**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

**FORM10-Q**

x** QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF**

**THESECURITIES EXCHANGE ACT OF 1934**

**FORTHE QUARTERLY PERIOD ENDED September 30, 2006**

**OR**

o **TRANSITION REPORT PURSUANT TO SECTION13 OR 15(d) OF**

**THESECURITIES EXCHANGE ACT OF 1934**

**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 check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days Yes  o    No  x

Indicate by check markwhether 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. (Check one):
| Large accelerated filer    o |   | Accelerated  filer    o |   | Non-accelerated  filer    x |
|--------------------------------------------------|--------|---------------------------------------------|--------|-------------------------------------------------|

 

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

The number of the registrant’s outstanding equity units at November 6,2006 was 21,612,000 common units.

 

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**HILANDHOLDINGS GP, LP**

**INDEX**
| **PART I. FINANCIAL INFORMATION**                                                                    | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------|
| Item 1. Financial Statements (Unaudited, except  December 31, 2005 Balance Sheet)                    |       |       |
| Consolidated Balance  Sheets                                                                         |       |       |
| Consolidated  Statements of Operations                                                               |       |       |
| Consolidated  Statements of Cash Flows                                                               |       |       |
| Consolidated  Statement of Changes in Owners’ Equity and Comprehensive Income                   |       |       |
| 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                                                               |       |       |

 

2

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**HILANDHOLDINGS GP, LP**

**Consolidated Balance Sheets**
| ** **                                                    | ** ** | **September 30,**                                      | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                    | ** ** | **2006**                                                    | ** ** | **2005**              | ** ** |
| ** **                                                    | ** ** | **(unaudited)**                                             | ** ** | **Predecessor**       | ** ** |
| ** **                                                    | ** ** | **(in thousands, except unit amounts)** | ** ** |
| **ASSETS**                                                    | ** ** | ** **                                                  | ** ** | ** **            | ** ** |
| **Current assets:**                                           | ** ** | ** **                                                  | ** ** | ** **            | ** ** |
| Cash and cash  equivalents                                    |       | $                                                           | 11,030     |                  | $          | 6,318 |   |
| Accounts receivable:                                          |       |                                                        |       |                  |       |
| Trade                                                         |       | 17,836                                                      |       | 21,893                |       |
| Affiliates                                                    |       | 944                                                         |       | 1,508                 |       |
|                                                          |       | 18,780                                                      |       | 23,401                |       |
| Fair value of  derivative assets                              |       | 4,322                                                       |       | 868                   |       |
| Other current assets                                          |       | 489                                                         |       | 395                   |       |
| Total current assets                                          |       | 34,621                                                      |       | 30,982                |       |
|                                                          |       |                                                        |       |                  |       |
| Property and equipment,  net                                  |       | 247,901                                                     |       | 120,715               |       |
| Intangibles, net                                              |       | 54,634                                                      |       | 41,179                |       |
| Fair value of  derivative assets                              |       | 2,549                                                       |       | 181                   |       |
| Other assets, net                                             |       | 2,049                                                       |       | 1,028                 |       |
|                                                          |       |                                                        |       |                  |       |
| **Total assets**                                              |       | $                                                           | 341,754    |                  | $          | 194,085 |   |
|                                                          |       |                                                        |       |                  |       |
| **LIABILITIES AND OWNERS’ EQUITY**                       | ** ** | ** **                                                  | ** ** | ** **            | ** ** |
| **Current liabilities:**                                      | ** ** | ** **                                                  | ** ** | ** **            | ** ** |
| Accounts payable                                              |       | $                                                           | 14,041     |                  | $          | 13,349 |   |
| Accounts  payable-affiliates                                  |       | 4,747                                                       |       | 5,819                 |       |
| Fair value of  derivative liabilities                         |       | 1,671                                                       |       | —                |       |
| Accrued liabilities                                           |       | 1,369                                                       |       | 1,426                 |       |
| Total current  liabilities                                    |       | 21,828                                                      |       | 20,594                |       |
|                                                          |       |                                                        |       |                  |       |
| Commitments and  contingencies (Note 9)                       |       |                                                        |       |                  |       |
| Long-term debt                                                |       | 134,318                                                     |       | 33,784                |       |
| Fair value of  derivative liabilities                         |       | 557                                                         |       | —                |       |
| Asset retirement  obligation                                  |       | 2,177                                                       |       | 1,024                 |       |
| Minority interests                                            |       | 142,043                                                     |       | 135,892               |       |
|                                                          |       |                                                        |       |                  |       |
| **Owners’ equity**                                       | ** ** | ** **                                                  | ** ** | ** **            | ** ** |
| Predecessor members’  equity                             |       | —                                                      |       | 2,770                 |       |
| Common unitholders  (21,612,000 units issued and outstanding) |       | 38,118                                                      |       | —                |       |
| Accumulated other  comprehensive income                       |       | 2,713                                                       |       | 21                    |       |
| **Total owners’ equity**                                 |       | 40,831                                                      |       | 2,791                 |       |
|                                                          |       |                                                        |       |                  |       |
| **Total liabilities and owners’ equity**                 |       | $                                                           | 341,754    |                  | $          | 194,085 |   |

 

The accompanyingnotes are an integral part of these financial statements.

3

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**HILANDHOLDINGS GP, LP**

**Consolidated Statements of Operations**

**Forthe Three and Nine Months Ended (Unaudited)**
| ** **                                                                         | ** ** | **Three Months Ended**                                     | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                         | ** ** | **September 30,**                                               | ** ** | **September 30,**          | ** ** |
| ** **                                                                         | ** ** | **2006**                                                             | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                         | ** ** | **(in thousands, except per unit amounts)** | ** ** |
| **Revenues:**                                                                      | ** ** | ** **                                                           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Midstream  operations                                                              |       |                                                                 |       |                            |       |   |   |   |   |
| Third parties                                                                      |       | $                                                                    | 55,137     |                            | $          | 39,608 |   | $ | 156,606 |   | $ | 91,780 |   |
| Affiliates                                                                         |       | 925                                                                  |       | 1,112                           |       | 3,194 |   | 3,514 |   |
| Compression  services, affiliate                                                   |       | 1,205                                                                |       | 1,205                           |       | 3,615 |   | 3,012 |   |
| Total revenues                                                                     |       | 57,267                                                               |       | 41,925                          |       | 163,415 |   | 98,306 |   |
|                                                                               |       |                                                                 |       |                            |       |   |   |   |   |
| **Operating  costs and expenses:**                                                 | ** ** | ** **                                                           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Midstream  purchases (exclusive of items shown separately below)                   |       | 26,480                                                               |       | 21,713                          |       | 78,389 |   | 50,750 |   |
| Midstream  purchases -affiliate (exclusive of items shown separately below)        |       | 13,129                                                               |       | 11,600                          |       | 39,576 |   | 26,798 |   |
| Operations and  maintenance                                                        |       | 4,569                                                                |       | 1,897                           |       | 11,140 |   | 5,083 |   |
| Depreciation,  amortization and accretion                                          |       | 6,462                                                                |       | 2,912                           |       | 16,256 |   | 6,924 |   |
| General and  administrative expenses                                               |       | 1,397                                                                |       | 542                             |       | 3,695 |   | 1,591 |   |
| Total operating  costs and expenses                                                |       | 52,037                                                               |       | 38,664                          |       | 149,056 |   | 91,146 |   |
| Operating income                                                                   |       | 5,230                                                                |       | 3,261                           |       | 14,359 |   | 7,160 |   |
|                                                                               |       |                                                                 |       |                            |       |   |   |   |   |
| **Other  income (expense):**                                                       | ** ** | ** **                                                           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest and  other income                                                         |       | 68                                                                   |       | 70                              |       | 221 |   | 112 |   |
| Amortization of  deferred loan costs                                               |       | (170                                                                 | )          | (83                             | )          | (402 | ) | (360 | ) |
| Interest expense                                                                   |       | (2,387                                                               | )          | (585                            | )          | (4,649 | ) | (766 | ) |
| Other income  (expense), net                                                       |       | (2,489                                                               | )          | (598                            | )          | (4,830 | ) | (1,014 | ) |
|                                                                               |       |                                                                 |       |                            |       |   |   |   |   |
| **Income  before minority interest in income of Hiland Partners, LP**              |       | 2,741                                                                |       | 2,663                           |       | 9,529 |   | 6,146 |   |
| Minority  interest in income of Hiland Partners, LP                                |       | (2,765                                                               | )          | (2,617                          | )          | (8,991 | ) | (5,577 | ) |
| **Net  income (loss)**                                                             |       | (24                                                                  | )          | $                               | 46         |   | 538 |   | $ | 569 |   |
| ** **                                                                         | ** ** | ** **                                                           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Less income  (loss) attributable to predecessor                                    |       | (155                                                                 | )          |                            |       | 407 |   |   |   |
| **Limited  partners’ interest in net income**                                 |       | $                                                                    | 131        |                            |       |   | $ | 131 |   |   |   |
| ** **                                                                         | ** ** | ** **                                                           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net  income per limited partners’ unit - basic and diluted**                |       | $                                                                    | 0.01       |                            |       |   | $ | 0.01 |   |   |   |
| ** **                                                                         | ** ** | ** **                                                           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Weighted average limited  partners’ units outstanding - basic and diluted** |       | 21,612                                                               |       |                            |       | 21,612 |   |   |   |

 

The accompanying notesare an integral part of these financial statements.

4

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**HILANDHOLDINGS GP, LP**

**Consolidated Statements of Cash Flows**

**Forthe Nine Months Ended (Unaudited)**
| ** **                                                                            | ** ** | **September 30,**  | ** ** | **September 30,** | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                            | ** ** | **2006**                | ** ** | **2005**               | ** ** |
| ** **                                                                            | ** ** | ** **              | ** ** | **Predecessor**        | ** ** |
| ** **                                                                            | ** ** | **(in thousands)** | ** ** |
| **Cash  flows from operating activities:**                                            | ** ** | ** **              | ** ** | ** **             | ** ** |
| Net income                                                                            |       | $                       | 538        |                   | $          | 569 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:    |       |                    |       |                   |       |
| Depreciation and  amortization                                                        |       | 16,209                  |       | 6,898                  |       |
| Accretion of  asset retirement obligation                                             |       | 47                      |       | 26                     |       |
| Amortization of  deferred loan cost                                                   |       | 402                     |       | 360                    |       |
| Gain on hedge  ineffectiveness                                                        |       | (133                    | )          | —                 |       |
| Unit based  compensation                                                              |       | 364                     |       | 52                     |       |
| Minority  interest in income of Hiland Partners, LP                                   |       | 8,991                   |       | 5,577                  |       |
| (Increase)  decrease in current assets, net of acquisition effects:                   |       |                    |       |                   |       |
| Accounts  receivable                                                                  |       | 4,057                   |       | (14,415                | )          |
| Accounts  receivable - affiliates                                                     |       | 864                     |       | (151                   | )          |
| Other current  assets                                                                 |       | (94                     | )          | (163                   | )          |
| Increase  (decrease) in current liabilities, net of acquisition effects:              |       |                    |       |                   |       |
| Accounts payable                                                                      |       | 692                     |       | (957                   | )          |
| Accounts  payable-affiliates                                                          |       | (1,658                  | )          | 2,730                  |       |
| Accrued  liabilities                                                                  |       | 231                     |       | 477                    |       |
| Increase in  other assets                                                             |       | (144                    | )          | —                 |       |
| **Net  cash provided by operating activities**                                        |       | 30,366                  |       | 1,003                  |       |
|                                                                                  |       |                    |       |                   |       |
| **Cash  flows from investing activities:**                                            | ** ** | ** **              | ** ** | ** **             | ** ** |
| Additions to  property and equipment                                                  |       | (47,989                 | )          | (2,770                 |       |
| Payments for  businesses acquired, less cash received                                 |       | (96,400                 | )          | (62,440                | )          |
| Proceeds from disposals  of property and equipment                                    |       | 111                     |       | —                 |       |
| **Net  cash used in investing activities**                                            |       | (144,278                | )          | (65,210                | )          |
|                                                                                  |       |                    |       |                   |       |
| **Cash  flows from financing activities:**                                            | ** ** | ** **              | ** ** | ** **             | ** ** |
| Proceeds from  public offering-net of underwriters discount                           |       | 139,617                 |       | —                 |       |
| Minority  interest proceeds from initial public offering of Hiland Partners, LP - net |       | —                  |       | 48,128                 |       |
| Redemption of  common units of Hiland Partners, LP from organizers                    |       | —                  |       | (6,278                 | )          |
| Distributions to  organizers                                                          |       | —                  |       | (3,851                 | )          |
| Cash not  contributed by organizers                                                   |       | —                  |       | (869                   | )          |
| Payment of initial  public offering costs of Hiland Partners, LP                      |       | —                  |       | (2,249                 | )          |
| Proceeds from  long-term borrowings                                                   |       | 135,535                 |       | 93,700                 |       |
| Payments on  long-term borrowings                                                     |       | (35,000                 | )          | (23,951                | )          |
| Debt issuance  costs                                                                  |       | (1,279                  | )          | (1,189                 | )          |
| Payment of  initial public offering costs                                             |       | (1,772                  | )          | —                 |       |
| Cash  distribution to controlling members for net assets of Hiland Partners GP,  LLC. |       | (137,817                | )          | —                 |       |
| Cash  distribution to controlling member for net assets of Hiland Partners, LLC.      |       | —                  |       | (26,980                | )          |
| Capital  contributions                                                                |       | 36,506                  |       | 100                    |       |
| Proceeds from  exercised unit options of Hiland Partners, LP                          |       | 1,094                   |       | —                 |       |
| Minority  interest cash distribution to unitholders of Hiland Partners, LP            |       | (16,509                 | )          | (4,675                 | )          |
| Cash  distribution to members of Hiland Partners GP, LLC                              |       | (1,750                  | )          | (883                   | )          |
| **Net  cash provided by financing activities**                                        |       | 118,625                 |       | 71,003                 |       |
|                                                                                  |       |                    |       |                   |       |
| Increase for the  period                                                              |       | 4,712                   |       | 6,796                  |       |
| Beginning of  period                                                                  |       | 6,318                   |       | 217                    |       |
| **End of  period**                                                                    |       | $                       | 11,030     |                   | $          | 7,013 |   |
| Supplementary  information                                                            |       |                    |       |                   |       |
| Cash paid for interest,  net of amounts capitalized                                   |       | $                       | 4,649      |                   | $          | 367 |   |

 

The accompanyingnotes are an integral part of these financial statements.

5

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| ** **                                                                                                                                                                                                                              | ** ** | **September 30,**  | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                                                                                                                                                              | ** ** | **2006**                | ** ** |
| ** **                                                                                                                                                                                                                              | ** ** | **(in thousands)** | ** ** |
| **Non-cash  investing and financing activities:**                                                                                                                                                                                       | ** ** | ** **              | ** ** |
|                                                                                                                                                                                                                                    |       |                    |       |
| May 10, 2006  purchase of limited partner common units of Hiland Partners, LP in excess of  proportionate historical financial cost basis of Hiland Partners, LP  allocated to property and equipment and intangible assets as follows: |       |                    |       |
| Property and  equipment                                                                                                                                                                                                                 |       | $                       | 4,488      |   |
| Customer  contracts                                                                                                                                                                                                                     |       | 6,980                   |       |
| Excess of cost over  proportionate equity interest                                                                                                                                                                                      |       | $                       | 11,468     |   |

 

The accompanyingnotes are an integral part of these financial statements

6

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**Hiland Holdings GP, LP**

**Consolidated Statement of Changes in Owners’ Equityand Comprehensive Income**

**For the Nine Months Ended September 30, 2006(Unaudited)**
| ** **                                                                                   | ** ** | ** **                                                  | ** ** | ** ** | ** ** | **Accumulated**   | ** ** | ** ** | ** ** | ** **        | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|------------|------------|-------------------|------------|------------|------------|-------------------|------------|
| ** **                                                                                   | ** ** | **Predecessor**                                             | ** ** | ** ** | ** ** | **Other**         | ** ** | ** ** | ** ** | **Total**         | ** ** |
| ** **                                                                                   | ** ** | **Members’**                                           | ** ** | **Common** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                                   | ** ** | **Equity**                                                  | ** ** | **Units**  | ** ** | **Income**        | ** ** | **Total**  | ** ** | **Income**        | ** ** |
| ** **                                                                                   | ** ** | **(in thousands, except unit amounts)** | ** ** |
| ** **                                                                                   |       |                                                        |       |       |       |              |       |       |       |              |       |
| Balance, January  1, 2006                                                                    |       | $                                                           | 2,770      |       | $          | —            |       | $          | 21         |              | $          | 2,791 |   |   |   |
|                                                                                         |       |                                                        |       |       |       |              |       |       |       |              |       |
| Capital  contributions                                                                       |       | 36,506                                                      |       | —     |       | —            |       | 36,506     |       |              |       |
|                                                                                         |       |                                                        |       |       |       |              |       |       |       |              |       |
| Cash  distributions                                                                          |       | (1,750                                                      | )          | —     |       | —            |       | (1,750     | )          |              |       |
|                                                                                         |       |                                                        |       |       |       |              |       |       |       |              |       |
| Member  compensation                                                                         |       | 24                                                          |       | —     |       | —            |       | 24         |       |              |       |
|                                                                                         |       |                                                        |       |       |       |              |       |       |       |              |       |
| Net income from  January 1, 2006 through September 25, 2006                                  |       | 407                                                         |       | —     |       | —            |       | 407        |       | $                 | 407        |   |
|                                                                                         |       |                                                        |       |       |       |              |       |       |       |              |       |
| Contribution of  member interest in Hiland Partners GP, LLC                                  |       | (37,957                                                     | )          | 37,957     |       | —            |       | —     |       |              |       |
|                                                                                         |       |                                                        |       |       |       |              |       |       |       |              |       |
| Proceeds from  initial public offering, net of underwriter discount (8,050,000 common units) |       | —                                                      |       | 139,617    |       | —            |       | 139,617    |       |              |       |
|                                                                                         |       |                                                        |       |       |       |              |       |       |       |              |       |
| Offering costs  of initial public offering                                                   |       | —                                                      |       | (1,772     | )          | —            |       | (1,772     | )          |              |       |
|                                                                                         |       |                                                        |       |       |       |              |       |       |       |              |       |
| Cash  distribution to controlling members for contribution of units                          |       | —                                                      |       | (137,817   | )          | —            |       | (137,817   | )          |              |       |
|                                                                                         |       |                                                        |       |       |       |              |       |       |       |              |       |
| Unit based  compensation                                                                     |       | —                                                      |       | 2          |       | —            |       | 2          |       |              |       |
|                                                                                         |       |                                                        |       |       |       |              |       |       |       |              |       |
| Other  comprehensive income reclassified to income on closed derivative transactions         |       | —                                                      |       | —     |       | (1,424            | )          | (1,424     | )          | (1,424            | )          |
|                                                                                         |       |                                                        |       |       |       |              |       |       |       |              |       |
| Change in fair  value of derivatives                                                         |       | —                                                      |       | —     |       | 4,116             |       | 4,116      |       | 4,116             |       |
|                                                                                         |       |                                                        |       |       |       |              |       |       |       |              |       |
| Net income from  September 25, 2006 through September 30, 2006                               |       | —                                                      |       | 131        |       | —            |       | 131        |       | 131               |       |
|                                                                                         |       |                                                        |       |       |       |              |       |       |       |              |       |
| Comprehensive  income                                                                        |       |                                                        |       |       |       |              |       |       |       | $                 | 3,230      |   |
|                                                                                         |       |                                                        |       |       |       |              |       |       |       |              |       |
| Balance September 30,  2006                                                                  |       | $                                                           | —     |       | $          | 38,118            |       | $          | 2,713      |              | $          | 40,831 |   |   |   |

 

The accompanyingnotes are an integral part of this financial statement.

7

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**HILANDHOLDINGS GP, LP**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

**THREE AND NINE MONTHS ENDEDSEPTEMBER 30, 2006 AND 2005**

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

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

Unless the contextrequires otherwise, references to “we”, “our,” “us,” “HPGP” or “the Partnership”are intended to mean the consolidated business and operations of HilandHoldings GP, LP. References to “HPGP GP” refer to Hiland Partners GPHoldings, LLC, which serves as our general partner. References to “HLND” areintended to mean the consolidated business and operations of Hiland Partners,LP and its subsidiaries. References to “HLND GP” refer to HilandPartners GP, LLC, the general partner of Hiland Partners, LP.

The consolidated financial statements presented in this Form 10-Q presentthe financial position and results of Hiland Partners GP, LLC (Predecessor) forperiods presented through September 24, 2006. The financial statements alsoinclude the results of operations of Hiland Holdings GP, LP for the period fromSeptember 25, 2006, the date Hiland Holdings GP, LP commenced operations. Thebalance sheet as of September 30, 2006 presents solely the consolidatedfinancial position of Hiland Holdings GP, LP.

Hiland HoldingsGP, LP, a Delaware limited partnership was formed in May 2006 to own andcontrol Hiland Partners GP, LLC, the general partner of Hiland Partners, LP andcertain other common and subordinated units in HLND. HLND GP was formed in October 2004to hold the 2% general partner ownership interest in HLND and serve as itsgeneral partner. HLND GP manages the operations of HLND. In connection with theclosing of our initial public offering, all of the membership interests in HLNDGP were contributed to us. HLND GP constitutes our predecessor. 

Our generalpartner, HPGP GP, manages our operations and activities, including, among otherthings, paying our expenses and establishing the quarterly cash distributionlevels for our common units and reserves that our general partner determines,in good faith, are necessary or appropriate to provide for the conduct of ourbusiness, to comply with applicable law, any of our debt instruments or otheragreements or to provide for future distributions to our unitholders for anyone or more of the upcoming four quarters.

HLND, a Delawarelimited partnership, was formed in October 2004 to acquire and operate certainmidstream natural gas plants, gathering systems and compression and waterinjection assets located in the states of Oklahoma, North Dakota, Wyoming,Texas and Mississippi that were previously owned by Continental Gas, Inc. (“CGI”)and Hiland Partners, LLC. HLND commenced operations on February 15,2005, and concurrently with the completion of its initial public offering, CGIcontributed a substantial portion of its net assets to HLND. 

CGI constitutesHLND’s predecessor. The transfer of ownership of net assets from CGI to HLNDrepresented a reorganization of entities under common control and was recordedat historical cost. Accordingly, the consolidated financial statements includethe historical operations of CGI prior to the transfer to HLND. CGI was formedin 1990 as a wholly owned subsidiary of Continental Resources, Inc. (“CRI”).

CGI operated inone segment, midstream, which involved the gathering, compressing, dehydrating,treating, and processing of natural gas and fractionating natural gas liquids,or NGLs. CGI historically has owned all of HLND’s 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 HLND acquired onFebruary 15, 2005, and the Bakken gathering system. The net assetsacquired by HLND on February 15, 2005 had a fair value of$48.6 million. Since its initial public offering, HLND has operated inmidstream and compression services segments. On September 26, 2005, HLNDacquired Hiland Partners, LLC, which at such time owned the Bakken gatheringsystem, for $92.7 million, $35.0 million of which was used to retireoutstanding Hiland Partners, LLC indebtedness. On May 1, 2006, HLND acquiredthe Kinta Area gathering assets from Enogex Gas Gathering, L.L.C., consistingof certain eastern Oklahoma gas gathering assets, for $96.4 million.  HLND financed the acquisition with $61.2million of borrowings from its credit facility and $35.0 million of proceedsfrom the issuance of 761,714 of its common units and 15,545 of its generalpartner equivalent units, both at $45.03 per unit to HLND GP.

The unauditedconsolidated financial statements for the three and nine months ended September 30, 2006 and 2005included herein have been prepared pursuant to the rules and regulations of theUnited States Securities and Exchange Commission (the “SEC”). The interimfinancial statements reflect all adjustments, which are in the opinion of ourmanagement, necessary for a fair presentation of our results for the interimperiods. Such adjustments are considered to be of a normal recurring nature.Results of operations for the three and nine months ended September 30, 2006are not necessarily indicative of the results of operations that will berealized for the year ending December 31, 2006. The accompanying consolidated financial statements and notes thereto ofHPGP should be read in conjunction with the consolidated financial statementsand notes thereto of HPGP included in HPGP’s Amended Registration statementForm S-1/A dated September 13, 2006. 

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***Principles of Consolidation***

Since we own andcontrol the general partner of HLND, the consolidated financial statementsinclude our accounts, the accounts of HLND GP and the accounts of HLND and itssubsidiaries. All significant intercompany transactions and balances have beeneliminated. The consolidated financial statements include the assets of HLND GPthat were contributed to us concurrently with the completion of our initialpublic offering on September 25, 2006. HLND GP commenced operations on February15, 2005, therefore amounts presented in these consolidated financialstatements and accompanying notes for the period February 15, 2005 to September25, 2006 relate to the consolidated accounts of HLND GP, HLND, its subsidiariesand its predecessor (CGI). The net assets and operations of assets owned by CGI(HLND’s predecessor) are reflected for all periods presented. Certain assets ofHiland Partners, LLC that were contributed to HLND concurrently with thecompletion of its initial public offering are reflected beginning February 15,2005 and the remaining net assets and operations of Hiland Partners, LLCacquired are reflected beginning September 1, 2005. Operations from theacquisition of the Kinta Area gathering assets are reflected only from May 1,2006.

***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.

***Cash and Cash Equivalents***

For financialreporting, we consider all highly liquid investments with maturity of threemonths or less at the time of purchase to be cash equivalents.

***Accounts Receivable***

The majority ofthe accounts receivable are due from companies in the oil and gas industry aswell as the utility industry. Credit is extended based on evaluation of ourcustomer’s financial condition. In certain circumstances, collateral, such asletters of credit or guarantees, is required. Accounts receivable are duewithin 30 days and are stated at amounts due from customers. We haveestablished various procedures to manage our credit exposure, including initialcredit approvals, credit limits and rights of offset. Credit losses are chargedto income when accounts are deemed uncollectible, determined on a case-by-casebasis when we believe the required payment of specific amounts owed is unlikelyto occur. These losses historically have been minimal. Therefore, an allowancefor uncollectible accounts is not required.

***Concentration and Credit Risk***

Financialinstruments that potentially subject us to concentrations of credit riskconsist principally of cash and cash equivalents and receivables. We place ourcash and cash equivalents with high-quality institutions and in money marketfunds. We derive our revenue from customers primarily in the natural gas andutility industries. These industry concentrations have the potential to impactour overall exposure to credit risk, either positively or negatively, in thatour customers could be affected by similar changes in economic, industry orother conditions. However, we believe that the credit risk posed by thisindustry concentration is offset by the creditworthiness of our customer base.Our portfolio of accounts receivable is comprised primarily of mid-size tolarge domestic corporate entities.

***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 derivativeinstruments is determined based on management estimates through utilization ofmarket data including forecasted forward natural gas and NGL prices as afunction of forward NYMEX natural gas and light crude prices. The fairvalue of long-term debt approximates its carrying value due to the variableinterest rate feature of such debt.

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***Long-Lived Assets***

In accordance withStatement of Financial Accounting Standards (SFAS) No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets”, we evaluate ourlong-lived assets of identifiable business activities for impairment whenevents or changes in circumstances indicate, in our management’s judgment, thatthe carrying value of such assets may not be recoverable. The determination ofwhether impairment has occurred is based on our management’s estimate ofundiscounted future cash flows attributable to the assets as compared to thecarrying value of the assets. If impairment has occurred, the amount of theimpairment recognized is determined by estimating the fair value for the assetsand recording a provision for loss if the carrying value is greater than fairvalue. For assets identified to be disposed of in the future, the carryingvalue of these assets is compared to the estimated fair value less the cost tosell determine if impairment is required. Until the assets are disposed of, anestimate of the fair value is re-determined when related events orcircumstances change.

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

·                  changes ingeneral economic conditions in regions in which HLND’s products are located;

·                  the availabilityand prices of NGL products and competing commodities;

·                  the availabilityand prices of raw natural gas supply;

·                  our ability tonegotiate favorable marketing agreements;

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

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

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

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

No impairmentcharges were recognized for the three and nine months ended September 30,2005 and 2006.

***Revenue Recognition***

Revenues for salesof natural gas and NGLs are recognized at the time all gathering and processingactivities are completed, the product is delivered and title istransferred.  Revenues related to ourcompression segment are recognized as monthly services are rendered under afour-year fixed-fee contract that we entered into concurrently with oursubsidiary’s initial public offering.

***Commodity Risk Management***

We engage in pricerisk management activities in order to minimize the risk from marketfluctuation in the price of natural gas. To qualify as a hedge, the pricemovements in the commodity derivatives must be highly correlated with theunderlying hedged commodity. Gains and losses related to commodity derivativeswhich qualify as hedges are recognized in income when the underlying hedgedphysical transaction closes and are included in the consolidated statements ofoperations as revenues from midstream operations.

