**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

** **

**x****  QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FORTHE QUARTERLY PERIOD ENDED MARCH 31, 2008**

 

**OR**

 

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

 

**FORTHE TRANSITION PERIODFROM             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)           |

 

**(580)242-6040**

(Registrant’stelephone number including area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days Yes     x   No     o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of“large accelerated filer,” “accelerated filer,” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer o                      |   | Accelerated filer x          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer o                        |   | Smaller reporting  company o |
| (Do not check if a  smaller reporting company) |   |                              |

 

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

 

The number of theregistrant’s outstanding equity units at May 5, 2008 was 21,603,000 commonunits.

 

 

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**HILAND****HOLDINGS GP****, LP**

**INDEX**

 
| **PART I. FINANCIAL INFORMATION**                                                               | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------|
| Item 1. Financial Statements (Unaudited, except  December 31, 2007 Balance Sheet)               |       |       |
| Consolidated Balance Sheets                                                                          |       | 3          |
| Consolidated Statements of Operations                                                                |       | 4          |
| Consolidated Statements of Cash Flows                                                                |       | 5          |
| Consolidated Statement of Changes in Partners’ Equity  and Comprehensive Income                 |       | 6          |
| Condensed  Notes to Consolidated Financial Statements                                                |       | 7          |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations |       | 25         |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risks                                 |       | 37         |
| Item 4. Controls and Procedures                                                                      |       | 38         |
| **PART II.  OTHER INFORMATION**                                                                 | ** ** | 39         |
| Item  1. Legal Proceedings                                                                           |       | 39         |
| Item 1A. Risk Factors                                                                                |       | 39         |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                 |       | 39         |
| Item 3. Defaults Upon Senior Securities                                                              |       | 39         |
| Item 4. Submission of Matters to a Vote of Security  Holders                                         |       | 39         |
| Item  5. Other Information                                                                           |       | 39         |
| Item 6. Exhibits                                                                                     |       | 39         |
| SIGNATURES                                                                                           |       | 40         |
| 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, LPConsolidated Balance Sheets**

 
| ** **                                                    | ** ** | **March 31,**                                          | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------|------------|-------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                    | ** ** | **2008**                                                    | ** ** | **2007**              | ** ** |
| ** **                                                    | ** ** | **(unaudited)**                                             | ** ** | ** **            | ** ** |
| ** **                                                    | ** ** | **(in thousands, except unit amounts)** | ** ** |
| **ASSETS**                                                    |       |                                                        |       |                  |       |
| **Current  assets:**                                          |       |                                                        |       |                  |       |
| Cash and cash  equivalents                                    |       | $                                                           | 11,483     |                  | $          | 10,602 |   |
| Accounts  receivable:                                         |       |                                                        |       |                  |       |
| Trade                                                         |       | 37,411                                                      |       | 31,842                |       |
| Affiliates                                                    |       | 1,098                                                       |       | 1,178                 |       |
|                                                          |       | 38,509                                                      |       | 33,020                |       |
| Fair value of  derivative assets                              |       | 1,050                                                       |       | 2,718                 |       |
| Other current  assets                                         |       | 2,730                                                       |       | 1,420                 |       |
| Total current  assets                                         |       | 53,772                                                      |       | 47,760                |       |
|                                                          |       |                                                        |       |                  |       |
| Property and  equipment, net                                  |       | 323,552                                                     |       | 323,073               |       |
| Intangibles, net                                              |       | 45,398                                                      |       | 46,937                |       |
| Fair value of  derivative assets                              |       | 594                                                         |       | 418                   |       |
| Other assets,  net                                            |       | 2,355                                                       |       | 2,098                 |       |
|                                                          |       |                                                        |       |                  |       |
| **Total  assets**                                             |       | $                                                           | 425,671    |                  | $          | 420,286 |   |
|                                                          |       |                                                        |       |                  |       |
| **LIABILITIES  AND PARTNERS’ EQUITY**                    | ** ** | ** **                                                  | ** ** | ** **            | ** ** |
| **Current  liabilities:**                                     |       |                                                        |       |                  |       |
| Accounts payable                                              |       | $                                                           | 26,105     |                  | $          | 24,713 |   |
| Accounts  payable-affiliates                                  |       | 10,638                                                      |       | 7,957                 |       |
| Fair value of  derivative liabilities                         |       | 7,748                                                       |       | 8,238                 |       |
| Accrued  liabilities and other                                |       | 2,593                                                       |       | 2,075                 |       |
| Total current  liabilities                                    |       | 47,084                                                      |       | 42,983                |       |
|                                                          |       |                                                        |       |                  |       |
| Commitments and  contingencies (Note 8)                       |       |                                                        |       |                  |       |
| Long-term debt,  net of current maturities                    |       | 235,307                                                     |       | 226,459               |       |
| Fair value of  derivative liabilities                         |       | —                                                      |       | 141                   |       |
| Asset retirement  obligation                                  |       | 2,191                                                       |       | 2,159                 |       |
| Minority  interests                                           |       | 123,856                                                     |       | 126,409               |       |
|                                                          |       |                                                        |       |                  |       |
| **Partners’  equity**                                    |       |                                                        |       |                  |       |
| Common  unitholders (21,603,000 units issued and outstanding) |       | 20,925                                                      |       | 25,560                |       |
| Accumulated  other comprehensive loss                         |       | (3,692                                                      | )          | (3,425                | )          |
| **Total  partners’ equity**                              |       | 17,233                                                      |       | 22,135                |       |
|                                                          |       |                                                        |       |                  |       |
| **Total  liabilities and partners’ equity**              |       | $                                                           | 425,671    |                  | $          | 420,286 |   |

 

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

 

3

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**HILANDHOLDINGS GP, LP**

**Consolidated Statements of Operations**

**Forthe Three Months Ended (unaudited)**

** **
| ** **                                                                   | ** ** | **March 31,**                                                   | ** ** | **March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                   | ** ** | **2008**                                                             | ** ** | **2007**           | ** ** |
| ** **                                                                   | ** ** | **(in thousands, except per unit amounts)** | ** ** |
| **Revenues:**                                                                | ** ** | ** **                                                           | ** ** | ** **         | ** ** |
| Midstream  operations                                                        |       |                                                                 |       |               |       |
| Third parties                                                                |       | $                                                                    | 89,253     |               | $          | 58,860 |   |
| Affiliates                                                                   |       | 1,021                                                                |       | 989                |       |
| Compression  services, affiliate                                             |       | 1,205                                                                |       | 1,205              |       |
| Total revenues                                                               |       | 91,479                                                               |       | 61,054             |       |
| **Operating  costs and expenses:**                                           | ** ** | ** **                                                           | ** ** | ** **         | ** ** |
| Midstream  purchases (exclusive of items shown separately below)             |       | 42,451                                                               |       | 31,881             |       |
| Midstream  purchases -affiliate (exclusive of items shown separately below)  |       | 26,167                                                               |       | 11,734             |       |
| Operations and  maintenance                                                  |       | 6,769                                                                |       | 4,970              |       |
| Depreciation,  amortization and accretion                                    |       | 9,216                                                                |       | 7,028              |       |
| General and  administrative expenses                                         |       | 2,684                                                                |       | 2,045              |       |
| Total operating  costs and expenses                                          |       | 87,287                                                               |       | 57,658             |       |
| Operating income                                                             |       | 4,192                                                                |       | 3,396              |       |
| **Other  income (expense):**                                                 | ** ** | ** **                                                           | ** ** | ** **         | ** ** |
| Interest and  other income                                                   |       | 104                                                                  |       | 127                |       |
| Amortization of  deferred loan costs                                         |       | (156                                                                 | )          | (110               | )          |
| Interest expense                                                             |       | (3,506                                                               | )          | (2,091             | )          |
| Other income  (expense), net                                                 |       | (3,558                                                               | )          | (2,074             | )          |
| **Income  before minority interest in loss (income) of Hiland Partners, LP** |       | 634                                                                  |       | 1,322              |       |
| Minority  interest in loss (income) of Hiland Partners, LP                   |       | 206                                                                  |       | (574               | )          |
| **Net  income**                                                              |       | $                                                                    | 840        |               | $          | 748 |   |
| ** **                                                                   | ** ** | ** **                                                           | ** ** | ** **         | ** ** |
| **Net  income per limited partners’ unit - basic**                      |       | $                                                                    | 0.04       |               | $          | 0.03 |   |
| **Net  income per limited partners’ unit -diluted**                     |       | $                                                                    | 0.04       |               | $          | 0.03 |   |
| **Weighted  average limited partners’ units outstanding - basic**       |       | 21,603                                                               |       | 21,600             |       |
| **Weighted  average limited partners’ units outstanding - diluted**     |       | 21,609                                                               |       | 21,605             |       |

 

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

 

4

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**HILAND HOLDINGS GP, LP**

**ConsolidatedStatements of Cash Flows**

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

** **
| ** **                                                                  | ** ** | **March 31,**      | ** ** | **March 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------|------------|--------------------|------------|
| ** **                                                                  | ** ** | **2008**                | ** ** | **2007**           | ** ** |
| ** **                                                                  | ** ** | **(in thousands)** | ** ** |
| **Cash  flows from operating activities:**                                  |       |                    |       |               |       |
| Net income                                                                  |       | $                       | 840        |               | $          | 748 |   |
| Adjustments to  reconcile net income to net cash provided by                |       |                    |       |               |       |
| operating  activities:                                                      |       |                    |       |               |       |
| Depreciation and  amortization                                              |       | 9,184                   |       | 7,009              |       |
| Accretion of  asset retirement obligation                                   |       | 32                      |       | 19                 |       |
| Amortization of  deferred loan cost                                         |       | 156                     |       | 110                |       |
| Loss (gain) on  derivative transactions                                     |       | 401                     |       | (69                | )          |
| Unit based  compensation                                                    |       | 409                     |       | 464                |       |
| Increase in  other assets                                                   |       | (91                     | )          | —             |       |
| Minority  interest in income (loss) of Hiland Partners, LP                  |       | (206                    | )          | 574                |       |
| (Increase)  decrease in current assets:                                     |       |                    |       |               |       |
| Accounts  receivable - trade                                                |       | (5,569                  | )          | (783               | )          |
| Accounts  receivable - affiliates                                           |       | 80                      |       | 93                 |       |
| Other current assets                                                        |       | (1,310                  | )          | 104                |       |
| Increase  (decrease) in current liabilities:                                |       |                    |       |               |       |
| Accounts payable  - trade                                                   |       | 3,665                   |       | 587                |       |
| Accounts payable  - affiliates                                              |       | 2,681                   |       | 130                |       |
| Accrued  liabilities and other                                              |       | 473                     |       | (45                | )          |
| **Net  cash provided by operating activities**                              |       | 10,745                  |       | 8,941              |       |
| **Cash  flows from investing activities:**                                  |       |                    |       |               |       |
| Additions to  property and equipment                                        |       | (10,403                 | )          | (16,538            | )          |
| Proceeds from  disposals of property and equipment                          |       | 6                       |       | —             |       |
| **Net  cash used in investing activities**                                  |       | (10,397                 | )          | (16,538            | )          |
| **Cash  flows from financing activities:**                                  |       |                    |       |               |       |
| Proceeds from  long-term borrowings                                         |       | 9,000                   |       | 12,100             |       |
| Payments on  Capital lease obligations                                      |       | (107                    | )          | —             |       |
| Debt issuance  costs                                                        |       | (317                    | )          | —             |       |
| Public offering  costs                                                      |       | (7                      | )          | (142               | )          |
| Proceeds from  Hiland Partners, LP unit options exercise                    |       | 611                     |       | 969                |       |
| Minority interest  cash distributions to unitholders of Hiland Partners, LP |       | (3,134                  | )          | (2,767             | )          |
| Cash  distributions to unitholders                                          |       | (5,513                  | )          | (4,484             | )          |
| ** **                                                                  |       |                    |       |               |       |
| **Net  cash provided by financing activities**                              |       | 533                     |       | 5,676              |       |
|                                                                        |       |                    |       |               |       |
| Increase  (decrease) for the period                                         |       | 881                     |       | (1,921             | )          |
| Beginning of  period                                                        |       | 10,602                  |       | 10,569             |       |
| **End of  period**                                                          |       | $                       | 11,483     |               | $          | 8,648 |   |
| Supplementary  information                                                  |       |                    |       |               |       |
| Cash paid for  interest, net of amounts capitalized                         |       | $                       | 3,226      |               | $          | 2,072 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements

 

5

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**Hiland Holdings GP, LP**

**ConsolidatedStatement of Changes in Partners’ Equity and Comprehensive Income**

**For the Three Months Ended March 31, 2008(unaudited)**

** **
| ** **                                                                           | ** ** | ** **         | ** ** | **Accumulated**   | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------|------------|-------------------|------------|------------|------------|-------------------|------------|
| ** **                                                                           | ** ** | ** **         | ** ** | **Other**         | ** ** | ** ** | ** ** | **Total**         | ** ** |
| ** **                                                                           | ** ** | **Common**         | ** ** | **Comprehensive** | ** ** | ** ** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                           | ** ** | **Units**          | ** ** | **(loss)**        | ** ** | **Total**  | ** ** | **Income**        | ** ** |
| ** **                                                                           | ** ** | **(in thousands)** | ** ** |
|                                                                                 |       |               |       |              |       |       |       |              |       |
| **Balance January 1, 2008**                                                     |       | $                  | 25,560     |              | $          | (3,425     | )          | $                 | 22,135     |   |   |   |
|                                                                                 |       |               |       |              |       |       |       |              |       |
| Periodic cash distributions                                                          |       | (5,513             | )          | —            |       | (5,513     | )          |              |       |
| Unit based compensation                                                              |       | 38                 |       | —            |       | 38         |       |              |       |
| Other comprehensive income reclassified to income on closed  derivative transactions |       | —             |       | 1,233             |       | 1,233      |       | $                 | 1,233      |   |
| Change in fair value of derivatives                                                  |       | —             |       | (1,500            | )          | (1,500     | )          | (1,500            | )          |
| Net income                                                                           |       | 840                |       | —            |       | 840        |       | 840               |       |
| Comprehensive income                                                                 |       |               |       |              |       |       |       | $                 | 573        |   |
| **Balance March 31, 2008**                                                      |       | $                  | 20,925     |              | $          | (3,692)    |       | $                 | 17,233     |   |   |   |

 

The accompanying notes are an integral part of this consolidatedfinancial statement.

 

6

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** **

**HILANDHOLDINGS GP, LP**

**CONDENSED NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS (UNAUDITED)**

**THREEMONTHS ENDED MARCH 31, 2008 and 2007**

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

 

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

 

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

 

Hiland Holdings GP, LP, aDelaware limited partnership, was formed in May 2006 to own HilandPartners GP, LLC, the general partner of Hiland Partners, LP and certain othercommon and subordinated units in Hiland Partners. Hiland Partners GP, LLC wasformed in October 2004 to hold the 2% general partner ownership interestin Hiland Partners and serve as its general partner. Hiland Partners GP, LLCmanages the operations of Hiland Partners. In connection with the closing ofour initial public offering, all of the membership interests in Hiland PartnersGP, LLC were contributed to us. Hiland Partners GP, LLC constitutes ourpredecessor.

 

Our general partner, HilandPartners GP Holdings, LLC manages our operations and activities, including,among other things, paying our expenses and establishing the quarterly cashdistribution levels for our common units and reserves that our general partnerdetermines, in good faith, are necessary or appropriate to provide for theconduct of our business, to comply with applicable law, any of our debtinstruments or other agreements or to provide for future distributions to ourunitholders for any one or more of the upcoming four quarters.

 

Hiland Partners, aDelaware limited partnership, was formed in October 2004 to acquire andoperate certain midstream natural gas plants, gathering systems and compressionand water injection assets located in the states of Oklahoma, North Dakota,Wyoming, Texas and Mississippi that were previously owned by Continental Gas, Inc.and Hiland Partners, LLC. Hiland Partners commenced operations on February 15,2005, and concurrently with the completion of its initial public offering,Continental Gas, Inc. contributed a substantial portion of its net assetsto Hiland Partners. The transfer of ownership of net assets from ContinentalGas, Inc. to Hiland Partners represented a reorganization of entitiesunder common control and was recorded at historical cost. Continental Gas, Inc.was formed in 1990 as a wholly owned subsidiary of Continental Resources, Inc.

