**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**x****  QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**FOR THEQUARTERLY PERIOD ENDED March 31, 2007**

**OR**

**o****  TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

**FORTHE TRANSITION PERIOD FROM             TO             **

**Commissionfile 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 checkwhether the 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 May 4, 2007 was 21,600,000 commonunits.

 

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**HILAND****HOLDINGS GP****, 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**
| ** **                                                                      | ** ** | **March 31,**                                          | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                      | ** ** | **2007**                                                    | ** ** | **2006**              | ** ** |
| ** **                                                                      | ** ** | **(unaudited)**                                             | ** ** | ** **            | ** ** |
| ** **                                                                      | ** ** | **(in thousands, except unit amounts)** | ** ** |
| **ASSETS**                                                                      |       |                                                        |       |                  |       |
| **Current assets:**                                                             |       |                                                        |       |                  |       |
| Cash and cash  equivalents                                                      |       | $                                                           | 8,648      |                  | $          | 10,569 |   |
| Accounts receivable:                                                            |       |                                                        |       |                  |       |
| Trade                                                                           |       | 24,485                                                      |       | 23,702                |       |
| Affiliates                                                                      |       | 1,191                                                       |       | 1,284                 |       |
|                                                                            |       | 25,676                                                      |       | 24,986                |       |
| Fair value of  derivative assets                                                |       | 3,647                                                       |       | 4,707                 |       |
| Other current assets                                                            |       | 841                                                         |       | 945                   |       |
| Total current assets                                                            |       | 38,812                                                      |       | 41,207                |       |
|                                                                            |       |                                                        |       |                  |       |
| Property and equipment,  net                                                    |       | 268,071                                                     |       | 257,003               |       |
| Intangibles, net                                                                |       | 51,555                                                      |       | 53,094                |       |
| Fair value of  derivative assets                                                |       | 1,267                                                       |       | 1,955                 |       |
| Other assets, net                                                               |       | 1,971                                                       |       | 1,939                 |       |
|                                                                            |       |                                                        |       |                  |       |
| **Total assets**                                                                |       | $                                                           | 361,676    |                  | $          | 355,198 |   |
|                                                                            |       |                                                        |       |                  |       |
| **LIABILITIES AND OWNERS’ EQUITY**                                         |       |                                                        |       |                  |       |
| **Current liabilities:**                                                        |       |                                                        |       |                  |       |
| Accounts payable                                                                |       | $                                                           | 19,748     |                  | $          | 19,161 |   |
| Accounts  payable—affiliates                                               |       | 4,542                                                       |       | 4,412                 |       |
| Fair value of  derivative liabilities                                           |       | 2,067                                                       |       | 1,902                 |       |
| Accrued liabilities                                                             |       | 1,414                                                       |       | 1,459                 |       |
| Total current  liabilities                                                      |       | 27,771                                                      |       | 26,934                |       |
|                                                                            |       |                                                        |       |                  |       |
| Commitments and  contingencies (Note 7)                                         |       |                                                        |       |                  |       |
| Long-term debt                                                                  |       | 159,418                                                     |       | 147,318               |       |
| Fair value of  derivative liabilities                                           |       | 274                                                         |       | 291                   |       |
| Asset retirement  obligation                                                    |       | 2,215                                                       |       | 2,196                 |       |
| Minority interests                                                              |       | 135,455                                                     |       | 137,302               |       |
|                                                                            |       |                                                        |       |                  |       |
| **Owners’ equity**                                                         |       |                                                        |       |                  |       |
| Common unitholders  (21,600,000 units issued and outstanding at March 31, 2007) |       | 35,140                                                      |       | 38,590                |       |
| Accumulated other  comprehensive income                                         |       | 1,403                                                       |       | 2,567                 |       |
| **Total owners’ equity**                                                   |       | 36,543                                                      |       | 41,157                |       |
|                                                                            |       |                                                        |       |                  |       |
| **Total liabilities and owners’ equity**                                   |       | $                                                           | 361,676    |                  | $          | 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 Months Ended (Unaudited)**
| ** **                                                                      | ** ** | **March 31,**                                                | ** ** | **March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                      | ** ** | **2007**                                                          | ** ** | **2006**           | ** ** |
| ** **                                                                      | ** ** | ** **                                                        | ** ** | **Predecessor**    | ** ** |
| ** **                                                                      | ** ** | **(in thousands, except unit amounts) ** | ** ** |
| **Revenues:**                                                                   | ** ** | ** **                                                        | ** ** | ** **         | ** ** |
| Midstream  operations                                                           |       |                                                              |       |               |       |
| Third parties                                                                   |       | $                                                                 | 58,860     |               | $          | 50,886 |   |
| Affiliates                                                                      |       | 989                                                               |       | 1,318              |       |
| Compression  services, affiliate                                                |       | 1,205                                                             |       | 1,205              |       |
| Total revenues                                                                  |       | 61,054                                                            |       | 53,409             |       |
| ** **                                                                      | ** ** | ** **                                                        | ** ** | ** **         | ** ** |
| **Operating  costs and expenses:**                                              | ** ** | ** **                                                        | ** ** | ** **         | ** ** |
| Midstream  purchases (exclusive of items shown separately below)                |       | 31,881                                                            |       | 27,155             |       |
| Midstream  purchases—affiliate (exclusive of items shown separately below) |       | 11,734                                                            |       | 14,380             |       |
| Operations and  maintenance                                                     |       | 4,970                                                             |       | 2,574              |       |
| Depreciation,  amortization and accretion                                       |       | 7,028                                                             |       | 4,137              |       |
| General and  administrative expenses                                            |       | 2,045                                                             |       | 1,038              |       |
| Total operating  costs and expenses                                             |       | 57,658                                                            |       | 49,284             |       |
| Operating income                                                                |       | 3,396                                                             |       | 4,125              |       |
| ** **                                                                      | ** ** | ** **                                                        | ** ** | ** **         | ** ** |
| **Other  income (expense):**                                                    | ** ** | ** **                                                        | ** ** | ** **         | ** ** |
| Interest and  other income                                                      |       | 127                                                               |       | 75                 |       |
| Amortization of  deferred loan costs                                            |       | (110                                                              | )          | (123               | )          |
| Interest expense                                                                |       | (2,091                                                            | )          | (535               | )          |
| Other income  (expense), net                                                    |       | (2,074                                                            | )          | (583               | )          |
|                                                                            |       |                                                              |       |               |       |
| **Income  before minority interest in income of Hiland Partners, LP**           |       | 1,322                                                             |       | 3,542              |       |
| Minority  interest in income of Hiland Partners, LP                             |       | (574                                                              | )          | (3,164             | )          |
| **Limited  partners’ interest in net income**                              |       | $                                                                 | 748        |               | $          | 378 |   |
|                                                                            |       |                                                              |       |               |       |
| **Net  income per limited partners’ unit—basic**                      |       | $                                                                 | 0.03       |               |       |   |
|                                                                            |       |                                                              |       |               |       |
| **Net  income per limited partners’ unit—diluted**                    |       | $                                                                 | 0.03       |               |       |   |
|                                                                            |       |                                                              |       |               |       |
| **Weighted  average limited partners’ units outstanding—basic**       |       | 21,600                                                            |       |               |       |
|                                                                            |       |                                                              |       |               |       |
| **Weighted average limited  partners’ units outstanding—diluted**     |       | 21,605                                                            |       |               |       |

 

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 Three Months Ended (Unaudited)**
| ** **                                                                         | ** ** | **March 31,**      | ** ** | **March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------|------------|
| ** **                                                                         | ** ** | **2007**                | ** ** | **2006**           | ** ** |
| ** **                                                                         | ** ** | ** **              | ** ** | **Predecessor**    | ** ** |
| ** **                                                                         | ** ** | **(in thousands)** | ** ** |
| **Cash  flows from operating activities:**                                         | ** ** | ** **              | ** ** | ** **         | ** ** |
| Net income                                                                         |       | $                       | 748        |               | $          | 378 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                    |       |               |       |
| Depreciation and  amortization                                                     |       | 7,009                   |       | 4,127              |       |
| Accretion of asset  retirement obligation                                          |       | 19                      |       | 10                 |       |
| Amortization of  deferred loan cost                                                |       | 110                     |       | 123                |       |
| Gain on  derivative transactions                                                   |       | (69                     | )          | (82                | )          |
| Unit based  compensation                                                           |       | 464                     |       | 115                |       |
| Minority  interest in income of Hiland Partners, LP                                |       | 574                     |       | 3,164              |       |
| (Increase)  decrease in current assets:                                            |       |                    |       |               |       |
| Accounts  receivable—trade                                                    |       | (783                    | )          | 6,126              |       |
| Accounts  receivable—affiliates                                               |       | 93                      |       | 318                |       |
| Other current  assets                                                              |       | 104                     |       | (202               | )          |
| Increase  (decrease) in current liabilities:                                       |       |                    |       |               |       |
| Accounts  payable—trade                                                       |       | 587                     |       | (3,511             | )          |
| Accounts  payable—affiliates                                                  |       | 130                     |       | (1,367             | )          |
| Accrued  liabilities                                                               |       | (45                     | )          | (164               | )          |
| **Net  cash provided by operating activities**                                     |       | 8,941                   |       | 9,035              |       |
| ** **                                                                         | ** ** | ** **              | ** ** | ** **         | ** ** |
| **Cash  flows from investing activities:**                                         | ** ** | ** **              | ** ** | ** **         | ** ** |
| Additions to  property and equipment                                               |       | (16,538                 | )          | (11,178            | )          |
| **Net  cash used in investing activities**                                         |       | (16,538                 | )          | (11,178            | )          |
| ** **                                                                         | ** ** | ** **              | ** ** | ** **         | ** ** |
| **Cash  flows from financing activities:**                                         | ** ** | ** **              | ** ** | ** **         | ** ** |
| Proceeds from  long-term borrowings                                                |       | 12,100                  |       | 8,000              |       |
| Debt issuance  costs                                                               |       | —                  |       | (11                | )          |
| Offering costs                                                                     |       | (142                    | )          | (17                | )          |
| Proceeds from  Hiland Partners, LP unit options exercise                      |       | 969                     |       | 892                |       |
| Minority  interest cash distribution to unitholders of Hiland Partners, LP         |       | (2,767                  | )          | (5,274             | )          |
| Cash  distribution to members of Hiland Partners GP, LLC                           |       | —                  |       | (302               | )          |
| Cash  distribution to unitholders                                                  |       | (4,484                  | )          | —             |       |
| **Net  cash provided by financing activities**                                     |       | 5,676                   |       | 3,288              |       |
|                                                                               |       |                    |       |               |       |
| Increase  (decrease) for the period                                                |       | (1,921                  | )          | 1,145              |       |
| Beginning of  period                                                               |       | 10,569                  |       | 6,318              |       |
| **End of  period**                                                                 |       | $                       | 8,648      |               | $          | 7,463 |   |
|                                                                               |       |                    |       |               |       |
| Supplementary  information                                                         |       |                    |       |               |       |
| Cash paid for interest,  net of amounts capitalized                                |       | $                       | 2,072      |               | $          | 505 |   |

 