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 qualifies forhedge accounting, depending on the nature of the hedge, changes in fair valuecan be offset against the change in fair value of the hedged item throughearnings or recognized in other comprehensive income until such time as thehedged item is recognized in earnings. To qualify for cash flow hedgeaccounting, the cash flows from the hedging instrument must be highly effectivein offsetting changes in cash flows due to changes in the underlying item beinghedged. In addition, all hedging relationships must be designated, 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

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something other than afinancial instrument or derivative instrument that will be delivered inquantities expected to be used or sold by the reporting entity over areasonable period in the normal course of business. Our forward natural gaspurchase and sales contracts are designated as normal purchases and sales.Substantially all of our forward contracts fall within a one-month to five-yearterm.

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 partners’equity and reclassified into earnings in the same period in which the hedged transactioncloses. The asset or liability related to the derivative instruments isrecorded on the balance sheet as fair value of derivative assets orliabilities. Any ineffective portion of the gain or loss is recognized inearnings immediately.

***Comprehensive Income (Loss)***

Comprehensiveincome includes net income and other comprehensive income, which includes, butis not limited to, changes in the fair value of derivative financialinstruments. Pursuant to SFAS No. 133, we record deferred unrealized hedge gainsand losses on our derivative financial instruments that qualify as cash flowhedges as other comprehensive income and record changes in the fair value ofour derivative financial instruments that qualify as cash flow hedges as othercomprehensive income, to the extent of our interest in HLND. Presented below isour comprehensive income for the three and nine months ended September 30, 2006and 2005:
|                                                        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                             | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net income                                             | ** ** | $                                | (24        | )                               | $          | 46 |   | $ | 538 |   | $ | 569 |   |
| Closed  derivative transactions reclassified to income |       | (1,275                           | )          | —                          |       | (1,424 | ) | — |   |
| Change in fair  value of derivatives                   |       | 3,933                            |       | —                          |       | 4,116 |   | — |   |
| Comprehensive Income                                   |       | $                                | 2,634      |                            | $          | 46 |   | $ | 3,230 |   | $ | 569 |   |

 

***Minority Interests***

The minorityinterest liability on our consolidated balance sheet as of September 30, 2006and December 31, 2005, reflects the outside ownership interest of HLND.Minority interest income is calculated by multiplying the minority interestowners’ proportionate ownership of limited partner units in HLND by the limitedpartners’ allocation of HLND’s net income. HLND’s net income is allocated toits limited partners and its general partner based on the proportionate shareof the contractually-determined cash distributions for the period, withadjustments made for incentive distributions specifically allocated to itsgeneral partner. All amounts we have received from HLND’s issuance and sale oflimited partner units have been recorded as increases to the minority interestliability.

***Net Income per Limited Partner Unit***

Net income perlimited partners unit is computed based on the weighted-average number ofcommon units outstanding during the period. The computation of diluted netincome per limited partner unit further assumes the dilutive effect of unitoptions and restricted unit awards. Net income per limited partner unit iscomputed by dividing net income applicable to limited partners and for thethree and nine month period ended September 30, 2006, after deducting netincome prior to the contribution of membership interests in HLND GP (beforeSeptember 25, 2006), by both the basic and diluted weighted-average numberof limited partnership units outstanding.

***Share-Based Compensation***

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

HPGP GP, thegeneral partner of HPGP, adopted the Hiland Holdings GP, LP Long-Term IncentivePlan for its employees and directors of its general partner and employees ofits affiliates.  The long-term incentive plan consists of threecomponents: unit options, restricted units and phantom units. The long-termincentive plan limits the number of units that may be delivered pursuant toawards to 2,160,000 units. The plan is administered by the board of directorsof our general partner or the compensation committee of the board of directorsof our general 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 amend thelong-term incentive plan or any part of the plan from time to time, includingincreasing the number of units that may be granted subject to unitholderapproval as may be required by

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applicable law or stockexchange rules. However, no change in any outstanding grant may be made thatwould materially reduce the benefits of the participant without the consent ofthe participant. 

Absent arestriction on distributions in the grant agreement, holders of restrictedunits will have the same rights to receive distributions on the restrictedunits (“UDRs”) as holders of common units. The compensation committee or theboard of directors of our general partner, in its discretion, may provide thatUDRs with respect to restricted units are subject to forfeiture or otherrestrictions, and if restricted, will be held, without interest, until the UDRvests or is forfeited, as the case may be. The compensation committee, in itsdiscretion, may also grant tandem distribution equivalent rights (“DERs”) withrespect to phantom units. These are rights that entitle the grantee to receivecash equal to the cash distributions made on the common units. DERs shall besubject to such terms as the compensation committee may, in its discretion,impose.

Under the grantagreement, UDRs on the restricted units will be held by us without interestuntil the restricted unit with respect to which the UDR was made becomes vestedor is forfeited. Upon vesting any UDRs being held with respect to such vestedrestricted unit will be paid to the holder. Upon forfeiture of the restrictedunit any UDRs being held with respect to such forfeited restricted unit will beforfeited.

In October 1995,the FASB issued SFAS No. 123, “Share-Based Payment,” which was revised inDecember 2004 (“SFAS 123R”).  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.We adopted SFAS 123R at the completion of our initial public offering onSeptember 25, 2006 and have used the permitted modified prospective methodbeginning as of the same date.

No options areoutstanding for the nine months ended September 30, 2006.

Upon completion ofour initial public offering, we granted 2,000 restricted common units to eachof our six independent directors.  Arestricted unit is a common unit that is subject to forfeiture.  Uponvesting, the grantee receives a common unit that is not subject toforfeiture.  The restricted units vest over a four-year period from thedate of issuance. The weighted average fair value at grant date was $20.00 perunit. Periodic distributions on the restricted units are held in trust by ourgeneral partner until the units vest. As of September 30, 2006, none of therestricted units had vested. 

As provided for inthe long-term incentive plan, each non-employee board member of HPGP GP on eachanniversary date of the initial reward is entitled to receive an additional1,000 restricted common units.

Compensationexpense related to the 12,000 restricted units issued is to be recognized overtheir respective four-year vesting period on a straight-line basis. During thethree months ended September 30, 2006, HPGP recorded $1 of expense related tothe 12,000 restricted units issued and will expense another $239 over the nextfour years. 

OnFebruary 15, 2005, HLND GP issued member based compensation awards with afair value of $118 to two of its members as compensation for services to berendered exclusively for HLND GP’s benefit. These Class B member interests werecontributed to us in connection with the closing of our initial publicoffering. The Class B common units vest over a three-year period from the dateof issuance. The Class B common units have substantially the same rights as thecommon units and, upon vesting, will become convertible at the election of theholder into common units.  Member basedcompensation expense related to the Class B common units was $8 and $21for three months ended September 30, 2006 and 2005, respectively and $25and $52 for the nine months ended September 30, 2006 and 2005,respectively.

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

HLND GP, thegeneral partner of HLND adopted the Hiland Partners, LP Long-Term IncentivePlan for its employees and directors of its general partner and employees ofits affiliates.  The long-term incentive plan currently permits anaggregate of 680,000 of HLND common units to be issued with respect to unitoptions, restricted units, and phantom units granted under the plan.  Nomore than 225,000 of the 680,000 common units may be issued with respect tovested restricted or phantom units.  The plan is administered by thecompensation committee of HLND GP’s board of directors. The plan willcontinue in effect until the earliest of (i) the date determined by the boardof directors of the general partner; (ii) the date that common units are nolonger available for payment of awards under the plan; or (iii) the tenthanniversary of the plan.

HLND GP’s board ofdirectors or compensation committee may, in their discretion, terminate,suspend or discontinue the long-term incentive plan at any time with respect toany units for which a grant has not yet been made.  HLND GP’s board ofdirectors or its compensation committee also has the right to alter or amendthe long-term incentive plan or any part of the plan from time to time,including increasing the number of units that may be granted, subject tounitholder approval if required by the exchange upon which the common units arelisted at that time.  No change in any outstanding grant may be made,however, that would materially impair the rights of the participant without theconsent of the participant. Under the unit option grant agreement, grantedoptions of common units will vest and become exercisable in one-thirdincrements on the anniversary of the grant date over three years. Vestedoptions are

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exercisable within theoption’s contractual life of ten years after the grant date.

SFAS 123R requiresthat the 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. HLND****adopted SFAS 123R as of January 1, 2006****andapplied SFAS 123R using the permitted modified prospective method beginning asof the same date. HLND expects no change to its cash flow presentation from theadoption of SFAS 123R since no tax benefits are recognized by them as a passthrough entity. HLND’s compensation expense for these awards is recognized onthe graded vesting attribution method. Units to be issued under HLND’sunit incentive plan may be from newly issued units. Prior to HLND’s adoption ofSFAS 123R on January 1, 2006, HLND applied Accounting Principles Board OpinionNo. 25 and related interpretations in accounting for their unit-basedcompensation awards. Accordingly, no compensation expense was recognized in2005 for HLND’s unit options granted during 2005. The following pro forma datawas calculated as if compensation cost for their unit-based compensation awardsduring the three and nine month periods ended September 30, 2005 was determinedbased upon the fair value at the grant date consistent with the methodologyprescribed under SFAS No. 123.
|                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|--------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **September 30, 2005** | ** ** | **September 30, 2005** | ** ** |
| Net income as  reported              |       | $                                | 46         |                             | $          | 569 |   |
| Share based  compensation adjustment |       | (8                               | )          | (16                              | )          |
| Pro forma net income                 |       | $                                | 38         |                             | $          | 553 |   |

 

The fair value ofeach option granted was estimated on the date of grant using the AmericanBinomial option pricing model that used the assumptions noted below. Expectedand weighted-average volatility is based on HLND’s peer group volatilityaverages as determined on the option grant dates. Expected volatility ofoptions granted ranged from 16% to 31% and weighted-average volatility rangedfrom 18% to 30%. Expected lives of 6.0 years are calculated by the simplifiedmethod as prescribed under SEC Staff Accounting Bulletin 107 and represents theperiod of time that unit options granted are expected to be outstanding. Therisk-free interest rate for periods within the contractual life of the optionis based on the ten-year U.S. Treasury yield in effect at the time of grant.The exercise price of the options granted equaled the market price of the unitson the grant date.

|                              | ** ** | **Nine Months Ended**  | ** ** | **Year Ended**             | ** ** |
|------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | **September 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|                         |       |                             |       |                            |       |
| Expected  volatility         |       | 16.1%  - 20.2%                   |       | 20.2%  - 31.0%                  |       |
|                         |       |                             |       |                            |       |
| Weighted-average  volatility |       | 18.0%                            |       | 29.4%                           |       |
|                         |       |                             |       |                            |       |
| Expected  dividend yield     |       | 6.4%                             |       | 5.2%                            |       |
|                         |       |                             |       |                            |       |
| Risk-free interest rate      |       | 4.5%                             |       | 4.5%                            |       |

 

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The followingtable summarizes information about outstanding options with respect to HLND’scommon units for the nine months ended September 30, 2006:
|                                    | ** ** | ** ** | ** ** | ** **         | ** ** | **Weighted-**   | ** ** | ** **         | ** ** |
|------------------------------------|------------|------------|------------|--------------------|------------|-----------------|------------|--------------------|------------|
| ** **                         | ** ** | ** ** | ** ** | **Weighted**       | ** ** | **Average**     | ** ** | ** **         | ** ** |
| ** **                         | ** ** | ** ** | ** ** | **Average**        | ** ** | **Remaining**   | ** ** | **Aggregate**      | ** ** |
| ** **                         | ** ** | ** ** | ** ** | **Exercise**       | ** ** | **Contractual** | ** ** | **Intrinsic**      | ** ** |
| **Options**                        | ** ** | **Units**  | ** ** | **Price ($)** | ** ** | **Term**        | ** ** | **Value ($)** | ** ** |
|                               |       |       |       |               |       |            |       |               |       |
| Outstanding at January  1, 2006    |       | 167,500    |       | $                  | 24.70      |            |       |               |       |   |
|                               |       |       |       |               |       |            |       |               |       |
| Granted                            |       | 28,000     |       | $                  | 39.62      |            |       |               |       |   |
|                               |       |       |       |               |       |            |       |               |       |
| Exercised                          |       | (47,533    | )          | $                  | 23.01      |            |       |               | $          | 811 |   |
|                               |       |       |       |               |       |            |       |               |       |
| Forfeited or expired               |       | (13,333    | )          | $                  | 22.50      |            |       |               |       |   |
|                               |       |       |       |               |       |            |       |               |       |
| Outstanding at  September 30, 2006 |       | 134,634    |       | $                  | 28.65      |            | 8.6        |               | $          | 2,413 |   |
|                               |       |       |       |               |       |            |       |               |       |
| Exercisable at September 30, 2006  |       | 7,801      |       | $                  | 33.82      |            | 8.3        |               | $          | 99 |   |

 

The weightedaverage grant date fair value of the 55,334 unit options vested during the ninemonths ended September 30, 2006 was $5.17 per unit. The weighted average grantdate fair value of 28,000 options granted during the nine months endedSeptember 30, 2006 was $4.33 per unit. As of September 30, 2006, there was $299of total unrecognized compensation cost related to unvested unit basedcompensation arrangements granted under HLND’s Plan. This cost is expected tobe recognized over a weighted-average period of 1.3 years.

On April 14, 2006,13,333 of the unit options issued on February 14, 2005, were forfeited. HLNDassumed no forfeitures in its fair value calculations, as HLND believes thisforfeiture is an isolated incident and is not indicative of the future.  Compensation expense for the three and ninemonths ended September 30, 2006 has been reduced by $7 and $13, respectively,as a result of the forfeiture.

During the yearended December 31, 2005, HLND issued 8,000 restricted common units tonon-employee board members of its general partner. A restricted unit is acommon unit that is subject to forfeiture.  Upon vesting, the granteereceives a common unit that is not subject to forfeiture.  The restrictedunits vest over a four-year period from the date of issuance. The weightedaverage fair value at grant date was $39.69 per unit. Periodic distributions onthe restricted units are held in trust by HLND GP until the units vest. As ofSeptember 30, 2006, one-fourth, or 2,000 of the restricted units had vested andwere converted to common units.

As provided for inthe long-term incentive plan, each non-employee board member of HLND GP on eachanniversary date of the initial award is entitled to receive an additional1,000 restricted common units.  Duringthe three months ended September 30, 2006 HLND issued 4,000 restricted commonunits with a weighted average fair value of $44.49 per unit to fournon-employee board members of HLND GP.

On August 11,2006, HLND GP elected two additional non-employee board members and issued4,000 restricted common units.  The weightedaverage fair value at grant date was $44.00 per unit. Periodic distributions onthese restricted units will be held in trust by HLND GP until the units vest.

Compensationexpense related to the 8,000 restricted units issued is to be recognized over theirrespective four-year vesting period on a straight-line basis. During the threemonths ended September 30, 2006, HLND recorded $11 of expense related to the8,000 restricted units issued and will expense another $352 over the next fouryears.

As a result ofadopting SFAS 123R, HLND’s net income was reduced by $89 and $268 for the threeand nine months ended September 30, 2006, respectively.

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***Accounting for Asset Retirement Obligations***

SFAS No. 143,“Accounting for Asset Retirement Obligations,” requires entities to record thefair value of a liability for an asset retirement obligation in the period inwhich it is incurred and a corresponding increase in the carrying amount of therelated long-lived asset. Subsequently, the asset retirement cost is allocatedto expense using a systematic and rational method and the liability is accretedto measure the change in liability due to the passage of time. The primaryimpact of this standard relates to dismantling and site restoration of certainof our plants and pipelines.

The followingtable summarizes our activity related to asset retirement obligations for theindicated period:
| Asset retirement obligation,  January 1, 2006       |   | $     | 1,024  |   |
|----------------------------------------------------------|--------|-------|--------|--------|
| Acquired in  Kinta Area asset acquisition on May 1, 2006 |   | 1,106 |   |
| Plus: accretion  expense                                 |   | 47    |   |
| Asset retirement  obligation, September 30, 2006         |   | $     | 2,177  |   |

 

***Recent Accounting Pronouncements***

InOctober 1995, the FASB issued SFAS No. 123, “Share-BasedPayments,” which was revised in December 2004 (“SFAS 123R”). SFAS 123Rrequires that the compensation cost relating to share-based paymenttransactions be recognized in financial statements and that cost will bemeasured based on the fair value of the equity or liability instruments issued.This standard requires entities to measure the cost of employee servicesreceived in exchange for stock or unit options based on the grant-date fairvalue of the award, and to recognize the cost over the period the employee isrequired to provide services for the award. We have applied SFAS 123R asof our first interim period and have used the permitted modified prospectivemethod beginning as of the same date.

In June 2005, theFASB issued EITF issue No. 04-5. In EITF 04-5, in which the Task Forcereached a consensus that the general partner in a limited partnership ispresumed to control that limited partnership regardless of the extent of thegeneral partner’s ownership in the limited partnership. The assessment ofwhether the rights of the limited partners should overcome the presumption ofcontrol by the general partner depends on whether the limited partners haveeither (a) the substantive ability to dissolve the limited partnership orotherwise remove the general partner without cause or (b) substantiveparticipating rights. We have applied this EITF as of our first interim periodand have used the permitted modified prospective method beginning as of thesame date.

In September 2006,the FASB issued SFAS No. 157 “Fair Value Measurements.”  SFAS No. 157 defines fair value as the pricethat would 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.  ThisStatement applies to derivatives and other financial instruments, whichStatement 133, *Accounting for DerivativeInstruments and Hedging Activities*, requires be measured at fairvalue at initial recognition and for all subsequent periods. This Statement iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2007 and interim periods within those fiscal years. We will applythe provisions of the Statement prospectively in our first interim period inthe fiscal year beginning on January 1, 2008 and we do not expect a change inour methodologies of fair value measurements.

In September 2006,the SEC staff issued Staff Accounting Bulletin No. 108, “Considering theEffects of Prior Year Misstatements when Quantifying Misstatements in CurrentYear Financial Statements.”  SAB 108 wasissued to provide consistency between how registrants quantify financialstatement misstatements. Historically, there have been two widely used methodsfor quantifying the effects of financial statement misstatements.  These methods are referred to as the “roll-over”and “iron curtain” method.  The roll-overmethod quantifies the amount by which the current year income statement ismisstated.  Exclusive reliance on anincome statement approach can result in the accumulation of errors on thebalance sheet that may not have been material to any individual incomestatement, but which may misstate one or more balance sheet accounts. The ironcurtain method quantifies the error as the cumulative amount by which the currentyear balance sheet is misstated. Exclusive reliance on a balance sheet approach can result indisregarding the effects of errors in the current year income statement thatresults from the correction of an error existing in previously issued financialstatements.  SAB 108 established anapproach that requires quantification of financial statement misstatementsbased on the effects of the misstatement on each of the company’s financialstatements and the related financial statement disclosures.  This approach is commonly referred to as the “dualapproach” because it requires quantification of errors under both the roll-overand iron curtain methods. We will initially apply SAB 108 in connection withthe preparation of our annual financial statements for the year ending December31, 2006, and we do not expect to record an adjustment.

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**Note 2: Initial Public Offering**

On May 26, 2006, aRegistration Statement on Form S-1 was filed with the United States Securitiesand Exchange Commission (the “SEC”) relating to a proposed initial publicoffering of limited partnership interests in HPGP.

On September 13,2006, the SEC declared our registration statement on Form S-1 effective. OnSeptember 19, 2006, we priced 7,000,000 common units in connection with ourinitial public offering at a price of $18.50 per unit. On September 20, 2006,our common units began trading on the NASDAQ National Market under the symbol “HPGP”. On September 25, 2006, we closed our initial public offering of 8,050,000common units, which included 1,050,000 common units issued pursuant to anover-allotment option that was exercised by the underwriters.  Totalproceeds from the sale of the units were $139.6 million, net of $9.3 million ofunderwriting commissions.

In connection withthe closing of our initial public offering, all of the membership interests inHLND GP (which owns the 2% general partner interest and all of the incentivedistribution rights in HLND), 1,301,471 HLND common units (including 761,714HLND common units previously owned by HLND GP) and 4,080,000 subordinated unitsof HLND were contributed to us, resulting in our ownership of a 57.0% limitedpartner interest in HLND. The contribution of HLND GP’s assets are reflected attheir historical carrying basis of $38.0 million because the contributions arefrom a related party. As consideration for this contribution, substantially allof the net proceeds from our initial public offering, after the retirement ofapproximately $35.0 million of outstanding debt of HLND GP, were distributed toHarold Hamm, The Harold Hamm DST Trust, The Harold Hamm HJ Trust, Randy Moederand Ken Maples (the “Contributing Parties”) and 13,550,000 common units andClass B common units in us were issued to the Contributing Parties.

**Note 3:HLND Equity Transactions and Contribution of Assets**

The assets andliabilities of CGI, excluding certain working capital assets, were contributedto HLND in exchange for 271,082 HLND common units, after redemption of 195,991common units, and 2,646,749 of its subordinated units. Existing bank debt ofCGI was repaid from a portion of the proceeds of HLND’s initial publicoffering. The assets of CGI transferred to HLND were recorded at historicalcost, as it was considered to be a reorganization of entities under commoncontrol, and CGI was considered HLND’s accounting predecessor. The followingtable presents the assets and liabilities of CGI immediately prior tocontributing assets to HLND:

**ContinentalGas, Inc. (Predecessor)**

**AssetsContributed to Hiland Partners, LP**

**As of February15, 2005**

**(inthousands)**
|                                            | ** ** | **Continental Gas,  Inc.  (Predecessor)  February 14, 2005** | ** ** | **Working Capital  Distributed to  Shareholders** | ** ** | **Contributed to  Hiland Partners, LP  February 15, 2005** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| **ASSETS**                                 | ** ** | ** **                                                                  | ** ** | ** **                                                  | ** ** | ** **                                                                          | ** ** |
| Current assets:                            |       |                                                                        |       |                                                        |       |                                                                                |       |
| Cash and cash  equivalents                 |       | $                                                                           | 869        |                                                        | $          | 869                                                                                 |       | $ | — |   |
| Accounts Receivable                        |       | 10,521                                                                      |       | 9,101                                                       |       | 1,420                                                                               |       |
| Inventories                                |       | 153                                                                         |       | —                                                      |       | 153                                                                                 |       |
| Other current assets                       |       | 291                                                                         |       | 2                                                           |       | 289                                                                                 |       |
| Total current assets                       |       | 11,834                                                                      |       | 9,972                                                       |       | 1,862                                                                               |       |
|                                       |       |                                                                        |       |                                                        |       |                                                                                |       |
| Property and equipment,  at cost, net      |       | 36,805                                                                      |       | —                                                      |       | 36,805                                                                              |       |
| Other assets, net                          |       | 3,388                                                                       |       | —                                                      |       | 3,388                                                                               |       |
|                                       |       |                                                                        |       |                                                        |       |                                                                                |       |
| Total assets                               |       | 52,027                                                                      |       | 9,972                                                       |       | 42,055                                                                              |       |
|                                       |       |                                                                        |       |                                                        |       |                                                                                |       |
| **LIABILITIES**                            | ** ** | ** **                                                                  | ** ** | ** **                                                  | ** ** | ** **                                                                          | ** ** |
| Current liabilities:                       |       |                                                                        |       |                                                        |       |                                                                                |       |
| Accounts payable                           |       | 11,703                                                                      |       | —                                                      |       | 11,703                                                                              |       |
| Accrued liabilities                        |       | 700                                                                         |       | —                                                      |       | 700                                                                                 |       |
| Current maturities of  long term debt      |       | 2,429                                                                       |       | —                                                      |       | 2,429                                                                               |       |
| Total current  liabilities                 |       | 14,832                                                                      |       | —                                                      |       | 14,832                                                                              |       |
|                                       |       |                                                                        |       |                                                        |       |                                                                                |       |
| Long term debt, net of  current maturities |       | 11,570                                                                      |       | —                                                      |       | 11,570                                                                              |       |
| Asset retirement  obligation               |       | 622                                                                         |       | —                                                      |       | 622                                                                                 |       |
| Total liabilities                          |       | 27,024                                                                      |       | —                                                      |       | 27,024                                                                              |       |
|                                       |       |                                                                        |       |                                                        |       |                                                                                |       |
| **NET ASSETS**                             |       | $                                                                           | 25,003     |                                                        | $          | 9,972                                                                               |       | $ | 15,031 |   |

 

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In considerationfor the contribution, the former owners of CGI received 467,073 of HLND’scommon units and 2,646,749 of the subordinated units. Immediately following theclosing of HLND’s initial public offering, 195,991 of the common units wereredeemed for approximately $4.1 million.

In connection withHLND’s formation and its initial public offering on February 15, 2005,certain assets and liabilities of Hiland Partners, LLC excluding the Bakkenassets were contributed to them on that date. In consideration for thecontribution, the non-managing members of Hiland Partners, LLC received 247,868of HLND’s common units and 1,404,586 of HLND’s subordinated units. Immediatelyfollowing the closing of the offering, 104,009 of the common units wereredeemed for approximately $2.2 million. The managing member of HilandPartners, LLC also received 5,059 of HLND’s common units and 28,665 of HLND’ssubordinated units, none of which were redeemed. The acquisition of the assetsof Hiland Partners, LLC was accounted for as a purchase and, as a result, theseassets were recorded at their fair value at the time of purchase. The followingtable presents the fair value of the assets and liabilities acquired fromHiland Partners, LLC on February 14, 2005.
| Accounts receivable and  other current assets                |   | $      | 162    |   |
|--------------------------------------------------------------|--------|--------|--------|--------|
| Property and equipment                                       |   | 31,600 |   |
| Intangible assets                                            |   | 26,800 |   |
| Other assets                                                 |   | 105    |   |
| Total assets acquired                                        |   | 58,667 |   |
| Less accounts payable  and other current liabilities assumed |   | (741   | )      |
| Less current portion of  long-term debt assumed              |   | (8,879 | )      |
| Less asset retirement  obligation assumed                    |   | (398   | )      |
| Fair value of net assets acquired                            |   | $      | 48,649 |   |

 

**Note 4:Acquisitions**

On May 1, 2006,HLND acquired certain gas gathering assets from Enogex Gas Gathering, L.L.C.for $96.4 million cash, including certain closing costs, financed withborrowings under our credit facility and an additional note payable to a bank.We refer to these assets as the Kinta Area gathering assets. A determinationwas made by our management of the fair value of these assets and liabilitiesprimarily using current replacement cost for the acquired gas gathering assetsand related equipment less estimated accumulated depreciation on suchreplacement costs and estimated discounted cash flows arising from futurerenegotiated customer contracts. The acquired assets, which are located in theeastern Oklahoma Arkoma Basin, have approximately 672 wellhead receipt pointsand include five separate low pressure natural gas gathering systems consistingof 569 miles of natural gas gathering pipelines and 23 compressor units capableof nearly 40,000 horsepower of compression. The natural gas gathering systemsoperate under contracts with producers that provide for services underfixed-fee arrangements. HLND will operate the Kinta Area gathering assetssubstantially differently than they were operated by the previous owner. Sincethere was no sufficient continuity of the Kinta Area gathering assets’operations prior to and after the acquisition, disclosure of prior financialinformation would not be material to an understanding of future operations.Therefore, the acquisition has been recorded as a purchase of assets and not abusiness, and no pro forma financial information is required to be presented.The following table presents the resulting allocation to the net assetsacquired and liabilities assumed on May 1, 2006:

| Pipelines, including right  of ways  |   | $      | 56,175 |   |
|--------------------------------------|--------|--------|--------|--------|
| Compressors                          |   | 22,221 |   |
| Other equipment and  buildings       |   | 8,618  |   |
| Customer relationships               |   | 10,492 |   |
|                                 |   | 97,506 |   |
| Asset retirement  obligation assumed |   | 1,106  |   |
| Net assets acquired                  |   | $      | 96,400 |   |

 

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

OnSeptember 26, 2005, HLND completed its acquisition of Hiland Partners, LLCfor approximately $92.7 million in cash, $35.0 million of which wasused to retire outstanding Hiland Partners, LLC indebtedness. The effectivedate of the acquisition was September 1, 2005. Hiland Partners, LLC’sprincipal asset was the Bakken gathering system located in Richland County,Montana. At the time of the acquisition, the Bakken gathering system consistedof approximately 256 miles of gas gathering pipeline, a natural gas processingplant, two compressor stations and one fractionation facility. The Bakkenprocessing plant and a portion of the gathering system became operational onNovember 8, 2004. To facilitate the closing of the acquisition, HLNDamended its senior secured revolving credit facility to increase its borrowingcapacity under the facility from $55.0 million to $125.0 million.HLND used a portion of this increased capacity to fund the acquisition.