 

Continental Gas, Inc.operated in one segment, midstream, which involved the gathering, compressing,dehydrating, treating, and processing of natural gas and fractionating naturalgas liquids, or NGLs. Continental Gas, Inc. historically has owned all ofHiland Partners’ natural gas gathering, processing, treating and fractionationassets other than the Worland,  Bakkenand Woodford Shale gathering systems. Hiland Partners, LLC historically ownedthe Worland gathering system and compression services assets, which HilandPartners acquired on February 15, 2005, and the Bakken gathering system.The net assets acquired by Hiland Partners on February 15, 2005 had a fairvalue of $48.6 million. Since its initial public offering, Hiland Partnershas operated in midstream and compression services segments. On September 26,2005, Hiland Partners acquired Hiland Partners, LLC, which at such time ownedthe Bakken gathering system, for $92.7 million, $35.0 million ofwhich was used to retire outstanding Hiland Partners, LLC indebtedness. On May 1,2006, Hiland Partners acquired the Kinta Area gathering assets from Enogex GasGathering, L.L.C., consisting of certain eastern Oklahoma gas gatheringassets, for $96.4 million.  HilandPartners financed this acquisition with $61.2 million of borrowings from itscredit facility and $35.0 million of proceeds from the issuance to HilandPartners GP, LLC, its general partner, of 761,714 common units and 15,545general partner equivalent units, both at $45.03 per unit. Hiland Partnersbegan construction of the Woodford Shale gathering system in the first quarterof 2007.  As of March 31, 2008,Hiland Partners has invested approximately $25.7 million in the gatheringsystem.

 

The unaudited financialstatements for thethree months ended March 31, 2008 and 2007 included herein have beenprepared pursuant to the rules and regulations of the United StatesSecurities and Exchange Commission (the “SEC”). The interim financialstatements reflect all adjustments, which in the opinion of our management, arenecessary for a fair presentation of our results for the interim periods. Suchadjustments are considered to be of a normal recurring nature. Results ofoperations for the three months ended March 31, 2008 are not necessarilyindicative of the results of operations that will be realized for the yearending December 31, 2008.  Theaccompanying consolidated financial statements and notes thereto should be readin conjunction with the consolidated financial statements and notes theretoincluded in our Form 10-K for the fiscal year ended December 31,2007.

 

7

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***Principles of Consolidation***

 

Because we own thegeneral partner of Hiland Partners, the consolidated financial statementsinclude our accounts, the accounts of Hiland Partners GP, LLC and the accountsof Hiland Partners and its subsidiaries. All significant intercompanytransactions and balances have been eliminated.

 

***Use of Estimates***

 

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

 

***Fair Value of Financial Instruments***

 

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

 

***Commodity Risk Management***

 

We engage in price riskmanagement activities in order to minimize the risk from market fluctuation inthe prices of natural gas and NGLs. To qualify as an accounting hedge, theprice movements in the commodity derivatives must be highly correlated with theunderlying hedged commodity. Gains and losses related to commodity derivativesthat qualify as accounting hedges are recognized in income when the underlyinghedged physical transaction closes and are included in the consolidatedstatements of operations as revenues from midstream operations. Gains andlosses related to commodity derivatives that are not designated as accountinghedges or do not qualify as accounting hedges are recognized in incomeimmediately, and are included in revenues from midstream operations in theconsolidated statement of operations.

 

SFAS No. 133, asamended, establishes accounting and reporting standards for derivativeinstruments, including certain derivative instruments embedded in othercontracts, and for hedging activities. SFAS No. 133 requires that anentity recognize all derivatives as either assets or liabilities in thestatement of financial position and measure those instruments at fair value.However, if a derivative does qualify for hedge accounting, depending on thenature of the hedge, changes in fair value can be offset against the change infair value of the hedged item through earnings or recognized in othercomprehensive income until such time as the hedged item is recognized inearnings. To qualify for cash flow hedge accounting, the cash flows from thehedging instrument must be highly effective in offsetting changes in cash flowsdue to changes in the underlying item being hedged. In addition, all hedgingrelationships must be designated, documented and reassessed periodically. SFAS No. 133also provides that normal purchases and normal sales contracts are not subjectto the statement. Normal purchases and normal sales are contracts that providefor the purchase or sale of something other than a financial instrument orderivative instrument that will be delivered in quantities expected to be usedor sold by the reporting entity over a reasonable period in the normal courseof business. Our fixed price physical forward natural gas sales contract inwhich we have contracted to sell natural gas quantities at a fixed price isdesignated as a normal sale. This forward sales contract expires on December 31,2008.

 

Currently, our derivativefinancial instruments that qualify for hedge accounting are designated as cashflow hedges. The cash flow hedge instruments hedge the exposure of variabilityin expected future cash flows that is attributable to a particular risk. Theeffective portion of the gain or loss on these derivative instruments isrecorded in accumulated other comprehensive income in partners’ equity andreclassified 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 or liabilities.Any ineffective portion of the gain or loss is recognized in earningsimmediately.

 

8

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***Comprehensive Income***

 

Comprehensive incomeincludes net income and other comprehensive income, which includes, but is notlimited to, changes in the fair value of derivative financial instruments.Pursuant to SFAS No. 133, for derivatives qualifying as accounting hedges,the effective portion of changes in fair value are recognized in partners’equity as accumulated other comprehensive income and reclassified to earningswhen the underlying hedged physical transaction closes, to the extent of ourinterest in Hiland Partners. Our comprehensive income for the three monthsended March 31, 2008 and 2007 is presented in the table below:

 

| ** **                                               | ** ** | **For the Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                               | ** ** | **2008**                                                               | ** ** | **2007** | ** ** |
| Net income                                               |       | $                                                                      | 840        |   | $ | 748 |   |
| Closed  derivative transactions reclassified from income |       | 1,233                                                                  |       | (332 | ) |
| Change in fair  value of derivatives                     |       | (1,500                                                                 | )          | (832 | ) |
| Comprehensive  income (loss)                             |       | $                                                                      | 573        |   | $ | (416 | ) |

 

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

 

Net income per limitedpartners’ unit is computed based on the weighted-average number of common unitsoutstanding during the period. The computation of diluted net income perlimited partner unit further assumes the dilutive effect of restricted unitawards. Net income per limited partners’ unit is computed by dividing netincome applicable to limited partners by both the basic and dilutedweighted-average number of limited partnership units outstanding.

 

***Minority Interests***

 

The minority interest onour consolidated balance sheets as of March 31, 2008 and December 31,2007 reflects the outside ownership interest of Hiland Partners. Minorityinterest in income is calculated by multiplying the minority interest owners’proportionate ownership of limited partner units in Hiland Partners by thelimited partners’ allocation of Hiland Partners’ net income. Hiland Partners’net income is allocated to its limited partners and its general partner basedon the proportionate share of the cash distributions declared for the period,with adjustments made for incentive distributions specifically allocated to itsgeneral partner. All amounts we have received from Hiland Partners’ issuanceand sale of limited partner units have been recorded as increases to theminority interest balance on the consolidated balance sheet.

 

***Contributions to Subsidiary***

 

The Partnership directlyand indirectly owns all of the equity interests in Hiland Partners GP, LLC, thegeneral partner of Hiland Partners. Hiland Partners GP, LLC is required to makecontributions to Hiland Partners each time Hiland Partners issues common unitsin order to maintain its 2% general partner ownership in Hiland Partners.Hiland Holdings or Hiland Partners GP, LLC was required to contribute $12 and$18 for the three months ended March 31, 2008 and 2007.

 

***Recent Accounting Pronouncements***

 

On March 19, 2008,the Financial Accounting Standards Board (“FASB”) issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities, an Amendmentof FASB Statement No. 133 (“SFAS 161”). SFAS 161 is intended to improvetransparency in financial reporting by requiring enhanced disclosures of anentity’s derivative instruments and hedging activities and their effects on theentity’s financial position, financial performance, and cash flows. SFAS 161 iseffective prospectively for financial statements issued for fiscal years andinterim periods beginning after November 15, 2008, with early applicationencouraged. SFAS 161 encourages, but does not require, comparative disclosuresfor periods prior to its initial adoption. SFAS 161 amends the currentqualitative and quantitative disclosure requirements for derivative instrumentsand hedging activities set forth in SFAS 133 and generally increases the levelof aggregation/disaggregation that will be required in an entity’s financialstatements. We are currently reviewing this Standard to determine the effect itwill have on our financial statements and disclosures therein.

 

On March 12, 2008,the Emerging Issues Task Force (“EITF”) reached consensus opinion on EITF IssueNo. 07-4, “Application of the two-class method under FASB Statement No. 128,Earnings per Share, to Master Limited Partnerships” 

 

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(“EITF No. 07-4”), which the FASB ratified at its March 26,2008 meeting. EITF No. 07-4 requires the calculation of a Master LimitedPartnership’s (“MLPs”) net earnings per limited partner unit for each periodpresented according to distributions declared and participation rights inundistributed earnings as if all of the earnings for that period had beendistributed. In periods with undistributed earnings above specified levels, thecalculation per the two-class method results in an increased allocation of suchundistributed earnings to the general partner and a dilution of earnings to thelimited partners. EITF No. 07-4 is effective for fiscal years beginningafter December 15, 2008, and is to be applied retrospectively to allperiods presented. Early application is not permitted. We will apply therequirements of EITF No. 07-4 as it pertains to MLPs upon its adoptionduring the quarter ended March 31, 2009.

 

In December 2007,the FASB issued SFAS No. 141(R), “Business Combinations.” This statementamends and replaces SFAS No. 141, but retains the fundamental requirementsin SFAS No. 141 that the purchase method of accounting be used for allbusiness combinations and an acquirer be identified for each businesscombination. The statement provides for how the acquirer recognizes andmeasures the identifiable assets acquired, liabilities assumed and anynon-controlling interest in the acquiree. SFAS No. 141(R) providesfor how the acquirer recognizes and measures the goodwill acquired in thebusiness combination or a gain from a bargain purchase. The statement alsodetermines what information to disclose to enable users to be able to evaluatethe nature and financial effects of the business combination. The provisions ofSFAS No. 141(R) apply prospectively to business combinations forwhich the acquisition date is on or after the beginning of the first annualreporting period beginning on or after December 15, 2008 and do not allowearly adoption. We are evaluating the new requirements of SFAS No. 141(R) andthe impact it will have on business combinations completed in 2009 orthereafter.

 

 In December 2007, the FASB issued SFAS No. 160,“Noncontrolling Interests in Consolidated Financial Statements – an amendmentof ARB No. 51.” SFAS No. 160 establishes accounting and reportingstandards that require the ownership interests in subsidiaries held by partiesother than the parent (minority interest) be clearly identified, labeled andpresented in the consolidated balance sheet within equity, but separate fromthe parent’s equity. SFAS No. 160 requires the equity amount ofconsolidated net income attributable to the parent and to the noncontrollinginterest be clearly identified and presented on the face of the consolidatedincome statement and that changes in a parent’s ownership interest while theparent retains its controlling financial interest in its subsidiary beaccounted for consistently and similarly as equity transactions. Consolidatednet income and comprehensive income will be determined without deductingminority interest; however, earnings-per-share information will continue to becalculated on the basis of the net income attributable to the parent’sshareholders. Additionally, SFAS No. 160 establishes a single method foraccounting for changes in a parent’s ownership interest in a subsidiary thatdoes not result in deconsolidation and that the parent recognize a gain or lossin net income when a subsidiary is deconsolidated. SFAS No. 160 iseffective for fiscal years beginning on or after December 15, 2008. Earlyadoption is not permitted. We do not expect this Statement will have a materialimpact on our financial position, results of operations or cash flows.

 

In February 2007,the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assetsand Financial Liabilities”. SFAS No. 159 expands opportunities to use fairvalue measurement in financial reporting and permits entities to choose tomeasure many financial instruments and certain other items at fair value. SFAS No. 159is effective for fiscal years beginning after November 15, 2007. ThisStatement was adopted by us effective January 1, 2008, at which time nofinancial assets or liabilities, not previously required to be recorded at fairvalue by other authoritative literature, were designated to be recorded at fairvalue. As such, the adoption of this Statement did not have any impact on ourfinancial position, results of operations or cash flows.

 

In September 2006,the FASB issued SFAS No. 157 “Fair Value Measurements.”  SFAS No. 157 defines fair value as theprice that would be received to sell an asset or paid to transfer a liabilityin an orderly 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.  SFAS No. 157applies to derivatives and other financial instruments, which  SFAS No 133, “Accounting for Derivative Instruments and Hedging Activities,”as amended, requires be measured at fair value at initial recognition and forall subsequent periods. SFAS No. 157 establishes a fair value hierarchywhich requires an entity to maximize the use of observable inputs and minimizethe use of unobservable inputs when measuring fair value. SFAS No. 157’shierarchy defines three levels of inputs that may be used to measure fairvalue. Level 1 refers to assets that have observable market prices, level 2assets do not have an “observable price” but do have inputs that are based onsuch prices in which components have observable data points and level 3 refersto assets in which one or more of the inputs do not have observable prices andcalibrated model parameters, valuation techniques or management’s assumptionsare used to derive the fair value. SFAS No. 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007 andinterim periods within those fiscal years. We elected to implement SFAS No. 157prospectively in the first quarter of 2008 with the one-year 

 

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deferral permitted by FASB Staff Position (FSP) 157-2 fornonfinancial assets and nonfinancial liabilities measured at fair value, exceptthose that are recognized or disclosed on a recurring basis (at leastannually). The deferral applies to nonfinancial assets and liabilities measuredat fair value in a business combination; impaired properties, plants andequipment; intangible assets and goodwill; and initial recognition of assetretirement obligations and restructuring costs for which we use fair value. Wedo not expect any significant impact to our consolidated financial statementswhen we implement SFAS No. 157 for these assets and liabilities. See Note5 “Fair Value Measurements of Financial Instruments.”

 

**Note 2: Propertyand Equipment and Asset Retirement Obligations**

 

Propertyand equipment consisted of the following for the periods indicated:

 

| ** **                                       | ** ** | **As of**     | ** ** | **As of**        | ** ** |
|--------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                                       | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Land                                             |       | $                  | 298        |                  | $          | 295 |   |
| Construction in  progress                        |       | 6,777              |       | 12,030                |       |
| Midstream  pipeline, plants and compressors      |       | 369,577            |       | 356,491               |       |
| Compression and  water injection equipment       |       | 19,310             |       | 19,258                |       |
| Other                                            |       | 4,189              |       | 3,958                 |       |
|                                             |       | 400,151            |       | 392,032               |       |
| Less:  accumulated depreciation and amortization |       | 76,599             |       | 68,959                |       |
|                                             |       | $                  | 323,552    |                  | $          | 323,073 |   |

 

During the three monthsended March 31, 2008 and 2007, we capitalized interest of $131 and $669,respectively.

 

In accordance with SFAS No. 143,“Accounting for Asset Retirement Obligations,” we have recorded the fair valueof liabilities for asset retirement obligations in the periods in which theyare incurred and corresponding increases in the carrying amounts of the relatedlong-lived assets. The asset retirement costs are subsequently allocated toexpense using a systematic and rational method and the liabilities are accretedto measure the change in liability due to the passage of time. The provisionsof this standard primarily apply to dismantlement and site restoration ofcertain of our plants and pipelines. We have evaluated our asset retirementobligations as of March 31, 2008 and have determined that revisions in thecarrying values are not necessary at this time. Asset retirement obligationstotaling $2,159 at January 1, 2008 increased to $2,191 at March 31,2008 as a result of accreting the obligation by $32.

 

**Note 3:   Intangible Assets**

 

Intangible assets consistof the acquired value of customer relationships, existing contracts to sellnatural gas and other NGLs and compression contracts, which do not havesignificant residual value. The customer relationships and the contracts arebeing amortized over their estimated lives of ten years. We review intangibleassets for impairment whenever events or circumstances indicate that thecarrying amounts may not be recoverable. If such a review should indicate thatthe carrying amount of intangible assets is not recoverable, we reduce thecarrying amount of such assets to fair value based on the discounted probablecash flows of the intangible assets. No impairments of intangible assets wererecorded during the three months ended March 31, 2008 or 2007. Intangibleassets consisted of the following at March 31, 2008 and December 31,2007:

 

| ** **                     | ** ** | **As of**     | ** ** | **As of**        | ** ** |
|--------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                     | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Gas sales  contracts           |       | $                  | 32,564     |                  | $          | 32,564 |   |
| Compression  contracts         |       | 18,515             |       | 18,515                |       |
| Customer  relationships        |       | 10,492             |       | 10,492                |       |
|                           |       | 61,571             |       | 61,571                |       |
| Less accumulated  amortization |       | 16,173             |       | 14,634                |       |
| Intangible  assets, net        |       | $                  | 45,398     |                  | $          | 46,937 |   |

 

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During each of the threemonths ended March 31, 2008 and 2007 we recorded $1,539 of amortizationexpense. Estimated aggregate amortization expense for the remainder of 2008 is$4,618 and $6,157 for each of the four succeeding fiscal years from 2009through 2012 and a total of $16,152 for all years thereafter.