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

4

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**HilandHoldings GP, LP**

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

**Forthe Three Months Ended March 31, 2007 (Unaudited)**
| ** **                                                                           | ** ** | ** **                                                  | ** ** | **Accumulated**   | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------|------------|------------|------------|-------------------|------------|
| ** **                                                                           | ** ** | ** **                                                  | ** ** | **Other**         | ** ** | ** ** | ** ** | **Total**         | ** ** |
| ** **                                                                           | ** ** | **Common**                                                  | ** ** | **Comprehensive** | ** ** | ** ** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                           | ** ** | **Units**                                                   | ** ** | **Income**        | ** ** | **Total**  | ** ** | **Income**        | ** ** |
| ** **                                                                           | ** ** | **(in thousands, except unit amounts)** | ** ** |
|                                                                                 |       |                                                        |       |              |       |       |       |              |       |
| **Balance,  January 1, 2007**                                                   |       | $                                                           | 38,590     |              | $          | 2,567      |       | $                 | 41,157     |   |   |   |
|                                                                                 |       |                                                        |       |              |       |       |       |              |       |
| Periodic cash  distributions                                                         |       | (4,484                                                      | )          | —            |       | (4,484     | )          |              |       |
|                                                                                 |       |                                                        |       |              |       |       |       |              |       |
| Unit based  compensation                                                             |       | 286                                                         |       | —            |       | 286        |       |              |       |
|                                                                                 |       |                                                        |       |              |       |       |       |              |       |
| Other  comprehensive income reclassified to income on closed derivative transactions |       | —                                                      |       | (332              | )          | (332       | )          | $                 | (332       | ) |
|                                                                                 |       |                                                        |       |              |       |       |       |              |       |
| Change in fair  value of derivatives                                                 |       | —                                                      |       | (832              | )          | (832       | )          | (832              | )          |
|                                                                                 |       |                                                        |       |              |       |       |       |              |       |
| Net income                                                                           |       | 748                                                         |       | —            |       | 748        |       | 748               |       |
|                                                                                 |       |                                                        |       |              |       |       |       |              |       |
| Comprehensive  income (loss)                                                         |       |                                                        |       |              |       |       |       | $                 | (416       | ) |
|                                                                                 |       |                                                        |       |              |       |       |       |              |       |
| **Balance March 31, 2007**                                                      |       | $                                                           | 35,140     |              | $          | 1,403      |       | $                 | 36,543     |   |   |   |

 

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

5

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**HILANDHOLDINGS GP, LP**

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

**March31, 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 a substantialportion of its net assets to Hiland Partners. The transfer of ownership of netassets from Continental Gas, Inc. to Hiland Partners represented areorganization of entities under common control and was recorded at historicalcost. Continental Gas, Inc. was formed in 1990 as a wholly ownedsubsidiary 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. The netassets acquired by Hiland Partners on February 15, 2005 had a fair valueof $48.6 million. Since its initial public offering, Hiland Partners hasoperated in midstream and compression services segments. On September 26,2005, Hiland Partners acquired Hiland Partners, LLC, which at such time ownedthe Bakken gathering system, for $92.7 million, $35.0 million ofwhich was used to retire outstanding Hiland Partners, LLC indebtedness. OnMay 1, 2006, Hiland Partners acquired the Kinta Area gathering assets fromEnogex Gas Gathering, L.L.C., consisting of certain eastern Oklahoma gasgathering assets, for $96.4 million. Hiland Partners financed this acquisition with $61.2 million ofborrowings from its credit facility and $35.0 million of proceeds from theissuance to Hiland Partners GP, LLC, its general partner, of 761,714 commonunits and 15,545 general partner equivalent units, both at $45.03 per unit.

The unauditedfinancial statements forthe three months ended March 31, 2007 and 2006 included herein have beenprepared pursuant to the rules and regulations of the United States Securitiesand Exchange Commission (the “SEC”). The interim financial statements reflectall adjustments, which are in the opinion of our management, necessary for afair presentation of our results for the interim periods. Such adjustments areconsidered to be of a normal recurring nature. Results of operations for thethree months ended March 31, 2007 are not necessarily indicative of the resultsof operations that will be realized for the year ending December 31, 2007.  The accompanying consolidated financialstatements and notes thereto should be read in conjunction with theconsolidated financial statements and notes thereto included in our Form10-K for the fiscal year ended December 31, 2006.

6

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***Principles of Consolidation***

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 of Financial Instruments***

Our financialinstruments, which require fair value disclosure, consist primarily of cash andcash equivalents, accounts receivable, financial derivatives, accounts payableand long-term debt. The carrying value of cash and cash equivalents, accountsreceivable and accounts payable are considered to be representative of theirrespective fair values, due to the short maturity of these instruments.Derivative instruments are reported in the accompanying consolidated financialstatements at fair value in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 133, “Accounting for Derivative Instruments andHedging Activities,” as amended. 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 Risk Management***

We engage in pricerisk management activities in order to minimize the risk from marketfluctuation in the prices of natural gas and NGLs. To qualify as a hedge, theprice movements 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.

Statement ofFinancial Accounting Standards (“SFAS”) No. 133, “Accounting forDerivative Instruments and Hedging Activities,” as amended, establishesaccounting and reporting standards for derivative instruments, includingcertain derivative instruments embedded in other contracts, and for hedgingactivities. SFAS No. 133 requires that an entity recognize all derivativesas either assets or liabilities in the statement of financial position andmeasure those instruments at fair value. However, if a derivative does qualifyfor hedge accounting, depending on the nature of the hedge, changes in fairvalue can be offset against the change in fair value of the hedged item throughearnings or recognized in other comprehensive income until such time as thehedged item is recognized in earnings. To qualify for cash flow hedge accounting,the cash flows from the hedging instrument must be highly effective inoffsetting changes in cash flows due to changes in the underlying item beinghedged. In addition, all hedging relationships must be designated, documented,and reassessed periodically. SFAS No. 133 also provides that normalpurchases and normal sales contracts are not subject to the statement. Normalpurchases and normal sales are contracts that provide for the purchase or saleof something other than a financial instrument or derivative instrument thatwill be delivered in quantities expected to be used or sold by the reportingentity over a reasonable period in the normal course of business. Our fixedprice physical forward natural gas purchase and sales contracts in which wehave contracted to purchase or sale natural gas quantities at fixed prices aredesignated as normal purchases and sales. Substantially all forward contractsfall 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.

7

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***Comprehensive Income (Loss)***

Comprehensiveincome (loss) includes net income and other comprehensive income, which includes,but is 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 monthsended March 31, 2007 and 2006 is presented in the table below:
|                                                                                      | ** ** | **For the Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2007**                                                               | ** ** | **2006** | ** ** |
| Net income                                                                           |       | $                                                                      | 748        |   | $ | 378 |   |
| Other  comprehensive income reclassified to income on closed derivative transactions |       | (332                                                                   | )          | — |   |
| Change in fair  value of derivatives                                                 |       | (832                                                                   | )          | 4 |   |
| Comprehensive income  (loss)                                                         |       | $                                                                      | (416       | ) | $ | 382 |   |

 

***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 net incomeper limited partner unit further assumes the dilutive effect of restricted unitawards. Net income per limited partners’ unit is computed by dividing netincome applicable to limited partners by both the basic and diluted weighted-averagenumber 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 during the three months ended March 31, 2007 or 2006. OnMay 1, 2006 Hiland Partners acquired the Kinta Area gathering assets andrecorded identifiable customer relationships of $10,492. 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 an additional $6,979 in contracts to sell natural gas for aportion of the amount that the purchase price exceeded the proportionateinterest in the underlying equity of Hiland Partners.

Intangible assetsconsisted of the following at March 31, 2007 and December 31, 2006:
|                                | ** ** | **As of**     | ** ** | **As of**        | ** ** |
|--------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **March 31,** | ** ** | **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 |       | 10,016             |       | 8,477                 |       |
| Intangible assets, net         |       | $                  | 51,555     |                  | $          | 53,094 |   |

 

During the threemonths ended March 31, 2007 and 2006 we recorded $1,539 and $1,103,respectively of amortization expense. Estimated aggregate amortization expensefor the remainder of 2007 is $4,618 and $6,157 for each of the four succeedingfiscal years from 2008 through 2011 and a total of $22,309 for all yearsthereafter.

***Accounting for Asset 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 and

8

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the liabilities areaccreted to measure the change in liability due to the passage of time. Theprovisions of this standard primarily apply to dismantlement and siterestoration of certain of our plants and pipelines. We have evaluated our assetretirement obligations as of March 31, 2007 and have determined thatrevisions in the carrying values are not necessary at this time. Our assetretirement obligations totaling $2,196 at January 1, 2007 increased to $2,215at March 31, 2007 as a result of accreting the obligation by $19.

***Minority Interests***

The minorityinterest on our consolidated balance sheets as of March 31, 2007 andDecember 31, 2006 reflects the outside ownership interest of Hiland Partners.Minority interest in income is calculated by multiplying the minority interestowners’ proportionate ownership of limited partner units in Hiland Partners bythe limited partners’ allocation of Hiland Partners’ net income. HilandPartners’ net income is allocated to its limited partners and its generalpartner based on the proportionate share of the contractually-determined cashdistributions for the period, with adjustments made for incentive distributionsspecifically allocated to its general partner. All amounts we have receivedfrom Hiland Partners’ issuance and sale of limited partner units have beenrecorded as increases to the minority interest balance on the consolidatedbalance sheet.

***Contributions to Subsidiary***

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 isrequired to make contributions to Hiland Partners each time Hiland Partnersissues common units in order to maintain its 2% general partner ownership inHiland Partners. Hiland Holdings or Hiland Partners GP, LLC was required tocontribute $19 and $18 for the three months ended March 31, 2007 and 2006.

***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-term incentiveplan limits the number of units that be delivered pursuant to awards to2,160,000 units. The plan is administered by the board of directors of ourgeneral partner or the compensation committee of the board of directors of ourgeneral partner. The plan will expire upon the first to occur of itstermination by the board of directors or the compensation committee, the datewhen no units remain available under the plan for awards or the tenthanniversary of the date the plan is approved by our unitholders. Awards thenoutstanding will continue pursuant to the terms of their grants.

The board ofdirectors of our general partner and the compensation committee of the boardmay terminate or amend the long-term incentive plan at any time with respect toany units for which a grant has not yet been made. Our board of directors andthe compensation committee of the board also have the right to alter or amendthe long-term incentive plan or any part of the plan from time to time,including increasing the number of units that may be granted subject tounitholder approval as may be required by applicable law or stock exchangerules. However, no change in any outstanding grant may be made that wouldmaterially reduce the benefits of the participant without the consent of theparticipant.

InOctober 1995, the FASB issued SFAS No. 123, “Share-Based Payment,”which was revised in December 2004 (“SFAS 123R”). SFAS 123R requires thatthe compensation cost relating to share-based payment transactions berecognized in the financial statements and that cost be measured based on thefair value of the equity or liability instruments issued. We adoptedSFAS 123R effective January 1, 2006 and have used the permittedmodified prospective method beginning as of the same date.

No options areoutstanding for the three months ended March 31, 2007.

We issued norestricted units during the three months ended March 31, 2007. As of March 31,2007 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 March 31, 2007, none ofthe restricted 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 threemonths ended March 31, 2007, we recorded $32 of expense related to the12,000 restricted units issued and will expense another $192 over the next fouryears.

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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 ascompensation for services to be rendered exclusively for Hiland Partners GP,LLC’s benefit. In connection with the closing of our initial public offering,these Class B member interests were exchanged for a calculated number ofour Class B common units, which had equal fair value. The Class B commonunits vest 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$3 and $8 for three months ended March 31, 2007 and 2006, respectively.

