We routinely monitor producer activity in the areas we serve to identify new supply opportunities.
Adjusted Gross Margin - Adjusted gross margin information is presented as a supplemental disclosure because it is a key measure used by management to evaluate the relationship between our gathering and processing revenues and our cost of operating our facilities, including our general and administrative overhead. Adjusted gross margin is not a measure calculated in accordance with GAAP as it does not include deductions for expenses such as interest and income tax which are necessary to maintain our business. In measuring our operating performance, adjusted gross margin should not be considered an alternative to, or more meaningful than, net income or operating cash flow determined in accordance with GAAP. Our adjusted gross margin may not be comparable to a similarly titled measure of another company because other entities may not calculate adjusted gross margin in the same manner. A reconciliation of adjusted gross margin to amounts reported under GAAP is presented in "Results of Operations" below.
Operating Expenses - Operating expenses are a separate measure that we use to evaluate the performance of our operations. These expenses are comprised primarily of direct labor, insurance, property taxes, repair and maintenance expense, utilities and contract services, and are largely independent of the volumes through our systems, but may fluctuate depending on the scale of our operations during a specific period. Our ability to manage operating expenses has a significant impact on our profitability and cash available for distribution.
EBITDA - We believe that EBITDA is a widely accepted financial indicator of a company's operational performance and its ability to incur and service debt, fund capital expenditures and make distributions. EBITDA is not a measure calculated in accordance with GAAP, as it does not include deductions for items such as depreciation, interest and income taxes, which are necessary to maintain our business. EBITDA should not be considered an alternative to net income, operating cash flow or any other measure of financial performance presented in accordance with GAAP. EBITDA calculations may vary among entities, so our computation may not be comparable to EBITDA measures of other entities.

In evaluating EBITDA, we believe that investors should also consider, among other things, the amount by which EBITDA exceeds interest costs, how EBITDA compares to principal payments on debt and how EBITDA compares to capital expenditures for each period. A reconciliation of EBITDA to amounts reported under GAAP is presented in "Results of Operations." EBITDA is also used as a supplemental performance measure by our management and by external users of our financial statements such as investors, commercial banks, research analysts and others, to assess:
• financial performance of our assets without regard to financing methods, capital structure or historical cost basis;
• our operating performance as compared to those of other companies in the midstream industry without regard to financing methods, capital structure or historical cost basis; and
• the viability of acquisitions and capital expenditure projects and the rates of return on investment opportunities.

Current Quarter Highlights
• The Corvette Plant was placed into service, providing enhanced compression assets and allowing more gathered volumes to be subject to the compression fee.
• Gathering and processing volumes decreased 3% and 5%, respectively, from the previous quarter as many producers in the Fort Worth Basin slowed their development activities in response to lower petroleum prices.

   RESULTS OF OPERATIONS
Three Months Ended March 31, 2009 Compared with Three Months Ended March 31,
2008
   The following table and discussion relates to our unaudited condensed
consolidated results of operations for the three month periods ended March 31,
2009 and 2008:

                                               Three Months Ended March 31,
                                                2009                    2008
                                            (In thousands, except volume data)
     Total revenues                       $          24,714        $       15,185
     Operations and maintenance expense               5,411                 4,950
     General and administrative expense               1,992                 1,817

     Adjusted gross margin                           17,311                 8,418
     Other income                                         -                     5

     EBITDA                                          17,311                 8,423
     Depreciation and accretion expense               5,041                 3,156
     Interest expense                                 2,873                 2,418
     Income tax provision (benefit)                     (37 )                 (35 )

     Net income                           $           9,434        $        2,884


     Volume Data:
     Volumes gathered (MMcf)                         23,785                14,551
     Volumes processed (MMcf)                        14,653                12,156

The following table summarizes our volumes for the three months ended March 31, 2009 and 2008:

                                            Gathering                Processing
                                        2009         2008         2009         2008
                                                          (MMcf)
         Cowtown System                15,107       12,565       14,653       12,156
         Lake Arlington Dry System      6,278        1,324            -            -
         Hill County Dry System         2,400          662            -            -


         Total                         23,785       14,551       14,653       12,156

The following table summarizes the changes in our revenues:

                                               Gathering          Processing          Other          Total
                                                                      (In thousands)
Revenue for the three months ended
March 31, 2008                                $     7,297        $      7,663        $   225        $ 15,185
Volume changes                                      4,630               1,574              -           6,204
Price changes                                       3,122                 203              -           3,325

Revenue for the three months ended
March 31, 2009                                $    15,049        $      9,440        $   225        $ 24,714

Total Revenues and Volumes - Approximately $6.2 million of the increase in revenue was due to the increases in volumes that we gathered and processed in the Fort Worth Basin. This volume increase is due to increased well connections related to the continued development of the Fort Worth Basin, particularly in the Hood County and Lake Arlington areas. Additionally, gathering revenues increased by approximately $2.8 million due mainly to the new compression charge that was effective September 1, 2008 and the compression assets at the Corvette Plant going into operation in February 2009. For all of 2009, we expect the decreased development activity by our customers to result in lower daily volumes than we had in the first quarter. The average volumes for all of 2009 could range between 5% and 10% lower than current quarter gathering and processing volumes.
Operations and Maintenance Expense - The increase in operations and maintenance expense was mainly due to the continued expansion of our natural gas gathering systems. However, the increases in our operations and maintenance expenses have been less significant than the increases in our throughput volumes and revenues when comparing the current quarter with the comparable 2008 period. We expect operations and maintenance expenses to be relatively flat for the remainder of 2009 despite the addition of the Corvette Plant. The Corvette Plant and related facilities being placed into service during the first quarter of 2009 contributed $0.6 million to the increase in operations and maintenance expenses.
General and Administrative Expense - The increase in general and administrative expense was primarily the result of our expanded operations and the increase in the allocable portion of Quicksilver's overhead costs as it has expanded its in-house capabilities for those areas that also benefit us, such as safety and purchasing. General and administrative expense includes equity-based compensation for each of the quarters ended March 31, 2009 and 2008 of $0.4 million.
Adjusted Gross Margin and EBITDA - Adjusted gross margin and EBITDA increased primarily as a result of the increase in revenues described above. As a percentage of revenues, adjusted gross margin and EBITBA increased from 55% in 2008 to approximately 70% in 2009, primarily due to the increase in revenues, which was partially offset by an increase in operations and maintenance expense associated with our current scale of operations and higher general and administrative expense.
Depreciation and Accretion Expense - Depreciation and accretion expense increased primarily as a result of the property, plant and equipment placed into service during 2008 and the first quarter of 2009 in expanding our gathering network and increasing our processing capability. The Corvette Plant being placed into service during the first quarter of 2009 contributed approximately $0.6 million to the increase in depreciation and accretion expense.
Interest Expense - Interest expense increased primarily due to the increases in the borrowings under the revolving credit agreement. The increase in capitalized interest for 2009 is related to the construction of the Corvette Plant.
The following table summarizes the details of interest expense for the three months ended March 31, 2009 and 2008:

                                              Three Months Ended March 31,
                                                2009                2008
                                                     (In thousands)
         Interest cost:
         Revolving credit facility          $       1,205       $         317
         Repurchase obligation                      1,383               1,433
         Subordinated note to Quicksilver             595                 798

         Total cost                                 3,183               2,548
         Less interest capitalized                   (310 )              (130 )