 

**Note 4: Derivatives**

 

Hiland Partners hasentered into certain derivative contracts that are classified as cash flowhedges in accordance with SFAS No. 133, as amended, and relate toforecasted sales in 2008 and 2009. Hiland Partners entered into these financialswap instruments to hedge forecasted natural gas and natural gas liquids (NGLs)sales or purchases against the variability in expected future cash flowsattributable to changes in commodity prices. Under these contractual swapagreements with Hiland Partners’ counterparty, Hiland Partners receives a fixedprice and pays a floating price or pays a fixed price and receives a floatingprice based on certain indices for the relevant contract period as theunderlying natural gas or NGL is sold or purchased.

 

Hiland Partners 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. Hiland Partners assesses, both atthe inception of the hedge and on an ongoing basis, whether the derivatives arehighly effective in offsetting changes in the fair value of hedged items.Highly effective is deemed to be a correlation range from 80% to 125% of thechange in cash flows of the derivative in offsetting the cash flows of thehedged transaction. If it is determined that a derivative is not highlyeffective as a hedge or it has ceased to be a highly effective hedge, due tothe loss of correlation between changes in natural gas or NGL reference pricesunder a hedging instrument and actual natural gas or NGL prices, HilandPartners will discontinue hedge accounting for the derivative and subsequentchanges in fair value for the derivative will be recognized immediately intoearnings. Hiland Partners assesses effectiveness using regression analysis andineffectiveness using the dollar offset method.

 

Derivatives are recordedon our consolidated balance sheet as assets or liabilities at fair value. Forderivatives qualifying as hedges, the effective portion of changes in fairvalue are recognized in partners’ equity as accumulated other comprehensiveloss and reclassified to earnings when the underlying hedged physicaltransaction closes. Changes in fair value of non-qualifying derivatives and theineffective portion of qualifying derivatives are recognized in earnings asthey occur. Actual amounts that will be reclassified will vary as a result offuture changes in prices. Hedge ineffectiveness is recorded in income while thehedge contract is open and may increase or decrease until settlement of the contract.Realized cash gains and losses on closed/settled instruments and hedgeineffectiveness are reflected in the contract month being hedged as anadjustment to midstream revenue.

 

Hiland Partners did notenter into any new derivative contracts in the three months ended March 31,2008. At December 31, 2007, Hiland Partners had entered into one financialinstrument that was designated as an open trade, in which Hiland Partnersreceived a NYMEX index price less a basis differential and paid a floating pricebased on certain indices for the relevant contract period as the underlyingnatural gas was sold. This open trade financial swap instrument was notdesignated as a hedge and did not qualify for hedge accounting. On January 8,2008, Hiland Partners negotiated a fixed price on the open trade and thefinancial swap instrument now qualifies for hedge accounting. During the threemonths ended March 31, 2008, we reclassified net losses of $1,233 onclosed/settled hedge transactions to midstream revenues out of accumulatedother comprehensive income and also recorded $1,500 out of accumulated othercomprehensive income for the increase in fair value of open derivatives.Included in minority interest on the balance sheet is $2,498 of the changes inthe net fair value of derivatives during the three months ended March 31,2008 attributable to minority interest. During the three months ended March 31,2008, we recorded losses of $401 on the ineffective portions of our qualifyingopen derivative transactions. At March 31, 2008, our accumulated othercomprehensive loss related to qualifying derivatives was $(3,692). Of thisamount, we anticipate $4,046 will be reclassified from earnings during the nexttwelve months and $354 will be reclassified to earnings in subsequent periods.

 

During the three monthsended March 31, 2007 we reclassified net gains of $332 on closed/settledhedge transactions to midstream revenues out of accumulated other comprehensiveloss and also recorded $832 out of accumulated other comprehensive loss for thedecrease in fair value of open derivatives. Included in minority interest onthe balance sheet is $800 of the changes in the net fair value of derivativesduring the three months ended March 31, 2007 attributable to minorityinterest. During the three months ended March 31, 2007, Hiland Partnersrecorded a gain of $83, on the non-qualifying open trade financial instrumentand losses of $14 on the ineffective portions of qualifying open derivativetransactions.

 

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The fair value ofderivative assets and liabilities are as follows for the indicated periods:

 

| ** **                                        | ** ** | **As of**     | ** ** | **As of**        | ** ** |
|---------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                                        | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Fair value of  derivative assets - current        |       | $                  | 1,050      |                  | $          | 2,718 |   |
| Fair value of  derivative assets - long term      |       | 594                |       | 418                   |       |
| Fair value of  derivative liabilities - current   |       | (7,748             | )          | (8,238                | )          |
| Fair value of  derivative liabilities - long term |       | —             |       | (141                  | )          |
| Net fair value  of derivatives                    |       | $                  | (6,104     | )                     | $          | (5,243 | ) |

 

The terms of HilandPartners’ derivative contracts currently extend out as far as December 2009.Our counterparty to all of our derivative contracts is BP Energy Company. Setforth below is the summarized notional amount and terms of all instruments heldfor price risk management purposes at March 31, 2008.

 

| ** **                                           | ** ** | ** **  | ** ** | **Average**          | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------|------------|-------------|------------|----------------------|------------|---------------------|------------|
| ** **                                           | ** ** | ** **  | ** ** | **Fixed/Open**       | ** ** | **Asset**           | ** ** |
| ** **                                           | ** ** | **Volume**  | ** ** | **Price**            | ** ** | **(Liability)**     | ** ** |
| **Description and Production Period** | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** | ** **          | ** ** |
| Natural Gas -  Sold Fixed for Floating Price Swaps   |       |        |       |                 |       |                |       |
| April 2008  - March 2009                   |       | 2,019,000   |       | $                    | 7.70       |                | $          | (2,026 | ) |
| April 2009  - December 2009                |       | 1,602,000   |       | $                    | 7.30       |                | 594        |   |
|                                                 |       |        |       |                 |       | $                   | (1,432     | ) |

 

| ** **                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-------------|------------|----------------------|------------|------------|------------|
| Natural Gas -  Buy Fixed for Floating Price Swaps |       |        |       |                 |       |       |       |
| April 2008  - December 2008             |       | 540,864     |       | $                    | 6.93       |       | $          | 1,050 |   |
|                                                   |            |             |            |                      |            |            |            |  |  |

 

| ** **                                                 | ** ** | **(Bbls)** | ** ** | **(per Gallon)** | ** ** | ** ** | ** ** |
|------------------------------------------------------------|------------|------------|------------|-----------------------|------------|------------|------------|
| Natural Gas  Liquids - Sold Fixed for Floating Price Swaps |       |       |       |                  |       |       |       |
| April 2008  - December 2008                      |       | 331,326    |       | $                     | 1.31       |       | $          | (5,722 | ) |
|                                                            |            |            |            |                       |            |            |            |  |  |

 

**Note 5:  ****Fair ValueMeasurements of Financial Instruments**

 

We adopted SFAS No. 157“Fair Value Measurements” beginning in the first quarter of 2008. SFAS No. 157defines fair value as the price that would be received to sell an asset or paidto transfer a liability in an orderly transaction between market participantsat the measurement date, establishes a framework for measuring fair value ingenerally accepted accounting principles (GAAP) such as fair value hierarchyused to classify the source of information used in fair value measurements(i.e., market based or non-market based) and expands disclosure about fairvalue measurements based on their level in the hierarchy.  SFAS No. 157 applies to derivatives andother financial instruments, which  SFAS No. 133,“Accounting for Derivative Instrumentsand Hedging Activities,” as amended, requires be measured at fair valueat initial recognition and for all subsequent periods. SFAS No. 157establishes a fair value hierarchy which requires an entity to maximize the useof observable inputs and minimize the use of unobservable inputs when measuringfair value. SFAS No. 157’s hierarchy defines three levels of inputs thatmay be used to measure fair value. Level 1 refers to assets that haveobservable market prices, level 2 assets do not have an “observable price” butdo have inputs that are based on such prices in which components haveobservable data points and level 3 refers to assets in which one or more of theinputs do not have observable prices and calibrated model parameters, valuationtechniques or management’s assumptions are used to derive the fair value.

 

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We use the fair valuemethodology outlined in SFAS No. 157 to value assets and liabilities forour outstanding fixed price cash flow swap derivative contracts. Valuations ofour natural gas and propane derivative contracts are based on published forwardprice curves for natural gas and propane and, as such, are defined as Level 2fair value hierarchy assets and liabilities. There are no published forwardprice curves for butanes or natural gasoline, and therefore, our butanes andnatural gasoline derivative contracts are defined as Level 3 fair valuehierarchy assets and liabilities. We value our butanes and natural gasolinederivative contracts based on calibrated model parameters relative to forwardpublished price curves for crude oil and comparative mark-to-market valuesreceived from our counterparty.  Thefollowing table represents the fair value hierarchy for our assets andliabilities at March 31, 2008:

 

| ** **                               | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|-----------|------------|
| Commodity -based  derivative assets      |       | $                | —     |             | $          | 1,644            |       | $         | —     |   | $ | 1,644 |   |
| Commodity -based  derivative liabilities |       | —           |       | (4,312           | )          | (3,436           | )          | (7,748    | )          |
| Total                                    |       | $                | —     |             | $          | (2,668           | )          | $         | (3,436     | ) | $ | (6,104 | ) |

 

Thefollowing table provides a summary of changes in the fair value of Hiland Partners’Level3 commodity-based derivatives for the three months ended March 31, 2008:

 

| ** **                                               | ** ** | **Fixed Price** | ** ** |
|----------------------------------------------------------|------------|----------------------|------------|
| ** **                                               | ** ** | **Cash Flow**   | ** ** |
| ** **                                               | ** ** | **Swaps**            | ** ** |
| Balance  January 1, 2008                            |       | $                    | (4,489     | ) |
| Cash settlements  from other comprehensive income (loss) |       | 1,418                |       |
| Net change in  other comprehensive income                |       | (365                 | )          |
| Balance  March 31, 2008                             |       | $                    | (3,436     | ) |

 

**Note 6: Long-TermDebt**

 

| ** **                                         | ** ** | **As of**     | ** ** | **As of**        | ** ** |
|----------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **                                         | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Hiland  Partners-Revolving Credit Facility         |       | $                  | 230,064    |                  | $          | 221,064 |   |
| Hiland  Holdings-Revolving Credit Facility         |       | 355                |       | 355                   |       |
| Capital lease  obligation                          |       | 5,478              |       | 5,585                 |       |
|                                               |       | 235,897            |       | 227,004               |       |
| Less current  portion of capital lease obligations |       | 590                |       | 545                   |       |
| Long-term debt                                     |       | $                  | 235,307    |                  | $          | 226,459 |   |

 

***Hiland Partners***

 

On February 6, 2008,Hiland Partners entered into a fourth amendment to its credit facility dated asof February 15, 2005. Pursuant to the fourth amendment, Hiland Partnershas, among other things, increased its borrowing base from $250 million to $300million and decreased the accordion feature in the facility from $100 millionto $50 million.  Hiland Partners’original credit facility dated May 2005 was first amended in September 2005,amended a second time in June 2006 and amended a third time in July 2007.

 

The fourth amendmentincreases Hiland Partners’ borrowing capacity under its senior securedrevolving credit facility to $300 million such that the facility now consistsof a $291 million senior secured revolving credit facility to be used forfunding acquisitions and other capital expenditures, issuance of letters ofcredit and general corporate purposes (the “Acquisition Facility”) and a $9.0million senior secured revolving credit facility to be used for working capitaland to fund distributions (the “Working Capital Facility”).

 

In addition, the creditfacility provides for an accordion feature, which permits Hiland Partners, ifcertain conditions are met, to increase the size of the Acquisition Facility byup to $50 million and allows for the issuance of letters of credit of up 

 

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to $15 million in the aggregate. The senior secured revolvingcredit facility also requires HIiland Partners to meet certain financial tests,including a maximum consolidated funded debt to EBITDA ratio of 4.0:1.0 as ofthe last day of any fiscal quarter; provided that in the event that HilandPartners makes certain permitted acquisitions or capital expenditures, thisratio may be increased to 4.75:1.0 for the three fiscal quarters following thequarter in which such acquisition or capital expenditure occurs; and a minimuminterest coverage ratio of 3.0:1.0.  Thecredit facility will mature in May 2011. At that time, the agreement willterminate and all outstanding amounts thereunder will be due and payable.

 

Hiland Partners’ obligationsunder the credit facility are secured by substantially all of its assets andguaranteed by Hiland Partners, and all of its subsidiaries, other than HilandOperating, LLC its operating company, which is the borrower under the creditfacility.

 

Indebtedness under thecredit facility will bear interest, at Hiland Partners’ 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) thePrime Rate in effect on such day, (b) the base CD rate in effect on suchday plus 1.50% and (c) the Federal Funds effective rate in effect on suchday plus 1⁄2 of 1%. A letter of credit fee will be payable for the aggregateamount of letters of credit issued under the credit facility at a percentageper annum equal to 1.0%. An unused commitment fee ranging from 25 to 50 basispoints per annum based on our ratio of consolidated funded debt to EBITDA willbe payable on the unused portion of the credit facility. During any step-upperiod, the applicable margin with respect to loans under the credit facilitywill be increased by 35 basis points per annum and the unused commitment feewill be increased by 12.5 basis points per annum. At March 31, 2008, theinterest rate on outstanding borrowings from Hiland Partners’ credit facilitywas 5.32%.

 

The credit facilityprohibits Hiland Partners from making distributions to unitholders if anydefault or event of default, as defined in the credit facility, has occurredand is continuing or would result from the distribution. In addition, thecredit facility contains various covenants that limit, among other things,subject to certain exceptions and negotiated “baskets,” Hiland Partners’ability to incur indebtedness, grant liens, make certain loans, acquisitionsand investments, make any material changes to the nature of its business, amendits material agreements, including its Omnibus Agreement, or enter into amerger, consolidation or sale of assets.

 

The credit facilitydefines EBITDA as Hiland Partners’ consolidated net income, plus income taxexpense, interest expense, depreciation, amortization and accretion expense,amortization of intangibles and organizational costs, non-cash unit basedcompensation expense, and adjustments for non-cash gains and losses onspecified derivative transactions and for other extraordinary items.

 

Upon the occurrence of anevent of default as defined in the credit facility, the lenders may, amongother things, be able to accelerate the maturity of the credit facility andexercise other rights and remedies as set forth in the credit facility.

 

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

 

As of March 31,2008, Hiland Partners had $230.1 million outstanding under this creditfacility and was in compliance with its financial covenants.

 

***Hiland Holdings***

 

On September 25,2006, concurrently with the closing of our initial public offering, thePartnership entered into a three-year $25.0 million secured revolving creditfacility. The facility will permit us, if certain conditions are met, toincrease borrowing capacity by up to an additional $25.0 million. The facilityis secured by all of our ownership interests in Hiland Partners and its generalpartner, other than the 2% general partner interest and the incentivedistribution rights.

 

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

 

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Indebtedness under thefacility bears interest, at our option, at either (i) an alternate baserate plus an applicable margin ranging from 100 to 150 basis points per annumor (ii) LIBOR plus an applicable margin ranging from 200 to 250 basispoints per annum in each case based on our ratio of consolidated funded debt toEBITDA. The alternate base rate is equal to the greatest of (a) the primerate in effect on such day, (b) the base CD rate in effect on such dayplus 1.50% and (c) the federal funds effective rate in effect on such dayplus  1/2  of 1%. A letter of credit fee will be 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. At March 31, 2008, the interest rate onoutstanding borrowings from our credit facility was 5.06%.

