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SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

Commission file number: 000-50067

Crosstex Energy, L.P.

2501 CEDAR SPRINGS, SUITE 600

(214) 953-9500

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

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes o          No þ

     As of October 29, 2004, the Registrant had 8,750,659 common units and 9,334,000 subordinated units outstanding.

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GLOSSARY OF TERMS

      As generally used in the energy industry and in this document, the following terms have the following meanings:

	/d = per day
	MMBtu = million British thermal units
	NGL’s = Natural gas liquids

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CROSSTEX ENERGY, L.P.

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

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CROSSTEX ENERGY, L.P.

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to consolidated financial statements.

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CROSSTEX ENERGY, L.P.

CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS’ EQUITY

See accompanying notes to consolidated financial statements.

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CROSSTEX ENERGY, L.P.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

See accompanying notes to consolidated financial statements.

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CROSSTEX ENERGY, L.P.

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to consolidated financial statements.

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CROSSTEX ENERGY, L.P.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

      Unless the context requires otherwise, references to “we”, “us”, “our” or the “Partnership” mean Crosstex Energy, L.P. and its consolidated subsidiaries.

      Crosstex Energy, L.P. (the Partnership), a Delaware limited partnership formed on July 12, 2002, is engaged in the gathering, transmission, treating, processing and marketing of natural gas. The Partnership connects the wells of natural gas producers to its gathering systems in the geographic areas of its gathering systems in order to purchase the gas production, treats natural gas to remove impurities to ensure that it meets pipeline quality specifications, processes natural gas for the removal of natural gas liquids or NGLs, transports natural gas and ultimately provides an aggregated supply of natural gas to a variety of markets. In addition, the Partnership purchases natural gas from producers not connected to its gathering systems for resale and sells natural gas on behalf of producers for a fee. The accompanying consolidated financial statements include the assets, liabilities, and results of operations of the Partnership (or CES as its predecessor) and its wholly owned subsidiaries. The consolidated operations are hereafter referred to herein collectively as the “Partnership.” All material intercompany balances and transactions have been eliminated. Certain reclassifications have been made to the consolidated financial statements for the prior years to conform to the current presentation.

      The accompanying consolidated financial statements are prepared in accordance with the instructions to Form 10-Q, are unaudited and do not include all the information and disclosures required by generally accepted accounting principles for complete financial statements. All adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations for the interim periods have been made and are of a recurring nature unless otherwise disclosed herein. The results of operations for such interim periods are not necessarily indicative of results of operations for a full year. All significant intercompany balances and transactions have been eliminated in consolidation. These consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in our restated annual report on Form 10-K/ A for the year ended December 31, 2003.

      The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management of the Partnership to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from these estimates.

      The new entities the Partnership formed to acquire LIG Pipeline Company and its subsidiaries, as discussed more fully in Note 3, are treated as taxable corporations for income tax purposes.

      For the nine months ended September 30, 2004, the Partnership recognized a current tax expense of $284,000 on the LIG entities net taxable income and a deferred tax benefit of $168,000. A deferred tax liability of $13,224,000 was recorded at the acquisition date. The deferred tax represents future taxes payable on the difference between the tax fair market value and tax basis of the net assets acquired based on our preliminary purchase price allocation.

      The Partnership applies the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25), and the related interpretations in accounting for the long-term

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

incentive plans. In accordance with APB No. 25 for fixed stock and unit options, compensation is recorded to the extent the fair value of the stock or unit exceeds the exercise price of the option at the measurement date. Compensation costs for fixed awards with pro rata vesting are recognized on a straight-line basis over the vesting period. In addition, compensation expense is recorded for variable options based on the difference between fair value of the stock or unit and exercise price of the options at period end.

