UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C.  20549

 

FORM 10-Q

 

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED March 31, 2005

 

OR

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM               TO              .

 

Commission file number:  000-51120

 

Hiland Partners, LP

(Exact name of Registrant as specified in its charter)

 

DELAWARE		71-0972724
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
205 West Maple, Suite 1100 Enid, Oklahoma		73701
(Address of principal executive offices)		(Zip code)
Registrant’s telephone number including area code (580) 242-6040

 

Indicate by check mark whether the 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  ý    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  ý

 

The number of the registrant’s outstanding equity units at May 6, 2005 was 2,720,000 common units, 4,080,000 subordinated units and a 2% general partnership interest.

 

 

HILAND PARTNERS, LP

INDEX

 

PART I. FINANCIAL INFORMATION	3
DESCRIPTION OF BUSINESS	3
Item 1. Financial Statements (Unaudited, except December 31, 2004 Balance Sheet)	5
Consolidated Balance Sheets	5
Consolidated Combined Statements of Operations	6
Consolidated Combined Statements of Cash Flows	7
Consolidated Combined Statements of Owners’ Equity	8
Notes to Consolidated Combined Financial Statements	9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 3. Quantitative and Qualitative Disclosures About Market Risks	33
Item 4. Controls and Procedures	33
PART II. OTHER INFORMATION	34
Item 1. Legal Proceedings	34
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	34
Item 3. Defaults Upon Senior Securities	34
Item 4. Submission of Matters to a Vote of Security Holders	34
Item 5. Other Information	34
Item 6. Exhibits	34
SIGNATURES	36
Certification of CEO under Section 302
Certification of CFO under Section 302
Certification of CEO under Section 906
Certification of CFO under Section 906

 

i

 

Cautionary Statement About Forward-Looking Statements

 

This Quarterly Report on Form 10-Q includes certain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act 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 we believe such forward-looking statements are based on reasonable assumptions and current expectations and projections about future events, no assurance can be given that every objective will be reached.

 

Actual results may differ materially from any results projected, forecasted, estimated or expressed in forward-looking statements since many of the factors that determine these results are subject to uncertainties and risks, difficult to predict, and beyond management’s control.  Such factors include:

 

•      the general economic conditions in the United States of America as well as the general economic conditions and currencies in foreign countries;

 

•      the continued ability to find and contract for new sources of natural gas supply;

 

•      the amount of natural gas transported on our gathering systems;

 

•      the level of throughput in our natural gas processing and treating facilities;

 

•      the fees we charge and the margins realized for our services;

 

•      the prices and market demand for, and the relationship between, natural gas and NGLs;

 

•      energy prices generally;

 

•      the level of domestic oil and natural gas production;

 

•      the availability of imported oil and natural gas;

 

•      actions taken by foreign oil and gas producing nations;

 

•      the political and economic stability of petroleum producing nations;

 

•      the weather in our operating areas;

 

•      the extent of governmental regulation and taxation;

 

•      hazards or operating risks incidental to the transporting, treating and processing of natural gas and NGLs that may not be fully covered by insurance;

 

•      competition from other midstream companies;

 

•      loss of key personnel;

 

•      the availability and cost of capital and our ability to access certain capital sources;

 

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

 

•      the costs and effects of legal and administrative proceedings;

 

•      the ability to successfully identify and consummate strategic acquisitions at purchase prices that are accretive to the our financial results; and

 

•      risks associated with the construction of new pipelines and treating and processing facilities or additions to our existing pipelines and facilities.

 

These factors are not necessarily all of the important factors that could cause actual results to differ materially from those expressed in any of our forward-looking statements.  Our future results will depend upon various other risks and uncertainties,

 

1

 

including, but not limited to those described under “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  Other unknown or unpredictable factors also could have material adverse effects on our future results.  You should not put undue reliance on any forward-looking statements.

 

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

 

2

 

PART I. FINANCIAL INFORMATION

 

DESCRIPTION OF BUSINESS

 

The financial statements presented in this Form 10-Q present the financial position and results of Continental Gas, Inc. (Predecessor) for periods presented through February 14, 2005.  The financial results of Continental Gas, Inc. pre-dates the commencement of operations of the Registrant, Hiland Partners, LP and subsequent transactions described below.

 

The financial statements for the three-month period ended March 31, 2005 also include the results of operations of Hiland Partners, LP for the period from February 15, 2005, the date Hiland Partners, LP commenced operations.  The balance sheet as of March 31, 2005 presents solely the consolidated financial position of Hiland Partners, LP.

 

Hiland Partners, LP is a Delaware limited partnership formed in October 2004 to own and operate the assets that have historically been owned and operated by Continental Gas, Inc. and Hiland Partners, LLC.  In connection with our initial public offering described below, the former owners of Continental Gas, Inc. and Hiland Partners, LLC and certain of our affiliates, including our general partner, contributed to us all of the assets and operations of Continental Gas, Inc., other than a portion of its working capital assets, and substantially all of the assets and operations of Hiland Partners, LLC, other than a portion of its working capital assets and the assets related to the Bakken gathering system, in exchange for an aggregate of 720,000 common units and 4,080,000 subordinated units, a 2% general partner interest in us and all of our incentive distribution rights, which entitle the general partner to increasing percentages of the cash we distribute in excess of $0.495 per unit per quarter. Harold Hamm and members of our management own a 100% managing member interest in Hiland Partners GP, LLC, our general partner.

 

Continental Gas, Inc. historically has owned all of our natural gas gathering, processing, treating and fractionation assets other than our Worland gathering system.  Prior to July 21, 2004, Continental Gas, Inc. was owned by Continental Resources, Inc., an independent exploration and development company owned by Harold Hamm, the Chairman of the Board of Directors of our general partner and the Harold Hamm DST and the Harold Hamm HJ Trusts, which are trusts established for the benefit of Harold Hamm’s children and which we refer to herein as the “Hamm Trusts.”  On July 21, 2004, Continental Resources, Inc. completed the transfer of Continental Gas, Inc. to Harold Hamm and the Hamm Trusts.  Hiland Partners, LLC historically owned our Worland gathering system, our compression services assets and the Bakken gathering system.  Hiland Partners, LLC is owned by the Hamm Trusts and an entity owned by Randy Moeder, our President and Chief Executive Officer and a director of our general partner.

 

On October 22, 2004, we filed a registration statement on Form S-1 with the United States Securities and Exchange Commission (the “SEC”) relating to a proposed underwritten initial public offering of limited partnership units in Hiland Partners, LP.