On March 14, 2007,Mr. Moeder announced his intention to resign. In connection with Mr. Moeder’sresignation we, our general partner and Mr. Moeder entered into a retentionagreement 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 will vest. The Class B common unitsthat are not vested will 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 $251 of expense for theperiod from March 15, 2007 through March 31, 2007 and will record another $92for the period from April 1, 2007 through April 16, 2007. On the same day, Mr.Moeder forfeited 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 their discretion,terminate, suspend or discontinue the long-term incentive plan at any time withrespect to any units for which a grant has not yet been made. Hiland PartnersGP, LLC’s board of directors or its compensation committee also has the rightto alter or amend the long-term incentive plan or any part of the plan fromtime to time, including increasing the number of units that may be granted,subject to unitholder approval if required by the exchange upon which thecommon units are listed at that time. No change in any outstanding grant may bemade, however, that would materially impair the rights of the participantwithout the consent of the participant. Under the unit option grant agreement,granted options of common units will vest and become exercisable in one-thirdincrements on the anniversary of the grant date over three years. Vestedoptions are exercisable within the option’s contractual life of ten years afterthe grant date.

SFAS 123Rrequires that the compensation cost relating to share-based paymenttransactions be recognized in the financial statements and that cost bemeasured based on the fair value of the equity or liability instruments issued.Hiland Partners adopted SFAS 123R as of January 1, 2006 and appliedSFAS 123R using the permitted modified prospective method beginning as ofthe same date. Hiland Partners expects no change to its cash flow presentationfrom the adoption of SFAS 123R since no tax benefits are recognized bythem as a pass through entity. Hiland Partners’ compensation expense for theseawards is recognized on the graded vesting attribution method. Units to beissued under Hiland Partners’ unit incentive plan may be from newly issuedunits. Prior to Hiland Partners’ adoption of SFAS 123R on January 1,2006, Hiland Partners applied Accounting Principles Board Opinion No. 25and related interpretations in accounting for their unit-based compensationawards.

There were no unitoptions granted during the three months ended March 31, 2007. The fair value ofeach option granted during the three months ended March 31, 2006 were estimatedon the date of grant using the American Binomial option pricing model that usedexpected volatility ranges from 16.1% to 20.2%, a weighted-average volatilityof 18.0%, an expected dividend yield of 5.2% and a risk-free interest rate of4.5%. Expected and weighted-average volatility was based on peer groupvolatility averages as determined on the option grant dates. Expected lives of6.0 years are calculated by the simplified method as prescribed under SEC StaffAccounting Bulletin 107 and represented the period of time that unit optionsgranted are expected to be outstanding. The risk-free interest rate for periodswithin the contractual life of the option is based on the U.S. Treasury yieldin effect at the time of grant. The

10

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exercise price of theoptions 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 three months ended March 31, 2007:
|                                      | ** ** | ** ** | ** ** | ** **         | ** ** | **Weighted-**   | ** ** | ** **    | ** ** |
|--------------------------------------|------------|------------|------------|--------------------|------------|-----------------|------------|---------------|------------|
| ** **                           | ** ** | ** ** | ** ** | **Weighted**       | ** ** | **Average**     | ** ** | **Aggregate** | ** ** |
| ** **                           | ** ** | ** ** | ** ** | **Average**        | ** ** | **Remaining**   | ** ** | **Intrinsic** | ** ** |
| ** **                           | ** ** | ** ** | ** ** | **Exercise**       | ** ** | **Contractual** | ** ** | **Value**     | ** ** |
| **Options**                          | ** ** | **Units**  | ** ** | **Price ($)** | ** ** | **Term**        | ** ** | **($)**       | ** ** |
| Outstanding at  January 1, 2007 |       | 128,468    |       | $                  | 28.24      |            |       |          |       |   |
| Granted                              |       | —     |       | $                  | —     |            |       |          |       |   |
| Exercised                            |       | (39,930    | )          | $                  | 24.26      |            |       |          | $          | 1,260 |   |
| Forfeited or  expired                |       | —     |       | $                  | —     |            |       |          |       |   |
| Outstanding at  March 31, 2007  |       | 88,538     |       | $                  | 30.03      |            | 8.2        |          | $          | 2,454 |   |
|                                 |       |       |       |               |       |            |       |          |       |
| Exercisable at  March 31, 2007  |       | 14,636     |       | $                  | 16.02      |            | 8.2        |          | $          | 611 |   |

 

In connection withMr. Moeder’s resignation, on March 14, 2007, (see Hiland Holdings GP, LP Long Term IncentivePlan above) Mr. Moeder’s 10,666 unvested Hiland Partners’ options topurchase Hiland Partners common units would vest pro rata as long as Mr. Moedercontinued 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 $18 of expense for the period from March 15, 2007 through March 31,2007 and will record another $6 for the period from April 1, 2007 through April16, 2007. On the same day, Mr. Moeder forfeited his remaining 8,767 unvestedHiland Partners unit options. The forfeiture of Mr. Moeder’s 8,767 unvestedunit options will reduce compensation expense for the period from April 1, 2007through April 16, 2007 by $16. On April 19, 2007, Mr. Moeder exercised his1,899 vested options 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 March 31, 2007 and 2006,Hiland Partners expensed $58 and $87, respectively, related to unit optionsthat were awarded in both 2006 and 2005.

Hiland Partnersissued no restricted units during the three months ended March 31, 2007.  As of March 31, 2007 and December 31, 2006,Hiland Partners had 19,000 restricted common units with a weighted average fairvalue at grant date of $44.12 per restricted unit outstanding. A restrictedunit is a common unit that is subject to forfeiture. The restricted units vestover a four-year period from the date of issuance. Periodic distributions onthe restricted units are held in trust by Hiland Partners GP, LLC until theunits vest. Upon vesting, the grantee receives a common unit that is notsubject to forfeiture. Each non-employee board member of Hiland Partners GP,LLC is entitled to receive an additional 1,000 restricted common units on eachanniversary date of the initial award.

Total compensationexpense related to restricted units was $120 and $20 for the three months endedMarch 31, 2007 and 2006, respectively. As of March 31, 2007, therewas $651 of total unrecognized compensation cost related to Hiland Partners’unvested restricted units. This cost is expected to be recognized over aweighted average period of 3.1 years.

***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 anorderly transaction between market participants at the measurement date,establishes a framework for measuring fair value in generally acceptedaccounting principles (GAAP) such as fair value hierarchy used to classify thesource of information used in fair value measurements (i.e., market based ornon-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 for Derivative Instruments andHedging Activities* , as amended, requires be measured at fair valueat 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.

**Note 2: Initial Public Offering**

On May 26,2006, a Registration Statement on Form S-1 was filed with the UnitedStates Securities and Exchange Commission (the “SEC”) relating to a proposedinitial public offering of limited partnership interests in Hiland Holdings.

OnSeptember 13, 2006, the SEC declared our registration statement onForm S-1 effective. On September 19, 2006, we priced 7,000,000 commonunits in connection with our initial public offering at a price of $18.50 perunit. On September 20, 2006, our common units began trading on the NASDAQNational Market under the symbol “HPGP”. On September 25, 2006, we closedour initial public offering of 8,050,000 common units, which included 1,050,000common units issued pursuant to an over-allotment option that was exercised bythe underwriters. Total proceeds from the sale of the units were $139.6million, net of $9.3 million of underwriting 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 HilandPartners GP, LLC’s assets are reflected at their historical carrying basisbecause the contributions are from a related party. As consideration for thiscontribution, substantially all of the net proceeds from our initial publicoffering, after the retirement of $36.0 million of outstanding debt and accruedinterest of Hiland Partners GP, LLC, were distributed to Harold Hamm, TheHarold Hamm DST Trust, The Harold Hamm HJ Trust, Randy Moeder and Ken Maples(the “Contributing Parties”) and 13,550,000 common units and Class Bcommon units in us were issued to the Contributing Parties.

**Note 3: Acquisition**

*KintaArea Gathering System*.  On May 1, 2006, Hiland Partners acquired certain gas gatheringassets from Enogex Gas Gathering, L.L.C. for $96.4 million cash, includingcertain closing costs, financed with borrowings under its credit facility andan additional note payable to a bank. We refer to these assets as the KintaArea gathering assets. A determination was made by our management of the fairvalue of these assets and liabilities primarily using current replacement costfor the acquired gas gathering assets and related equipment less estimatedaccumulated depreciation on such replacement costs and estimated discountedcash flows arising from future renegotiated customer contracts. The acquiredassets, which are located in the eastern Oklahoma Arkoma Basin, haveapproximately 672 wellhead receipt points and include five separate lowpressure natural gas gathering systems consisting of 569 miles of natural gasgathering pipelines and 23 compressor units capable of nearly 40,000 horsepowerof compression. The natural gas gathering systems operate under contracts withproducers that provide for services under fixed-fee arrangements. HilandPartners operates the Kinta Area gathering assets substantially differentlythan they were operated by the previous owner. Since there was no sufficientcontinuity of the Kinta Area gathering assets’ operations prior to and afterthe acquisition, disclosure of prior financial information would not bematerial to an understanding of future operations. Therefore, the acquisitionhas been recorded as a purchase of assets and not a business, and no pro formafinancial information is required to be presented.

The followingtable presents the resulting allocation to the net assets acquired and liabilitiesassumed 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.

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**Note 4: Propertyand Equipment**
|                                                  | ** ** | **As of**     | ** ** | **As of**        | ** ** |
|--------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                                       | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| Land                                             |       | $                  | 267        |                  | $          | 255 |   |
| Construction in  progress                        |       | 51,449             |       | 48,610                |       |
| Midstream  pipeline, plants and compressors      |       | 244,107            |       | 230,645               |       |
| Compression and  water injection equipment       |       | 19,270             |       | 19,270                |       |
| Other                                            |       | 2,696              |       | 2,471                 |       |
|                                             |       | 317,789            |       | 301,251               |       |
| Less: accumulated  depreciation and amortization |       | 49,718             |       | 44,248                |       |
|                                             |       | $                  | 268,071    |                  | $          | 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 threemonths ended March 31, 2007 and 2006, we capitalized interest of $669 and$101, 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 afloating price 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 changes infair 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 recorded in income while thehedge contract is open and may increase or decrease until settlement of thecontract. Realized cash gains and losses on closed/settled instruments andhedge ineffectiveness are reflected in the contract month being hedged as anadjustment to midstream revenues.

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,currently designated as an open trade, Hiland Partners receives a NYMEX indexprice less a basis differential and pays a floating price based on certainindices for the relevant contract period as the underlying natural gas is sold.The open trade financial swap instrument has not been designated as a hedge.The forecasted non-cash unrealized gain on the open trade financial swapinstrument has been recorded as an increase in midstream revenues in thecurrent period.

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During the threemonths ended March 31, 2007 we reclassified net gains of $332 onclosed/settled hedge transactions to midstream revenues out of accumulatedother comprehensive income and also recorded $832 out of accumulated othercomprehensive income for the decrease in fair value of open derivatives.Included in minority interest on the balance sheet is $800 of the changes inthe net fair value of derivatives during the three months ended March 31,2007 attributable to minority interest. During the three months endedMarch 31, 2007, Hiland Partners recorded a gain of $83, on thenon-qualifying open trade financial instrument and losses of $14 on theineffective portions of qualifying open derivative transactions. AtMarch 31, 2007 our accumulated other comprehensive income related toderivatives was $1,403. Of this amount we anticipate $869 will be reclassifiedto earnings during the next 12 months and $534 will be reclassified to earningsin subsequent periods.