      Had compensation cost for the Partnership been determined based on the fair value at the grant date for awards in accordance with SFAS No. 123, Accounting for Stock Based Compensation, the Partnership’s net income would have been as follows (in thousands, except per unit amounts):

      The fair value of each option is estimated on the date of grant using the Black Scholes option-pricing model with the following weighted average assumptions used for Partnership unit grants in the nine months ended September 30, 2004:

      No Crosstex Energy, Inc. (CEI) options were granted to officers or employees in 2004. Stock based compensation associated with the CEI option plan with respect to officers and employees is recorded by the Partnership since CEI has no operating activities, other than its interest in the Partnership.

      CEI modified certain outstanding options attributable to its shares of common stock in the first quarter of 2003, which allowed the option holders to elect to be paid in cash for the modified options based on the fair value of the options. The total number of CEI options which were modified was approximately 364,000. These modified options have been accounted for using variable accounting as of the option modification date. The Partnership accounted for the modified options as variable options until the holders elected to cash out the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

options or the election to cash out the options lapsed. CEI was responsible for paying the intrinsic value of the options for the holders who elected to cash out their options. December 31, 2003 was the last valuation date that a holder of modified options could elect the cash-out alternative. Accordingly, effective January 1, 2004, the remaining modified options are accounted for as fixed options. Beginning in the first quarter of 2003, the Partnership recognized stock compensation expense based on the estimated fair value of the modified options at period end. The Partnership recognized stock-based compensation expense of approximately $1.6 million and $4.6 million related to the variable options for the three and nine months ended September 30, 2003, respectively.

      In February 2004, 75,000 restricted shares in CEI were issued to senior management under its long-term incentive plan with an intrinsic value of $2,183,000. The CEI restricted shares vest over a three-year period and the intrinsic value is amortized into stock-based compensation expense over the vesting period. In February 2004, 1,406 Partnership restricted units with an intrinsic value of $29,000 were issued to a director, at his election, for his 2004 annual director fee. These restricted units were vested upon issuance and the intrinsic value of the units was charged to stock-based compensation expense.

      Basic earnings per unit was computed by dividing net income by the weighted average number of limited partner units outstanding for the three and nine months ended September 30, 2004 and 2003. The computation of diluted earnings per unit further assumes the dilutive effect of unit options and the restricted units.

      Effective March 29, 2004, the Partnership completed a two-for-one split on its outstanding limited partnership units. All unit amounts for prior periods presented herein have been restated to reflect this unit split.

      The following are the unit amounts used to compute the basic and diluted earnings per limited partner unit for the three and nine months ended September 30, 2004 and 2003 (in thousands):

      All outstanding units were included in the computation of diluted earnings per unit.

      In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51. In December 2003, the FASB issued FIN No. 46R which clarified certain issues identified in FIN 46. FIN No. 46R requires an entity to consolidate a variable interest entity if it is designated as the primary beneficiary of that entity even if the entity does not have a majority of voting interests. A variable interest entity is generally defined as an entity where its equity is unable to finance its activities or where the owners of the entity lack the risk and rewards of ownership. The provisions of this

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

statement apply at inception for any entity created after January 31, 2003. For an entity created before February 1, 2003, the provisions of this Interpretation must be applied at the beginning of the first interim or annual period ending after March 15, 2004. In January 2004, the Partnership adopted FIN No. 46R and began consolidating its joint venture interest in the Crosstex DC Gathering, J.V. (CDC), previously accounted for using the equity method of accounting. The consolidated carrying amount for the joint venture is based on the historical costs of the assets, liabilities and non-controlling interests of the joint venture since its formation in January 2003 which approximates the carrying amount of the assets, liabilities and non-controlling interests in the consolidated financial statements as if FIN No. 46R had been effective upon inception of the joint venture.

      In July 2004, we determined that clerical errors had occurred in 2002 accounting that resulted in certain reconciling items not being properly cleared from accounts payable, accounts receivable and accrued gas purchases with an offsetting decrease in income of $1.7 million in 2002. As a result of correcting these errors, we have restated our consolidated balance sheet and consolidated statements of changes in partners’ equity for the year ended December 31, 2003 which are included in our Form 10-K/ A filed on August 10, 2004.

