**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

ý  **QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended March 31, 2006**

** **

**OR**

 

o  **TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**Commission File No. 1-10403**

 

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**TEPPCO Partners, L.P.**

(Exact name of Registrant as specified in its charter)

** **

| **Delaware**            | ** ** | **76-0291058**         |
|-------------------------|------------|------------------------|
| (State of Incorporation |       | (I.R.S. Employer       |
| or Organization)        |       | Identification Number) |

 

**2929 Allen Parkway**

**P.O. Box 2521**

**Houston, Texas 77252-2521**

(Address of principal executive offices, including zip code)

 

**(713) 759-3636**

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filedall reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has been subjectto such filing requirements for the past 90 days.

 

Yes ý****No o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Checkone):    Large accelerated filer ý     Accelerated Filer o     Non-accelerated Filer o

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). Yes o      No ý

 

Indicate the number of shares outstanding of each of theissuer’s classes of common stock, as of the latest practicable date. LimitedPartner Units outstanding as of May 2, 2006:  69,963,554

 

 

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**TEPPCO PARTNERS, L.P.**

 

**TABLE OF CONTENTS**

 
| **PART I. FINANCIAL INFORMATION**                                                                                                              | ** **                                                                                      |
|------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **Item 1. **                                                                                                                              | **Financial Statements**                                                                        | ** ** |
| **Consolidated Balance Sheets as of  March 31, 2006 (unaudited) and December 31, 2005 (unaudited)**                                            | ** **                                                                                      |
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **Consolidated Statements of  Income for the three months ended March 31, 2006 (unaudited) and 2005 (unaudited) (as restated)**           | ** **                                                                                      |
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **Consolidated Statements of  Cash Flows for the three months ended March 31, 2006 (unaudited) and 2005 (unaudited) (as restated)**       | ** **                                                                                      |
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **Consolidated Statement of  Partners’ Capital for the three months ended March 31, 2006 (unaudited)**                               | ** **                                                                                      |
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **Consolidated Statements of  Comprehensive Income for the three months ended March 31, 2006 (unaudited)  and 2005 (unaudited) (as restated)** | ** **                                                                                      |
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **Notes to the Consolidated  Financial Statements (unaudited)**                                                                                | ** **                                                                                      |
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **Item 2.**                                                                                                                                    | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** | ** ** |
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **Cautionary  Note Regarding Forward-Looking Statements**                                                                                      | ** **                                                                                      |
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **Item 3.**                                                                                                                                    | **Quantitative  and Qualitative Disclosures About Market Risk**                                 | ** ** |
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **Item 4.**                                                                                                                                    | **Controls and  Procedures**                                                                    | ** ** |
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **PART II. OTHER  INFORMATION**                                                                                                                | ** **                                                                                      |
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **Item 1.**                                                                                                                                    | **Legal Proceedings**                                                                           | ** ** |
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **Item 1A.**                                                                                                                                   | **Risk Factors**                                                                                | ** ** |
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **Item 6.**                                                                                                                                    | **Exhibits**                                                                                    | ** ** |
| ** **                                                                                                                                     | ** **                                                                                      | ** ** |
| **Signatures**                                                                                                                                 | ** **                                                                                      |

 

i

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** **

**PART I. FINANCIAL INFORMATION**

** **

**Item 1. Financial Statements**

** **

**TEPPCO PARTNERS,  L.P.**

** **

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

**(inthousands)**

** **
| ** **                                                                                                           | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                           | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| **ASSETS**                                                                                                           | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current assets:                                                                                                      |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                           |       | $                  | 89         |                  | $          | 119 |   |
| Accounts  receivable, trade (net of allowance for doubtful accounts of $100 and $250)                                |       | 975,293            |       | 803,373               |       |
| Accounts  receivable, related parties                                                                                |       | 2,810              |       | 5,207                 |       |
| Inventories                                                                                                          |       | 46,584             |       | 29,069                |       |
| Other                                                                                                                |       | 50,174             |       | 61,361                |       |
| Total current  assets                                                                                                |       | 1,074,950          |       | 899,129               |       |
| Property, plant  and equipment, at cost (net of accumulated depreciation and amortization of  $492,818 and $474,332) |       | 1,936,755          |       | 1,960,068             |       |
| Equity  investments                                                                                                  |       | 347,376            |       | 359,656               |       |
| Intangible  assets                                                                                                   |       | 368,630            |       | 376,908               |       |
| Goodwill                                                                                                             |       | 16,944             |       | 16,944                |       |
| Other assets                                                                                                         |       | 69,927             |       | 67,833                |       |
| Total assets                                                                                                         |       | $                  | 3,814,582  |                  | $          | 3,680,538 |   |
|                                                                                                                 |       |               |       |                  |       |
| **LIABILITIES AND PARTNERS’  CAPITAL**                                                                          |       |               |       |                  |       |
|                                                                                                                 |       |               |       |                  |       |
| Current  liabilities:                                                                                                |       |               |       |                  |       |
| Accounts payable  and accrued liabilities                                                                            |       | $                  | 974,988    |                  | $          | 800,033 |   |
| Accounts  payable, related parties                                                                                   |       | 6,197              |       | 11,836                |       |
| Accrued interest                                                                                                     |       | 14,967             |       | 32,840                |       |
| Other accrued  taxes                                                                                                 |       | 13,193             |       | 16,532                |       |
| Other                                                                                                                |       | 36,247             |       | 75,970                |       |
| Total current  liabilities                                                                                           |       | 1,045,592          |       | 937,211               |       |
| Senior Notes                                                                                                         |       | 1,112,054          |       | 1,119,121             |       |
| Other long-term  debt                                                                                                |       | 435,000            |       | 405,900               |       |
| Other  liabilities and deferred credits                                                                              |       | 22,677             |       | 16,936                |       |
| Commitments and  contingencies                                                                                       |       |               |       |                  |       |
| Partners’  capital:                                                                                             |       |               |       |                  |       |
| Accumulated  other comprehensive income                                                                              |       | 1,918              |       | 11                    |       |
| General  partner’s interest                                                                                     |       | (62,669            | )          | (61,487               | )          |
| Limited  partners’ interests                                                                                    |       | 1,260,010          |       | 1,262,846             |       |
| Total partners’  capital                                                                                        |       | 1,199,259          |       | 1,201,370             |       |
| Total  liabilities and partners’ capital                                                                        |       | $                  | 3,814,582  |                  | $          | 3,680,538 |   |

 

See accompanying Notes to Unaudited ConsolidatedFinancial Statements.

 

1

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**TEPPCO PARTNERS, L.P.**

** **

**CONSOLIDATED STATEMENTS OF INCOME**

**(Unaudited)**

**(in thousands, except per Unitamounts)**

 
| ** **                                                       | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                       | ** ** | **March 31,**               | ** ** |
| ** **                                                       | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                                       | ** ** | ** **                       | ** ** | **(as restated)** | ** ** |
| Operating  revenues:                                             | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Sales of  petroleum products                                     |       | $                                | 2,396,346  |   | $ | 1,385,067 |   |
| Transportation –  Refined products                          |       | 31,799                           |       | 34,965 |   |
| Transportation –  LPGs                                      |       | 29,421                           |       | 32,231 |   |
| Transportation –  Crude oil                                 |       | 8,923                            |       | 9,172 |   |
| Transportation –  NGLs                                      |       | 10,653                           |       | 10,219 |   |
| Gathering –  Natural gas                                    |       | 41,375                           |       | 36,560 |   |
| Other                                                            |       | 17,852                           |       | 15,577 |   |
| Total operating  revenues                                        |       | 2,536,369                        |       | 1,523,791 |   |
|                                                             |       |                             |       |   |   |
| Costs and  expenses:                                             |       |                             |       |   |   |
| Purchases of  petroleum products                                 |       | 2,371,165                        |       | 1,371,090 |   |
| Operating,  general and administrative                           |       | 55,579                           |       | 49,880 |   |
| Operating fuel  and power                                        |       | 14,297                           |       | 11,070 |   |
| Depreciation and  amortization                                   |       | 28,757                           |       | 25,611 |   |
| Taxes – other  than income taxes                            |       | 5,311                            |       | 5,406 |   |
| Gains on sales  of assets                                        |       | (1,378                           | )          | (498 | ) |
| Total costs and  expenses                                        |       | 2,473,731                        |       | 1,462,559 |   |
| Operating income                                                 |       | 62,638                           |       | 61,232 |   |
|                                                             |       |                             |       |   |   |
| Interest expense  – net                                     |       | (21,143                          | )          | (19,287 | ) |
| Equity earnings                                                  |       | 989                              |       | 4,094 |   |
| Other income –  net                                         |       | 899                              |       | 266 |   |
| Income from  continuing operations                               |       | 43,383                           |       | 46,305 |   |
|                                                             |       |                             |       |   |   |
| Income from  discontinued operations                             |       | 1,607                            |       | 1,124 |   |
| Gain on sale of  discontinued operations                         |       | 17,884                           |       | — |   |
| Discontinued  operations                                         |       | 19,491                           |       | 1,124 |   |
| Net income                                                       |       | $                                | 62,874     |   | $ | 47,429 |   |
|                                                             |       |                             |       |   |   |
| Net Income  Allocation:                                          |       |                             |       |   |   |
| Limited Partner  Unitholders income from continuing operations   |       | $                                | 30,628     |   | $ | 32,947 |   |
| Limited Partner  Unitholders income from discontinued operations |       | 13,760                           |       | 800 |   |
| Total Limited  Partner Unitholders net income allocation         |       | 44,388                           |       | 33,747 |   |
|                                                             |       |                             |       |   |   |
| General Partner  income from continuing operations               |       | 12,755                           |       | 13,358 |   |
| General Partner  income from discontinued operations             |       | 5,731                            |       | 324 |   |
| Total General  Partner net income allocation                     |       | 18,486                           |       | 13,682 |   |
| Total net income  allocated                                      |       | $                                | 62,874     |   | $ | 47,429 |   |
|                                                             |       |                             |       |   |   |
| Basic and  diluted net income per Limited Partner Unit:          |       |                             |       |   |   |
| Continuing  operations                                           |       | $                                | 0.43       |   | $ | 0.53 |   |
| Discontinued  operations                                         |       | 0.20                             |       | 0.01 |   |
| Basic and  diluted net income per Limited Partner Unit           |       | $                                | 0.63       |   | $ | 0.54 |   |
|                                                             |       |                             |       |   |   |
| Weighted average  Limited Partner Units outstanding              |       | 69,964                           |       | 62,999 |   |

 

See accompanying Notes to Unaudited ConsolidatedFinancial Statements.