During the threemonths ended March 31, 2006 we recorded $4 into accumulated other comprehensiveincome for the favorable change in fair value of open derivatives. For the sameperiod, we recorded $180 to minority interest on the consolidated balance sheetrelated to changes in the net fair value of open derivatives. Included inmidstream revenues from third parties for the three months ended March 31, 2006is a realized non-cash gain of $82 resulting from the ineffective portions ofour qualifying open derivative transactions. At March 31, 2006 our accumulatedother comprehensive income related to derivatives was $25.

The fair value ofderivative assets and liabilities are as follows for the indicated periods:
|                                                      | ** ** | **As of**     | ** ** | **As of**        | ** ** |
|------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                                           | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| Fair value of  derivative assets—current        |       | $                  | 3,647      |                  | $          | 4,707 |   |
| Fair value of  derivative assets—long term      |       | 1,267              |       | 1,955                 |       |
| Fair value of  derivative liabilities—current   |       | (2,067             | )          | (1,902                | )          |
| Fair value of  derivative liabilities—long term |       | (274               | )          | (291                  | )          |
| Net fair value of  derivatives                       |       | $                  | 2,573      |                  | $          | 4,469 |   |

 

The terms of ourderivative contracts currently extend out as far as December 2009. Our counterpartyto all of our derivative contracts are BP Energy Company and BP CorporationNorth America, Inc. Set forth below is the summarized notional amount and termsof all instruments held for price risk management purposes at March 31,2007.
|                                                                   | ** ** | ** **  | ** ** | ** **           | ** ** | **Fair Value** | ** ** |
|-------------------------------------------------------------------|------------|-------------|------------|----------------------|------------|---------------------|------------|
| ** **                                                        | ** ** | ** **  | ** ** | **Average**          | ** ** | **Asset**           | ** ** |
| **Description and Production Period**              | ** ** | **Volume**  | ** ** | **Fixed Price** | ** ** | **(Liability)**     | ** ** |
| ** **                                                        | ** ** | ** **  | ** ** | ** **           | ** ** | ** **          | ** ** |
|                                                              |       |        |       |                 |       |                |       |
| **Natural  Gas—Sold Fixed for Floating Price Swaps**         |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| April 2007  - March 2008                                |       | 1,620,000   |       | $                    | 8.02       |                | $          | 3,647 |   |
| April  2008-December 2008                                         |       | 1,215,000   |       | 8.00                 |       | 1,184               |       |
| January 2009  - December 2009                           |       | 1,068,000   |       | $                    | 7.06       |                | (274       | ) |
|                                                              |       |        |       |                 |       | $                   | 4,557      |   |
| **Natural  Gas - Sold Open for Floating Price Swaps**             |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| January 2009 -  December 2009                                     |       | 1,068,000   |       | $                    | 7.42       |                | $          | 83 |   |
|                                                              |       |        |       |                 |       |                |       |
| **Natural  Gas—Buy Fixed for Floating Price Swaps**          |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| April 2007  - March 2008                                |       | 600,000     |       | $                    | 8.87       |                | $          | (783 | ) |
|                                                              |       |        |       |                 |       |                |       |
| **Natural  Gas Liquids—Sold Fixed for Floating Price Swaps** |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(Bbls)**  | ** ** | **(per Gallon)**     | ** ** | ** **          | ** ** |
| April 2007 -  March 2008                                |       | 152,652     |       | $                    | 1.13       |                | $          | (1,284 | ) |

 

14

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**Note 6: Long-TermDebt**
|                                            | ** ** | **As of**     | ** ** | **As of**        | ** ** |
|--------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                                 | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| Hiland  Partners-Revolving Credit Facility |       | $                  | 159,064    |                  | $          | 147,064 |   |
| Hiland Holdings-Revolving  Credit Facility |       | 354                |       | 254                   |       |
| Long-Term Debt                             |       | $                  | 159,418    |                  | $          | 147,318 |   |

 

***Hiland Partners***

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. Thefacility currently consists of a $191.0 million senior secured revolvingcredit facility to be used for funding acquisitions and other capitalexpenditures, issuance of letters of credit and general corporate purposes (the“revolving acquisition facility”); and a $9.0 million senior securedrevolving credit facility to be used for working capital and to funddistributions (the “revolving working capital facility”).

In addition, thecredit facility provides for an accordion feature, which permits HilandPartners, if certain conditions are met, to increase the size of the revolvingacquisition facility by up to $150 million and allows for the issuance ofletters of credit of up to $15.0 million in the aggregate. The creditfacility 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 under thecredit 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 March 31,2007, 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 the occurrenceof an event of default as defined in the credit facility, the lenders may,among other things, be able to accelerate the maturity of the credit facilityand exercise other rights and remedies as set forth in the credit facility.

The credit facilitylimits distributions to Hiland Partners’ unitholders to available cash, asdefined by the agreement, and borrowings to fund such distributions are onlypermitted under the revolving working capital facility. The revolving workingcapital facility is subject to an annual “clean-down” period of 15 consecutivedays in which the amount outstanding under the revolving

15

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working capital facilityis reduced to zero.

As ofMarch 31, 2007, Hiland Partners had $159.1 million outstanding underthis credit facility 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.

***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 theincentive distribution rights.

The facility willmature on September 25, 2009 at which time all outstanding amountsthereunder 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) theprime rate in effect on such day, (b) the base CD rate in effect on suchday plus 1.50% and (c) the federal funds effective rate in effect on suchday plus  1/2  of 1%. A letter of credit fee will be payablefor the aggregate amount of letters of credit issued under the facility at apercentage per annum equal to 2.0%. A commitment fee ranging from 25 to 50basis points per annum based on our ratio of consolidated funded debt to EBITDAwill be payable on the average daily unused portion of the facility for the quartermost recently ended. At March 31, 2007, the interest rate on outstandingborrowings 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 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).

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 ofMarch 31, 2007, we had $0.4 million outstanding under this creditfacility and were in compliance with our financial covenants.

**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

16

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market as derivatives. Asummary of the fixed price physical forward sales contracts is presented in thetable below:
|                                       | ** ** | ** **  | ** ** | **Average**          | ** ** |
|---------------------------------------|------------|-------------|------------|----------------------|------------|
| ** **                            | ** ** | ** **  | ** ** | **Fixed Price** | ** ** |
| **Production Period**            | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** |
|                                  |       |        |       |                 |       |
| April 2007  - March 2008    |       | 1,335,000   |       | $                    | 7.26       |   |
| April 2008 -  December 2008 |       | 900,000     |       | $                    | 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 expenses for the three months endedMarch 31, 2007 and 2006 of $63 and $41, 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.Our management believes that compliance with federal, state or localenvironmental laws and regulations will not have a material adverse effect onour 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.

We lease officespace from a related entity (Please read Note 9). We lease certain facilities,vehicles and equipment under operating leases, most of which contain annualrenewal options. For the three months ended March 31, 2007 and 2006, rentexpense was $514 and $159, respectively, under these leases.

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 intends to expandthe Badlands gas gathering system and processing plant located in BowmanCounty, North Dakota. This expansion project will include the construction of a40,000 Mcf/d nitrogen rejection plant and the expansion of the existingBadlands field gathering infrastructure. The expansion project, now targeted tobegin operations in June 2007, is expected to reach a total cost ofapproximately $49.5 million, including an additional $9.5 million tobe invested by the third quarter of 2007 to further expand the system. HilandPartners is currently funding this expansion project using its existing bankcredit facility. As of March 31, 2007, Hiland Partners has invested $40.7 millionin the expansion project.

**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**       | ** ** |
| ** ** | ** ** | **March 31,**          | ** ** |
| ** ** | ** ** | **2007**                    | ** ** | **2006** | ** ** |
| Customer 1 |       | 29                          | %          | 19 | % |
| Customer 2 |       | 16                          | %          | 18 | % |
| Customer 3 |       | 14                          | %          | 13 | % |
| Customer 4 |       | 9                           | %          | — |   |
| Customer 5 |       | 7                           | %          | 7 | % |

 

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:

17

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|                                  | ** ** | **For the Three** | ** ** |
|----------------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **Months Ended**       | ** ** |
| ** **                       | ** ** | **March 31,**          | ** ** |
| ** **                       | ** ** | **2007**                    | ** ** | **2006** | ** ** |
| Supplier 1  (affiliated company) |       | 27                          | %          | 34 | % |
| Supplier 2                       |       | 26                          | %          | 23 | % |
| Supplier 3                       |       | 15                          | %          | 14 | % |
| Supplier 4                       |       | 5                           | %          | 4 | % |
| Supplier 5                       |       | 4                           | %          | 9 | % |

 

**Note 9: Related PartyTransactions**

Hiland Partnerspurchases natural gas and NGLs from affiliated companies. Purchases of productfrom affiliates totaled $11.7 million and $14.4 million for the threemonths ended March 31, 2007 and 2006, respectively. Hiland Partners alsosells natural gas and NGLs to affiliated companies. Sales of product toaffiliates totaled $1.0 million and $1.3 million for the three monthsended March 31, 2007 and 2006, respectively. Compression revenues fromaffiliates were $1.2 million for each of the three months ended March 31,2007 and 2006.

Accountsreceivable-affiliates of $1,191 at March 31, 2007 include $1,111 from oneaffiliate for midstream sales. Accounts receivable-affiliates of $1,284 atDecember 31, 2006, includes $1,260 from one affiliate for midstream sales.

Accountspayable-affiliates of $4,542 at March 31, 2007 include $4,238 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

We utilizeaffiliated companies to provide services to our plants and pipelines andcertain administrative services. The total amount paid to these companies was$94 and $54 during the three months ended March 31, 2007 and 2006,respectively.

We lease officespace under operating leases directly or indirectly from an affiliate. Rentspaid associated with these leases totaled $32 and $25 for the three monthsended March 31, 2007 and 2006, respectively.

**Note 10: ReportableSegments**

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

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

(2)   Compression which is providing aircompression and water injection services for Continental Resources, Inc.’soil and gas secondary recovery operations that 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 $331,171 at March 31, 2007. Assets attributable to compressionoperations totaled $30,505. All but $15 of the total capital expenditures of$16,538 for the three months ended March 31, 2007 was attributable tomidstream operations.