      In April 2004, the Partnership acquired, through its wholly-owned subsidiary Crosstex Louisiana Energy, L.P., the LIG Pipeline Company and its subsidiaries (LIG Inc., Louisiana Intrastate Gas Company, L.L.C., LIG Chemical Company, LIG Liquids Company, L.L.C. and Tuscaloosa Pipeline Company) (collectively, “LIG”) from American Electric Power (“AEP”) in a negotiated transaction for $73.5 million. LIG consists of approximately 2,000 miles of gas gathering and transmission systems located in 32 parishes extending from northwest and north-central Louisiana through the center of the state to south and southeast Louisiana. The Partnership financed the acquisition in April through borrowings under its amended bank credit facility.

      We have utilized the purchase method of accounting for this acquisition with an acquisition date of April 1, 2004. The purchase price and our preliminary allocation thereof are as follows (in thousands):

      The purchase price allocation for the LIG acquisition has not been finalized because the Partnership’s valuation consultant has not issued its report related to the purchase price allocation.

      On June 30, 2003, the Partnership completed the acquisition of certain assets from Duke Energy Field Services, L.P. (DEFS) for $68.1 million, including the effect of certain purchase price adjustments. The assets acquired included: the Mississippi pipeline system, a 12.4% interest in the Seminole gas processing

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

plant, the Conroe gas plant and gathering system and the Alabama pipeline system. The Partnership has accounted for this acquisition as a business combination in accordance with SFAS No. 141, Business Combinations. We have utilized the purchase method of accounting for this acquisition with an acquisition date of June 30, 2003.

      Operating results for the DEFS assets have been included in the Statements of Operations since June 30, 2003, and operating results for the LIG assets have been included in the Statements of Operations since April 1, 2004. The following unaudited pro forma results of operations assumes that the DEFS acquisition and the LIG acquisition occurred on January 1, 2003 (in thousands, except per unit amounts):

      The Partnership owns a 7.86% weighted average interest as the general partner in the five gathering systems of Crosstex Pipeline Partners, L.P. (CPP), a 20.31% interest as a limited partner in CPP, 50% interest in the J.O.B. J.V. and a 50% interest in CDC. In January 2004, the Partnership began consolidating its investment in CDC pursuant to FIN No. 46R. The Partnership accounts for its investments in J.O.B. J.V. and CPP under the equity method, as it exercises significant influence in operating decisions as a general partner in CPP and as a 50% owner in the joint venture. Under this method, the Partnership carries its investments at cost and records its equity in net earnings of the affiliated partnerships as income in other income (expense) in the consolidated statement of operations, and distributions received from them are recorded as a reduction in the Partnership’s investment in the affiliated partnership.

      In connection with the formation of CDC, the Partnership agreed to loan the CDC partner up to $1.5 million for its initial capital contribution. The loan bears interest at an annual rate of prime plus 2%. CDC makes payments directly to the Partnership attributable to CDC partner’s 50% share of distributable cash flow to repay the loan. Any balance remaining on the note is due in August 2007. The current portion of loan receivable of $575,000 from the CDC partner is included in current notes receivable as of September 30, 2004. The remaining balance of $1,060,000 is included in other non-current assets as of September 30, 2004.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      As of September 30, 2004 and December 31, 2003, long-term debt consisted of the following (dollars in thousands):

      In conjunction with the April 2004 acquisition of the LIG Pipeline Company and its subsidiaries discussed in Note (3), the Partnership amended its bank credit facility to increase the borrowing base under its senior secured revolving acquisition facility from $70 million to $100 million and to increase the borrowing base under its senior secured revolving credit working capital and letter of credit facility from $50 million to $100 million. Additionally, the current ratio covenant was eliminated under this amendment. In June 2004, the bank credit facility was further amended allowing for an increase in senior secured notes to $125 million and eliminating the minimum tangible net worth covenant.