 

2

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**TEPPCO PARTNERS, L.P.**

** **

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(Unaudited)**

**(in thousands)**

 
| ** **                                                                                                 | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                 | ** ** | **March 31,**               | ** ** |
| ** **                                                                                                 | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                                                                                 | ** ** | ** **                       | ** ** | **(as restated)** | ** ** |
| Cash flows from  operating activities:                                                                     |       |                             |       |   |   |
| Net income from  continuing operations                                                                     |       | $                                | 43,383     |   | $ | 46,305 |   |
| Adjustments to  reconcile net income to cash provided by operating activities from continuing  operations: |       |                             |       |   |   |
| Depreciation and  amortization                                                                             |       | 28,757                           |       | 25,611 |   |
| Earnings in  equity investments                                                                            |       | (989                             | )          | (4,094 | ) |
| Distributions  from equity investments                                                                     |       | 16,297                           |       | 4,719 |   |
| Gains on sales  of assets                                                                                  |       | (1,378                           | )          | (498 | ) |
| Non-cash portion  of interest expense                                                                      |       | 443                              |       | 405 |   |
| (Increase)  decrease in accounts receivable                                                                |       | (171,920                         | )          | 34,354 |   |
| Decrease in  accounts receivable, related parties                                                          |       | 2,397                            |       | 9,849 |   |
| Increase in  inventories                                                                                   |       | (17,488                          | )          | (1,791 | ) |
| (Increase)  decrease in other current assets                                                               |       | 11,187                           |       | (605 | ) |
| Increase  (decrease) in accounts payable and accrued expenses                                              |       | 134,962                          |       | (77,556 | ) |
| Decrease in  accounts payable, related parties                                                             |       | (5,639                           | )          | (20,519 | ) |
| Other                                                                                                      |       | (2,919                           | )          | (1,654 | ) |
| Net cash  provided by operating activities from continuing operations                                      |       | 37,093                           |       | 14,526 |   |
| Cash flows from  discontinued operations                                                                   |       | 1,631                            |       | 1,277 |   |
| Net cash  provided by operating activities                                                                 |       | 38,724                           |       | 15,803 |   |
|                                                                                                       |       |                             |       |   |   |
| Cash flows from  investing activities:                                                                     |       |                             |       |   |   |
| Proceeds from  sales of assets                                                                             |       | 39,030                           |       | 510 |   |
| Investment in  Mont Belvieu Storage Partners, L.P.                                                         |       | (1,720                           | )          | — |   |
| Purchase of  assets                                                                                        |       | —                           |       | (7,101 | ) |
| Capital  expenditures                                                                                      |       | (38,272                          | )          | (27,589 | ) |
| Net cash used in  investing activities                                                                     |       | (962                             | )          | (34,180 | ) |
|                                                                                                       |       |                             |       |   |   |
| Cash flows from  financing activities:                                                                     |       |                             |       |   |   |
| Proceeds from  revolving credit facilities                                                                 |       | 187,700                          |       | 138,700 |   |
| Repayments on  revolving credit facilities                                                                 |       | (158,600                         | )          | (59,700 | ) |
| Distributions  paid                                                                                        |       | (66,892                          | )          | (58,658 | ) |
| Net cash  provided by (used in) financing activities                                                       |       | (37,792                          | )          | 20,342 |   |
|                                                                                                       |       |                             |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                                      |       | (30                              | )          | 1,965 |   |
|                                                                                                       |       |                             |       |   |   |
| Cash and cash  equivalents at beginning of period                                                          |       | 119                              |       | 16,422 |   |
| Cash and cash  equivalents at end of period                                                                |       | $                                | 89         |   | $ | 18,387 |   |
|                                                                                                       |       |                             |       |   |   |
| **Supplemental  disclosure of cash flows:**                                                                |       |                             |       |   |   |
| Cash paid for  interest (net of amounts capitalized)                                                       |       | $                                | 38,450     |   | $ | 36,759 |   |

 

See accompanying Notes to Unaudited ConsolidatedFinancial Statements.

 

3

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**TEPPCO PARTNERS, L.P.**

** **

**CONSOLIDATED STATEMENT OFPARTNERS’ CAPITAL**

**(Unaudited)**

**(in thousands, except Unitamounts)**

 
| ** **                                                | ** ** | **Outstanding** | ** ** | ** **         | ** ** | ** **         | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
|-----------------------------------------------------------|------------|-----------------|------------|--------------------|------------|--------------------|------------|-------------------|------------|------------|------------|
| ** **                                                | ** ** | **Limited**     | ** ** | **General**        | ** ** | **Limited**        | ** ** | **Other**         | ** ** | ** ** | ** ** |
| ** **                                                | ** ** | **Partner**     | ** ** | **Partner’s** | ** ** | **Partners’** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                | ** ** | **Units**       | ** ** | **Interest**       | ** ** | **Interests**      | ** ** | **Income**        | ** ** | **Total**  | ** ** |
|                                                      |       |            |       |               |       |               |       |              |       |       |       |
| Partners’  capital at December 31, 2005              |       | 69,963,554      |       | $                  | (61,487    | )                  | $          | 1,262,846         |       | $          | 11         |   | $ | 1,201,370 |   |
| Net income  allocation                                    |       | —          |       | 18,486             |       | 44,388             |       | —            |       | 62,874     |       |
| Cash  distributions                                       |       | —          |       | (19,668            | )          | (47,224            | )          | —            |       | (66,892    | )          |
| Changes in fair  values of crude oil cash flow hedges     |       | —          |       | —             |       | —             |       | 236               |       | 236        |       |
| Changes in fair  values of interest rate cash flow hedges |       | —          |       | —             |       | —             |       | 1,671             |       | 1,671      |       |
|                                                      |       |            |       |               |       |               |       |              |       |       |       |
| Partners’  capital at March 31, 2006                 |       | 69,963,554      |       | $                  | (62,669    | )                  | $          | 1,260,010         |       | $          | 1,918      |   | $ | 1,199,259 |   |

 

See accompanying Notes to Unaudited ConsolidatedFinancial Statements.

 

4

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**TEPPCO PARTNERS,  L.P.**

** **

**CONSOLIDATED STATEMENTS OFCOMPREHENSIVE INCOME**

**(Unaudited)**

**(inthousands)**

 
| ** **                                                | ** ** | **Three Months Ended   March 31,** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                | ** ** | **2006**                                               | ** ** | **2005** | ** ** |
| ** **                                                | ** ** | ** **                                             | ** ** | **(as restated)** | ** ** |
|                                                      |       |                                                   |       |   |   |
| Net income                                                |       | $                                                      | 62,874     |   | $ | 47,429 |   |
|                                                      |       |                                                   |       |   |   |
| Changes in fair  values of crude oil cash flow hedges     |       | 236                                                    |       | — |   |
| Changes in fair  values of interest rate cash flow hedges |       | 1,671                                                  |       | — |   |
|                                                      |       |                                                   |       |   |   |
| Comprehensive  income                                     |       | $                                                      | 64,781     |   | $ | 47,429 |   |

 

Seeaccompanying Notes to Unaudited Consolidated Financial Statements.

 

5

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**TEPPCO PARTNERS, L.P.**

** **

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**NOTE 1. ORGANIZATIONAND BASIS OF PRESENTATION**

** **

TEPPCO Partners, L.P. (the “Partnership”), a Delawarelimited partnership, is a master limited partnership formed in March 1990. Weoperate through TE Products Pipeline Company, Limited Partnership (“TE Products”),TCTM, L.P. (“TCTM”) and TEPPCO Midstream Companies, L.P. (“TEPPCO Midstream”). Collectively,TE Products, TCTM and TEPPCO Midstream are referred to as the “Operating Partnerships.”  Texas Eastern Products Pipeline Company, LLC(the “Company” or “General Partner”), a Delaware limited liability company,serves as our general partner and owns a 2% general partner interest in us.

 

As used in this Report, “we,” “us,” “our,” the “Partnership”and “TEPPCO” mean TEPPCO Partners, L.P. and, where the context requires,include our subsidiaries.

 

Through February 23, 2005, the General Partner was anindirect wholly owned subsidiary of Duke Energy Field Services, LLC (“DEFS”), ajoint venture between Duke Energy Corporation (“Duke Energy”) andConocoPhillips. Duke Energy held an interest of approximately 70% in DEFS, andConocoPhillips held the remaining interest of approximately 30%. On February24, 2005, the General Partner was acquired by DFI GP Holdings L.P. (formerlyEnterprise GP Holdings L.P.) (“DFI”), an affiliate of EPCO, Inc. (“EPCO”), aprivately held company controlled by Dan L. Duncan, for approximately $1.1billion. As a result of the transaction, DFI owns and controls the 2% generalpartner interest in us and has the right to receive the incentive distributionrights associated with the general partner interest. In conjunction with anamended and restated administrative services agreement, EPCO performs allmanagement, administrative and operating functions required for us, and wereimburse EPCO for all direct and indirect expenses that have been incurred inmanaging us. As a result of the sale of our General Partner, DEFS and DukeEnergy continued to provide some administrative services for us for a period ofup to one year after the sale, at which time, we or EPCO assumed these services.Prior to the sale of our General Partner, DEFS also managed and operatedcertain of our TEPPCO Midstream assets for us under contractual agreements. We assumedthe operations of these assets from DEFS, and certain DEFS employees becameemployees of EPCO effective June 1, 2005.

 

In connection with our formation, the Company received2,500,000 Deferred Participation Interests (“DPIs”). Effective April 1, 1994,the DPIs were converted to Limited Partner Units, but they have not been listedfor trading on the New York Stock Exchange. These Limited Partner Units wereassigned to Duke Energy when ownership of the Company was transferred from DukeEnergy to DEFS in 2000. On February 24, 2005, DFI entered into an LP UnitPurchase and Sale Agreement with Duke Energy and purchased these 2,500,000Limited Partner Units for $104.0 million. As of March 31, 2006, none of theseLimited Partner Units had been sold by DFI.

 

The accompanying unaudited consolidated financialstatements reflect all adjustments that are, in the opinion of our management,of a normal and recurring nature and necessary for a fair statement of ourfinancial position as of March 31, 2006, and the results of our operations andcash flows for the periods presented. The results of operations for the threemonths ended March 31, 2006, are not necessarily indicative of results of ouroperations for the full year 2006. You should read these interim financialstatements in conjunction with our consolidated financial statements and notesthereto presented in the TEPPCO Partners, L.P. Annual Report on Form 10-K forthe year ended December 31, 2005. We have reclassified certain amounts fromprior periods to conform to the current presentation.

 

We restated our consolidated financial statements andrelated financial information for the three months ended March 31, 2005, for anaccounting correction. See Note 16 for a discussion of the restatement adjustmentand the impact on previously issued financial statements.

 

6

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**Business Segments**

 

We operate and report in three business segments:transportation and storage of refined products, liquefied petroleum gases (“LPGs”)and petrochemicals (“Downstream Segment”); gathering, transportation, marketingand storage of crude oil and distribution of lubrication oils and specialtychemicals (“Upstream Segment”); and gathering of natural gas, fractionation ofnatural gas liquids (“NGLs”) and transportation of NGLs (“Midstream Segment”). Ourreportable segments offer different products and services and are managedseparately because each requires different business strategies.

 

Our interstate transportation operations, includingrates charged to customers, are subject to regulations prescribed by theFederal Energy Regulatory Commission (“FERC”). We refer to refined products,LPGs, petrochemicals, crude oil, NGLs and natural gas in this Report,collectively, as “petroleum products” or “products.”

 

**Net Income Per Unit**

 

Basic net income per Limited Partner Unit (“Unit” or “Units”)is computed by dividing net income, after deduction of the General Partner’sinterest, by the weighted average number of Units outstanding (a total of 70.0million Units and 63.0 million Units for the three months ended March 31, 2006and 2005, respectively). The General Partner’s percentage interest in our netincome is based on its percentage of cash distributions from Available Cash foreach period (see Note 9). The General Partner was allocated $18.5 million(representing 29.4%) of net income for the three months ended March 31, 2006and $13.7 million (representing 28.85%) of our net income for the three monthsended March 31, 2005. The General Partner’s percentage interest in our netincome increases as cash distributions paid per Unit increase, in accordancewith the Third Amended and Restated Agreement of Limited Partnership of TEPPCOPartners, L.P. (“Partnership Agreement”).

 

Diluted net income per Unit equaledbasic net income per Unit for each of the three months ended March 31, 2006 and2005, as there were no dilutive instruments outstanding.

 

**New Accounting Pronouncements**

 

**In December 2004,the Financial Accounting Standards Board (“FASB”) issued**Statement of Financial Accounting Standards (“SFAS”) No. 123(R) (revised 2004), *Share-Based Payment*. SFAS 123(R) is arevision of SFAS No. 123, *Accounting forStock-Based Compensation*, as amended by SFAS No. 148,*Accounting for Stock-Based Compensation – Transitionand Disclosure* and supersedes Accounting Principles Board (“APB”)Opinion No. 25, *Accounting for Stock Issuedto Employees*. SFAS 123(R) requires that the cost resulting from allshare-based payment transactions be recognized in the financial statements atfair value. In April 2005, both the FASB and the Securities and ExchangeCommission decided to delay the effective date for public companies toimplement SFAS 123(R). SFAS 123(R) is now effective for public companies forannual periods beginning after June 15, 2005. Accordingly, we adopted SFAS123(R) in the first quarter of 2006. We adopted SFAS 123(R) under the modifiedprospective transition method. Our 2000 Long Term Incentive Plan and our 2005Phantom Unit Plan are liability awards under the provisions of this statement. Noadditional compensation expense has been recorded in connection with theadoption of SFAS 123(R) as we have historically recorded the associatedliabilities at fair value. The adoption of SFAS 123(R) did not have a materialeffect on our financial position, results of operations or cash flows.

