ** ** | **Income  Available to  Limited  Partners  (Numerator)** | ** ** | **Limited  Partner Units  (Denominator)** | ** ** | **Per Unit  Amount** | ** ** |
| Income per limited  partner unit—basic:        |       |                                                                        |       |                                                                |       |   |   |   |   |   |   |   |   |
| Income available to  limited unitholder             |       | $                                                                           | 1,139      |                                                                |       |   | $ | 0.05 |   | $ | 1,887 |   |   |   | $ | 0.09 |   |
| Weighted average  limited partner units outstanding |       |                                                                        |       | 21,600                                                              |       |   |   |   |   | 21,600 |   |   |   |
| Income per limited  partner unit—diluted:      |       |                                                                        |       |                                                                |       |   |   |   |   |   |   |   |   |
| Restricted units                                    |       |                                                                        |       | 6                                                                   |       |   |   |   |   | 6 |   |   |   |
| Income available to common unitholders              |       | $                                                                           | 1,139      |                                                                | 21,606     |   | $ | 0.05 |   | $ | 1,887 |   | 21,606 |   | $ | 0.09 |   |

 

**Note 12: Owners’ Capitaland Cash Distributions**

***Hiland Holdings***

Hiland Holdingsunitholders (limited partners) have only limited voting rights on mattersaffecting our operations and activities and, therefore, limited ability toinfluence our management’s decisions regarding our business. Unitholders didnot select our general partner or elect the board of directors of our generalpartner and effectively have no right to select our general partner or electits board of directors in the future. Unitholders’ voting rights are furtherrestricted by our partnership agreement, which provides that any units held bya person that owns 20% or more of any class of units then outstanding, otherthan the general partner, its affiliates, their transferees and persons whoacquired such units with the prior approval of the board of directors of ourgeneral partner, cannot be voted on any matter. In addition, our partnershipagreement contains provisions limiting the ability of our unitholders to callmeetings or to acquire information about our operations, as well as otherprovisions limiting a unitholders’ ability to influence the manner or directionof our management.

Our PartnershipAgreement requires that we distribute all of our cash on hand at the end ofeach quarter less reserves established at our general partner’s discretion. Werefer to this as “available cash.” Initially our only cash-generating assetsare our interests in Hiland Partners from which we receive quarterlydistributions. The amount of available cash may be greater than or less thanthe minimum quarterly distributions.

All distributionspaid by Hiland Holdings to common unitholders, including amounts paid toaffiliate owners were as follows (in thousands, except per unit amounts):

| Date Cash Distribution Paid | ** ** | **Per Unit Cash  Distribution  Amount** | ** ** | **Total Cash  Distribution** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------|------------|-----------------------------------|------------|
| 02/19/07                                   |       | $                                                 | 0.0132     |                              | $          | 285 |   |
| 02/19/07                                   |       | 0.2075                                            |       | 4,484                             |       |
| 05/18/07                                   |       | 0.2075                                            |       | 4,485                             |       |
| 08/17/07(a)                                |       | 0.2200                                            |       | 4,755                             |       |
|                                       |       | $                                                 | 0.6482     |                              | $          | 14,009 |   |

 

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(a)          This cash distributionwas announced on July 25, 2007 and will be paid on August 17, 2007 toall unitholders of record as of August 8, 2007.

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***HilandPartners***

The unitholders(limited partners) of Hiland Partners have only limited voting rights onmatters affecting its operations and activities and, therefore, limited abilityto influence its management’s decisions regarding its business. Unitholders didnot select Hiland Partners GP, LLC as general partner or elect its board ofdirectors and effectively have no right to select a general partner or electits board of directors in the future. Unitholders’ voting rights are furtherrestricted by Hiland Partners’ partnership agreement, which provides that anyunits held by a person that owns 20% or more of any class of units thenoutstanding, other than the general partner, its affiliates, their transfereesand persons who acquired such units with the prior approval of Hiland PartnersGP, LLC’s board of directors, cannot be voted on any matter. In addition,Hiland Partners’ partnership agreement contains provisions limiting the abilityof its unitholders to call meetings or to acquire information about itsoperations, as well as other provisions limiting a unitholder’s ability toinfluence the manner or direction of Hiland Partners’ management.

Hiland Partners’partnership agreement requires that it distribute all of its cash on hand atthe end of each quarter, less reserves established at Hiland Partners GP, LLC’sdiscretion. We refer to this as “available cash.” The amount of available cashmay be greater than or less than the minimum quarterly distributions describedbelow. In general, Hiland Partners will pay any cash distribution made eachquarter in the following manner:

·         first,98% to the common units and 2% to our general partner, until each common unithas received a minimum quarterly distribution of $0.45 plus any arrearages fromprior quarters;

·         second,98% to the subordinated units and 2% to our general partner, until eachsubordinated unit has received a minimum quarterly distribution of $0.45; and

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

If cashdistributions per unit exceed $0.495 in any quarter, Hiland Partners GP, LLC asgeneral partner will receive increasing percentages, up to a maximum of 50% ofthe cash Hiland Partners distributes in excess of that amount. We refer tothese distributions as “incentive distributions.”

The distributionson the subordinated units may be reduced or eliminated if necessary to ensurethe common units receive their minimum quarterly distribution. Subordinatedunits will not accrue arrearages. The subordination period will end once HilandPartners meets certain financial tests, but not before March 31, 2010.These financial tests require Hiland Partners to have earned and paid theminimum quarterly distribution on all of its outstanding units for threeconsecutive four-quarter periods. When the subordination period ends, allremaining subordinated units will convert into common units on a one-for-onebasis and the common units will no longer be entitled to arrearages. As of June30, 2007 we own 4,080,000 subordinated units, which is all of, Hiland Partners’subordinated units.

Presented below are cash distributions to HilandPartners, common and subordinated unitholders, including amounts to affiliateowners and regular and incentive distributions to Hiland Partners GP, LLC paidby Hiland Partners from January 1, 2006 forward (in thousands, except per unitamounts):
| ** **                                     | ** ** | **Per Unit Cash** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **               | ** ** | ** **          | ** ** | ** **       | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|------------|------------|------------------|------------|--------------------------|------------|---------------------|------------|------------------|------------|
| ** **                                     | ** ** | **Distribution**            | ** ** | **Common** | ** ** | **Subordinated** | ** ** | **General Partner** | ** ** | **Total Cash** | ** ** |
| **Date Cash Distribution Paid** | ** ** | **Amount**                  | ** ** | **Units**  | ** ** | **Units**        | ** ** | **Regular**              | ** ** | **Incentive**       | ** ** | **Distribution** | ** ** |
| 02/14/06                                       |       | $                           | 0.6250     |       | $          | 2,724            |       | $                        | 2,550      |                | $          | 112              |       | $ | 249 |   | $ | 5,635 |   |
| 05/15/06                                       |       | 0.6500                      |       | 2,858      |       | 2,652            |       | 119                      |       | 315                 |       | 5,944            |       |
| 08/14/06                                       |       | 0.6750                      |       | 3,485      |       | 2,754            |       | 136                      |       | 414                 |       | 6,789            |       |
| 11/14/06                                       |       | 0.7000                      |       | 3,623      |       | 2,856            |       | 145                      |       | 637                 |       | 7,261            |       |
| 02/14/07                                       |       | 0.7125                      |       | 3,694      |       | 2,907            |       | 150                      |       | 749                 |       | 7,500            |       |
| 05/15/07                                       |       | 0.7125                      |       | 3,724      |       | 2,907            |       | 151                      |       | 752                 |       | 7,534            |       |
| 08/14/07 (a)                                   |       | 0.7325                      |       | 3,837      |       | 2,989            |       | 158                      |       | 932                 |       | 7,916            |       |
|                                           |       | $                           | 4.8075     |       | $          | 23,945           |       | $                        | 19,615     |                | $          | 971              |       | $ | 4,048 |   | $ | 48,579 |   |

 

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(a)          This cash distributionwas announced on July 25, 2007 and will be paid on August 14, 2007 to allunitholders of record as of August 8, 2007.

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Presented beloware cash distributions by Hiland Partners to us and Hiland Partners GP, LLCfrom January 1, 2006 forward (in thousands, except per unit amounts):
| ** **                                     | ** ** | **Per Unit Cash** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **               | ** ** | ** **          | ** ** | ** **       | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|------------|------------|------------------|------------|--------------------------|------------|---------------------|------------|------------------|------------|
| ** **                                     | ** ** | **Distribution**            | ** ** | **Common** | ** ** | **Subordinated** | ** ** | **General Partner** | ** ** | **Total Cash** | ** ** |
| **Date Cash Distribution Paid** | ** ** | **Amount**                  | ** ** | **Units**  | ** ** | **Units**        | ** ** | **Regular**              | ** ** | **Incentive**       | ** ** | **Distribution** | ** ** |
| 02/14/06                                       |       | $                           | 0.6250     |       | $          | —           |       | $                        | —     |                | $          | 112              |       | $ | 249 |   | $ | 361 |   |
| 05/15/06                                       |       | 0.6500                      |       | —     |       | —           |       | 119                      |       | 315                 |       | 434              |       |
| 08/14/06                                       |       | 0.6750                      |       | 514        |       | —           |       | 136                      |       | 414                 |       | 1,064            |       |
| 11/14/06                                       |       | 0.7000                      |       | 557        |       | 186              |       | 145                      |       | 637                 |       | 1,525            |       |
| 02/14/07                                       |       | 0.7125                      |       | 927        |       | 2,907            |       | 150                      |       | 749                 |       | 4,733            |       |
| 5/15/07                                        |       | 0.7125                      |       | 927        |       | 2,907            |       | 151                      |       | 752                 |       | 4,737            |       |
| 8/14/07 (a)                                    |       | 0.7325                      |       | 953        |       | 2,989            |       | 158                      |       | 932                 |       | 5,032            |       |
|                                           |       | $                           | 4.8075     |       | $          | 3,878            |       | $                        | 8,989      |                | $          | 971              |       | $ | 4,048 |   | $ | 17,886 |   |

 

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(a)          This cash distributionwas announced on July 25, 2007 and will be paid on August 14, 2007 to allunitholders of record as of August 8, 2007.

**Note 13: Subsequent Events**

On July 13, 2007,Hiland Partners entered into a third amendment to its credit agreement dated asof February 15, 2005. Pursuant to the third amendment, it has, among otherthings, increased its borrowing base from $200 million to $250 million and decreasedthe accordion feature in the facility from $150 million to $100 million.

The thirdamendment increases Hiland Partners borrowing capacity under its senior securedrevolving credit facility to $250 million such that the facility now consistsof a $241 million senior secured revolving credit facility to be used forfunding acquisitions and other capital expenditures, issuance of letters ofcredit and general corporate purposes (the “Acquisition Facility”) and a $9.0million senior secured revolving credit facility to be used for working capitaland to fund distribution (the “Working Capital Facility”).