To the extent ofHLND’s non-controlling ownership, the acquisition was accounted for using thepurchase method of accounting under SFAS No. 141, “Business Combinations.”As of the date of the acquisition, Hiland Partners, LLC was an entity partiallyowned

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by an affiliate who, atthe time, was HLND GP’s controlling member. Accordingly, 49% of the Bakkengathering system assets, for which estimated fair value was in excess ofhistorical basis, have been recorded at historical cost and 51% of the Bakkengathering system assets have been recorded at fair value. A cash distributionof $27.0 million made to this affiliate and $0.8 million made to HLND GP,as reported as a reduction of owners’ equity, reflects the difference in thepurchase price paid to this affiliate and his cost basis in the net assets ofHiland Partners, LLC. The fair value of the assets acquired has also beenreduced by imputed interest expense from September 1, 2005, the effectivedate of the acquisition, through the closing date, September 26, 2005. Thefollowing table presents the resulting allocation to the net assets acquiredand liabilities assumed at the effective date of acquisition:

| Cash and cash equivalents                                                                         |   | $      | 300    |   |
|---------------------------------------------------------------------------------------------------|--------|--------|--------|--------|
| Accounts receivable                                                                               |   | 3,708  |   |
| Other current assets                                                                              |   | 20     |   |
| Property, plant and  equipment                                                                    |   | 49,873 |   |
| Customer contracts                                                                                |   | 17,589 |   |
| Total assets acquired                                                                             |   | 71,490 |   |
| Accounts payable                                                                                  |   | (6,217 | )      |
| Accrued liabilities                                                                               |   | (125   | )      |
| Total liabilities  assumed                                                                        |   | (6,342 | )      |
| Net assets of Hiland  Partners, LLC                                                               |   | 65,148 |   |
| Imputed interest  expense                                                                         |   | (289   | )      |
| Purchase price of net assets of Hiland Partners, LLC less  distribution to the controlling member |   | $      | 64,859 |   |

 

The operations ofthe Bakken gathering system are included in our statement of operations andstatement of cash flows from September 1, 2005 forward. The operations ofthe assets acquired from Hiland Partners, LLC are included in our statement ofoperations and statement of cash flows from February 15, 2005 forward. Hadthe acquisitions been made effective January 1, 2005, the operations ofthe assets would have been included in our consolidated financial statementsfor the indicated periods with the following pro forma impact on theconsolidated statements of operations. The unaudited pro forma financialinformation is not necessarily indicative of the results of operations thatactually would have been achieved had the acquisitions occurred at that time.
| ** **                                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                     | ** ** | **September 30, 2005** | ** ** | **September 30, 2005** | ** ** |
| Revenues as reported                           |       | $                                | 41,925     |                             | $          | 98,306 |   |
| Revenues from acquired  interests              |       | 1,869                            |       | 18,649                           |       |
| Pro forma revenues                             |       | $                                | 43,794     |                             | $          | 116,955 |   |
|                                           |       |                             |       |                             |       |
| Net income as reported                         |       | $                                | 2,663      |                             | $          | 6,146 |   |
| Loss from acquired interests                   |       | (622                             | )          | (4,176                           | )          |
| Pro forma net income  before minority interest |       | 2,041                            |       | 1,970                            |       |
| Minority interest in  income of HLND           |       | (2,010                           | )          | (1,488                           | )          |
| Pro forma net income                           |       | $                                | 31         |                             | $          | 482 |   |

 

**Note 5: Propertyand Equipment**

|                                                  | ** ** | **As of**         | ** ** | **As of**        | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                       | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Land                                             |       | $                      | 255        |                  | $          | 225 |   |
| Construction in  progress                        |       | 41,349                 |       | 3,676                 |       |
| Midstream pipeline,  plants and compressors      |       | 223,812                |       | 122,927               |       |
| Compression and water  injection equipment       |       | 19,268                 |       | 19,264                |       |
| Other                                            |       | 2,419                  |       | 1,689                 |       |
|                                             |       | 287,103                |       | 147,781               |       |
| Less: accumulated  depreciation and amortization |       | 39,202                 |       | 27,066                |       |
|                                             |       | $                      | 247,901    |                  | $          | 120,715 |   |

 

On May 10,2006, HLND GP purchased 761,714 common units and 15,545 general partner unitsfor $35.0 million. HLND GP recorded additional pipeline and processingplant cost of $4,488 for a portion of the amount that the unit purchase priceexceeded the proportionate interest in the underlying equity of HLND.

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We capitalizedinterest of $479 and $811 during the three and nine months ended September 30,2006, respectively.  As of September 30,2006 we have capitalized $843 of interest relating to constructed assets placedin service and construction in progress. We did not capitalize any interest during the same periods in 2005.

**Note 6: IntangibleAssets**

Intangible assets consist of the acquired value ofcustomer relationships, existing contracts to sell natural gas and other NGLsand compression contracts, which do not have significant residual value. Thecustomer relationships and the contracts are being amortized over estimatedlives of ten years. We review intangible assets for impairment whenever eventsor circumstances indicate that the carrying amounts may not be recoverable. Ifsuch a review should indicate that the carrying amount of intangible assets isnot recoverable, we reduce the carrying amount of such assets to fair valuebased on the discounted probable cash flows of the intangible assets. Noimpairment of intangible assets has been recorded as of September 30,2006.  Intangible assets consistedof the following at September 30, 2006 and December 31, 2005:
|                                | ** ** | **As of**         | ** ** | **As of**        | ** ** |
|--------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                     | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Gas sales contracts            |       | $                      | 32,564     |                  | $          | 25,585 |   |
| Compression contracts          |       | 18,515                 |       | 18,515                |       |
| Customer relationships         |       | 10,492                 |       | —                |       |
|                           |       | 61,571                 |       | 44,100                |       |
| Less accumulated  amortization |       | 6,937                  |       | 2,921                 |       |
| Intangible assets, net         |       | $                      | 54,634     |                  | $          | 41,179 |   |

 

On May 10,2006, HLND GP purchased 761,714 common units and 15,545 general partner unitsfor $35.0 million. HLND GP recorded an additional $6,979 in contracts tosell natural gas for a portion of the amount that the purchase price exceededthe proportionate interest in the underlying equity of HLND.

There were no intangible assets prior to February15, 2005.

**Note 7: Derivatives**

HLND has enteredinto certain financial swap instruments that are classified as cash flow hedgesin accordance with SFAS No. 133, as amended, and relate to forecastedsales in 2006, 2007 and 2008. HLND entered into these instruments to hedgeforecasted natural gas and natural gas liquids (NGLs) sales or purchasesagainst the variability in expected future cash flows attributable to changesin commodity prices. Under all but one of these contractual swap agreementswith HLND’s counterparties, HLND receives a fixed price and pays a floatingprice based on certain indices for the relevant contract period as theunderlying natural gas or NGL is sold. In one agreement, HLND pays a fixedprice and receives a floating price based on certain indices for the relevantcontract period as the underlying natural gas is purchased.

HLND formallydocuments all relationships between hedging instruments and the items beinghedged, including its risk management objective and strategy for undertakingthe hedging transactions. This includes matching the natural gas and NGLfutures, the “sold fixed for floating price” or “buy fixed for floating price”contracts, to the forecasted transactions. HLND assesses, both at the inceptionof the hedge and on an ongoing basis, whether the derivatives are highlyeffective in offsetting changes in the fair value of hedged items. A derivativeis deemed to be highly effective when changes in its cash flows correlatewithin a range of 80% to 125% to offsetting cash flows of the hedgedtransaction. If it is determined that a derivative is not highly effective as ahedge or it has ceased to be a highly effective hedge, due to the loss ofcorrelation between changes in natural gas or NGL reference prices under ahedging instrument and actual natural gas or NGL prices, HLND will discontinuehedge accounting for the derivative and subsequent changes in fair value forthe derivative will be recognized immediately into earnings. HLND assesseseffectiveness using regression analysis and ineffectiveness using the dollaroffset method.

Derivatives arerecorded on our consolidated balance sheet as assets or liabilities at fairvalue. For derivatives qualifying as hedges, the effective portion of changesin fair value are recognized in owners’ equity as accumulated othercomprehensive income and reclassified to earnings when the underlying hedgedphysical transaction closes. For non-qualifying derivatives and for theineffective portion of qualifying derivatives, changes in fair value arerecognized in earnings as they occur. Actual amounts that will be reclassifiedwill vary as a result of future changes in prices. Hedge ineffectiveness is recordedin income while the hedge contract is open and may increase or decrease untilsettlement of the contract. Realized cash gains and losses on closed/settledinstruments are reflected in the contract month being hedged as an adjustmentto HLND’s midstream revenue.

During the ninemonth period ended September 30, 2006 we recorded $2,692 in accumulated othercomprehensive income. For the same period, we recorded an additional minorityinterest liability on the consolidated balance sheet of $1,797 as accumulatedother

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comprehensive income.During the three months ended September 30, 2006 we reclassified net gains of$1,275 on closed/settled hedge transactions to midstream revenues out of othercomprehensive income and also recorded $3,933 to other comprehensive income forthe favorable change in fair value of open derivatives. During the three andnine months ended September 30, 2006, HLND recorded losses of $31 and gains of$133, respectively, on the ineffective portions of our qualifying openderivative transactions. At September 30, 2006 our accumulated othercomprehensive income related to derivatives was $2,713. Of this amount weanticipate $1,562 will be reclassified to earnings during the next twelvemonths and $1,151 will be reclassified to earnings in subsequent periods.Actual amounts that will be reclassified will vary as a result of futurechanges in prices. Ineffective gains or losses are recorded in income while thehedge contract is open and may increase or decrease until settlement of thecontract. Realized gains and losses on these instruments are reflected in thecontract month being hedged as an adjustment to HLND’s midstream revenue. Wehad no derivatives or derivative transactions during the three or nine monthsended September 30, 2005. The fair value of derivative assets and liabilities are as followsfor the indicated periods:

|                                                   | ** ** | **As of**         | ** ** | **As of**        | ** ** |
|---------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                        | ** ** | **2006**               | ** ** | **2005**              | ** ** |
|                                              |       |                   |       |                  |       |
| Fair value of  derivative assets - current        |       | $                      | 4,322      |                  | $          | 868 |   |
| Fair value of  derivative assets - long term      |       | 2,549                  |       | 181                   |       |
| Fair value of  derivative liabilities - current   |       | (1,671                 | )          | —                |       |
| Fair value of  derivative liabilities - long term |       | (557                   | )          | —                |       |
| Net fair value of derivatives                     |       | $                      | 4,643      |                  | $          | 1,049 |   |

 

The terms of ourderivative contracts currently extend out as far as December 2008.  Our counterparty to all of our derivativecontracts is BP Energy Company. Set forth below is the summarized notionalamount and terms of all instruments held for price risk management purposes atSeptember 30, 2006.
| ** **                                           | ** ** | ** **  | ** ** | ** **           | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------|------------|-------------|------------|----------------------|------------|---------------------|------------|
| ** **                                           | ** ** | ** **  | ** ** | **Average**          | ** ** | **Asset**           | ** ** |
| **Description and Production Period** | ** ** | **Volume**  | ** ** | **Fixed Price** | ** ** | **(Liability)**     | ** ** |
| ** **                                           | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| Natural Gas - Sold  Fixed for Floating Price Swaps   |       |        |       |                 |       |                |       |
| October 2006 -  September 2007                       |       | 1,620,000   |       | $                    | 8.26       |                | $          | 4,280 |   |
| October 2007 - December  2008                        |       | 2,025,000   |       | $                    | 8.00       |                | 2,544      |   |
|                                                 |       |        |       |                 |       | $                   | 6,824      |   |

 
| ** **                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-------------|------------|-----------------|------------|------------|------------|
| Natural Gas - Buy Fixed  for Floating Price Swaps |       |        |       |            |       |       |       |
| October 2006 -  September 2007                    |       | 600,000     |       | $               | 8.87       |       | $          | (1,516 | ) |
| October 2007 - March  2008                        |       | 300,000     |       | $               | 8.87       |       | (398       | ) |
|                                              |       |        |       |            |       | $          | (1,914     | ) |

 
| ** **                                                 | ** ** | **(Bbls)** | ** ** | **(per Gallon)** | ** ** | ** ** | ** ** |
|------------------------------------------------------------|------------|------------|------------|------------------|------------|------------|------------|
| Natural Gas Liquids -  Sold Fixed for Floating Price Swaps |       |       |       |             |       |       |       |
| October 2006 -  September 2007                             |       | 152,652    |       | $                | 1.13       |       | $          | (113 | ) |
| October 2007 - March  2008                                 |       | 76,326     |       | $                | 1.13       |       | (154       | ) |
|                                                       |       |       |       |             |       | $          | (267       | ) |

 

**Note 8: Long-TermDebt**
|                                 | ** ** | **As of**         | ** ** | **As of**        | ** ** |
|---------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                      | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| HLND-Revolving Credit  Facility |       | $                      | 134,064    |                  | $          | 33,784 |   |
| HPGP-Revolving Credit  Facility |       | 254                    |       | —                |       |
| Long-Term Debt                  |       | $                      | 134,318    |                  | $          | 33,784 |   |

 

***HLND***

OnFebruary 15, 2005, concurrently with the closing of HLND’s initial publicoffering, HLND entered into a three-year $55.0 million senior securedrevolving credit

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facility. The creditfacility consisted of a $47.5 million senior secured revolving creditfacility to be used for funding acquisitions and other capital expenditures,issuance of letters of credit and general corporate purposes (the “revolvingacquisition facility”) and a $7.5 million senior secured revolving creditfacility to be used for working capital and to fund distributions (the “revolvingworking capital facility”).

On September 26,2005, concurrently with the acquisition of Hiland Partners, LLC, HLNDamended their credit facility to increase borrowing capacity under the facilityfrom $55.0 million to $125.0 million, consisting of a$117.5 million acquisition facility and a $7.5 million workingcapital facility.  On September 26,2005, HLND incurred $93.7 million of indebtedness under the creditfacility in connection with the acquisition of Hiland Partners, LLC.

On November 21,2005, HLND completed their second public offering of common units. HLND used$65.2 million of the $66.1 million net proceeds from the offering to repay amajority of the credit facility borrowings used to fund the acquisition ofHiland Partners, LLC.

OnSeptember 8, 2006, HLND entered into a second amendment to their creditfacility to, among other things, increase borrowing base to $200 millionand revise certain covenants. The facility currently consists of a $191.0 millionsenior secured revolving credit facility to be used for funding acquisitionsand other capital expenditures, issuance of letters of credit and generalcorporate purposes (the “revolving acquisition facility”); and a$9.0 million senior secured revolving credit facility to be used forworking capital and to fund distributions (the “revolving working capitalfacility”).

In addition, thecredit facility provides for an accordion feature, which permits HLND, ifcertain conditions are met, to increase the size of the revolving acquisitionfacility by up to $150 million and allows for the issuance of letters ofcredit of up to $15.0 million in the aggregate. The credit facility willmature in May 2011. At that time, the agreement will terminate and alloutstanding amounts thereunder will be due and payable.

HLND’s obligationsunder the credit facility are secured by substantially all of its assets andguaranteed by HLND, and all of its subsidiaries, other than the operatingcompany, which is the borrower under the credit facility.

Indebtedness underthe credit facility will bear interest, at HLNDs’ option, at either (i) analternate base rate plus an applicable margin ranging from 50 to 125 basispoints per annum or (ii) LIBOR plus an applicable margin ranging from 150to 225 basis points per annum based on our ratio of consolidated funded debt toEBITDA. The Alternate Base Rate is a rate per annum equal to the greatest of(a) 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 for theaggregate amount of letters of credit issued under the credit facility at apercentage per annum equal to 1.0%. An unused commitment fee ranging from 25 to50 basis points per annum based on our ratio of consolidated funded debt toEBITDA will be payable on the unused portion of the credit facility. During anystep-up period, the applicable margin with respect to loans under the creditfacility will be increased by 35 basis points per annum and the unusedcommitment fee will be increased by 12.5 basis points per annum.

The creditfacility prohibits HLND from making distributions to unitholders if any defaultor event of default, as defined in the credit facility, has occurred and iscontinuing or would result from the distribution. In addition, the creditfacility contains various covenants that limit, among other things, subject tocertain exceptions and negotiated “baskets,” our ability to incur indebtedness,grant liens, make certain loans, acquisitions and investments, make anymaterial changes to the nature of its business, amend its material agreements,including its omnibus agreement or enter into a merger, consolidation or saleof assets.

The creditfacility also contains covenants requiring HLND to maintain a maximumconsolidated funded debt to EBITDA ratio of 4.0:1.0, provided that in the eventHLND makes certain permitted acquisitions or capital expenditures, the creditfacility allows this ratio to increase to 4.75:1.0 for the following threefiscal quarters (a “step-up period”) and a minimum interest coverage ratio of3.0:1.0.

The creditfacility defines EBITDA as HLND’s consolidated net income, plus income tax expense,interest expense, depreciation and amortization expense, amortization ofintangibles and organizational costs, non-cash unit based compensation expense,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 the creditfacility.

The creditfacility limits distributions to HLND’s 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.

As of September30, 2006, HLND had $134.1 million outstanding under this credit facilityand was in compliance with its financial covenants.

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***HLNDGP***

On May 1, 2006HLND GP entered into an unsecured credit agreement under which it borrowed$35.0 million to purchase 761,714 common units and 15,545 general partner unitsfrom HLND. The loan was guaranteed by all HLND GP’s members and matured and waspaid in full upon the completion of our initial public offering on September25, 2006. HLND GP’s board of directors, as well as the conflicts committee ofits board of directors, consisting of independent directors, approved thetransaction.

***HPGP***

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 facilitywill permit us, if certain conditions are met, to increase borrowing capacityby up to an additional $25.0 million. The facility is secured by all of ourownership interests in HLND and its general partner, other than the 2% generalpartner interest and the incentive distribution 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 250 basispoints per annum in each case based on our ratio of consolidated funded debt toEBITDA. The alternate base rate is equal to the greatest of (a) the primerate in effect on such day, (b) the base CD rate in effect on such dayplus 1.50% and (c) the federal funds effective rate in effect on such day plus1/2 of 1%. A letter of credit fee will be payable for the aggregate amount of lettersof credit issued under the facility at a percentage per annum equal to 2.0%. Acommitment fee ranging from 25 to 50 basis points per annum based on our ratioof consolidated funded debt to EBITDA will be payable on the average dailyunused portion of the facility for the quarter most recently ended.

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 HLND common and subordinated units and certain other assetsheld by us and certain of our subsidiaries at the end of each fiscal quarterand (ii) the maximum available amount of the facility (currently $25.0million).

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,**enter into agreements restricting our ability to grantliens on our assets or amend the facility,**makecertain loans, acquisitions and investments or**enter into a merger, 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 facility mustbe reduced to zero.

As of September30, 2006, we had $0.3 million outstanding under this credit facility andwere in compliance with our financial covenants.

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**Note 9: Commitmentsand Contingencies**

HLND has executedvarious natural gas fixed price physical forward sales contracts onapproximately 100,000 MMBtu per month for the remainder of 2006 and all of 2007and 2008 with fixed prices ranging from $4.47 to $9.52 per MMBtu in 2006, $4.49to $9.13 per MMBtu in 2007 and $8.43 per MMBtu in 2008.  These contracts have been designated asnormal sales under SFAS No. 133 and are therefore not marked to market asderivatives.  A summary of the fixedprice physical forward sales contracts is presented in the table below:

|                                | ** ** | ** **  | ** ** | **Average**          | ** ** |
|--------------------------------|------------|-------------|------------|----------------------|------------|
| ** **                     | ** ** | ** **  | ** ** | **Fixed Price** | ** ** |
| **Production Period**     | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** |
|                           |       |        |       |                 |       |
| October 2006 -  September 2007 |       | 1,200,000   |       | $                    | 6.86       |   |
| October 2007 - December 2008   |       | 1,500,000   |       | $                    | 8.11       |   |

 

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 endedSeptember 30, 2006 and 2005 of $55 and $31, respectively.  Expense for the nine months ended September30, 2006 and 2005 was $141 and $72, respectively.

We jointlyparticipate with other affiliated companies in a self-insurance pool (the “Pool”)covering health and workers’ compensation claims made by employees up to thefirst $150 and $500, respectively, per claim. Any amounts paid above these arereinsured through third party providers. Premiums charged to the Partnershipare based on estimated costs per employee of the Pool. Property and generalliability insurance is maintained through third-party providers with a $100deductible 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 regulatory proceedings in which we are currently involved, periodically wemay be a party to regulatory proceedings. The results of regulatory proceedings cannot be predicted withcertainty; however, our management believes that we presently do not havematerial potential liability in connection with regulatory proceedings thatwould have a significant financial impact on our consolidated financialcondition, results of operations or cash flows.

A summary of ourcontractual cash obligations as of September 30, 2006, which include expansionprojects on our Badlands, Kinta Area and Bakken gathering systems, is presentedbelow:
| ** **                                | ** ** | **Payment Due by Period** | ** ** |
|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                | ** ** | **Total**                                | ** ** | **Due in** | ** ** | **Due in** | ** ** | **Due in** | ** ** | **Due in** | ** ** | ** ** | ** ** |
| **Type of Obligation**          | ** ** | **Obligation**                           | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** |
| ** **                                | ** ** | **(in thousands)**                  | ** ** |
| HPGP’s revolving credit  facility    |       | $                                        | 254        |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 254 |   |
| HLND’s revolving credit  facility    |       | 134,064                                  |       | — |   | — |   | — |   | — |   | 134,064 |   |
| Contracts on internal  expansion projects |       | 11,554                                   |       | 5,111 |   | 6,443 |   | — |   | — |   | — |   |
| Operating leases and  service agreements  |       | 2,693                                    |       | 281 |   | 1,083 |   | 325 |   | 325 |   | 679 |   |
| Total contractual cash obligations        |       | $                                        | 148,565    |   | $ | 5,392 |   | $ | 7,526 |   | $ | 325 |   | $ | 325 |   | $ | 134,997 |   |

 

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**Note 10: SignificantCustomers and Suppliers**

All of HLNDrevenues are domestic revenues. The following table presents HLND’s top fivemidstream customers as a percent of total revenue for the periods indicated:

|            | ** ** | **For the Three** | ** ** | **For the Nine** | ** ** |
|------------|------------|-----------------------------|------------|----------------------------|------------|
| ** ** | ** ** | **Months Ended**       | ** ** | **Months Ended**      | ** ** |
| ** ** | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** ** | ** ** | **2006**                    | ** ** | **2005**                   | ** ** | **2006** | ** ** | **2005** | ** ** |
| Customer 1 |       | 11                          | %          | 14                         | %          | 17 | % | 25 | % |
| Customer 2 |       | 15                          | %          | —                     |       | 16 | % | — |   |
| Customer 3 |       | 14                          | %          | 6                          | %          | 14 | % | 3 | % |
| Customer 4 |       | 11                          | %          | 14                         | %          | 11 | % | 7 | % |
| Customer 5 |       | 17                          | %          | 12                         | %          | 12 | % | 19 | % |

 

All of HLND’spurchases are from domestic sources. The following table presents HLND’s topfive midstream suppliers as a percent of total midstream purchases for theperiods indicated:

|                                  | ** ** | **For the Three** | ** ** | **For the Nine** | ** ** |
|----------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **                       | ** ** | **Months Ended**       | ** ** | **Months Ended**      | ** ** |
| ** **                       | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                       | ** ** | **2006**                    | ** ** | **2005**                   | ** ** | **2006** | ** ** | **2005** | ** ** |
| Supplier 1 (affiliated  company) |       | 33                          | %          | 34                         | %          | 34 | % | 33 | % |
| Supplier 2                       |       | 23                          | %          | 31                         | %          | 24 | % | 32 | % |
| Supplier 3                       |       | 13                          | %          | 5                          | %          | 13 | % | 2 | % |
| Supplier 4                       |       | 5                           | %          | 11                         | %          | 7 | % | 13 | % |
| Supplier 5                       |       | 4                           | %          | 2                          | %          | 4 | % | 1 | % |

 

**Note 11: RelatedParty Transactions**

HLND purchasesnatural gas and NGLs from affiliated companies. Purchases of product fromaffiliates totaled $13.1 million and $11.6 million for the threemonths ended September 30, 2006 and 2005, respectively, and $39.6 millionand $26.8 million for the nine months ended September 30, 2006 and 2005,respectively. HLND also sells natural gas and NGLs to affiliated companies.Sales of product to affiliates totaled $0.9 million and $1.1 millionfor the three months ended September 30, 2006 and 2005, respectively, and$3.2 million and $3.5 million for the nine months ended September 30,2006 and 2005, respectively. Compression revenues from affiliates were$1.2 million for each of the three months ended September 30, 2006 and2005 and were $3.6 million and $3.0 million for the nine months endedSeptember 30, 2006 and 2005, respectively.

Accountsreceivable from affiliates of $944 at September 30, 2006 includes $928 from oneaffiliate for midstream sales. Accounts receivable from affiliates of $1,508 atDecember 31, 2005 includes $1,451 from the same affiliate for midstreamsales.

Accounts payableto affiliates of $4,747 at September 30, 2006 includes $4,399 due to oneaffiliate for midstream purchases. Accounts payable to affiliates of $5,819 atDecember 31, 2005 includes $5,684 payable to the same affiliate formidstream purchases.

HLND utilizesaffiliated companies to provide services to its plants and pipelines andcertain administrative costs. The total amount paid to these companies was $64and $15 during the three months ended September 30, 2006 and 2005,respectively, and $180 and $74 during the nine months ended September 30, 2006and 2005, respectively.

HLND leases officespace under operating leases directly or indirectly from an affiliate. Rentspaid associated with these leases totaled $32 and $19 for the three monthsended September 30, 2006 and 2005, respectively, and totaled $86 and $57 forthe nine months ended September 30, 2006 and 2005, respectively.

**Note 12: BusinessSegments**

OnFebruary 15, 2005, certain assets and liabilities of Hiland Partners, LLCwere contributed to HLND in conjunction with its initial public offering. As aresult of this transaction, HLND has distinct operating segments for whichadditional financial information must be reported. Prior to February 15,2005, HLND did not have operating segments. HLND’s operations are nowclassified into two reportable segments:

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(1)   Midstream,which is the gathering, compressing, dehydrating, treating and processing ofnatural gas and fractionating NGLs.

(2)   Compression,which is providing air compression and water injection services for CRI’s oiland gas secondary recovery operations that are ongoing in North Dakota.

These operatingsegments reflect the way HLND manages its operations.  HLND’s operations are conducted in the UnitedStates.  General and administrativecosts, which consist of executive management, accounting and finance,operations and engineering, marketing and business development, are allocatedto the individual business segments based on revenues.

Midstream assetstotaled $309,474 at September 30, 2006. Assets attributable to compressionoperations totaled $32,280. All but $72 of the total capital expenditures of$47,989 for the nine months ended September 30, 2006 was attributable tomidstream operations.