         Interest expense                   $       2,873       $       2,418

Liquidity and Capital Resources
The volumes of natural gas gathered and processed through our systems are dependent upon the natural gas volumes produced by our customers, which may be affected by prevailing natural gas prices, the availability and cost of capital, the level of successful drilling activity and other factors beyond their control. Although Quicksilver has mitigated its near-term exposure to low prices through the use of derivative financial instruments covering portions of its expected 2009 and 2010 production, we cannot predict whether or when natural gas prices will increase or decrease. In addition, there continues to be uneasiness in the credit and financial markets. In response, Quicksilver and other customers have announced year-over-year reductions in their planned levels of capital expenditures and drilling activity for 2009. If these conditions were to persist or worsen over a prolonged period of time, we could experience significant reductions in volumes through our systems and therefore reductions of revenues and cash flows. Our sources of liquidity include:
• cash generated from operations;
• borrowings under our revolving credit agreement; and
• future capital market transactions.

We believe that the cash generated from these sources will be sufficient to meet our expected $0.37 per unit quarterly cash distributions during 2009 and satisfy our short-term working capital and capital expenditure requirements.

Cash Flows

                                                   Three Months Ended March 31,
                                                     2009                 2008
                                                          (In thousands)
   Net cash provided by operating activities    $      10,146        $      12,843
   Net cash used in investing activities              (22,952 )            (32,681 )
   Net cash provided by financing activities           12,854               18,950

Our cash flows are significantly influenced by Quicksilver's production in the Fort Worth Basin. As Quicksilver and others have developed the Fort Worth Basin, we have expanded our gathering and processing facilities to serve the additional volumes produced by such development.
Cash Flows Provided by Operating Activities - The decrease in cash flows provided by operating activities resulted primarily from the timing of cash due to or due from Quicksilver, partially offset by increased revenues and higher profitability associated with the natural gas gathered and processed through our systems.
Cash Flows Used in Investing Activities - The decrease in cash flows used in investing activities resulted from the lower capital expenditures used to expand our gathering system and processing capabilities. For the three months ended March 31, 2009 we spent $5.8 million on gathering assets and $17.2 million on processing facilities, which included $16.4 million related to the Corvette Plant. Additionally, the cash flows used in investing activities during the first quarter of 2009 include the payment of $16.6 million that was incurred and accrued on or before December 31, 2008.
Cash Flows Provided by Financing Activities - Cash flows provided by financing activities in the first quarter of 2009 consisted primarily of the proceeds from borrowings under our credit agreement of $22.0 million used to expand our gathering system and processing facilities, partially offset by distributions of $9.1 million to our unitholders.
Information regarding historical and pending cash distributions is included in Note 3 to our condensed consolidated interim financial statements included in Item 1 of Part I of this quarterly report. Capital Expenditures
The midstream energy business is capital intensive, requiring significant investment for the acquisition or development of new facilities, particularly in emerging production areas such as the Fort Worth Basin. We categorize our capital expenditures as either:
• expansion capital expenditures, which are made to construct additional assets, expand and upgrade existing systems, acquire additional assets; or

• maintenance capital expenditures, which are made to replace partially or fully depreciated assets, to maintain the existing operating capacity of our assets and extend their useful lives, or to maintain existing system volumes and related cash flows.