 

On February 9, 2005, the SEC declared our registration statement on Form S-1 effective and we priced 2,000,000 common units for the initial public offering at a price of $22.50 per unit.  On February 10, 2005, our common units began trading on the Nasdaq National Market under the symbol “HLND”.  On February 15, 2005, we closed our initial public offering of 2,300,000 common units, which included a 300,000 unit over-allotment option that was exercised by the underwriters.  Total proceeds from the sale of the units were $48.1 million, net of $3.6 million of underwriting commissions.  The proceeds of the public offering were used to: (i) repay approximately $22.9 million of outstanding indebtedness, (ii) pay the remaining $2.2 million of expenses associated with the offering and the related formation transactions, (iii) make a distribution of approximately $3.9 million to the former owners of Hiland Partners, LLC in reimbursement of certain capitalized expenditures related to the assets of Hiland Partners, LLC that were contributed to us, (iv) pay $0.6 million of deferred debt issuance costs related to the credit facility, (v) replenish approximately $12.2 million of working capital and (vi) redeem an aggregate of 300,000 common units from an affiliate of Harold Hamm and the Hamm Trusts for $6.3 million.

 

Concurrently with the closing of our initial public offering, we established a $55.0 million credit facility through our operating company, Hiland Operating, LLC, with MidFirst Bank, a federally chartered savings association located in Oklahoma City, Oklahoma, as administrative agent and a lender, with an option to increase the amount to $90.0 million under certain conditions.  As of May 6, 2005, we had no indebtedness outstanding under the credit facility.

 

In reviewing the financial statements discussed herein, you should be aware of the following:

 

•      The assets of Continental Gas, Inc. transferred to us are recorded at historical cost as it is considered a reorganization of entities under common control.  The acquisition of the assets of Hiland Partners, LLC was accounted for as a purchase and, as a result, these assets are recorded at their fair value at the time of purchase, which occurred concurrent with the closing of our initial public offering.

 

3

 

•      The financial statement for the three-month period ended March 31, 2005 for Hiland Partners, LP includes the results of operations of the assets acquired from Hiland Partners, LLC only from February 15, 2005, the date Hiland Partners, LP commenced operations and acquired the assets.

 

•      Prior to our formation, Hiland Partners, LLC owned our Horse Creek air compression facility and our Cedar Hills water injection facility.  In 2002, Hiland Partners, LLC entered into a five-year lease agreement with Continental Resources, Inc., pursuant to which Hiland Partners, LLC leased the facilities to Continental Resources, Inc.  Continental Resources, Inc. used its own personnel to operate the facilities, and Hiland Partners, LLC made no operational decisions.  In connection with our formation and our initial public offering, we entered into a four-year services agreement with Continental Resources, Inc., effective as of January 28, 2005, that replaced the existing lease.  Under the services agreement, we own and operate the facilities and provide air compression and water injection services to Continental Resources, Inc. for a fee.  As part of the new agreement, the personnel at Continental Resources, Inc. that operated the facilities are now employed by us.  Under the new services agreement, we will receive a fixed payment of approximately $4.8 million per year as compared to $3.8 million under the prior lease agreement.  In connection with the new services arrangement, we will incur approximately $1.0 million per year in additional operating costs.

 

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion of the initial public offering and related transactions and agreements.

 

References in this quarterly report on Form 10-Q to “we,” “our,” “us,” or similar terms refer to Hiland Partners, LP and its operating subsidiaries after giving effect to the formation transactions described above.

 

4

 

Item 1. Financial Statements

 

HILAND PARTNERS, LP

CONTINENTAL GAS, INC. (PREDECESSOR)

Consolidated Balance Sheets

 

		Hiland Partners, LP March 31, 2005			Continental Gas, Inc. (Predecessor) December 31, 2004
		(Unaudited)
		(in thousands, except unit amounts)
ASSETS
Current Assets:
Cash and cash equivalent		$	3,202		$	217
Accounts receivable:
Trade		10,527			9,663
Affiliates		909			758
		11,436			10,421
Inventories		153			153
Other current assets		311			118
Total current assets		15,102			10,909
Property and equipment, net		67,622			37,075
Intangible assets, net		26,465			—
Other assets, net		797			1,191
Total assets		$	109,986		$	49,175
LIABILITIES AND PARTNERS’ EQUITY
Current liabilities:
Accounts payable		$	6,104		$	5,649
Accounts payable - affiliates		2,698			2,998
Accrued liabilities		703			327
Current maturities of long-term debt		—			2,429
Total current liabilities		9,505			11,403
Commitment and contingencies		—			—
Long-term debt, net of current maturities		—			12,643
Asset retirement obligation		1,024			619
Owners’ equity:
Predecessor stockholders’ equity		—			24,510
Common unitholders (2,720,000 units issued and outstanding March 31, 2005)		47,854			—
Subordinated unitholders (4,080,000 units issued and outstanding at March 31, 2005)		49,791			—
General partner interest (2% interest with 138,776 equivalent units outstanding March 31, 2005)		1,812			—
Total owners’ equity		99,457			24,510
Total liabilities and owners’ equity		$	109,986		$	49,175

 

The accompanying notes are an integral part of these financial statements.

 

5

 

HILAND PARTNERS, LP

CONTINENTAL GAS, INC. (PREDECESSOR)

Consolidated Combined Statements of Operations

For the Three Months Ended (Unaudited)

 

		Hiland Partners, LP March 31,			Continental Gas, Inc. (Predecessor) March 31,
		2005			2004
		(in thousands, except per unit data)
Revenues:
Midstream operations
Third parties		$	24,191		$	20,235
Affiliates		984			815
Compression services, affiliate		603			—
Total revenues		25,778			21,050
Operating costs and expenses:
Midstream purchases (exclusive of items shown below)		13,860			10,827
Midstream purchases - affiliate (exclusive of items shown below)		6,343			6,983
Operations and maintenance		1,577			1,196
Depreciation, amortization and accretion		1,677			847
General and administrative		353			264
Total operating costs and expenses		23,810			20,117
Operating income		1,968			933
Other income (expense):
Interest and other income		7			13
Amortization of deferred loan costs		(205		)	(25		)
Interest expense		(134		)	(169		)
Total other income (expense)		(332		)	(181		)
Income from continuing operations		1,636			752
Discontinued operations, net		—			15
Net Income		1,636			$	767
Less income attributable to predecessor		493
Less general partner interest in net income		23
Limited partners’ interest in net income		$	1,120
Net income per limited partners’ unit – basic		$	0.16
Net income per limited partners’ unit – diluted		$	0.16
Weighted average limited partners’ units outstanding -basic		6,800
Weighted average limited partners’ units outstanding -diluted		6,840

 

The accompanying notes are an integral part of these financial statements.