In addition, thethird amendment provides for an accordion feature, which permits HilandPartners if certain conditions are met, to increase the size of the AcquisitionFacility by up to $100 million and allows for the issuance of letters of creditof up to $15 million in the aggregate.  The senior secured revolvingcredit facility also requires Hiland Partners to meet certain financial tests,including a maximum consolidated funded debt to EBITDA ratio of 4.0:1.0 as ofthe last day of any fiscal quarter; provided that in the event that thePartnership makes certain permitted acquisitions or capital expenditures, thisratio may be increased to 4.75:1.0 for the three fiscal quarters following thequarter in which such acquisition or capital expenditure occurs; and a minimuminterest coverage ratio of 3.0:1.0.

On July 16, 2007,Hiland Partners entered into natural gas liquid (“NGL”) cash flow swaps addingto Hiland Partners hedges for forecasted NGL sales through calendar year 2008.Under the swap agreements Hiland Partners pays it counterparty floating indexprices and receives fixed prices of $1.35 per gallon on 24,093 Bbls/monthduring August 2007 through December 2007 and $1.31 per gallon on 33,634Bbls/month during calendar year 2008.

On July 16, 2007,Hiland Partners also entered into natural gas cash flow swaps adding to HilandPartners hedges for forecasted natural gas purchases through calendar year 2008. Under the swap agreement Hiland Partners receives floating index prices andpays its counterparty fixed prices of $5.56 per MMBtu on 33,235 MMBtu/monthduring August 2007 through December 2007 and $6.97 per MMBtu on 53,381MMBtu/month during calendar year 2008.

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**HILANDHOLDINGS GP, LP**

**Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

Unless the contextrequires otherwise, references to “we,” “our,” “us,” “Hiland Holdings” or “thePartnership” are intended to mean the consolidated business and operations ofHiland Holdings GP, LP. References to “Hiland Partners” are intended to meanthe consolidated business and operations of Hiland Partners, LP and itssubsidiaries.

**CautionaryStatement About Forward-Looking Statements**

This quarterlyreport on Form 10-Q includes certain “forward-looking statements” withinthe 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 such forward-lookingstatements are based on reasonable assumptions and current expectations andprojections about future events, no assurance can be given that every objectivewill be reached.

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

·      our ability to paydistributions to our unitholders;

·      our expected receipt ofdistributions from Hiland Partners;

·      the general economicconditions in the United States of America as well as the general economicconditions and currencies in foreign countries;

·      the continued ability ofHiland Partners to find and contract for new sources of natural gas supply;

·      the amount of natural gastransported on Hiland Partners’ gathering systems;

·      the level of throughput inHiland Partners’ natural gas processing and treating facilities;

·      the fees Hiland Partnerscharges and the margins realized for its services;

·      the prices and market demandfor, and the relationship between, natural gas and natural gas liquids, or(NGLs);

·      energy prices generally;

·      the level of domestic oiland natural gas production;

·      the availability of importedoil and natural gas;

·      actions taken by foreign oiland gas producing nations;

·      the political and economicstability of petroleum producing nations;

·      the weather in Hiland Partners’operating areas;

·      the extent of governmentalregulation and taxation;

·      hazards or operating risksincidental to the transporting, treating and processing of natural gas and NGLsthat may not be fully covered by insurance;

·      competition from othermidstream companies;

·      loss of key personnel;

·      the availability and cost ofcapital and Hiland Partners’ ability to access certain capital sources;

·      changes in laws andregulations to which we and Hiland Partners are subject, including tax,environmental, transportation and employment regulations;

·      the costs and effects oflegal and administrative proceedings;

24

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·      the ability to successfullyidentify and consummate strategic acquisitions at purchase prices that areaccretive to the Hiland Partners’ financial results; and

·      risks associated with theconstruction of new pipelines and treating and processing facilities oradditions to Hiland Partners’ existing pipelines and facilities.

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

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.

**Overview of Hiland Holdings**

We are a Delawarelimited partnership formed in May 2006 to own Hiland Partners GP,LLC, the general partner of Hiland Partners, and certain other common andsubordinated units in Hiland Partners. We reflect our ownership interest inHiland Partners on a consolidated basis, which means that our financial resultsare combined with Hiland Partners’ financial results. The non-controllinglimited partner interest in Hiland Partners is reflected as an expense in ourresults of operations and as a liability on our consolidated balance sheet.Hiland Partners GP, LLC’s results of operations principally reflect the resultsof operations of Hiland Partners and are adjusted for non-controlling partners’interests in Hiland Partners’ net income.

Our cashgenerating assets consist of our direct or indirect ownership interests in HilandPartners. Hiland Partners is principally engaged in gathering, compressing,dehydrating, treating, processing and marketing natural gas, fractionatingnatural gas liquids and providing air compression and water injection servicesfor oil and gas secondary recovery operations. Our aggregate ownershipinterests in Hiland Partners consist of the following:

·      the 2% general partnerinterest in Hiland Partners;

·      100% of the incentivedistribution rights in Hiland Partners; and

·      1,301,471 common units and 4,080,000subordinated units of Hiland Partners, representing a 57.8% limited partnerinterest in Hiland Partners.

Hiland Partners isrequired by its partnership agreement to distribute all of its cash on hand atthe end of each quarter, after establishing reserves to provide for the properconduct of its business or to provide funds for future distributions. HilandPartners announced its quarterly distribution to $0.7325 per unit for thequarter ended June 30, 2007. This distribution will be paid on August 14,2007 to unitholders of record on August 8, 2007.

Our primaryobjective is to increase our cash distributions to our unitholders by activelyassisting Hiland Partners in executing its business strategy. We intend tosupport Hiland Partners in implementing its business strategy by assisting inidentifying, evaluating and pursuing growth opportunities. In the future, it ispossible that we may also support the growth of Hiland Partners through the useof our capital resources, which could involve loans or capital contributions toHiland Partners to provide funding for the acquisition of a business or anasset or for an internal growth project. In addition, we may provide HilandPartners with other forms of credit support, such as guarantees relating to financinga project or other types of support related to a merger or acquisitiontransaction.

25

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CashDistributions.   The following table sets forth the distributionsthat we have received from Hiland Partners during the periods indicated.
|                                                                                 | ** ** | ** **                                          | ** ** | **Hiland Partners**                          | ** ** | ** **               | ** ** | **Hiland Partners** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **                                                                      | ** ** | **Hiland Holdings**                            | ** ** | **GP, LLC**                                  | ** ** | **Hiland Holdings** | ** ** | **GP, LLC**         | ** ** |
| ** **                                                                      | ** ** | **GP, LP**                                     | ** ** | **(Predecessor)**                                 | ** ** | **GP, LP**          | ** ** | **(Predecessor)**        | ** ** |
| ** **                                                                      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
| ** **                                                                      | ** ** | **2007 (a)**                                   | ** ** | **2006**                                          | ** ** | **2007 (a)**        | ** ** | **2006**                 | ** ** |
| Distributions  from Hiland Partners’ common units                          |       | $                                                   | 927        |                                              | $          | —                   |       | $                        | 1,854      |   | $ | — |   |
| Distributions  from Hiland Partners’ subordinated units                    |       | 2,907                                               |       | —                                            |       | 5,814                    |       | —                   |       |
| Distributions  from ownership interest in Hiland Partners’ general partner |       | 151                                                 |       | 119                                               |       | 301                      |       | 231                      |       |
| Distributions  from Hiland Partners’ incentive distribution rights         |       | 752                                                 |       | 315                                               |       | 1,501                    |       | 564                      |       |
|  Total                                                                     |       | $                                                   | 4,737      |                                              | $          | 434                      |       | $                        | 9,470      |   | $ | 795 |   |

 

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(a)  Because we own Hiland Partners GP, LLC thedistributions to us include the distributions made to Hiland Partners GP, LLCand to us in 2007.

**Overview of Hiland Partners**

Hiland Partners isengaged 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. HilandPartners’ operations are primarily located in the Mid-Continent and RockyMountain regions of the United States.

Hiland Partnersmanages its business and analyzes and reports its results of operations on asegment basis. Hiland Partners’ operations are divided into two businesssegments:

·      *Midstream Segment,* which is engaged in gathering andprocessing of natural gas primarily in the Mid-Continent and Rocky Mountainregions. Within this segment, Hiland Partners also provides certain relatedservices for compression, dehydrating, and treating of natural gas and thefractionation of NGLs. The midstream segment generated 93.3% and 91.3% of thetotal segment margin for the six months ended June 30, 2007 and 2006,respectively.

·      *Compression Segment,* which is engaged in providing aircompression and water injection services for oil and gas secondary recoveryoperations that are ongoing in North Dakota. The compression segment generated6.7% and 8.7% of the total segment margin for the six months ended June 30,2007 and 2006, respectively.

Hiland Partners’midstream assets currently consist of 13 natural gas gathering systems withapproximately 1,929 miles of gas gathering pipelines, five natural gasprocessing plants, seven natural gas treating facilities and three NGLfractionation facilities. Hiland Partners’ compression assets consist of twoair compression facilities and a water injection plant.

Hiland Partners’results of operations are determined primarily by five interrelated variables:(1) the volume of natural gas gathered through its pipelines; (2) thevolume of natural gas processed; (3) the volume of NGLs fractionated;(4) the levels and relationship of natural gas and NGL prices; and(5) Hiland Partners’ current contract portfolio. Because Hiland Partners’profitability is a function of the difference between the revenues it receivesfrom its operations, including revenues from the products it sells, and thecosts associated with conducting its operations, including the costs of productsit purchases, increases or decreases in Hiland Partners’ revenues alone are notnecessarily indicative of increases or decreases in its profitability. To alarge extent, Hiland Partners’ contract portfolio and the pricing environmentfor natural gas and NGLs will dictate increases or decreases in itsprofitability. Hiland Partners’ profitability is also dependent upon prices andmarket demand for natural gas and NGLs, which fluctuate with changes in marketand economic conditions and other factors.

**Recent Events**

On July 13, 2007,Hiland Partners completed a third amendment to its existing credit agreement toincrease its borrowing base by $50 million from $200 million to $250 million.

On June 19, 2007,Mr. Joseph L. Griffin was appointed Chief Executive Officer, President and adirector of our general partner. Mr. Griffin replaces Mr. Randy Moeder, whoresigned on April 16, 2007.

**Historical Results of Operations**

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

26

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Our historicalfinancial information for periods prior to September 25, 2006 reflects thefinancial results of Hiland Partners GP, LLC our predecessor. Accordingly, thediscussion of our financial position and results of operations in this “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”reflects the operating activities and results of operations of us beginningSeptember 25, 2006.

Hiland Partnersacquisition of the Kinta Area gathering assets from Enogex Gas Gathering,L.L.C. on May 1, 2006 was accounted for as a purchase of assets.  Resultsof operations from the Kinta Area gathering assets are only reflected from May1, 2006.