The tables belowpresent information for the reportable segments for the three and nine monthsended September 30, 2006 and 2005.
| ** **                                                       | ** ** | **For the Three Months Ended September 30,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2006**                                                                   | ** ** | **2005** | ** ** |
| ** **                                                       | ** ** | **Midstream**                                                              | ** ** | **Compression** | ** ** | **Total** | ** ** | **Midstream** | ** ** | **Compression** | ** ** | **Total** | ** ** |
| Revenues                                                         |       | $                                                                          | 56,062     |   | $ | 1,205 |   | $ | 57,267 |   | $ | 40,720 |   | $ | 1,205 |   | $ | 41,925 |   |
| Operating costs and  expenses:                                   |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Midstream purchases  (exclusive of items shown separately below) |       | 39,609                                                                     |       | — |   | 39,609 |   | 33,313 |   | — |   | 33,313 |   |
| Operations and  maintenance                                      |       | 4,367                                                                      |       | 202 |   | 4,569 |   | 1,744 |   | 153 |   | 1,897 |   |
| Depreciation and  amortization                                   |       | 5,569                                                                      |       | 893 |   | 6,462 |   | 2,024 |   | 888 |   | 2,912 |   |
| General and administrative  expenses                             |       | 1,368                                                                      |       | 29 |   | 1,397 |   | 528 |   | 14 |   | 542 |   |
| Total operating  costs and expenses                              |       | 50,913                                                                     |       | 1,124 |   | 52,037 |   | 37,609 |   | 1,055 |   | 38,664 |   |
| Income from operations                                           |       | $                                                                          | 5,149      |   | $ | 81 |   | 5,230 |   | $ | 3,111 |   | $ | 150 |   | 3,261 |   |
| Other income (expense):                                          |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest and other  income                                       |       |                                                                       |       |   |   | 68 |   |   |   |   |   | 70 |   |
| Amortization of  deferred loan costs                             |       |                                                                       |       |   |   | (170 | ) |   |   |   |   | (83 | ) |
| Interest expense                                                 |       |                                                                       |       |   |   | (2,387 | ) |   |   |   |   | (585 | ) |
| Minority interest in  income of Hiland Partners, LP              |       |                                                                       |       |   |   | (2,765 | ) |   |   |   |   | (2,617 | ) |
| Total other  income (expense)                                    |       |                                                                       |       |   |   | (5,254 | ) |   |   |   |   | (3,215 | ) |
| Net income                                                       |       |                                                                       |       |   |   | $ | (24 | ) |   |   |   |   | $ | 46 |   |

 

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| ** **                                                       | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2006**                                                                  | ** ** | **2005** | ** ** |
| ** **                                                       | ** ** | **Midstream**                                                             | ** ** | **Compression** | ** ** | **Total** | ** ** | **Midstream** | ** ** | **Compression** | ** ** | **Total** | ** ** |
| Revenues                                                         |       | $                                                                         | 159,800    |   | $ | 3,615 |   | $ | 163,415 |   | $ | 95,294 |   | $ | 3,012 |   | $ | 98,306 |   |
| Operating costs and  expenses:                                   |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Midstream purchases  (exclusive of items shown separately below) |       | 117,965                                                                   |       |   |   | 117,965 |   | 77,548 |   | — |   | 77,548 |   |
| Operations and  maintenance                                      |       | 10,509                                                                    |       | 631 |   | 11,140 |   | 4,712 |   | 371 |   | 5,083 |   |
| Depreciation and  amortization                                   |       | 13,577                                                                    |       | 2,679 |   | 16,256 |   | 4,697 |   | 2,227 |   | 6,924 |   |
| General and  administrative expenses                             |       | 3,614                                                                     |       | 81 |   | 3,695 |   | 1,544 |   | 47 |   | 1,591 |   |
| Total operating  costs and expenses                              |       | 145,665                                                                   |       | 3,391 |   | 149,056 |   | 88,501 |   | 2,645 |   | 91,146 |   |
| Income from operations                                           |       | $                                                                         | 14,135     |   | $ | 224 |   | 14,359 |   | $ | 6,793 |   | $ | 367 |   | 7,160 |   |
| Other income (expense):                                          |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Interest and other  income                                       |       |                                                                      |       |   |   | 221 |   |   |   |   |   | 112 |   |
| Amortization of  deferred loan costs                             |       |                                                                      |       |   |   | (402 | ) |   |   |   |   | (360 | ) |
| Interest expense                                                 |       |                                                                      |       |   |   | (4,649 | ) |   |   |   |   | (766 | ) |
| Minority interest in  income of Hiland Partners, LP              |       |                                                                      |       |   |   | (8,991 | ) |   |   |   |   | (5,577 | ) |
| Total other  income (expense)                                    |       |                                                                      |       |   |   | (13,821 | ) |   |   |   |   | (6,591 | ) |
| Net income                                                       |       |                                                                      |       |   |   | $ | 538 |   |   |   |   |   | $ | 569 |   |

 

**Note 13: NetIncome per Limited Partner Unit**

The computation ofbasic net income per limited partner unit is based on the weighted-average numberof common units outstanding during the period.  Thecomputation of diluted earnings per unit further assumes the dilutive effect ofunit options and restricted units. Net income per unit applicable to limited partners is computed bydividing net income applicable to limited partners after deducting net incomeattributable to the Predecessor (before September 25, 2006), by theweighted-average number of limited partnership units outstanding.
|                                                            | ** ** | **For the Three and Nine Months Ended  September 30, 2006** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **Income  Available to  Limited  Partners**                                                    | ** ** | **Limited  Partner Units** | ** ** | **Per Unit  Amount** | ** ** |
| ** **                                                 | ** ** | **(Numerator)**                                                                                     | ** ** | **(Denominator)** | ** ** | ** ** | ** ** |
| Income per  limited partner unit – basic and diluted: |       |                                                                                                |       |   |   |   |   |
| Income available  to limited unitholder                    |       | $                                                                                                   | 131        |   |   |   | $ | 0.01 |   |
| Weighted average  limited partner units outstanding        |       |                                                                                                |       | 21,600,000 |   |   |   |
| Income available to  common unitholders                    |       | $                                                                                                   | 131        |   | 21,600,000 |   | $ | 0.01 |   |

 

**Note 14: Partners’Capital and Cash Distributions**

***HPGP***

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

Our partnershipagreement requires that we distribute all of our cash on hand at the end ofeach quarter less reserves established at

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our general partner’sdiscretion. We refer to this as “available cash.” Initially our onlycash-generating assets are our interests in HLND from which we receivequarterly distributions. The amount of available cash may be greater than orless than the minimum quarterly distributions.

On October 24,2006, the Board of Directors of HPGP GP, our general partner announced our cashdistribution for the third quarter of 2006. The declared quarterly distributionwill be $0.2025 per unit (an annualized rate of $0.81 per unit). Thedistribution will be prorated for the portion of the third quarter we were apublic company and is expected to be paid on or about February 19, 2007 tounitholders of record on or about February 5, 2007.

***HLND***

The unitholders(limited partners) of HLND have only limited voting rights on matters affectingits operations and activities and, therefore, limited ability to influence itsmanagement’s decisions regarding its business. Unitholders did not select HLNDGP as general partner or elect its board of directors and effectively have noright to select a general partner or elect its board of directors in thefuture. Unitholders’ voting rights are further restricted by HLND’s partnershipagreement, which provides that any units held by a person that owns 20% or moreof any class of units then outstanding, other than the general partner, itsaffiliates, their transferees and persons who acquired such units with theprior approval of HLND GP’s board of directors, cannot be voted on any matter.In addition, HLND’s partnership agreement contains provisions limiting theability of 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 HLND’s management.

HLND’s partnershipagreement requires that it distribute all of its cash on hand at the end ofeach quarter, less reserves established at HLND GP’s discretion. We refer tothis as “available cash.” The amount of available cash may be greater than orless than the minimum quarterly distributions described below. In general, HLNDwill pay any cash distribution made each quarter in the following manner:

·                  first, 98% tothe common units, pro rata, and 2% to HLND GP, until each common unit hasreceived a minimum quarterly distribution of $0.45 plus any arrearages fromprior quarters;

·               second, 98% to thesubordinated units, pro rata, and 2% to HLND GP, until each subordinated unithas received a minimum quarterly distribution of $0.45; and

·               third, 98% to allunits, pro rata, and 2% to HLND GP, until each unit has received a distributionof $0.495.

If cashdistributions per unit exceed $0.495 in any quarter, HLND GP as general partnerwill receive increasing percentages, up to a maximum of 50% of the cash HLNDdistributes in excess of that amount. We refer to these distributions as “incentivedistributions.”

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 HLNDmeets certain financial tests, but not before March 31, 2010. Thesefinancial tests require HLND to have earned and paid the minimum quarterlydistribution on all of its outstanding units for three consecutive four-quarterperiods. When the subordination period ends, all remaining subordinated unitswill convert into common units on a one-for-one basis, and the common unitswill no longer be entitled to arrearages.

All distributionspaid by HLND to common and subordinated unitholders, including amounts paid toaffiliate owners and regular and incentive distributions paid to HLND GP wereas follows (in thousands, except per unit amounts):
| **Date Cash** | ** ** | **Per Unit Cash** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **               | ** ** | ** **          | ** ** | ** **       | ** ** |
|--------------------|------------|-----------------------------|------------|------------|------------|------------------|------------|--------------------------|------------|---------------------|------------|------------------|------------|
| **Distribution**   | ** ** | **Distribution**            | ** ** | **Common** | ** ** | **Subordinated** | ** ** | **General Partner** | ** ** | **Total Cash** | ** ** |
| **Paid**           | ** ** | **Amount**                  | ** ** | **Units**  | ** ** | **Units**        | ** ** | **Regular**              | ** ** | **Incentive**       | ** ** | **Distribution** | ** ** |
| ** **         | ** ** | ** **                  | ** ** | ** ** | ** ** | ** **       | ** ** | ** **               | ** ** | ** **          | ** ** | ** **       | ** ** |
| 05/13/05           |       | $                           | 0.2250     |       | $          | 612              |       | $                        | 918        |                | $          | 31               |       | $ | — |   | $ | 1,561 |   |
| 08/12/05           |       | 0.4625                      |       | 1,258      |       | 1,887            |       | 64                       |       | —              |       | 3,209            |       |
| 11/14/05           |       | 0.5125                      |       | 1,398      |       | 2,091            |       | 72                       |       | 18                  |       | 3,579            |       |
| 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           | (a)        | 0.7000                      |       | 3,623      |       | 2,856            |       | 145                      |       | 637                 |       | 7,261            |       |
|               |       | $                           | 3.8500     |       | $          | 15,958           |       | $                        | 15,708     |                | $          | 679              |       | $ | 1,633 |   | $ | 33,978 |   |

 

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(a) This cash distributionwas announced on October 24, 2006 and will be paid on November 14, 2006 to allunitholders of record as of November 6, 2006.

27

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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,” “HPGP” or “the Partnership”are intended to mean the consolidated business and operations of HilandHoldings GP, LP. References to “HPGP GP” refer to Hiland Partners GPHoldings, LLC, which serves as our general partner. References to “HLND” areintended to mean the consolidated business and operations of Hiland Partners, LPand its subsidiaries. References to “HLND GP” refer to Hiland Partners GP,LLC, the general partner of Hiland Partners, LP.

**CautionaryStatement About Forward-Looking Statements**

This QuarterlyReport on Form 10-Q includes certain “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934.  These statements includestatements regarding our plans, goals, beliefs or current expectations.Statements using words such as “anticipate,” “believe,” “intend,” “project,” “plan,”“continue,” “estimate,” “forecast,” “may,” “will,” or similar expressions helpidentify forward-looking statements.  Although we believe suchforward-looking statements are based on reasonable assumptions and currentexpectations and projections about future events, no assurance can be giventhat every objective will be reached.

Our actual resultsmay differ 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:

·               ourability to pay distributions to our unitholders;

·               our expectedreceipt of distributions from HLND;

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

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

·               the amount ofnatural gas transported on HLND’s gathering systems;

·               the level ofthroughput in HLND’s natural gas processing and treating facilities;

·               the fees HLNDcharges and the margins realized for its services;

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

·               energy pricesgenerally;

·               the level ofdomestic oil and natural gas production;

·               the availability ofimported oil and natural gas;

·               actions taken byforeign oil and gas producing nations;

·               the political andeconomic stability of petroleum producing nations;

·               the weather in HLND’soperating areas;

·               the extent ofgovernmental regulation and taxation;

·               hazards oroperating risks incidental to the transporting, treating and processing of naturalgas and NGLs that may not be fully covered by insurance;

·               competition fromother midstream companies;

·               loss of keypersonnel;

·               the availabilityand cost of capital and HLND’s ability to access certain capital sources;

28

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

·               the costs andeffects of legal and administrative proceedings;

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

·               risks associatedwith the construction of new pipelines and treating and processing facilitiesor additions to HLND’s existing pipelines and facilities.

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

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**

We are a Delawarelimited partnership formed on May 2006 to own and control HLND GP, thegeneral partner of HLND, and certain other common and subordinated units inHLND. HLND, a publicly traded Delaware limited partnership (NASDAQ: HLND)formed in October 2004, 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. HLND’s operations are primarilylocated in the Mid-Continent and Rocky Mountain regions of the United States.

On September 19,2006, we priced 7,000,000 common units in connection with our initial publicoffering, and on September 20, 2006, our common units began trading on the NASDAQNational Market under the symbol “HPGP”.  On September 25, 2006, weclosed our initial public offering of 8,050,000 common units, which included1,050,000 common units issued pursuant to an over-allotment option that wasexercised by the underwriters.  Total proceeds from the sale of the unitswere $139.6 million, net of $9.3 million of underwriting commissions.

In connection withthe closing of our initial public offering, all of the membership interests inHLND GP (which owns the 2% general partner interest and all of the incentivedistribution rights in HLND), 1,301,471 HLND common units (including 761,714HLND common units previously owned by HLND GP) and 4,080,000 subordinated unitsof HLND were contributed to us, resulting in our ownership of a 57.0% limitedpartner interest in HLND. The contributions of HLND GP’s assets are reflectedat their historical carrying basis of $38.0 million because the contributionsare from a related party. As consideration for this contribution, substantiallyall of the net proceeds from our initial public offering, after the retirementof approximately $35.0 million of outstanding debt of HLND GP, were distributedto Harold Hamm, The Harold Hamm DST Trust, The Harold Hamm HJ Trust, RandyMoeder and Ken Maples (the “Contributing Parties”) and 13,550,000 common unitsand Class B common units in us were issued to the Contributing Parties.

Our generalpartner, HPGP GP, manages our operations and activities, including, among otherthings, paying our expenses and establishing the quarterly cash distributionlevels for our common units and reserves that our general partner determines,in good faith, are necessary or appropriate to provide for the conduct of ourbusiness, to comply with applicable law, any of our debt instruments or otheragreements or to provide for future distributions to our unitholders for anyone or more of the upcoming four quarters.

Our primaryobjective is to increase our cash distributions to our unitholders by activelyassisting HLND in executing its business strategy. We intend to support HLND inimplementing its business strategy by assisting in identifying, evaluating andpursuing growth opportunities. We may support the growth of HLND through theuse of our capital resources, including purchasing HLND units or lending fundsto HLND to provide funding for the acquisition of a business or an asset or foran internal growth project. In addition, we may provide HLND with other formsof credit support, such as guarantees relating to financing a project or othertypes of support related to a merger or acquisition transaction.

HLND completed itsinitial public offering of 2,300,000 common units on February 15, 2005,receiving net proceeds of $48.1 million. The proceeds from the publicoffering were used to (1) pay remaining offering costs of$2.2 million and deferred debt issuance costs of $0.6 million, (2)pay outstanding indebtedness of $22.9 million, (3) redeem$6.3 million of common units from an affiliate of Harold Hamm and the HammTrusts, and (4) make a $3.9 million distribution to the previous owners ofHiland Partners, LLC. HLND retained $12.2 million to replenish workingcapital.

29

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ContinentalGas, Inc. historically owned all of HLND natural gas gathering,processing, treating and fractionation assets other than the Worland and Bakkengathering systems and certain systems acquired or constructed since HLND’sformation. Hiland Partners, LLC historically has owned the Worland gatheringsystem, HLND compression services assets and the Bakken gathering system.

In connection withHLND’s initial public offering, the former owners of Continental Gas, Inc.and Hiland Partners, LLC and certain of HLND’s affiliates, including itsgeneral partner, contributed all of the assets and operations of ContinentalGas, Inc., other than a portion of its working capital assets, andsubstantially all of the assets and operations of Hiland Partners, LLC, otherthan a portion of its working capital assets and the assets related to theBakken gathering system, to HLND in exchange for an aggregate of 720,000 commonunits and 4,080,000 subordinated units, a 2% general partner interest in HLNDand all of the incentive distribution rights.

EffectiveSeptember 1, 2005, HLND consummated the Bakken acquisition pursuant towhich we acquired Hiland Partners, LLC, an Oklahoma limited liability company,for approximately $92.7 million in cash, $35.0 million of which wasused to retire outstanding Hiland Partners, LLC indebtedness. At the time ofthis acquisition, Hiland Partners, LLC’s principal asset was the Bakkengathering system located in eastern Montana.

HLND completed afollow-on public offering of 1,630,000 common units on November 21, 2005,receiving net proceeds of $66.1 million, including HLND GP’s contribution of$1.4 million to maintain its 2.0% interest. HLND used $65.2 million of the proceeds from the public offering torepay a portion of the credit facility borrowings it had previously used tofund the acquisition ofHiland Partners, LLC.

On May 1, 2006,HLND acquired Enogex Gas Gathering, L.L.C.’s eastern Oklahoma “Kinta Area”gathering assets for $96.4 million.  HLNDfinanced the acquisition with $61.2 million of borrowings from its creditfacility and $35.0 million of proceeds from the issuance to HLND GP of 761,714common units and 15,545 general partner equivalent units at $45.03 per unit.

We are engaged ingathering, compressing, dehydrating, treating, processing and marketing naturalgas, fractionating NGLs and providing air compression and water injectionservices for oil and gas secondary recovery operations. Our operations areprimarily located in the Mid-Continent and Rocky Mountain regions of the UnitedStates.

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

·                    *MidstreamSegment*, which is engaged in gathering and processing of natural gasprimarily in the Mid-Continent and Rocky Mountain regions.  Within thissegment, we also provide certain related services for compression, dehydration,and treatment of natural gas and the fractionation of NGLs.  This segmentgenerated approximately 93% and 86% of our total segment margin for the threemonths ended September 30, 2006 and 2005, respectively, and 92% and 85% of ourtotal segment margin for the nine months ended September 30, 2006 and 2005,respectively.

·                    *CompressionSegment*, which is engaged in providing air compression and waterinjection services for oil and gas secondary recovery operations that areongoing in North Dakota.  For the three months ended September 30, 2006and 2005, this segment generated approximately 7% and 14% of our total segmentmargin, respectively.  For the ninemonths ended September 30, 2006 and 2005, this segment generated approximately8% and 15% of our total segment margin, respectively.

Our midstreamassets consist of thirteen natural gas gathering systems with approximately1,800 miles of gas gathering pipelines, five natural gas processingplants, three natural gas treating facilities and three NGL fractionationfacilities. Our compression assets consist of two air compression facilitiesand a water injection plant.

We were formed inMay 2006 and therefore do not have any historical financial statements. As aresult of the completion of our initial public offering on September 25, 2006,we own and control the general partner of HLND, and therefore commencing onthat date our consolidated financial statements include the net assets andoperations of us, the accounts of our general partner, the accounts of HLND GPand the accounts of HLND and its subsidiaries. The non-controlling limitedpartner interests in HLND is reflected as an expense in our results ofoperations and as a liability on our consolidated balance sheet. We currentlyhave no operating activities apart from those conducted by HLND, and our cashflows will be derived solely from cash distributions from HLND.

Prior to September25, 2006, our predecessor historical consolidated financial statements are ofHLND GP and principally reflect the results of operations of HLND and areadjusted for non-controlling partners’ interests in HLND’s net income. HLND GPcommenced operations on February 15, 2005 upon the formation of HLND. Ourhistorical financial information for periods prior to February 15, 2005reflect the financial results of HLND’s predecessor, Continental Gas, Inc.Accordingly, the discussion of our financial position and results of operationsin this “Management’s Discussion and Analysis of Financial Condition andResults of Operations” reflects the operating activities and results ofoperations of consolidated HPGP for the periods after September 25, 2006 and ofconsolidated HLND GP for periods after February 15, 2005 and ContinentalGas, Inc. for periods before February 15, 2005.

30

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***Historical Results of Operations***

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

·                    The assets of CGI (Predecessor)were transferred at historical cost as it is considered a reorganization ofentities under common control.  Accordingly, our historical financialstatements for the periods prior to February 15, 2005 are the financialstatements of CGI.

·                    Our acquisition of certain netassets from Hiland Partners, LLC in connection with HLND’s initial publicoffering was accounted for as a purchase and, as a result, these assets arerecorded at their fair value at the time of purchase, which occurred concurrentwith the closing of HLND’s initial public offering on February 15, 2005. Therefore, the results of operations from the Worland gathering system andcompression assets are only reflected from February 15, 2005, the date of HLND’sinitial public offering.

·                    As stated above, prior to HLND’s formation,Hiland Partners, LLC owned the Horse Creek air compression and the Cedar Hillswater injection facility.  These assets have historically been under alease agreement with Continental Resources, Inc.  In connection with HLND’sformation and HLND’s initial public offering, we entered into a four-yearservices agreement with Continental Resources, Inc., effective as of January28, 2005, that replaced the existing lease.  Under the services agreement,we own and operate the facilities and provide air compression and waterinjection services to Continental Resources, Inc. for a fee.

·                    HLND’s acquisition of HilandPartners, LLC on September 26, 2005 was accounted for as a purchase forcontrolling member interest acquired.   As a result of 49% of the outstandingmembership interests of Hiland Partners, LLC being partially owned by anaffiliate who, at the time, was controlling member of HLND GP, 49% of the netassets of Hiland Partners, LLC, for which estimated fair value was in excess ofhistorical basis, have been recorded at historical cost and 51% of the assetshave been recorded at fair value.  The results of operations from ourBakken gathering system, the primary asset of  Hiland Partners, LLC at thetime of this acquisition, are only reflected from September 1, 2005,theeffective acquisition date.

·                    HLND’s acquisition of the KintaArea gathering assets from Enogex Gas Gathering, L.L.C. on May 1, 2006 wasaccounted for as a purchase of assets. Results of operations from the Kinta Area gathering assets are onlyreflected from May 1, 2006.

**Resultsof Operations**

Set forth in thetables below are financial and operating data for us and our predecessor, HLNDGP, and HLND’s predecessor, CGI, for the periods indicated. Operations from theWorland gathering system and compression assets contributed by Hiland Partners,LLC are reflected only from February 15, 2005, the date of HLND’s initialpublic offering.  Operations from theacquisition of the Bakken gathering system assets are reflected only fromSeptember 1, 2005.  Operations from theacquisition of the Kinta Area gathering assets are reflected only from May 1,2006.

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| ** **                                                       | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| ** **                                                       | ** ** | ** **                                               | ** ** | **Hiland** | ** ** | ** ** | ** ** | **Hiland** | ** ** |
| ** **                                                       | ** ** | **Hiland**                                               | ** ** | **Partners** | ** ** | ** ** | ** ** | **Partners** | ** ** |
| ** **                                                       | ** ** | **Holdings**                                             | ** ** | **GP, LLC** | ** ** | ** ** | ** ** | **GP, LLC** | ** ** |
| ** **                                                       | ** ** | **GP, LP (4)**                                 | ** ** | **(Predecessor) (5)** | ** ** | **Total (6)** | ** ** | **(Predecessor) (5)** | ** ** |
| ** **                                                       | ** ** | **(in thousands)**                                  | ** ** |
| **Total  Segment Margin Data:**                                  | ** ** | ** **                                               |       |   |   |   |   | ** ** | ** ** |
| Midstream  revenues                                              |       | $                                                        | 3,656      |   | $ | 52,406 |   | $ | 56,062 |   | $ | 40,720 |   |
| Midstream  purchases                                             |       | 2,583                                                    |       | 37,026 |   | 39,609 |   | 33,313 |   |
| Midstream  segment margin                                        |       | 1,073                                                    |       | 15,380 |   | 16,453 |   | 7,407 |   |
| Compression  revenues (1)                                        |       | 79                                                       |       | 1,126 |   | 1,205 |   | 1,205 |   |
| Total segment  margin (2)                                        |       | $                                                        | 1,152      |   | $ | 16,506 |   | $ | 17,658 |   | $ | 8,612 |   |
|                                                             |       |                                                     |       |   |   |   |   |   |   |
| **Summary  of Operations Data:**                                 | ** ** | ** **                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Midstream  revenues                                              |       | $                                                        | 3,656      |   | $ | 52,406 |   | $ | 56,062 |   | $ | 40,720 |   |
| Compression  revenues                                            |       | 79                                                       |       | 1,126 |   | 1,205 |   | 1,205 |   |
| Total revenues                                                   |       | 3,735                                                    |       | 53,532 |   | 57,267 |   | 41,925 |   |
|                                                             |       |                                                     |       |   |   |   |   |   |   |
| Midstream  purchases (exclusive of items shown separately below) |       | 2,583                                                    |       | 37,026 |   | 39,609 |   | 33,313 |   |
| Operations and  maintenance                                      |       | 298                                                      |       | 4,271 |   | 4,569 |   | 1,897 |   |
| Depreciation,  amortization and accretion                        |       | 427                                                      |       | 6,035 |   | 6,462 |   | 2,912 |   |
| General and  administrative                                      |       | 105                                                      |       | 1,292 |   | 1,397 |   | 542 |   |
| Total operating  costs and expenses                              |       | 3,413                                                    |       | 48,624 |   | 52,037 |   | 38,664 |   |
| Operating income                                                 |       | 322                                                      |       | 4,908 |   | 5,230 |   | 3,261 |   |
| Other income  (expense)                                          |       | (119                                                     | )          | (2,370 | ) | (2,489 | ) | (598 | ) |
| Income before  minority interest in income of HLND               |       | 203                                                      |       | 2,538 |   | 2,741 |   | 2,663 |   |
| Minority  interest in income of HLND                             |       | (72                                                      | )          | (2,693 | ) | (2,765 | ) | (2,617 | ) |
| **Net  income (loss)**                                           |       | $                                                        | 131        | ** ** | $ | (155 | ) | $ | (24 | ) | $ | 46 |   |
|                                                             |       |                                                     |       |   |   |   |   |   |   |
| HLND operating  data:                                            |       |                                                     |       |   |   |   |   |   |   |
| Natural gas  sales (MMBTU/d)                                     |       |                                                     |       |   |   | 69,563 |   | 46,815 |   |
| NGL sales  (Bbls/d)                                              |       |                                                     |       |   |   | 3,239 |   | 1,911 |   |
| Natural gas gathered  (MMBtu/d) (3)                              |       |                                                     |       |   |   | 129,168 |   | — |   |

 

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| ** **                                                       | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                                                       | ** ** | ** **                                              | ** ** | **Hiland** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Hiland**                                              | ** ** | **Partners** | ** ** | ** ** | ** ** | **Hiland** | ** ** | **Continental** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Holdings**                                            | ** ** | **GP, LLC** | ** ** | ** ** | ** ** | **Partners,** | ** ** | **Gas, Inc.** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **GP, LP (4)**                                | ** ** | **(Predecessor) (5)** | ** ** | **Total (6)** | ** ** | **GP, LLC (7)** | ** ** | **(Predecessor) (8)** | ** ** | **Total (6)** | ** ** |
| ** **                                                       | ** ** | **(in thousands)**                                 | ** ** |
| **Total  Segment Margin Data:**                                  |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Midstream revenues                                               |       | $                                                       | 10,422     |   | $ | 149,378 |   | $ | 159,800 |   | $ | 83,481 |   | $ | 11,813 |   | $ | 95,294 |   |
| Midstream  purchases                                             |       | 7,693                                                   |       | 110,272 |   | 117,965 |   | 67,801 |   | 9,747 |   | 77,548 |   |
| Midstream  segment margin                                        |       | 2,729                                                   |       | 39,106 |   | 41,835 |   | 15,680 |   | 2,066 |   | 17,746 |   |
| Compression  revenues (1)                                        |       | 236                                                     |       | 3,379 |   | 3,615 |   | 3,012 |   | — |   | 3,012 |   |
| Total segment  margin (2)                                        |       | $                                                       | 2,965      |   | $ | 42,485 |   | $ | 45,450 |   | $ | 18,692 |   | $ | 2,066 |   | $ | 20,758 |   |
|                                                             |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| **Summary  of Operations Data:**                                 | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Midstream  revenues                                              |       | $                                                       | 10,422     |   | $ | 149,378 |   | $ | 159,800 |   | $ | 83,481 |   | $ | 11,813 |   | $ | 95,294 |   |
| Compression revenues                                             |       | 236                                                     |       | 3,379 |   | 3,615 |   | 3,012 |   | — |   | 3,012 |   |
| Total revenues                                                   |       | 10,658                                                  |       | 152,757 |   | 163,415 |   | 86,493 |   | 11,813 |   | 98,306 |   |
|                                                             |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Midstream  purchases (exclusive of items shown separately below) |       | 7,693                                                   |       | 110,272 |   | 117,965 |   | 67,801 |   | 9,747 |   | 77,548 |   |
|                                                             |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Operations and  maintenance                                      |       | 727                                                     |       | 10,413 |   | 11,140 |   | 4,303 |   | 780 |   | 5,083 |   |
| Depreciation,  amortization and accretion                        |       | 1,054                                                   |       | 15,202 |   | 16,256 |   | 6,412 |   | 512 |   | 6,924 |   |
| General and  administrative                                      |       | 253                                                     |       | 3,442 |   | 3,695 |   | 1,425 |   | 166 |   | 1,591 |   |
| Total operating  costs and expenses                              |       | 9,727                                                   |       | 139,329 |   | 149,056 |   | 79,941 |   | 11,205 |   | 91,146 |   |
| Operating income                                                 |       | 931                                                     |       | 13,428 |   | 14,359 |   | 6,552 |   | 608 |   | 7,160 |   |
| Other income  (expense)                                          |       | (247                                                    | )          | (4,583 | ) | (4,830 | ) | (899 | ) | (115 | ) | (1,014 | ) |
| Income before  minority interest in income of HLND               |       | 684                                                     |       | 8,845 |   | 9,529 |   | 5,653 |   | 493 |   | 6,146 |   |
| Minority  interest in income of HLND                             |       | (553                                                    | )          | (8,438 | ) | (8,991 | ) | (5,577 | ) | — |   | (5,577 | ) |
| **Net  income**                                                  |       | $                                                       | 131        |   | $ | 407 |   | $ | 538 |   | $ | 76 |   | $ | 493 |   | $ | 569 |   |
|                                                             |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| HLND operating  data:                                            |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Natural gas  sales (MMBTU/d)                                     |       |                                                    |       |   |   | 64,796 |   |   |   |   |   | 43,044 |   |
| NGL sales  (Bbls/d)                                              |       |                                                    |       |   |   | 3,256 |   |   |   |   |   | 1,561 |   |
| Natural gas gathered  (MMBtu/d) (3)                              |       |                                                    |       |   |   | 72,657 |   |   |   |   |   | — |   |

 

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

(2)          Reconciliationof total segment margin to operating income:

(3)          Naturalgas gathered for fee (MMBtu/d) represents natural gas volumes gatheredassociated with the Kinta Area gathering assets we acquired on May 1, 2006 inwhich we do not take title to the gas.