 

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

 

The credit facility alsocontains covenants requiring a maximum consolidated funded debt to EBITDA ratioof 3.0:1.0 for the four fiscal quarters most recently ended and a minimuminterest coverage ratio of 3.0:1.0.

 

The amount we may borrowunder the facility is limited to the lesser of: (i) 50% of the sum of thevalue of the Hiland Partners common and subordinated units and certain otherassets held by us and certain of our subsidiaries at the end of each fiscalquarter and (ii) the maximum available amount of the facility (currently$25.0 million).

 

The facility prohibits usfrom making distributions to unitholders if any default or event of default, asdefined in the credit facility, has occurred and is continuing or would resultfrom the distribution. In addition, the facility contains various covenantsthat limit, among other things, subject to certain exceptions and negotiated “baskets,”our ability to incur indebtedness, grant liens, enter into agreementsrestricting our ability to grant liens on our assets or amend the facility,make certain loans, acquisitions and investments or enter into a merger,consolidation or sale of assets.

 

The facility limitsdistributions to our unitholders to our available cash, as defined in ourpartnership agreement. Restricted payments under the facility are subject to anannual “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 March 31,2008, we had $0.4 million outstanding under this credit facility and werein compliance with our financial covenants.

 

***Capital Lease Obligations***

 

During the third quarterof 2007, Hiland Partners incurred two separate capital lease obligations at theBakken and Badlands gathering systems. Under the terms of a capital leaseagreement for a rail loading facility and an associated products pipeline atthe Bakken gathering system, Hiland Partners has agreed to repay a businesspartner a predetermined amount over a period of eight years. Once fully paid,title to the leased assets will transfer to Hiland Partners no later than theend of the eight-year period commencing from the inception date of the lease.Hiland Partners also incurred a capital lease obligation for the aid toconstruct several electric substations at Hiland Partners’ Badlands gatheringsystem which, by agreement, will be repaid in equal monthly installments over aperiod of five years.

 

During the three monthsended March 31, 2008, Hiland Partners made principal payments of $107 onthe above described capital lease obligations. The current portion of the capital lease obligations presented in thetable above is included in accrued liabilities and other in the balance sheet.

 

**Note 7:  Share-Based Compensation**

 

***Hiland Holdings GP, LP Long Term IncentivePlan***

 

Hiland Holdings GP, thegeneral partner of Hiland Holdings, adopted the Hiland Holdings GP, LPLong-Term Incentive Plan for its employees and directors of its general partnerand employees of its affiliates. The long-term incentive plan consists of threecomponents: unit options, restricted units and phantom units. The long-termincentive plan limits the number of units that be delivered pursuant to awardsto 2,160,000 units. The plan is administered by the board of directors of ourgeneral partner or the compensation committee of the board of directors of ourgeneral partner. The plan will expire upon the 

 

16

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first to occur of its termination by the board of directors or thecompensation committee, the date when no units remain available under the planfor awards or the tenth anniversary of the date the plan is approved by ourunitholders. Awards then outstanding will continue pursuant to the terms oftheir grants.

 

The board of directors ofour general partner and the compensation committee of the board may terminateor amend the long-term incentive plan at any time with respect to any units forwhich a grant has not yet been made. Our board of directors and thecompensation committee of the board also have the right to alter or amend thelong-term incentive plan or any part of the plan from time to time, includingincreasing the number of units that may be granted subject to unitholderapproval as may be required by applicable law or stock exchange rules. However,no change in any outstanding grant may be made that would materially reduce thebenefits of the participant without the consent of the participant. Restrictedcommon units granted vest and become exercisable in one-fourth increments onthe anniversary of the grant date over four years. A restricted unit is acommon unit that is subject to forfeiture, and upon vesting, the granteereceives a common unit that is not subject to forfeiture. Distributions onunvested restricted common units are held in trust by our general partner untilthe units vest, at which time the distributions are distributed to the grantee.

 

As provided for in thelong-term incentive plan, each non-employee board member of Hiland Partners GPHoldings, LLC on each anniversary date of the initial reward is entitled toreceive an additional 1,000 restricted common units. We issued no restrictedunits during the three months ended March 31, 2008. As of March 31,2008 and December 31, 2007, we had 15,000 restricted common unitsoutstanding with a weighted average fair value at grant date of $23.30 perrestricted unit. Compensation expense related to the 12,000 restricted unitsissued is to be recognized over their respective four-year vesting period onthe graded vesting attribution method. We recorded compensation expense relatedto the restricted units of $35 and $32 for the three months ended March 31,2008 and 2007, respectively, and will record additional compensation expense of$206 over the next four years.

 

***Hiland Partners, LP Long Term IncentivePlan***

 

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

 

Hiland Partners GP, LLC’sboard of directors or compensation committee may, in their discretion,terminate, suspend or discontinue the long-term incentive plan at any time withrespect to any units for which a grant has not yet been made. Hiland PartnersGP, LLC’s board of directors or its compensation committee also has the rightto alter or amend the long-term incentive plan or any part of the plan fromtime to time, including increasing the number of units that may be granted,subject to unitholder approval if required by the exchange upon which thecommon units are listed at that time. No change in any outstanding grant may bemade, however, that would materially impair the rights of the participantwithout the consent of the participant. Under the unit option grant agreement,granted options of common units will vest and become exercisable in one-thirdincrements on the anniversary of the grant date over three years. Vestedoptions are exercisable within the option’s contractual life of ten years afterthe grant date. Restricted common units granted vest and become exercisable inone-fourth increments on the anniversary of the grant date over four years. Arestricted unit is a common unit that is subject to forfeiture, and uponvesting, the grantee receives a common unit that is not subject to forfeiture.Distributions on unvested restricted common units are held in trust by HilandPartners’ general partner until the units vest, at which time the distributionsare distributed to the grantee. Granted phantom common units are generally moreflexible than restricted units and vesting periods and distribution rights mayvary with each grant. A phantom unit is a common unit that is subject toforfeiture and is not considered issued until it vests. Upon vesting, holdersof phantom units will receive (i) a common unit that is not subject toforfeiture, cash in lieu of the delivery of such unit equal to the fair marketvalue of the unit on the vesting date, or a combination thereof, at thediscretion of our general partner’s board of directors and (ii) thedistributions held in trust, if applicable, related to the vested units.

 

*PhantomUnits. * On February 4, 2008, Hiland Partnersgranted 7,500 phantom units to Mr. Matthew S. Harrison, ours and HilandPartners’ new Chief Financial Officer (“CFO”), formerly Vice President ofBusiness Development. The phantom units granted vest over a three-year periodfrom the date of issuance and distributions are held in trust by HilandPartners’ 

 

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general partner until the units vest. On February 25, 2008, Hiland Partners granted 2,500 phantom unitsto a key employee that vest over a four-year period from the date of issuanceand do not accumulate distributions. On March 19, 2008, Mr. KenMaples, ours and Hiland Partners’ former CFO, resigned and the 5,000 phantomunits Hiland Partners granted to him in November 2007 were forfeited.Hiland Partners granted no phantom units during the three months ended March 31,2007.

 

The followingtable summarizes information about Hiland Partners’ phantom units for the threemonths ended March 31, 2008:

 

| ** **                    | ** ** | ** ** | ** ** | **Weighted**      | ** ** |
|-------------------------------|------------|------------|------------|-------------------|------------|
| ** **                    | ** ** | ** ** | ** ** | **Average**       | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **Fair Value**    | ** ** |
| ** **                    | ** ** | ** ** | ** ** | **At Grant** | ** ** |
| ** **                    | ** ** | **Units**  | ** ** | **Date ($)**      | ** ** |
| Unvested January 1, 2008 |       | 42,825     |       | $                 | 50.12      |   |
| Granted                       |       | 10,000     |       | $                 | 49.36      |   |
| Forfeited                     |       | (5,000     | )          | $                 | 48.80      |   |
| Unvested March 31, 2008  |       | 47,825     |       | $                 | 50.10      |   |

 

During the threemonths ended March 31, 2008, Hiland Partners incurred compensation expenseof $279 related to phantom units. Hiland Partners will recognize additionalexpense of $1,881 over the next four years, and the additional expense is to berecognized over a weighted average period of 3.4 years.

 

*RestrictedUnits.*   HilandPartners issued no restricted units during the three months ended March 31,2008.  As of March 31, 2008 and December 31, 2007, HilandPartners had 19,375 restricted common units outstanding with a weighted averagefair value at grant date of $46.57 per restricted unit outstanding. Totalcompensation expense related to restricted units was $84 and $120 for the threemonths ended March 31, 2008 and 2007, respectively. As of March 31,2008, there was $475 of total unrecognized cost related to unvested restrictedunits. This cost is to be recognized over a weighted average period of 2.5years.

 

*UnitOptions.*   There have beenno unit options granted since March 2006. As a result of adopting SFAS No. 123Ron the modified prospective basis beginning on January 1, 2006, during thethree months ended March 31, 2008 and 2007, Hiland Partners expensed $8and $58, respectively, related to unit options that were awarded in both 2006and 2005. Hiland Partners’ basic and diluted earnings per unit were reduced by$0.01 for the three months ended March 31, 2007 as a result of the $87additional compensation recognized under SFAS No. 123R.

 

The followingtable summarizes information about Hiland Partners’ common unit options for thethree months ended March 31, 2008:

 

| ** **                          | ** ** | ** ** | ** ** | ** **         | ** ** | **Weighted-**         | ** ** | ** **         | ** ** |
|-------------------------------------|------------|------------|------------|--------------------|------------|-----------------------|------------|--------------------|------------|
| ** **                          | ** ** | ** ** | ** ** | **Weighted**       | ** ** | **Average**           | ** ** | ** **         | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Average**        | ** ** | **Remaining**         | ** ** | **Aggregate**      | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Exercise**       | ** ** | **Contractual**       | ** ** | **Intrinsic**      | ** ** |
| **Options**                         | ** ** | **Units**  | ** ** | **Price ($)** | ** ** | **Term (Years)** | ** ** | **Value ($)** | ** ** |
| Outstanding at January 1, 2008 |       | 75,041     |       | $                  | 28.24      |                  |       |               |       |   |
| Granted                             |       | —     |       |               |       |                  |       |               |       |
| Exercised                           |       | (22,039    | )          | $                  | 27.71      |                  |       |               | $          | 462 |   |
| Forfeited or expired                |       | (500       | )          | $                  | 43.00      |                  |       |               |       |   |
| Outstanding at March 31, 2008  |       | 52,502     |       | $                  | 32.43      |                  | 7.4        |               | $          | 686 |   |
| Exercisable at March 31, 2008  |       | 35,834     |       | $                  | 23.87      |                  | 7.2        |               | $          | 775 |   |

 

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**Note 8: Commitments and Contingencies**

 

Hiland Partners hasexecuted a natural gas fixed price physical forward sales contract on 100,000MMBtu per month for the remainder of 2008 with a fixed price of $8.43 perMMBtu.  This contract has been designatedas a normal sale under SFAS No. 133 and is therefore not marked to marketas a derivative.

 

We maintain a definedcontribution 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 ended March 31,2008 and 2007 of $75 and $63, respectively.

 

We maintain our healthand workers’ compensation insurance through third-party providers. Property andgeneral liability insurance is also maintained through third-party providerswith a $100 deductible on each policy.

 

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

 

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

 

We and Hiland Partnerslease office space from a related entity (Note 10). We lease certainfacilities, vehicles and equipment under operating leases, most of whichcontain annual renewal options. For the three months ended March 31, 2008and 2007, rent expense was $616 and $514, respectively, under these leases.

 

**Note 9: Significant Customers and Suppliers**

 

All of Hiland Partners’revenues are domestic revenues. The following table presents Hiland Partners’top midstream customers as a percent of total revenue for the periodsindicated:

 

| ** ** | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|------------|------------|--------------------------------------------------------------------|------------|
| ** ** | ** ** | **2008**                                                           | ** ** | **2007** | ** ** |
| Customer 1 |       | 21                                                                 | %          | 29 | % |
| Customer 2 |       | 19                                                                 | %          | 14 | % |
| Customer 3 |       | 15                                                                 | %          | 16 | % |
| Customer 4 |       | 10                                                                 | %          | 6 | % |

 

All of Hiland Partners’purchases are from domestic sources. The following table presents HilandPartners’ top midstream suppliers as a percent of total midstream purchases forthe periods indicated:

 

| ** **                       | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                       | ** ** | **2008**                                                           | ** ** | **2007** | ** ** |
| Supplier 1  (affiliated company) |       | 38                                                                 | %          | 27 | % |
| Supplier 2                       |       | 19                                                                 | %          | 26 | % |
| Supplier 3                       |       | 15                                                                 | %          | 15 | % |

 

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**Note 10: Related Party Transactions**

 

Hiland Partners purchasesnatural gas and NGLs from affiliated companies. Purchases of product fromaffiliates totaled $26,167 and $11,734 for the three months ended March 31,2008 and 2007, respectively. Hiland Partners also sells natural gas and NGLs toaffiliated companies. Sales of product to affiliates totaled $1,021 and $989for the three months ended March 31, 2008 and 2007, respectively.Compression revenues from affiliates were $1,205 for each of the three monthsended March 31, 2008 and 2007.

 

Accountsreceivable-affiliates of $1,098 at March 31, 2008 include $1,005 from oneaffiliate for midstream sales. Accounts receivable-affiliates of $1,178 at December 31,2007, includes $1,090 from one affiliate for midstream sales.

 

Accountspayable-affiliates of $10,638 at March 31, 2008 include $10,145 due to oneaffiliate for midstream purchases. Accounts payable-affiliates of $7,957 at December 31,2007 include $7,094 payable to the same affiliate for midstream purchases

 

We utilize affiliatedcompanies to provide services to our plants and pipelines and certainadministrative services. The total expenditures to these companies was $152 and$94 during the three months ended March 31, 2008 and 2007, respectively.

 

We and Hiland Partnerslease office space under operating leases directly or indirectly from anaffiliate. Rent expense associated with these leases totaled $38 and $32 forthe three months ended March 31, 2008 and 2007, respectively.

 

**Note 11: Reportable Segments**

 

Hiland Partners hasdistinct operating segments for which additional financial information must bereported. Hiland Partners’ operations are classified into two reportablesegments:

 

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

 

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

 

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

 

Midstream assets totaled$398,710 at March 31, 2008. Assets attributable to compression operationstotaled $26,961. All but $14 of the total capital expenditures of $8,130 forthe three months ended March 31, 2008 was attributable to midstreamoperations. All but $15 of the total capital expenditures of $16,538 for thethree months ended March 31, 2007 was attributable to midstreamoperations.