**Our Results of Operations**

The results of ouroperations discussed below principally reflect the activities of HilandPartners. Because our consolidated financial statements include the results ofHiland Partners, our financial statements are substantially similar to the financialstatements of Hiland Partners. However, our consolidated balance sheet includesa minority interest amount that reflects the proportion of Hiland Partnersowned by its unitholders other than us. Similarly, the ownership interests inHiland Partners held by its unitholders other than us are reflected in ourconsolidated income statement as minority interest. The minority interestamounts are not reflected on Hiland Partners’ financial statements.

Set forth in thetables below are financial and operating data for us and our predecessor,Hiland Partners GP, LLC. for the periods indicated.
|                                                                  | ** ** | **Hiland  Holdings  GP, LP**                   | ** ** | **Hiland  Partners  GP, LLC  (Predecessor)** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                       | ** ** | **Three Months Ended June 30,** | ** ** |
| ** **                                                       | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** |
| ** **                                                       | ** ** | **(in thousands)**                             | ** ** |
| **Total  Segment Margin Data:**                                  | ** ** | ** **                                          | ** ** | ** **                                        | ** ** |
| Midstream  revenues                                              |       | $                                                   | 65,411     |                                              | $          | 51,534 |   |
| Midstream  purchases                                             |       | 47,916                                              |       | 36,821                                            |       |
| Midstream  segment margin                                        |       | 17,495                                              |       | 14,713                                            |       |
| Compression  revenues(1)                                         |       | 1,205                                               |       | 1,205                                             |       |
| Total segment  margin(2)                                         |       | $                                                   | 18,700     |                                              | $          | 15,918 |   |
| **Summary  of Operations Data:**                                 | ** ** | ** **                                          | ** ** | ** **                                        | ** ** |
| Midstream  revenues                                              |       | $                                                   | 65,411     |                                              | $          | 51,534 |   |
| Compression  revenues                                            |       | 1,205                                               |       | 1,205                                             |       |
| Total revenues                                                   |       | 66,616                                              |       | 52,739                                            |       |
| Operating costs  and expenses:                                   |       |                                                |       |                                              |       |
| Midstream  purchases (exclusive of items shown separately below) |       | 47,916                                              |       | 36,821                                            |       |
| Operations and  maintenance expenses                             |       | 4,980                                               |       | 3,998                                             |       |
| Depreciation,  amortization and accretion                        |       | 7,326                                               |       | 5,657                                             |       |
| General and  administrative expenses                             |       | 2,285                                               |       | 1,259                                             |       |
| Total operating  costs and expenses                              |       | 62,507                                              |       | 47,735                                            |       |
| Operating income                                                 |       | 4,109                                               |       | 5,004                                             |       |
| Other income  (expense), net                                     |       | (2,331                                              | )          | (1,758                                            | )          |
| Income before  minority interest in Hiland Partners, LP          |       | 1,778                                               |       | 3,246                                             |       |
| Minority  interest in income of Hiland Partners, LP              |       | (639                                                | )          | (3,062                                            | )          |
| Net income                                                       |       | $                                                   | 1,139      |                                              | $          | 184 |   |
|                                                             |       |                                                |       |                                              |       |
| Hiland Partners  Operating Data:                                 |       |                                                |       |                                              |       |
| Natural gas  sales (MMBtu/d)                                     |       | 78,085                                              |       | 65,090                                            |       |
| NGL sales  (Bbls/d)                                              |       | 4,304                                               |       | 3,285                                             |       |
| Natural gas gathered  (MMBtu/d) (3)                              |       | 128,529                                             |       | 87,385                                            |       |

 

27

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|                                                                  | ** ** | **Hiland  Holdings  GP, LP**                 | ** ** | **Hiland  Partners  GP, LLC  (Predecessor)** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                       | ** ** | **Six Months Ended June 30,** | ** ** |
| ** **                                                       | ** ** | **2007**                                          | ** ** | **2006**                                          | ** ** |
| ** **                                                       | ** ** | **(in thousands)**                           | ** ** |
| **Total  Segment Margin Data:**                                  | ** ** | ** **                                        | ** ** | ** **                                        | ** ** |
| Midstream  revenues                                              |       | $                                                 | 125,259    |                                              | $          | 103,738 |   |
| Midstream  purchases                                             |       | 91,531                                            |       | 78,356                                            |       |
| Midstream  segment margin                                        |       | 33,728                                            |       | 25,382                                            |       |
| Compression  revenues(1)                                         |       | 2,410                                             |       | 2,410                                             |       |
| Total segment  margin(2)                                         |       | $                                                 | 36,138     |                                              | $          | 27,792 |   |
| **Summary  of Operations Data:**                                 | ** ** | ** **                                        | ** ** | ** **                                        | ** ** |
| Midstream  revenues                                              |       | $                                                 | 125,259    |                                              | $          | 103,738 |   |
| Compression  revenues                                            |       | 2,410                                             |       | 2,410                                             |       |
| Total revenues                                                   |       | 127,669                                           |       | 106,148                                           |       |
| Operating costs  and expenses:                                   |       |                                              |       |                                              |       |
| Midstream  purchases (exclusive of items shown separately below) |       | 91,531                                            |       | 78,356                                            |       |
| Operations and  maintenance expenses                             |       | 9,950                                             |       | 6,571                                             |       |
| Depreciation,  amortization and accretion                        |       | 14,352                                            |       | 9,794                                             |       |
| General and  administrative expenses                             |       | 4,330                                             |       | 2,298                                             |       |
| Total operating  costs and expenses                              |       | 120,163                                           |       | 97,019                                            |       |
| Operating income                                                 |       | 7,506                                             |       | 9,129                                             |       |
| Other income  (expense), net                                     |       | (4,406                                            | )          | (2,341                                            | )          |
| Income before  minority interest in Hiland Partners, LP          |       | 3,100                                             |       | 6,788                                             |       |
| Minority  interest in income of Hiland Partners, LP              |       | (1,213                                            | )          | (6,226                                            | )          |
| Net income                                                       |       | $                                                 | 1,887      |                                              | $          | 562 |   |
|                                                             |       |                                              |       |                                              |       |
| Hiland Partners  Operating Data:                                 |       |                                              |       |                                              |       |
| Natural gas  sales (MMBtu/d)                                     |       | 76,313                                            |       | 62,374                                            |       |
| NGL sales  (Bbls/d)                                              |       | 4,146                                             |       | 3,265                                             |       |
| Natural gas gathered  (MMBtu/d) (3)                              |       | 124,671                                           |       | 43,934                                            |       |

 

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

(2***)*** Reconciliation oftotal segment margin to operating income:
|                                           | ** ** | **Hiland  Holdings  GP, LP**                   | ** ** | **Hiland  Partners  GP, LLC  (Predecessor)** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **Three Months Ended June 30,** | ** ** |
| ** **                                | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** |
| ** **                                | ** ** | **(in thousands)**                             | ** ** |
| Operating income                          |       | $                                                   | 4,109      |                                              | $          | 5,004 |   |
| ADD:                                      |       |                                                |       |                                              |       |
| Operations and  maintenance expenses      |       | 4,980                                               |       | 3,998                                             |       |
| Depreciation,  amortization and accretion |       | 7,326                                               |       | 5,657                                             |       |
| General and  administrative expenses      |       | 2,285                                               |       | 1,259                                             |       |
| Total segment margin                      |       | $                                                   | 18,700     |                                              | $          | 15,918 |   |

 

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|                                           | ** ** | **Hiland  Holdings  GP, LP**                 | ** ** | **Hiland  Partners  GP, LLC  (Predecessor)** | ** ** |
|-------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **Six Months Ended June 30,** | ** ** |
| ** **                                | ** ** | **2007**                                          | ** ** | **2006**                                          | ** ** |
| ** **                                | ** ** | **(in thousands)**                           | ** ** |
| Operating income                          |       | $                                                 | 7,506      |                                              | $          | 9,129 |   |
| ADD:                                      |       |                                              |       |                                              |       |
| Operations and  maintenance expenses      |       | 9,950                                             |       | 6,571                                             |       |
| Depreciation,  amortization and accretion |       | 14,352                                            |       | 9,794                                             |       |
| General and  administrative expenses      |       | 4,330                                             |       | 2,298                                             |       |
| Total segment margin                      |       | $                                                 | 36,138     |                                              | $          | 27,792 |   |

 

We view totalsegment margin, a non-GAAP financial measure, as a separate performance measureof the core profitability of our operations. We review total segment marginmonthly for a consistency and trend analysis. We define midstream segmentmargin as midstream revenue less midstream purchases. Midstream purchasesinclude the following costs and expenses: cost of natural gas and NGLspurchased by us from third parties, cost of natural gas and NGLs purchased byus from affiliates, and the cost of crude oil purchased by us from thirdparties. We define compression segment margin as the revenue derived from ourcompression segment.

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(3) Natural gasgathered for fee (MMBtu/d) represents natural gas volumes gathered associatedwith the Kinta Area gathering assets acquired on May 1, 2006 in which HilandPartners does not take title to the gas.

***Three Months EndedJune 30, 2007 Compared with Three Months Ended June 30, 2006***

***Revenues.***  Total revenues(midstream and compression) were $66.6 million for the three months ended June30, 2007 compared to $52.7 million for the three months ended June 30, 2006, anincrease of $13.9 million, or 26.3%.  This $13.9 million increase was dueto increased natural gas sales volumes of 12,995 MMBtu/day (MMBtu per day)primarily related to the acquisition of the Kinta Area gathering assetseffective May 1, 2006 and increased NGL sales volumes of 1,019 Bbls/day (Bblsper day) largely attributable to the Bakken and Eagle Chief gathering systems.The increase in revenues is also attributable to slightly higher realizednatural gas and NGL prices during the three months ended June 30, 2007 comparedto the same period in 2006.  Revenuesfrom compression assets were the same for both periods.

Midstream revenueswere $65.4 million for the three months ended June 30, 2007 compared to $51.5million for the three months ended June 30, 2006, a net increase of $13.9million, or 26.9%. Of the $13.9 million increase, $12.0 million was primarilyattributable to revenues from natural gas sales volumes and gathering feevolumes related to the Kinta Area gathering assets acquisition effective May 1,2006 and increased natural gas and NGL sales volumes at the Bakken and EagleChief gathering systems and $1.9 million of the increase was attributable toslightly higher realized natural gas NGL prices during the three months endedJune 30, 2007 compared to the same period in 2006. The Woodford Shale gatheringsystem, which began production in late April, 2007, accounted for 9.1% of the$13.9 million increase contributing $1.3 million to midstream revenues.