** **

In June 2005, the Emerging Issues Task Force (“EITF”) reachedconsensus in EITF 04-5, *Determining Whethera General Partner, or the General Partners as a Group, Controls a LimitedPartnership or Similar Entity When the Limited Partners Have Certain Rights*,to provide guidance on how general partners in a limited partnership shoulddetermine whether they control a limited partnership and therefore shouldconsolidate it. The EITF agreed that the presumption of general partner controlwould be overcome only when the limited partners have 

 

7

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either of two types of rights. The first type, referred to as “kick-outrights,” is the right to dissolve or liquidate the partnership or otherwiseremove the general partner without cause. The second type, referred to as “participatingrights,” is the right to effectively participate in significant decisions madein the ordinary course of the partnership’s business. The kick-out rights andthe participating rights must be substantive in order to overcome thepresumption of general partner control. The consensus is effective for generalpartners of all new limited partnerships formed and for existing limitedpartnerships for which the partnership agreements are modified subsequent tothe date of FASB ratification (June 29, 2005). For existing limitedpartnerships that have not been modified, the guidance in EITF 04-5 iseffective no later than the beginning of the first reporting period in fiscalyears beginning after December 15, 2005. Although this EITF did not directlyimpact us, it did impact our General Partner. Our General Partner adopted thisEITF on January 1, 2006. The adoption of EITF 04-5 resulted in theconsolidation of our results of operations and balance sheet into itsconsolidated financial statements.

 

In May 2005, the FASB issued SFAS No. 154, *Accounting Changes and Error Corrections*. SFAS154 establishes new standards on accounting for changes in accountingprinciples. All such changes must be accounted for by retrospective applicationto the financial statements of prior periods unless it is impracticable to doso. SFAS 154 completely replaces APB Opinion No. 20, *Accounting Changes,*and SFAS No. 3, *Reporting Accounting Changes in Interim Periods*.However, it carries forward the guidance in those pronouncements with respectto accounting for changes in estimates, changes in the reporting entity, andthe correction of errors. SFAS 154 is effective for accounting changes anderror corrections made in fiscal years beginning after December 15, 2005, withearly adoption permitted for changes and corrections made in years beginningafter June 1, 2005. The application of SFAS 154 does not affect the transitionprovisions of any existing pronouncements, including those that are in thetransition phase as of the effective date of SFAS 154. The adoption of SFAS 154did not have a material effect on our financial position, results of operationsor cash flows.

 

**In September 2005,the EITF reached consensus in EITF 04-13, *Accounting for Purchasesand Sales of Inventory with the Same Counterparty*, to define when apurchase and a sale of inventory with the same party that operates in the sameline of business should be considered a single nonmonetary transaction subjectto APB Opinion No. 29, *Accounting for NonmonetaryTransactions*. Two or more inventory transactions with the same partyshould be combined if they are entered into in contemplation of one another. TheEITF also requires entities to account for exchanges of inventory in the sameline of business at fair value or recorded amounts based on inventoryclassification. The guidance in EITF 04-13 is effective for new inventoryarrangements entered into in reporting periods beginning after March 15, 2006. Weare currently evaluating what impact EITF 04-13 will have on our financialstatements, but at this time, we do not believe that the adoption of EITF 04-13will have a material effect on our financial position, results of operations orcash flows.**

** **

**NOTE 2. GOODWILLAND OTHER INTANGIBLE ASSETS**

** **

**Goodwill**

** **

Goodwill represents the excess of purchase price overfair value of net assets acquired and is presented on the consolidated balancesheets net of accumulated amortization. We account for goodwill under SFAS No.142, *Goodwill and Other Intangible Assets,*whichwas issued by the FASB in July 2001. SFAS 142 prohibits amortization ofgoodwill, but instead requires testing for impairment at least annually. Wetest goodwill for impairment annually at December 31.

 

To perform an impairment test of goodwill, we haveidentified our reporting units and have determined the carrying value of eachreporting unit by assigning the assets and liabilities, including the existinggoodwill, to those reporting units. We then determine the fair value of eachreporting unit and compare it to 

 

8

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the carrying value of the reporting unit. We will continue to comparethe fair value of each reporting unit to its carrying value on an annual basisto determine if an impairment loss has occurred. There have been no goodwillimpairment losses recorded since the adoption of SFAS 142.

 

The following table presents thecarrying amount of goodwill at both March 31, 2006 and December 31, 2005, bybusiness segment (in thousands):

 
| ** ** | ** ** | **Downstream   Segment** | ** ** | **Midstream   Segment** | ** ** | **Upstream   Segment** | ** ** | **Segments   Total** | ** ** |
|------------|------------|-------------------------------|------------|------------------------------|------------|-----------------------------|------------|---------------------------|------------|
| ** ** | ** ** | ** **                    | ** ** | ** **                   | ** ** | ** **                  | ** ** | ** **                | ** ** |
| Goodwill   |       | $                             | —     |                         | $          | 2,777                       |       | $                         | 14,167     |   | $ | 16,944 |   |
|            |            |                               |            |                              |            |                             |            |                           |            |  |  |  |  |

 

**Other Intangible Assets**

 

The following table reflects thecomponents of intangible assets, including excess investments, being amortizedat March 31, 2006, and December 31, 2005 (in thousands):

 
| ** **                               | ** ** | **March 31, 2006**    | ** ** | **December 31, 2005** | ** ** |
|------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization**   | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| Intangible  assets:                      |       |                            |       |                            |       |   |   |   |   |
| Gathering and  transportation agreements |       | $                               | 464,337    |                            | $          | (126,293 | ) | $ | 464,337 |   | $ | (118,921 | ) |
| Fractionation  agreement                 |       | 38,000                          |       | (15,200                         | )          | 38,000 |   | (14,725 | ) |
| Other                                    |       | 9,898                           |       | (2,112                          | )          | 10,226 |   | (2,009 | ) |
| Subtotal                                 |       | 512,235                         |       | (143,605                        | )          | 512,563 |   | (135,655 | ) |
|                                     |       |                            |       |                            |       |   |   |   |   |
| Excess  investments:                     |       |                            |       |                            |       |   |   |   |   |
| Centennial  Pipeline LLC                 |       | 33,390                          |       | (13,681                         | )          | 33,390 |   | (12,947 | ) |
| Seaway Crude  Pipeline Company           |       | 27,100                          |       | (3,937                          | )          | 27,100 |   | (3,764 | ) |
| Subtotal                                 |       | 60,490                          |       | (17,618                         | )          | 60,490 |   | (16,711 | ) |
|                                     |       |                            |       |                            |       |   |   |   |   |
| Total intangible  assets                 |       | $                               | 572,725    |                            | $          | (161,223 | ) | $ | 573,053 |   | $ | (152,366 | ) |

 

SFAS 142 requires that intangibleassets with finite useful lives be amortized over their respective estimateduseful lives. If an intangible asset has a finite useful life, but the preciselength of that life is not known, that intangible asset shall be amortized overthe best estimate of its useful life. At a minimum, we will assess the usefullives and residual values of all intangible assets on an annual basis todetermine if adjustments are required. Amortization expense on intangibleassets was $8.0 million and $7.1 million for the three months ended March 31,2006 and 2005, respectively. Amortization expense on excess investmentsincluded in equity earnings was $0.9 million and $1.2 million for the threemonths ended March 31, 2006 and 2005, respectively.

 

The values assigned to our intangibleassets for natural gas gathering contracts on the Jonah Gas GatheringSystem (“Jonah”) and the Val Verde GasGathering System (“Val Verde”) are amortized on aunit-of-production basis, based upon the actual throughput of the systemscompared to the expected total throughput for the lives of the contracts. On aquarterly basis, we may obtain limited production forecasts and updatedthroughput estimates from some of the producers on the systems, and as aresult, we evaluate the remaining expected useful lives of the contract assetsbased on the best available information. Revisions to these estimates may occuras additional production information is made available to us.

 

The values assigned to ourfractionation agreement and other intangible assets are generally amortized ona straight-line basis. Our fractionation agreement is being amortized over itscontract period of 20 years. The amortization periods for our other intangibleassets, which include non-compete and other agreements, range from 3 

 

9

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years to 15 years. The value of $8.7 million assigned to our crudesupply and transportation intangible customer contracts is being amortized on aunit-of-production basis.

 

The value assigned to our excessinvestment in Centennial Pipeline LLC was created upon its formation. Approximately $30.0 million is related toa contract and is being amortized on a unit-of-production basis based upon thevolumes transported under the contract compared to the guaranteed totalthroughput of the contract over a 10-year life. The remaining $3.4 million isrelated to a pipeline and is being amortized on a straight-line basis over thelife of the pipeline, which is 35 years. The value assigned to our excessinvestment in Seaway Crude Pipeline Company was created upon acquisition of our 50% ownership interest in 2000. We areamortizing the $27.1 million excess investment on a straight-line basis over a39-year life related primarily to the life of the pipeline.

 

The following table sets forth theestimated amortization expense of intangible assets and the estimatedamortization expense allocated to equity earnings for the years ending December31 (in thousands):

 
| ** ** | ** ** | **Intangible Assets** | ** ** | **Excess Investments** | ** ** |
|------------|------------|----------------------------|------------|-----------------------------|------------|
| 2006       |       | $                          | 32,477     |                        | $          | 4,691 |   |
| 2007       |       | 33,379                     |       | 5,113                       |       |
| 2008       |       | 32,950                     |       | 5,438                       |       |
| 2009       |       | 30,703                     |       | 6,878                       |       |
| 2010       |       | 27,322                     |       | 7,042                       |       |
|            |            |                            |            |                             |            |  |  |

 

**NOTE 3. INTERESTRATE SWAPS**

** **

In October 2001, TE Products entered into an interestrate swap agreement to hedge its exposure to changes in the fair value of itsfixed rate 7.51% Senior Notes due 2028. We designated this swap agreement as afair value hedge. The swap agreement has a notional amount of $210.0 millionand matures in January 2028 to match the principal and maturity of the TEProducts Senior Notes. Under the swap agreement, TE Products pays a floatingrate of interest based on a three-month U.S. Dollar LIBOR rate, plus a spreadof 147 basis points, and receives a fixed rate of interest of 7.51%. During thethree months ended March 31, 2006 and 2005, we recognized reductions ininterest expense of $0.7 million and $1.8 million, respectively, related to thedifference between the fixed rate and the floating rate of interest on theinterest rate swap. During the quarters ended March 31, 2006 and 2005, wemeasured the hedge effectiveness of this interest rate swap and noted that nogain or loss from ineffectiveness was required to be recognized. The fair valueof this interest rate swap was a loss of approximately $7.0 million and $0.9million at March 31, 2006, and December 31, 2005, respectively.