 

6

 

HILAND PARTNERS, LP

CONTINENTAL GAS, INC. (PREDCESSOR)

Consolidated Combined Statements of Cash Flows

For the Three Months Ended (Unaudited)

 

		Hiland Partners, LP March 31,			Continental Gas, Inc. (Predecessor) March 31,
		2005			2004
		(in thousands)
Cash flows from operating activities:
Net income		$	1,636		$	767
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		1,669			847
Change in asset retirement obligation		8			13
Amortization of deferred loan cost		205			25
Change in current assets and current liabilities net of effects of the Hiland Partners, LLC acquisition:
(Increase) decrease in current assets:
Accounts receivable		(9,849		)	1,122
Account receivable – affiliates		(151		)	12
Inventories		—			122
Other current assets		(147		)	—
Increase (decrease) in current liabilities:
Accounts payable		(221		)	365
Accounts payable – affiliates		(300		)	(94		)
Accrued liabilities		311			(150		)
Net cash provided by (used in) operating activities		(6,839		)	3,029
Cash flows from investing activities:
Additions to property and equipment		(281		)	(1,328		)
Net cash used for investing activities		(281		)	(1,328		)
Cash flows from financing activities:
Proceeds from public offering -net		48,128			—
Redemption of common units		(6,278		)	—
Distribution to organizers		(3,851		)	—
Cash not contributed by organizers		(869		)	—
Payment on long-term borrowings		(23,951		)	(607		)
Debt issuance costs		(825		)	(7		)
Payment of offering costs		(2,249		)	—
Net cash provided (used by) financing activities		10,105			(614		)
Increase (decrease) for the period		2,985			1,087
Beginning of period		217			496
End of period		$	3,202		$	1,583
Supplementary information:
Cash paid for interest		$	153		$	170

 

See Note 4 for non-cash business combination transactions.

 

The accompanying notes are an integral part of these financial statements.

 

7

 

HILAND PARTNERS, LP

CONTINENTAL GAS, INC. (PREDECESSOR)

Consolidated Combined Statement of Partners’ Equity

(Unaudited)

 

		Hiland Partners, LP
		Continental Gas, Inc. (Predecessor)			Common Units			Subordinated Units			General Partner Interest			Total
		(in thousands)
Balance December 31, 2004		$	24,510		$	—		$	—		$	—		$	24,510
Assets and liabilities not contributed to Hiland Partners, LP		(9,972		)	—			—			—			(9,972		)
Net income through February 14, 2005		493			—			—			—			493
Allocation of net parent investment to unitholders		(15,031		)	2,191			12,418			422			—
Contribution of Hiland Partners, LLC by owners		—			7,092			40,190			1,367			48,649
Proceeds from initial public offering, net of underwriter discount		—			48,128			—			—			48,128
Offering costs					(3,365		)	—			—			(3,365		)
Redemption of Common Units from Organizers		—			(6,278		)	—			—			(6,278		)
Distributions		—			(362		)	(3,489		)	—			(3,851		)
Net income from February 15, 2005 through March 31, 2005		—			448			672			23			1,143
Balance March 31, 2005		$	—		$	47,854		$	49,791		$	1,812		$	99,457

 

The accompanying notes are an integral part of these financial statements.

 

8

 

HILAND PARTNERS, LP

CONTINENTAL GAS, INC. (PREDECESSOR)

NOTES TO CONSOLIDATED COMBINED FINANCIAL STATEMENTS (UNAUDITED)

AS OF AND FOR THE THREE MONTHS ENDED MARCH, 2004, AND 2005

 

(in thousands, except unit amounts and per unit amounts or unless otherwise noted)

 

Note 1:  Description of Business and Summary of Significant Accounting Policies

 

Interim Financial Statements

 

The financial statements for the three months ended March 31, 2004 and 2005 included herein have been prepared without audit, pursuant to the rules and regulation of the United States Securities and Exchange Commission (the “SEC”).  The statements of operations, cash flow and partners’ equity include the accounts of Continental Gas, Inc. (“CGI”) through February 14, 2005 and Hiland Partners, LP ( the “Partnership”) for the period from February 15, 2005 to March 31, 2005.  The accompanying condensed consolidated financial statements and related notes should be read in conjunction with the audited financial statements of Continental Gas, Inc. (Predecessor) and Hiland Partners, LLC, and notes thereto, for the year ended December 31, 2004 as presented in the Partnership’s  Form 10-K for the year ended December 31, 2004.

 

The interim financial statements reflect all adjustments, which are in the opinion of management, necessary for a fair presentation of our results for the interim periods to the extent permitted by GAAP.  Such adjustments are considered to be of a normal recurring nature.  Results of operations for the three months ended March 31, 2005 are not necessarily indicative of the results of operations that will be realized for the year ending December 31, 2005.

 

Principles of Consolidation

 

The consolidated financial statements include our accounts and those of our subsidiaries. All significant intercompany transactions and balances have been eliminated. In addition, the consolidated financial statements include the financial position and results of operations of assets owned by CGI or Hiland Partners, LLC that were contributed to the Partnership concurrently with the completion of our initial public offering.

 

Description of Business

 

Hiland Partners, LP was formed in October, 2004 to acquire and operate certain of the midstream natural gas plants, gathering systems, and compression and water injection assets previously owned by CGI and Hiland Partners, LLC.

 

CGI was formed in 1990 as a wholly owned subsidiary of Continental Resources, Inc. (“CRI”). CGI operates in one business, midstream, which is the gathering, compressing, dehydrating, treating, and processing of natural gas and fractionating natural gas liquids, or NGLs. CGI connects the wells of natural gas producers in its market areas to its gathering systems, treats natural gas to remove impurities, processes natural gas for the removal of NGLs and sells the resulting products to a variety of intermediate purchasers. CGI owns and operates three processing plants with associated compressor stations, fractionation facilities and approximately 650 miles of gathering pipeline. These plants and associated gathering systems are located in Oklahoma and North Dakota. CGI also owns three small gathering systems consisting of approximately 20 miles of pipeline and compressor stations. These gathering systems are located in Texas, Mississippi and Oklahoma.

 

CGI had minor interests in producing oil and gas properties located primarily in North Dakota. The properties were acquired over several years while CGI was a subsidiary of CRI. CGI does not to intend to pursue the exploration for and development of oil and natural gas and, accordingly, conveyed its interest in these properties effective May 31, 2004 to CRI. Therefore this activity is presented as discontinued operations.

 

In July 2004, CRI sold all of the issued and outstanding capital stock of CGI to the shareholders of CRI at fair value. The stock sale transaction was approved by all of the independent members of the Board of Directors of CRI, and the independent members of the Board of Directors were provided with an opinion as to the fairness of the stock sale transaction, from a financial point of view. CGI and CRI were previously reported as a consolidated entity.