Natural gas salesvolumes were 78,085 MMBtu/d for the three months ended June 30, 2007 comparedto 65,090 MMBtu/d for the three months ended June 30, 2006, an increase of12,995 MMBtu/d, or 20.0%.  Of the 12,995 MMBtu/d increase, 6,275, or 48.3%was attributable to the natural gas volumes as a result of the Kinta Areagathering system acquisition effective May 1, 2006. The increase in natural gassales volumes was also attributable to increased volumes at both the Bakken andEagle Chief gathering systems and the Woodford Shale gathering system, which contributed1,364 MMBtu/d to the increase in natural gas sales volumes. NGL sales volumeswere 4,304 Bbls/d for the three months ended June 30, 2007 compared to 3,285Bbls/d for the three months ended June 30, 2006, an increase of 1,019 Bbls/d,or 31.0%.  Nearly all of the 1,019 Bbls/d increase was attributable toincreased NGL sales volumes at the Bakken and Eagle Chief gathering systems.The Woodford Shale gathering system contributed 143 Bbls/d to the increase inNGL sales volumes.

The averagerealized natural gas sales prices were $6.03 per MMBtu for the three monthsended June 30, 2007 compared to $5.82 per MMBtu for the three months ended June30, 2006, an increase of $0.21 per MMBtu, or 3.6%.  Average realized NGLsales prices were $1.09 per gallon for the three months ended June 30, 2007compared to $1.08 per gallon for the three months ended June 30, 2006, a slightincrease of $0.01 per gallon or 0.9%.  The change in average realizednatural gas and NGL sales prices was primarily a result of slightly higherindex prices due to a tightening of supply and demand fundamentals for energy,which caused crude oil and natural gas prices to rise during the three monthsended June 30, 2007 compared to the three months ended June 30, 2006.

Net cash receivedfrom a counterparty on cash flow swap contracts that began on May 1, 2006 fornatural gas derivative transactions that closed during the three months endedJune 30, 2007 and 2006 was $1.4 million and $1.0 million, respectively. These

29

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receipts increasedaverage realized natural gas sales prices by $0.19 per MMBtu in 2007 and by$0.17 per MMBtu in 2006.  Cash paid to acounterparty on cash flow swap contracts that began on September 1, 2006 forNGL derivative transactions that closed during the three months ended June 30,2007 was $0.5 million. These payments decreased average realized natural gassales prices by $0.02 per gallon in 2007. There were no closed NGL derivativetransactions during the three months ended June 30, 2006.

Fees earned from128,529 MMBtu/d of natural gas gathered, in which title is not taken to thegas, related to the Kinta Area gathering assets acquired on May 1, 2006 were$2.8 million for the three months ended June 30, 2007. Similar fees earned fromMay through June 2006 averaging 130,362 MMBtu/d of natural gas gathered was$1.8 million.

Compressionrevenues were $1.2 million for the each of the three months ended June 30, 2007and 2006.

***Midstream Purchases.***  Midstreampurchases were $47.9 million for the three months ended June 30, 2007 comparedto $36.8 million for the three months ended June 30, 2006, an increase of $11.1million, or 30.1%.  The $11.1 million increase primarily consists of $5.4million, $3.5 million and $2.2 million attributable to increased purchasedresidue gas volumes at the Eagle Chief, Kinta Area and Bakken gatheringsystems, respectively.  The WoodfordShale gathering system accounted for 10.1% of the $11.1 million increasecontributing $1.1 million to midstream purchases.

***Operations and Maintenance.*** Operations and maintenance expense totaled $5.0 million for the three monthsended June 30, 2007 compared with $4.0 million for the three months ended June30, 2006, an increase of $1.0 million, or 24.6%. Of this increase, $0.9million, or 93.7% was attributable to operations and maintenance at the KintaArea gathering system.  Operations andmaintenance expense increased by $0.3 million at the Badlands gatheringfacility largely due to compressor rentals and other related costs associatedwith the expansion project but was offset by reduced expenses at most of theother gathering systems as a result of continued effort to reduce costs.  The Woodford Shale gathering system accountedfor 6.4% of the increase in operations and maintenance expense.

***Depreciation, Amortization and Accretion.*** Depreciation, amortization and accretion expense totaled $7.3 million for thethree months ended June 30, 2007 compared with $5.7 million for the threemonths ended June 30, 2006, an increase of $1.6 million, or 29.5%.  Ofthis increase, $0.7 million, or 45.0% was attributable to depreciation andamortization on the Kinta Area gathering system. The increase is alsoattributable to additional depreciation of $0.4 million, or 25.8%, at theBakken gathering system and $0.3 million, or 18.8%, at the Eagle Chief, Matliand Badlands gathering systems.

***General and Administrative.*** General and administrative expense totaled $2.3 million for the three monthsended June 30, 2007 compared with $1.3 million for the three months ended June30, 2006, an increase of $1.0 million, or 81.5%.  The increase isprimarily attributable to acquisition evaluation expenses and increasedsalaries and additional staffing, including costs to recruit our new CEO, aswell as, the expense relating to the recalculated fair value of the Class Bcommon units. The increase is also attributable to the costs of being a newpublic company, including the costs of audit and tax preparation fees.

***Other Income (Expense).*** Otherincome (expense) totaled ($2.3) million for the three months ended June 30,2007 compared with ($1.8) million for the three months ended June 30, 2006, anincrease in expense of $0.5 million.  The increase is primarilyattributable to interest expense from borrowings for the acquisition of theKinta Area gathering assets effective May 1, 2006 and plant and pipelineconstruction related to various internal expansion projects.

***Minority Interest.  ***Minority interest in income of Hiland Partners, which represents the allocationof Hiland Partners earnings to its limited partner interests not owned byHiland Holdings, totaled $0.6 million for the three months ended June 30, 2007compared to $3.1 million for the three months ended June 30, 2006. This$2.5 million decrease is attributable to the increase in ownership of HilandPartners. At June 30, 2007 Hiland Holdings’ aggregate ownership interest inHiland Partners consisted of the 2% general partner interest; 100% of theincentive distribution rights; and 1,301,471 common units and 4,080,000 subordinatedunits of Hiland Partners, representing a 57.8% limited partner interest inHiland Partners as compared to June 30, 2006, at which time Hiland Partners GP,LLC’s aggregate ownership interest in Hiland Partners consisted of the 2%general partner interest in Hiland Partners and 100% of the incentivedistribution rights in Hiland Partners.

***Six Months EndedJune 30, 2007 Compared with Six Months Ended June 30, 2006***

***Revenues.***  Total revenues(midstream and compression) were $127.7 million for the six months ended June30, 2007 compared to $106.2 million for the six months ended June 30, 2006, anincrease of $21.5 million, or 20.3%.  This $21.5 million increase was dueto increased natural gas sales volumes of 13,939 MMBtu/day primarily related tothe acquisition of the Kinta Area gathering assets effective May 1, 2006 andincreased NGL sales volumes of 881 Bbls/day largely attributable to the Bakken,Eagle Chief and Matli gathering systems, partially offset by lower averagerealized natural gas and NGL sales prices in 2007 as compared to the sameperiod in 2006.  Revenues fromcompression assets were the same for both periods.

Midstream revenueswere $125.2 million for the six months ended June 30, 2007 compared to $103.7million for the six months ended June 30, 2006, a net increase of $21.5million, or 20.7%. Of this net increase in midstream revenues, $28.9 millionwas primarily attributable to revenues from natural gas sales volumes andgathering fee volumes related to the Kinta Area gathering assets

30

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acquisition effective May1, 2006 and increased natural gas and NGL sales volumes at the Bakken, EagleChief and Matli gathering systems.  Theincrease of $28.9 million attributable to increased natural gas, NGL and gatheringfee volumes was reduced by $7.4 million due to lower average realized naturalgas and NGL sales prices. The Woodford Shale gathering system, which beganproduction in late April, 2007 accounted for 5.9% of the $21.5 million increasecontributing $1.3 million to midstream revenues.

Natural gas salesvolumes were 76,313 MMBtu/d for the six months ended June 30, 2007 compared to62,374 MMBtu/d for the six months ended June 30, 2006, an increase of 13,939MMBtu/d, or 22.3%.  Of the 13,939 MMBtu/d increase, 8,843, or 63.4% wasattributable to the natural gas volumes as a result of the Kinta gatheringsystem acquisition effective May 1, 2006. The increase in natural gas salesvolumes was also attributable to increased volumes at both the Bakken and EagleChief gathering systems and the Woodford Shale gathering system, whichcontributed 1,364 MMBtu/d to the increase in natural gas sales volumes.  NGL sales volumes were 4,146 Bbls/d for thesix months ended June 30, 2007 compared to 3,265 Bbls/d for the six monthsended June 30, 2006, an increase of 881 Bbls/d, or 27.0%.  Of the 881Bbls/d increase, 841 Bbls/d, or 92.5% was attributable to increased NGL salesvolumes at the Bakken, Eagle Chief and Matli gathering systems.

Average realizednatural gas sales prices were $6.11 per MMBtu for the six months ended June 30,2007 compared to $6.48 per MMBtu for the six months ended June 30, 2006, adecrease of $0.37 per MMBtu, or 5.7%.  In addition, average realized NGLsales prices were $1.02 per gallon for the six months ended June 30, 2007 comparedto $1.04 per gallon for the six months ended June 30, 2006, a decrease of $0.02per gallon or 1.9%.  The change in average realized natural gas and NGLsales prices was primarily a result of lower index prices due to a softening ofsupply and demand fundamentals for energy, which caused crude oil and naturalgas prices to fall during the six months ended June 30, 2007 compared to thesix months ended June 30, 2006.

Net cash receivedfrom a counterparty on cash flow swap contracts that began on May 1, 2006 fornatural gas derivative transactions that closed during the six months endedJune 30, 2007 and 2006 was $2.0 million and $1.0 million, respectively. Thesereceipts increased average realized natural gas sales prices by $0.14 per MMBtuin 2007 and by $0.09 per MMBtu in 2006. Cash paid to a counterparty on cash flow swap contracts that began onSeptember 1, 2006 for NGL derivative transactions that closed during the sixmonths ended June 30, 2007 was $0.5 million. These payments decreased averagerealized natural gas sales prices by $0.01 per gallon in 2007. There were noclosed NGL derivative transactions during the six months ended June 30, 2006.

Fees earned from124,671 MMBtu/d of natural gas gathered, in which title is not taken to thegas, related to the Kinta Area gathering assets acquired on May 1, 2006 were$5.4 million for the six months ended June 30, 2007. Similar fees earned fromMay through June 2006 averaging 130,362 MMBtu/d of natural gas gathered was$1.8 million.

Compressionrevenues were $2.4 million for the each of the six months ended June 30, 2007and 2006.