 

**During 2002, weentered into interest rate swap agreements, designated as fair value hedges, tohedge our exposure to changes in the fair value of our fixed rate 7.625% SeniorNotes due 2012. The swap agreements had a combined notional amount of $500.0million and matured in 2012 to match the principal and maturity of the SeniorNotes. Under the swap agreements, we paid a floating rate of interest based ona U.S. Dollar LIBOR rate, plus a spread, and received a fixed rate of interestof 7.625%. These swap agreements were later terminated in 2002 resulting ingains of $44.9 million. The gains realized from the swap terminations have beendeferred as adjustments to the carrying value of the Senior Notes and are beingamortized using the effective interest method as reductions to future interestexpense over the remaining term of the Senior Notes. At March 31, 2006, theunamortized balance of the deferred gains was $31.3 million. In the event ofearly extinguishment of the Senior Notes, any remaining unamortized gains wouldbe recognized in the consolidated statement of income at the time ofextinguishment.**

 

10

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**In January 2006, weentered into interest rate swap agreements with a total notional amount of$200.0 million to hedge our exposure to increases in the benchmark interestrate underlying our variable rate revolving credit facility. These interestrate swaps mature in January 2008. We designated these swap agreements as cashflow hedges. Under the swap agreements, we pay a fixed rate of interest rangingfrom 4.67% to 4.695% and receive a floating rate based on a three-month U.S.Dollar LIBOR rate. Because these swaps are designated as cash flow hedges, thechanges in fair value, to the extent the swaps are effective, are recognized inother comprehensive income until the hedged interest costs are recognized inearnings. During the three months ended March 31, 2006, we recognized increasesin interest expense of $0.1 million related to the difference between the fixedrate and the floating rate of interest on the interest rate swaps. During thethree months ended March 31, 2006, we measured the hedge effectiveness of theseinterest rate swaps and noted that no gain or loss from ineffectiveness wasrequired to be recognized. The total fair value of the interest rate swapagreements was a gain of approximately $1.7 million at March 31, 2006.**

** **

**NOTE 4. ACQUISITIONS**

** **

**Mexia Pipeline**

 

On March 31, 2005, we purchased crude oil pipelineassets for $7.1 million from BP Pipelines (North America) Inc. (“BP”). Theassets include approximately 158 miles of pipeline, which extend from Mexia,Texas, to the Houston, Texas, area and two stations in south Houston withconnections to a BP pipeline that originates in south Houston. We funded thepurchase through borrowings under our revolving credit facility, and weallocated the purchase price to property, plant and equipment. We haveintegrated these assets into our South Texas pipeline system, which is includedin our Upstream Segment.

 

**NOTE 5. DISPOSITIONSAND DISCONTINUED OPERATIONS**

** **

**Pioneer Plant**

** **

On March 31, 2006, we sold our ownership interest inthe Pioneer silica gel natural gas processing plant located near Opal, Wyoming,together with Jonah’s rights to process natural gas originating from the Jonahand Pinedale fields, located in southwest Wyoming to an affiliate of EnterpriseProducts Partners L.P. (“Enterprise”) for $38.0 million in cash. The Pioneerplant was not an integral part of our Midstream Segment operations, and naturalgas processing is not a core business. We have no continuing involvement in theoperations or results of this plant. This transaction was reviewed and approvedby the Audit and Conflicts Committee of the board of directors of our GeneralPartner and of the general partner of Enterprise, and a fairness opinion wasrendered by an independent third-party.  Thesales proceeds will be used to fund organic growth projects, retire debt andfor other general partnership purposes. The carrying value of the Pioneer plantat March 31, 2006, prior to the sale, was $19.7 million. Costs associated withthe completion of the transaction are estimated to be approximately $0.4million.

 

11

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Condensed statements of income for the Pioneer plant,which is classified as discontinued operations, for the three months endedMarch 31, 2006 and 2005, are presented below (in thousands): 

 
| ** **                               | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **March 31,**               | ** ** |
| ** **                               | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                     |       |                             |       |   |   |
| Sales of  petroleum products             |       | $                                | 3,810      |   | $ | 2,142 |   |
| Other                                    |       | 921                              |       | 672 |   |
| Total operating  revenues                |       | 4,731                            |       | 2,814 |   |
| Purchases of  petroleum products         |       | 2,861                            |       | 1,370 |   |
| Operating,  general and administrative   |       | 182                              |       | 138 |   |
| Depreciation and  amortization           |       | 51                               |       | 152 |   |
| Taxes – other  than income taxes    |       | 30                               |       | 30 |   |
| Total costs and  expenses                |       | 3,124                            |       | 1,690 |   |
| Net income from  discontinued operations |       | $                                | 1,607      |   | $ | 1,124 |   |

 

Assets of the discontinued operations consisted of thefollowing at December 31, 2005 (in thousands):

 
| ** **                         | ** ** | **December 31,   2005** | ** ** |
|------------------------------------|------------|------------------------------|------------|
| Inventories                        |       | $                            | 7          |   |
| Property and  equipment, net       |       | 19,812                       |       |
| Assets of  discontinued operations |       | $                            | 19,819     |   |

 

Cash flows from discontinued operations for the threemonths ended March 31, 2006 and 2005, are presented below (in thousands):

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|
| ** **                                     | ** ** | **March 31,**               | ** ** |
| ** **                                     | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                           |       |                             |       |   |   |
| Cash flows from  operating activities:         |       |                             |       |   |   |
| Net income                                     |       | $                                | 19,491     |   | $ | 1,124 |   |
| Depreciation and  amortization                 |       | 51                               |       | 152 |   |
| Gain on sale of  Pioneer plant                 |       | (17,884                          | )          | — |   |
| (Increase)  decrease in inventories            |       | (27                              | )          | 1 |   |
|                                           |       |                             |       |   |   |
| Total cash flows  from discontinued operations |       | $                                | 1,631      |   | $ | 1,277 |   |

 

12

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**NOTE 6. INVENTORIES**

** **

Inventories are valued at the lower ofcost (based on weighted average cost method) or market. The costs ofinventories did not exceed market values at March 31, 2006, and December 31, 2005.The major components of inventories were as follows (in thousands):

 
| ** **                                | ** ** | **March 31,** | ** ** | **December 31, ** | ** ** |
|-------------------------------------------|------------|--------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **2006**           | ** ** | **2005**                    | ** ** |
| Crude oil (1)                             |       | $                  | 18,359     |                        | $          | 3,021 |   |
| Refined products                          |       | 3,801              |       | 4,461                       |       |
| LPGs                                      |       | 9,103              |       | 7,403                       |       |
| Lubrication oils  and specialty chemicals |       | 6,361              |       | 5,740                       |       |
| Materials and  supplies                   |       | 8,361              |       | 8,203                       |       |
| Other                                     |       | 599                |       | 241                         |       |
| Total                                     |       | $                  | 46,584     |                        | $          | 29,069 |   |

 

----

(1)  At March 31, 2006, substantially all of ourcrude oil inventory was subject to forward sales contracts.

 

**NOTE 7. EQUITY INVESTMENTS**

** **

Through one of our indirect wholly owned subsidiaries,we own a 50% ownership interest in Seaway Crude Pipeline Company (“Seaway”). Theremaining 50% interest is owned by ConocoPhillips. We operate the Seaway assets.Seaway owns a pipeline that carries mostly imported crude oil from a marineterminal at Freeport, Texas, to Cushing, Oklahoma, and from a marine terminalat Texas City, Texas, to refineries in the Texas City and Houston, Texas, areas.The Seaway Crude Pipeline Company Partnership Agreement provides for varyingparticipation ratios throughout the life of Seaway. From June 2002 through December31, 2005, we received 60% of revenue and expense of Seaway. For 2006, we areallocated 60% of revenue and expense for the period January 1, 2006, throughMay 12, 2006, and 40% for the period May 13, 2006, through December 31, 2006.Our share of revenue and expense of Seaway is 47% for 2006. Thereafter, we willreceive 40% of revenue and expense of Seaway. During the three months ended March31, 2006 and 2005, we received distributions from Seaway of $8.5 million and $4.7million, respectively. During the three months ended March 31, 2006 and 2005,we did not invest any additional funds in Seaway.

 

TE Products owns a 50% ownership interest inCentennial Pipeline LLC (“Centennial”), and Marathon Petroleum Company LLC (“Marathon”)owns the remaining 50% interest. Centennial owns an interstate refinedpetroleum products pipeline extending from the upper Texas Gulf Coast tocentral Illinois. During the three months ended March 31, 2006 and 2005, TEProducts did not invest any additional funds in Centennial. TE Products has not received any distributions fromCentennial since its formation.

 

TE Products owns a 50% ownership interest in MontBelvieu Storage Partners, L.P. (“MB Storage”), and Louis Dreyfus EnergyServices L.P. (“Louis Dreyfus”) owns the remaining 50% interest. MB Storageowns storage capacity at the Mont Belvieu fractionation and storage complex anda short haul transportation shuttle system that ties Mont Belvieu, Texas, tothe upper Texas Gulf Coast energy marketplace. MB Storage is aservice-oriented, fee-based venture serving the fractionation, refining andpetrochemical industries with substantial capacity and flexibility for thetransportation, terminaling and storage of NGLs, LPGs and refined products. MBStorage has no commodity trading activity. TE Products operates the facilitiesfor MB Storage.

 

For the years ended December 31, 2006 and 2005, TE Productsreceives the first $1.7 million per quarter (or $6.78 million on an annualbasis) of MB Storage’s income before depreciation expense, as defined in the Agreementof Limited Partnership of MB Storage. TE Products’ share of MB Storage’s earningsmay be adjusted annually by the partners of MB Storage. Any amount of MBStorage’s annual income before depreciation expense in excess of $6.78 million isallocated evenly 

 

13

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between TE Products and Louis Dreyfus. Depreciation expense on assetseach party originally contributed to MB Storage is allocated between TEProducts and Louis Dreyfus based on the net book value of the assetscontributed. Depreciation expense on assets constructed or acquired by MBStorage subsequent to formation is allocated evenly between TE Products andLouis Dreyfus. For the three months ended March 31, 2006 and 2005, TE Products’sharing ratio in the earnings of MB Storage was approximately 57.9% and 58.1%,respectively. During the three months ended March 31, 2006, TE Productsreceived distributions from MB Storage of $7.8 million and contributed $1.7million to MB Storage. During the three months ended March 31, 2005, TEProducts received no distributions from MB Storage and made no contributions toMB Storage.

 

We use the equity method of accounting to account forour investments in Seaway, Centennial and MB Storage. Summarized combinedfinancial information for Seaway, Centennial and MB Storage for the threemonths ended March 31, 2006 and 2005, is presented below (in thousands):  

 
| ** ** | ** ** | **Three Months Ended   March 31,** | ** ** |
|------------|------------|--------------------------------------------------------|------------|
| ** ** | ** ** | **2006**                                               | ** ** | **2005** | ** ** |
| Revenues   |       | $                                                      | 38,635     |   | $ | 38,529 |   |
| Net income |       | 7,041                                                  |       | 11,257 |   |
|            |            |                                                        |            |  |  |  |  |

 

Summarized combined balance sheet information forSeaway, Centennial and MB Storage as of March 31, 2006, and December 31, 2005,is presented below (in thousands):

 
| ** **              | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **              | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| Current assets          |       | $                  | 37,564     |                  | $          | 60,082 |   |
| Noncurrent  assets      |       | 626,964            |       | 630,212               |       |
| Current  liabilities    |       | 23,866             |       | 32,242                |       |
| Long-term debt          |       | 150,000            |       | 150,000               |       |
| Noncurrent  liabilities |       | 14,235             |       | 13,626                |       |
| Partners’  capital |       | 476,427            |       | 494,426               |       |
|                         |            |                    |            |                       |            |  |  |

 

**NOTE 8. DEBT**

** **

## **Senior Notes**

## ** **

On January 27, 1998, TE Products completed theissuance of $180.0 million principal amount of 6.45% Senior Notes due 2008, and$210.0 million principal amount of 7.51% Senior Notes due 2028 (collectivelythe “TE Products Senior Notes”). The 6.45% TE Products Senior Notes were issuedat a discount of $0.3 million and are being accreted to their face value overthe term of the notes. The 6.45% TE Products Senior Notes due 2008 may not beredeemed prior to their maturity on January 15, 2008. The 7.51% TE ProductsSenior Notes due 2028, issued at par, may be redeemed at any time after January15, 2008, at the option of TE Products, in whole or in part, at the followingredemption prices (expressed in percentages of the principal amount) during thetwelve months beginning January 15 of the years indicated:

 
| ** ** | ** ** | **Redemption** | ** ** |
|------------|------------|----------------|------------|
| **Year**   | ** ** | **Price**      | ** ** |
|       |       |           |       |
| 2008       |       | 103.755        | %          |
| 2009       |       | 103.380        | %          |
| 2010       |       | 103.004        | %          |
| 2011       |       | 102.629        | %          |
| 2012       |       | 102.253        | %          |
| 2013       |       | 101.878        | %          |
| 2014       |       | 101.502        | %          |
| 2015       |       | 101.127        | %          |
| 2016       |       | 100.751        | %          |
| 2017       |       | 100.376        | %          |

 

14

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and thereafter at 100% ofthe principal amount, together in each case with accrued interest at theredemption date.