 

As of the date of the closing of the public offering, CGI, through a series of steps, became Continental Gas Operating, LP.  This entity is a wholly-owned subsidiary of the Partnership.

 

Hiland Partners, LLC was formed in September 2000 as an Oklahoma limited liability company. Hiland Partners, LLC operates in two businesses: midstream, which is the gathering, compressing, dehydrating, treating, processing and marketing of natural gas and

 

9

 

fractionating NGLs; and compression, which is providing air compression and water injection services for oil and gas secondary recovery operations that are ongoing in North Dakota.

 

Hiland Partners, LLC connects the wells of natural gas producers in its market area to its gathering system, treats natural gas to remove impurities, processes natural gas for the removal of NGLs and sells the resulting products to a variety of intermediate purchasers. Hiland Partners, LLC owns and operates one processing plant with associated compressor stations, fractionation facilities and approximately 150 miles of gathering pipeline. The plant and associated gathering system is located in Wyoming. Hiland Partners, LLC is in the process of constructing a processing plant and gathering system in Montana (the “Bakken gathering system”).

 

Hiland Partners, LLC leased several large compressors to CRI, an affiliated entity. Certain Hiland Partners, LLC owners also own approximately 9% of CRI common stock. These compressors supply compressed air and water for use in a secondary oil recovery project in North Dakota for which CRI is the operator.  Effective January 28, 2005, the agreements were revised into a services agreement (see also Note 4).

 

Hiland Partners, LLC formed a subsidiary, Hiland Energy Partners, LLC, and conveyed all of its assets, other than its assets related to the Bakken gathering system, to Hiland Energy Partners, LLC. As of the date of the closing of the public offering, Hiland Energy Partners, LLC, through a series of steps, became a wholly-owned subsidiary of the Partnership.

 

In October 2004, Hiland Partners, LP filed a registration statement on Form S-1 with the Securities and Exchange Commission, relating to its proposed initial public offering. On February 15, 2005, the Partnership closed its offering and (a) substantially all of CGI’s assets and liabilities were transferred to Continental Gas Operating, LP, (b) substantially all of Hiland Partners, LLC’s assets less the Bakken gathering system were transferred to Hiland Energy Partners, LLC, and (c) all of the interests in these two operating entities were transferred to Hiland Partners, LP.

 

Use of Estimates

 

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

 

Cash and Cash Equivalents

 

The Partnership considers all highly liquid investments with maturity of three months or less at the time of purchase to be cash equivalents.

 

Accounts Receivable

 

The majority of the accounts receivable are due from independent companies in the oil and gas industry as well as the utility industry. Credit is extended based on evaluation of the customer’s financial condition. In certain circumstances, collateral, such as letters of credit or guarantees, is required. Accounts receivable are due within 30 days and are stated at amounts due from customers. The Partnership has established various procedures to manage its credit exposure, including initial credit approvals, credit limits and rights of offset. Credit losses are charged to income when accounts are deemed uncollectible, determined on a case-by-case basis when the Partnership believes the required payment of specific amounts owed is unlikely to occur. These losses historically have been minimal; therefore, an allowance for uncollectible accounts is not required.

 

Inventories

 

Inventories consist primarily of compressors and associated equipment. Inventories are stated at the lower of cost or estimated net realizable value.

 

Concentration and Credit Risk

 

Financial instruments that potentially subject the Partnership to concentrations of credit risk consist principally of cash and cash equivalents and receivables.

 

The Partnership places its cash and cash equivalents with high-quality institutions and in money market funds. The Partnership derives its revenue from customers primarily in the natural gas and utility industries. These industry concentrations have the potential to impact the Partnership’s overall exposure to credit risk, either positively or negatively, in that the Partnership’s customers could be affected by similar changes in economic, industry or other conditions. However, the Partnership believes that the credit risk posed by this industry concentration is offset by the creditworthiness of the Partnership’s customer base. The Partnership’s portfolio of accounts receivable is comprised primarily of mid-size to large domestic corporate entities.

 

10

 

Fair Value of Financial Instruments

 

The Partnership’s financial instruments, which require fair value disclosure, consist primarily of cash, accounts receivable, accounts payable and bank debt. The carrying value of cash, accounts receivable and accounts payable are considered to be representative of their respective fair values, due to the short maturity of these instruments. The fair value of long-term debt approximates its carrying value based on the borrowing rates currently available to the Partnership for bank loans with similar terms and maturities.

 

Intangible and Other Assets

 

Intangible assets consist of the acquired value of existing contracts to sell natural gas and other NGLs and compression contracts, which have a significant residual value.  The contracts are being amortized over ten years.  The deferred loan costs are being amortized over the life of the credit facility.

 

The table below details the gross carrying amount and accumulated amortization:

 

		As of March 31,
		2005			2004
Gas sales contracts, gross		$	8,285		$	—
Compression contracts, gross		18,515			—
Total intangibles, gross		26,800			—
Accumulated amortization, gas sales contracts		104			—
Accumulated amortization, compression contracts		231			—
Total accumulated amortization		335			—
Net intangible assets		$	26,465		$	—

 

Intangible amortization for the quarters ended March 31, 2004 and 2005, was $0 and $335, respectively. Deferred loan cost amortization for the quarters ended March 31, 2004 and 2005, was $25 and $205, respectively.

 

Long-Lived Assets

 

In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Partnership evaluates its long-lived assets of identifiable business activities for impairment when events or changes in circumstances indicate, in management’s judgment, that the carrying value of such assets may not be recoverable. The determination of whether impairment has occurred is based on management’s estimate of undiscounted future cash flows attributable to the assets as compared to the carrying value of the assets. If impairment has occurred, the amount of the impairment recognized is determined by estimating the fair value for the assets and recording a provision for loss if the carrying value is greater 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 less the cost to sell to determine if impairment is required. Until the assets are disposed of, an estimate of the fair value is redetermined when related events or circumstances change.

 

When determining whether impairment of one of the Partnership’s long-lived assets has occurred, the Partnership must estimate the undiscounted cash flows attributable to the asset or asset group. The Partnership’s estimate of cash flows is based on assumptions regarding the volume of reserves providing asset cash flow and future NGL product and natural gas prices. The amount of reserves and drilling activity are dependent in part on natural gas prices. Projections of reserves and future commodity prices are inherently subjective and contingent upon a number of variable factors, including, but not limited to:

 

•      changes in general economic conditions in regions in which the Partnership’s products are located;

•      the availability and prices of NGL products and competing commodities;

•      the availability and prices of raw natural gas supply;

•      the Partnership’s ability to negotiate favorable marketing agreements;

•      the risks that third party oil and gas exploration and production activities will not occur or be successful;

•      the Partnership’s dependence on certain significant customers and producers of natural gas; and

•      competition from other midstream service providers and processors, including major energy companies.