33

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|                                                                 | ** ** | **Three Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| ** **                                                      | ** ** | ** **                                               | ** ** | **Hiland** | ** ** | ** ** | ** ** | **Hiland** | ** ** |
| ** **                                                      | ** ** | **Hiland**                                               | ** ** | **Partners** | ** ** | ** ** | ** ** | **Partners** | ** ** |
| ** **                                                      | ** ** | **Holdings**                                             | ** ** | **GP, LLC** | ** ** | ** ** | ** ** | **GP, LLC** | ** ** |
| ** **                                                      | ** ** | **GP, LP (4)**                                 | ** ** | **(Predecessor) (5)** | ** ** | **Total (6)** | ** ** | **(Predecessor) (5)** | ** ** |
| ** **                                                      | ** ** | **(in thousands)**                                  | ** ** |
| **Reconciliation  of Total Segment Margin to Operating Income** |       |                                                     |       |   |   |   |   |   |   |
| Operating income                                                |       | $                                                        | 322        |   | $ | 4,908 |   | $ | 5,230 |   | $ | 3,261 |   |
| Add:                                                            |       |                                                     |       |   |   |   |   |   |   |
| Operations and  maintenance expenses                            |       | 298                                                      |       | 4,271 |   | 4,569 |   | 1,897 |   |
| Depreciation,  amortization and accretion                       |       | 427                                                      |       | 6,035 |   | 6,462 |   | 2,912 |   |
| General and  administrative expenses                            |       | 105                                                      |       | 1,292 |   | 1,397 |   | 542 |   |
| Total segment margin                                            |       | $                                                        | 1,152      |   | $ | 16,506 |   | $ | 17,658 |   | $ | 8,612 |   |

 
| ** **                                                      | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                                                      | ** ** | ** **                                              | ** ** | **Hiland** | ** ** | ** ** | ** ** | **Hiland** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **Hiland**                                              | ** ** | **Partners** | ** ** | ** ** | ** ** | **Partners** | ** ** | **Continental** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **Holdings**                                            | ** ** | **GP, LLC** | ** ** | ** ** | ** ** | **GP, LLC** | ** ** | **Gas, Inc.** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **GP, LP (4)**                                | ** ** | **(Predecessor) (5)** | ** ** | **Total (6)** | ** ** | **(Predecessor) (5)** | ** ** | **(Predecessor) (8)** | ** ** | **Total (6)** | ** ** |
| ** **                                                      | ** ** | **(in thousands)**                                 | ** ** |
| **Reconciliation  of Total Segment Margin to Operating Income** | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating income                                                |       | $                                                       | 931        |   | $ | 13,428 |   | $ | 14,359 |   | $ | 6,552 |   | $ | 608 |   | $ | 7,160 |   |
| Add:                                                            |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Operations and  maintenance expenses                            |       | 727                                                     |       | 10,413 |   | 11,140 |   | 4,303 |   | 780 |   | 5,083 |   |
| Depreciation,  amortization and accretion                       |       | 1,054                                                   |       | 15,202 |   | 16,256 |   | 6,412 |   | 512 |   | 6,924 |   |
| General and administrative  expenses                            |       | 253                                                     |       | 3,442 |   | 3,695 |   | 1,425 |   | 166 |   | 1,591 |   |
| Total segment margin                                            |       | $                                                       | 2,965      |   | $ | 42,485 |   | $ | 45,450 |   | $ | 18,692 |   | $ | 2,066 |   | $ | 20,758 |   |

 

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.

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(4)            Amountspresented in the Hiland Holdings GP, LP column include only the consolidatedoperations beginning on September 25, 2006.  These amounts include thecontribution of assets and member interest from HLND GP at the completion of ourinitial public offering.

(5)            Amountspresented in the HLND GP, LLC Predecessor columns include only the consolidatedoperations of for the period beginning February 15, 2005 to September 25, 2006.

(6)            Totalincome and expense items included in our Consolidated Statements of Operationsand our predecessor are included in this Form 10-Q for the stated period.

(7)            Amountspresented in the HLND, LP column include only the activity for the periodbeginning on February 15, 2005.  These amounts include the operations ofthe Worland gathering system and compression assets acquired from HilandPartners, LLC at the completion of our initial public offering.

(8)            Amountspresented in the Predecessor columns include only the operations of CGI for theperiod prior to HLND’s initial public offering on February 15, 2005.

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** **

**ThreeMonths Ended September 30, 2006 Compared with Three Months Ended September 30,2005**

***Revenues.***  Total revenues(midstream and compression) were $57.3 million for the three months endedSeptember 30, 2006 compared to $41.9 million for the three months endedSeptember 30, 2005, an increase of $15.4 million, or 36.6%.  This increasewas primarily attributable to (i) increased volumes of approximately 13,230MMBtu/d (MMBtu per day) of natural gas sales and 1,250 Bbls/d (Bbls per day) ofNGL sales attributable to our acquisition of the Bakken gathering systemeffective September 1, 2005 and (ii) increased volumes of approximately 8,380MMBtu/d of natural gas sales and 129,168 MMbtu/d of natural gas gathered fromthe Kinta Area gathering assets we acquired on May 1, 2006.

Midstream revenueswere $56.1 million for the three months ended September 30, 2006 compared to$40.7 million for the three months ended September 30, 2005, an increase of$15.4 million, or 37.7%. Of this increase, $18.7 million was primarilyattributable to higher residue natural gas sales volumes and $6.9 million wasattributable to higher NGL sales volumes. The midstream revenues attributableto the increase in natural gas sales volumes were offset by a 17.9% decline inaverage realized natural gas sales prices, or $10.2 million.  The volume increases are primarilyattributable to the Bakken gathering system we acquired effective September 1,2005 and the Kinta Area gathering assets we acquired on May 1, 2006.

Natural gas salesvolumes were 69,563 MMBtu/d for the three months ended September 30, 2006compared to 46,815 MMBtu/d for the three months ended September 30, 2005, anincrease of 22,748 MMBtu/d, or 48.6%.  Of the 22,748 MMBtu/d increase,13,233 MMBtu/d (58.2%) was attributable to natural gas volumes as a result ofour Bakken gathering system acquisition effective September 1, 2005 and 8,381MMBtu/d (36.8%) was attributable to natural gas volumes as a result of ourKinta Area gathering assets we acquired on May 1, 2006. Our NGL sales volumeswere 3,239 Bbls/d for the three months ended September 30, 2006 compared to1,911 Bbls/d for the three months ended September 30, 2005, an increase of1,328 Bbls/d, or 69.5%.  Of the 1,328 Bbls/d increase, 1,259 Bbls/d(94.8%) was attributable to our Bakken gathering system.

Average realizednatural gas sales prices were $5.98 per MMBtu for the three months endedSeptember 30, 2006 compared to $7.28 per MMBtu for the three months endedSeptember 30, 2005, a decrease of $1.30 per MMBtu, or 17.9%.  Averagerealized NGL sales prices were $1.09 per gallon for both of the three monthsended September 30, 2006 and 2005. The decrease in natural gas prices wasprimarily due to a softening of supply and demand fundamentals for natural gas,which caused natural gas prices to fall during the three months ended September30, 2006 compared to the three months ended September 30, 2005.

Cash received fromour counterparty on cash flow swap contracts for natural gas derivativetransactions that closed during the three months ended September 30, 2006totaled $1.4 million.  This gainincreased average realized natural gas sales prices to $5.98 per MMBtu from$5.76 per MMBtu, an increase of $0.22 per MMBtu, (3.8%).  We had no derivative transactions during thethree months ended September 30, 2005.

Fees earned from129,168 MMBtu/d of natural gas gathered, in which we do not take title to thegas, related to our Kinta Area gathering assets were $2.7 million for the threemonths ended September 30, 2006.  We had nosimilar fees from natural gas gathering during the three months ended September30, 2005.

Compressionrevenues were $1.2 million for the each of the three months ended September 30,2006 and 2005.

***Midstream Purchases.***  Midstreampurchases were $39.6 million for the three months ended September 30, 2006compared to $33.3 million for the three months ended September 30, 2005, a netincrease of $6.3 million, or 18.9%.  The net increase of $6.3 million wasattributable to a $7.6 million increase in purchases as a result of our Bakkengathering system acquisition effective September 1, 2005 and a $3.3 millionincrease was attributable to purchases as a result of our Kinta Area gatheringassets we acquired on May 1, 2006, both of which were offset by the effect ofreduced realized natural gas sales prices of $4.6 million.

***Operations and Maintenance.*** Operations and maintenance expense totaled $4.6 million for the three monthsended September 30, 2006 compared with $1.9 million for the three months endedSeptember 30, 2005, an increase of $2.7 million, or 140.9%. Of this increase,$1.7 million, or 63.7% was attributable to operations and maintenance as aresult of our Kinta Area gathering assets we acquired on May 1, 2006 and $0.6million, or 23.9% was attributable to operations and maintenance at our Bakkengathering system we acquired effective September 1, 2005.

***Depreciation, Amortization andAccretion.***  Depreciation, amortization and accretionexpense totaled $6.5 million for the three months ended September 30, 2006compared with $2.9 million for the three months ended September 30, 2005, anincrease of $3.6 million, or 121.9%.  Of this increase, $2.0 million, or55.4% was attributable to depreciation and amortization on our Kinta Areagathering assets we acquired on May 1, 2006 and $1.5 million, or 41.2% wasattributable to depreciation and amortization on our Bakken gathering system weacquired effective September 1, 2005.

***General andAdministrative.***  General and administrative expensetotaled $1.4 million for the three months ended September 30, 2006 comparedwith $0.5 million for the three months ended September 30, 2005, an increase of$0.9 million, or 157.8%.  The increase is primarily attributable toincreased salaries and additional staffing of $0.3 million as a result ofgrowth and $0.3 million in

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Sarbanes-Oxley internalcontrol compliance costs and audit and tax preparation fees.

***Other******Income (Expense).*** Otherincome (expense) totaled ($2.5) million for the three months ended September30, 2006 compared with ($0.6) million for the three months ended September 30,2005, an increase in expense of $1.9 million.  The increase is primarilyattributable to interest expense associated with borrowings of $61.2 million onHLND’s credit facility to partially finance the Kinta Area gathering assetsHLND acquired on May 1, 2006 and the interest expense associated with thepartial financing of HLND’s acquisition of the Bakken gathering systemeffective September 1, 2005. This increase is also attributable to$0.6 million of interest expense associated with borrowings by HLND GP of$35.0 million to finance the purchase of the 761,714 common units of HLND.

***Minority Interest. ***Minorityinterest in income of Hiland Partners, LP, which represents the allocation ofHLND earnings to its limited partner interests not owned by HPGP, increased to$2.8 million for the three months ended September 30, 2006 from $2.6 millionfor the prior year comparable period. This $0.2 million increase is primarily attributable to an increase inHiland Partners’ overall net income and an increase in its outstanding limitedpartner units due to its November 2005 offering of common units and itsissuance of 761,714 common units in May 2006.

**NineMonths Ended September 30, 2006 Compared with Nine Months Ended September 30,2005**

***Revenues.***  Total revenues(midstream and compression) were $163.4 million for the nine months endedSeptember 30, 2006 compared to $98.3 million for the nine months endedSeptember 30, 2005, an increase of $65.1 million, or 66.2%.  This increasewas primarily attributable to (i) increased volumes of approximately 14,200MMBtu/d of natural gas sales, and 1,600 Bbls/d of NGL sales attributable to ouracquisition of the Bakken gathering system effective September 1, 2005, (ii)increased volumes of approximately 7,597 MMBtu/d of natural gas sales and129,644 MMBtu/d of natural gas gathered for the five months ended September 30,2006 from the Kinta Area gathering assets we acquired on May 1, 2006 (iii)additional volumes attributable to the Worland gathering system which wascontributed to us on February 15, 2005 and (iv) increased revenues fromcompression assets also contributed to us on February 15, 2005.

Midstream revenueswere $159.8 million for the nine months ended September 30, 2006 compared to$95.3 million for the nine months ended September 30, 2005, an increase of$64.5 million, or 67.7%. Of this increase, $61.0 million was primarilyattributable to higher residue natural gas and NGL sales volumes and $3.5million was attributable to higher NGL sales prices offset by a slight decreasein average realized natural gas prices. The Bakken gathering system we acquiredeffective September 1, 2005 represented $43.3 million, or 67.2% of the volumeincrease while the increase in volumes attributable to the Kinta Area gatheringassets we acquired on May 1, 2006 represented $11.8 million, or 18.2%. Theinclusion of Worland gathering system for the entire nine months in 2006 ascompared to only seven and one-half months of the corresponding period in 2005also contributed to the volume increase for the nine months ended September 30,2006 as compared to the corresponding period in 2005.

Natural gas salesvolumes were 64,796 MMBtu/d for the nine months ended September 30, 2006compared to 43,044 MMBtu/d for the nine months ended September 30, 2005, anincrease of 21,752 MMBtu/d, or 50.5%.  Of the 21,752 MMBtu/d increase,14,178 MMBtu/d, or 65.2% was attributable to the natural gas volumes as aresult of our Bakken gathering system acquisition effective September 1, 2005and 7,597 MMBtu/d, or 34.9% was attributable to the natural gas volumes as aresult of our Kinta Area gathering assets we acquired on May 1, 2006. Our NGLsales volumes were 3,256 Bbls/d for the nine months ended September 30, 2006compared to 1,561 Bbls/d for the nine months ended September 30, 2005, anincrease of 1,695 Bbls/d, or 108.6%.  Of the 1,695 Bbls/d increase, 1,599,or 94.3% was attributable to our Bakken gathering system. These increases involumes were also attributable in part to the inclusion of the Worlandgathering system for the entire nine months in 2006 as compared to only sevenand one-half months of the corresponding period in 2005.

Average realizednatural gas sales prices were $6.30 per MMBtu for the nine months endedSeptember 30, 2006 compared to $6.35 per MMBtu for the nine months endedSeptember 30, 2005, a decrease of $0.05 per MMBtu, or 0.8%.  Averagerealized NGL sales prices were $1.06 per gallon for the nine months endedSeptember 30, 2006 compared to $0.95 per gallon for the nine months endedSeptember 30, 2005, an increase of $0.11 per gallon or 11.6%.  The changein our average realized NGL sales prices was primarily a result of higher indexprices due to a tightening of supply and demand fundamentals for energy, whichcaused crude oil prices to rise during the nine months ended September 30, 2006compared to the nine months ended September 30, 2005.

Cash received fromour counterparty on cash flow swap contracts that began on May 1, 2006 fornatural gas derivative transactions that closed during the nine months endedSeptember 30, 2006 totaled $2.4 million. This gain increased average realized natural gas sales prices to $6.30per MMBtu from $6.16 per MMBtu, an increase of $0.14 per MMBtu, or 2.3%.  We had no derivative transactions during thenine months ended September 30, 2005.

Fees earned from afive-month average of 129,644 MMBtu/d of natural gas gathered, in which we donot take title to the gas, related to our Kinta Area gathering assets weacquired on May 1, 2006 were $4.5 million for the nine months ended September30, 2006. The five-month average of 129,644 equates to an average 72,657 forthe nine months ended September 30, 2006. We had no similar fees from natural gas gathering during the nine monthsended September 30, 2005.

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Compressionrevenues were $3.6 million for the nine months ended September 30, 2006compared to $3.0 million for the nine months ended September 30, 2005, anincrease of $0.6 million or 20.0%.  Thecompression assets were contributed by Hiland Partners, LLC on February 15,2005, and accordingly, revenues from these assets were only included for sevenand one-half months of the nine months ended September 30, 2005.

***Midstream Purchases.***  Midstreampurchases were $118.0 million for the nine months ended September 30, 2006compared to $77.6 million for the nine months ended September 30, 2005, anincrease of $40.4 million, or 52.1%.  Of the $40.4 million increase, $28.9million, or 71.5% was attributable to purchases as a result of our Bakkengathering system acquisition effective September 1, 2005 and $5.4 million, or13.3% was attributable to purchases as a result of our Kinta Area gatheringassets we acquired on May 1, 2006.  Theincrease in purchases is also attributable to the inclusion of the Worlandgathering system for the entire nine months in 2006 as compared to only sevenand one-half months of the corresponding period in 2005.

***Operations and Maintenance.*** Operations and maintenance expense totaled $11.1 million for the nine monthsended September 30, 2006 compared with $5.1 million for the nine months endedSeptember 30, 2005, an increase of $6.0 million, or 119.2%. Of this increase,$2.8 million, or 46.4% was attributable to operations and maintenance as aresult of our Kinta Area gathering assets we acquired on May 1, 2006 and $2.1million, or 34.6% was attributable to operations and maintenance at our Bakkengathering system we acquired effective September 1, 2005. The increase inoperations and maintenance is also attributable to the inclusion of theWorland gathering system for the entire nine months in 2006 as compared to onlyseven and one-half months of the corresponding period in 2005.

***Depreciation, Amortization andAccretion.***  Depreciation, amortization and accretionexpense totaled $16.2 million for the nine months ended September 30, 2006compared with $6.9 million for the nine months ended September 30, 2005, anincrease of $9.4 million, or 134.8%.  Of this increase, $5.1 million, or54.3% was attributable to depreciation and amortization on our Bakken gatheringsystem we acquired effective September 1, 2005 and $3.3 million, or 35.7% wasattributable to depreciation and amortization on our Kinta Area gatheringassets we acquired on May 1, 2006. The increase in depreciation, amortizationand accretion is also attributable to the inclusion of the Worland gatheringsystem for the entire nine months in 2006 as compared to only seven andone-half months of the corresponding period in 2005.

***General andAdministrative.***  General and administrative expensetotaled $3.7 million for the nine months ended September 30, 2006 compared with$1.6 million for the nine months ended September 30, 2005, an increase of $2.1million, or 132.2%.  The increase is primarily attributable to increasedsalaries and additional staffing of $0.9 million as a result of growth and $0.8million in Sarbanes-Oxley internal control compliance costs and audit and taxpreparation fees.

***Other Income (Expense).*** Otherincome (expense) totaled ($4.8) million for the nine months ended September 30,2006 compared with ($1.0) million for the nine months ended September 30, 2005,an increase in expense of $3.8 million.  The increase is primarilyattributable to interest expense associated with borrowings of $61.2 million onHLND’s credit facility to partially finance the Kinta Area gathering assetsHLND acquired on May 1, 2006 and the interest expense associated with thepartial financing of HLND’s acquisition of the Bakken gathering systemeffective September 1, 2005. This increase is also attributable to$1.1 million of interest expense associated with borrowings by HLND GP of$35.0 million to finance the purchase of the 761,714 common units of HLND.

***Minority Interest. ***Minorityinterest in income of Hiland Partners, LP, which represents the allocation ofHLND earnings to its limited partner interests not owned by HPGP, increased to$9.0 million for the nine months ended September 30, 2006 from $5.6 million forthe prior year comparable period.  This$3.4 million increase is primarily attributable to an increase in HilandPartners’ overall net income and an increase in its outstanding limited partnerunits due to its November 2005 offering of common units and its issuance of761,714 common units in May 2006.

**LIQUIDITYAND CAPITAL RESOURCES**

***Overview***

We rely ondistributions from HLND to fund cash requirements for our operations. Cashgenerated from operations, borrowings under HLND’s credit facility and fundsfrom private or public equity and future debt offerings are HLND’s primarysources of liquidity. We believe that funds from these sources should besufficient to meet both HLND’s short-term working capital requirements and itslong-term capital expenditure requirements. HLND’s ability to pay distributionsto unitholders, to fund planned capital expenditures and to make acquisitionsdepends upon HLND’s future operating performance, and more broadly, on theavailability of equity and debt financing, which will be affected by prevailingeconomic conditions in HLND’s industry and financial, business and otherfactors, some of which are beyond HLND’s control.

***Cash Flows from Operating Activities***

Our cash flowsfrom operating activities increased by $29.4 million to $30.4 million for thenine months ended September 30,

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2006 from $1.0 millionfor the nine months ended September 30, 2005.  Approximately $9.3 millionof the increase is attributable to higher depreciation and amortization duringthe nine months ended September 30, 2006 as compared to the nine months endedSeptember 30, 2005.  In addition, changesin working capital items exclusive of cash contributed $4.1 million to cashflows from operating activities during the nine months ended September 30, 2006as compared to reducing cash flows from operating activities by $12.5 millionfor the nine months ended September 30, 2005. The use of cash in operating activities in 2005 was primarily a resultof replenishing our accounts receivable after the closing of our initial publicoffering and increased accounts receivable as a result of higher realizedprices for natural gas and NGLs.  Inconnection with HLND’s formation, the $9.1 million accounts receivables of CGIwas retained by former owners of CGI. Decreased natural gas and NGL prices at September 30, 2006 as comparedto natural gas and NGL prices at December 31, 2005, offset by the effect of ouracquisition of the Kinta Area gathering assets contributed to decreases inaccounts receivable and accrued midstream revenues during the nine months endedSeptember 30, 2006.  Accounts payable andaccrued midstream purchases during the nine months ended September 30, 2006decreased due to a reduction in natural gas and NGL purchase prices atSeptember 30, 2006 as compared to natural gas and NGL prices at December 31,2005, but was somewhat offset by increased vendor payables relating to internalexpansion and growth projects and additional accounts payable relating to theoperations of the Kinta Area gathering assets acquired on May 1, 2006.

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

Cash flows used ininvesting activities, which represent investments in property and equipment andpayments made for acquisitions, increased to $144.3 million from $65.2 million,an increase of $79.1 million for the nine months ended September 30, 2006 ascompared to the nine months ended September 30, 2005. The increase is primarilya result of the Kinta Area gathering assets acquisition on May 1, 2006, theongoing progress on our Badlands expansion project and continued growth at ourBakken gathering system.

###### ***CashFlows from Financing Activities***

Our cash flowsfrom financing activities increased to $118.6 million for the nine months endedSeptember 30, 2006 from $71.0 million for the nine months ended September 30,2005. HPGP completed its initial public offering of 8,050,000 common units onSeptember 25, 2006, receiving net proceeds of $139.6 million. Theproceeds from the public offering were used to repay approximately $1.8 millionin offering costs, $35.0 million of outstanding debt of the HLND, GP, plusaccrued interest of approximately $1.0 million, and distributed to theContributing Parties as follows: (1) $57.5 million to Mr. Hamm,(2) $24.1 million to the Harold Hamm DST Trust,(3) $16.1 million to the Harold Hamm HJ Trust,(4) $2.9 million to Randy Moeder and (5) $1.2 million toKen Maples. During the nine months ended September 30, 2006, HLND borrowed$100.3 million under its credit facility to partially fund the Kinta Areagathering assets acquisition on May 1, 2006 and to fund its internal expansionprojects at Badlands, Kinta Area and Bakken. On May 1, 2006, HLND GPborrowed $35.0 million to purchase 761,714 common units and 15,545 generalpartner units of HLND, which was used by HLND to complete the Kinta Areagathering assets acquisition on the same day. During the nine months endedSeptember 30, 2006 we incurred $0.4 million of debt issuance costs and HLNDincurred $0.9 million. During the nine months ended September 30, 2006, HLND GP’smembers contributed $0.5 million as a capital contribution. During the ninemonths ended September 30, 2006, HLND distributed $16.5 million tominority interest unitholders, and HLND GP distributed $1.8 million to itsmembers. HLND completed its initial public offering of 2,300,000 common unitson February 15, 2005, receiving net proceeds of $48.1 million. The proceedsfrom the public offering were used to (1) pay remaining offering costs of $2.2million and deferred debt issuance costs of $0.6 million, (2) pay outstandingindebtedness of $22.9 million, (3) redeem $6.3 million of common units from anaffiliate of Harold Hamm and the Hamm Trusts, and (4) make a $3.9 milliondistribution to the previous owners of Hiland Partners, LLC.  We retained$12.2 million to replenish working capital. During the nine months endedSeptember 30, 2005, HLND GP’s members contributed $0.1 million as a capitalcontribution. During the nine months ended September 30, 2005, HLND distributed$4.7 million to minority interest unitholders, and HLND GP distributed$0.9 million to its members. During the period from January 1, 2005 toFebruary 14, 2005, CGI repaid $1.1 million of its outstanding indebtedness.

***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 capital expenditures,which are capital expenditures made to replace partially or fully depreciatedassets to maintain the existing operating capacity of HLND’s assets and toextend their useful lives, or other capital expenditures that are incurred inmaintaining existing system volumes and related cash flows; and

·                    expansion capital expenditures suchas those to acquire additional assets to grow HLND’s business, to expand andupgrade gathering systems, processing plants, treating facilities andfractionation facilities and to construct or acquire similar systems orfacilities.

We believe thatcash generated from the operations of HLND’s business will be sufficient tomeet anticipated maintenance capital expenditures and anticipate that expansioncapital expenditures will be funded through long-term borrowings or other debtfinancings

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and/or equityofferings.  See “Credit Facility” below for information related to ourcredit agreements.

A summary of ourcontractual cash obligations as of September 30, 2006, which includes expansionprojects on our Badlands, Kinta Area and Bakken gathering systems, is presentedbelow:
| ** **                                | ** ** | **Payment Due by Period** | ** ** |
|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                | ** ** | **Total**                                | ** ** | **Due in** | ** ** | **Due in** | ** ** | **Due in** | ** ** | **Due in** | ** ** | ** ** | ** ** |
| **Type of Obligation**          | ** ** | **Obligation**                           | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** |
| ** **                                | ** ** | **(in thousands)**                  | ** ** |
| HPGP’s revolving  credit facility    |       | $                                        | 254        |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 254 |   |
| HLND’s revolving  credit facility    |       | 134,064                                  |       | $ | — |   | $ | — |   | $ | — |   | $ | — |   | 134,064 |   |
| Contracts on  internal expansion projects |       | 11,554                                   |       | 5,111 |   | 6,443 |   | — |   | — |   | — |   |
| Operating leases  and service agreements  |       | 2,693                                    |       | 281 |   | 1,083 |   | 325 |   | 325 |   | 679 |   |
| Total contractual cash  obligations       |       | $                                        | 148,565    |   | $ | 5,392 |   | $ | 7,526 |   | $ | 325 |   | $ | 325 |   | $ | 134,997 |   |

 

***Badlands Expansion Project***

On November 8,2005, HLND entered into a new 15-year definitive Gas Purchase Agreement withContinental Resources, Inc. under which HLND will gather, treat and processadditional natural gas, which is produced as a by-product of ContinentalResources’ secondary oil recovery operations, in the areas specified by thecontract.  In order to fulfill our obligations under the agreement, weintend to expand our Badlands gas gathering system and processing plant locatedin Bowman County, North Dakota.  This expansion project will include theconstruction of a 40,000 Mcf/d nitrogen rejection plant and the expansion ofour existing Badlands field gathering infrastructure.  The expansionproject, which is targeted for completion in the first quarter of 2007, isexpected to cost approximately $40.0 million, which we intend to fund using ourexisting bank credit facility. As of September 30, 2006, we have invested$30.5 million in the expansion project. Moreover, we expect to spend anadditional $9.5 million in 2007 to expand the system. As of September 30, 2006,we have contractual obligations, including operating lease and serviceagreements related to the expansion project at our Badlands gathering system,totaling $9.3 million.  The cost toexpand the system may exceed our expected costs if our assumptions as toconstruction costs or other factors are incorrect or as a result of otherevents that are beyond our control.

***BakkenExpansion Project***

We have has plansto install additional gathering and compression infrastructure at our Bakkenfacility in order to reach the system’s expected capacity of approximately25,000 Mcf/d. We expect this expansion will be completed in the fourth quarterof 2006.  We also intend to expand the existing NGL fractionationfacilities in order to fractionate the expected increased NGL volumes from bothour Bakken plant and our Badlands plant.  We expect this expansion will becompleted in the second quarter of 2007. As of September 30, 2006, we have $0.7 million remaining on contractualobligations to purchase two new compressors which we expect to be operationalby the fourth quarter of 2006.

***OtherExpansion Projects***

At our Kinta Areagathering systems, we intend to install four amine-treating facilities toremove excess carbon dioxide levels from the gas and install additionalcompression facilities to expand the current capacity by approximately 11,000Mcf/d. We expect these expansion projects will be completed by first quarter2007.  As of September 30, 2006, we have contractual obligations relatedto the amine-treating facilities of $1.1 million. We also plan to installadditional pipelines and compression facilities at our Eagle Chief gatheringsystem in order to increase our current system capacity from approximately30,000 Mcf/d to approximately 35,500 Mcf/d due to increased volumes on thissystem.  We expect this expansion project will be completed by fourthquarter 2006.