 

The TE Products Senior Notes do not have sinking fundrequirements. Interest on the TE Products Senior Notes is payable semiannuallyin arrears on January 15 and July 15 of each year. The TE Products Senior Notesare unsecured obligations of TE Products and rank pari passu with all otherunsecured and unsubordinated indebtedness of TE Products. The indenturegoverning the TE Products Senior Notes contains covenants, including, but notlimited to, covenants limiting the creation of liens securing indebtedness andsale and leaseback transactions. However, the indenture does not limit ourability to incur additional indebtedness. As of March 31, 2006, TE Products wasin compliance with the covenants of the TE Products Senior Notes.

 

On February 20, 2002, we completed the issuance of$500.0 million principal amount of 7.625% Senior Notes due 2012. The 7.625%Senior Notes were issued at a discount of $2.2 million and are being accretedto their face value over the term of the notes. The Senior Notes may beredeemed at any time at our option with the payment of accrued interest and amake-whole premium determined by discounting remaining interest and principalpayments using a discount rate equal to the rate of the United States Treasurysecurities of comparable remaining maturity plus 35 basis points. The indenturegoverning our 7.625% Senior Notes contains covenants, including, but notlimited to, covenants limiting the creation of liens securing indebtedness andsale and leaseback transactions. However, the indenture does not limit ourability to incur additional indebtedness. As of March 31, 2006, we were incompliance with the covenants of these Senior Notes.

 

On January 30, 2003, we completed the issuance of$200.0 million principal amount of 6.125% Senior Notes due 2013. The 6.125%Senior Notes were issued at a discount of $1.4 million and are being accretedto their face value over the term of the notes. The Senior Notes may beredeemed at any time at our option with the payment of accrued interest and amake-whole premium determined by discounting remaining interest and principalpayments using a discount rate equal to the rate of the United States Treasurysecurities of comparable remaining maturity plus 35 basis points. The indenturegoverning our 6.125% Senior Notes contains covenants, including, but notlimited to, covenants limiting the creation of liens securing indebtedness andsale and leaseback transactions. However, the indenture does not limit ourability to incur additional indebtedness. As of March 31, 2006, we were incompliance with the covenants of these Senior Notes.

 

The following table summarizes the estimated fairvalues of the Senior Notes as of March 31, 2006, and December 31, 2005 (inmillions):

 
| ** **                                        | ** ** | ** **            | ** ** | **Fair Value**            | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|--------------------------------|------------|
| ** **                                        | ** ** | **Face   Value** | ** ** | **March 31,   2006** | ** ** | **December 31,   2005** | ** ** |
|                                              |       |                  |       |                           |       |   |   |
| 6.45% TE  Products Senior Notes, due January 2008 |       | $                     | 180.0      |                           | $          | 182.6 |   | $ | 183.7 |   |
| 7.625% Senior  Notes, due February 2012           |       | 500.0                 |       | 537.9                          |       | 552.0 |   |
| 6.125% Senior  Notes, due February 2013           |       | 200.0                 |       | 200.0                          |       | 205.6 |   |
| 7.51% TE  Products Senior Notes, due January 2028 |       | 210.0                 |       | 223.4                          |       | 224.1 |   |
|                                                   |            |                       |            |                                |            |  |  |  |  |  |

 

We have entered into interest rate swap agreements tohedge our exposure to changes in the fair value on a portion of the Senior Notesdiscussed above (see Note 3).

 

## **Revolving Credit Facility**

## ** **

On June 27, 2003, we entered into a $550.0 millionunsecured revolving credit facility with a three year term, including theissuance of letters of credit of up to $20.0 million (“Revolving CreditFacility”). The interest rate is based, at our option, on either the lender’sbase rate plus a spread, or LIBOR plus a spread in effect at the time of theborrowings. Financial covenants in the Revolving Credit Facility require thatwe maintain a ratio of Consolidated Funded Debt to Pro Forma EBITDA (as definedand calculated in the facility) of less than 4.75 to 1.00 

 

15

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(subject to adjustment for specified acquisitions) and a ratio ofEBITDA to Interest Expense (as defined and calculated in the facility) of atleast 3.00 to 1.00, in each case with respect to specified twelve month periods.Other restrictive covenants in the Revolving Credit Facility limit our abilityto, among other things, incur additional indebtedness, make distributions inexcess of Available Cash (see Note 9), incur liens, engage in specifiedtransactions with affiliates and complete mergers, acquisitions and sales ofassets. On October 21, 2004, we amended and restated our Revolving CreditFacility to (i) increase the facility size to $600.0 million, (ii) extend theterm to October 21, 2009, (iii) remove certain restrictive covenants, (iv)increase the available amount for the issuance of letters of credit up to$100.0 million and (v) decrease the LIBOR rate spread charged at the time ofeach borrowing. On February 23, 2005, we amended our Revolving Credit Facilityto remove the requirement that DEFS must at all times own, directly orindirectly, 100% of our General Partner, to allow for its acquisition by DFI(see Note 1). During the second quarter of 2005, we used a portion of theproceeds from an equity offering in May 2005 to repay a portion of theRevolving Credit Facility. On December 13, 2005, we again amended our RevolvingCredit Facility as follows:

 

•      Totalbank commitments increased from $600.0 million to $700.0 million. The amendmentalso provided that the commitments under the credit facility may be increasedup to a maximum of $850.0 million upon our request, subject to lender approval andthe satisfaction of certain other conditions.

•      Thefacility fee and the borrowing rate then in effect were reduced by 0.275%.

•      Thematurity date of the credit facility was extended from October 21, 2009, toDecember 13, 2010. Also under the terms of the amendment, we may request up totwo, one-year extensions of the maturity date. These extensions, if requested,will become effective subject to lender approval and satisfaction of certainother conditions.

•      Theamendment also removed the $100.0 million limit on the total amount of standbyletters of credit that can be outstanding under the credit facility.

 

At March 31, 2006, $435.0million was outstanding under the Revolving Credit Facility at a weightedaverage interest rate of 5.3%. At March 31, 2006, we were in compliance withthe covenants of this credit facility.

 

The following table summarizes the principal amountsoutstanding under all of our debt instruments as of March 31, 2006, andDecember 31, 2005 (in thousands):

 
| ** **                                                         | ** ** | **March 31,   2006** | ** ** | **December 31,   2005** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|
|                                                               |       |                           |       |                              |       |
| Revolving Credit  Facility, due December 2010                      |       | $                              | 435,000    |                              | $          | 405,900 |   |
| 6.45% TE  Products Senior Notes, due January 2008                  |       | 179,945                        |       | 179,937                           |       |
| 7.625% Senior  Notes, due February 2012                            |       | 498,714                        |       | 498,659                           |       |
| 6.125% Senior  Notes, due February 2013                            |       | 199,023                        |       | 198,988                           |       |
| 7.51% TE  Products Senior Notes, due January 2028                  |       | 210,000                        |       | 210,000                           |       |
| Total borrowings                                                   |       | 1,522,682                      |       | 1,493,484                         |       |
| Adjustment to  carrying value associated with hedges of fair value |       | 24,372                         |       | 31,537                            |       |
| Total Debt  Instruments                                            |       | $                              | 1,547,054  |                              | $          | 1,525,021 |   |

 

**Letter of Credit**

 

At March 31, 2006, we had outstanding an$11.9 million standby letter of credit in connection with crude oil purchasedin the first quarter of 2006. This amount is expected to be paid during thesecond quarter of 2006.

 

16

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**NOTE 9. PARTNERS’ CAPITAL AND DISTRIBUTIONS**

 

## **Quarterly Distributions ofAvailable Cash**

## ** **

We make quarterly cash distributions of all of our availablecash, generally defined in our Partnership Agreement as consolidated cashreceipts less consolidated cash disbursements and cash reserves established bythe General Partner in its reasonable discretion (“Available Cash”). Pursuantto the Partnership Agreement, the General Partner receives incrementalincentive cash distributions when unitholders’ cash distributions exceedcertain target thresholds as follows:

 
| ** **                                                           | ** ** | ** **      | ** ** | **General** | ** ** |
|----------------------------------------------------------------------|------------|-----------------|------------|-------------|------------|
| ** **                                                           | ** ** | **Unitholders** | ** ** | **Partner** | ** ** |
| Quarterly Cash  Distribution per Unit:                               |       |            |       |        |       |
| Up to Minimum  Quarterly Distribution ($0.275 per Unit)              |       | 98              | %          | 2           | %          |
| First Target -  $0.276 per Unit up to $0.325 per Unit                |       | 85              | %          | 15          | %          |
| Second Target -  $0.326 per Unit up to $0.45 per Unit                |       | 75              | %          | 25          | %          |
| Over Second  Target - Cash distributions greater than $0.45 per Unit |       | 50              | %          | 50          | %          |

 

The following table reflects the allocation of totaldistributions paid during the three months ended March 31, 2006 and 2005 (inthousands, except per Unit amounts):

 
| ** **                              | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Limited Partner  Units                  |       | $                                                    | 47,224     |   | $ | 41,736 |   |
| General Partner  Ownership Interest     |       | 964                                                  |       | 852 |   |
| General Partner  Incentive              |       | 18,704                                               |       | 16,070 |   |
| Total Cash  Distributions Paid          |       | $                                                    | 66,892     |   | $ | 58,658 |   |
| Total Cash  Distributions Paid Per Unit |       | $                                                    | 0.675      |   | $ | 0.6625 |   |

 

On May 5, 2006, we will pay a cashdistribution of $0.675 per Unit for the quarter ended March 31, 2006. The firstquarter 2006 cash distribution will total $66.9 million.

 

**General Partner’s Interest**

 

As of March 31, 2006, and December 31,2005, we had deficit balances of $62.7 million and $61.5 million, respectively,in our General Partner’s equity account. These negative balances do notrepresent assets to us and do not represent obligations of the General Partnerto contribute cash or other property to us. The General Partner’s equityaccount generally consists of its cumulative share of our net income less cashdistributions made to it plus capital contributions that it has made to us (seeour Consolidated Statement of Partners’ Capital for a detail of the GeneralPartner’s equity account). For the three months ended March 31, 2006, theGeneral Partner was allocated $18.5 million (representing 29.4%) of our netincome and received $19.7 million in cash distributions.

 

Capital Accounts, as defined under ourPartnership Agreement, are maintained for our General Partner and our limitedpartners. The Capital Account provisions of our Partnership Agreementincorporate principles established for U.S. federal income tax purposes and arenot comparable to the equity accounts reflected under accounting principlesgenerally accepted in the United States in our financial statements. Under ourPartnership Agreement, the General Partner is required to make additionalcapital contributions to us upon the issuance of any additional Units ifnecessary to maintain a Capital Account balance equal to 1.999999% of the totalCapital Accounts of all partners. At March 31, 2006, and December 31, 2005, theGeneral Partner’s Capital Account balance substantially exceeded thisrequirement.