 

11

 

Any significant variance in any of the above assumptions or factors could materially affect the Partnership’s cash flows, which could require the Partnership to record an impairment of an asset.

 

Revenue Recognition

 

Revenues for sales of natural gas and NGLs are recognized at the time all gathering and processing activities are completed, the product is delivered and title is transferred. Revenues for compression services are recognized when the services under the agreement are performed. Revenues from oil and gas production (discontinued operations) are recorded in the month produced and title is transferred to the purchaser.

 

Derivatives

 

Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS No. 133 provides that normal purchases and normal sales contracts are not subject to the statement. Normal purchases and normal sales are contracts that provide for the purchase or sale of something other than a financial instrument or derivative instrument that will be delivered in quantities expected to be used or sold by the reporting entity over a reasonable period in the normal course of business. The Partnership’s forward natural gas purchase and sales contracts qualify as normal purchases and sales. Substantially all forward contracts fall within a one-month to five-year term.

 

Property and Equipment

 

The Partnership’s property and equipment are carried at cost. Depreciation and amortization of all equipment is determined under the straight-line method using various rates based on useful lives, 10 to 22 years for pipeline and processing plants, and 3 to 10 years for corporate and other assets. The cost of assets and related accumulated depreciation is removed from the accounts when such assets are disposed of, and any related gains or losses are reflected in current earnings. Maintenance, repairs and minor replacements are expensed as incurred. Costs of replacements constituting improvement are capitalized.

 

Environmental Costs

 

Environmental costs are expensed if they relate to an existing condition caused by past operations and do not contribute to current or future revenue generation. Liabilities are recorded when site restoration and environmental remediation and cleanup obligations are either known or considered probable and can be reasonably estimated. Recoveries of environmental costs through insurance, indemnification arrangements or other sources are included in other assets to the extent such recoveries are considered probable.

 

Income Taxes

 

The Partnership and its predecessor are not subject to income taxes. Accordingly, there is no provision for income taxes included in the consolidated financial statements. Taxable income, gain, loss and deductions are allocated to the partners who are responsible for payment of any income taxes thereon.

 

Description of Equity Interest in the Partnership

 

The common and subordinated units represent limited partner interests in the Partnership.  The holders of units are entitled to participate in partnership distributions and exercise the rights and privileges available to limited partners under the partnership agreement of the Partnership.

 

The common units have the right to receive minimum quarterly distributions of $0.45 per unit, or $1.80 on an annualized basis, plus any arrearages on the common units, before any distribution is made to the holders of subordinated units.  In addition, if the aggregate ownership of common and subordinated units owned by persons other than the general partner and its affiliates is less than 20%, the general partner will have a right to call the common units at a price not less than the then-current market price of the common units.

 

The subordinated units generally receive quarterly cash distributions only when common units have received a minimum quarterly distribution of $0.45 per unit for each quarter since the commencement of operations.  Subordinated units will convert into common units on a one-for-one basis when the subordination period ends.  The subordination period will end when the Partnership meets financial tests specified in the partnership agreement but generally cannot end before March 31, 2010.  The subordinated units have an early conversion-to-common-units potential of 25% of the subordinated units after March 31, 2008 and another 25% after March 31, 2009, if certain distribution targets are achieved.

 

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The general partner is entitled to at least 2% of all distributions made by the partnership.  In addition, the general partner holds incentive distribution rights, which allow the general partner to receive a higher percentage of quarterly distributions of available cash from operating surplus after the minimum quarterly distributions have been achieved, and as additional target levels are met.  The higher percentages range from 15% to 50%.  There were no distributions during the first quarter of 2005.

 

Net Income per Limited Partners’ Unit

 

The computation of net income per limited partners’ unit is based on the weighted-average number of common and subordinated units outstanding during the period. Net income per unit applicable to limited partners is computed by dividing net income applicable to limited partners, after deducting the general partner’s 2% interest and incentive distributions, and after deducting net income attributable to the Predecessor (before February 15, 2005), by the weighted-average number of limited partnership units outstanding. The following is a reconciliation of the limited partner units used in the calculations of income per limited partner unit and income per limited partner unit - assuming dilution:

 

		Income Available to Limited Partners (Numerator)			Limited Partner Units (Denominator)			Per Unit Amount
For the quarter ended March 31, 2005:
Income per limited partner unit -basic:
Income available to limited unitholders		$	1,120					$	0.16
Weighted average limited partner units outstanding					6,800,000
Income per limited partner unit – assuming dilution:
Unit Options					40,000
Income available to common unitholders plus assumed conversions		$	1,120		6,840,000			$	0.16

 

Transportation and Exchange Imbalances

 

In the course of transporting natural gas and NGLs for others, the Partnership may receive for redelivery different quantities of natural gas or NGLs than the quantities actually redelivered. These transactions result in transportation and exchange imbalance receivables or payables that are recovered or repaid through the receipt or delivery of natural gas or NGLs in future periods, if not subject to cashout provisions. Imbalance receivables are included in accounts receivable and imbalance payables are included in accounts payable on the balance sheets and marked-to-market using current market prices in effect for the reporting period of the outstanding imbalances. Changes in market value and the settlement of any such imbalance at a price greater than or less than the recorded imbalance results in either an upward or downward adjustment, as appropriate, to the cost of natural gas sold. As of March 31, 2004 and 2005, the Partnership had no imbalance receivables or payables.

 

Segment reporting

 

In accordance with SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information,” the Partnership’s reportable business segments have been identified based on the differences in the products or services provided (see Note 11).

 

Share-Based Compensation

 

The Partnership applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its share-based compensation awards.  Accordingly, no compensation cost has been recognized for unit options granted in the accompanying consolidated financial statements.  The following pro forma data is calculated as if compensation cost for the Partnership’s share-based compensation awards (see also Note 10) was determined based upon the fair value at the grant date consistent with the methodology prescribed under SFAS No. 123.