We anticipate that we will continue to make capital expenditures to develop our gathering and processing network as Quicksilver continues to expand its development efforts in the Fort Worth Basin. Consequently, our ability to develop and maintain sources of funds to meet our capital requirements is critical to our ability to meet our growth objectives and to maintain our distribution levels.
During the quarter ended March 31, 2009, we increased gross property, plant and equipment by $13.0 million, including expansion capital expenditures of approximately $3.9 million, $2.5 million in maintenance capital expenditures, $3.2 million in asset retirement cost and $3.4 million in capital expenditures related to assets subject to repurchase obligations. We expect remaining capital expenditures for 2009 to be approximately $28 million, excluding any expenditures to reacquire or develop assets subject to repurchase obligations.
Additionally, Quicksilver has the right to complete construction of the Hill County Dry System, which we are obligated to purchase from Quicksilver at fair market value. These assets are included in the repurchase obligation to Quicksilver with an aggregate amount of $60.3 million, including accrued interest. We have two years to repurchase the Hill County Dry System from the date we receive notice from Quicksilver that the system is complete and has commenced commercial service. Quicksilver expects to incur capital expenditures of approximately $7 million for the Hill County Dry System in 2009.
We have the option to purchase certain laterals connected to the Cowtown Pipeline from Quicksilver at their original construction cost. Quicksilver provided us notice during April 2009 that assets with an original construction cost of $62.5 million were available for purchase. These assets are included in the repurchase obligation to Quicksilver with an aggregate amount of $67.8 million, including accrued interest. We have two years from the date of notice to exercise our repurchase option on these assets. We have not determined which assets we will exercise our repurchase option for or the exact timing for completing the repurchase.
We operate Quicksilver's midstream assets subject to repurchase for which we receive a fee of $75,000 per month.
We regularly review opportunities for both organic growth projects and acquisitions that will enhance our financial performance. Since we strive to distribute most of our available cash to our unitholders, we will depend on a combination of borrowings under our revolving credit agreement, operating cash flows and debt or equity offerings to finance any future growth capital expenditures or acquisitions.
Debt
Credit Agreement - At March 31, 2009, the lenders' commitments under our credit agreement were $235 million and may be further increased to as much as $350 million with lender approval. Based on our results through March 31, 2009, our total borrowing capacity is $235 million and our borrowings were $196.9 million. The weighted average interest rate as of March 31, 2009 was 2.3%. KGS was in compliance with all debt covenants as of March 31, 2009.
At March 31, 2009, our revolving credit agreement required us to maintain a ratio of our consolidated trailing 12-month EBITDA (as defined in our credit agreement) to our net interest expense of not less than 2.5 to 1.0; and a ratio of total indebtedness to consolidated trailing 12-month EBITDA of not more than 4.5 to 1.0. Furthermore, this credit agreement contains various covenants that limit, among other things, our ability to:
• incur further indebtedness;
• grant liens;
• pay distributions; and
• engage in transactions with affiliates.

Our repurchase obligations to Quicksilver, our obligations to Quicksilver under the subordinated note described below, and the capitalized or non-cash interest thereon, are excluded for purposes of determining our covenant compliance.

Subordinated Note - The principal payment for the quarter ended March 31, 2009 was prevented by the debt ratio requirements of the subordinated note. Interest expense of $0.6 million recognized during the three months ended March 31, 2009 was added to the outstanding principal amount. The interest rate at March 31, 2009 was 4.0%.
For a more complete description of our indebtedness, see Note 6, Long-Term Debt, to the consolidated financial statements in our 2008 Annual Report on Form 10-K.
Repurchase Obligations to Quicksilver - The information regarding repurchase obligations to Quicksilver is included in Note 2 to our condensed consolidated interim financial statements included in Item 1 of Part I of this quarterly report.
Recently Issued Accounting Standards
The information regarding recent accounting pronouncements is included in Note 2 to our condensed consolidated interim financial statements included in Item 1 of Part I of this quarterly report.

Critical Accounting Estimates
Management's discussion and analysis of financial condition and results of operations are based on our condensed consolidated interim financial statements and related footnotes contained within Item 1 of Part I of this quarterly report. Our critical accounting estimates used in the preparation of the consolidated financial statements were discussed in our 2008 Annual Report on Form 10-K. These critical estimates, for which no significant changes have occurred in the three months ended March 31, 2009, include estimates and assumptions pertaining to:
• Depreciation expense and capitalization limits for property, plant and equipment;
• Repurchase obligations to Quicksilver;
• Asset retirement obligations; and
• Equity-based compensation.

The process of preparing financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are based upon what we believe is the best information available at the time of the estimates or assumptions. The estimates and assumptions could change materially as conditions within and beyond our control change. Accordingly, actual results could differ materially from those estimates.