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The tables belowpresent information for the reportable segments for the three months endedMarch 31, 2007 and 2006.
| ** **                                                       | ** ** | **For the Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2007**                                                               | ** ** | **2006** | ** ** |
| ** **                                                       | ** ** | **Midstream**                                                          | ** ** | **Compression** | ** ** | **Total** | ** ** | **Midstream** | ** ** | **Compression** | ** ** | **Total** | ** ** |
| Revenues                                                         |       | $                                                                      | 59,849     |   | $ | 1,205 |   | $ | 61,054 |   | $ | 52,204 |   | $ | 1,205 |   | $ | 53,409 |   |
| Operating costs  and expenses:                                   |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |
| Midstream  purchases (exclusive of items shown separately below) |       | 43,615                                                                 |       | — |   | 43,615 |   | 41,535 |   | — |   | 41,535 |   |
| Operations and  maintenance                                      |       | 4,802                                                                  |       | 168 |   | 4,970 |   | 2,386 |   | 188 |   | 2,574 |   |
| Depreciation and  amortization                                   |       | 6,135                                                                  |       | 893 |   | 7,028 |   | 3,244 |   | 893 |   | 4,137 |   |
| General and  administrative expenses                             |       | 2,005                                                                  |       | 40 |   | 2,045 |   | 1,015 |   | 23 |   | 1,038 |   |
| Total operating  costs and expenses                              |       | 56,557                                                                 |       | 1,101 |   | 57,658 |   | 48,180 |   | 1,104 |   | 49,284 |   |
| Operating income                                                 |       | $                                                                      | 3,292      |   | $ | 104 |   | 3,396 |   | $ | 4,024 |   | $ | 101 |   | 4,125 |   |
| Other income  (expense):                                         |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |
| Interest and  other income                                       |       |                                                                   |       |   |   | 127 |   |   |   |   |   | 75 |   |
| Amortization of  deferred loan costs                             |       |                                                                   |       |   |   | (110 | ) |   |   |   |   | (123 | ) |
| Interest expense                                                 |       |                                                                   |       |   |   | (2,091 | ) |   |   |   |   | (535 | ) |
| Minority  interest in income of Hiland Partners, LP              |       |                                                                   |       |   |   | (574 | ) |   |   |   |   | (3,164 | ) |
| Net income                                                       |       |                                                                   |       |   |   | $ | 748 |   |   |   |   |   | $ | 378 |   |
|                                                             |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                                     |       | $                                                                      | 331,171    |   | $ | 30,505 |   | $ | 361,676 |   | $ | 164,092 |   | $ | 34,067 |   | $ | 198,159 |   |
| Capital expenditures                                             |       | $                                                                      | 16,523     |   | $ | 15 |   | $ | 16,538 |   | $ | 11,110 |   | $ | 68 |   | $ | 11,168 |   |

 

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

The computation ofbasic net income per limited partner unit is based on the weighted-averagenumber of common units outstanding during the period. The computation ofdiluted earnings per unit further assumes the dilutive effect of restrictedunits. Net income per unit applicable to limited partners is computed bydividing net income applicable to limited partners by the weighted-averagenumber of limited partnership units outstanding. The following is areconciliation of the limited partner units used in the calculations of incomeper limited partner unit—basic and income per limited partner unit—dilutedassuming dilution for the three months ended March 31, 2007:
|                                                     | ** ** | **For the Three Months Ended March 31, 2007** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **Income  Available to  Limited  Partners**                                 | ** ** | **Limited  Partner Units** | ** ** | **Per Unit** | ** ** |
| ** **                                          | ** ** | **(Numerator)**                                                                  | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| Income per  limited partner unit—basic:        |       |                                                                             |       |   |   |   |   |
| Income available  to limited unitholder             |       | $                                                                                | 748        |   |   |   | $ | 0.03 |   |
| Weighted average  limited partner units outstanding |       |                                                                             |       | 21,600 |   |   |   |
| Income per  limited partner unit—diluted:      |       |                                                                             |       |   |   |   |   |
| Restricted units                                    |       |                                                                             |       | 5 |   |   |   |
| Income available to  common unitholders             |       | $                                                                                | 748        |   | 21,605 |   | $ | 0.03 |   |

 

**Note 12: ****Owners’ Capital and CashDistributions**

***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.

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Our Partnership Agreementrequires that we distribute all of our cash on hand at the end of each quarterless reserves established at our general partner’s discretion. We refer to thisas “available cash.” Initially our only cash-generating assets are ourinterests in Hiland Partners from which we receive quarterly distributions. Theamount of available cash may be greater than or less than the minimum quarterlydistributions.

All distributionspaid by Hiland Holdings to common unitholders, including amounts paid toaffiliate owners were as follows (in thousands, except per unit amounts):
|                                                | ** ** | **Per Unit Cash** | ** ** | ** **          | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|---------------------|------------|
| ** **                                     | ** ** | **Distribution**            | ** ** | **Total Cash** | ** ** |
| **Date Cash Distribution Paid** | ** ** | **Amount**                  | ** ** | **Distribution**    | ** ** |
| 02/19/07                                       |       | $                           | 0.0132     |                | $          | 285 |   |
| 02/19/07                                       |       | 0.2075                      |       | 4,484               |       |
| 05/18/07 (a)                                   |       | 0.2075                      |       | 4,484               |       |
|                                           |       | $                           | 0.4282     |                | $          | 9,253 |   |

 

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(a)          This cash distributionwas announced on April 25, 2007 and will be paid on May 18, 2007 toall unitholders of record as of May 4, 2007.

***Hiland Partners***

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, pro rata, and 2% to Hiland Partners GP, LLC, untileach common unit has received a minimum quarterly distribution of $0.45 plusany arrearages from prior quarters;

·         second,98% to the subordinated units, pro rata, and 2% to Hiland Partners GP, LLC,until each subordinated unit has received a minimum quarterly distribution of$0.45; and

·         third, 98% to all units,pro rata, and 2% to Hiland Partners GP, LLC, 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 the minimumquarterly distribution on all of its outstanding units for three consecutivefour-quarter periods. When the subordination period ends, all remainingsubordinated units will convert into common units on a one-for-one basis andthe common units will no longer be entitled to arrearages. As of March 31,2007 we own 4,080,000 subordinated units, which is all of, Hiland Partners’subordinated units.

20

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Presented beloware cash distributions to Hiland Partners, common and subordinated unitholders,including amounts to affiliate owners and regular and incentive distributionsto Hiland Partners GP, LLC paid by Hiland Partners from 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     |       | $          | 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 (a)                                   |       | 0.7125                      |       | 3,724      |       | 2,907            |       | 151                      |       | 752                 |       | 7,534            |       |
|                                           |       | $                           | 4.0750     |       | $          | 20,108           |       | $                        | 16,626     |                | $          | 813              |       | $ | 3,116 |   | $ | 40,663 |   |

 

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(a)          This cash distributionwas announced on April 25, 2007 and will be paid on May 15, 2007 toall unitholders of record as of May 4, 2007.

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(a)                                     |       | 0.7125                      |       | 927        |       | 2,907            |       | 151                      |       | 752                 |       | 4,737            |       |
|                                           |       | $                           | 4.0750     |       | $          | 2,925            |       | $                        | 6,000      |                | $          | 813              |       | $ | 3,116 |   | $ | 12,854 |   |

 

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(a)          This cash distributionwas announced on April 25, 2007 and will be paid on May 15, 2007 toall unitholders of record as of May 4, 2007.

**Note 13:Subsequent Event**

On April 24, 2007,Hiland Partners entered into an agreement to construct and operate gatheringpipelines and related facilities associated with the development of anadditional portion of acreage owned by Continental Resources, Inc. in theWoodford Shale Play in the Arkoma Basin of southeastern Oklahoma. Thisadditional acreage dedication consists of approximately 12,000 gross acres thatare contiguous with the 23,000 gross acres that were dedicated from ContinentalResources, Inc. in December 2006. The dedicated 35,000 gross acres are locatedin Hughes County. We estimate the capital investment related to this additionalacreage dedication in the first year to be approximately $6.5 million andtotaling up to approximately $13 million over the next four years. The initialterm of the agreement is 10 years. The agreement grants Hiland Partners theright to process the gas and further provides that Hiland Partners will receivecertain fixed fees for the dehydration, gathering and compression of the gas.

With thededication of this additional acreage, Hiland Partners’ total capitalinvestment in the Woodford Shale Play over the next fours years is estimated tobe approximately $36 million. Plans also include building a 40,000 Mcf/drefrigeration processing plant and the installation of field gathering,compression and associated equipment.

On April 16, 2007,the board of directors of our general partner formally accepted Randy Moeder’s(our President and Chief Executive Officer, and director of our generalpartner) resignation effective immediately. Mr. Harold Hamm, chairman of the board of directors of our generalpartner was appointed interim President and Chief Executive Officer until asuccessor is named.

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**HILANDHOLDINGS GP, LP**

**Item2. 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 pay distributions to our unitholders;

·         our expected receipt of distributions 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 throughputin Hiland Partners’ natural gas processing and treating facilities;

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

·         the prices and marketdemand for, 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 ofimported oil and natural gas;

·         actions taken by foreignoil and gas producing nations;

·         the political andeconomic stability of petroleum producing nations;

·         the weather in HilandPartners’ operating areas;

·         the extent ofgovernmental regulation and taxation;

·         hazards or operatingrisks incidental to the transporting, treating and processing of natural gasand NGLs that may not be fully covered by insurance;

·         competition from othermidstream companies;

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·         loss of key personnel;

·         the availability and costof capital 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;

·         the ability tosuccessfully identify and consummate strategic acquisitions at purchase pricesthat are accretive to the Hiland Partners’ financial results;

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

·         the ability tosuccessfully replace Randy Moeder as Chief Executive Officer, President anddirector of our general partner.

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 inHiland Partners. 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 partner interest inHiland Partners;

·         100% of the incentive distributionrights in Hiland Partners; and

·         1,301,471 common units and 4,080,000 subordinated units ofHiland Partners, representing a 57.8% limited partner interest in HilandPartners.

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 $0.7125 per unit for thequarter ended March 31, 2007. This distribution will be paid onMay 15, 2007 to unitholders of record on May 4, 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 tofinancing a project or other types of support related to a merger oracquisition transaction.

*Cash Distributions.  *The following table sets forth the distributions that we have received fromHiland Partners during the periods indicated.

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|                                                                                 | ** ** | **Hiland Holdings  GP, LP**                | ** ** | **Hiland Partners  GP, LLC  (Predecessor)** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **Three Months Ended March 31,** | ** ** |
| ** **                                                                      | ** ** | **2007(a)**                                          | ** ** | **2006**                                              | ** ** |
|                                                                            |       |                                                 |       |                                                  |       |
| Distributions on Hiland Partners’ common units                             |       | $                                                    | 927        |                                                  | $          | — |   |
| Distributions on Hiland Partners’ subordinated units                       |       | 2,907                                                |       | —                                                |       |
| Distributions from ownership interest in Hiland  Partners’ general partner |       | 150                                                  |       | 112                                                   |       |
| Distributions from Hiland Partners’ incentive  distribution rights         |       | 749                                                  |       | 249                                                   |       |
| Total                                                                           |       | $                                                    | 4,733      |                                                  | $          | 361 |   |

 

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(a)               Becausewe own Hiland Partners GP, LLC the distributions to us include thedistributions made to Hiland Partners GP, LLC and 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 ingathering and processing of natural gas primarily in the Mid-Continent andRocky Mountain regions. Within this segment, Hiland Partners also providescertain related services for compression, dehydrating, and treating of naturalgas and the fractionation of NGLs. The midstream segment generated 93.1% and89.9%of the total segment margin for the three months ended March 31, 2007and 2006, respectively.

·         *Compression Segment,* which is engaged inproviding air compression and water injection services for oil and gassecondary recovery operations that are ongoing in North Dakota. The compressionsegment generated 6.9% and 10.1%of the total segment margin for the threemonths ended March 31, 2007 and 2006, respectively.