 

13

 

		Quarters Ended March 31,
		2005			2004
Net income as reported		$	1,636		$	767
Less income attributable to predecessor		493
Net income (net of predecessor income)		1,143
Less general partner interest		23
Limited partner’s interest in net income		1,120
Adjustment (net of general partner’s interest)		(133		)
Limited partner’s interest in proforma net income		$	987
Net income per limited partner unit as reported, basic		$	0.16
Net income per limited partner unit as reported, diluted		$	0.16
Adjustment, basic		$	(0.01	)
Adjustment, diluted		$	(0.02	)
Proforma net income per limited partner unit, basic		$	0.15
Proforma net income per limited partner unit, diluted		$	0.14
Weighted average limited partner units outstanding, basic		6,800,000
Weighted average limited partner units outstanding, diluted		6,840,000

 

The fair value of each option grant is estimated on the date of grant using the American Binomial option pricing model with the following weighted average assumptions used for grants in 2005, respectively: risk-free interest rates of 4.54 percent; 5.37 percent dividend yield; no assumed forfeitures; expected lives of 6.0 years; and volatility of 31 percent.  The pro forma amounts above are not likely to be representative of future years because there is no assurance that additional awards will be made each year.

 

Asset Retirement Obligations

 

SFAS No. 143, “Accounting for Asset Retirement Obligations”

 

The Partnership records the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset. Subsequently, the asset retirement cost is allocated to expense using a systematic and rational method and the liability is accreted to measure the change in liability due to the passage of time.

 

The following table summarizes CGI’s activity through February 14, 2005 and the Partnership’s activity from February 15, 2005 through March 31, 2005 related to asset retirement obligations:

 

Asset Retirement Obligation, January 1, 2005			$	619
Plus:	Asset Retirement Obligation accretion expense to February 14, 2005		3
Asset Retirement Obligation, February 14, 2005			622
Plus:	Asset Retirement Obligation acquired from Hiland Partners, LLC		397
	Asset Retirement Obligation accretion expense to March 31, 2005		5
Asset Retirement Obligation, March 31, 2005			$	1,024

 

Recent Accounting Pronouncements

 

SFAS No. 123R, “Share-Based Payment”

 

In October 1995, the FASB issued SFAS No. 123, “Share-Based Payments,” which was revised in December 2004 (collectively, “FASB 123R”).  FASB 123R requires that the compensation cost relating to share-based payment transactions be recognized in financial statements.  That cost will be measured based on the fair value of the equity or liability instruments issued.  The effect of the standard will be to require entities to measure the cost of employee services received in exchange for stock options based on the grant-date fair value of the award, and to recognize the cost over the period the employee is required to provide services for the award.

 

In accordance with SEC Release No. 33-8568, the Partnership will adopt SFAS 123R as of the first interim period beginning on or after January 1, 2006.  The Partnership expects to apply the Statement using the permitted modified retrospective method beginning January 1, 2006. The Partnership is still evaluating the impact of this statement on its financial statements.

 

None of the entities (the Partnership, CGI, or Hiland Partners, LLC) had issued any options prior to February 10, 2005.

 

SFAS No. 153 (“SFAS 153”), “Exchanges of Nonmonetary Assets-an amendment of APB Opinion No. 29.”

 

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In December 2004, the FASB issued SFAS 153, which amends APB Opinion No. 29 by eliminating the exception to the fair-value principle for exchanges of similar productive assets, which were accounted for under APB Opinion No. 29 based on the book value of the asset surrendered with no gain or loss recognition. SFAS 153 also eliminates APB 29’s concept of culmination of an earnings process. The amendment requires that an exchange of nonmonetary assets be accounted for at fair value if the exchange has commercial substance and fair value is determinable within reasonable limits. Commercial substance is assessed by comparing the entity’s expected cash flows immediately before and after the exchange. If the difference is significant, the transaction is considered to have commercial substance and should be recognized at fair value. SFAS 153 is effective for nonmonetary transactions occurring in fiscal periods beginning after June 15, 2005. The impact of SFAS 153 will depend on the nature and extent of any exchanges of nonmonetary assets after the effective date, but we do not currently expect SFAS 153 to have a material impact on our consolidated results of operations, cash flows or financial position.

 

EITF Issue No. 03-13 (“EITF 03-13”), Applying the Conditions in Paragraph 42 of SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, in Determining Whether to Report Discontinued Operations.”

 

In November 2004, the EITF reached a consensus with respect to evaluating whether the criteria in SFAS 144 has been met for classifying as a discontinued operation a component of an entity that either has been disposed of or is classified as held for sale. To qualify as a discontinued operations, SFAS 144 requires that the cash flows of the disposed component be eliminated from the operations of the ongoing entity and that the ongoing entity not have any significant continuing involvement in the operations of the disposed component after the disposal transaction. The consensus in EITF 03-13 clarifies that the cash flows of the eliminated component are not considered to be eliminated if the continuing cash flows represent “direct” cash flows, as defined in the consensus. The consensus also requires that the assessment of whether significant continuing involvement exists be made from the perspective of the disposed component. The assessment should consider whether (a) the continuing entity retains an interest in the disposed component sufficient to enable it to exert significant influence over the disposed component’s operating and financial policies or (b) the entity and the disposed component are parties to a contract or agreement that gives rise to significant continuing involvement by the ongoing entity. The consensus is to be applied prospectively to a component of an entity that is either disposed or classified held for sale in fiscal periods beginning after December 15, 2004. The impact of EITF 03-13 will depend on the nature and extent of any long-lived assets disposed of or held for sale after the effective date, but we do not currently expect EITF 03-13 to have a material impact on our consolidated results of operations, cash flows or financial position.

 

Note 2:  Property and Equipment

 

		As of March 31,			As of December 31,
		2005			2004
Land		$	225		$	127
Pipelines and plants		66,853			55,475
Compression and water injection equipment		19,200			—
Other		3,415			2,209
		89,693			57,811
Less: accumulated depreciation and amortization		22,071			20,736
		$	67,622		$	37,075

 

Depreciation and amortization charged to expense, including discontinued operations, totaled $878 and $1,669 for the quarters ended March 31, 2004 and 2005, respectively.

 

Note 3:  Long-Term Debt

 

		As of March 31,			As of December 31,
		2005 (b)			2004 (a)
Note payable - bank		$	—		$	15,072
Less: current portion		—			2,429
Long-term portion		$	—		$	12,643

 

15

 

(a)   Concurrently with the closing of the initial public offering, the debt was paid in full from offering proceeds.

 

(b)   Concurrently with the closing of the initial public offering, the Partnership established a $55.0 million credit facility through its operating company that consists of:

•      a $47.5 million senior secured revolving credit facility to be used for funding acquisitions and other capital expenditures, issuance of letters of credit, and general corporate purposes (the “revolving acquisition facility”); and

•      a $7.5 million senior secured revolving credit facility to be used for working capital and to fund distributions (the “revolving working capital facility”).