***Financial Derivatives and Commodity Hedges***

We have enteredinto certain financialderivative instruments that are classified as cash flow hedges in accordancewith SFAS No. 133, as amended, and relate to forecasted sales in 2006, 2007 and2008. We entered into these instruments to hedge the forecasted natural gas andNGL sales or purchases against the variability in expected future cash flowsattributable to changes in market prices. The swap instruments are contractualagreements between us and or counterparty to exchange obligations of money asthe underlying natural gas or NGLs are sold or purchased. Under these swapagreements, we either receive or pay a monthly net settlement that isdetermined by the difference between a fixed price and a floating price basedon certain indices for the relevant contract period for the agreed uponvolumes.  The following tableprovides information about these financial derivative instruments for theperiods indicated:

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|                                                      | ** ** | ** **  | ** ** | ** **           | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------|------------|-------------|------------|----------------------|------------|---------------------|------------|
| ** **                                           | ** ** | ** **  | ** ** | **Average**          | ** ** | **Asset**           | ** ** |
| **Description and Production Period** | ** ** | **Volume**  | ** ** | **Fixed Price** | ** ** | **(Liability)**     | ** ** |
| ** **                                           | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| Natural Gas -  Sold Fixed for Floating Price Swaps   |       |        |       |                 |       |                |       |
| October 2006 -  September 2007                       |       | 1,620,000   |       | $                    | 8.26       |                | $          | 4,280 |   |
| October 2007 -  December 2008                        |       | 2,025,000   |       | $                    | 8.00       |                | 2,544      |   |
|                                                 |       |        |       |                 |       | $                   | 6,824      |   |

 
|                                                   | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-------------|------------|-----------------|------------|------------|------------|
| Natural Gas -  Buy Fixed for Floating Price Swaps |       |        |       |            |       |       |       |
| October 2006 -  September 2007                    |       | 600,000     |       | $               | 8.87       |       | $          | (1,516 | ) |
| October 2007 -  March 2008                        |       | 300,000     |       | $               | 8.87       |       | (398       | ) |
|                                              |       |        |       |            |       | $          | (1,914     | ) |

 
|                                                            | ** ** | **(Bbls)** | ** ** | **(per Gallon)** | ** ** | ** ** | ** ** |
|------------------------------------------------------------|------------|------------|------------|------------------|------------|------------|------------|
| Natural Gas  Liquids - Sold Fixed for Floating Price Swaps |       |       |       |             |       |       |       |
| October 2006 -  September 2007                             |       | 152,652    |       | $                | 1.13       |       | $          | (113 | ) |
| October 2007 -  March 2008                                 |       | 76,326     |       | $                | 1.13       |       | (154       | ) |
|                                                       |       |       |       |             |       | $          | (267       | ) |

 

In addition to thecontractual obligations noted in the table above, HLND has executed variousnatural gas fixed price physical forward sales contracts on approximately100,000 MMBtu per month for the remainder of 2006 and all of 2007 and 2008 withfixed prices ranging from $4.47 to $9.52 per MMBtu in 2006, $4.49 to $9.13 perMMBtu in 2007 and $8.43 per MMBtu in 2008. These contracts have been designated as normal sales under SFASNo. 133 and are therefore not marked to market as derivatives.  A summary of our fixed price physical forwardsales contracts is presented in the table below:
|                                | ** ** | ** **  | ** ** | **Average**          | ** ** |
|--------------------------------|------------|-------------|------------|----------------------|------------|
| ** **                     | ** ** | ** **  | ** ** | **Fixed Price** | ** ** |
| **Production Period**     | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** |
|                           |       |        |       |                 |       |
| October 2006 -  September 2007 |       | 1,200,000   |       | $                    | 6.86       |   |
| October 2007 - December  2008  |       | 1,500,000   |       | $                    | 8.11       |   |

 

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

We had nooff-balance sheet arrangements as of September 30, 2006.

***Credit Facility***

***HLND GP***

On May 1, 2006,HLND GP entered into an unsecured credit agreement under which it borrowed$35.0 million to purchase 761,714 common units and 15,545 general partner unitsfrom HLND. The loan was guaranteed by all HLND GP’s members and matured and waspaid in full upon the completion of our initial public offering on September25, 2006. HLND GP’s board of directors, as well as the conflicts committee of itsboard of directors, consisting of independent directors, approved thetransaction.

***HPGP***

OnSeptember 25, 2006, concurrently with the closing of our initial publicoffering, HPGP entered into a three-year $25.0 million secured revolvingcredit facility.  The facility willpermit us, if certain conditions are met, to increase borrowing capacity by upto an additional $25.0 million. The facility will be secured by all of ourownership interests in HLND and its general partner, other than the 2% generalpartner interest and the incentive distribution rights.

The facility willmature on the third anniversary of the initial public offering, at which timeall outstanding amounts thereunder become 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 250 basispoints per annum in each

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case based on our ratioof consolidated funded debt to EBITDA. The alternate base rate is 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 effective ratein 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 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.

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 HLND common and subordinated units and certain other assetsheld by us and certain of our subsidiaries at the end of each fiscal quarterand (ii) the maximum available amount of the facility (currently $25.0million). For purposes of this calculation, the value of (i) the HLNDcommon units on any date shall be the closing price for such units as reflectedon the Nasdaq Global Market on any date, and (ii) the HLND subordinatedunits on any date shall be deemed to equal 85% of the value of the HLND commonunits on such date.

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,**enter into agreements restricting our ability to grantliens on our assets or amend the facility,**makecertain loans, acquisitions and investments or**enter into a merger, consolidation or sale of assets.

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

As of September30, 2006, we had $0.3 million outstanding under this credit facility andwere in compliance with our financial covenants.

***HLND***

Concurrently withthe closing of its initial public offering, HLND entered into a three-year$55.0 million senior secured revolving credit facility.  On September 26, 2005, concurrently withthe closing of the Bakken acquisition, HLND amended this facility to increaseits borrowing capacity under the facility to $125.0 million. On May 1,2006, HLND, through its wholly owned operating subsidiary, Hiland Operating,LLC completed the acquisition of Enogex Gas Gathering, L.L.C.’s easternOklahoma Kinta Area gathering assets for $96.4 million in cash. HLND used $61.2million of our bank revolving credit facility to partially fund theacquisition.

OnSeptember 8, 2006, HLND entered into a second amendment to our creditfacility to, among other things, increase its borrowing base to$200 million and revise certain covenants. The facility currently consistsof a $191.0 million senior secured revolving credit facility to be usedfor funding acquisitions and other capital expenditures, issuance of letters ofcredit and general corporate purposes (the “revolving acquisition facility”);and a $9.0 million senior secured revolving credit facility to be used forworking capital and to fund distributions (the “revolving working capitalfacility”).

In addition, HLND’scredit facility provides for an accordion feature, which permits us, if certainconditions are met, to increase the size of the revolving acquisition facilityby up to $150 million and allows for the issuance of letters of credit ofup to $15.0 million in the aggregate. The credit facility will mature inMay 2011. At that time, the agreement will terminate and all outstandingamounts thereunder will be due and payable.

HLND’s obligationsunder the credit facility are secured by substantially all of its assets andguaranteed by HLND, and all of its subsidiaries, other than its operatingcompany, which is the borrower under the credit facility.

Indebtedness underthe credit facility will bear interest, at HLND’s option, at either (i) anAlternate Base Rate plus an applicable margin ranging from 50 to 125 basispoints per annum or (ii) LIBOR plus an applicable margin ranging from 150to 225 basis points per annum based on our ratio of consolidated funded debt toEBITDA. The Alternate Base Rate is a rate per annum equal to the greatest of(a) 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 bepayable for the aggregate amount of letters of credit issued under the creditfacility at a percentage per annum equal to 1.0%. An unused commitment feeranging from 25 to 50 basis points per annum based on our ratio of consolidatedfunded debt to EBITDA will be payable on the unused portion of the credit

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facility. During anystep-up period, the applicable margin with respect to loans under the creditfacility will be increased by 35 basis points per annum and the unusedcommitment fee will be increased by 12.5 basis points per annum.

The creditfacility prohibits HLND from making distributions to unitholders if any defaultor event of default, as defined in the credit facility, has occurred and iscontinuing or would result from the distribution. In addition, the creditfacility contains various covenants that limit, among other things, subject tocertain exceptions and negotiated “baskets,” HLND’s 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 HLND to maintain a maximumconsolidated funded debt to EBITDA ratio of 4.0:1.0, provided that in the eventwe make certain permitted acquisitions or capital expenditures, the creditfacility allows this ratio to increase to 4.75:1.0 for the following threefiscal quarters (a “step-up period”) and a minimum interest coverage ratio of3.0:1.0.

The creditfacility defines EBITDA as consolidated net income, plus income tax expense,interest expense, depreciation and amortization expense, amortization ofintangibles and organizational costs, non-cash unit based compensation expense,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 creditfacility limits distributions to HLND’s 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.

As of September30, 2006, HLND had $134.1 million outstanding under the credit facilityand were in compliance with its financial covenants.

***Impact of Inflation***

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

**RecentAccounting Pronouncements**

In October 1995the FASB issued SFAS No. 123, “Share-Based Payment,” which was revised inDecember 2004 (“SFAS 123R”) FASB 123R requires that the compensationcost relating to share-based payment transactions be recognized in thefinancial statements and that cost be measured based on the fair value of theequity or liability instruments issued. We adopted SFAS 123R as of January1, 2006 and applied SFAS 123R using the permitted modified prospective methodbeginning as of the same date and our unearned deferred compensation of $289 asof January 1, 2006 has been eliminated against common unit equity. Prior toJanuary 1, 2006 we recorded and unamortized compensation related to restrictedunit awards as unearned compensation in equity. We expect no change to our cashflow presentation from the adoption of SFAS 123R since no tax benefits arerecognized by us as a pass through entity. Our compensation expense for theseawards is recognized on the accelerated attribution method. Units to be issuedunder our unit incentive plan will result from newly issued units. Nocompensation expense was recognized in 2005 for our unit options granted during2005. Prior to our adoption of SFAS 123R on January 1, 2006, we appliedAccounting Principles Board Opinion No. 25 and related interpretations inaccounting for our unit-based compensation awards. We had 152,300 options outstandingas of September 30, 2006.

In September 2006,the FASB issued SFAS No. 157 “Fair Value Measurements.”  SFAS No. 157 defines fair value as the pricethat would 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.  ThisStatement applies to derivatives and other financial instruments, whichStatement 133, *Accounting for DerivativeInstruments and Hedging Activities*, requires be measured at fairvalue at initial recognition and for all subsequent periods. This Statement iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2007 and interim periods within those fiscal years. We will applythe provisions of the Statement prospectively in our first interim period inthe fiscal year beginning on January 1, 2008 and we do not expect a change inour methodologies of fair value measurements.

In September 2006,the SEC staff issued Staff Accounting Bulletin No. 108, “Considering theEffects of Prior Year Misstatements when Quantifying Misstatements in CurrentYear Financial Statements.”  SAB 108 wasissued to provide consistency between how registrants quantify financialstatement misstatements. Historically, there have been two widely used methodsfor quantifying the effects of financial statement misstatements.  These methods are referred to as the “roll-over”and “iron curtain” method.  The roll-

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over method quantifiesthe amount by which the current year income statement is misstated.  Exclusive reliance on an income statementapproach can result in the accumulation of errors on the balance sheet that maynot have been material to any individual income statement, but which maymisstate one or more balance sheet accounts. The iron curtain method quantifiesthe error as the cumulative amount by which the current year balance sheet ismisstated.  Exclusive reliance on a balancesheet approach can result in disregarding the effects of errors in the currentyear income statement that results from the correction of an error existing inpreviously issued financial statements. SAB 108 established an approach that requires quantification offinancial statement misstatements based on the effects of the misstatement oneach of the company’s financial statements and the related financial statementdisclosures.  This approach is commonlyreferred to as the “dual approach” because it requires quantification of errorsunder both the roll-over and iron curtain methods. We will initially apply SAB108 in connection with the preparation of our annual financial statements forthe year ending December 31, 2006 and we do not expect to record an adjustment.

**SignificantAccounting Policies and Estimates**

The selection andapplication of accounting policies is an important process that has developedas our business activities have evolved and as the accounting rules havedeveloped.  Accounting rules generally do not involve a selection amongalternatives, but involve the implementation and interpretation of existingrules, and the use of judgment applied to the specific set of circumstancesexisting in our business.  We make every effort to properly comply withall applicable rules on or before their adoption, and we believe the properimplementation and consistent application of the accounting rules arecritical.  For further details on our accounting policies, you should readNote 1 of the accompanying Notes to Financial Statements.

***Revenue Recognition*.   **Revenues forsales of natural gas and NGLs product sales are recognized at the time theproduct is delivered and title is transferred.  Revenues for compressionservices are recognized when the services under the agreement are performed.

***Derivatives.   ***Weutilize derivative financial instruments to reduce commodity price risks. We donot hold or issue derivative financial instruments for trading purposes.Statement of Financial Accounting Standards (or SFAS) No. 133, Accountingfor Derivative Instruments and Hedging Activities, which was amended inSeptember 2000 by SFAS No. 138 and in May 2003 by SFAS No. 149,establishes accounting and reporting standards for derivative instruments andhedging activities. It requires that an entity recognize all derivatives aseither assets or liabilities in the statement of financial condition andmeasure those instruments at fair value. Derivatives that are not designated ashedges are adjusted to fair value through income. If the derivative is designatedas a hedge, depending upon the nature of the hedge, changes in the fair valueof the derivatives are either offset against the fair value of assets,liabilities or firm commitments through income, or recognized in othercomprehensive income until the hedged item is recognized in income. Theineffective portion of a derivative’s change in fair value is immediatelyrecognized into income. If a derivative no longer qualifies for hedgeaccounting the amounts in accumulated other comprehensive income will be immediatelycharged to operations.

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

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

***Commodity Price Risks. *** Ourprofitability is affected by volatility in prevailing NGL and natural gasprices.  Historically, changes in the prices of most NGL products havegenerally correlated with changes in the price of crude oil.  NGL andnatural gas prices are volatile and are impacted by changes in the supply anddemand for NGLs and natural gas, as well as market uncertainty.  Toillustrate the impact of changes in prices for natural gas and NGLs on ouroperating results, we have provided below, a matrix that reflects, for the ninemonths ended September 30, 2006, the impact on our total segment margin of a$0.01 per gallon change (increase or decrease) in NGL prices coupled with a$0.10 per MMBtu change (increase or decrease) in the price of naturalgas.  The magnitude of the impact on total segment margin of changes innatural gas and NGL prices presented may not be representative of the magnitudeof the impact on total segment margin for different commodity prices orcontract portfolios.  Natural gas prices can also affect our profitabilityindirectly by influencing the level of drilling activity and relatedopportunities for our services.

|                    | ** ** | ** ** | ** ** | **Natural Gas Price Change** | ** ** |
|--------------------|------------|------------|------------|---------------------------------------------|------------|
| ** **         | ** ** | ** ** | ** ** | **($/MMBtu)**                               | ** ** |
|               |       |       |       | $                                           | 0.10       |   | $ | (0.10 | ) |
|               |       |       |       |                                        |       |   |   |
| **NGL  Price**     |       | $          | 0.01       |                                        | $          | 81,000 |   | $ | 51,000 |   |
| **Change ($/gal)** |       | $          | (0.01      | )                                           | $          | (56,000 | ) | $ | (182,000 | ) |

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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 swap contracts, we havehedged a portion of our expected exposure to natural gas prices and NGL pricesin 2006, 2007 and 2008. 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)**     | ** ** |
| ** **                                           | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)**      | ** ** | ** **          | ** ** |
| Natural Gas -  Sold Fixed for Floating Price Swaps   |       |        |       |                 |       |                |       |
| October 2006 -  September 2007                       |       | 1,620,000   |       | $                    | 8.26       |                | $          | 4,280 |   |
| October 2007 -  December 2008                        |       | 2,025,000   |       | $                    | 8.00       |                | 2,544      |   |
|                                                 |       |        |       |                 |       | $                   | 6,824      |   |

 
|                                                   | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-------------|------------|-----------------|------------|------------|------------|
| Natural Gas -  Buy Fixed for Floating Price Swaps |       |        |       |            |       |       |       |
| October 2006 -  September 2007                    |       | 600,000     |       | $               | 8.87       |       | $          | (1,516 | ) |
| October 2007 -  March 2008                        |       | 300,000     |       | $               | 8.87       |       | (398       | ) |
|                                              |       |        |       |            |       | $          | (1,914     | ) |

 
|                                                            | ** ** | **(Bbls)** | ** ** | **(per Gallon)** | ** ** | ** ** | ** ** |
|------------------------------------------------------------|------------|------------|------------|------------------|------------|------------|------------|
| Natural Gas  Liquids - Sold Fixed for Floating Price Swaps |       |       |       |             |       |       |       |
| October 2006 -  September 2007                             |       | 152,652    |       | $                | 1.13       |       | $          | 113 |   |
| October 2007 -  March 2008                                 |       | 76,326     |       | $                | 1.13       |       | (154       | ) |
|                                                       |       |       |       |             |       | $          | (267       | ) |

 

In addition to thecontractual obligations noted in the table above, we have executed variousnatural gas fixed price physical forward sales contracts on approximately100,000 MMBtu per month for the remainder of 2006 and all of 2007 and 2008 withfixed prices ranging from $4.47 to $9.52 per MMBtu in 2006, $4.49 to $9.13 perMMBtu in 2007 and $8.43 per MMBtu in 2008. These contracts have been designated as normal sales under SFASNo. 133 and are therefore not marked to market as derivatives.  A summary of our fixed price physical forwardsales contracts is presented in the table below:
|                                | ** ** | ** **  | ** ** | **Average**          | ** ** |
|--------------------------------|------------|-------------|------------|----------------------|------------|
| ** **                     | ** ** | ** **  | ** ** | **Fixed Price** | ** ** |
| **Production Period**     | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** |
|                           |       |        |       |                 |       |
| October 2006 -  September 2007 |       | 1,200,000   |       | $                    | 6.86       |   |
| October 2007 - December  2008  |       | 1,500,000   |       | $                    | 8.11       |   |

 

***Interest Rate Risk*.**   We are exposed tochanges in interest rates as a result of our credit facilities, which havefloating interest rates. On September 25, 2006, HPGP borrowed $0.3 millionto finance the costs related to the closing of our $25.0 million securedrevolving credit facility. On May 1, 2006, HLND borrowed $61.2 million to partiallyfund the Kinta Area assets acquisition from Enogex Gas Gathering, L.L.C. Duringthe nine months ended September 30, 2006, HLND borrowed another $20.4 millionto fund various expansion projects.  Asof September 30, 2006, HLND had approximately $134.1 million of indebtednessoutstanding under its credit facility.  The impact of a 100 basis pointincrease in interest rates on the amount of current debt would result in anincrease in interest expense and a corresponding decrease in net income of approximately$1.3 million annually.

***Credit Risk*.**   Counterpartiespursuant to the terms of their contractual obligations expose us to potentiallosses as a result of nonperformance.  HLND’s four largest customers forthe nine months ended September 30, 2006, accounted for approximately 17%, 16%,14% and 12%, respectively, of our revenues.  Consequently, changes withinone or more of these companies operations have the potential to impact, bothpositively and negatively, our credit exposure. Our counterparty for all of ourderivative instruments as of September 30, 2006 is BP Energy Company.

**Item4.   Controls and Procedures**

**Evaluationof Disclosure Controls and Procedures**

(a)  Evaluation ofdisclosure controls and procedures.

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Our principalexecutive officer and principal financial officer have evaluated, as requiredby Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “ExchangeAct”), our disclosure controls and procedures (as defined in Exchange Act Rule13a-15(e)) as of the end of the period covered by this quarterly report onForm 10-Q.   Based on that evaluation, the principal executiveofficer and principal financial officer concluded that the design and operationof our disclosure controls and procedures are effective in ensuring thatinformation we are required to disclose in the reports that we file or submitunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in the Securities and Exchange Commission’s rulesand forms.

(b) Changes ininternal control over financial reporting.

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

**PART II.OTHER INFORMATION**

**Item1. Legal Proceedings**

We are a party tovarious legal and regulatory proceedings, none of which we believe will have amaterial adverse impact on our financial condition, results of operations orcash flows.

 **Item 1A. Risk Factors**

*Limitedpartner interests are inherently different from capital stock of a corporation,although many of the business risks to which we are subject are similar tothose that would be faced by a corporation engaged in a similar business. Youshould consider carefully the following risk factors together with all of theother information included in this prospectus in evaluating an investment inour common units. The following risks could materially and adversely affect ourbusiness, financial condition or results of operations. In that case, theamount of the distributions on our common units could be materially andadversely affected, the trading price of our common units could decline and youcould lose all or part of your investment.*

**Risks Inherent in an Investmentin Us**

***Ouronly cash-generating assets are our 2% general partner interest, all of theincentive distribution rights and a 57.0% limited partner interest in HLND. Ourcash flow and our ability to make distributions are therefore completelydependent upon the ability of HLND to make cash distributions to its partners,including us.***

The amount of cashthat HLND can distribute to its partners each quarter, including us,principally depends upon the amount of cash it generates from its operations,which will fluctuate from quarter to quarter based on, among other things:

·                                          the amountof natural gas gathered on HLND’s pipelines;

·                                          the throughputvolumes at HLND’s processing, treating and fractionation plants;

·                                          the price ofnatural gas;

·                                          therelationship between natural gas and NGL prices;

·                                          the level ofHLND’s operating costs;

·                                          the weatherin HLND’s operating areas;

·                                          the level ofcompetition from other midstream energy companies;

·                                          the feesHLND charges and the margins HLND realizes for its services; and

·                                          ourcontinued success in our operation and management of HLND through our ownershipof its general partner.

In addition, theactual amount of cash HLND will have available for distribution will depend onother factors, some of which are beyond its control, including:

·                                          the level ofcapital expenditures it makes;

·                                          theavailability, if any, and cost of acquisitions;

·                                          debt servicerequirements;

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·                                          fluctuationsin working capital needs;

·                                          HLND’sability to make working capital borrowings under its revolving credit agreementto make distributions;

·                                          prevailingeconomic conditions; and

·                                          the amount,if any, of cash reserves established by HLND’s general partner for the properconduct of HLND’s business.

Because of thesefactors, HLND may not have sufficient available cash each quarter to pay itscurrent declared quarterly distribution of $0.70 per unit or any other amount.You should also be aware that the amount of cash that HLND has available fordistribution depends primarily upon its cash flow, including cash flow fromfinancial reserves and working capital borrowings, and is not solely a functionof profitability, which will be affected by non-cash items. As a result, HLNDmay be able to make cash distributions during periods when HLND records lossesand may not be able to make cash distributions during periods when HLND recordsnet income, which could adversely effect our ability to pay distributions onour common units.

***If weare presented with certain business opportunities, HLND will have the firstright to pursue such opportunities.***

We are party to anon-competition agreement with HLND and its general partner pursuant to whichwe and our general partner will not engage in (subject to certain exceptions),whether by acquisition, construction, investment in debt or equity interests ofany person or otherwise, the business of gathering, treating, processing andtransportation of natural gas in North America, the transportation andfractionation of NGLs in North America and constructing, buying or selling anyassets related to the foregoing businesses other than through our interests inHLND. These non-competition obligations will not terminate unless we no longercontrol HLND. If an acquisition opportunity in respect of any of the abovebusinesses is presented to us, then we must notify HLND of such opportunity andHLND will have the first right to acquire such assets. If we desire to constructassets related to the foregoing businesses, we must first offer to sell thoseassets to HLND at our actual construction costs. As a result, any expansion ofour operations beyond our current ownership interests in HLND will require usto engage in activities falling outside the purview of the non-competitionagreement and in which we may have little or no operational experience.

***Inthe future, we may not have sufficient cash to pay our quarterly distributionor to increase distribution***

Because our currentexclusive source of operating cash flow consists of cash distributions fromHLND, the amount of distributions we are able to make to our unitholders willfluctuate based on the level of distributions HLND makes to its partners,including us. We cannot assure you that HLND will continue to make quarterlydistributions at its current level of $0.70 per unit, or any other amount, orincrease its quarterly distributions in the future. In addition, while we wouldexpect to increase or decrease distributions to our unitholders if HLNDincreases or decreases distributions to us, the timing and amount of suchchanges in distributions, if any, will not necessarily be comparable to thetiming and amount of any changes in distributions made by HLND to us. The reservesestablished by the board of directors of our general partner for our estimated$0.7 million incremental annual general and administrative expenses of being apublic company, our other operating expenses, our debt service requirements, ifany, and our future distributions may affect the distributions we make to ourunitholders. Prior to making any distributions to our unitholders, we willreimburse our general partner and its affiliates for all direct and indirectexpenses incurred by them on our behalf. Our general partner will determine theamount of these reimbursed expenses. The reimbursement of these expenses, inaddition to the other factors listed above, could adversely affect the amountof distributions we make to our unitholders. We cannot guarantee that in thefuture we will be able to pay distributions or that any distributions HLND doespay to us will allow us to pay distributions at or above our quarterlydistribution of $0.2025 per unit.

***Asubstantial portion of our partnership interests in HLND are subordinated toHLND’s common units, which would result in decreased distributions to us ifHLND is unable to meet its minimum quarterly distribution.***

We own, directlyor indirectly, 5,381,471 units representing limited partner interests in HLND,of which approximately 75.8% are subordinated units and 24.2% are common units.During the subordination period, the subordinated units will not receive anydistributions in a quarter until HLND has paid the minimum quarterlydistribution of $0.45 per unit, plus any arrearages in the payment of theminimum quarterly distribution from prior quarters, on all of the outstandingHLND common units. Distributions on the subordinated units are therefore moreuncertain than distributions on HLND’s common units. Furthermore, nodistributions may be made on the incentive distribution rights until theminimum quarterly distribution has been paid on all outstanding HLND units.Therefore, distributions with respect to the incentive distribution rights areeven more uncertain than distributions on the subordinated units. Neither thesubordinated units nor the incentive distribution rights are entitled to anyarrearages from prior quarters. Generally, the subordination period ends, andthe subordinated units convert into common units of HLND, only after March 31,2010 and only upon the satisfaction of certain financial tests.

***HLND’sgeneral partner, with our consent, may limit or modify the incentivedistributions we are entitled to receive in order to facilitate HLND’s growthstrategy. Our general partner’s board of directors can give this consentwithout a vote of our unitholders.***

We indirectly ownthe incentive distribution rights in HLND that entitle us to receive increasingpercentages, up to a maximum of

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48%, of any cashdistributed by HLND as certain target distribution levels are reached in excessof $0.495 per HLND unit in any quarter. A substantial portion of the cash flowwe receive from HLND is provided by these incentive distribution rights. Theboard of directors of HLND’s general partner may reduce the level of theincentive distribution rights payable to us with our consent, which we mayprovide without the approval of our unitholders if our general partnerdetermines that such reduction does not adversely affect our limited partnersin any material respect. For example, the board of directors of HLND may electto limit the incentive distribution we are entitled to receive with respect toa particular acquisition or unit issuance by HLND. This situation could ariseif a potential acquisition might not be accretive to HLND’s unitholders if asignificant portion of that acquisition’s cash flows would be paid as incentivedistributions to us. By limiting the level of incentive distributions inconnection with a particular acquisition or issuance of HLND’s units, the cashflows associated with such acquisition could be accretive to HLND’s unitholdersas well as substantially beneficial to us. Prior to approving such a reduction,the board of directors of HLND’s general partner would be required to considerits fiduciary obligations to HLND’s common unitholders as well as to us. Ourpartnership agreement specifically permits our general partner to authorize thegeneral partner of HLND to limit or modify the incentive distribution rightsheld by us if our general partner determines that such reduction does notadversely affect our limited partners in any material respect. These reductionsmay be permanent reductions in the incentive distribution rights or may bereductions with respect to cash flows from the potential acquisition. Ifdistributions on the incentive distribution rights were reduced for the benefitof the HLND common units, the total amount of cash distributions we wouldreceive from HLND, and therefore the amount of cash distributions we could payto our unitholders, would be reduced.

***Areduction in HLND’s distributions will disproportionately affect the amount ofcash distributions to which we are currently entitled.***

Our ownership ofthe incentive distribution rights in HLND entitles us to receive our pro ratashare of specified percentages of total cash distributions made by HLND withrespect to any particular quarter only in the event that HLND distributes morethan $0.495 per HLND unit for such quarter. As a result, the holders of HLND’scommon units have a priority over the holders of HLND’s incentive distributionrights to the extent of cash distributions by HLND up to and including $0.495per unit for any quarter. Our incentive distribution rights entitle us toreceive increasing percentages, up to 48%, of all cash distributed by HLND. Thedistribution of $0.70 per limited partner unit declared by HLND for the quarterended September 30, 2006 entitles us to receive 50% (including our current 2%general partner interest) in addition to cash distributed in respect of our57.0% limited partner interest, of the incremental cash distribution from HLNDin excess of its target distribution level of $0.675 per limited partner unit.This means, at the current distribution rate, that we are effectively entitledto 10.8% of all of the cash distributed by HLND in respect of our generalpartner interest and incentive distribution rights in addition to cashdistributed in respect of our 57.0% limited partner interest. If HLND decreasesthe amount of its distribution from $0.70 to $0.675 per common unit perquarter, we would no longer be entitled to receive 50% of any incremental cashdistribution that HLND makes, and the effective percentage of total cashdistributed to which we are entitled in respect of our general partner interestand incentive distribution rights in addition to cash distributed in respect ofour limited partner interest will decrease to 8.1%. As a result, any suchreduction in quarterly cash distributions from HLND would have the effect ofdisproportionately reducing the amount of all distributions that we receivefrom HLND based on our ownership interest in the incentive distribution rightsin HLND.

***Ourability to meet our financial needs may be adversely affected by our cashdistribution policy and our lack of operational assets.***

Our partnershipagreement requires us to distribute all of our available cash quarterly. Ouronly cash generating assets are our direct and indirect ownership interests inHLND, and we currently have no independent operations separate from those ofHLND. Moreover, as discussed above, a reduction in HLND’s distributions willdisproportionately affect the amount of cash distributions we receive. Giventhat our cash distribution policy is to distribute available cash and notretain it and that our only cash generating assets are direct and indirectownership interests in HLND, we may not have enough cash to meet our needs ifany of the following events occur:

·                                          an increasein general and administrative expenses;

·                                          an increasein principal and interest payments on our outstanding debt; or

·                                          an increasein cash needs of HLND or its subsidiaries that reduces HLND distributions.

The occurrence ofany of these events would reduce our available cash and adversely affect ourability to make cash distributions to our unitholders.