 

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The tables below presentinformation for the reportable segments for the three months ended March 31,2008 and 2007.

 
| ** **                                                       | ** ** | **For the Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                       | ** ** | **2008**                                                               | ** ** | **2007** | ** ** |
| ** **                                                       | ** ** | **Midstream**                                                          | ** ** | **Compression** | ** ** | ** ** | ** ** | **Midstream** | ** ** | **Compression** | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **Segment**                                                            | ** ** | **Segment** | ** ** | **Total** | ** ** | **Segment** | ** ** | **Segment** | ** ** | **Total** | ** ** |
| ** **                                                       | ** ** | ** **                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                                         |       | $                                                                      | 90,274     |   | $ | 1,205 |   | $ | 91,479 |   | $ | 59,849 |   | $ | 1,205 |   | $ | 61,054 |   |
| Operating costs  and expenses:                                   |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |
| Midstream purchases  (exclusive of items shown separately below) |       | 68,618                                                                 |       | — |   | 68,618 |   | 43,615 |   | — |   | 43,615 |   |
| Operations and  maintenance                                      |       | 6,541                                                                  |       | 228 |   | 6,769 |   | 4,802 |   | 168 |   | 4,970 |   |
| Depreciation and  amortization                                   |       | 8,321                                                                  |       | 895 |   | 9,216 |   | 6,135 |   | 893 |   | 7,028 |   |
| General and  administrative expenses                             |       | 2,654                                                                  |       | 30 |   | 2,684 |   | 2,005 |   | 40 |   | 2,045 |   |
| Total operating  costs and expenses                              |       | 86,134                                                                 |       | 1,153 |   | 87,287 |   | 56,557 |   | 1,101 |   | 57,658 |   |
| Operating income  (loss)                                         |       | $                                                                      | 4,140      |   | $ | 52 |   | 4,192 |   | $ | 3,292 |   | $ | 104 |   | 3,396 |   |
| Other income  (expense):                                         |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |
| Interest and  other income                                       |       |                                                                   |       |   |   | 104 |   |   |   |   |   | 127 |   |
| Amortization of  deferred loan costs                             |       |                                                                   |       |   |   | (156 | ) |   |   |   |   | (110 | ) |
| Interest expense                                                 |       |                                                                   |       |   |   | (3,506 | ) |   |   |   |   | (2,091 | ) |
| Minority  interest in loss (income) of Hiland Partners, LP       |       |                                                                   |       |   |   | 206 |   |   |   |   |   | (574 | ) |
| Net income                                                       |       |                                                                   |       |   |   | $ | 840 |   |   |   |   |   | $ | 748 |   |

 

**Note 12: Net Income per Limited Partners’ Unit**

 

The computation of basicnet income per limited partners’ unit is based on the weighted-average numberof common units outstanding during the period. The computation of dilutedearnings per unit further assumes the dilutive effect of restricted units. Netincome per unit applicable to limited partners is computed by dividing netincome applicable to limited partners by the weighted-average number of limitedpartnership units outstanding. The following is a reconciliation of the limitedpartner units used in the calculations of income per limited partner unit—basicand income per limited partner unit—diluted assuming dilution for the threemonths ended March 31, 2008 and 2007:

 
| ** **                                                     | ** ** | **Income**              | ** ** | ** **             | ** ** | ** **        | ** ** |
|----------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                                     | ** ** | **Available to**   | ** ** | ** **             | ** ** | ** **        | ** ** |
| ** **                                                     | ** ** | **Limited**             | ** ** | **Limited**            | ** ** | ** **        | ** ** |
| ** **                                                     | ** ** | **Partners**            | ** ** | **Partner Units** | ** ** | **Per Unit** | ** ** |
| ** **                                                     | ** ** | **(Numerator)**         | ** ** | **(Denominator)**      | ** ** | **Amount**        | ** ** |
| ** **                                                     | ** ** | **(in thousands)** | ** ** | ** **             | ** ** |
| **For the Three Months Ended March 31, 2008**             |       |                    |       |                   |       |              |       |
| Income per  limited partner unit -basic:                       |       |                    |       |                   |       |              |       |
| Income available  to limited partners                          |       | $                       | 840        |                   |       |              | $          | 0.04 |   |
| Weighted average  limited partner units outstanding            |       |                    |       | 21,603                 |       |              |       |
| Income per  limited partner unit – diluted:               |       |                    |       |                   |       |              |       |
| Restricted units                                               |       |                    |       | 6                      |       |              |       |
| Income available  to limited partners plus assumed conversions |       | $                       | 840        |                   | 21,609     |              | $          | 0.04 |   |
|                                                           |       |                    |       |                   |       |              |       |
| **For the Three Months Ended March 31, 2007**             |       |                    |       |                   |       |              |       |
| Income per  limited partner unit -basic:                       |       |                    |       |                   |       |              |       |
| Income available  to limited partners                          |       | $                       | 748        |                   |       |              | $          | 0.03 |   |
| Weighted average  limited partner units outstanding            |       |                    |       | 21,600                 |       |              |       |
| Income per  limited partner unit – diluted:               |       |                    |       |                   |       |              |       |
| Restricted units                                               |       |                    |       | 5                      |       |              |       |
| Income available  to limited partners plus assumed conversions |       | $                       | 748        |                   | 21,605     |              | $          | 0.03 |   |

 

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**Note 13: ****Partners’ Equity and Cash Distributions**

 

***Hiland Holdings***

 

Our unitholders (limitedpartners) have only limited voting rights on matters affecting our operationsand activities and, therefore, limited ability to influence our management’sdecisions regarding our business. Unitholders did not select our generalpartner or elect the board of directors of our general partner and effectivelyhave no right to select our general partner or elect its board of directors inthe future. Unitholders’ voting rights are further restricted by ourpartnership agreement, which provides that any units held by a person that owns20% 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 Partnership Agreementrequires that we distribute all of our cash on hand at the end of each quarter,less reserves established at our general partner’s discretion. We refer to thisas “available cash.” Initially our only cash-generating assets are ourinterests in Hiland Partners from which we receive quarterly distributions. Theamount of available cash may be greater than or less than the minimum quarterlydistributions.

 

All distributions paid byHiland Holdings to common unitholders from January 1, 2007 forward,including amounts paid to affiliate owners, were as follows (in thousands,except per unit amounts):

 

| **Date Cash** | ** ** | **Per Unit Cash** | ** ** | ** **          | ** ** |
|--------------------|------------|-----------------------------|------------|---------------------|------------|
| **Distribution**   | ** ** | **Distribution**            | ** ** | **Total Cash** | ** ** |
| **Paid**           | ** ** | **Amount**                  | ** ** | **Distribution**    | ** ** |
|               |       |                        |       |                |       |
| 02/19/07           |       | $                           | 0.2075     |                | $          | 4,484 |   |
| 05/18/07           |       | 0.2075                      |       | 4,484               |       |
| 08/17/07           |       | 0.2200                      |       | 4,755               |       |
| 11/19/07           |       | 0.2300                      |       | 4,972               |       |
| 02/19/08           |       | 0.2550                      |       | 5,513               |       |
| 05/19/08 (a)       |       | 0.2800                      |       | 6,053               |       |
|               |       | $                           | 1.4000     |                | $          | 30,261 |   |

 

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(a)          Thiscash distribution was announced on April 25, 2008 and will be paid on May 19,2008 to all unitholders of record as of May 5, 2008.

 

***Hiland Partners***

 

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

 

Hiland Partners’partnership agreement requires that it distribute all of its cash on hand atthe end of each quarter, less reserves established at Hiland Partners GP, LLC’sdiscretion. We refer to this as “available cash.” The amount of available 

 

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cash may be greater than or less than the minimum quarterlydistributions described below. In general, Hiland Partners will pay any cashdistribution made each quarter in the following manner:

 

·         first, 98%to the common units, pro rata, and 2% to Hiland Partners GP, LLC, until eachcommon unit has received a minimum quarterly distribution of $0.45 plus anyarrearages from prior quarters;

 

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

 

·         third, 98%to all units, pro rata, and 2% to Hiland Partners GP, LLC, until each unit hasreceived a distribution of $0.495.

 

If cash distributions perunit exceed $0.495 in any quarter, Hiland Partners GP, LLC as general partnerwill receive increasing percentages, up to a maximum of 50% of the cash HilandPartners distributes in excess of that amount. We refer to these distributionsas “incentive distributions.”

 

The distributions on thesubordinated units may be reduced or eliminated if necessary to ensure thecommon units receive their minimum quarterly distribution. Subordinated unitswill not accrue arrearages. The subordination period will end with respect tocertain portions of the subordinated units once Hiland Partners meets certainfinancial tests, but will not end with respect to all subordinated units beforeMarch 31, 2010. These financial tests require Hiland Partners to have earnedand paid the minimum quarterly distribution on all of its outstanding units forthree consecutive four-quarter periods. When the subordination period ends, allremaining subordinated units will convert into common units on a one-for-onebasis and the common units will no longer be entitled to arrearages. HilandPartners expects that certain financial tests will have been met when HilandPartners makes its distribution for the quarter ended March 31, 2008 on May 14,2008, such that 25% of the subordinated units will be converted to common unitson the second day following distribution. As of March 31, 2008 we own4,080,000 subordinated units, which is all of Hiland Partners’ subordinatedunits.

 

Presented below are cashdistributions to Hiland Partners common and subordinated unitholders, includingamounts to affiliate owners and regular and incentive distributions to HilandPartners GP, LLC paid by Hiland Partners from January 1, 2007 forward (inthousands, except per unit amounts):

 

| **Date Cash** | ** ** | **Per Unit Cash** | ** ** | ** ** | ** ** | ** **       | ** ** | ** **               | ** ** | ** **          | ** ** | ** **        | ** ** |
|--------------------|------------|-----------------------------|------------|------------|------------|------------------|------------|--------------------------|------------|---------------------|------------|-------------------|------------|
| **Distribution**   | ** ** | **Distribution**            | ** ** | **Common** | ** ** | **Subordinated** | ** ** | **General Partner** | ** ** | **Total Cash** | ** ** |
| **Paid**           | ** ** | **Amount**                  | ** ** | **Units**  | ** ** | **Units**        | ** ** | **Regular**              | ** ** | **Incentive**       | ** ** | **Distributions** | ** ** |
| 02/14/07           |       | $                           | 0.7125     |       | $          | 3,694            |       | $                        | 2,907      |                | $          | 150               |       | $ | 749 |   | $ | 7,500 |   |
| 05/15/07           |       | 0.7125                      |       | 3,724      |       | 2,907            |       | 151                      |       | 752                 |       | 7,534             |       |
| 08/14/07           |       | 0.7325                      |       | 3,837      |       | 2,989            |       | 158                      |       | 932                 |       | 7,916             |       |
| 11/14/07           |       | 0.7550                      |       | 3,959      |       | 3,080            |       | 167                      |       | 1,134               |       | 8,340             |       |
| 02/14/08           |       | 0.7950                      |       | 4,169      |       | 3,243            |       | 182                      |       | 1,492               |       | 9,086             |       |
| 05/14/08 (a)       |       | 0.8275                      |       | 4,364      |       | 3,376            |       | 194                      |       | 1,789               |       | 9,723             |       |
|               |       | $                           | 4.5350     |       | $          | 23,747           |       | $                        | 18,502     |                | $          | 1,002             |       | $ | 6,848 |   | $ | 50,099 |   |

 

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(a)          Thiscash distribution was announced on April 25, 2008 and will be paid on May 14,2008 to all unitholders of record as of May 5, 2008.

 

Presented below are cashdistributions by Hiland Partners to us and Hiland Partners GP, LLC from January 1,2007 forward (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**       | ** ** | **Distributions** | ** ** |
| 02/14/07           |       | $                           | 0.7125     |       | $          | 927              |       | $                        | 2,907      |                | $          | 150               |       | $ | 749 |   | $ | 4,733 |   |
| 05/15/07           |       | 0.7125                      |       | 927        |       | 2,907            |       | 151                      |       | 752                 |       | 4,737             |       |
| 08/14/07           |       | 0.7325                      |       | 953        |       | 2,989            |       | 158                      |       | 932                 |       | 5,032             |       |
| 11/14/07           |       | 0.7550                      |       | 983        |       | 3,080            |       | 167                      |       | 1,134               |       | 5,364             |       |
| 02/14/08           |       | 0.7950                      |       | 1,035      |       | 3,243            |       | 182                      |       | 1,492               |       | 5,952             |       |
| 05/14/08 (a)       |       | 0.8275                      |       | 1,077      |       | 3,376            |       | 194                      |       | 1,789               |       | 6,436             |       |
|               |       | $                           | 4.5350     |       | $          | 5,902            |       | $                        | 18,502     |                | $          | 1,002             |       | $ | 6,848 |   | $ | 32,254 |   |

 

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(a)          Thiscash distribution was announced on April 25, 2008 and will be paid on May 14,2008 to all unitholders of record as of May 5, 2008.

 

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**CautionaryStatement About Forward-Looking Statements**

 

This quarterly report on Form 10-Qincludes certain “forward-looking statements” within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934. These statements include statements regarding our plans, goals,beliefs or current expectations. Statements using words such as “anticipate,” “believe,”“intend,” “project,” “plan,” “continue,” “estimate,” “forecast,” “may,” “will”or similar expressions help identify forward-looking statements. Although webelieve such forward-looking statements are based on reasonable assumptions andcurrent expectations and projections about future events, no assurance can begiven that every objective will be reached.

 

Actual results may differmaterially from any results projected, forecasted, estimated or expressed inforward-looking statements since many of the factors that determine theseresults are subject to uncertainties and risks, difficult to predict, andbeyond management’s control. Such factors include:

 

·         our ability to pay distributions toour unitholders;

 

·         our expected receipt of distributionsfrom Hiland Partners;

 

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

 

·         thecontinued ability of Hiland Partners to find and contract for new sources ofnatural gas supply;

 

·         the amountof natural gas transported on Hiland Partners’ gathering systems;

 

·         the level ofthroughput in Hiland Partners’ natural gas processing and treating facilities;

 

·         the feesHiland Partners charges and the margins realized for its services;

 

·         the pricesand market demand for, and the relationship between, natural gas and naturalgas liquids, or (NGLs);

 

·         energyprices generally;

 

·         the level ofdomestic oil and natural gas production;

 

·         theavailability of imported oil and natural gas;

 

·         actionstaken by foreign oil and gas producing nations;

 

·         thepolitical and economic stability of petroleum producing nations;

 

·         the weatherin Hiland Partners’ operating areas;

 

·         the extentof governmental regulation and taxation;

 

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

 

·         competitionfrom other midstream companies;

 

·         loss of keypersonnel;

 

·         theavailability and cost of capital and Hiland Partners’ ability to access certaincapital sources;

 

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

 

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·         the costsand effects of legal and administrative proceedings;

 

·         the abilityto successfully identify and consummate strategic acquisitions at purchaseprices that are accretive to the Hiland Partners’ financial results; and

 

·         risksassociated with the construction of new pipelines and treating and processingfacilities or additions to Hiland Partners’ existing pipelines and facilities.

 

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

 

All forward-lookingstatements attributable to us are qualified in their entirety by thiscautionary statement. We undertake no duty to update our forward-lookingstatements to reflect the impact of events or circumstances after the date ofthe forward-looking statements.

 

**Item2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

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

 

**Overviewof Hiland Holdings**

 

We are a Delaware limitedpartnership formed in May 2006 to own Hiland Partners GP, LLC, thegeneral partner of Hiland Partners, and certain other common and subordinatedunits in Hiland Partners We reflect our ownership interest in Hiland Partnerson a consolidated basis, which means that our financial results are combinedwith Hiland Partners’ financial results. The non-controlling limited partnerinterest in Hiland Partners is reflected as an expense in our results ofoperations and as a liability on our consolidated balance sheet. HilandPartners GP, LLC’s results of operations principally reflect the results ofoperations of Hiland Partners and are adjusted for non-controlling partners’interests in Hiland Partners’ net income.

 

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

 

·         the 2% general partner interest inHiland Partners;

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

·         1,301,471 common units and 4,080,000subordinated units of Hiland Partners, representing a 57.6% limited partnerinterest in Hiland Partners.

 

Hiland Partners isrequired by its partnership agreement to distribute all of its cash on hand atthe end of each quarter, after establishing reserves to provide for the properconduct of its business or to provide funds for future distributions. HilandPartners announced its quarterly distribution to $0.8275 per unit for thequarter ended March 31, 2008. This distribution will be paid on May 14,2008 to unitholders of record on May 5, 2008.

 

Our primary objective isto increase our cash distributions to our unitholders by actively assistingHiland Partners in executing its business strategy. We intend to support HilandPartners in implementing its business strategy by assisting in identifying,evaluating and pursuing growth opportunities. In the future, it is possiblethat we may also support the growth of Hiland Partners through the use of ourcapital resources, which could involve loans or capital contributions to HilandPartners to provide funding for the acquisition of a business or an asset orfor an internal growth project. In addition, we may provide Hiland Partnerswith other forms of credit support, such as guarantees relating to financing aproject or other types of support related to a merger or acquisitiontransaction.

 

25

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*Cash Distributions.  * Thefollowing table sets forth the distributions that we have received from HilandPartners during the periods indicated.

 

| ** **                                                                      | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Distributions on  Hiland Partners’ common units                            |       | $                                                    | 1,035      |   | $ | 927 |   |
| Distributions on  Hiland Partners’ subordinated units                      |       | 3,243                                                |       | 2,907 |   |
| Distributions  from ownership interest in Hiland Partners’ general partner |       | 182                                                  |       | 150 |   |
| Distributions  from Hiland Partners’ incentive distribution rights         |       | 1,492                                                |       | 749 |   |
| Total                                                                           |       | $                                                    | 5,952      |   | $ | 4,733 |   |

 

Becausewe own Hiland Partners GP, LLC the distributions to us include thedistributions made to Hiland Partners GP, LLC.

 

**Overview of Hiland Partners**

 

Hiland Partners isengaged in gathering, compressing, dehydrating, treating, processing andmarketing natural gas, fractionating NGLs and providing air compression andwater injection services for oil and gas secondary recovery operations. HilandPartners’ operations are primarily located in the Mid-Continent and RockyMountain regions of the United States.