      In June 2004, the Partnership completed a private placement offering of $75 million in senior secured notes with Prudential Capital Group. The notes mature in 10 years, with an average life of eight years, have an annual coupon of 6.96% and are callable after three years at 103.5% of par. The notes were used to repay borrowings under the Partnership’s revolving credit facility.

      As part of the $75 million private placement, the Master Shelf Agreement (the “Agreement”) governing the notes was amended, the following being the significant amendments:

	•	increased the aggregate amount of notes that may be issued under the Agreement to $125 million;
	•	extended the issuance period from June 2006 to June 2007;
	•	established a release of collateral provision should the Partnership obtain a senior unsecured debt rating of investment grade by certain rating agencies; and
	•	provided a call premium on the $75 million placement beginning June 2007 through June 2013 at rates declining from 3.50% to 0%. The notes are not callable prior to June 2007.

      In October 2002, the Partnership entered into an interest rate swap covering a principal amount of $20 million for a period of two years. The Partnership is subject to interest rate risk on its acquisition credit facility. The interest rate swap reduces this risk by fixing the LIBOR rate, prior to credit margin, at 2.29%, on $20 million of related debt outstanding over the term of the swap agreement which expires on November 1, 2004. The Partnership has accounted for this swap as a cash flow hedge of the variable interest payments related to the $20 million of the acquisition credit facility outstanding. Accordingly, unrealized gains or losses relating to the swap which are recorded in other comprehensive income will be reclassified from other comprehensive income to interest expense over the period hedged. The fair value of the interest rate swap at September 30, 2004 was a $32,000 liability and is included in fair value of derivative liabilities.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      In accordance with the partnership agreement, the Partnership must make distributions of 100% of available cash, as defined in the partnership agreement, within 45 days following the end of each quarter. Distributions will generally be made 98% to the common and subordinated unitholders and 2% to the general partner, subject to the payment of incentive distributions to the extent that certain target levels of cash distributions are achieved. Under the quarterly incentive distribution provisions, generally our general partner is entitled to 13% of amounts we distribute in excess of $0.25 per unit, 23% of the amounts we distribute in excess of $0.3125 per unit and 48% of amounts we distribute in excess of $0.375 per unit. Incentive distributions totaling $1,474,000 and $3,728,000 were earned by our general partner for the three months and nine months ended September 30, 2004. To the extent there is sufficient available cash, the holders of common units are entitled to receive the minimum quarterly distribution of $0.25 per unit, plus arrearages, prior to any distribution of available cash to the holders of subordinated units. Subordinated units will not accrue any arrearages with respect to distributions for any quarter.

      The Partnership has declared a third quarter 2004 distribution of $0.43 per unit to be paid on November 18, 2004.

      The Partnership manages its exposure to fluctuations in commodity prices by hedging the impact of market fluctuations. Swaps are used to manage and hedge prices and location risk related to these market exposures. Swaps are also used to manage margins on offsetting fixed-price purchase or sale commitments for physical quantities of natural gas and NGLs.

      The fair value of derivative assets and liabilities, excluding the interest rate swap, are as follows (in thousands):

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Set forth below is the summarized notional amount and terms of all instruments held for price risk management purposes (not held for trading purposes) at September 30, 2004 (all quantities are expressed in British Thermal Units). The remaining term of the contracts extend no later than December 2005, with no single contract longer than six months. The Partnership’s counterparties to hedging contracts include UBS Financial, Morgan Stanley Capital Group, BP Corporation, Duke Energy Trading and Marketing, and AEP Energy Services. Changes in the fair value of the Partnership’s derivatives related to Producer Services gas marketing activities are recorded in earnings. The effective portion of changes in the fair value of cash flow hedges is recorded in accumulated other comprehensive income until the related anticipated future cash flow is recognized in earnings.