Hiland Partners’midstream assets currently consist of 13 natural gas gathering systems withapproximately 1,863 miles of gas gathering pipelines, five natural gasprocessing plants, three 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 ofproducts it purchases, increases or decreases in Hiland Partners’ revenuesalone are not necessarily indicative of increases or decreases in itsprofitability. To a large extent, Hiland Partners’ contract portfolio and thepricing environment for natural gas and NGLs will dictate increases ordecreases in its profitability. Hiland Partners’ profitability is alsodependent upon prices and market demand for natural gas and NGLs, whichfluctuate with changes in market and economic conditions and other factors.

**Recent Events**

On May 1,2006, Hiland Partners acquired Enogex Gas Gathering, L.L.C.’s eastern OklahomaKinta Area gathering assets for $96.4 million. Hiland Partners financed theacquisition with $61.2 million of borrowings from its credit facility and $35.0million of proceeds from the issuance to Hiland Partners GP, LLC of 761,714common units and 15,545 general partner equivalent units at $45.03 per unit.The purchase price was equal to the average closing price of Hiland Partners’common units for the three trading days immediately proceeding May 1,2006. Hiland Partners GP, LLC entered into a credit agreement under which itborrowed $35.0 million to purchase the Hiland Partner units. The obligation wasunsecured and guaranteed by the members of Hiland Partners GP, LLC. HilandPartners GP, LLC’s board of directors, as well as the conflicts committee ofthe board of directors, consisting of two independent directors, approved thetransaction.

On September 25,2006 we completed our initial public offering of 8,050,000 common unitsreceiving net proceeds of $139.6 million, net of $9.3 million ofunderwriting commissions. In connection with the closing of our initial publicoffering, all of the

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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 HilandPartners GP, LLC’s assets are reflected at their historical carrying basisbecause the contributions are from a related party. As consideration for thiscontribution, substantially all of the net proceeds from our initial publicoffering, after the retirement of $36.0 million of outstanding debt and accruedinterest of Hiland Partners GP, LLC, were distributed to Harold Hamm, TheHarold Hamm DST Trust, The Harold Hamm HJ Trust, Randy Moeder and Ken Maples(the “Contributing Parties”) and 13,550,000 common units and Class Bcommon units in us were issued to the Contributing Parties.

On April 16, 2007,the board of directors of our general partner formally accepted Randy Moeder’s(our President, Chief Executive Officer, and director of our general partner)resignation effective immediately.  Mr.Harold Hamm, chairman of the board of directors of our general partner wasappointed interim President and Chief Executive Officer until a successor isnamed.

**HistoricalResults 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.

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.  Results of operations from the Kinta Areagathering assets are only reflected from May 1, 2006.

**OurResults 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 thefinancial statements of Hiland Partners. However, our consolidated balancesheet includes a minority interest amount that reflects the proportion ofHiland Partners owned by its unitholders other than us. Similarly, theownership interests in Hiland Partners held by its unitholders other than usare reflected in our consolidated income statement as minority interest. Theminority interest amounts are not reflected on Hiland Partners’ financialstatements.

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Set forth in thetables below are financial and operating data for us and our predecessor,Hiland Partners GP, LLC. for the periods indicated.
|                                                                  | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                                       | ** ** | **Hiland  Holdings  GP, LP**                    | ** ** | **Hiland  Partners  GP, LLC  (Predecessor)** | ** ** |
| ** **                                                       | ** ** | **(in thousands)**                              | ** ** |
| **Total  Segment Margin Data:**                                  | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Midstream  revenues                                              |       | $                                                    | 59,849     |   | $ | 52,204 |   |
| Midstream  purchases                                             |       | 43,615                                               |       | 41,535 |   |
| Midstream segment  margin                                        |       | 16,234                                               |       | 10,669 |   |
| Compression  revenues(1)                                         |       | 1,205                                                |       | 1,205 |   |
| Total segment  margin(2)                                         |       | $                                                    | 17,439     |   | $ | 11,874 |   |
| **Summary  of Operations Data:**                                 | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Midstream  revenues                                              |       | $                                                    | 59,849     |   | $ | 52,204 |   |
| Compression  revenues                                            |       | 1,205                                                |       | 1,205 |   |
| Total revenues                                                   |       | 61,054                                               |       | 53,409 |   |
| Operating costs  and expenses:                                   |       |                                                 |       |   |   |
| Midstream  purchases (exclusive of items shown separately below) |       | 43,615                                               |       | 41,535 |   |
| Operations and  maintenance expenses                             |       | 4,970                                                |       | 2,574 |   |
| Depreciation,  amortization and accretion                        |       | 7,028                                                |       | 4,137 |   |
| General and  administrative expenses                             |       | 2,045                                                |       | 1,038 |   |
| Total operating  costs and expenses                              |       | 57,658                                               |       | 49,284 |   |
| Operating income                                                 |       | 3,396                                                |       | 4,125 |   |
| Other income  (expense), net                                     |       | (2,074                                               | )          | (583 | ) |
| Income before  minority interest in Hiland Partners, LP          |       | 1,322                                                |       | 3,542 |   |
| Minority  interest in income of Hiland Partners, LP              |       | (574                                                 | )          | (3,164 | ) |
| Net income                                                       |       | $                                                    | 748        |   | $ | 378 |   |
|                                                             |       |                                                 |       |   |   |
| Hiland Partners  Operating Data:                                 |       |                                                 |       |   |   |
| Natural gas  sales (MMBtu/d)                                     |       | 74,521                                               |       | 59,627 |   |
| NGL sales  (Bbls/d)                                              |       | 3,986                                                |       | 3,245 |   |
| Natural gas gathered  (MMBtu/d) (3)                              |       | 120,770                                              |       | — |   |

 

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

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(2***)***Reconciliation oftotal segment margin to operating income:

|                                           | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                | ** ** | **Hiland  Holdings  GP, LP**                    | ** ** | **Hiland  Partners  GP, LLC  (Predecessor)** | ** ** |
| ** **                                | ** ** | **(in thousands)**                              | ** ** |
|                                      |       |                                                 |       |   |   |
| Operating income                          |       | $                                                    | 3,396      |   | $ | 4,125 |   |
| ADD:                                      |       |                                                 |       |   |   |
| Operations and  maintenance expenses      |       | 4,970                                                |       | 2,574 |   |
| Depreciation,  amortization and accretion |       | 7,028                                                |       | 4,137 |   |
| General and  administrative expenses      |       | 2,045                                                |       | 1,038 |   |
| Total segment margin                      |       | $                                                    | 17,439     |   | $ | 11,874 |   |

 

(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.

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

***Three Months Ended March 31, 2007 Compared with ThreeMonths Ended March 31, 2006***

***Revenues.  *** Total revenues(midstream and compression) were $61.1 million for the three months endedMarch 31, 2007 compared to $53.4 million for the three months endedMarch 31, 2006, an increase of $7.7 million, or 14.3%. This $7.7 millionincrease was due to increased natural gas sales volumes of 14,894 MMBtu/d(MMBtu per day) primarily related to the acquisition of the Kinta Areagathering assets effective May 1, 2006 and increased NGL sales volumes of 741 Bbl/day(Bbls per day) largely attributable to the Bakken and Eagle Chief gatheringsystems, both of which were offset by lower average realized natural gas andNGL sales prices in 2007 as compared to the same period in 2006.  Revenues from compression assets were thesame for both periods.

Midstream revenueswere $59.8 million for the three months ended March 31, 2007 compared to$52.2 million for the three months ended March 31, 2006, an increase of$7.6 million, or 14.6%. Of this increase, $19.8 million was attributable toresidue natural gas sales and gathering volumes from the Kinta Area gatheringassets acquisition effective May 1, 2006 and increased natural gas and NGLsales volumes at the Bakken and Eagle Chief gathering systems.  The increase of $19.8 million attributable toincreased natural gas, NGL and gathering fee volumes was reduced by $12.1million due to lower average realized natural gas and NGL sales prices.

Natural gas salesvolumes were 74,521 MMBtu/d for the three months ended March 31, 2007 comparedto 59,627 MMBtu/d for the three months ended March 31, 2006, an increase of14,894 MMBtu/d, or 25.0%.  Of the 14,894 MMBtu/d increase, 11,441, or76.8% was attributable to the natural gas volumes as a result of the Kintagathering system acquisition effective May 1, 2006. The NGL sales volumes were3,986 Bbls/d for the three months ended March 31, 2007 compared to 3,245 Bbls/dfor the three months ended March 31, 2006, an increase of 741 Bbls/d, or 22.8%. Of the 741 Bbls/d increase, 660 Bbls/d, or 89.1% was attributable to increasedNGL sales volumes at the Bakken and Eagle Chief gathering systems.

The averagerealized natural gas sales prices were $6.19 per MMBtu for the three monthsended March 31, 2007 compared to $7.20 per MMBtu for the three months endedMarch 31, 2006, a decrease of $1.01 per MMBtu, or 14.0%.  In addition,average realized NGL sales prices were $0.94 per gallon for the three monthsended March 31, 2007 compared to $1.00 per gallon for the three months endedMarch 31, 2006, a decrease of $0.06 per gallon or 6.0%.  The change inaverage realized natural gas and NGL sales prices was primarily a result oflower index prices due to a softening of supply and demand fundamentals forenergy, which caused crude oil and natural gas prices to fall during the threemonths ended March 31, 2007 compared to the three months ended March 31, 2006.

27

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Cash received fromHiland Partners’ counterparty on cash flow swap contracts that began onMay 1, 2006 for natural gas derivative transactions that closed during thethree months ended March 31, 2007 totaled $0.6 million. This gain increasedaverage realized natural gas sales prices to $6.19 per MMBtu from $6.10 perMMBtu, an increase of $0.09 per MMBtu, or 1.5%. There were no closed derivativetransactions during the three months ended March 31, 2006.

Fees earned from120,770 MMBtu/d of natural gas gathered, in which Hiland Partners does not taketitle to the gas, relates to the Kinta Area gathering assets acquired on May 1,2006 were $2.6 million for the three months ended March 31, 2007. There were nosimilar fees from natural gas gathering during the three months ended March 31,2006.

Our compressionrevenues were $1.2 million for the each of the three months ended March 31,2007 and 2006

***Midstream Purchases.  ***Midstream purchases were $43.6 million for the three months ended March 31,2007 compared to $41.5 million for the three months ended March 31, 2006,an increase of $2.1 million, or 5.0%. The $2.1 million increase primarilyconsists of $4.9 million attributable to purchased residue gas from the KintaArea gathering assets and $2.2 million attributable to increased purchasedresidue gas volumes at the Bakken and Eagle Chief gathering systems. Thecombined increase of $7.1 million was primarily offset by $5.0 million inreduced payments to producers due to lower natural gas and NGL purchasesprices, which generally are closely related to fluctuations in natural gas andNGL sales prices.

***Operations and Maintenance.  ***Operations and maintenance expense totaled $5.0 million for the three monthsended March 31, 2007 compared with $2.6 million for the three months endedMarch 31, 2006, an increase of $2.4 million, or 93.1%. Of this increase,$1.7 million, or 70.6% was attributable to operations and maintenance at theKinta Area gathering system and $0.5 million, or 18.4%, was attributable toincreased operations at the Bakken and Eagle Chief gathering systems.

***Depreciation, Amortization and Accretion.  ***Depreciation, amortization and accretion expense totaled $7.0 million for thethree months ended March 31, 2007 compared with $4.1 million for the threemonths ended March 31, 2006, an increase of $2.9 million, or 69.9%. Ofthis increase, $2.0 million, or 69.8% was attributable to depreciation andamortization on the Kinta Area gathering system. The increase is alsoattributable to additional depreciation of $0.6 million, or 21.5% at the Bakkenand Eagle Chief gathering systems.