***Midstream Purchases.*** Midstreampurchases were $91.5 million for the six months ended June 30, 2007 compared to$78.3 million for the six months ended June 30, 2006, an increase of $13.2million, or 16.8%.  The $13.2 million increase primarily consists of $4.9million attributable to purchased residue gas from the Kinta Area gatheringassets. The remaining increase in midstream purchases was attributable toincreased purchased residue gas volumes at the Bakken and Eagle Chief gatheringsystems. The increase in volumes was offset by reduced payments to producersdue to lower natural gas and NGL purchases prices, which generally are closelyrelated to fluctuations in natural gas and NGL sales prices. The Woodford Shalegathering system accounted for $1.1 million, or 8.5%, of the increase inmidstream purchases.

***Operations and Maintenance. ***Operations andmaintenance expense totaled $10.0 million for the six months ended June 30,2007 compared with $6.6 million for the six months ended June 30, 2006, anincrease of $3.4 million, or 51.4%. Of this increase, $2.6 million, or 77.3%was attributable to operations and maintenance at the Kinta Area gatheringsystem. Operations and maintenance expense increased by $0.6 million at theBadlands gathering facility largely due to compressor rentals and other relatedcosts associated with the expansion project***.***

***Depreciation, Amortization and Accretion.  ***Depreciation, amortization and accretion expense totaled $14.4 million for thesix months ended June 30, 2007 compared with $9.8 million for the six monthsended June 30, 2006, an increase of $4.6 million, or 46.5%. Of thisincrease, $2.7 million, or 60.8% was attributable to depreciation and amortizationon the Kinta Area gathering system. The increase is also attributable toadditional depreciation of $0.7 million, or 15.0% at the Bakken gatheringsystem.

***General and Administrative.  ***General and administrative expense totaled $4.3 million for the six monthsended June 30, 2007 compared with $2.3 million for the six months endedJune 30, 2006, an increase of 2.0 million, or 88.2%. The increase isprimarily attributable to acquisition evaluation expenses and increasedsalaries and additional staffing, including costs to recruit the new CEO, aswell as, the expense relating to the recalculated fair value of the Class Bcommon units. The increase is also attributable to the costs of being a newpublic company, including the costs of audit and tax preparation fees and thecost of an unsuccessful.

***Other Income (Expense).***  Other income (expense) totaled ($4.4) million for the six months ended June 30,2007 compared with ($2.3) million for the six months ended June 30, 2006,an increase in expense of $2.1 million. The increase is primarily attributableto additional interest expense from borrowings for the acquisition of the KintaArea gathering assets effective May 1, 2006 and plant and pipeline constructionrelated to various internal expansion projects.

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***Minority Interest.  ***Minority interestin income of Hiland Partners, which represents the allocation of HilandPartners earnings to its limited partner interests not owned by HilandHoldings, totaled $1.2 million for the six months ended June 30, 2007 comparedto $6.2 million for the six months ended June 30, 2006. This $5.0 milliondecrease is attributable to the increase in ownership of Hiland Partners. AtJune 30, 2007 Hiland Holdings’ aggregate ownership interest in Hiland Partnersconsisted of the 2% general partner interest; 100% of the incentivedistribution rights; and 1,301,471 common units and 4,080,000 subordinatedunits of Hiland Partners, representing a 57.8% limited partner interest inHiland Partners as compared to June 30, 2006, at which time Hiland Partners GP,LLC’s aggregate ownership interest in Hiland Partners consisted of the 2%general partner interest in Hiland Partners and 100% of the incentivedistribution rights in Hiland Partners.

**LIQUIDITY AND CAPITAL RESOURCES**

***Overview***

We rely on distributionsfrom Hiland Partners to fund cash requirements for our operations. Cashgenerated from operations, borrowings under Hiland Partners’ credit facilityand funds from private or public equity and future debt offerings are HilandPartners’ primary sources of liquidity. We believe that funds from thesesources should be sufficient to meet both Hiland Partners’ short-term workingcapital requirements and its long-term capital expenditure requirements. HilandPartners’ ability to pay distributions to unitholders, to fund planned capitalexpenditures and to make acquisitions depends upon Hiland Partners’ futureoperating performance, and more broadly, on the availability of equity and debtfinancing, which will be affected by prevailing economic conditions in HilandPartners’ industry and financial, business and other factors, many of which arebeyond Hiland Partners’ control.

***Cash Flows fromOperating Activities***

 Cash flowsfrom operating activities decreased by $7.7 million to $19.2 million for thesix months ended June 30, 2007 from $26.9 million for the six months ended June30, 2006. During the six months ended June 30, 2007 we received cash flows fromcustomers of approximately $126.1 million, had cash payments to our suppliersand employees of approximately $102.5 million and payment of interest expenseof $4.4 million, net of amounts capitalized, resulting in cash received fromour operating activities of $19.2 million. During the same six month period in2006, we received cash flows from customers of approximately $112.3 million,had cash payments to our suppliers and employees of approximately $83.2 millionand payment of interest expense of $2.2 million, net of amounts capitalized,resulting in cash received from our operating activities of $26.9 million.Changes in cash receipts and payments are primarily due to the timing ofcollections at the end of our reporting periods. We collect and pay largereceivables and payables at the end of each calendar month. The timing of thesepayments and receipts may vary by a day or two between month-end periods andcause fluctuations in cash received or paid. Natural gas volumes from the KintaArea gathering assets acquired effective May 1, 2006 and increased natural gasand NGL volumes from the Bakken and Eagle Chief gathering systems, offset bylower natural gas sales prices contributed to increases in accounts receivable,accrued midstream revenues, accounts payable and accrued midstream purchasesduring the six months ended June 30, 2007. Working capital items, exclusive ofcash, contributed $1.2 million and $10.0 million to cash flows from operatingactivities during the six months ended June 30, 2007 and 2006, respectively.Net income for the six months ended June 30, 2007 was $1.9 million, an increaseof $1.3 million from a net income of $0.6 million for the six months ended June30, 2006.  Depreciation increased by $4.5 million to $14.3 million for thesix months ended June 30, 2007 from $9.8 million for the six months ended June30, 2006.

***Cash Flows Used forInvesting Activities***

Cash flows usedfor investing activities representing investments in property and equipment,excluding $96.4 million used for the Kinta Area acquisition on May 1, 2006 ,increased by $3.0 million to $36.7 million for the six months ended June 30,2007 from $33.7 million for the six months ended June 30, 2006. This $3.0million increase is largely attributable to cash invested at the Badlandsexpansion project and continued growth at the Bakken gathering system.

***Cash Flows fromFinancing Activities***

Cash flows fromfinancing activities decreased to $16.9 million for the six months ended June30, 2007 from $105.5 million for the six months ended June 30, 2006.During the six months ended June 30, 2007, Hiland Partners borrowed $30.5 millionunder its credit facility to fund its internal expansion projects and received$1.0 million from issuing Hiland Partners common units as a result of theexercise of 42,362 vested unit options. During the six months ended June 30,2007, we made a distribution of $9.0 million to our unitholders and HilandPartners distributed $5.6 million to its minority interest unitholders.During the six months ended June 30, 2006, Hiland Partners borrowed $81.8million under its credit facility to partially fund the Kinta Area gatheringassets acquisition on May 1, 2006 and to fund internal expansion projects atboth Badlands and Bakken. On May 1, 2006, Hiland Partners GP, LLC borrowed$35.0 million to purchase 761,714 common units and 15,545 general partner unitsof Hiland Partners which was used by Hiland Partners to complete the Kinta Areagathering assets acquisition on the same day. During, the six months ended June30, 2006 we incurred $0.3 million of debt issuance costs and Hiland Partnersincurred $0.9 million. During the six months ended June 30, 2006, HilandPartners GP, LLC’s members contributed $0.5 million as a capital contribution.Hiland Partners received $1.0 million from issuing Hiland Partners common unitsas a result of the exercise of 43,200 vested unit options. Hiland Partnersdistributed $10.8 million to minority interest unitholders and HilandPartners GP, LLC distributed $0.7 million to its members.

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***CapitalRequirements***

The midstreamenergy business is capital intensive, requiring significant investment tomaintain and upgrade existing operations. Our capital requirements haveconsisted primarily of, and we anticipate will continue to be:

·   maintenance capitalexpenditures, which are capital expenditures made to replace partially or fullydepreciated assets to maintain the existing operating capacity of HilandPartners’ assets and to extend their useful lives, or other capitalexpenditures that are incurred in maintaining existing system volumes andrelated cash flows; and

·   expansioncapital expenditures such as those to acquire additional assets to grow HilandPartners’ business, to expand and upgrade gathering systems, processing plants,treating facilities and fractionation facilities and to construct or acquiresimilar systems or facilities.

Hiland Partnersbelieves that cash generated from the operations of its business will besufficient to meet anticipated maintenance capital expenditures for the nexttwelve months. Given Hiland Partners objective of growth throughacquisitions and expansions, Hiland Partners anticipates that it will continueto invest significant amounts of capital to grow and acquire assets. HilandPartners actively considers a variety of assets for potential acquisitions. Weanticipate that expansion capital expenditures will be funded through long-termborrowings or other debt financings and/or equity offerings.

***Badlands ExpansionProject***

OnNovember 8, 2005, Hiland Partners entered into a new 15-year definitivegas purchase agreement with Continental Resources, Inc. under which HilandPartners will gather, treat and process additional natural gas, which isproduced as a by-product of Continental Resources, Inc.’s secondary oilrecovery operations, in the areas specified by the contract. In order tofulfill the obligations under the agreement, Hiland Partners is expanding itsBadlands gas gathering system and processing plant located in Bowman County,North Dakota. This expansion project includes the construction of a40,000 Mcf/d nitrogen rejection plant and the expansion of the existingBadlands field gathering infrastructure. The expansion project, which beganoperations in the third quarter 2007, was initially expected to reach a totalcost of approximately $49.5 million. As of June 30, 2007, Hiland Partnershas invested $52.1 million in the expansion project and believe the totalinvestment will not exceed $56.0 million. Hiland Partners is currently fundingthis expansion project using its existing bank credit facility.

***FinancialDerivatives and Commodity Hedges.***

Hiland Partnershas entered into certain financial derivative instruments that are classifiedas cash flow hedges in accordance with SFAS No. 133, as amended, andrelate to forecasted sales in 2007, 2008 and 2009. Hiland Partners entered intothese instruments to hedge the forecasted natural gas and natural gas liquidsales or purchases against the variability in expected future cash flowsattributable to changes in market prices. The swap instruments are contractualagreements between counterparties to exchange obligations of money as theunderlying natural gas or natural gas liquids are sold or purchased. Underthese swap agreements, Hiland Partners either receives or pays a monthly netsettlement that is determined by the difference between a fixed price and afloating price based on certain indices for the relevant contract period forthe agreed upon volumes. One financial swap instrument currently does notqualify for hedge accounting.