***Ourrate of growth may be reduced to the extent we purchase additional units fromHLND, which will reduce the percentage of the cash we receive from theincentive distribution rights.***

Our businessstrategy includes supporting the growth of HLND through the use of our capitalresources, including purchasing HLND units or lending funds to HLND to providefunding for the acquisition of a business or an asset or for an internal growthproject. To the extent we purchase common or subordinated units or securitiesnot entitled to a current distribution from HLND, the rate of our distributiongrowth may be reduced, at least in the short term, as less of our cashdistributions will come from our

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ownership of HLNDincentive distribution rights, whose distributions increase at a faster ratethan those of our other securities.

***Ourunitholders do not elect our general partner or vote on our general partner’sdirectors, and affiliates of our general partner own a sufficient number of ourcommon units to allow them to block any attempt to remove our general partner.***

Unlike the holdersof common stock in a corporation, our unitholders have only limited votingrights on matters affecting our business and, therefore, limited ability toinfluence management’s decisions regarding our business. Our unitholders didnot elect our general partner or the directors of our general partner and willhave no right to elect our general partner or the directors of our generalpartner on an annual or other continuing basis in the future. Furthermore, ifour unitholders are dissatisfied with the performance of our general partner,they will have little ability to remove our general partner. Our general partnercannot be removed except upon the vote of the holders of at least 66 2⁄3%of the outstanding units voting together as a single class. Affiliates of ourgeneral partner own 62.7% of our common units. This ownership level will enableour general partner and its affiliates to prevent our general partner’sinvoluntary removal. Our unitholders’ voting rights are further restricted bythe provision in our partnership agreement stating that any units held by aperson that owns 20% or more of any class of units then outstanding, other thanour general partner, its affiliates, their transferees and persons who acquiredsuch units with the prior approval of the board of directors of the generalpartner, cannot be voted on any matter. In addition, our partnership agreementcontains provisions limiting the ability of our unitholders to call meetings orto acquire information about our operations, as well as other provisionslimiting the ability of our unitholders to influence the manner or direction ofour management. As a result of these provisions, the price at which our commonunits will trade may be lower because of the absence or reduction of a takeoverpremium in the trading price.

***Restrictionsin our credit facility could limit our ability to make distributions to ourunitholders, borrow additional funds or capitalize on business opportunities.***

Our creditfacility contains various operating and financial restrictions and covenants.Our ability to comply with these restrictions and covenants may be affected byevents beyond our control, including prevailing economic, financial andindustry conditions. If we are unable to comply with these restrictions andcovenants, a significant portion of any future indebtedness under our creditfacility may become immediately due and payable, and our lenders’ commitment tomake further loans to us under our credit facility may terminate. We might nothave, or be able to obtain, sufficient funds to make these acceleratedpayments. In addition, our obligations under our credit facility will besecured by substantially all of our assets, and if we are unable to repay anyfuture indebtedness under our credit facility, the lenders could seek toforeclose on such assets. Our payment of principal and interest on any futureindebtedness will reduce our cash available for distribution on our units. Ourcredit facility will limit our ability to pay distributions to our unitholdersif we are not in compliance with our financial covenants, during an event ofdefault or if an event of default would result from the distribution.

In addition, anyfuture levels of indebtedness may:

·                                          adverselyaffect our ability to obtain additional financing for future operations orcapital needs;

·                                          limit ourability to pursue acquisitions and other business opportunities; or

·                                          make ourresults of operations more susceptible to adverse economic or operatingconditions.

Variouslimitations in our credit facility and any future financing agreements mayreduce our ability to incur additional indebtedness, to engage in sometransactions or to capitalize on business opportunities.

***Ifdistributions on our common units are not paid with respect to any fiscalquarter, including those at the anticipated initial distribution rate, ourunitholders will not be entitled to receive such payments in the future.***

Our distributionsto our unitholders are not cumulative. Consequently, if distributions on ourcommon units are not paid with respect to any fiscal quarter, including thoseat the anticipated initial distribution rate, our unitholders will not beentitled to receive such payments in the future.

***Wemay issue an unlimited number of limited partner interests without the consentof our unitholders, which will dilute your ownership interest in us and mayincrease the risk that we will not have sufficient available cash to maintainor increase our per unit distribution level.***

At any time we mayissue an unlimited number of limited partner interests of any type without theapproval of our unitholders on terms and conditions established by our generalpartner. The issuance by us of additional common units or other equitysecurities of equal or senior rank will have the following effects:

·                                          ourunitholders’ proportionate ownership interest in us will decrease;

·                                          the amountof cash available for distribution on each unit may decrease;

·                                          the relativevoting strength of each previously outstanding unit may be diminished;

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·                                          the ratio oftaxable income to distributions may increase; and

·                                          the marketprice of the common units may decline.

***Themarket price of our common units could be adversely affected by sales ofsubstantial amounts of our common units in the public market, including salesby our existing partners.***

Sales by us or anyof our existing unitholders, including the Contributing Parties, of asubstantial number of our common units in the public markets following thisoffering, or the perception that such sales might occur, could have a materialadverse effect on the price of our common units or could impair our ability toobtain capital through an offering of equity securities. The ContributingParties own 13,550,000 of our 21,612,000 outstanding common units. All of ourcommon units owned by the Contributing Parties are subject to resalerestrictions under 180-day lock-up agreements with our underwriters. Thelock-up agreements with the underwriters may be waived at the discretion of theunderwriters. When the 180-day lock up period expires or in the event theserestrictions are waived, we or the Contributing Parties may sell a substantialnumber of common units. We do not know whether any such sale would be made inthe public market or in a private placement, nor do we know what impact suchpotential or actual sales would have on our common unit price in the future.

***Thecontrol of our general partner may be transferred to a third party withoutunitholder consent.***

Our generalpartner may transfer its general partner interest to a third party in a mergeror in a sale of all or substantially all of its assets without the consent ofour unitholders. Furthermore, there is no restriction in our partnershipagreement on the ability of Harold Hamm or the owners of our general partner totransfer their ownership interests in our general partner to a third party. Thenew owner of our general partner would then be in a position to replace theboard of directors and officers of our general partner and the general partnerof HLND and to control the decisions taken by the board of directors andofficers.

***HLND’sunitholders have the right to remove HLND’s general partner with the approvalof 66 2⁄3% of all units, which would cause us to lose our generalpartner interest and incentive distribution rights in HLND and the ability tomanage HLND.***

We currentlymanage HLND through HLND GP our wholly-owned subsidiary. HLND’s partnershipagreement, however, gives unitholders of HLND the right to remove the generalpartner of HLND upon the affirmative vote of holders of 66 2⁄3% ofHLND’s outstanding units. If HLND GP, LLC were removed as general partner ofHLND, it would receive cash or common units in exchange for its 2% generalpartner interest and the incentive distribution rights and would lose itsability to manage HLND. While the common units or cash we would receive areintended under the terms of HLND’s partnership agreement to fully compensate usin the event such an exchange is required, the value of these common units orinvestments we make with the cash over time may not be equivalent to the valueof the general partner interest and the incentive distribution rights had weretained them.

***Ourability to sell our partnership interests in HLND may be limited by securitieslaw restrictions and liquidity constraints.***

Substantially allof the 1,301,471 common units and 4,080,000 subordinated units of HLND that weown are unregistered, restricted securities within the meaning of Rule 144under the Securities Act of 1933. Unless we exercise our registration rightswith respect to these common units (including common units we receive uponconversion of the subordinated units), we are limited to selling into themarket in any three-month period an amount of HLND common units that does notexceed the greater of 1% of the total number of common units outstanding or theaverage weekly reported trading volume of the common units for the fourcalendar weeks prior to the sale. Furthermore, there is no public market forHLND’s subordinated units and we do not expect one to develop. If we wererequired to sell subordinated units for any reason, we likely would receive adiscount to the current market price of HLND’s common units, and that discountmay be substantial. We face contractual limitations on our ability to sell ourgeneral partner interest and incentive distribution rights in HLND and themarket for such interests is illiquid.

***Youmay not have limited liability if a court finds that unitholder actionconstitutes control of our business.***

As a limitedpartner in a partnership organized under Delaware law, you could be held liablefor our obligations to the same extent as a general partner if a courtdetermined that the right or the exercise of the right by our unitholders as agroup to remove or replace our general partner, to approve some amendments tothe partnership agreement or to take other action under our partnershipagreement constituted participation in the ‘‘control’’ of our business. Ourgeneral partner generally has unlimited liability for the obligations of thepartnership, except for those contractual obligations of the partnership thatare expressly made without recourse to our general partner. Additionally, thelimitations on the liability of holders of limited partner interests for theobligations of a limited partnership have not been clearly established in manyjurisdictions. Under certain circumstances, our unitholders may have to repayamounts wrongfully distributed to them. Under Section 17-607 of the DelawareRevised Uniform Limited Partnership Act, neither we nor HLND may make adistribution to our unitholders if the distribution would cause our or HLND’srespective liabilities to exceed the fair value of our respective assets.Delaware law provides that for a period of three years from the date of theimpermissible distribution, partners who received the distribution and who knewat the time of the distribution that it violated Delaware law will be liable tothe partnership for the distribution amount. Liabilities to partners on accountof their partnership interest and liabilities that are non-recourse to thepartnership are not counted for purposes of determining whether a distributionis permitted.

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***Increasesin interest rates may cause the market price of our common units to decline.***

Like all equityinvestments, an investment in our common units is subject to certain risks. Inexchange for accepting these risks, investors may expect to receive a higherrate of return than would otherwise be obtainable from lower-risk investments.Accordingly, as interest rates rise, the ability of investors to obtain higherrisk-adjusted rates of return by purchasing government-backed debt securitiesmay cause a corresponding decline in demand for riskier investments generally,including yield-based equity investments such as publicly traded limitedpartnership interests. Reduced demand for our common units resulting frominvestors seeking other more favorable investment opportunities may cause thetrading price of our common units to decline.

***If inthe future we cease to manage and control HLND through our ownership of thegeneral partner interest in HLND, we may be deemed to be an investment companyunder the Investment Company Act of 1940.***

If we cease tomanage and control HLND and are deemed to be an investment company under theInvestment Company Act of 1940 because of our ownership interests in HLND, wewould either have to register as an investment company under the InvestmentCompany Act of 1940, obtain exemptive relief from the Commission or modify ourorganizational structure or our contract rights to fall outside the definitionof an investment company. Registering as an investment company could, amongother things, materially limit our ability to engage in transactions withaffiliates, including the purchase and sale of certain securities or otherproperty to or from our affiliates, restrict our ability to borrow funds orengage in other transactions involving leverage and require us to addadditional directors who are independent of us or our affiliates. Theoccurrence of all or some of these events would adversely affect the price ofour common units.

***Themarket price of our common units may be volatile, and you may not be able toresell our common units at or above the initial public offering price.***

The market priceof our common units could be subject to significant fluctuations, and maydecline below the initial public offering price. You may not be able to resellyour common units at or above the initial public offering price. The followingfactors could affect our common unit price:

·                                          the amountof HLND’s distribution to its partners, including us;

·                                          HLND’soperating and financial performance and prospects;

·                                          quarterlyvariations in the rate of growth of HLND’s financial indicators, such asrevenue, net income and cash flow;

·                                          changes inrevenue, net income or cash flow estimates or publication of research reportsby analysts;

·                                          level ofinvestor interest in purchasing our common units due to the very limited numberof publicly traded entities whose assets consist exclusively of general partnerinterests in a publicly traded limited partnership;

·                                          speculationin the press or investment community;

·                                          sales of ourcommon units by us or our unitholders, including the Contributing Parties;

·                                          actions byour unitholders;

·                                          announcementsby HLND or its competitors of significant contracts, acquisitions, strategicpartnerships, joint ventures or capital commitments;

·                                          lack ofliquidity, which may result in wide bid-ask spreads and limit the number ofinvestors who are able to buy our common units;

·                                          fluctuationsin HLND’s common unit price;

·                                          interestrates;

·                                          generalmarket conditions; and

·                                          domestic andinternational economic, legal and regulatory factors unrelated to ourperformance.

The stock marketsin general experience extreme volatility that often is unrelated to theoperating performance of particular companies and partnerships. These broadmarket fluctuations may adversely affect the trading price of our common units.

***Theamount of cash that we will be able to distribute to you will be reduced by theincremental costs associated with our being a public company, other general andadministrative expenses and any reserves that our general partner determines,in good faith,***

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***arenecessary or appropriate to provide for the conduct of our business, compliancewith law or agreements and future distributions.***

Before we can paydistributions to our unitholders, we must first pay or reserve funds for ourexpenses, including the costs of being a public company, which we expect to beapproximately $725,000 per year, and other operating expenses. Furthermore, ourgeneral partner may, in good faith, establish cash reserves to provide forfuture debt service requirements, if any, and to afford us the ability to makefuture distributions during periods of limited cash flows. In addition, in theevent that HLND issues additional common units, HLND GP, LLC, our wholly-ownedsubsidiary, has the right to make a capital contribution in order to maintainits 2% general partner interest in HLND. Our general partner may also reservefunds to enable HLND GP, LLC to make such a capital contribution. Our expensesand the reserves established by our general partner will reduce our cashavailable for distribution to you.

***HLNDmay issue additional common units or other equity securities, which mayincrease the risk that HLND will not have sufficient available cash to maintainor increase its cash distribution level.***

HLND has widelatitude to issue additional HLND common units on the terms and conditionsestablished by HLND’s general partner. The payment of distributions on theseadditional HLND common units may increase the risk that HLND will be unable tomaintain or increase its quarterly cash distribution per unit, which in turnmay reduce the amount of incentive distributions we receive and the availablecash that we have to distribute to our unitholders.

***IfHLND’s general partner is not fully reimbursed or indemnified for obligationsand liabilities it incurs in managing the business and affairs of HLND, it maynot be able to satisfy its obligations, and its cash flows will be reduced,which will in turn reduce distributions to you.***

The generalpartner of HLND and its affiliates may make expenditures on behalf of HLND forwhich they will seek reimbursement from HLND. In addition, under Delawarepartnership law, the general partner, in its capacity as the general partner ofHLND, has unlimited liability for the obligations of HLND, such as its debtsand environmental liabilities, except for those contractual obligations of HLNDthat are expressly made without recourse to the general partner. For example,HLND’s credit facility and certain of its gas purchase agreements do notcontain such an express non-recourse contractual provision, and HLND may, fromtime to time, enter into other agreements that do not contain such provisions.To the extent HLND GP, LLC incurs obligations on behalf of HLND, it is entitledto be reimbursed or indemnified by HLND. If HLND does not reimburse orindemnify its general partner, HLND GP, LLC may be unable to satisfy theseliabilities or obligations, which would reduce its cash flows, which will inturn reduce distributions to you.

**Risks Inherent in HLND’s Business**

Because we aresubstantially dependent on the distributions we receive from HLND, risks toHLND’s operations are also risks to us. We have set forth below risks to HLND’sbusiness and operations, the occurrence of which could negatively impact itsfinancial performance and decrease the amount of cash it is able to distributeto us.

***A significantdecrease in natural gas production in HLND’s areas of operation would reduceHLND’s ability to make distributions to its unitholders, including us.***

HLND’s gatheringsystems are connected to natural gas reserves and wells from which theproduction will naturally decline over time, which means that cash flowsassociated with these wells will also decline over time. To maintain orincrease throughput levels on its gathering systems and the utilization rate atits processing plants and its treatment and fractionation facilities, HLND mustcontinually obtain new natural gas supplies. HLND’s ability to obtainadditional sources of natural gas depends in part on the level of successfuldrilling activity near its gathering systems. Fluctuations in energy prices cangreatly affect production rates and investments by third parties in thedevelopment of new oil and natural gas reserves. Drilling activity generallydecreases as oil and natural gas prices decrease. Natural gas prices have beenhigh in recent years compared to historical periods. HLND has no control overthe level of drilling activity in its areas of operations, the amount ofreserves associated with the wells or the rate at which production from a wellwill decline. In addition, HLND has no control over producers or theirproduction decisions, which are affected by, among other things, prevailing andprojected energy prices, demand for hydrocarbons, the level of reserves,geological considerations, governmental regulations and the availability and costof capital. Because HLND’s new sources of supply are often obtained from theassociated gas that is produced in connection with oil drilling operations,declines in oil prices, even without a commensurate decline in prices fornatural gas, can adversely affect its ability to obtain new gas supplies.

***IfHLND fails to obtain new sources of natural gas supply, its revenues and cashflow may be adversely affected, and its ability to make distributions to itsunitholders, including us, may be reduced.***

HLND facescompetition in acquiring new natural gas supplies and may not be able to obtainadditional contracts for natural gas supplies. Competition for natural gassupplies is primarily based on the location of pipeline facilities, pricingarrangements, reputation, efficiency, flexibility and reliability. HLND’s majorcompetitors for natural gas supplies and markets include (1) Western GasResources, Inc., Ringwood Gathering and Duke Energy Field Services LLC at itsEagle Chief gathering system, (2) Enogex, Inc. at its Matli gathering system,(3) Bear Paw Energy, a subsidiary of ONEOK Partners, L.P., at its Badlands andBakken gathering systems and (4) CenterPoint Energy Field Services at the KintaArea gathering system. Many of HLND’s competitors have greater financial

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resources than HLND does,which may better enable them to pursue additional gathering and processingopportunities.

***HLNDdepends on certain key producers for a significant portion of its supply ofnatural gas and the loss of any of these key producers could reduce HLND’ssupply of natural gas and adversely affect its financial results.***

For the ninemonths ended September 30, 2006, Continental Resources, Chesapeake Energy andEnerplus Resources USA, Corp. supplied HLND with approximately 34%, 24% and13%, respectively, of its total natural gas volumes. Each of HLND’s natural gasgathering systems is dependent on one or more of these producers. To the extentthat these producers reduce the volumes of natural gas that they supply to HLNDas a result of competition or otherwise, HLND would be adversely affectedunless it were able to acquire comparable supplies of natural gas on comparableterms from other producers, which may not be possible in areas where theproducer that reduces its volumes is the primary producer in the area.

***HLNDgenerally does not obtain independent evaluations of natural gas reservesdedicated to it gathering systems; therefore, volumes of natural gas gatheredon its gathering systems in the future could be less than anticipated.***

HLND generallydoes not obtain independent evaluations of natural gas reserves connected toits gathering systems due to the unwillingness of producers to provide reserveinformation as well as the cost of such evaluations. Accordingly, HLND does nothave estimates of total reserves dedicated to its systems or the anticipatedlife of such reserves. If the total reserves or estimated life of the reservesconnected to HLND’s gathering systems is less than anticipated and HLND isunable to secure additional sources of natural gas, then the volumes of naturalgas gathered on its gathering systems in the future could be less thananticipated. A decline in the volumes of natural gas gathered on its gatheringsystems would have an adverse effect on HLND’s results of operations, financialcondition and ability to make distributions.

***HLNDis exposed to the credit risks of its key customers, and any materialnonpayment or nonperformance by these key customers could reduce HLND’s abilityto make distributions to its unitholders.***

HLND is subject torisks of loss resulting from nonpayment or nonperformance by its customers. Anymaterial nonpayment or nonperformance by its key customers could reduce HLND’sability to make distributions to its unitholders. Furthermore, some of HLND’scustomers may be highly leveraged and subject to their own operating andregulatory risks, which increases the risk that they may default on theirobligations to HLND.

***HLND’scash flow is affected by the volatility of natural gas and NGL product prices,which could adversely affect its ability to make distributions to itsunitholders.***

HLND is subject tosignificant risks due to frequent and often substantial fluctuations incommodity prices. In the past, the prices of natural gas and NGLs have beenextremely volatile, and this volatility is expected to continue. The NYMEXdaily settlement price for the prompt month contract in 2005 and the first ninemonths of 2006 ranged from a high of $15.38 per MMBtu to a low of $4.20 perMMBtu. A composite of the weighted monthly average NGLs price based on HLND’saverage NGLs composition in 2005 and the first nine months of 2006 ranged froma high of approximately $1.15 per gallon to a low of $0.71 per gallon. Themarkets and prices for natural gas and NGLs depend upon factors beyond HLND’scontrol. These factors include demand for oil, natural gas and NGLs, whichfluctuate with changes in market and economic conditions and other factors,including:

·                                          the impactof weather on the demand for oil and natural gas;

·                                          the level ofdomestic oil and natural gas production;

·                                          theavailability of imported oil and natural gas;

·                                          actionstaken by foreign oil and gas producing nations;

·                                          theavailability of local, intrastate and interstate transportation systems;

·                                          the availabilityand marketing of competitive fuels;

·                                          the impactof energy conservation efforts; and

·                                          the extentof governmental regulation and taxation.

HLND operatesunder two types of contractual arrangements under which its midstream segmentmargin is exposed to increases and decreases in the price of natural gas andNGLs: percentage-of-proceeds and percentage-of-index arrangements. Underpercentage-of-proceeds arrangements, HLND generally purchases natural gas fromproducers for an agreed percentage of proceeds or upon an index-related price,and then sells the resulting residue gas and NGLs or NGL products atindex-related prices. Under percentage-of-index arrangements, HLND purchasesnatural gas from producers at a fixed percentage of the index price for thenatural gas they produce and subsequently sells the residue gas and NGLs or NGLproducts at market prices. Under both of these types of contracts HLND’srevenues and total segment margin increase or decrease, whichever isapplicable, as the price of natural gas and NGLs fluctuates.**]**

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***HLNDmay not successfully balance its purchases of natural gas and its sales ofresidue gas and NGLs, which increases its exposure to commodity price risks.***

HLND may not besuccessful in balancing its purchases and sales. In addition, a producer couldfail to deliver promised volumes or deliver in excess of contracted volumes, ora purchaser could purchase less than contracted volumes. Any of these actionscould cause HLND’s purchases and sales not to be balanced. If HLND’s purchasesand sales are not balanced, it will face increased exposure to commodity pricerisks and could have increased volatility in operating income.

***HLND’sconstruction of new assets or the expansion of existing assets may not resultin revenue increases and is subject to regulatory, environmental, political,legal and economic risks, which could adversely affect results of operationsand financial condition.***

One of the waysHLND may grow its business is through the construction of new midstream assetsor the expansion of existing systems such as the Badlands expansion project.The construction of additions or modifications to existing systems, and theconstruction of new midstream assets involve numerous regulatory,environmental, political and legal uncertainties beyond HLND’s control andrequire the expenditure of significant amounts of capital. If HLND undertakesthese projects, they may not be completed on schedule at the budgeted cost, orat all. Moreover, revenues may not increase immediately upon the expenditure offunds on a particular project. For instance, if HLND expands a new pipeline,the construction may occur over an extended period of time, and HLND will notreceive any material increases in revenues until the project is completed.Moreover, HLND may construct facilities to capture anticipated future growth inproduction in a region in which such growth does not materialize. Since HLND isnot engaged in the exploration for and development of oil and natural gasreserves, it often does not have access to estimates of potential reserves inan area prior to constructing facilities in such area. To the extent HLNDrelies on estimates of future production in its decision to construct additionsto its systems, such estimates may prove to be inaccurate because there arenumerous uncertainties inherent in estimating quantities of future production.As a result, new facilities may not be able to attract enough throughput toachieve expected investment return, which could adversely affect HLND’s resultsof operations, financial condition and ability to make distributions.

***Achange in the characterization of some of HLND’s assets by federal, state orlocal regulatory agencies or a change in policy by those agencies may result inincreased regulation of HLND’s assets, which may cause its revenues to declineand operating expenses to increase.***

As a natural gasgatherer and intrastate pipeline company, HLND generally is exempt from FederalEnergy Regulatory Commission, or FERC, regulation under the Natural Gas Act of1938, or NGA, but FERC regulation still affects HLND’s business and the marketfor its products. FERC’s policies and practices across the range of its naturalgas regulatory activities, including, for example, its policies on open accesstransportation, ratemaking, capacity release, and market center promotion,indirectly affect intrastate markets. In recent years, FERC has pursuedpro-competitive policies in its regulation of interstate natural gas pipelines.However, we cannot assure you that FERC will continue this approach as itconsiders matters such as pipeline rates and rules and policies that may affectrights of access to natural gas transportation capacity. In addition, thedistinction between FERC-regulated transmission service and federallyunregulated gathering services is the subject of regular litigation, so, insuch a circumstance, the classification and regulation of some of HLND’sgathering facilities may be subject to change based on future determinations bythe FERC and the courts. Other state and local regulations also affect HLND’sbusiness. HLND’s gathering lines are subject to ratable take and commonpurchaser statutes in states in which it operates. Ratable take statutesgenerally require gatherers to take, without undue discrimination, natural gasproduction that may be tendered to the gatherer for handling. Similarly, commonpurchaser statutes generally require gatherers to purchase without unduediscrimination as to source of supply or producer. These statutes restrict HLND’sright as an owner of gathering facilities to decide with whom it contracts topurchase or transport natural gas. Federal law leaves any economic regulationof natural gas gathering to the states. States in which HLND operates haveadopted complaint based regulation of natural gas gathering activities, whichallows natural gas producers and shippers to file complaints with stateregulators in an effort to resolve grievances relating to natural gas gatheringaccess and rate discrimination. While HLND’s proprietary gathering linescurrently are subject to limited state regulation, there is a risk that statelaws will be changed, which may give producers a stronger basis to challengeproprietary status of a line, or the rates, terms and conditions of a gatheringline providing transportation service.

***HLNDmay incur significant costs and liabilities in the future resulting from afailure to comply with new or existing environmental regulations or anaccidental release of hazardous substances into the environment.***

HLND’s operationsare subject to stringent and complex federal, state and local environmentallaws and regulations. These include, for example, (i) the federal Clean Air Actand comparable state laws and regulations that impose obligations related toair emissions, (ii) the federal Resource Conservation and Recovery Act, orRCRA, and comparable state laws that impose requirements for the handling anddisposal of waste from HLND’s facilities and (iii) the ComprehensiveEnvironmental Response, Compensation and Liability Act of 1980, or CERCLA, alsoknown as ‘‘Superfund,’’ and comparable state laws that regulate the cleanup ofhazardous substances that may have been released at properties currently orpreviously owned or operated by HLND or locations to which it has sent wastefor disposal. Failure to comply with these laws and regulations or newlyadopted laws or regulations may trigger a variety of administrative, civil andcriminal enforcement measures, including the assessment of monetary penalties,the imposition of remedial requirements, and the issuance of orders enjoiningfuture operations. Certain environmental statutes, including CERCLA andanalogous state laws and regulations, impose strict, joint and severalliability for costs required to clean up and restore

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sites where hazardoussubstances have been disposed or otherwise released. Moreover, it is notuncommon for neighboring landowners and other third parties to file claims forpersonal injury and property damage allegedly caused by the release ofhazardous substances or other waste products into the environment. There isinherent risk of the incurrence of environmental costs and liabilities in HLND’sbusiness due to its handling of natural gas and other petroleum products, airemissions related to its operations, and historical industry operations andwaste disposal practices. For example, an accidental release from one of HLND’spipelines or processing facilities could subject it to substantial liabilitiesarising from environmental cleanup and restoration costs, claims made byneighboring landowners and other third parties for personal injury and propertydamage, and fines or penalties for related violations of environmental laws orregulations. Moreover, the possibility exists that stricter laws, regulationsor enforcement policies could significantly increase HLND’s compliance costsand the cost of any remediation that may become necessary. HLND may not be ableto recover these costs from insurance.

***IfHLND does not make acquisitions on economically acceptable terms, its futuregrowth will be limited.***

HLND’s ability togrow depends on its ability to make acquisitions that result in an increase inthe cash generated from operations per unit. If HLND is unable to make theseaccretive acquisitions either because it is: (1) unable to identify attractiveacquisition candidates or negotiate acceptable purchase contracts with them,(2) unable to obtain financing for these acquisitions on economicallyacceptable terms, or (3) outbid by competitors, then HLND’s future growth andability to increase distributions will be limited. Furthermore, even if HLNDdoes make acquisitions that it believes will be accretive, these acquisitionsmay nevertheless result in a decrease in the cash generated from operations perunit and reduce our cash available to pay distributions. Any acquisition,including HLND’s recent acquisition of the Kinta Area gathering assets,involves potential risks, including, among other things:

·                                          mistakenassumptions about revenues and costs, including synergies;

·                                          an inabilityto integrate successfully the businesses acquired;

·                                          theassumption of unknown liabilities;

·                                          limitationson rights to indemnity from the seller;

·                                          thediversion of management’s attention from other business concerns;

·                                          unforeseendifficulties operating in new product areas or new geographic areas; and

·                                          customer orkey employee losses at the acquired businesses.

If HLNDconsummates any future acquisitions, its capitalization and results ofoperations may change significantly, and you will not have the opportunity toevaluate the economic, financial and other relevant information that HLND willconsider in determining the application of these funds and other resources.HLND’s acquisition strategy is based, in part, on its expectation of ongoingdivestitures of midstream assets by large industry participants. A materialdecrease in such divestitures would limit HLND’s opportunities for futureacquisitions and could adversely affect its operations and cash flows availablefor distribution to unitholders.