 

17

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Net income is allocated between theGeneral Partner and the limited partners in the same proportion as aggregatecash distributions made to the General Partner and the limited partners duringthe period. This is generally consistent with the manner of allocating net incomeunder our Partnership Agreement. Net income determined under our PartnershipAgreement, however, incorporates principles established for U.S. federal incometax purposes and is not comparable to net income reflected under accountingprinciples generally accepted in the United States in our financial statements.

 

Cash distributions that we make duringa period may exceed our net income for the period. We make quarterly cashdistributions of all of our Available Cash, generally defined in ourPartnership Agreement as consolidated cash receipts less consolidated cashdisbursements and cash reserves established by the General Partner in its solediscretion. Cash distributions in excess of net income allocations and capitalcontributions during the year ended December 31, 2005, and the three monthsended March 31, 2006, resulted in deficits in the General Partner’s equityaccount at December 31, 2005, and March 31, 2006. Future cash distributionsthat exceed net income will result in an increase in the deficit balance in theGeneral Partner’s equity account.

 

According to the Partnership Agreement, in the event of ourdissolution, after satisfying our liabilities, our remaining assets would bedivided among our limited partners and the General Partner generally in thesame proportion as Available Cash but calculated on a cumulative basis over thelife of the Partnership. If a deficit balance still remains in the GeneralPartner’s equity account after all allocations are made between the partners,the General Partner would not be required to make whole any such deficit.

 

**NOTE 10. RELATED PARTYTRANSACTIONS**

 

**EPCO and Affiliates and DukeEnergy, DEFS and Affiliates**

 

We do not have any employees. We aremanaged by the Company, which prior to February 23, 2005, was an indirectwholly owned subsidiary of DEFS. According to our Partnership Agreement, theCompany was entitled to reimbursement of all direct and indirect expensesrelated to our business activities. As a result of the change in ownership ofthe General Partner on February 24, 2005, all of our management, administrativeand operating functions are performed by employees of EPCO, pursuant to anadministrative services agreement. We reimburse EPCO for the allocated costs ofits employees who perform operating, management and other administrativefunctions for us (see Note 1).

 

18

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The following table summarizes the related partytransactions with EPCO and affiliates and DEFS and affiliates for the threemonths ended March 31, 2006 and 2005 (in millions):

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|
| ** **                                        | ** ** | **March 31,**               | ** ** |
| ** **                                        | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Revenues from  EPCO and affiliates: (1)           | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Transportation –  NGLs                       |       | $                                | 1.7        |   | $ | 0.9 |   |
| Transportation –  LPGs                       |       | 1.7                              |       | 0.8 |   |
|                                              |       |                             |       |   |   |
| Costs and  Expenses from EPCO and affiliates: (1) |       |                             |       |   |   |
| Payroll and  administrative (2)                   |       | 29.2                             |       | — |   |
| Purchases of  petroleum products (3)              |       | 5.7                              |       | — |   |
|                                              |       |                             |       |   |   |
| Revenues from  DEFS and affiliates: (4)           |       |                             |       |   |   |
| Sales of  petroleum products (5)                  |       | —                           |       | 4.3 |   |
| Transportation –  NGLs                       |       | —                           |       | 2.8 |   |
| Gathering –  Natural gas – Jonah        |       | —                           |       | 0.5 |   |
| Transportation –  LPGs                       |       | —                           |       | 0.7 |   |
| Other operating  revenues                         |       | —                           |       | 2.4 |   |
|                                              |       |                             |       |   |   |
| Costs and  Expenses from DEFS and affiliates: (4) |       |                             |       |   |   |
| Payroll and  administrative (2) (6)               |       | —                           |       | 16.2 |   |
| Purchases of  petroleum products                  |       | —                           |       | 38.5 |   |
|                                                   |            |                                  |            |  |  |  |  |

 

----

(1)   Operating revenues earned andexpenses incurred from activities with EPCO and its affiliates are consideredrelated party transactions beginning February 24, 2005, at which time a changein ownership of the General Partner.occurred

 

(2)   Substantially all of thesecosts were related to payroll, payroll related expenses and administrativeexpenses incurred in managing us and our subsidiaries.

 

(3)   Includes purchases ofcondensate and expenses related to Lubrication Services, Inc.’s (“LSI”) use ofan affiliate of EPCO as a transporter.

 

(4)   Operating revenues earned andexpenses incurred from activities with DEFS and its affiliates are consideredrelated party transactions prior to February 23, 2005, at which time a changein ownership of the General Partner occurred.

 

(5)   Includes LSI sales oflubrication oils and specialty chemicals and Jonah NGL sales in connection withJonah’s Pioneer processing plant operations, which began operating in 2004. Amountsassociated with the Pioneer plant are reflected as discontinued operations inthe accompanying financial statements.

 

(6)   Includes operating costs andexpenses related to DEFS managing and operating the Jonah and Val Verde systemsand the Chaparral NGL pipeline on our behalf under a contractual agreementestablished at the time of acquisition of each asset. In connection with thechange in ownership of our General Partner, we have assumed these activities.

 

At March 31, 2006 and December 31, 2005, we had areceivable from EPCO and affiliates of $2.3 million and $4.3 million,respectively, related to sales and transportation services provided to EPCO andaffiliates. At March 31, 2006 and December 31, 2005, we had a payable to EPCOand affiliates of $5.2 million and $9.8 million, respectively, related todirect payroll, payroll related costs and other operational related costs.

 

Beginning February 24, 2005, the majority of ourinsurance coverage, including property, liability, business interruption, autoand directors and officers’ liability insurance, was obtained through EPCO. Forthe three months ended March 31, 2006, we incurred insurance expense related topremiums paid by EPCO of $2.7 million. At March 31, 2006 and December 31, 2005,we had insurance reimbursement receivables due from EPCO of $1.3 million.

 

19

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On March 31, 2006, we sold our ownership interest inthe Jonah Pioneer silica gel natural gas processing plant located near Opal,Wyoming, together with Jonah’s rights to process natural gas originating fromthe Jonah and Pinedale fields, located in southwest Wyoming to an affiliate ofEnterprise for $38.0 million. We recognized a gain of approximately $17.9million on the sale of this asset (see Note 5).

 

In February 2006, we entered into a letter of intentwith an affiliate of Enterprise related to the formation of a joint venture forthe construction and financing of the expansion of the Jonah system. The letterof intent stipulates that Enterprise will be responsible for all activitiesrelated to the construction of the Jonah expansion, including advancing allamounts necessary to plan, engineer and construct the Jonah expansion(anticipated to be approximately $200.0 million). The amounts Enterpriseadvances to the project will constitute a subscription for an equity interestin the proposed joint venture. We have the option to return to Enterprise up to100% of the amount of the subscription. If we return any portion of thesubscription to Enterprise, our relative interests in the proposed jointventure will be adjusted accordingly. The proposed joint venture will terminatewithout liability to either party if we return 100% of the subscription(including carrying costs and expenses). Through March 31, 2006, Enterprise hasincurred approximately $55.3 million related to this expansion.

 

**NOTE 11. EMPLOYEE BENEFIT PLANS**

 

## **Retirement Plans**

## ** **

The TEPPCO Retirement Cash Balance Plan (“TEPPCO RCBP”)was a non-contributory, trustee-administered pension plan. In addition, theTEPPCO Supplemental Benefit Plan (“TEPPCO SBP”) was a non-contributory,nonqualified, defined benefit retirement plan, in which certain executiveofficers participated. The TEPPCO SBP was established to restore benefitreductions caused by the maximum benefit limitations that apply to qualifiedplans. The benefit formula for all eligible employees was a cash balanceformula. Under a cash balance formula, a plan participant accumulated aretirement benefit based upon pay credits and current interest credits. The paycredits were based on a participant’s salary, age and service. We used aDecember 31 measurement date for these plans.

 

On May 27, 2005, the TEPPCO RCBP and the TEPPCO SBPwere amended. Effective May 31, 2005, participation in the TEPPCO RCBP wasfrozen, and no new participants were eligible to be covered by the plan afterthat date. Effective December 31, 2005, all plan benefits accrued were frozen,participants received no additional pay credits after that date, and all planparticipants were 100% vested regardless of their years of service. The TEPPCORCBP plan was terminated effective December 31, 2005, and plan participantshave the option to receive their benefits either through a lump sum payment in2006 or through an annuity. In April 2006, we received a determination letterfrom the IRS providing IRS approval of the plan termination. For those planparticipants who elect to receive an annuity, we will purchase an annuitycontract from an insurance company in which the plan participant owns theannuity, absolving us of any future obligation to the participant. Participantsin the TEPPCO SBP received pay credits through November 30, 2005, and receivedlump sum benefit payments in December 2005. Both the RCBP and SBP benefitpayments are discussed below.

 

In June 2005, we recorded a curtailment charge of $0.1million in accordance with SFAS No. 88, *Employers’ Accounting forSettlements and Curtailments of Defined Benefit Pension Plans and forTermination Benefits*, as a result of the TEPPCO RCBP and TEPPCO SBPamendments. As of May 31, 2005, the following assumptions were changed forpurposes of determining the net periodic benefit costs for the remainder of2005: the discount rate, the long-term rate of return on plan assets, and theassumed mortality table. The discount rate was decreased from 5.75% to 5.00% toreflect rates of returns on bonds currently available to settle the liability. Theexpected long-term rate of return on plan assets was changed from 8% to 2% dueto the movement of plan funds 

 

20

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from equity investments into short-term money market funds. Themortality table was changed to reflect overall improvements in mortalityexperienced by the general population. The curtailment charge arose due to theaccelerated recognition of the unrecognized prior service costs. We recordedadditional settlement charges of approximately $0.2 million in the fourthquarter of 2005 relating to the TEPPCO SBP. We expect to record additionalsettlement charges of approximately $4.0 million in 2006 relating to the TEPPCORCBP for any existing unrecognized losses upon the plan termination and finaldistribution of the assets to the plan participants.

 

The components of net pension benefits costs for theTEPPCO RCBP and the TEPPCO SBP for the three months ended March 31, 2006 and 2005,were as follows (in thousands):

 
| ** **                                     | ** ** | **Three Months Ended   March 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                               | ** ** | **2005** | ** ** |
| Service cost  benefit earned during the period |       | $                                                      | —     |   | $ | 1,005 |   |
| Interest cost on  projected benefit obligation |       | 251                                                    |       | 225 |   |
| Expected return  on plan assets                |       | (121                                                   | )          | (300 | ) |
| Amortization of  prior service cost            |       | —                                                 |       | 2 |   |
| Amortization of  actuarial losses              |       | 35                                                     |       | — |   |
| Recognized net  actuarial loss                 |       | —                                                 |       | 10 |   |
| Net pension  benefits costs                    |       | $                                                      | 165        |   | $ | 942 |   |

 

## **Other Postretirement Benefits**

## ** **

We provided certain health care and life insurancebenefits for retired employees on a contributory and non-contributory basis (“TEPPCOOPB”). Employees became eligible for these benefits if they met certain age andservice requirements at retirement, as defined in the plans. We provided afixed dollar contribution, which did not increase from year to year, towardsretired employee medical costs. The retiree paid all health care cost increasesdue to medical inflation. We used a December 31 measurement date for this plan.

 

In May 2005, benefits provided to employees under theTEPPCO OPB were changed. Employees eligible for these benefits received themthrough December 31, 2005, however, effective December 31, 2005, these benefitswere terminated. As a result of this change in benefits and in accordance withSFAS No. 106, *Employers’ Accounting for PostretirementBenefits Other Than Pensions*, we recorded a curtailment credit ofapproximately $1.7 million in our accumulated postretirement obligation which reducedour accumulated postretirement obligation to the total of the expectedremaining 2005 payments under the TEPPCO OPB. The employees participating inthis plan at that time were transferred to DEFS, who is expected to providepostretirement benefits to these retirees. We recorded a one-time settlement toDEFS in the third quarter of 2005 of $0.4 million for the remainingpostretirement benefits.