***General and Administrative.  ***General and administrative expense totaled $2.0 million for the three monthsended March 31, 2007 compared with $1.0 million for the three months endedMarch 31, 2006, an increase of 1.0 million, or 97.0%. The increase isattributable to increased salaries and additional staffing, as well as, thecost of being a new public company, including the costs of audit and taxpreparation fees. The increase is also attributable to the expense relating tothe recalculated fair value of the remaining unvested Class B common units.

***Other Income (Expense).***  Other income (expense) totaled ($2.1) million for the three months ended March31, 2007 compared with ($0.6) million for the three months ended March 31,2006, an increase in expense of $1.5 million. The increase is primarilyattributable to additional interest expense from borrowings relating to theacquisition of the Kinta Area gathering assets effective May 1, 2006.

***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 March 31, 2007compared to $3.2 million for the three months ended March 31, 2006. This$2.6 million decrease is attributable to the increase in ownership of HilandPartners. At March 31, 2007 Hiland Holdings’ aggregate ownership interest inHiland Partners consisted of the2% general partner interest; 100%of the incentive distribution rights; and 1,301,471 common units and 4,080,000 subordinated units ofHiland Partners, representing a 57.8% limited partner interest in HilandPartners as compared to March 31, 2006, at which time Hiland Partners GP, LLC’saggregate ownership interest in Hiland Partners consisted of the 2% general partner interest inHiland Partners and 100% of theincentive distribution rights in Hiland Partners.

**LIQUIDITY AND CAPITAL RESOURCES**

***Overview***

We rely ondistributions from Hiland Partners to fund cash requirements for ouroperations. Cash generated from operations, borrowings under Hiland Partners’credit facility and funds from private or public equity and future debtofferings are Hiland Partners’ primary sources of liquidity. We believe thatfunds from these sources should be sufficient to meet both Hiland Partners’short-term working capital requirements and its long-term capital expenditurerequirements. Hiland Partners’ ability to pay distributions to unitholders, tofund planned capital expenditures and to make acquisitions depends upon HilandPartners’ future operating performance, and more broadly, on the availabilityof equity and debt financing, which will be affected by prevailing economicconditions in Hiland Partners’ industry and financial, business and otherfactors, many of which are beyond Hiland Partners’ control.

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***Cash Flows from Operating Activities***

 Cash flows from operating activities decreasedby $0.1 to $8.9 million for the three months ended March 31, 2007 from $9.0million for the three months ended March 31, 2006. During the three monthsended March 31, 2007 we received cash flows from customers of approximately$60.5 million attributable to increased natural gas and NGLs volumes offset bylower natural gas and NGL sales prices, had cash payments to our suppliers andemployees of approximately $49.5 million and payment of interest expense of$2.1 million, net of amounts capitalized, resulting in cash received from ouroperating activities of $8.9 million. During the same three month period in2006, we received cash flows from customers of approximately $59.7 millionattributable to increased volumes of natural gas and NGLs and increased naturalgas and NGL sales prices, had cash payments to our suppliers and employees ofapproximately $50.2 million and payment of interest expense of $0.5 million,net of amounts capitalized, resulting in cash received from our operatingactivities of $9.0 million. Changes in cash receipts and payments are primarilydue to the timing of collections at the end of our reporting periods. Wecollect and pay large receivables and payables at the end of each calendarmonth. The timing of these payments and receipts may vary by a day or twobetween month-end periods and cause fluctuations in cash received or paid.Natural gas and NGL volumes from our Kinta Area gathering assets acquiredeffective May 1, 2006 and increased volumes from our Bakken and Eagle chiefgathering systems, offset by lower natural gas and natural gas liquids salesprices contributed to increases in accounts receivable, accrued midstreamrevenues, accounts payable and accrued midstream purchases during the threemonths ended March 31, 2007. Working capital items, exclusive of cash,contributed $0.1 million and $1.2 million to cash flows from operatingactivities during the three months ended March 31, 2007 and 2006, respectively.Net income for the three months ended March 31, 2007 was $0.7 million, anincrease of $0.3 million from a net income of $0.4 million for the three monthsended March 31, 2006.  Depreciation increased by $2.8 million to $7.0 millionfor the three months ended March 31, 2007 from $4.1 million for the threemonths ended March 31, 2006.

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

Cash flows used ininvesting activities, which represent investments in property and increased by$5.3 million to $16.5 million for the three months ended March 31, 2007 from$11.2 million for the three months ended March 31, 2006 largely due to theongoing progress on the Badlands expansion project and continued growth at theBakken gathering system.

***Cash Flows from Financing Activities***

Cash flows fromfinancing activities increased to $5.7 million for the three months ended March31, 2007 from $3.3 million for the three months ended March 31, 2006.During the three months ended March 31, 2007, Hiland Partners borrowed $12.0million under its credit facility to fund its internal expansion projects andreceived $1.0 million from issuing Hiland Partners common units as a resultof  the exercise of 39,930 vested unitoptions. During the three months ended March 31, 2007, we made a distributionof $4.5 million to our unitholders and Hiland Partners distributed$2.8 million to its minority interest unitholders. During the three monthsended March 31, 2006, Hiland Partners borrowed $8.0 million under its creditfacility to fund its internal expansion projects and received $0.9 million fromissuing Hiland Partners common units as a result of the exercise of 39,633vested unit options. Hiland Partners distributed $5.3 million to minorityinterest unitholders and Hiland Partners GP, LLC distributed $0.3 millionto its members.

***Capital Requirements***

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

·         expansion capitalexpenditures such as those to acquire additional assets to grow Hiland Partners’business, to expand and upgrade gathering systems, processing plants, treatingfacilities and fractionation facilities and to construct or acquire similarsystems or facilities.

Given HilandPartners objective of growth through acquisitions and expansions, HilandPartners anticipates that it will continue to invest significant amounts ofcapital to grow and acquire assets. Hiland Partners actively considers avariety of assets for potential acquisitions.

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***BadlandsExpansion Project***

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 intends to expandthe Badlands gas gathering system and processing plant located in BowmanCounty, North Dakota. This expansion project will include the construction of a40,000 Mcf/d nitrogen rejection plant and the expansion of the existingBadlands field gathering infrastructure. The expansion project, now targeted tobegin operations in June 2007, is expected to reach a total cost ofapproximately $49.5 million, including an additional $9.5 million tobe invested by the third quarter of 2007 to further expand the system. HilandPartners is currently funding this expansion project using its existing bankcredit facility. As of March 31, 2007, Hiland Partners has invested $40.7million in the expansion project. The cost to expand the system may exceed ourexpected costs if our assumptions as to construction costs or other factors areincorrect or as a result of other events that are beyond our control.

***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, we either receive or pay a monthly net settlement thatis determined by the difference between a fixed price and a floating pricebased on certain indices for the relevant contract period for the agreed uponvolumes. One financial swap instrument currently does not qualify for hedgeaccounting.

The followingtable provides information about these financial derivative instruments for theperiods indicated:
|                                                                   | ** ** | ** **  | ** ** | ** **           | ** ** | **Fair Value** | ** ** |
|-------------------------------------------------------------------|------------|-------------|------------|----------------------|------------|---------------------|------------|
| ** **                                                        | ** ** | ** **  | ** ** | **Average**          | ** ** | **Asset**           | ** ** |
| **Description and Production Period**              | ** ** | **Volume**  | ** ** | **Fixed Price** | ** ** | **(Liability)**     | ** ** |
|                                                              |       |        |       |                 |       |                |       |
| **Natural  Gas—Sold Fixed for Floating Price Swaps**         |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| April 2007  - March 2008                                |       | 1,620,000   |       | $                    | 8.02       |                | $          | 3,647 |   |
| April  2008-December 2008                                         |       | 1,215,000   |       | 8.00                 |       | 1,184               |       |
| January 2009  - December 2009                           |       | 1,068,000   |       | $                    | 7.06       |                | (274       | ) |
|                                                              |       |        |       |                 |       | $                   | 4,557      |   |
| **Natural  Gas - Sold Open for Floating Price Swaps**             |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| January 2009 -  December 2009                                     |       | 1,068,000   |       | $                    | 7.42       |                | $          | 83 |   |
|                                                              |       |        |       |                 |       |                |       |
| **Natural  Gas—Buy Fixed for Floating Price Swaps**          |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| April 2007  - March 2008                                |       | 600,000     |       | $                    | 8.87       |                | $          | (783 | ) |
|                                                              |       |        |       |                 |       |                |       |
| **Natural  Gas Liquids—Sold Fixed for Floating Price Swaps** |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(Bbls)**  | ** ** | **(per Gallon)**     | ** ** | ** **          | ** ** |
| April 2007 -  March 2008                                |       | 152,652     |       | $                    | 1.13       |                | $          | (1,284 | ) |

 

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:

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|                                       | ** ** | ** **  | ** ** | **Average**          | ** ** |
|---------------------------------------|------------|-------------|------------|----------------------|------------|
| ** **                            | ** ** | ** **  | ** ** | **Fixed Price** | ** ** |
| **Production Period**            | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** |
|                                  |       |        |       |                 |       |
| April 2007  - March 2008    |       | 1,335,000   |       | $                    | 7.26       |   |
| April 2008 -  December 2008 |       | 900,000     |       | $                    | 8.43       |   |

 

***Off-BalanceSheet Arrangements.***

We had nosignificant off-balance sheet arrangements as of March 31, 2007.

***Credit Facility***

***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 Holdings***

OnSeptember 25, 2006, concurrently with the closing of our initial publicoffering, Hiland Holdings 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.

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 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 will be payable forthe aggregate amount of letters of credit issued under the facility at apercentage per annum equal to 2.0%. A commitment fee ranging from 25 to 50basis points per annum based on our ratio of consolidated funded debt to EBITDAwill be payable on the average daily unused portion of the facility for thequarter most recently ended. At March 31, 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 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.

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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 ofMarch 31, 2007, we had $0.4 million outstanding under this creditfacility and were in compliance with our financial covenants.

***Hiland Partners***

On June 8,2006, Hiland Partners entered into a second amendment to its credit facilityto, among other things, increase its borrowing base from the February 15, 2005original borrowing base of $55.0 million, first amended on September 26, 2005to $125.0 million, to $200.0 million and revise certain covenants. Thefacility currently consists of a $191.0 million senior secured revolvingcredit facility to be used for funding acquisitions and other capitalexpenditures, issuance of letters of credit and general corporate purposes (the“revolving acquisition facility”); and a $9.0 million senior securedrevolving credit facility to be used for working capital and to funddistributions (the “revolving working capital facility”).