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The followingtable provides information about these financial derivative instruments enteredinto as of June 30, 2007 for the periods indicated:
|                                                                   | ** ** | ** **  | ** ** | ** **           | ** ** | **Fair Value** | ** ** |
|-------------------------------------------------------------------|------------|-------------|------------|----------------------|------------|---------------------|------------|
| ** **                                                        | ** ** | ** **  | ** ** | **Average**          | ** ** | **Asset**           | ** ** |
| **Description and Production Period**              | ** ** | **Volume**  | ** ** | **Fixed Price** | ** ** | **(Liability)**     | ** ** |
| ** **                                                        | ** ** | ** **  | ** ** | ** **           | ** ** | ** **          | ** ** |
| **Natural  Gas—Sold Fixed for Floating Price Swaps**         |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| July 2007 –  June 2008                             |       | 1,800,000   |       | $                    | 7.92       |                | $          | 3,760 |   |
| July 2008 – December  2008                                   |       | 990,000     |       | 7.84                 |       | 756                 |       |
| January 2009 –  December 2009                      |       | 1,068,000   |       | $                    | 7.06       |                | (387       | ) |
|                                                              |       |        |       |                 |       | $                   | 4,129      |   |
|                                                              |       |        |       |                 |       |                |       |
| **Natural  Gas - Sold Open for Floating Price Swaps**             |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| January 2009 – December 2009                                 |       | 1,068,000   |       | $                    | 7.42       |                | $          | 182 |   |
|                                                              |       |        |       |                 |       |                |       |
| **Natural  Gas—Buy Fixed for Floating Price Swaps**          |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| July 2007 – March 2008                                  |       | 450,000     |       | $                    | 8.87       |                | $          | (954 | ) |
|                                                              |       |        |       |                 |       |                |       |
| **Natural  Gas Liquids—Sold Fixed for Floating Price Swaps** |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(Bbls)**  | ** ** | **(per Gallon)**     | ** ** | ** **          | ** ** |
| July 2007 –  March 2008                            |       | 114,489     |       | $                    | 1.13       |                | $          | (1,501 | ) |

 

On July 16, 2007,Hiland Partners entered into natural gas liquid (“NGL”) cash flow swaps addingto Hiland Partners hedges for forecasted NGL sales through calendar year 2008.Under the swap agreements Hiland Partners pays it counterparty floating indexprices and receives fixed prices of $1.35 per gallon on 24,093 Bbls/monthduring August 2007 through December 2007 and $1.31 per gallon on 33,634Bbls/month during calendar year 2008.

On July 16, 2007,Hiland Partners also entered into natural gas cash flow swaps adding to HilandPartners hedges for forecasted natural gas purchases through calendar year2008.  Under the swap agreement Hiland Partners receives floating indexprices and pays its counterparty fixed prices of $5.56 per MMBtu on 33,235MMBtu/month during August 2007 through December 2007 and $6.97 per MMBtu on53,381 MMBtu/month during calendar year 2008.

In addition to thecontractual obligations noted in the table above, Hiland Partners has executedvarious natural gas fixed price physical forward sales contracts onapproximately 115,000 MMBtu per month for 2007 and 100,000 MMBtu per month for2008 with fixed prices ranging from $4.49 to $9.13 per MMBtu in 2007 and $8.43per MMBtu in 2008. These contracts have been designated as normal sales underSFAS No. 133 and are therefore not marked to market as derivatives. Asummary of our fixed price physical forward sales contracts is presented in thetable below:
|                                           | ** ** | ** **  | ** ** | **Average**          | ** ** |
|-------------------------------------------|------------|-------------|------------|----------------------|------------|
| ** **                                | ** ** | ** **  | ** ** | **Fixed Price** | ** ** |
| **Production Period**                | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** |
| ** **                                | ** ** | ** **  | ** ** | ** **           | ** ** |
| July 2007 –  June 2008          |       | 1,290,000   |       | $                    | $7.62      |   |
| July 2008 –  December 2008 |       | 600,000     |       | $                    | 8.43       |   |

 

***Off-Balance SheetArrangements.***

We had nosignificant off-balance sheet arrangements as of June 30, 2007.

***Credit Facility***

***Hiland Holdings***

OnSeptember 25, 2006, concurrently with the closing of our initial publicoffering, we entered into a three-year $25.0 million secured revolvingcredit facility. The facility will permit us, if certain conditions are met, toincrease borrowing capacity by up to an additional $25.0 million. The facilitywill be secured by all of our ownership interests in Hiland Partners and itsgeneral partner, other than the 2% general partner interest and the incentivedistribution rights.

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The facility willmature on September 25, 2009, at which time all outstanding amounts thereunderbecome due and payable.

Loans under thefacility will bear interest, at our option, at either (i) an alternate baserate plus an applicable margin ranging from 100 to 150 basis points per annumor (ii) LIBOR plus an applicable margin ranging from 200 to 250 basispoints per annum in each case based on our ratio of consolidated funded debt toEBITDA. The alternate base rate is equal to the greatest of (a) the primerate in effect on such day, (b) the base CD rate in effect on such dayplus 1.50% and (c) the federal funds effective rate in effect on such dayplus 1/2 of 1%. A letter of credit fee will be payable for the aggregate amountof letters of credit issued under the facility at a percentage per annum equalto 2.0%. A commitment fee ranging from 25 to 50 basis points per annum based onour ratio of consolidated funded debt to EBITDA will be payable on the average dailyunused portion of the facility for the quarter most recently ended. At June 30,2007, the interest rate on outstanding borrowings from our credit facility was7.32%.

The facilitycontains several covenants that, among other things, require the maintenance oftwo financial performance ratios, restrict the payment of distributions tounitholders, and require financial reports to be submitted periodically to thefinancial institutions.

The creditfacility also contains covenants requiring a maximum consolidated funded debtto EBITDA ratio of 3.0:1.0 for the four fiscal quarters most recently ended anda minimum interest coverage ratio of 3.0:1.0.

The amount we mayborrow under the facility is limited to the lesser of: (i) 50% of the sumof the value of the Hiland Partners common and subordinated units and certainother assets held by us and certain of our subsidiaries at the end of eachfiscal quarter and (ii) the maximum available amount of the facility(currently $25.0 million). For purposes of this calculation, the value of(i) the Hiland Partners common units on any date shall be the closingprice for such units as reflected on the Nasdaq National Market on any date,and (ii) the Hiland Partners subordinated units on any date shall bedeemed to equal 85% of the value of the Hiland Partners common units on suchdate.

The facilityprohibits us from making distributions to unitholders if any default or eventof default, as defined in the credit facility, has occurred and is continuingor would result from the distribution. In addition, the facility containsvarious covenants that limit, among other things, subject to certain exceptionsand negotiated “baskets,” our ability to incur indebtedness, grant liens, enterinto agreements restricting our ability to grant liens on our assets or amendthe facility, make certain loans, acquisitions and investments or enter into amerger, consolidation or sale of assets.

The facilitylimits distributions to our unitholders to our available cash, as defined inour partnership agreement. Restricted payments under the facility are subjectto an annual “clean-down” period of 15 consecutive days in which the amountoutstanding that relates to funding the restricted payments under the facilitymust be reduced to zero.

As of June 30,2007, we had $0.4 million outstanding under this credit facility and werein compliance with our financial covenants.

***Hiland Partners GP,LLC***

On May 1,2006, Hiland Partners GP, LLC entered into an unsecured credit agreement underwhich it borrowed $35.0 million to purchase 761,714 common units and 15,545general partner units from Hiland Partners. The loan was guaranteed by allHiland Partners GP, LLC’s members and matured and was paid in full upon thecompletion of our initial public offering on September 25, 2006. HilandPartners GP, LLC’s board of directors, as well as the conflicts committee ofits board of directors, consisting of independent directors, approved thetransaction.

***Hiland Partners***

On July 13, 2007,Hiland Partners entered into a third amendment to its credit agreement dated asof February 15, 2005. Pursuant to the third amendment, Hiland Partners may,among other things, increase its borrowing base from $200 million to $250million and decrease the accordion feature in the facility from $150 million to$100 million.

The thirdamendment increased Hiland Partners borrowing capacity under its senior securedrevolving credit facility to $250 million such that the facility now consistsof a $241 million senior secured revolving credit facility to be used forfunding acquisitions and other capital expenditures, issuance of letters ofcredit and general corporate purposes (the “Acquisition Facility”) and a $9.0million senior secured revolving credit facility to be used for working capitaland to fund distribution (the “Working Capital Facility”).

In addition, thethird amendment provides for an accordion feature, which permits HilandPartners if certain conditions are met, to increase the size of the AcquisitionFacility by up to $100 million and allows for the issuance of letters of creditof up to $15 million in the aggregate.  The senior secured revolvingcredit facility also requires Hiland Partners to meet certain financial tests,including a maximum consolidated funded debt to EBITDA ratio of 4.0:1.0 as ofthe last day of any fiscal quarter; provided that in the event that thePartnership makes certain permitted acquisitions or capital expenditures, thisratio may be increased to 4.75:1.0 for the three fiscal quarters following thequarter in which such acquisition or capital expenditure occurs; and a minimuminterest coverage ratio of 3.0:1.0.

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On June 8,2006, Hiland Partners entered into a second amendment to their credit facilityto, among other things, increase its borrowing base from February 15, 2005original borrowing base of $55.0 million, first amended on September 26, 2005to $125.0 million, to $200 million and revise certain covenants. Thecredit facility will mature in May 2011. At that time, the agreement willterminate and all outstanding amounts thereunder will be due and payable.

Hiland Partners’obligations under the credit facility are secured by substantially all of itsassets and guaranteed by Hiland Partners, and all of its subsidiaries, otherthan Hiland Operating, LLC its operating company, which is the borrower underthe credit facility.

Indebtedness underthe credit facility will bear interest, at Hiland Partners’ option, at either(i) an alternate base rate plus an applicable margin ranging from 50 to125 basis points per annum or (ii) LIBOR plus an applicable margin rangingfrom 150 to 225 basis points per annum based on our ratio of consolidatedfunded debt to EBITDA. The Alternate Base Rate is a rate per annum equal to thegreatest of (a) the Prime Rate in effect on such day, (b) the base CDrate in effect on such day plus 1.50% and (c) the Federal Funds effectiverate in effect on such day plus 1⁄2 of 1%. A letter of credit fee will be payablefor the aggregate amount of letters of credit issued under the credit facilityat a percentage per annum equal to 1.0%. An unused commitment fee ranging from25 to 50 basis points per annum based on our ratio of consolidated funded debtto EBITDA will be payable on the unused portion of the credit facility. Duringany step-up period, the applicable margin with respect to loans under thecredit facility will be increased by 35 basis points per annum and the unusedcommitment fee will be increased by 12.5 basis points per annum. At June 30,2007, the interest rate on outstanding borrowings from Hiland Partners’ creditfacility was 7.32%.