 

Hiland Partners managesits business and analyzes and reports its results of operations on a segmentbasis. Hiland Partners’ 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 this segment,Hiland Partners also provides certain related services for compression,dehydrating, and treating of natural gas and the fractionation of NGLs. Themidstream segment generated 94.7% of total segment margin for the three monthsended March 31, 2008 and 93.1% of total segment margin for the threemonths ended March 31, 2007.

 

·    *CompressionSegment,* which is engaged in providing air compression and waterinjection services for oil and gas secondary recovery operations that areongoing in North Dakota. The compression segment generated 5.3% of totalsegment margin for the three months ended March 31, 2008 and 6.9% of totalsegment margin for the three months ended March 31, 2007.

 

Hiland Partners’midstream assets currently consist of 14 natural gas gathering systems withapproximately 2,030 miles of gas gathering pipelines, five natural gasprocessing plants, seven natural gas treating facilities and three NGLfractionation facilities.  HilandPartners’ compression assets consist of two air compression facilities and awater injection plant.

 

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

 

**Recent Events**

 

*DistributionIncrease.  *On April 25,2008, we declared a cash distribution for the first quarter of 2008. Thisdeclared quarterly distribution on ourcommon units increased to $0.28 per unit (an annualized rate of $1.12 per unit)from our most recent distribution of $0.255 per unit (an annualized rate of$1.02 per unit). This represents a 9.8% increase over the prior quarter and a34.9% increase over the distribution for the same quarter of the prior year.The distribution will be paid on May 19, 2008 to unitholders of record on May 4,2008.

 

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*Officer Selection.*  On April 16, 2008, we appointed Mr. MatthewS. Harrison to the positions of Chief Financial Officer, Vice President -Finance, Secretary and director of our general partner. Mr. Harrison hadbeen serving as Interim CFO since April 4, 2008 subsequent to theresignation of our former CFO, Ken Maples, on March 19, 2008.  Mr. Harrison first joined HilandPartners’ executive management team on February 4, 2008 when he wasappointed to the position of Vice President of Business Development of HilandPartners’ general partner.

 

*Badlands Gathering System. *Thenitrogen rejection plant at Hiland Partners’ Badlands gathering system in NorthDakota was inoperable for 29 days from February 5, 2008 to March 5,2008. The plant was taken out of service when it was discovered that a primarypiece of equipment had failed.

 

*Hiland Partners’ Credit Facility Amendment. * On February 6,2008,  Hiland Partners completed a fourthamendment to its existing credit agreement to increase its borrowing base by$50 million from $250 million to $300 million. For a more complete discussionof Hiland Partners’ credit facility, please see “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—Liquidity and CapitalResources—Credit Facility.”

 

**Historical Results of Operations**

 

Our historical results ofoperations for the periods presented may not be comparable, either from periodto period or going forward due to (i) increased volumes and associatedoperationg expenses and Hiland Partners’ Badlands gathering system as a resultof the construction of Hiland Partners’ nitrogen rejection plant, which becameoperational in August 2007 and (ii) volumes and operating expenses atHiland Partners’ Woodford Shale gathering system, which commenced production inApril 2007.

 

**Our Results of Operations**

 

The results of ouroperations discussed below principally reflect the activities of HilandPartners. Because our consolidated financial statements include the results ofHiland Partners, our financial statements are substantially similar to thefinancial statements of Hiland Partners. However, our consolidated balancesheet includes a minority interest amount that reflects the proportion ofHiland Partners owned by its unitholders other than us. Similarly, theownership interests in Hiland Partners held by its unitholders other than usare reflected in our consolidated income statement as minority interest. Theminority interest amounts are not reflected on Hiland Partners’ financialstatements.

 

Set forth in the tablesbelow are certain financial and operating data for the periods indicated.

 

| ** **                                                               | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                               | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| ** **                                                               | ** ** | **(in thousands)**                              | ** ** |
| **Total  Segment Margin Data:**                                          |       |                                                 |       |   |   |
| Midstream  revenues                                                      |       | $                                                    | 90,274     |   | $ | 59,849 |   |
| Midstream  purchases                                                     |       | 68,618                                               |       | 43,615 |   |
| Midstream  segment margin                                                |       | 21,656                                               |       | 16,234 |   |
| Compression  revenues (1)                                                |       | 1,205                                                |       | 1,205 |   |
| Total segment  margin (2)                                                |       | $                                                    | 22,861     |   | $ | 17,439 |   |
|                                                                     |       |                                                 |       |   |   |
| **Summary  of Operations Data:**                                         |       |                                                 |       |   |   |
| Midstream  revenues                                                      |       | $                                                    | 90,274     |   | $ | 59,849 |   |
| Compression  revenues                                                    |       | 1,205                                                |       | 1,205 |   |
| Total revenues                                                           |       | 91,479                                               |       | 61,054 |   |
|                                                                     |       |                                                 |       |   |   |
| Midstream  purchases (exclusive of items shown separately below)         |       | 68,618                                               |       | 43,615 |   |
| Operations and  maintenance                                              |       | 6,769                                                |       | 4,970 |   |
| Depreciation,  amortization and accretion                                |       | 9,216                                                |       | 7,028 |   |
| General and  administrative                                              |       | 2,684                                                |       | 2,045 |   |
| Total operating  costs and expenses                                      |       | 87,287                                               |       | 57,658 |   |
| Operating income                                                         |       | 4,192                                                |       | 3,396 |   |
| Other income  (expense), net                                             |       | (3,558)                                              |       | (2,074) |   |
| Income before  minority interest in loss (income) of Hiland Partners, LP |       | 634                                                  |       | 1,322 |   |
| Minority  interest in loss (income) of Hiland Partners, LP               |       | 206                                                  |       | (574) |   |
| **Net  income**                                                          |       | $                                                    | 840        |   | $ | 748 |   |
|                                                                     |       |                                                 |       |   |   |
| **Hiland  Partners Operating Data:**                                     |       |                                                 |       |   |   |
| Inlet natural  gas (MCF/d)                                               |       | 227,431                                              |       | 200,088 |   |
| Natural gas  sales (MMBTU/d)                                             |       | 85,773                                               |       | 74,521 |   |
| NGL sales  (Bbls/d)                                                      |       | 5,275                                                |       | 3,986 |   |

 

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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:

 

| ** **                                                      | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| ** **                                                      | ** ** | **(in thousands)**                              | ** ** |
| **Reconciliation  of Total Segment Margin to Operating Income** |       |                                                 |       |   |   |
| Operating income                                                |       | $                                                    | 4,192      |   | $ | 3,396 |   |
| Add:                                                            |       |                                                 |       |   |   |
| Operations and  maintenance expenses                            |       | 6,769                                                |       | 4,970 |   |
| Depreciation,  amortization and accretion                       |       | 9,216                                                |       | 7,028 |   |
| General and  administrative expenses                            |       | 2,684                                                |       | 2,045 |   |
| Total segment  margin                                           |       | $                                                    | 22,861     |   | $ | 17,439 |   |

 

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

 

**Three Months Ended March 31,2008 Compared with Three Months Ended March 31, 2007**

 

***Revenues.***  Total revenues(midstream and compression) were $91.5 million for the three months ended March 31,2008 compared to $61.1 million for the three months ended March 31, 2007,an increase of $30.4 million, or 49.8%.  This $30.4 million increase wasdue to (i) increased natural gas sales volumes of 11,252 MMBtu/day (MMBtuper day) primarily related to our Woodford Shale gathering system whichcommenced production in April 2007, (ii) increased NGL sales volumesof 1,286 Bbls/day (Bbls per day) largely attributable to our Badlands andWoodford Shale gathering systems and (iii) significantly higher averagerealized natural gas and NGL sales prices for the three months ended March 31,2008 as compared to the same period in 2007, resulting in increased revenue atour Bakken, Eagle Chief and Matli gathering systems.  Revenues fromcompression assets were the same for both periods.

 

Midstream revenues were$90.3 million for the three months ended March 31, 2008 compared to $59.8million for the three months ended March 31, 2007, a net increase of $30.4million, or 50.8%. Of this net increase in midstream revenues, approximately$11.5 million was attributable to revenues from natural gas and NGL sales volumesat the Woodford Shale gathering system and increased natural gas and NGL salesvolumes at the Bakken and Badlands gathering systems, and $18.9 million wasattributable to significantly higher average realized natural gas and NGL salesprices for the three months ended 

 

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March 31, 2008 as compared to the same period in 2007, resultingin increased revenues for nearly all of our gathering systems.

 

Inlet natural gas was227,431 Mcf/d (Mcf per day) for the three months ended March 31, 2008compared to 200,088 Mcf/d for the three months ended March 31, 2007, a netincrease of 27,343 Mcf/d, or 13.7%.  Thisincrease is primarily attributable to volume growth at the Woodford Shale andBadlands gathering systems.

 

Natural gas sales volumeswere 85,773 MMBtu/d for the three months ended March 31, 2008 compared to74,521 MMBtu/d for the three months ended March 31, 2007, an increase of11,252 MMBtu/d, or 15.1%.  The 11,252 MMBtu/d increase was almost entirelyattributable to the natural gas sales volumes at the Woodford Shale gatheringsystem. NGL sales volumes were 5,272 Bbls/d for the three months ended March 31,2008 compared to 3,986 Bbls/d for the three months ended March 31, 2007,an increase of 1,286 Bbls/d, or 32.3%.  This increase is primarilyattributable to volume growth at the Woodford Shale and Badlands gatheringsystems.

 

Average realized naturalgas sales prices were $7.33 per MMBtu for the three months ended March 31,2008 compared to $6.19 per MMBtu for the three months ended March 31,2007, an increase of $1.14 per MMBtu, or 18.4%.  In addition, averagerealized NGL sales prices were $1.40 per gallon for the three months ended March 31,2008 compared to $0.94 per gallon for the three months ended March 31,2007, an increase of $0.46 per gallon or 48.9%.  The increase in averagerealized natural gas and NGL sales prices was primarily a result of higherindex prices for natural gas and posted prices for NGLs during the three monthsended March 31, 2008 compared to the three months ended March 31,2007.

 

Cash received from HilandPartners’ counterparty on cash flow swap contracts for natural gas derivativetransactions that closed during the three months ended March 31, 2008totaled $0.2 million.  This gain increased average realized natural gassales prices to $7.33 per MMBtu from $7.31 per MMBtu, an increase of $0.02 perMMBtu.  Cash paid to Hiland Partners’counterparty on cash flow swap contracts for NGL derivative transactions thatclosed during the three months ended March 31, 2008 totaled $2.2million.   This loss decreased average realized NGL sales prices to$1.40 per gallon from $1.51 per gallon, a decrease of $0.11 per gallon.  Cash received from Hiland Partners’counterparty on cash flow swap contracts for natural gas derivativetransactions that closed during the three months ended March 31, 2007totaled $0.6 million.  This gainincreased average realized natural gas sales prices to $6.19 per MMBtu from$6.10 per MMBtu, an increase of $0.09 per MMBtu, or 1.5%.  Cash paid to Hiland Partners’ counterparty oncash flow swap contracts for NGL derivative transactions that closed during thethree months ended March 31, 2007 were insignificant.

 

Compression revenues were$1.2 million for the each of the three months ended March 31, 2008 and2007.

 

***Midstream Purchases.***  Midstreampurchases were $68.6 million for the three months ended March 31, 2008compared to $43.6 million for the three months ended March 31, 2007, anincrease of $25.0 million, or 57.3%.  The $25.0 million increase primarilyconsists of $11.7 million attributable to purchased gas from the Woodford Shalegathering system and $11.4 million attributable to increased purchased gasvolumes at the Bakken, Eagle Chief and Matli gathering systems. The remaining$1.9 million increase in midstream purchases was primarily attributable toincreased payments to producers due to higher natural gas and NGL purchaseprices, which generally are closely related to fluctuations in natural gas andNGL sales prices.

 

***Midstream Segment Margin .*** Midstream segment margin was $21.7 million for the three months ended March 31,2008 compared to $16.2 million for the three months ended March 31, 2007,an increase of $5.5 million, or 33.4%. The increase is primarily due to favorable gross processing spreads,significantly higher average realized natural gas and NGL prices and the volumegrowth at the Woodford Shale and appreciably expanded Badlands gatheringsystems which commenced production in April 2007 and August 2007,respectively.  The increase in midstreamsegment margin was offset by approximately $2.3 million of forgone margin as aresult of the nitrogen rejection plant being taken out of service due toequipment failure during the three months ended March 31, 2008.

 

***Operations and Maintenance.*** Operations and maintenance expense totaled $6.8 million for the three monthsended March 31, 2008 compared with $5.0 million for the three months endedMarch 31, 2007, an increase of $1.8 million, or 36.2%. Of this increase,$0.9 million, or 51.5%, was attributable to increased operations andmaintenance at the Badlands gathering system and $0.6 million, or 35.4%, wasattributable to operations at the Woodford Shale gathering system.

 

***Depreciation, Amortization and Accretion.*** Depreciation, amortization and accretion expense totaled $9.2 million for thethree months ended March 31, 2008 compared with $7.0 million for the threemonths ended March 31, 2007, an increase of $2.2 million, or 31.1 %. Of this increase, $0.8 million was attributable to increased depreciation onthe Badlands gathering 

 

29

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system, $0.5 million was attributable to increased depreciation on theBakken gathering system and another $0.5 million was attributable to theWoodford Shale gathering system.

 

***General and Administrative.*** General and administrative expense totaled $2.7 million for the three monthsended March 31, 2008 compared with $2.0 million for the three months endedMarch 31, 2007, an increase of $0.7 million, or 31.3%.  Of thisincrease, $0.5 million, or 73.1%, is attributable to the timing of executiveannual cash bonuses and additional staffing, and $0.1 million, or 21.3%,  is attributable to increased costs of being apublic company, including the costs of audit and tax preparation fees..

 

***Other Income (Expense).*** Otherincome (expense) totaled ($3.6) million for the three months ended March 31,2008 compared with ($2.1) million for the three months ended March 31,2007, an increase in expense of $1.4 million.  The increase is primarilyattributable to additional interest expense from borrowings on Hiland Partners’credit facility to fund the expansion project at the Badlands gathering systemand to construct the Woodford Shale gathering system.

 

***Minority Interest. *** Minority interest in (loss) income of HilandPartners, which represents the allocation of Hiland Partners loss or earningsto its limited partner interests not owned by Hiland Holdings, totaled $(0.2)million for the three months ended March 31, 2008 compared to $0.6 million forthe three months ended March 31, 2007. The $0.2 million loss for the threemonths ended March 31, 2008 is the result of the excess of net income allocatedto us related to our 2% general partner interest, including 100% of the incentive distributionrights, over Hiland Partners’ net income for the three months ended March 31,2008.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

***Overview***

 

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

 

***Cash Flows from Operating Activities***

 

 Cash flows from operating activities increasedby $1.8 million to $10.7 million for the three months ended March 31, 2008from $8.9 million for the three months ended March 31, 2007.  Duringthe three months ended March 31, 2008 we received cash flows fromcustomers of approximately $85.2 million attributable to increased natural gasand NGLs volumes and significantly higher average realized natural gas and NGLsales prices, had cash payments to our suppliers and employees of approximately$71.3 million and payment of interest expense of $3.2 million, net of amountscapitalized, resulting in cash received from operating activities of $10.7million. During the same three month period in 2007, we received cash flowsfrom customers of approximately $60.5 million attributable to increased volumesof natural gas and NGLs decreased by lower natural gas and NGL sales prices,had cash payments to our suppliers and employees of approximately $49.5 millionand payment of interest expense of $2.1 million, net of amounts capitalized,resulting in cash received from our operating activities of $8.9 million.Changes in cash receipts and payments are primarily due to the timing ofcollections at the end of our reporting periods. We collect and pay largereceivables and payables at the end of each calendar month. The timing of thesepayments and receipts may vary by a day or two between month-end periods andcause fluctuations in cash received or paid. Contributions to cash flows fromoperating activities from workling capital items exclusive of cash wasinsignificant for the three months ended March 31, 2008 compared to $0.1million for the three months ended March 31, 2007. Net income for thethree months ended March 31, 2008 was $.8 million, an increase of $0.1million from a net income of $0.7 million for the three months ended March 31,2007.  Depreciation increased by $2.2 million to $9.2 million for thethree months ended March 31, 2008 from $7.0 million for the three monthsended March 31, 2007.