 

The components of net postretirement benefits cost forthe TEPPCO OPB for the three months ended March 31, 2006 and 2005, were asfollows (in thousands):

 
| ** **                                                      | ** ** | **Three Months Ended   March 31, ** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2006**                                                     | ** ** | **2005** | ** ** |
|                                                            |       |                                                         |       |   |   |
| Service cost  benefit earned during the period                  |       | $                                                            | —     |   | $ | 49 |   |
| Interest cost on  accumulated postretirement benefit obligation |       | —                                                       |       | 42 |   |
| Amortization of  prior service cost                             |       | —                                                       |       | 32 |   |
| Recognized net  actuarial loss                                  |       | —                                                       |       | 4 |   |
| Net  postretirement benefits costs                              |       | $                                                            | —     |   | $ | 127 |   |

 

21

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## **Effective June 1, 2005, the payrollfunctions performed by DEFS for our General Partner were transferred from DEFSto EPCO. For those employees who were receiving certain other postretirementbenefits at the time of the acquisition of our General Partner by DFI, DEFS isexpected to continue to provide these benefits to those employees. EffectiveJune 1, 2005, EPCO began providing certain other postretirement benefits tothose employees who became eligible for the benefits after June 1, 2005, andwill charge those benefit related costs to us. As a result of these changes, werecorded a $1.2 million reduction in our other postretirement obligation inJune 2005.**

## ** **

## **Estimated Future Benefit Contributions**

## ** **

We do not expect to make further contributions to ourretirement plans and other postretirement benefit plans.

 

**NOTE 12. SEGMENT INFORMATION**

 

We have three reporting segments:

 

•      OurDownstream Segment, which is engaged in the transportation and storage ofrefined products, LPGs and petrochemicals;

 

•      OurUpstream Segment, which is engaged in the gathering, transportation, marketingand storage of crude oil and distribution of lubrication oils and specialtychemicals; and

 

•      OurMidstream Segment, which is engaged in the gathering of natural gas,fractionation of NGLs and transportation of NGLs.

 

The amounts indicated below as “Partnership and Other”relate primarily to intersegment eliminations and assets that we hold that havenot been allocated to any of our reporting segments.

 

Our Downstream Segment revenues are earned fromtransportation and storage of refined products and LPGs, intrastatetransportation of petrochemicals, sale of product inventory and other ancillaryservices. The two largest operating expense items of the Downstream Segment arelabor and electric power. We generally realize higher revenues during the firstand fourth quarters of each year since our operations are somewhat seasonal.Refined products volumes are generally higher during the second and thirdquarters because of greater demand for gasolines during the spring and summerdriving seasons. LPGs volumes are generally higher from November through Marchdue to higher demand for propane, a major fuel for residential heating. OurDownstream Segment also includes the results of operations of the northernportion of the Dean Pipeline, which transports refinery grade propylene fromMont Belvieu to Point Comfort, Texas. Our Downstream Segment also includes ourequity investments in Centennial and MB Storage (see Note 7).

 

Our Upstream Segment revenues are earned fromgathering, transportation, marketing and storage of crude oil and distributionof lubrication oils and specialty chemicals, principally in Oklahoma, Texas,New Mexico and the Rocky Mountain region. Marketing operations consistprimarily of aggregating purchased crude oil along our pipeline systems, orfrom third party pipeline systems, and arranging the necessary transportationlogistics for the ultimate sale or delivery of the crude oil to localrefineries, marketers or other end users. Our Upstream Segment also includesour equity investment in Seaway (see Note 7). Seaway consists of large diameterpipelines that transport crude oil from Seaway’s marine terminals on the U.S.Gulf Coast to Cushing, Oklahoma, a crude oil distribution point for the centralUnited States, and to refineries in the Texas City and Houston areas.

 

22

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Our Midstream Segment revenues are earned from thegathering of natural gas in the Green River Basin in southwestern Wyoming,through Jonah, and the gathering of coal bed methane and conventional naturalgas in the San Juan Basin in New Mexico and Colorado, through Val Verde;transportation of NGLs from two trunkline NGL pipelines in South Texas, two NGLpipelines in East Texas and a pipeline system (Chaparral) from West Texas andNew Mexico to Mont Belvieu; and the fractionation of NGLs in Colorado.

 

The table below includes financialinformation by reporting segment for the three months ended March 31, 2006 and 2005(in thousands):

 
| ** **                                           | ** ** | **Three Months Ended March 31, 2006** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                           | ** ** | **Downstream  Segment**                                        | ** ** | **Upstream   Segment** | ** ** | **Midstream  Segment** | ** ** | **Segments   Total** | ** ** | **Partnership  and Other** | ** ** | **Consolidated** | ** ** |
| ** **                                           | ** ** | ** **                                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales of  petroleum products                         |       | $                                                              | —     |   | $ | 2,400,436 |   | $ | — |   | $ | 2,400,436 |   | $ | (4,090 | ) | $ | 2,396,346 |   |
| Operating  revenues                                  |       | 74,067                                                         |       | 11,146 |   | 56,377 |   | 141,590 |   | (1,567 | ) | 140,023 |   |
| Purchases of  petroleum products                     |       | —                                                         |       | 2,376,396 |   | 125 |   | 2,376,521 |   | (5,356 | ) | 2,371,165 |   |
| Operating  expenses, including power                 |       | 40,496                                                         |       | 18,609 |   | 16,383 |   | 75,488 |   | (301 | ) | 75,187 |   |
| Depreciation and  amortization expense               |       | 10,297                                                         |       | 3,271 |   | 15,189 |   | 28,757 |   | — |   | 28,757 |   |
| Gains on sales  of assets                            |       | (7                                                             | )          | — |   | (1,371 | ) | (1,378 | ) | — |   | (1,378 | ) |
| Operating income                                     |       | 23,281                                                         |       | 13,306 |   | 26,051 |   | 62,638 |   | — |   | 62,638 |   |
| Equity earnings  (losses)                            |       | (1,266                                                         | )          | 2,255 |   | — |   | 989 |   | — |   | 989 |   |
| Other income –  net                             |       | 779                                                            |       | 44 |   | 76 |   | 899 |   | — |   | 899 |   |
| Earnings before  interest from continuing operations |       | 22,794                                                         |       | 15,605 |   | 26,127 |   | 64,526 |   | — |   | 64,526 |   |
| Discontinued  operations                             |       | —                                                         |       | — |   | 19,491 |   | 19,491 |   | — |   | 19,491 |   |
| Earnings before  interest                            |       | $                                                              | 22,794     |   | $ | 15,605 |   | $ | 45,618 |   | $ | 84,017 |   | $ | — |   | $ | 84,017 |   |

 

23

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| ** **                                           | ** ** | **Three Months Ended March 31, 2005** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                           | ** ** | **Downstream   Segment**                                  | ** ** | **Upstream   Segment** | ** ** | **Midstream   Segment** | ** ** | **Segments   Total** | ** ** | **Partnership   and Other** | ** ** | **Consolidated** | ** ** |
| ** **                                           | ** ** | **(as restated)**                                         | ** ** | **(as restated)** | ** ** | ** ** | ** ** | **(as restated)** | ** ** | ** ** | ** ** | **(as restated)** | ** ** |
| Sales of  petroleum products                         |       | $                                                              | —     |   | $ | 1,385,067 |   | $ | — |   | $ | 1,385,067 |   | $ | — |   | $ | 1,385,067 |   |
| Operating  revenues                                  |       | 78,167                                                         |       | 11,713 |   | 50,184 |   | 140,064 |   | (1,340 | ) | 138,724 |   |
| Purchases of  petroleum products                     |       | —                                                         |       | 1,372,430 |   | — |   | 1,372,430 |   | (1,340 | ) | 1,371,090 |   |
| Operating  expenses, including power                 |       | 37,186                                                         |       | 15,445 |   | 13,725 |   | 66,356 |   | — |   | 66,356 |   |
| Depreciation and  amortization expense               |       | 9,561                                                          |       | 3,501 |   | 12,549 |   | 25,611 |   | — |   | 25,611 |   |
| (Gains) losses  on sales of assets                   |       | (92                                                            | )          | 1 |   | (407 | ) | (498 | ) | — |   | (498 | ) |
| Operating income                                     |       | 31,512                                                         |       | 5,403 |   | 24,317 |   | 61,232 |   | — |   | 61,232 |   |
| Equity earnings  (losses)                            |       | (1,821                                                         | )          | 5,915 |   | — |   | 4,094 |   | — |   | 4,094 |   |
| Other income –  net                             |       | 149                                                            |       | 75 |   | 42 |   | 266 |   | — |   | 266 |   |
| Earnings before  interest from continuing operations |       | 29,840                                                         |       | 11,393 |   | 24,359 |   | 65,592 |   | — |   | 65,592 |   |
| Discontinued  operations                             |       | —                                                         |       | — |   | 1,124 |   | 1,124 |   | — |   | 1,124 |   |
| Earnings before  interest                            |       | $                                                              | 29,840     |   | $ | 11,393 |   | $ | 25,483 |   | $ | 66,716 |   | $ | — |   | $ | 66,716 |   |

 

The following table provides totalassets, capital expenditures and significant non-cash investing activities foreach segment as of and for the periods ended March 31, 2006, and December 31, 2005(in thousands):

 
| ** **                     | ** ** | **Downstream   Segment** | ** ** | **Upstream   Segment** | ** ** | **Midstream   Segment** | ** ** | **Segments   Total** | ** ** | **Partnership   and Other** | ** ** | **Consolidated** | ** ** |
|--------------------------------|------------|-------------------------------|------------|-----------------------------|------------|------------------------------|------------|---------------------------|------------|---------------------------------------|------------|------------------|------------|
| ** **                     | ** ** | ** **                    | ** ** | ** **                  | ** ** | ** **                   | ** ** | ** **                | ** ** | ** **                            | ** ** | ** **       | ** ** |
| March 31, 2006:                |       |                          |       |                        |       |                         |       |                      |       |                                  |       |             |       |
| Total assets                   |       | $                             | 1,042,072  |                        | $          | 1,551,395                    |       | $                         | 1,228,193  |                                  | $          | 3,821,660        |       | $ | (7,078 | ) | $ | 3,814,582 |   |
| Capital  expenditures          |       | 11,772                        |       | 7,601                       |       | 18,876                       |       | 38,249                    |       | 48                                    |       | 38,297           |       |
| ** **                     | ** ** | ** **                    | ** ** | ** **                  | ** ** | ** **                   | ** ** | ** **                | ** ** | ** **                            | ** ** | ** **       | ** ** |
| December 31,  2005:            |       |                          |       |                        |       |                         |       |                      |       |                                  |       |             |       |
| Total assets                   |       | $                             | 1,056,217  |                        | $          | 1,353,492                    |       | $                         | 1,280,548  |                                  | $          | 3,690,257        |       | $ | (9,719 | ) | $ | 3,680,538 |   |
| Capital  expenditures          |       | 58,609                        |       | 40,954                      |       | 119,837                      |       | 219,400                   |       | 1,153                                 |       | 220,553          |       |
| Non-cash  investing activities |       | 1,429                         |       | —                      |       | —                       |       | 1,429                     |       | —                                |       | 1,429            |       |

 

The following table reconciles the segments’ earningsbefore interest to consolidated net income for the three months ended March 31,2006 and 2005 (in thousands):

 
| ** **                   | ** ** | **Three Months Ended   March 31,** | ** ** |
|------------------------------|------------|--------------------------------------------------------|------------|
| ** **                   | ** ** | **2006**                                               | ** ** | **2005** | ** ** |
| ** **                   | ** ** | ** **                                             | ** ** | **(as restated)** | ** ** |
| Earnings before  interest    |       | $                                                      | 84,017     |   | $ | 66,716 |   |
| Interest expense  – net |       | (21,143                                                | )          | (19,287 | ) |
| Net income                   |       | $                                                      | 62,874     |   | $ | 47,429 |   |

 

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**NOTE 13. COMMITMENTS AND CONTINGENCIES**

 

**Litigation**

 

In the fall of 1999 and on December 1, 2000, theGeneral Partner and TE Products were named as defendants in two separatelawsuits in Jackson County Circuit Court, Jackson County, Indiana, styled *Ryan E. McCleery and Marcia S. McCleery, et al. v. Texas EasternCorporation, et al.*(including the General Partner and TE Products)and*Gilbert Richards and Jean Richards v. TexasEastern Corporation, et al.*(including the General Partner and TEProducts). In both cases, the plaintiffs contend, among other things, that weand other defendants stored and disposed of toxic and hazardous substances andhazardous wastes in a manner that caused the materials to be released into theair, soil and water. They further contend that the release caused damages tothe plaintiffs. In their complaints, the plaintiffs allege strict liability forboth personal injury and property damage together with gross negligence,continuing nuisance, trespass, criminal mischief and loss of consortium. Theplaintiffs are seeking compensatory, punitive and treble damages. On January27, 2005, we entered into Release and Settlement Agreements with the McCleeryplaintiffs and the Richards plaintiffs dismissing all of these plaintiffs’claims on terms that did not have a material adverse effect on our financialposition, results of operations or cash flows. Although we did not settle withall plaintiffs and we therefore remain named parties in the *Ryan E. McCleery and Marcia S. McCleery, et al. v. Texas EasternCorporation, et al*. action, a co-defendant has agreed to indemnifyus for all remaining claims asserted against us. Consequently, we do notbelieve that the outcome of these remaining claims will have a material adverseeffect on our financial position, results of operations or cash flows.