The creditfacility prohibits Hiland Partners from making distributions to unitholders ifany default or event of default, as defined in the credit facility, hasoccurred and is continuing or would result from the distribution. In addition,the credit facility contains various covenants that limit, among other things,subject to certain exceptions and negotiated “baskets,” our ability to incurindebtedness, grant liens, make certain loans, acquisitions and investments,make any material changes to the nature of its business, amend its materialagreements, including its Omnibus Agreement, which contains non-compete andindemnity provisions with affiliates, or enter into a merger, consolidation orsale of assets.

The creditfacility also contains covenants requiring Hiland Partners to maintain amaximum consolidated funded debt to EBITDA ratio of 4.0:1.0, provided that inthe event Hiland Partners makes certain permitted acquisitions or capitalexpenditures, the credit facility allows this ratio to increase to 4.75:1.0 forthe following three fiscal quarters (a “step-up period”) and a minimum interestcoverage ratio of 3.0:1.0.

The creditfacility defines EBITDA as Hiland Partners’ consolidated net income, plusincome tax expense, interest expense, depreciation and amortization expense,amortization of intangibles and organizational costs, non-cash unit basedcompensation expense, and adjustments for non-cash gains and losses onspecified derivative transactions and for other extraordinary items.

Upon theoccurrence of an event of default as defined in the credit facility, thelenders may, among other things, be able to accelerate the maturity of thecredit facility and exercise other rights and remedies as set forth in thecredit facility.

The creditfacility limits distributions to Hiland Partners’ unitholders to availablecash, as defined by the agreement, 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 June 30,2007, Hiland Partners had $177.6 million outstanding under this creditfacility and was in compliance with its financial covenants.

***Impact of Inflation***

Inflation in theUnited 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**

InFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value Optionfor Financial Assets and Financial Liabilities”. SFAS No. 159 expandsopportunities to use fair value measurement in financial reporting and permitsentities to choose to measure many financial instruments and certain otheritems at fair value. SFAS No. 159 is effective for fiscal years beginningafter November 15, 2007. We have not decided if we will choose to measureany eligible financial assets and liabilities at fair value.

InSeptember 2006, the FASB issued SFAS No. 157 “Fair ValueMeasurements.”  SFAS No. 157 defines fair value as the price thatwould be received to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurement date, establishes aframework for measuring fair value in generally accepted accounting principles(GAAP) such as fair value hierarchy used to classify the source of informationused in fair value measurements (i.e., market based or non-market based)

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and expands disclosureabout fair value measurements based on their level in the hierarchy. ThisStatement applies to derivatives and other financial instruments, whichStatement 133,*  Accounting forDerivative Instruments and Hedging Activities*  , as amended, requires be measured at fairvalue at initial recognition and for all subsequent periods. This Statement iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2007 and interim periods within those fiscal years. We willapply the provisions of the Statement prospectively in our first interim periodin the fiscal year beginning on January 1, 2008 and we do not expect achange in our methodologies of fair value measurements.

**Significant Accounting Policies andEstimates**

***Revenue Recognition****.  * Revenues for sales andgathering of natural gas and NGLs product sales are recognized at the time theproduct is delivered and title, if applicable, is transferred. Revenues forcompression services are recognized when the services under the agreement areperformed. Revenues from oil and gas production (discontinued operations) wererecorded in the month produced and title was transferred to the purchaser.

***Derivatives****.  * We utilize derivative financial instruments toreduce commodity price risks. We do not hold or issue derivative financialinstruments for trading purposes. Statement of Financial Accounting Standards(or SFAS) No. 133, “Accounting for Derivative Instruments and HedgingActivities”, which was amended in June 2000 by SFAS No. 138 and inMay 2003 by SFAS No. 149, establishes accounting and reportingstandards for derivative instruments and hedging activities. It requires thatan entity recognize all derivatives as either assets or liabilities in thestatement of financial condition and measure those instruments at fair value.Derivatives that are not designated as hedges are adjusted to fair valuethrough income. If the derivative is designated as a hedge, depending upon thenature of the hedge, changes in the fair value of the derivatives are eitheroffset against the fair value of assets, liabilities or firm commitmentsthrough income, or recognized in other comprehensive income until the hedgeditem is recognized in income. The ineffective portion of a derivative’s changein fair value is immediately recognized into income. If a derivative no longerqualifies for hedge accounting the amounts in accumulated other comprehensiveincome will be immediately charged to operations.

***Depreciation and Amortization.****  * Depreciation of all equipmentis determined under the straight-line method using various rates based onuseful lives, 10 to 22 years for pipeline and processing plants, and 3 to10 years for corporate and other assets. The cost of assets and relatedaccumulated depreciation is removed from the accounts when such assets aredisposed of, and any related gains or losses are reflected in current earnings.Maintenance, repairs and minor replacements are expensed as incurred. Costs ofreplacements constituting improvement are capitalized. Intangible assetsconsist of the acquired value of existing contracts to sell natural gas andother NGLs, compression contracts and identifiable customer relationships,which do not have significant residual value. The contracts are being amortizedover their estimated lives of ten years.

***Asset Retirement Obligations****.  * SFAS No. 143 “Accountingfor Asset Retirement Obligations” requires entities to record the fair value ofa liability for an asset retirement obligation in the period in which it isincurred and a corresponding increase in the carrying amount of the relatedlong-lived asset. Subsequently, the asset retirement cost is allocated toexpense using a systematic and rational method and the liability is accreted tomeasure the change in liability due to the passage of time. The primary impactof this standard relates to our estimated costs for dismantling and siterestoration of certain of our plants and pipelines. Estimating future asstretirement obligations requires us to make estimates and judgments regardingtiming, existence of a liability, as well as what constitutes adequaterestoration. We use the present value of estimated cash flows related to ourasset retirement obligation to determine the fair value, generally as estimatedby third party consultants. The present value calculation requires us to makenumerous assumptions and judgments, including the ultimate costs of dismantlingand site restoration, inflation factors, credit adjusted discount rates, timingof settlement and changes in the legal, regulatory, environmental and politicalenvironments. To the extent future revisions to these assumptions impact thepresent value of the existing asset retirement obligation liability, acorresponding adjustment will be required to the related asset. We believe theestimates and judgments reflected in our financial statements are reasonablebut are necessarily subject to the uncertainties we have just described.Accordingly, any significant variance in any of the above assumptions orfactors could materially affect our cash flows.

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

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

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·                  changes ingeneral economic conditions in regions in which the Partnership’s products arelocated;

·                  the availabilityand prices of NGL products and competing commodities;

·                  the availabilityand prices of raw natural gas supply;

·                  our ability tonegotiate favorable marketing agreements;

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

·                  our dependenceon certain significant customers and producers of natural gas; and

·                  competition fromother midstream service providers and processors, including major energycompanies.

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.

***Share Based Compensation.****  * In October 1995, theFASB issued SFAS No. 123, “Share-Based Payment,” which was revised inDecember 2004 (“SFAS 123R”). SFAS 123R requires that the compensation costrelating to share-based payment transactions be recognized in the financialstatements and that cost be measured based on the fair value of the equity orliability instruments issued. We adopted SFAS 123R September 25, 2006 andHiland Partners adopted SFAS 123R January 1, 2006. We have applied SFAS123R using the permitted modified prospective method beginning as of the samedate. Hiland Partners had unearned deferred compensation of $289 as ofJanuary 1, 2006 which has been eliminated against Hiland Partners commonunit equity. Prior to January 1, 2006, Hiland Partners recorded anyunamortized compensation related to restricted unit awards as unearnedcompensation in equity. We expect no change to cash flow presentation from theadoption of SFAS 123R since no tax benefits were recognized by Hiland Partnersas a pass through entity.

We estimate thefair value of each option granted on the date of grant using the AmericanBinomial option-pricing model. In estimating the fair value of each option, weuse our peer group volatility averages as determined on the option grant dates.We calculate expected lives of the options under the simplified method asprescribed by the SEC Staff Accounting Bulletin 107 and have used a risk freeinterest rate based on the applicable U.S. Treasury yield in effect at the timeof grant. Our compensation expense for these awards is recognized onthe graded vesting attribution method. Units to be issued under our unitincentive plan may be from newly issued units. Prior to Hiland Partnersadoption of SFAS 123R on January 1, 2006, they applied AccountingPrinciples Board Opinion No. 25 and related interpretations in accountingfor the unit-based compensation awards.

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

Market risk is therisk of loss arising from adverse changes in market rates and prices. Theprincipal market risk to which we are exposed is commodity price risk fornatural gas and NGLs. We also incur, to a lesser extent, risks related tointerest rate fluctuations.

We do not engagein commodity energy trading activities.

***Commodity Price Risks.  *** Ourprofitability is affected by volatility in prevailing NGL and natural gasprices. Historically, changes in the prices of most NGL products have generallycorrelated with changes in the price of crude oil. NGL and natural gas pricesare volatile and are impacted by changes in the supply and demand for NGLs andnatural gas, as well as market uncertainty. Our cash flow is affected by thevolatility of natural gas and NGL product prices, which could adversely affectour ability to make distributions to unitholders. To illustrate the impact ofchanges in prices for natural gas and NGLs on our operating results, we haveprovided the table below, which reflects, for the six months ended June 30,2007, the impact on our total segment margin of a $0.01 per gallon change(increase or decrease) in NGL prices coupled with a $0.10 per MMBtu change(increase or decrease) in the price of natural gas. The magnitude of the impacton total segment margin of changes in natural gas and NGL prices presented maynot be representative of the magnitude of the impact on total segment marginfor different commodity prices or contract portfolios. Natural gas prices canalso affect our profitability indirectly by influencing the level of drillingactivity and related opportunities for our services.
|                                | ** ** | **For the Six Months Ended June 30, 2007** | ** ** |
|--------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                     | ** ** | **Natural Gas Price Change ($/MMBtu)**                    | ** ** |
|       |       |                                                                          |       | $ | 0.10 |   | $ | (0.10 | ) |
| **NGL  Price**                 |       | $                                                                             | 0.01       |   | $ | 293,000 |   | $ | 63,000 |   |
| **Change  ($/gal)**            |       | $                                                                             | (0.01      | ) | $ | (66,000 | ) | $ | (297,000 | ) |

 

 We manage thiscommodity price exposure through an integrated strategy that includesmanagement of our contract portfolio, optimization of our assets and the use ofderivative contracts. As a result of these derivative contracts, we have hedgeda portion of our expected exposure to natural gas prices and natural gas liquidprices in 2007, 2008 and 2009. We continually monitor our hedging and contractportfolio and expect to continue to adjust our hedge position as conditionswarrant. The following table provides information