In addition, thecredit facility provides for an accordion feature, which permits HilandPartners, if certain conditions are met, to increase the size of the revolvingacquisition facility by up to $150 million and allows for the issuance ofletters of credit of up to $15.0 million in the aggregate. The creditfacility will mature in May 2011. At that time, the agreement will terminateand 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 Hiland Partners ratio ofconsolidated funded debt to EBITDA. The Alternate Base Rate is a rate per annumequal to the greatest of (a) the Prime Rate in effect on such day,(b) the base CD rate in effect on such day plus 1.50% and (c) theFederal Funds effective rate in effect on such day plus 1/2 of 1%. A letter ofcredit fee will be payable for the aggregate amount of letters of credit issuedunder the credit facility at a percentage per annum equal to 1.0%. An unusedcommitment fee ranging from 25 to 50 basis points per annum based on our ratioof consolidated funded debt to EBITDA will be payable on the unused portion ofthe credit facility. During any step-up period, the applicable margin withrespect to loans under the credit facility will be increased by 35 basis pointsper annum and the unused commitment fee will be increased by 12.5 basis pointsper annum. At March 31, 2007, the interest rate on outstanding borrowings fromHiland Partners’ credit facility 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 the Omnibus Agreement or enter into a merger,consolidation or sale 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 we make certain permitted acquisitions or capital expenditures, thecredit facility allows this ratio to increase to 4.75:1.0 for the followingthree fiscal quarters (a “step-up period”) and a minimum interest coverageratio of 3.0:1.0.

The creditfacility defines EBITDA as our consolidated net income, plus income taxexpense, interest expense, depreciation and amortization expense, amortizationof intangibles and organizational costs, non-cash unit based compensationexpense, and adjustments for non-cash gains and losses on specified derivativetransactions 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 credit facilitylimits distributions to Hiland Partners unitholders to available cash, asdefined by the agreement, and borrowings to fund such distributions are onlypermitted under the revolving working capital facility. The revolving workingcapital facility is subject to an annual “clean-down” period of 15 consecutivedays in which the amount outstanding under the revolving working capitalfacility is reduced to zero.

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As of March 31,2007, Hiland Partners had $159.1 million outstanding under the creditfacility and were in compliance with its financial covenants.

***Impactof Inflation***

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

**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 anorderly transaction between market participants at the measurement date,establishes a framework for measuring fair value in generally acceptedaccounting principles (GAAP) such as fair value hierarchy used to classify thesource of information used in fair value measurements (i.e., market based ornon-market based) and expands disclosure about fair value measurements based ontheir level in the hierarchy. This Statement applies to derivatives and otherfinancial instruments, which Statement 133,*  Accounting for Derivative Instruments andHedging Activities* , as amended, requires be measured at fair valueat 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**

***RevenueRecognition****.  *Revenues for sales and gathering of natural gas and NGLs product sales arerecognized at the time the product is delivered and title, if applicable, istransferred. Revenues for compression services are recognized when the servicesunder the agreement are performed. Revenues from oil and gas production(discontinued operations) were recorded in the month produced and title wastransferred 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 asset

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retirement obligationsrequires us to make estimates and judgments regarding timing, existence of aliability, as well as what constitutes adequate restoration. We use the presentvalue of estimated cash flows related to our asset retirement obligation todetermine the fair value, generally as estimated by third party consultants.The present value calculation requires us to make numerous assumptions andjudgments, including the ultimate costs of dismantling and site restoration,inflation factors, credit adjusted discount rates, timing of settlement andchanges in the legal, regulatory, environmental and political environments. Tothe extent future revisions to these assumptions impact the present value ofthe existing asset retirement obligation liability, a corresponding adjustmentwill be required to the related asset. We believe the estimates and judgmentsreflected in our financial statements are reasonable but are necessarilysubject to the uncertainties we have just described. Accordingly, anysignificant variance in any of the above assumptions or factors couldmaterially 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 gas prices.The amount of reserves and drilling activity are dependent in part on naturalgas prices. Projections of reserves and future commodity prices are inherentlysubjective and contingent upon a number of variable factors, including, but notlimited to:

·         changesin general economic conditions in regions in which the Partnership’s productsare located;

·         theavailability and prices of NGL products and competing commodities;

·         theavailability and prices of raw natural gas supply;

·         ourability to negotiate favorable marketing agreements;

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

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

·         competition from other midstreamservice providers and processors, including major energy companies.

Any significantvariance in any of the above assumptions or factors could materially affect ourcash flows, which could require us to record an impairment of an asset.

***Share Based Compensation.****  * In October 1995 the FASBissued 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 onJanuary 1, 2006, they applied Accounting PrinciplesBoard Opinion No. 25 and related interpretations in accounting for theunit-based compensation awards.

**Item3.  Quantitative and QualitativeDisclosures 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.

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We do not engage incommodity 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 three months endedMarch 31, 2007, the impact on our total segment margin of a $0.01 pergallon change (increase or decrease) in NGL prices coupled with a $0.10 perMMBtu change (increase or decrease) in the price of natural gas. The magnitudeof the impact on total segment margin of changes in natural gas and NGL pricespresented may not be representative of the magnitude of the impact on totalsegment margin for different commodity prices or contract portfolios. Naturalgas prices can also affect our profitability indirectly by influencing thelevel of drilling activity and related opportunities for our services.
|                                      | ** ** | **For the Three Months Ended March 31, 2007** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **Natural Gas Price Change ($/MMBtu)**                       | ** ** |
|        |       |                                                                             |       | $ | 0.10 |   | $ | (0.10 | ) |
| **NGL  Price**                       |       | $                                                                                | 0.01       |   | $ | 120,000 |   | $ | 41,000 |   |
| **Change  ($/gal)**                  |       | $                                                                                | (0.01      | ) | $ | (41,000 | ) | $ | (121,000 | ) |

 

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 about our derivativeinstruments 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)**      | ** ** | ** **          | ** ** |
| April 2007  - March 2008                                |       | 1,620,000   |       | $                    | 8.02       |                | $          | 3,647 |   |
| April  2008-December 2008                                         |       | 1,215,000   |       | 8.00                 |       | 1,184               |       |
| January 2009  - December 2009                           |       | 1,068,000   |       | $                    | 7.06       |                | (274       | ) |
|                                                              |       |        |       |                 |       | $                   | 4,557      |   |
| **Natural  Gas - Sold Open for Floating Price Swaps**             |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| January 2009 -  December 2009                                     |       | 1,068,000   |       | $                    | 7.42       |                | $          | 83 |   |
|                                                              |       |        |       |                 |       |                |       |
| **Natural  Gas—Buy Fixed for Floating Price Swaps**          |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| April 2007  - March 2008                                |       | 600,000     |       | $                    | 8.87       |                | $          | (783 | ) |
|                                                              |       |        |       |                 |       |                |       |
| **Natural  Gas Liquids—Sold Fixed for Floating Price Swaps** |       |        |       |                 |       |                |       |
| ** **                                                        | ** ** | **(Bbls)**  | ** ** | **(per Gallon)**     | ** ** | ** **          | ** ** |
| April 2007 -  March 2008                                |       | 152,652     |       | $                    | 1.13       |                | $          | (1,284 | ) |

 

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 presented in thetable below:

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|                                       | ** ** | ** **  | ** ** | **Average**          | ** ** |
|---------------------------------------|------------|-------------|------------|----------------------|------------|
| ** **                            | ** ** | ** **  | ** ** | **Fixed Price** | ** ** |
| **Production Period**            | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** |
|                                  |       |        |       |                 |       |
| April 2007  - March 2008    |       | 1,335,000   |       | $                    | 7.26       |   |
| April 2008 -  December 2008 |       | 900,000     |       | $                    | 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 March 31, 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 March 31,2007, Hiland Partners had approximately $159.1 million of indebtednessoutstanding under its credit facility. The impact of a 100 basis point increaseor decrease in interest rates on the amount of current debt would result in anincrease or decrease in interest expense and a corresponding decrease orincrease in net income of approximately $1.6 million annually.

***CreditRisk.****  *Counterparties pursuant to the terms of their contractual obligations expose usto potential losses as a result of nonperformance. Hiland Partners’ fourlargest customers for the three months ended March 31, 2007 accounting forapproximately 29%, 16%, 14% and 9%, respectively, of revenues. Consequently,changes within one or more of these companies’ operations have the potential toimpact, both positively and negatively, our credit exposure. Our counterpartyfor all of our derivative instruments as of March 31, 2007 is BP EnergyCo. and BP Corporation North America, Inc.

**Item4.  Controls and Procedures**

**Evaluation of Disclosure Controls andProcedures**

(a) Evaluation ofdisclosure controls and procedures.

Our interimprincipal executive officer and principal financial officer have evaluated, asrequired by Rule 13a-15(b) under the Securities Exchange Act of 1934(the “Exchange Act”), our disclosure controls and procedures (as defined inExchange Act Rule 13a-15(e)) as of the end of the period covered by thisquarterly report on Form 10-Q.  Based on that evaluation, theprincipal interim executive officer and principal financial officer concludedthat the design and operation of our disclosure controls and procedures areeffective in ensuring that information we are required to disclose in thereports that we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms.

(b) Changes in internalcontrol 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**

**Item1.  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**

***Our failure to replace Randy Moeder, our current ChiefExecutive Officer, with an individual with the required level of experience andexpertise in a timely manner, could have an adverse impact on our operationsand business strategy.***

On March 14, 2007,Randy Moeder announced his intension to resign as Chief Executive Officer anddirector of both our general partner and the general partner of Hiland Partnersto pursue other career opportunities. On April 16, 2007, the board of directorsof our general partner formally accepted Mr. Moeder’s resignation. Mr. Moederhas served as the Chief Executive Officer of Hiland Partners’ general partnersince its inception in October 2004 and has been involved with the predecessorbusinesses since April 1998. Mr. Harold Hamm, Chairman of the board ofdirectors of our general partner was appointed interim President and ChiefExecutive Officer until a successor is named. Mr. Hamm is also heading up acommittee to secure a replacement for Mr. Moeder. However, if we

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are unsuccessful inreplacing Mr. Moeder with an individual with the required level of experienceand expertise in a timely manner, our operations and business strategy could bematerially and adversely affected.

***Wehave adopted certain valuation methodologies that may result in a shift ofincome, gain, loss and deduction between the general partner and theunitholders.  The IRS may challenge thistreatment, which could adversely affect the value of the common units.***

When we issueadditional units or engage in certain other transactions, we determine the fairmarket value of our assets and allocate any unrealized gain or lossattributable to our assets to the capital accounts of our unitholders and ourgeneral partner.  Our methodology may beviewed as understating the value of our assets. In that case, there may be a shift of income, gain, loss and deductionbetween certain unitholders and the general partner, which may be unfavorableto such unitholders.  Moreover,subsequent purchasers of common units may have a greater portion of theirInternal Revenue Code Section 743(b) adjustment allocated to our tangibleassets and a lesser portion allocated to our intangible assets.  The IRS may challenge our valuation methods,or our allocation of the Section 743(b) adjustment attributable to our tangibleand intangible assets, and allocations of income, gain, loss and deductionbetween the general partner and certain of our unitholders.

A successful IRSchallenge to these methods or allocations could adversely affect the amount oftaxable income or loss being allocated to our unitholders. It also could affectthe amount of gain from our unitholders’ sale of common units and could have anegative impact on the value of the common units or result in audit adjustmentsto our unitholders’ tax returns without the benefit of additional deductions.

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

**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 Matters**

None

**Item 6.Exhibits**
| Exhibit  Number | ** ** | **Description**                                                                                    |
|-----------------|------------|----------------------------------------------------------------------------------------------------|
| 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, on the10th day of May, 2007.
|            | **HILAND HOLDINGS GP, LP** |
|------------|----------------------------|
| ** ** | **By:**                    | **Hiland Partners GP Holdings, LLC, its general  partner** |
|       | By:                        | /s/ HAROLD HAMM |
|       |                       | Harold Hamm |
|       | * *                   | *Interim 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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