 

The Partnership has the right, no more than once in each fiscal year, to increase the size of the revolving acquisition facility; provided that each such increase shall be at least $10.0 million and in no event may the amount of the revolving acquisition facility exceed $82.5 million in the aggregate, and provided further that at the time of such request no default has occurred or would result due to such increase and subject to additional conditions set forth in the credit facility.  In addition, the revolving acquisition facility allows for the issuance of letters of credit of up to $5.0 million in the aggregate.  The credit facility matures in February, 2008.

 

Indebtedness under the credit facility bears interest, at the Partnership’s option, at either (i) an Alternate Base Rate plus an applicable margin ranging from 50 to 175 basis points per annum or (ii) LIBOR plus an applicable margin ranging from 150 to 275 basis points per annum based on our ratio of total debt to EBITDA, as defined.  The Alternate Base Rate is a rate per annum equal to the greatest of (a) the Prime Rate in effect on such date, (b) the base CD rate in effect on such day plus 1.5% and (c) the Federal Funds effective rate in effect on such day plus ½ of 1%.  An unused commitment fee ranging from 30 to 50 basis points per annum based on our total debt to EBITDA is payable on the unused portion of the credit facility.

 

The credit facility prohibits us from making distributions to unitholders if any default or event of default, as defined in the credit facility, has occurred and is continuing or would result from the distribution.  In addition, the credit facility contains various covenants that limit, among other things,  our ability to borrow, merge or dispose assets. The credit facility also contains covenants requiring the Partnership to maintain EBITDA and interest coverage ratios and tangible net worth of at least $55 million.

 

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

 

The credit facility limits distributions to unitholders to available cash as defined, and borrowings to fund such distributions are only permitted under the revolving working capital facility.  The revolving working capital facility is subject to an annual “clean-down” period of 15 consecutive days in which the amount outstanding under the revolving working capital facility is reduced to $0.

 

As of March 31, 2005, no amounts were outstanding under the credit facility.

 

Note 4:  Initial Public Offering of Hiland Partners, LP

 

On October 22, 2004, a Registration Statement on Form S-1 was filed with the SEC relating to a proposed initial public offering of limited partnership interests in Hiland Partners, LP.  Hiland Partners, LP was formed to own and operate the assets that have historically been owned and operated by CGI and Hiland Partners, LLC.

 

On February 9, 2005, we priced 2,000,000 common units for the public offering; and on February 10, 2005, our common units began trading on the NASDAQ National Market under the symbol “HLND”.  On February 15, 2005, we closed our initial public offering of 2,300,000 common units, which included a 300,000 unit over-allotment option that was exercised by the underwriters.  Total proceeds from the sale of the units were $48.1 million, net of $3.6 million of underwriting commissions.

 

All of our initial assets were contributed by the former owners of CGI, Hiland Partners, LLC, and certain of our affiliates, including our general partner, in exchange for an aggregate of 720,000 common units and 4,080,000 subordinated units, a 2% general partner interest in us and all of our incentive distribution rights, which entitle the general partner to increasing percentages of the cash we distribute in excess of $0.495 per unit per quarter. The assets of GCI transferred to the Partnership are recorded at historical cost as it is considered to be a reorganization of entities under common control and CGI is considered the Partnership’s accounting predecessor. The acquisition of the assets of Hiland Partners, LLC was accounted for as a purchase and, as a result, these assets were recorded at their fair value at the time of purchase.

 

16

 

The following table presents the assets and liabilities of our predecessor immediately prior to contributing assets to Hiland Partners, LP, and assets and liabilities contributed to Hiland Partners, LP, and the predecessor’s assets and liabilities that were not contributed to Hiland Partners, LP.

 

Continental Gas, Inc. (Predecessor)
As of February 14, 2005
(in thousands)

 

		Continental Gas, Inc. (Predecessor) February 14, 2005			Net Assets Not Contributed			Contributed to Hiland Partners, LP 15-Feb-05
ASSETS
Current assets:
Cash and cash equivalents		$	869		$	869		$	—
Accounts Receivable		10,521			9,101			1,420
Inventories		153			—			153
Other current assets		291			2			289
Total Current Assets		11,834			9,972			1,862
Property and equipment, at cost, net		36,805			—			36,805
Other assets, net		3,388			—			3,388
Total assets		52,027			9,972			42,055
LIABILITIES
Current liabilities:
Accounts payable		11,703			—			11,703
Accrued liabilities		700			—			700
Current maturities of long term debt		2,429			—			2,429
Total current liabilities		14,832			—			14,832
Commitments and contingencies		—			—			—
Long term debt, net of current maturities		11,570			—			11,570
Asset retirement obligation		622			—			622
Total liabilities		27,024			—			27,024
NET ASSETS		$	25,003		$	9,972		$	15,031

 

 

In consideration for the transfer, Harold Hamm and the Hamm Trusts received 467,073 common units and 2,646,749 subordinated units of the Partnership.  Immediately following the closing of the offering, 195,991 of the common units were redeemed for approximately $4.1 million.

 

17

 

The following table presents the assets and liabilities of Hiland Partners, LLC as of February 14, 2005, the assets excluded from the acquisition, and the fair value of the assets acquired.

 

Hiland Partners, LLC
As of February 14, 2005
(in thousands)

 

		Hiland Partners, LLC 14-Feb-05			Net Assets Not Contributed			Assets Contributed to Hiland Partners, LP 15-Feb-05			Fair Value
ASSETS
Current assets:
Cash and cash equivalents		$	964		$	964		$	—		$	—
Accounts Receivable		2,619			2,503			116			116
Other current assets		56			10			46			46
Total Current Assets		3,639			3,477			162			162
Property and equipment, at cost, net		50,063			29,858			20,205			31,600
Intangible Assets		—			—			—			26,800
Other assets, net		194			89			105			105
Total assets		53,896			33,424			20,472			58,667
LIABILITIES
Current liabilities:
Accounts payable		5,048			4,372			676			676
Accrued liabilities		95			30			65			65
Current maturities of long term debt		11,100			2,221			8,879			8,879
Total current liabilities		16,243			6,623			9,620			9,620
Commitments and contingencies		—			—			—			—
Long term debt, net of current maturities		24,253			24,253			—			—
Asset retirement obligation		398			—			398			398
Total liabilities		40,894			30,876			10,018			10,018
NET ASSETS		$	13,002		$	2,548		$	10,454		$	48,649

 

In consideration for the transfer:

 

a.   The Hamm Trusts received 247,868 common units and 1,404,586 subordinated units of the Partnership.  Immediately following the closing of the offering, 104,009 of the common units were redeemed for approximately $2.2 million.