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about ourderivative instruments for the periods indicated:
|                                                                  | ** ** | ** **  | ** ** | ** **           | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------------------|------------|-------------|------------|----------------------|------------|---------------------|------------|
| ** **                                                       | ** ** | ** **  | ** ** | **Average**          | ** ** | **Asset**           | ** ** |
| **Description and Production Period**             | ** ** | **Volume**  | ** ** | **Fixed Price** | ** ** | **(Liability)**     | ** ** |
| ** **                                                       | ** ** | ** **  | ** ** | ** **           | ** ** | ** **          | ** ** |
| **Natural Gas—Sold Fixed for Floating Price Swaps**         | ** ** | ** **  | ** ** | ** **           | ** ** | ** **          | ** ** |
| ** **                                                       | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| July 2007  - June 2008                                 |       | 1,800,000   |       | $                    | 7.92       |                | $          | 3,760 |   |
| July  2008-December 2008                                         |       | 990,000     |       | 7.84                 |       | 756                 |       |
| January 2009  - December 2009                          |       | 1,068,000   |       | $                    | 7.06       |                | (387       | ) |
|                                                             |       |        |       |                 |       | $                   | 4,129      |   |
|                                                             |       |        |       |                 |       |                |       |
| **Natural Gas - Sold Open for Floating Price Swaps**             | ** ** | ** **  | ** ** | ** **           | ** ** | ** **          | ** ** |
| ** **                                                       | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| January  2009 - December 2009                                    |       | 1,068,000   |       | $                    | 7.42       |                | $          | 182 |   |
|                                                             |       |        |       |                 |       |                |       |
| **Natural Gas—Buy Fixed for Floating Price Swaps**          | ** ** | ** **  | ** ** | ** **           | ** ** | ** **          | ** ** |
| ** **                                                       | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| July  2007 - March 2008                                     |       | 450,000     |       | $                    | 8.87       |                | $          | (954 | ) |
|                                                             |       |        |       |                 |       |                |       |
| **Natural Gas Liquids—Sold Fixed for Floating Price Swaps** | ** ** | ** **  | ** ** | ** **           | ** ** | ** **          | ** ** |
| ** **                                                       | ** ** | **(Bbls)**  | ** ** | **(per Gallon)**     | ** ** | ** **          | ** ** |
| July 2007  - March 2008                                |       | 114,489     |       | $                    | 1.13       |                | $          | (1,501 | ) |

 

On July 16, 2007,Hiland Partners entered into natural gas liquid (“NGL”) cash flow swaps addingto Hiland Partners hedges for forecasted NGL sales through calendar year 2008.Under the swap agreements Hiland Partners pays it counterparty floating indexprices and receives fixed prices of $1.35 per gallon on 24,093 Bbls/monthduring August 2007 through December 2007 and $1.31 per gallon on 33,634Bbls/month during calendar year 2008.

On July 16, 2007,Hiland Partners also entered into natural gas cash flow swaps adding to HilandPartners hedges for forecasted natural gas purchases through calendar year2008.  Under the swap agreement Hiland Partners receives floating indexprices and pays its counterparty fixed prices of $5.56 per MMBtu on 33,235MMBtu/month during August 2007 through December 2007 and $6.97 per MMBtu on53,381 MMBtu/month during calendar year 2008.

In addition to thederivative instruments noted in the table above, Hiland Partners has executedvarious natural gas fixed price physical forward sales contracts onapproximately 115,000 MMBtu per month for 2007 and 100,000 MMBtu per month for2008 with fixed prices ranging from $4.49 to $9.13 per MMBtu in 2007 and $8.43per MMBtu in 2008. These contracts have been designated as normal sales underSFAS No. 133 and are therefore not marked to market as derivatives. Asummary of our fixed price physical forward sales contracts is
|                                     | ** ** | ** **  | ** ** | **Average**          | ** ** |
|-------------------------------------|------------|-------------|------------|----------------------|------------|
| ** **                          | ** ** | ** **  | ** ** | **Fixed Price** | ** ** |
| **Production Period**          | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** |
|                                |       |        |       |                 |       |
| July 2007 -  June 2008         |       | 1,290,000   |       | $                    | 7.62       |   |
| July 2008 - December 2008 |       | 600,000     |       | $                    | 8.43       |   |

 

***Interest Rate Risk.***   We areexposed to changes in interest rates as a result of our credit facilities,which have floating interest rates. As of June 30, 2007, we hadapproximately $0.4 million of indebtedness outstanding under our creditfacility which was used to finance the costs related to the closing of our$25.0 million secured revolving credit facility. As of June 30, 2007,Hiland Partners had approximately $177.6 million of indebtedness outstandingunder its credit facility. The impact of a 100 basis point increase or decreasein interest rates on the amount of Hiland Partners’ debt would result in anincrease or decrease in interest expense and a corresponding decrease orincrease in net income of approximately $1.8 million annually.

***Credit Risk.****  * Counterparties pursuant to the terms of theircontractual obligations expose us to potential losses as a result ofnonperformance. Hiland Partners’ four largest customers for the six monthsended June 30, 2007 accounted for approximately 25%, 15%, 14% and 10%,respectively, of revenues. Consequently, changes within one or more of thesecompanies’ operations have the potential to impact, both positively andnegatively, our credit exposure. Our counterparty for all of our derivativeinstruments as of June 30, 2007 is BP Energy Company and BP Corporation NorthAmerica, Inc.

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**Item4.  Controls and Procedures**

**Evaluation of Disclosure Controls andProcedures**

(a) Evaluation ofdisclosure controls and procedures.

Our management,under the supervision of and with the participation of our principal executiveofficer and principal financial officer, has evaluated the effectiveness of ourdisclosure controls and procedures, as such term is defined in Rules 13a-15(e)and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”), as of the end of the period covered by this report. Our disclosurecontrols and procedures are designed to provide reasonable assurance that theinformation required to be disclosed by us in our reports filed or submittedunder the Exchange Act is accumulated and communicated to management, includingour principal executive officer and principal financial officer, as appropriateto allow timely decisions regarding required disclosure and is recorded,processed, summarized and reported within the time periods specified in therules and forms of the Securities and Exchange Commission. Based on suchevaluation, our principal executive officer and principal financial officerhave concluded that our disclosure controls and procedures were effective as ofJune 30, 2007 at the reasonable assurance level. Our management does not expectthat our disclosure controls and procedures or our internal control overfinancial reporting will prevent all errors and all fraud. Further, the designof disclosure controls and internal control over financial reporting mustreflect the fact that there are resource constraints, and the benefits ofcontrols must be considered relative to their costs. Because of the inherentlimitations in all control systems, no evaluation of controls can provideabsolute assurance that all control issues and instances of fraud, if any,within a company have been detected.

(b) Changes ininternal control over financial reporting.

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

**PART II.OTHER INFORMATION**

**Item 1.  Legal Proceedings**

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

**Item 1A. Risk Factors**

In addition to theother information set forth in this report, you should carefully consider thefactors discussed in Part I, Item 1A. “Risk Factors” in our Annual Report on Form10-K for the year ended December 31, 2006 and in Part II, Item 1A. “RiskFactors” in our Quarterly Report on Form 10-Q for the quarter ended March 31,2007, which could materially affect our business, financial condition or futureresults. The risks described in our Annual Report on Form 10-K and in ourQuarterly Report on Form 10-Q are not the only risks facing our Company.Additional risks and uncertainties not currently known to us or that wecurrently deem to be immaterial also may materially adversely affect ourbusiness, financial condition and/or operating results.

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

None.

**Item 3.Defaults Upon Senior Securities**

None.

**Item 4.Submission of Matters to a Vote of Security Holders**

None.

**Item 5.Other Information**

On July 16, 2007,Hiland Partners entered into natural gas liquid (“NGL”) cash flow swaps addingto Hiland Partners hedges for forecasted NGL sales through calendar year 2008.Under the swap agreements Hiland Partners pays it counterparty floating indexprices and receives fixed prices of $1.35 per gallon on 24,093 Bbls/monthduring August 2007 through December 2007 and $1.31 per gallon on 33,634Bbls/month during calendar year 2008.

On July 16, 2007,Hiland Partners also entered into natural gas cash flow swaps adding to HilandPartners hedges for forecasted

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natural gaspurchases through calendar year 2008.  Under the swap agreement HilandPartners receives floating index prices and pays its counterparty fixed pricesof $5.56 per MMBtu on 33,235 MMBtu/month during August 2007 through December2007 and $6.97 per MMBtu on 53,381 MMBtu/month during calendar year 2008.

On July 13, 2007,Hiland Partners entered into a third amendment to its credit agreement dated asof February 15, 2005. Pursuant to the third amendment, Hiland Partners may,among other things, increase its borrowing base from $200 million to $250million and decrease the accordion feature in the facility from $150 million to$100 million.

The thirdamendment increased Hiland Partners borrowing capacity under its senior securedrevolving credit facility to $250 million such that the facility now consistsof a $241 million senior secured revolving credit facility to be used forfunding acquisitions and other capital expenditures, issuance of letters ofcredit and general corporate purposes (the “Acquisition Facility”) and a $9.0million senior secured revolving credit facility to be used for working capitaland to fund distribution (the “Working Capital Facility”).

In addition, thethird amendment provides for an accordion feature, which permits HilandPartners if certain conditions are met, to increase the size of the AcquisitionFacility by up to $100 million and allows for the issuance of letters of creditof up to $15 million in the aggregate.  The senior secured revolvingcredit facility also requires Hiland Partners to meet certain financial tests,including a maximum consolidated funded debt to EBITDA ratio of 4.0:1.0 as ofthe last day of any fiscal quarter; provided that in the event that thePartnership makes certain permitted acquisitions or capital expenditures, thisratio may be increased to 4.75:1.0 for the three fiscal quarters following thequarter in which such acquisition or capital expenditure occurs; and a minimuminterest coverage ratio of 3.0:1.0.

**Item 6.Exhibits**
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                                                                |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.25                | ** ** | Third Amendment, dated as of July 13, 2007, to  Credit Agreement dated as of February 15, 2005 among Hiland Operating, LLC  and the lenders thereto (incorporated by reference to Exhibit 10.1 of Hiland  Partners, LP’s form 8-K filed on July 18, 2007) |
| 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**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized in the city of Enid, Oklahoma, onthe 9th  dayof August, 2007.
|            | **HILAND HOLDINGS GP, LP** |
|------------|----------------------------|
| ** ** | **By:**                    | **Hiland Partners GP Holdings, LLC, its general  partner** |
| ** ** | ** **                 | ** ** |
|       | By:                        | /s/ JOSEPH L. GRIFFIN |   |
|       |                       | Joseph L. Griffin |
|       | * *                   | *Chief Executive Officer, President and Director* |
|       | * *                   | * * |
|       | * *                   | * * |
|       | By:                        | /s/ KEN MAPLES |   |
|       |                       | Ken Maples |
|       | * *                   | *Chief Financial Officer, Vice President-Finance,  Secretary* |
|       | * *                   | *and Director* |

 

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