 

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

 

Cash flows used ininvesting activities, which represent investments in property and equipmentdecreased by $6.1 million to $10.4 million for the three months ended March 31,2008 from $16.5 million for the three months ended March 31, 

 

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2007 predominately due to reduced capital investing in the three monthsended March 31, 2008 related to the Badlands nitrogen rejection plant thatwas under construction during the first three months of 2007.

 

***Cash Flows from Financing Activities***

 

Cash flows from financingactivities decreased to $0.5 million for the three months ended March 31,2008 from $5.7 million for the three months ended March 31, 2007. Duringthe three months ended March 31, 2008, Hiland Partners borrowed $9.0million under its credit facility to fund its internal expansion projects andreceived $0.6 million from issuing Hiland Partners common units as a resultof  the exercise of 22,039 vested unitoptions. During the three months ended March 31, 2008, Hiland Partnersalso incurred debt issuance costs of $0.3 million associated with the fourthamendment to its credit facility amended in February 2008 and made $0.1million payments on capital lease obligations. During the three months ended March 31,2008, we made a distribution of $5.5 million to our unitholders and HilandPartners distributed $3.1 million to its minority interest unitholders.During the three months ended March 31, 2007, Hiland Partners borrowed$12.1 million under its credit facility to fund its internal expansion projectsand received $1.0 million from issuing Hiland Partners common units as a resultof the exercise of 39,930 vested unit options. During the three months ended March 31,2007, we made a distribution of $4.5 million to our unitholders, HilandPartners distributed $2.8 million to its minority interest unitholders andHiland Partners paid deferred offering costs of $0.1 million associated withHiland Partners’ S-3/A registration statement filed with the SEC on January 23,2007.

 

***Capital Requirements***

 

The midstream energybusiness is capital intensive, requiring significant investment to maintain andupgrade existing operations. Our capital requirements have consisted primarilyof, and we anticipate will continue to be:

 

·         maintenancecapital expenditures, which are capital expenditures made to replace partiallyor fully depreciated assets to maintain the existing operating capacity ofHiland Partners’ assets and to extend their useful lives, or other capitalexpenditures that are incurred in maintaining existing system volumes andrelated cash flows; and

 

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

 

We believe that cashgenerated from the operations of Hiland Partners’ business will be sufficientto meet anticipated maintenance capital expenditures for the next twelvemonths. Given Hiland Partners objective of growth through acquisitions andexpansions, Hiland Partners anticipates that it will continue to investsignificant amounts of capital to grow and acquire assets. Hiland Partnersactively considers a variety of assets for potential acquisitions. Weanticipate that expansion capital expenditures will be funded through long-termborrowings or other debt financings and/or equity offerings. See “CreditFacility” below for information related to our credit agreements.

 

***Woodford Shale***

 

Hiland Partners is continuing to develop the WoodfordShale gathering system located in the Woodford Shale reservoir area in theArkoma Basin of southeastern Oklahoma,just to the west of our Kinta Area gathering systems. The gathering system isbeing designed to provide low-pressure and highly reliable gathering,compression and dehydration services. During the third quarter of 2008, thegathering infrastructure is expected to include up to 17,400 horsepower ofcompression to provide takeaway capacity in excess of 65,000 Mcf/d.  As of March 31, 2008, Hiland Partnershas invested $25.7 million in this internal expansion project.

 

***FinancialDerivatives and Commodity Hedges.***

 

Hiland Partners hasentered into certain derivative contracts that are classified as cash flowhedges in accordance with SFAS No. 133, as amended, and relate toforecasted sales in 2008 and 2009. Hiland Partners entered into these financialswap instruments to hedge the forecasted natural gas and NGL sales or purchasesagainst the variability in expected future cash flows attributable to changesin commodity prices. The swap instruments are contractual agreements betweencounterparties to exchange obligations of money as the underlying natural gasor natural gas liquids are sold or purchased. Under these swap agreements,Hiland Partners receives a fixed price and pays a floating price or pays afixed price and receives a floating price based on certain indices for therelevant contract period as the underlying natural gas or NGL is sold orpurchased.

 

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The following tableprovides information about these financial derivative instruments for theperiods indicated:

 

| ** **                                           | ** ** | ** **  | ** ** | **Average**          | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------|------------|-------------|------------|----------------------|------------|---------------------|------------|
| ** **                                           | ** ** | ** **  | ** ** | **Fixed/Open**       | ** ** | **Asset**           | ** ** |
| **Description and Production Period** | ** ** | **Volume**  | ** ** | **Price**            | ** ** | **(Liability)**     | ** ** |
| ** **                                           | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** | ** **          | ** ** |
| Natural Gas -  Sold Fixed for Floating Price Swaps   |       |        |       |                 |       |                |       |
| April 2008  - March 2009                   |       | 2,019,000   |       | $                    | 7.70       |                | $          | (2,026 | ) |
| April 2009  - December 2009                |       | 1,602,000   |       | $                    | 7.30       |                | 594        |   |
|                                                 |       |        |       |                 |       | $                   | (1,432     | ) |

 

| ** **                                        | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-------------|------------|----------------------|------------|------------|------------|
| Natural Gas -  Buy Fixed for Floating Price Swaps |       |        |       |                 |       |       |       |
| April 2008  - December 2008             |       | 540,864     |       | $                    | 6.93       |       | $          | 1,050 |   |
|                                                   |            |             |            |                      |            |            |            |  |  |

 

| ** **                                                                                             | ** ** | **(Bbls)** | ** ** | **(per Gallon)** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------|------------|------------|------------|
| Natural Gas Liquids - Sold Fixed for Floating Price Swaps |       |       |       |                  |       |       |       |
| April 2008  - December 2008                                                                  |       | 331,326    |       | $                     | 1.31       |       | $          | (5,722) |   |
|                                                                                                        |            |            |            |                       |            |            |            |  |  |

 

In addition to thecontractual obligations noted in the table above, Hiland Partners has executedone natural gas fixed price physical forward sales contract on 100,000 MMBtuper month with a fixed price of $8.43 per MMBtu for the remainder of2008.  This contract has been designated as normal sales under SFAS No. 133and is therefore not marked to market as a derivative.

 

***Off-BalanceSheet Arrangements.***

 

We had no significantoff-balance sheet arrangements as of March 31, 2008.

 

***Credit Facility***

 

***Hiland Holdings***

 

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

 

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

 

Loans under the facilitywill bear interest, at our option, at either (i) an alternate base rateplus an applicable margin ranging from 100 to 150 basis points per annum or (ii) LIBORplus an applicable margin ranging from 200 to 250 basis points per annum ineach case based on our ratio of consolidated funded debt to EBITDA. Thealternate base rate is equal to the greatest of (a) the prime rate ineffect on such day, (b) the base CD rate in effect on such day plus 1.50%and (c) the federal funds effective rate in effect on such day plus 1/2 of1%. 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. At March 31,2008, the interest rate on outstanding borrowings from our credit facility was5.06%.

 

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

 

The credit facility alsocontains covenants requiring a maximum consolidated funded debt to EBITDA ratioof 3.0:1.0 for the four fiscal quarters most recently ended and a minimum interestcoverage ratio of 3.0:1.0.

 

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The amount we may borrowunder the facility is limited to the lesser of: (i) 50% of the sum of thevalue of the Hiland Partners common and subordinated units and certain otherassets held by us and certain of our subsidiaries at the end of each fiscalquarter and (ii) the maximum available amount of the facility (currently$25.0 million). For purposes of this calculation, the value of (i) theHiland Partners common units on any date shall be the closing price for suchunits as reflected on the Nasdaq National Market on any date, and (ii) theHiland Partners subordinated units on any date shall be deemed to equal 85% ofthe value of the Hiland Partners common units on such date.

 

The facility prohibits usfrom making distributions to unitholders if any default or event of default, asdefined in the credit facility, has occurred and is continuing or would resultfrom the distribution. In addition, the facility contains various covenantsthat limit, among other things, subject to certain exceptions and negotiated “baskets,”our ability to incur indebtedness, grant liens, enter into agreementsrestricting our ability to grant liens on our assets or amend the facility,make certain loans, acquisitions and investments or enter into a merger,consolidation or sale of assets.

 

The facility limitsdistributions to our unitholders to our available cash, as defined in ourpartnership agreement. Restricted payments under the facility are subject to anannual “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 March 31,2008, we had $0.4 million outstanding under this credit facility and werein compliance with our financial covenants.

 

***Hiland Partners***

 

On February 6, 2008,Hiland Partners entered into a fourth amendment to its credit facility dated asof February 15, 2005. Pursuant to the fourth amendment, Hiland Partnershas, among other things, increased its borrowing base from $250 million to $300million and decreased the accordion feature in the facility from $100 millionto $50 million.   Hiland Partners’original credit facility dated May 2005 was first amended in September 2005,amended a second time in June 2006 and amended a third time in July 2007.

 

The fourth amendmentincreases Hiland Partners’ borrowing capacity under its senior securedrevolving credit facility to $300 million such that the facility now consistsof a $291 million senior secured revolving credit facility to be used forfunding acquisitions and other capital expenditures, issuance of letters ofcredit and general corporate purposes (the “Acquisition Facility”) and a $9.0million senior secured revolving credit facility to be used for working capitaland to fund distributions (the “Working Capital Facility”).

 

In addition, the fourthamendment provides for an accordion feature, which permits Hiland Partners, ifcertain conditions are met, to increase the size of the Acquisition Facility byup to $50 million and allows for the issuance of letters of credit of up to $15million in the aggregate.  The senior secured revolving credit facilityalso requires Hiland Partners to meet certain financial tests, including amaximum consolidated funded debt to EBITDA ratio of 4.0:1.0 as of the last dayof any fiscal quarter; provided that in the event that the Partnership makescertain permitted acquisitions or capital expenditures, this ratio may beincreased to 4.75:1.0 for the three fiscal quarters following the quarter inwhich such acquisition or capital expenditure occurs; and a minimum interestcoverage ratio of 3.0:1.0. The credit facility will mature in May 2011. Atthat time, the agreement will terminate and all outstanding amounts thereunderwill be due and payable.

 

Hiland Partners’obligations under the credit facility are secured by substantially all ofHiland Partners’ assets and guaranteed by Hiland Partners, and all of HilandPartners’ subsidiaries, other than Hiland Partners’ operating company, which isthe borrower under the credit facility.

 

Indebtedness under thecredit facility will bear interest, at Hiland Partners’ option, at either (i) anAlternate Base Rate, as defined therin, plus an applicable margin ranging from50 to 125 basis points per annum or (ii) LIBOR plus an applicable marginranging from 150 to 225 basis points per annum based on Hiland Partners’ ratioof consolidated funded debt to EBITDA. The Alternate Base Rate is a rate perannum equal to the greatest of (a) the Prime Rate in effect on such day, (b) thebase CD rate in effect on such day plus 1.50% and (c) the Federal Fundseffective rate in effect 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 Hiland Partners’ ratio ofconsolidated funded debt to EBITDA will be payable on the unused portion of thecredit facility. During any step-up period, the applicable margin with respectto loans under the credit facility will be increased by 35 basis 

 

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points per annum and the unused commitment fee will be increased by12.5 basis points per annum. At March 31, 2008, the interest rate onoutstanding borrowings from Hiland Partners’ credit facility was 5.32%

 

The credit facilityprohibits Hiland Partners from making distributions to unitholders if anydefault or event of default, as defined in the credit facility, has occurredand is continuing or would result from the distribution. In addition, thecredit facility contains various covenants that limit, among other things, subjectto certain exceptions and negotiated “baskets,” Hiland Partners’ ability toincur indebtedness, grant liens, make certain loans, acquisitions andinvestments, make any material changes to the nature of its business, amend itsmaterial agreements, including the Omnibus Agreement or enter into a merger,consolidation or sale of assets.

 

The credit facilitydefines EBITDA as Hiland Partners’ consolidated net income, plus income taxexpense, interest expense, depreciation, amortization and accretion expense,amortization of intangibles and organizational costs, non-cash unit basedcompensation expense, and adjustments for non-cash gains and losses onspecified derivative transactions and for other extraordinary items.

 

Upon the occurrence of anevent of default as defined in the credit facility, the lenders may, amongother things, be able to accelerate the maturity of the credit facility andexercise other rights and remedies as set forth in the credit facility.

 

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

 

As of March 31,2008, Hiland Partners had $230.1 million outstanding under its creditfacility and was in compliance with its financial covenants.

 

***Impactof Inflation***

 

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

 

**Recent Accounting Pronouncements**

 

On March 19, 2008,the Financial Accounting Standards Board (FASB) issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities, an Amendmentof FASB Statement No. 133 (“SFAS 161”). SFAS 161 is intended to improvetransparency in financial reporting by requiring enhanced disclosures of anentity’s derivative instruments and hedging activities and their effects on theentity’s financial position, financial performance, and cash flows. SFAS 161 iseffective prospectively for financial statements issued for fiscal years andinterim periods beginning after November 15, 2008, with early applicationencouraged. SFAS 161 encourages, but does not require, comparative disclosuresfor periods prior to its initial adoption. SFAS 161 amends the current qualitativeand quantitative disclosure requirements for derivative instruments and hedgingactivities set forth in SFAS 133 and generally increases the level ofaggregation/disaggregation that will be required in an entity’s financialstatements. We are currently reviewing this Standard to determine the effect itwill have on our financial statements and disclosures therein.

 

On March 12, 2008,the Emerging Issues Task Force (“EITF”) reached consensus opinion on EITF IssueNo. 07-4, “Application of the two-class method under FASB Statement No. 128,Earnings per Share, to Master Limited Partnerships” (“EITF No. 07-4”),which the FASB ratified at its March 26, 2008 meeting. EITF No. 07-4requires the calculation of a Master Limited Partnership’s (“MLPs”) net earningsper limited partner unit for each period presented according to distributionsdeclared and participation rights in undistributed earnings as if all of theearnings for that period had been distributed. In periods with undistributedearnings above specified levels, the calculation per the two-class methodresults in an increased allocation of such undistributed earnings to thegeneral partner and a dilution of earnings to the limited partners. EITF No. 07-4is effective for fiscal years beginning after December 15, 2008, and is tobe applied retrospectively to all periods presented. Early application is notpermitted. We will apply the requirements of EITF No. 07-4 as it pertainsto MLPs upon its adoption during the quarter ended March 31, 2009.

 

In December 2007,the FASB issued SFAS No. 141(R), “Business Combinations.” This statementamends and replaces SFAS No. 141, but retains the fundamental requirementsin SFAS No. 141 that the purchase method of accounting be used for allbusiness combinations and an acquirer be identified for each businesscombination. The statement provides for how 

 

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the acquirer recognizes and measures the identifiable assets acquired,liabilities assumed and any non-controlling interest in the acquiree.SFAS No.141(R) provides for how the acquirer recognizes and measuresthe goodwill acquired in the business combination or a gain from a bargainpurchase. The statement also determines what information to disclose to enableusers to be able to evaluate the nature and financial effects of the businesscombination. The provisions of SFAS No.141(R) apply prospectively tobusiness combinations for which the acquisition date is on or after thebeginning of the first annual reporting period beginning on or after December 15,2008 and do not allow early adoption. We are evaluating the new requirements ofSFAS No. 141(R) and the impact it will have on business combinationscompleted in 2009 or thereafter.

 

In December 2007,the FASB issued SFAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements — an amendment of ARB No. 51.” SFAS No. 160establishes accounting and reporting standards that require the ownershipinterests in subsidiaries held by parties other than the parent (minorityinterest) be clearly identified, labeled, and presented in the consolidatedbalance sheet within equity, but separate from the parent’s equity. SFAS No. 160requires the equity amount of consolidated net income attributable to theparent and to the noncontrolling interest be clearly identified and presentedon the face of the consolidated income statement and that changes in a parent’sownership interest while the parent retains its controlling financial interestin its subsidiary be accounted for consistently and similarly as equitytransactions. Consolidated net income and comprehensive income will bedetermined without deducting minority interest; however, earnings-per-shareinformation will continue to be calculated on the basis of the net incomeattributable to the parent’s shareholders. Additionally, SFAS No. 160establishes a single method for accounting for changes in a parent’s ownershipinterest in a subsidiary that does not result in deconsolidation and that theparent recognize a gain or loss in net income when a subsidiary isdeconsolidated. SFAS No. 160 is effective for fiscal years beginning on orafter December 15, 2008. Early adoption is not permitted. We do not expectthis Statement will have a material impact on our financial position, resultsof operations or cash flows.