 

b.   Equity Financial Services, Inc. received 5,059 common units and 28,665 subordinated units of the Partnership, none of which were redeemed.

 

As a part of the transactions, Harold Hamm, the Hamm Trusts, Equity Financial Services, Inc., Mr. Moeder, and Mr. Maples received an aggregate of 138,776 equivalent units of the General Partner, representing substantially all of the ownership of the general partner and a 2% equity ownership of the Partnership.

 

We used the proceeds of the public offering to:  redeem an aggregate of 300,000 common units from Harold Hamm and the Hamm Trusts for $6.3 million; repay $14.0 million in debt owed by CGI and $8.9 million in debt acquired from Hiland Partners, LLC; pay the remaining $2.2 million of expenses associated with the offering and formation transactions; pay $0.6 million of debt issuance costs related to the credit facility; distribute $3.9 million to the former owners of Hiland Partners, LLC in reimbursement of certain capitalized expenditures related to the assets of Hiland Partners, LLC that were contributed to the Partnership; and replenish approximately $12.2 million of working capital.

 

In connection with this offering, we entered into a four-year agreement with CRI, an affiliate of Harold Hamm, under which they agreed to pay us an operating fee of approximately $402,000 per month for us to provide air and water compression service for CRI’s

 

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secondary recovery operations in North Dakota.  We have recorded $603,000 of revenues from CRI under the compression services agreement for the period from February 15, 2005 through March 31, 2005.

 

We also entered into an omnibus agreement with CRI that became effective February 15, 2005 (the “Omnibus Agreement”) and determines the services CRI will provide to us and the liabilities from which CRI will indemnify us.  Under the agreement, CRI will charge us the lower of CRI’s cost or $50,000 per year for a two-year period for certain general, administrative and information technology support.  Continental Resources, Inc., Hiland Partners, LLC, and Continental Gas Holdings, Inc. agreed to indemnify the Partnership for income tax liabilities arising from operations prior to the closing of the offering and Continental Resources, Inc. agreed to indemnify the Partnership for liabilities associated with oil and gas properties conveyed by Continental Gas, Inc. to Continental Resources, Inc. for a period of five years from the closing date of the offering.  In addition, Harold Hamm, Hiland Partners, LLC, and Continental Resources, Inc. agreed, with certain exceptions, not to engage in, whether by acquisition or otherwise, midstream and NGL gathering and processing in the continental United States.  In addition, Hiland Partners, LLC has granted the Partnership a two-year option to purchase its Bakken gas gathering system pursuant to the Omnibus Agreement.  For a description of this agreement, please read “Item 13.  Certain Relationships and Related Party Transactions – Omnibus Agreement” of the Partnership’s Form 10-K for the fiscal year ended December 31, 2004.

 

Note 5:  Pro forma Operations

 

The acquisition of assets from Hiland Partners, LLC discussed above occurred on February 15, 2005. Had the acquisition been made effective January 1, 2004, the operations of the assets acquired from Hiland Partners, LLC would have been included in our consolidated financial statements for each subsequent period with the following pro forma impact on the consolidated combined statements of operations.

 

		Three Months Ended March 31,
		2005			2004
		(in thousands)
Revenues as reported		$	25,778		$	21,050
Revenues from Hiland Partners, LLC		1,318			2,906
Pro forma revenues		$	27,096		$	23,956
Net income as reported		$	1,636		$	767
Additional income from acquired interest		377			1,198
Pro forma net income		2,013			$	1,965
Less general partner interest in proforma net income		40
Limited partners’ interest in proforma net income		$	1,973
Proforma net income per limited partner unit, basic		$	0.29
Proforma net income per limited partner unit, diluted		$	0.29
Weighted average limited partner units outstanding, basic		6,800,000
Weighted average limited partner units outstanding, diluted		6,840,000

 

Note 6:  Commitments and Contingencies

 

The Partnership has executed fixed price physical forward sales contracts on approximately 50,000 MMBtu per month through December 2007 with weighted average fixed prices per MMBtu of $4.53, $4.47 and $4.49, respectively, for years 2005 through 2007. Such contracts qualify as normal sales under SFAS No. 133 and are therefore not marked to market as derivatives.

 

The Partnership maintains a defined contribution retirement plan for its employees under which it makes discretionary contributions to the plan based on a percentage of eligible employees’ compensation. Through March 31, 2004 and 2005, contributions to the plan were 5.0% of eligible employees’ compensation. Expense for the three months ended March 31, 2004 and 2005 was $16 and $25, respectively.

 

The Partnership and other affiliated companies participate jointly in a self-insurance pool (the “Pool”) covering health and workers’ compensation claims made by employees up to the first $150,000 and $500,000, respectively, per claim. Any amounts paid above these are reinsured through third party providers. Premiums charged to the Partnership are based on estimated costs per employee of the Pool. No additional premium assessments are anticipated for periods prior to March 31, 2005. Property and general liability insurance is maintained through third-party providers with a $100,000 deductible on each policy.

 

19

 

The Partnership is a party to various regulatory proceedings and various other litigation that it believes will not have a materially adverse impact on the Partnership’s financial condition, results of operations or cash flows.

 

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

 

Note 7:  Significant Customers and Suppliers

 

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

 

		For the Quarters Ended March 31,
		2005			2004
Customer 1		32	%		56	%
Customer 2		24	%		14	%
Customer 3		3	%		6	%
Customer 4		11	%		7	%
Customer 5		10	%		—

 

All purchases are from domestic sources. The following table presents the Partnership’s top midstream suppliers as a percent of total midstream purchases for the periods indicated:

 

		For the Quarters Ended March 31,
		2005			2004
Supplier 1 (affiliated company)		30	%		39	%
Supplier 2		16	%		18	%
Supplier 3		34	%		25	%

 

Note 8:  Related Party Transactions

 

The Partnership purchases natural gas and NGLs from affiliated companies. Purchases of product totaled $6,983 and $6,343 for the quarters ended March 31, 2004 and 2005, respectively.

 

The Partnership utilizes unconsolidated affiliated companies to provide services to its plants and pipelines and certain administrative costs. The total amount paid to these companies was $46 and $31 during the quarters ended March 31, 2004 and 2005, respectively.

 

The Partnership leases office space under operating leases directly or indirectly from the principal unitholder. Rent expense for these leases totaled $10 and $19 for the quarters ended March 31, 2004 and 2005, respectively.

 

Note 9:  Discontinued Operations

 

During the first quarter of 2004, CGI determined it would no longer pursue its interests in direct production of oil and gas. Amounts for oil and gas income and expense are presented in these statements as discontinued operations. Effective May 31, 2004, CGI transferred all its interests in its oil and gas properties to CRI.

 

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