***HLND’sability to engage in construction projects and to make acquisitions willrequire access to a substantial amount of capital.***

HLND’s ability toengage in construction projects or to make acquisitions is dependent on obtainingadequate sources of outside financing, including commercial borrowings andother debt and common unit issuances. While the initial funding of HLND’sacquisitions may consist of debt financing, HLND’s financial strategy is tofinance acquisitions approximately equally with equity and debt, and HLND wouldexpect to repay such debt with proceeds of equity issuances to achieve thisrelatively balanced financing ratio. If HLND is unable to finance its growththrough external sources or is unable to achieve its targeted debt/equityratios, or if the cost of such financing is higher than expected, HLND may berequired to forgo certain construction projects or acquisition opportunities orsuch construction projects or acquisition opportunities may not result in expectedincreases in distributable cash flow. Accordingly, the inability of HLND toobtain adequate sources of financing on economically acceptable terms may limitHLND’s growth opportunities, which could have a negative impact on our cashavailable to pay distributions.

***Costreimbursements due to HLND’s general partner may be substantial and will reducecash available for distribution to holders of HLND’s common units.***

Prior to makingany distribution on its common units, HLND will reimburse its general partnerfor expenses it incurs on HLND’s behalf. The reimbursement of expenses couldadversely affect HLND’s ability to pay cash distributions to holders of itscommon units, including us. HLND’s general partner will determine the amount ofthese expenses. In addition, HLND’s general partner and its affiliates mayperform other services for HLND for which HLND will be charged fees asdetermined by its general partner.

***IfHLND is unable to obtain new rights-of-way or the cost of renewing existingrights-of-way increases, then it may be unable to fully execute its growthstrategy, its cash flows and ability to make distributions could be adverselyaffected.***

The constructionof additions to HLND’s existing gathering assets may require it to obtain newrights-of-way prior to constructing new pipelines. HLND may be unable to obtainsuch rights-of-way to connect new natural gas supplies to its existing

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gathering lines orcapitalize on other attractive expansion opportunities. Additionally, it maybecome more expensive for HLND to obtain new rights-of-way or to renew existingrights-of-way. If the cost of obtaining new rights-of-way or renewing existingrights-of-way increases, then HLND’s cash flows and cash available fordistribution could be adversely affected.

***HLND’sbusiness involves many hazards and operational risks, some of which may not befully covered by insurance. If a significant accident or event occurs that isnot fully insured, its operations and financial results could be adverselyaffected.***

HLND’s operationsare subject to the many hazards inherent in the gathering, treating, processingand fractionation of natural gas and NGLs, including:

·                                          damage topipelines, related equipment and surrounding properties caused by tornadoes,floods, fires and other natural disasters and acts of terrorism;

·                                          inadvertentdamage from construction and farm equipment;

·                                          leaks ofnatural gas, NGLs and other hydrocarbons or losses of natural gas or NGLs as aresult of the malfunction of measurement equipment or facilities at receipt ordelivery points;

·                                          fires andexplosions; and

·                                          otherhazards, including those associated with high-sulfur content, or sour gas, thatcould also result in personal injury and loss of life, pollution and suspensionof operations.

These risks couldresult in substantial losses due to personal injury and/or loss of life, severedamage to and destruction of property and equipment and pollution or otherenvironmental damage and may result in curtailment or suspension of HLND’srelated operations. A natural disaster or other hazard affecting the areas inwhich HLND operates could have a material adverse effect on its operations.HLND is not fully insured against all risks incident to its business. Inaccordance with typical industry practice, HLND does not have any propertyinsurance on any of its underground pipeline systems that would cover damage tothe pipelines. HLND is not insured against all environmental accidents thatmight occur, other than those considered to be sudden and accidental. In addition,HLND does not have business interruption insurance. If a significant accidentor event occurs that is not fully insured, it could adversely affect HLND’soperations and financial condition.

***Restrictionsin HLND’s credit facility limits its ability to make distributions and maylimit its ability to capitalize on acquisition and other businessopportunities.***

HLND’s creditfacility contains various covenants limiting its ability to incur indebtedness,grant liens, engage in transactions with affiliates, make distributions to itsunitholders and capitalize on acquisition or other business opportunities. Italso contains covenants requiring HLND to maintain certain financial ratios andtests. HLND is prohibited from making any distribution to unitholders if suchdistribution would cause a default or an event of default under its creditfacility.  Any subsequent refinancing ofHLND’s current indebtedness or any new indebtedness could have similar orgreater restrictions. As of September 30, 2006, HLND’s total outstandinglong-term indebtedness was approximately $134.1 million, all under its seniorsecured revolving credit facility. Payments of principal and interest on theindebtedness will reduce the cash available for distribution on HLND’s units.

***Dueto HLND’s lack of asset diversification, adverse developments in its midstreamoperations would reduce its ability to make distributions to its unitholders.***

HLND reliesexclusively on the revenues generated from its gathering, dehydration,treating, processing, fractionation and compression services businesses, and asa result, its financial condition depends upon prices of, and continued demandfor, natural gas and NGLs. Due to HLND’s lack of diversification in asset type,an adverse development in one of these businesses would have a significantlygreater impact on HLND’s financial condition and results of operations than ifit maintained more diverse assets.

***Increasesin interest rates, which have recently been increasing from record lows, couldadversely impact HLND’s unit price and its ability to issue additional equity,make acquisitions, reduce debt or finance internal growth projects.***

If the overalleconomy strengthens, it is likely that monetary policy will tighten further,resulting in higher interest rates to counter possible inflation. Interestrates on future credit facilities and debt offerings could be higher thancurrent levels, causing HLND’s financing costs to increase accordingly. As withother yield oriented securities, HLND’s unit price is impacted by the level ofits cash distributions and implied distribution yield. The distribution yieldis often used by investors to compare and rank related yield orientedsecurities for investment decision making purposes. Therefore, changes in interestrates, either positive or negative, may affect the yield requirements ofinvestors who invest in HLND’s units, and a rising interest rate environmentcould have an adverse impact on HLND’s unit price and its ability to issueadditional equity to make acquisitions, reduce debt or finance internal growthprojects.

***HLND’shedging activities may have a material adverse effect on its earnings,profitability, cash flows, including its ability to make distributions, andfinancial condition.***

HLND utilizes derivativefinancial instruments related to the future price of natural gas and the futureprice of NGLs with the

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intent of reducingvolatility in its cash flows due to fluctuations in commodity prices. WhileHLND’s hedging activities are designed to reduce commodity price risk, HLNDremains exposed to fluctuations in commodity prices to some extent. The extentof HLND’s commodity price exposure is related largely to the effectiveness andscope of its hedging activities. For example, the derivative instruments HLNDutilizes are based on posted market prices, which may differ significantly fromthe actual natural gas prices or NGLs prices that HLND realizes in itsoperations. Furthermore, HLND’s hedges relate to only a portion of the volumeof its expected sales and, as a result, HLND will continue to have directcommodity price exposure to the unhedged portion. HLND’s actual future salesmay be significantly higher or lower than estimated at the time it entered intoderivative transactions for such period. If the actual amount is higher thanestimated, HLND will have greater commodity price exposure than intended. Ifthe actual amount is lower than the amount that is subject to HLND’s derivativefinancial instruments, HLND might be forced to satisfy all or a portion of itsderivative transactions without the benefit of the cash flow from its sale orpurchase of the underlying physical commodity, resulting in a substantialdiminution of liquidity. As a result of these factors, HLND’s hedgingactivities may not be as effective as intended in reducing the volatility ofits cash flows, and in certain circumstances may actually increase thevolatility of its cash flows, which could adversely affect its ability to makedistributions to unitholders, including us. In addition, HLND’s hedgingactivities are subject to the risks that a counterparty may not perform itsobligation under the applicable derivative instrument, the terms of thederivative instruments are imperfect, and HLND’s hedging procedures may not beproperly followed. We cannot assure you that the steps HLND takes to monitorits derivative financial instruments will detect and prevent violations of itsrisk management policies and procedures, particularly if deception or otherintentional misconduct is involved.

***Terroristattacks, and the threat of terrorist attacks, have resulted in increased coststo HLND’s business. Continued hostilities in the Middle East or other sustainedmilitary campaigns may adversely impact HLND’s results of operations.***

The long-termimpact of terrorist attacks, such as the attacks that occurred on September 11,2001, and the threat of future terrorist attacks on the energy transportationindustry in general, and on HLND in particular, is not known at this time.Increased security measures taken by HLND as a precaution against possibleterrorist attacks have resulted in increased costs to its business. Uncertaintysurrounding continued hostilities in the Middle East or other sustainedmilitary campaigns may affect HLND’s operations in unpredictable ways,including the disruption of markets for natural gas, NGLs and NGL products, andthe possibility that infrastructure facilities could be direct targets of, orindirect casualties of, an act of terror. Changes in the insurance markets attributableto terrorist attacks may make certain types of insurance more difficult forHLND to obtain. Moreover, the insurance that may be available to HLND may besignificantly more expensive than its existing insurance coverage. Instabilityin the financial markets as a result of terrorism or war could also affect HLND’sability to raise capital.

**RisksRelated to Conflicts of Interest**

***HaroldHamm controls our general partner, which has sole responsibility for conductingour business and managing our operations. Affiliates of Harold Hamm and ourgeneral partner have conflicts of interest and limited fiduciary duties, whichmay permit them to favor their own interests to your detriment.***

The ContributingParties directly or indirectly own a 62.7% limited partner interest in us. Inaddition, Harold Hamm controls our general partner. Conflicts of interest mayarise between the Contributing Parties and their affiliates, including ourgeneral partner, on the one hand, and us and our unitholders, on the other hand.As a result of these conflicts, our general partner may favor its own interestsand the interests of its affiliates over the interests of our unitholders.These conflicts include, among others, the following situations:

·                                          Harold Hammand his affiliates control Continental Resources; neither our partnershipagreement nor any other agreement requires Continental Resources to pursue abusiness strategy that favors us;

·                                          our generalpartner is allowed to take into account the interests of parties other than us,in resolving conflicts of interest;

·                                          our generalpartner has limited its liability and reduced its fiduciary duties, and hasalso restricted the remedies available to our unitholders for actions that,without the limitations, might constitute breaches of fiduciary duty;

·                                          our generalpartner determines the amount and timing of asset purchases and sales, capitalexpenditures, borrowings, issuance of additional limited partner securities,and reserves, each of which can affect the amount of cash that is distributedto unitholders;

·                                          our generalpartner determines which costs incurred by it and its affiliates arereimbursable by us;

·                                          ourpartnership agreement does not restrict our general partner from causing us topay it or its affiliates for any services rendered to us or entering intoadditional contractual arrangements with any of these entities on our behalf;

·                                          our generalpartner controls the enforcement of obligations owed to us by our generalpartner and its affiliates; and

·                                          our generalpartner decides whether to retain separate counsel, accountants, or others toperform services for us.

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***Althoughwe control and manage HLND through our ownership of its general partner, HLND’sgeneral partner owes fiduciary duties to HLND and HLND’s unitholders, which mayconflict with our interests.***

Conflicts ofinterest exist and may arise in the future as a result of the relationshipsbetween us and our affiliates, including HLND’s general partner, on the onehand, and HLND and its limited partners, on the other hand. The directors andofficers of HLND’s general partner have fiduciary duties to manage HLND in amanner beneficial to us, its owner. At the same time, HLND’s general partnerhas a fiduciary duty to manage HLND in a manner beneficial to HLND and itslimited partners. The board of directors of HLND’s general partner will resolveany such conflict and has broad latitude to consider the interests of allparties to the conflict. The resolution of these conflicts may not always be inour best interest or that of our unitholders. For example, conflicts ofinterest may arise in the following situations:

·                                          theallocation of shared overhead expenses to HLND and us;

·                                          the termsand conditions of any contractual agreements between us and our affiliates, onthe one hand, and HLND, on the other hand;

·                                          theinterpretation and enforcement of contractual obligations between us and ouraffiliates, on the one hand, and HLND, on the other hand;

·                                          thedetermination of the amount of cash to be distributed to HLND’s unitholders andthe amount of cash to be reserved for the future conduct of HLND’s business;

·                                          the decisionwhether HLND should make acquisitions and on what terms; and

·                                          thedetermination of whether HLND should use cash on hand, borrow or issue equityto raise cash to finance acquisitions or expansion capital projects, repayindebtedness, meet working capital needs, pay distributions to HLND’sunitholders or otherwise.

***Thefiduciary duties of our general partner’s officers and directors may conflictwith those of HLND GP, LLC, HLND’s general partner.***

Conflicts ofinterest may arise because of the relationships between HLND’s general partner,HLND and us. Our general partner’s directors and officers have fiduciary dutiesto manage our business in a manner beneficial to us, our unitholders and theowners of our general partner. Some of our general partner’s directors and allof its officers are also directors and officers of HLND’s general partner, andhave fiduciary duties to manage the business of HLND in a manner beneficial toHLND and HLND’s unitholders. The resolution of these conflicts may not alwaysbe in our best interest or that of our unitholders.

***Ourpartnership agreement limits our general partner’s fiduciary duties to us andour unitholders and restricts the remedies available to our unitholders foractions taken by our general partner that might otherwise constitute breachesof fiduciary duty.***

Our partnershipagreement contains provisions that reduce the standards to which our generalpartner would otherwise be held by state fiduciary duty law. For example, ourpartnership agreement:

·                                          permits ourgeneral partner to make a number of decisions in its individual capacity, asopposed to in its capacity as our general partner. This entitles our generalpartner to consider only the interests and factors that it desires, and it hasno duty or obligation to give any consideration to any interest of, or factorsaffecting, us, our affiliates or any limited partner. Examples include theexercise of our general partner’s limited call right, its rights to vote ortransfer the units it owns, its registration rights and its determinationwhether or not to consent to any merger or consolidation of our partnership oramendment to our partnership agreement;

·                                          providesthat our general partner will not have any liability to us or our unitholdersfor decisions made in its capacity as a general partner so long as it acted ingood faith, meaning it believed the decisions were in the best interests of ourpartnership;

·                                          generallyprovides that affiliated transactions and resolutions of conflicts of interestnot approved by the audit and conflicts committees of the board of directors ofour general partner and not involving a vote of unitholders must be on terms noless favorable to us than those generally being provided to or available fromunrelated third parties or be ‘‘fair and reasonable’’ to us and that, indetermining whether a transaction or resolution is ‘‘fair and reasonable,’’ ourgeneral partner may consider the totality of the relationships among theparties involved, including other transactions that may be particularlyadvantageous or beneficial to us;

·                                          providesthat in resolving conflicts of interest, it will be presumed that in making itsdecision the general partner acted in good faith, and in any proceeding broughtby or on behalf of any limited partner or us, the person bringing orprosecuting such proceeding will have the burden of overcoming suchpresumption; and

·                                          providesthat our general partner and its officers and directors will not be liable formonetary damages to us, our limited partners for any acts or omissions unlessthere has been a final and non-appealable judgment entered by a

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court of competentjurisdiction determining that the general partner or those other persons actedin bad faith or engaged in fraud or willful misconduct or, in the case of acriminal matter, acted with knowledge that such person’s conduct was criminal.

In order to becomea limited partner of our partnership, our unitholders are required to agree tobe bound by the provisions in the partnership agreement, including the provisionsdiscussed above.

***Ourgeneral partner’s affiliates may compete with us.***

Our partnershipagreement provides that our general partner will be restricted from engaging inany business activities other than acting as our general partner and thoseactivities incidental to its ownership of interests in us. While Harold Hammand his affiliates, including Continental Resources, are prohibited throughFebruary 2010, subject to certain exceptions, from engaging in, whether byacquisition, construction, investment in debt or equity interests of any personor otherwise, the business of gathering, treating, processing andtransportation of natural gas in North America, the transportation andfractionation of NGLs in North America, and constructing, buying or selling anyassets related to the foregoing businesses, nothing prohibits Harold Hamm orhis affiliates, including Continental Resources, from competing with us inother business opportunities. If Harold Hamm and his affiliates compete with usor HLND, our results of operations and cash available for distribution may beadversely affected.

***Ourability to obtain debt financing will be affected by HLND’s and HPGPGP’s creditratings.***

If we decide toobtain our own credit rating, any future downgrading of HLND’s or HPGP GP’scredit rating would likely also result in a downgrading of our credit rating.Regardless of whether we have our own credit rating, a downgrading of HLND’s orHPGP GP’s credit rating could limit our ability to obtain financing in thefuture upon favorable terms, if at all.

***Allof our executive officers face conflicts in the allocation of their time to ourbusiness.***

Our generalpartner shares officers and administrative personnel with HLND’s generalpartner to operate both our business and HLND’s business. Our general partner’sofficers, who are also the officers of HLND’s general partner, will allocatethe time they and our general partner’s other employees spend on our behalf andon behalf of HLND. These officers face conflicts regarding the allocation oftheir and our other employees’ time, which may adversely affect our or HLND’sresults of operations, cash flows and financial condition. These allocationsmay not necessarily be the result of arm’s-length negotiations between HLND’sgeneral partner and our general partner.

***Ourgeneral partner has a limited call right that may require you to sell yourcommon units at an undesirable time or price.***

If at any timemore than 80% of our outstanding common units are owned by our general partnerand its affiliates, our general partner will have the right, but not theobligation, which it may assign to any of its affiliates or to us, to acquireall, but not less than all, of the remaining common units held by unaffiliatedpersons at a price not less than their then-current market price. As a result,you may be required to sell your common units at an undesirable time or priceand may not receive any return on your investment. You may also incur a taxliability upon a sale of your common units. Affiliates of our general partnerown 62.7% of our total common units.

**Tax Risksto Our Common Unitholders**

***If weor HLND were treated as a corporation for federal income tax purposes, or if weor HLND were to become subject to a material amount of entity level taxationfor state tax purposes, then our cash available for distribution to you wouldbe substantially reduced.***

The value of ourinvestment in HLND depends largely on HLND being treated as a partnership forfederal income tax purposes, which requires that 90% or more of HLND’s grossincome for every taxable year consist of qualifying income, as defined inSection 7704 of the Internal Revenue Code. HLND may not meet this requirementor current law may change so as to cause, in either event, HLND to be treatedas a corporation for federal income tax purposes or otherwise subject tofederal income tax. Moreover, the anticipated after-tax benefit of aninvestment in our common units depends largely on our being treated as apartnership for federal income tax purposes. We have not requested, and do notplan to request, a ruling from the Internal Revenue Services, or IRS, on thisor any other matter affecting us. If HLND were treated as a corporation forfederal income tax purposes, it would pay federal income tax on its taxableincome at the corporate tax rate, which is currently a maximum of 35%.Distributions to us would generally be taxed again as corporate distributions,and no income, gains, losses, deductions or credits would flow through to us.As a result, there would be a material reduction in our anticipated cash flowand distributions to you, likely causing a substantial reduction in the valueof our units. If we were treated as a corporation for federal income taxpurposes, we would pay federal income tax on our taxable income at thecorporate tax rate. Distributions to you would generally be taxed again ascorporate distributions, and no income, gains, losses, deductions or creditswould flow through to you. Because a tax would be imposed upon us as acorporation, our cash available for distribution to you would be substantiallyreduced. Thus, treatment of us as a corporation would result in a materialreduction in our anticipated cash flow, likely causing a substantial reductionin the value of our units. Current law may change, causing us or HLND to betreated as a corporation for federal income tax purposes or otherwisesubjecting us or HLND to entity level taxation. Because of widespread statebudget deficits and other reasons, several states are evaluating ways tosubject partnerships to entity level taxation

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through the imposition ofstate income, franchise or other forms of taxation. In 2008, HLND must beginpaying a new annual entity level tax imposed by the State of Texas on a portionof its prior year revenue. Imposition of such a tax on us or HLND by Texas, orany other state, will reduce our cash available for distribution to you. HLND’spartnership agreement provides that if a law is enacted or existing law ismodified or interpreted in a manner that subjects HLND to taxation as acorporation or otherwise subjects HLND to entity-level taxation for federal,state or local income tax purposes, the minimum quarterly distribution amountand the target distribution amounts will be adjusted to reflect the impact ofthat law on HLND. Likewise, our cash distributions will be reduced if we orHLND are subjected to any form of an entity-level taxation.

***Ifthe IRS contests the federal income tax positions we or HLND take, the marketfor our common units or HLND’s limited partner units may be adversely impacted,and the costs of any contest will reduce cash available for distribution to ourunitholders.***

We have notrequested a ruling from the IRS with respect to our treatment as a partnershipfor federal income tax purposes or any other matter that affects us. Moreover,HLND has not requested any ruling from the IRS with respect to its treatment asa partnership for federal income tax purposes or any other matter that affectsit. The IRS may adopt positions that differ from the positions we or HLND take.It may be necessary to resort to administrative or court proceedings to sustainsome or all of the positions we or HLND take. A court may disagree with some orall of the positions we or HLND take. Any contest with the IRS may materiallyand adversely impact the market for our common units or HLND units and theprice at which they trade. In addition, the cost of any contest between HLNDand the IRS will result in a reduction in cash available for distribution toHLND unitholders and thus indirectly by us, as a unitholder and as the owner ofthe general partner of HLND. Moreover, the costs of any contest between us andthe IRS will result in a reduction in cash available for distribution to ourunitholders and thus will be borne indirectly by our unitholders.

***Youmay be required to pay taxes on income from us even if you do not receive anycash distributions from us.***

Because ourunitholders will be treated as partners to whom we will allocate taxable incomewhich could be different in amount than the cash we distribute, you will berequired to pay any federal income taxes and, in some cases, state and localincome taxes on your share of our taxable income, whether or not you receivecash distributions from us. You may not receive cash distributions from usequal to your share of our taxable income or even equal to the tax liabilitythat results from the taxation of your share of our taxable income.

***Taxgain or loss on disposition of our common units could be more or less than expected.***

If you sell yourcommon units, you will recognize a gain or loss equal to the difference betweenthe amount realized and the adjusted tax basis in those common units. Priordistributions to you in excess of the total net taxable income allocated to you,which decreased the tax basis in your common units, will, in effect, becometaxable income to you if the common units are sold at a price greater than yourtax basis in those common units, even if the price is less than the originalcost. A substantial portion of the amount realized, whether or not representinggain, may be ordinary income to you. In addition, if you sell your units, youmay incur a tax liability in excess of the amount of cash you receive from thesale.

***Tax-exemptentities and foreign persons face unique tax issues from owning common unitsthat may result in adverse tax consequences to them.***

Investment incommon units by tax-exempt entities, including employee benefit plans andindividual retirement accounts (known as IRAs) and non-U.S. persons raisesissues unique to them. For example, virtually all of our income allocated toorganizations exempt from federal income tax, including IRAs and otherretirement plans, will be unrelated business taxable income and will be taxableto such a unitholder. Distributions to non-U.S. persons will be reduced bywithholding taxes imposed at the highest effective applicable tax rate, andnon-U.S. persons will be required to file United States federal income taxreturns and pay tax on their share of our taxable income.

***Wetreat each purchaser of our common units as having the same tax benefitswithout regard to the common units purchased. The IRS may challenge thistreatment, which could adversely affect the value of our common units.***

Because we cannotmatch transferors and transferees of common units, we will adopt depreciationand amortization positions that may not conform with all aspects of existingTreasury Regulations. A successful IRS challenge to those positions couldadversely affect the amount of tax benefits available to our unitholders. Italso could affect the timing of these tax benefits or the amount of gain on thesale of common units and could have a negative impact on the value of ourcommon units or result in audits of and adjustments to our unitholders’ taxreturns.

***Thesale or exchange of 50% or more of our capital and profits interests during anytwelve-month period will result in the termination of our partnership forfederal income tax purposes.***

We will beconsidered to have terminated our partnership for federal income tax purposesif there is a sale or exchange of 50% or more of the total interests in ourcapital and profits within a twelvemonth period. Likewise, HLND will beconsidered to have terminated its partnership for federal income tax purposesif there is a sale or exchange of 50% or more of the total interests in HLND’scapital and profits within a twelve-month period. A termination would, amongother things, result in the closing of our taxable year for all unitholders andcould result in a deferral of depreciation deductions allowable in computingour taxable income or

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HLND’s taxable income forthe year in which the termination occurs. Thus, if this occurs you will beallocated an increased amount of federal taxable income for the year in whichwe are considered to be terminated as a percentage of the cash distributed toyou with respect to that period. Although the amount of increase cannot beestimated because it depends upon numerous factors including the timing of thetermination, the amount could be material. Our termination, or the terminationof HLND, currently would not affect our classification, or the classificationof HLND, as a partnership for federal income tax purposes, but instead, we orHLND would be treated as a new partnership for tax purposes. If treated as anew partnership, we must make new elections and could be subject to penaltiesif we are unable to determine that a termination occurred.

***Youwill likely be subject to state and local taxes and return filing requirementsin states where you do not live as a result of investing in our common units.***

In addition tofederal income taxes, our unitholders will likely be subject to other taxes,including state and local taxes, unincorporated business taxes and estate,inheritance or intangible taxes that are imposed by the various jurisdictionsin which we or HLND do business or own property now or in the future, even ifour unitholders do not reside in any of those jurisdictions. Our unitholderslikely will be required to file state and local income tax returns and paystate and local income taxes in some or all of these jurisdictions. Further,unitholders may be subject to penalties for failure to comply with thoserequirements. It is the responsibility of each unitholder to file all UnitedStates federal, state and local tax returns that may be required of suchunitholder. Our counsel has not rendered an opinion on the state or local taxconsequences of an investment in our common units.

**Item2. Unregistered Sales of Equity Securities and Use of Proceeds**

As described inNote 2: Initial Public Offering, included in the Notes to the ConsolidatedFinancial Statements (Unaudited) included under Part I, Item 1, whichinformation is incorporated by reference into this item, we issued 13,550,000common units and Class B common units in us to the Contributing Parties inconnection with our formation and initial public offering.  In so doing, we relied on the exemption fromregistration provided by Section 4(2) of the Securities Act of 1933, asamended.

On September 25,2006, we received net proceeds of $137.8 million from the sale of 8,050,000common units in our initial public offering, after deducting underwritingdiscounts and commissions, the structuring fee payable to certain of ourunderwriters and offering expenses payable by us of approximately $11.1million. We used the net proceeds from this offering to repay approximately$36.0 million of outstanding debt of the general partner of Hiland Partners andto make a $101.8 million distribution to the Contributing Parties, includingMr. Hamm and certain members of management. The cash distributed to theContributing Parties was distributed as follows: (1) $57.5 million to Mr. Hamm,(2) $24.1 million to the Harold Hamm DST Trust, (3) $16.1 million to the HaroldHamm HJ Trust, (4) $2.9 million to Randy Moeder and (5) $1.2 million to KenMaples.

**Item3. Defaults Upon Senior Securities**

None.

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

None.

**Item5. Other Matters**

None.

**Item6. Exhibits**
| Exhibit  Number | ** ** | **Description**                                                                                                                                                             |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 1.1             | —     | Underwriting Agreement by and between Hiland  Holdings GP, LP and Lehman Brothers Inc., as representative of the  underwriters named therein dated as of September 19, 2006 |
| 3.1             | —     | Amended and Restated Agreement of Limited  Partnership of Hiland Holdings dated as of September 25, 2006                                                                    |
| 3.2             | —     | Amended and Restated Limited Liability Company  Agreement of Hiland Partners GP Holdings, LLC dated as of September 25, 2006                                      |
| 31.1            | —     | Certification of Chief Executive Officer under  Section 302 of the Sarbanes-Oxley Act of 2002                                                                          |
| 31.2            | —     | Certification of Chief Financial Officer under  Section 302 of the Sarbanes-Oxley Act of 2002                                                                          |
| 32.1            | —     | Certification of Chief Executive Officer under  Section 906 of the Sarbanes-Oxley Act of 2002                                                                          |
| 32.2            | —     | Certification of Chief Financial Officer under  Section 906 of the Sarbanes-Oxley Act of 2002                                                                          |

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**SIGNATURES**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized in the city of Enid, Oklahoma, onthe 13th day of November, 2006.
|            | ** ** | **HILAND HOLDINGS GP, LP**                |
|------------|------------|-------------------------------------------|
|       |       |                                      |
| ** ** | ** ** | **By: Hiland Partners GP Holdings, LLC,** |
| ** ** | ** ** | ** its general partner**             |
|       |       | By:                                       | /s/ Randy Moeder |
|       |       |                                      | Randy Moeder |
|       |       |                                      | Chief Executive Officer, President and Director |
|       |       |                                      |   |
|       |       | By:                                       | /s/ Ken Maples |
|       |       |                                      | Ken Maples |
|       |       |                                      | Chief Financial Officer, Vice President—Finance, |
|       |       |                                      | Secretary and Director |

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**Exhibit Index**
| 1.1    | — | Underwriting Agreement by and between Hiland  Holdings GP, LP and Lehman Brothers Inc., as representative of the  underwriters named therein dated as of September 19, 2006 |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                        |
| 3.1    | — | Amended and Restated Agreement of Limited  Partnership of Hiland Holdings dated as of September 25, 2006                                                                    |
|   |   |                                                                                                                                                                        |
| 3.2    | — | Amended and Restated Limited Liability Company  Agreement of Hiland Partners GP Holdings, LLC dated as of September 25,  2006                                          |
|   |   |                                                                                                                                                                        |
|   |   |                                                                                                                                                                        |
| 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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