 

In February 2007,the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assetsand Financial Liabilities.” SFAS No. 159 expands opportunities to use fairvalue measurement in financial reporting and permits entities to choose tomeasure many financial instruments and certain other items at fair value. SFAS No. 159is effective for fiscal years beginning after November 15, 2007. ThisStatement was adopted by us effective January 1, 2008, at which time nofinancial assets or liabilities, not previously required to be recorded at fairvalue by other authoritative literature, were designated to be recorded at fairvalue. As such, the adoption of this Statement did not have any impact on ourfinancial position, results of operations or cash flows.

 

In September 2006,the FASB issued SFAS No. 157 “Fair Value Measurements.”  SFAS No. 157 defines fair value as theprice that would be received to sell an asset or paid to transfer a liabilityin an orderly 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.  SFAS No. 157applies to derivatives and other financial instruments, which SFAS No. 133,“Accounting for Derivative Instrumentsand Hedging Activities,” as amended, requires be measured at fair valueat initial recognition and for all subsequent periods. SFAS No. 157establishes a fair value hierarchy which requires an entity to maximize the useof observable inputs and minimize the use of unobservable inputs when measuringfair value. SFAS No. 157’s hierarchy defines three levels of inputs thatmay be used to measure fair value. Level 1 refers to assets that haveobservable market prices, level 2 assets do not have an “observable price” butdo have inputs that are based on such prices in which components have observabledata points and level 3 refers to assets in which one or more of the inputs donot have observable prices and calibrated model parameters, valuationtechniques or management’s assumptions are used to derive the fair value. SFAS No. 157is effective for financial statements issued for fiscal years beginning after November 15,2007 and interim periods within those fiscal years. We elected to implementSFAS No. 157 prospectively in the first quarter of 2008 with the one-yeardeferral permitted by FASB Staff Position (FSP) 157-2 for nonfinancialassets and nonfinancial liabilities measured at fair value, except those thatare recognized or disclosed on a recurring basis (at least annually). Thedeferral applies to nonfinancial assets and liabilities measured at fair valuein a business combination; impaired properties, plants and equipment;intangible assets and goodwill; and initial recognition of asset retirementobligations and restructuring costs for which we use fair value. We do notexpect any significant impact to our consolidated financial statements when weimplement SFAS No. 157 for these assets and liabilities.

 

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**Significant Accounting Policies and Estimates**

 

*RevenueRecognition**.  * Revenues for sales and of natural gas and NGLsproduct sales are recognized at the time the product is delivered and title istransferred. Revenues for compression services are recognized when the servicesunder the agreement are performed.

 

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

 

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

 

*AssetRetirement Obligations.  * SFAS No. 143, “Accounting for Asset RetirementObligations” requires entities to record the fair value of a liability for anasset retirement obligation in the period in which it is incurred and acorresponding increase in the carrying amount of the related long-lived asset.Subsequently, the asset retirement cost is allocated to expense using asystematic and rational method and the liability is accreted to measure thechange in liability due to the passage of time. The primary impact of thisstandard relates to our estimated costs for dismantling and site restoration ofcertain of our plants and pipelines. Estimating future asset retirementobligations requires us to make estimates and judgments regarding timing,existence of a liability, as well as what constitutes adequate restoration. Weuse the present value of estimated cash flows related to our asset retirementobligation to determine the fair value, generally as estimated by third partyconsultants. The present value calculation requires us to make numerousassumptions and judgments, including the ultimate costs of dismantling and siterestoration, inflation factors, credit adjusted discount rates, timing ofsettlement and changes in the legal, regulatory, environmental and politicalenvironments. To the extent future revisions to these assumptions impact thepresent value of the existing asset retirement obligation liability, acorresponding adjustment will be required to the related asset. We believe theestimates and judgments reflected in our financial statements are reasonablebut are necessarily subject to the uncertainties we have just described.Accordingly, any significant variance in any of the above assumptions orfactors could materially affect our cash flows.

 

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

 

When determining whetherimpairment of one of our long-lived assets has occurred, we must estimate theundiscounted cash flows attributable to the asset or asset group. Our estimateof cash flows is based on assumptions regarding the volume of reservesproviding asset cash flow and future NGL product and natural gas prices. Theamount of reserves and drilling 

 

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activity are dependent in part on natural gas prices. Projections of reservesand future commodity prices are inherently subjective and contingent upon anumber of variable factors, including, but not limited to:

 

·         changes in general economic conditions inregions in which the Partnership’s products are located;

·         the availability and prices of NGLproducts and competing commodities;

·         the availability and prices of rawnatural gas supply;

·         our ability to negotiate favorablemarketing agreements;

·         the risks that third party oil and gasexploration and production activities will not occur or be successful;

·         our dependence on certain significantcustomers and producers of natural gas; and

·         competition from other midstream serviceproviders and processors, including major energy companies.

 

Any significant variancein any of the above assumptions or factors could materially affect our cashflows, which could require us to record an impairment of an asset.

 

*ShareBased Compensation.  * In October 1995 the FASB issued SFAS No. 123,“Share-Based Payment,” which was revised in December 2004 (“SFAS 123R”).SFAS 123R requires 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 September 25, 2006 and Hiland Partners adopted SFAS123R January 1, 2006. We have applied SFAS 123R using the permitted modifiedprospective method beginning as of the same date. Hiland Partners had unearneddeferred compensation of $289 as of January 1, 2006 which has beeneliminated against Hiland Partners common unit equity. Prior to January 1,2006 Hiland Partners recorded any unamortized compensation related torestricted unit awards as unearned compensation in equity. We expect no changeto cash flow presentation from the adoption of SFAS 123R since no tax benefitswere recognized by Hiland Partners as a pass through entity.

 

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

 

**Item 3.  Quantitative and Qualitative Disclosuresabout Market Risk**

 

Market risk is the riskof loss arising from adverse changes in market rates and prices. The principalmarket risk to which we are exposed is commodity price risk for natural gas andNGLs. We also incur, to a lesser extent, risks related to interest ratefluctuations. We do not engage in commodity energy trading activities.

 

***Commodity Price Risks.  *** Our profitability is affected byvolatility in prevailing NGL and natural gas prices. Historically, changes inthe prices of most NGL products have generally correlated with changes in theprice of crude oil. NGL and natural gas prices are volatile and are impacted bychanges in the supply and demand for NGLs and natural gas, as well as marketuncertainty. Our cash flow is affected by the volatility of natural gas and NGLproduct prices, which could adversely affect our ability to make distributionsto unitholders. To illustrate the impact of changes in prices for natural gasand NGLs on our operating results, we have provided the table below, whichreflects, for the three months ended March 31, 2008, the impact on ourmidstream segment margin of a $0.01 per gallon change (increase or decrease) inNGL prices coupled with a $0.10 per MMBtu change (increase or decrease) in theprice of natural gas. The magnitude of the impact on total segment margin ofchanges in natural gas and NGL prices presented may not be representative ofthe magnitude of the impact on total segment margin for different commodityprices or contract portfolios. Natural gas prices can also affect ourprofitability indirectly by influencing the level of drilling activity andrelated opportunities for our services.

 

| ** **         | ** ** | ** ** | ** ** | **Natural Gas Price Change ($/MMBtu)** | ** ** |
|--------------------|------------|------------|------------|------------------------------------------------------------|------------|
| ** **         | ** ** | ** ** | ** ** | **$0.10**                                                  | ** ** | **$(0.10)** | ** ** |
| **NGL Price**      |       | $          | 0.01       |                                                       | $          | 144,000 |   | $ | 113,000 |   |
| **Change ($/gal)** |       | $          | (0.01      | )                                                          | $          | (112,000 | ) | $ | (144,000 | ) |

 

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We manage this commodityprice exposure through an integrated strategy that includes management of ourcontract portfolio, optimization of our assets and the use of derivativecontracts. As a result of these derivative contracts, we have hedged a portionof our expected exposure to natural gas prices and natural gas liquid prices in2008 and 2009. We continually monitor our hedging and contract portfolio andexpect to continue to adjust our hedge position as conditions warrant. Thefollowing table provides information about our derivative instruments for theperiods indicated:

 

| ** **                                                                                | ** ** | ** **  | ** ** | **Average**          | ** ** | **Fair Value** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------|------------|----------------------|------------|---------------------|------------|
| ** **                                                                                | ** ** | ** **  | ** ** | **Fixed/Open**       | ** ** | **Asset**           | ** ** |
| **Description and Production Period**                                      | ** ** | **Volume**  | ** ** | **Price**            | ** ** | **(Liability)**     | ** ** |
| Natural Gas - Sold Fixed for Floating Price Swaps | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** | ** **          | ** ** |
| April 2008  - March 2009                                                        |       | 2,019,000   |       | $                    | 7.70       |                | $          | (2,026 | ) |
| April 2009  - December 2009                                                     |       | 1,602,000   |       | $                    | 7.30       |                | 594        |   |
|                                                                                      |       |        |       |                 |       | $                   | (1,432     | ) |

 

| Natural Gas - Buy Fixed for Floating Price Swaps | ** ** | **(MMBtu)** | ** ** | **(per MMBtu)** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------|------------|-------------|------------|----------------------|------------|------------|------------|
| April 2008  - December 2008                                                    |       | 540,864     |       | $                    | 6.93       |       | $          | 1,050 |   |
|                                                                                          |            |             |            |                      |            |            |            |  |  |

 

| Natural Gas Liquids - Sold Fixed for Floating Price Swaps | ** ** | **(Bbls)** | ** ** | **(per Gallon)** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------|------------|------------|------------|
| April 2008  - December 2008                                                                  |       | 331,326    |       | $                     | 1.31       |       | $          | (5,722 | ) |
|                                                                                                        |            |            |            |                       |            |            |            |  |  |

 

In addition to thederivative instruments noted in the table above, Hiland Partners has executedone natural gas fixed price physical forward sales contract on 100,000 MMBtuper month with a fixed price of $8.43 per MMBtu for the remainder of2008.  This contract has been designated as normal sales under SFAS No. 133and is therefore not marked to market as a derivative.

 

***Interest Rate Risk.***   We are exposed to changes in interestrates as a result of our credit facilities, which have floating interestrates. As of March 31, 2008 we had approximately $0.4 million ofindebtedness outstanding under our credit facility which was used to financethe costs related to the closing of our $25.0 million secured revolvingcredit facility. As of March 31, 2008, Hiland Partners had approximately$230.1 million of indebtedness outstanding under its credit facility. Theimpact of a 100 basis point increase in interest rates on the amount of currentdebt would result in an increase in interest expense and a correspondingdecrease in net income of approximately $2.3 million annually.

 

***CreditRisk.****  * Counterparties pursuant to the terms oftheir contractual obligations expose us to potential losses as a result ofnonperformance. Hiland Partners’ four largest customers for the three monthsended March 31, 2008 accounting for approximately 22%, 19%, 14% and 10%,respectively, of revenues. Consequently, changes within one or more of thesecompanies’ operations have the potential to impact, both positively andnegatively, our credit exposure. Hiland Partners’ counterparty for all of itsderivative instruments as of March 31, 2008 is BP Energy Company.

 

**Item 4.  Controls and Procedures)**

 

**Evaluation of Disclosure Controls and Procedures**

 

(a) Evaluation ofdisclosure controls and procedures.

 

As required by Rule 13a-15(b) under theSecurities Exchange Act of 1934, as amended, we have evaluated, under thesupervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, the effectivenessof the design and operation of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act)as of the end of the period covered by this Quarterly Report on Form 10-Q.Based upon that evaluation, our principal executive officer and principalfinancial officer concluded that our disclosure controls and procedures wereeffective as of March 31, 2008, to ensure that information is accumulatedand communicated to our management, including our principal executive officerand principal financial officer, as appropriate, to allow timely decisionsregarding required disclosure and is recorded, processed, summarized andreported within the time periods specified in the rules and forms of theSEC.

 

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(b) Changes ininternal control over financial reporting.

 

During the three months ended March 31, 2008,there were no changes in our system of internal control over financialreporting (as defined in Rules 13a-15(f) and 15d-15(f) under theExchange Act) that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**PART IIOTHER INFORMATION**

 

**Item1.  Legal Proceedings**

 

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

 

**Item 1A.Risk Factors**

 

In addition to the otherinformation set forth in this report, you should carefully consider the factorsdiscussed in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-Kfor the year ended December 31, 2007, which could materially affect ourbusiness, financial condition or future results. The risks described in ourAnnual Report on Form 10-K are not the only risks facing our Company.Additional risks and uncertainties not currently known to us or that wecurrently deem to be immaterial also may materially adversely affect ourbusiness, financial condition and/ or operating results.

 

**Item 2. Unregistered Sales of EquitySecurities and Use of Proceeds**

 

None.

 

**Item 3. Defaults Upon SeniorSecurities**

 

None.

 

**Item 4. Submission of Matters to aVote of Security Holders**

 

None.

 

**Item 5. Other Information**

 

None.

 

**Item 6.Exhibits**

 
| **Exhibit********Number** | ** ** | ** ** | **Description**                                                                                                                                                                                                       |
|---------------------------|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   3.1           |       | —     | Certificate of Limited  Partnership of Hiland Holdings GP, LP (incorporated by reference to  Exhibit 3.1 of Registrant’s Statement on form S-1 (File  No. 333-134491))                                 |
|   3.2           |       | —     | Form of Amended  and Restated Agreement of Limited Partnership of Hiland Holdings GP, LP  (incorporated by reference to Exhibit 3.2 of Registrant’s Statement on  form S-1 (File No. 333-134491)) |
|   3.3           |       | —     | Certificate of  Formation of Hiland Partners GP Holdings, LLC (incorporated by reference to  Exhibit 3.3 of Registrant’s Statement on form S-1 (File  No. 333-134491))                                 |
|   3.4           |       | —     | Form of Amended  and Restated Limited Liability Company Agreement of Hiland Partners GP  Holdings, LLC(incorporated by reference to Exhibit 3.4 of  Registrant’s Statement on form S-1            |
| 31.1                      |       | —     | Certification of Chief  Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                    |
| 31.2                      |       | —     | Certification of Chief  Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                    |
| 32.1                      |       | —     | Certification of Chief  Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                    |
| 32.2                      |       | —     | Certification of Chief  Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                    |

 

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized in the city of Enid, Oklahoma, onthe 9th day of May, 2008.

 
|            | **HILAND HOLDINGS GP, LP** |
|------------|----------------------------|
| ** ** | **By:**                    | **Hiland Partners GP Holdings, LLC, its general  partner** |
|       | By:                        | /s/ Joseph L. Griffin |
|       |                       | Joseph L. Griffin |   |   |
| * *   | * *                   | * Chief Executive Officer, President and  Director* |
| * *   | * *                   | * * |
| * *   | * *                   | * * |
|       | By:                        | /s/ Matthew S. Harrison |
|       |                       | Matthew S. Harrison |
| * *   | * *                   | *Chief Financial Officer, Vice President-Finance,  Secretary  and Director* |

 

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**Exhibit Index**

** **
| **Exhibit********Number** | ** ** | ** ** | **Description**                                                                                                                                                                                                       |
|---------------------------|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   3.1           |       | —     | Certificate of Limited  Partnership of Hiland Holdings GP, LP (incorporated by reference to Exhibit 3.1  of Registrant’s Statement on form S-1 (File No. 333-134491))                                  |
|   3.2           |       | —     | Form of Amended  and Restated Agreement of Limited Partnership of Hiland Holdings GP, LP  (incorporated by reference to Exhibit 3.2 of Registrant’s Statement on  form S-1 (File No. 333-134491)) |
|   3.3           |       | —     | Certificate of  Formation of Hiland Partners GP Holdings, LLC (incorporated by reference to  Exhibit 3.3 of Registrant’s Statement on form S-1 (File  No. 333-134491))                                 |
|   3.4           |       | —     | Form of Amended and  Restated Limited Liability Company Agreement of Hiland Partners GP Holdings, LLC(incorporated  by reference to Exhibit 3.4 of Registrant’s Statement on form S-1                       |
| 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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