 

On December 21, 2001, TE Products was named as adefendant in a lawsuit in the 10th Judicial District, Natchitoches Parish,Louisiana, styled *Rebecca L. Grisham et al. v. TE ProductsPipeline Company, Limited Partnership*. In this case, the plaintiffscontend that our pipeline, which crosses the plaintiffs’ property, leaked toxicproducts onto their property and, consequently caused damages to them. We havefiled an answer to the plaintiffs’ petition denying the allegations, and we aredefending ourselves vigorously against the lawsuit. The plaintiffs have notstipulated the amount of damages they are seeking in the suit; however, thiscase is covered by insurance, subject to applicable policy limits. We do notbelieve that the outcome of this lawsuit will have a material adverse effect onour financial position, results of operations or cash flows.

 

In May 2003, the General Partner was named as adefendant in a lawsuit styled *John R. James, et al. v. JGraves Insulation Company, et al.* as filed in the first JudicialDistrict Court, Caddo Parish, Louisiana. There are numerous plaintiffsidentified in the action that are alleged to have suffered damages as a resultof alleged exposure to asbestos-containing products and materials. According tothe petition and as a result of a preliminary investigation, the GeneralPartner believes that the only claim asserted against it results from oneindividual for the period from July 1971 through June 1972, who is alleged tohave worked on a facility owned by the General Partner’s predecessor. Thisperiod represents a small portion of the total alleged exposure period fromJanuary 1964 through December 2001 for this individual. The individual’s claimsinvolve numerous employers and alleged job sites. The General Partner has beenunable to confirm involvement by the General Partner or its predecessors withthe alleged location, and it is uncertain at this time whether this case iscovered by insurance. Discovery is planned, and the General Partner intends todefend itself vigorously against this lawsuit. The plaintiffs have notstipulated the amount of damages that they are seeking in this suit. We areobligated to reimburse the General Partner for any costs it incurs related tothis lawsuit. We cannot estimate the loss, if any, associated with this pendinglawsuit. We do not believe that the outcome of this lawsuit will have amaterial adverse effect on our financial position, results of operations orcash flows.

 

On August 5, 2005, we were named as a third-partydefendant in a matter styled *ConocoPhillips, et al. v.BP Amoco Seaway Products Pipeline Company*as filed in the 55thJudicial District of Harris County, Texas. ConocoPhillips alleged a right toindemnity from BP Amoco Seaway Products Pipeline Company (“BP Amoco”) for 

 

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tax liability incurred by ConocoPhillips as a result of the reversemerger of Seaway Pipeline Company (the “Original Seaway Partnership”). Thereverse merger of the Original Seaway Partnership was undertaken in preparationfor our purchase of ARCO Pipe Line Company pursuant to the Amended and RestatedPurchase Agreement (the “Purchase Agreement”) dated May 10, 2000, between usand Atlantic Richfield Company. BP Amoco claimed a right to indemnity from usunder the Purchase Agreement if BP Amoco were to have any indemnity liabilityto ConocoPhillips. ConocoPhillips alleged the income tax liability to beapproximately $4.0 million. On January 20, 2006, we entered into a settlementagreement with BP Amoco dismissing and resolving all of BP Amoco’s claims. Theterms of the settlement did not have a material adverse effect on our financialposition, results of operations or cash flows.

 

In 1991, we were named as a defendant in a matterstyled *Jimmy R. Green, et al. v. Cities Service Refinery,et al.*as filed in the 26th Judicial District Court ofBossier Parish, Louisiana. The plaintiffs in this matter reside or formerlyresided on land that was once the site of a refinery owned by one of our co-defendants.The former refinery is located near our Bossier City facility. Plaintiffs haveclaimed personal injuries and property damage arising from allegedcontamination of the refinery property. The plaintiffs have recently pursuedcertification as a class and have significantly increased their demand toapproximately $175.0 million. This revised demand includes amounts forenvironmental restoration not previously claimed by the plaintiffs. We havenever owned any interest in the refinery property made the basis of thisaction, and we do not believe that we contributed to any alleged contaminationof this property. While we cannot predict the ultimate outcome, we do notbelieve that the outcome of this lawsuit will have a material adverse effect onour financial position, results of operations or cash flows.

 

In addition to the litigation discussed above, we havebeen, in the ordinary course of business, a defendant in various lawsuits and aparty to various other legal proceedings, some of which are covered in whole orin part by insurance. We believe that the outcome of these lawsuits and otherproceedings will not individually or in the aggregate have a future materialadverse effect on our consolidated financial position, results of operations orcash flows.

 

**Regulatory Matters**

 

Our processing and fractionation plants, pipelines,and associated facilities are subject to multiple environmental obligations andpotential liabilities under a variety of federal, state and local laws andregulations. These include, without limitation: the Comprehensive EnvironmentalResponse, Compensation, and Liability Act; the Resource Conservation andRecovery Act; the Clean Air Act; the Federal Water Pollution Control Act or theClean Water Act; the Oil Pollution Act; and analogous state and local laws andregulations. Such laws and regulations affect many aspects of our present andfuture operations, and generally require us to obtain and comply with a widevariety of environmental registrations, licenses, permits, inspections andother approvals, with respect to air emissions, water quality, wastewaterdischarges, and solid and hazardous waste management. Failure to comply withthese requirements may expose us to fines, penalties and/or interruptions inour operations that could influence our results of operations. If an accidentalleak, spill or release of hazardous substances occurs at any facilities that weown, operate or otherwise use, or where we send materials for treatment ordisposal, we could be held jointly and severally liable for all resultingliabilities, including investigation, remedial and clean-up costs. Likewise, wecould be required to remove or remediate previously disposed wastes or propertycontamination, including groundwater contamination. Any or all of this couldmaterially affect our results of operations and cash flows.

 

We believe that our operations and facilities are insubstantial compliance with applicable environmental laws and regulations, andthat the cost of compliance with such laws and regulations will not have amaterial adverse effect on our results of operations or financial position. Wecannot ensure, however, that existing environmental regulations will not berevised or that new regulations will not be adopted or become applicable to us.The clear trend in environmental regulation is to place more restrictions andlimitations on activities that may be perceived to 

 

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affect the environment, and thus there can be no assurance as to theamount or timing of future expenditures for environmental regulation complianceor remediation, and actual future expenditures may be different from theamounts we currently anticipate. Revised or additional regulations that resultin increased compliance costs or additional operating restrictions,particularly if those costs are not fully recoverable from our customers, couldhave material adverse effect on our business, financial position, results ofoperations and cash flows. At March 31, 2006, and December 31, 2005, we have anaccrued liability of $2.3 million and $2.4 million, respectively, related tosites requiring environmental remediation activities.

 

On March 26, 2004, a decision in *ARCOProducts Co., et al. v. SFPP*, Docket Nos. OR96-2-000 et al., wasissued by the FERC, which made several significant determinations with respectto finding “changed circumstances” under the Energy Policy Act of 1992 (“EP Act”).The decision largely clarifies, but does not fully quantify, the standardrequired for a complainant to demonstrate that an oil pipeline’s rates are nolonger subject to the rate protection of the EP Act by demonstrating that asubstantial change in circumstances has occurred since 1992 with respect to thebasis of the rates being challenged. In the decision, the FERC found that alimited number of rate elements will significantly affect the economic basisfor a pipeline company’s rates. The elements identified in the decision arevolume changes, allowed total return and total cost-of-service (including majorcost elements such as rate base, tax rates and tax allowances, among others). TheFERC did reject, however, the use of changes in tax rates and income taxallowances as stand-alone factors. Judicial review of that decision, which hasbeen sought by a number of parties to the case, is currently pending before theU.S. Court of Appeals for the District of Columbia Circuit. We have not yetdetermined the impact, if any, that the decision, if it is ultimately upheld,would have on our rates if they were reviewed under the criteria of thisdecision.

 

On July 20, 2004, the District of Columbia Circuitissued an opinion in *BP West Coast Products LLCv. FERC*. In reviewing a series of orders involving SFPP, L.P., thecourt held among other things that the FERC had not adequately justified itspolicy of providing an oil pipeline limited partnership with an income taxallowance equal to the proportion of its income attributable to partnershipinterests owned by corporate partners. Under the FERC’s initial ruling, SFPP,L.P. was permitted an income tax allowance on its cost-of-service filing forthe percentage of its net operating (pre-tax) income attributable topartnership units held by corporations, and was denied an income tax allowanceequal to the percentage attributable to partnership units held by non-corporatepartners. The court remanded the case back to the FERC for further review. Followingthe court’s remand, on May 4, 2005, the FERC issued its Policy Statement onIncome Tax Allowances, which permits regulated partnerships, limited liabilitycompanies and other pass-through entities an income tax allowance on theirincome attributable to any owner that has an actual or potential income taxliability on that income, regardless whether the owner is an individual orcorporation. If there is more than one level of pass-through entities, theregulated company income must be traced to where the ultimate tax liabilitylies. The Policy Statement is to be applied in individual cases, and theregulated entity bears the burden of proof to establish the tax status of itsowners. On December 16, 2005, the FERC issued the first of those decisions, inan order involving SFPP (the “SFPP Order”). The SFPP Order confirmed that amaster limited partnership is entitled to a tax allowance with respect topartnership income for which there is an “actual or potential income taxliability” and determined that a unitholder that is required to file a Form1040 or Form 1120 tax return that includes partnership income or loss ispresumed to have an actual or potential income tax liability sufficient tosupport a tax allowance on that partnership income. The FERC also establishedcertain other presumptions, including that corporate unitholders are presumedto be taxed at the maximum corporate tax rate of 35% while individualunitholders (and certain other types of unitholders taxed like individuals) arepresumed to be taxed at a 28% tax rate. The SFPP Order remains subject tofurther administrative proceedings, including review by the FERC of compliancefilings made by SFPP on March 7, 2006, as well as judicial review. The ultimateoutcome of the FERC’s inquiry on income tax allowance should not affect ourcurrent rates and rate structure because our rates are not based on cost-of-servicemethodology. However, the outcome of the income tax allowance would becomerelevant to us should we (i) elect in the future to use cost-of-service tosupport our rates, or (ii) be required to use such methodology to defend ourindexed rates.

 

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In 1994, the Louisiana Department of EnvironmentalQuality (“LDEQ”) issued a compliance order for environmental contamination atour Arcadia, Louisiana, facility. In 1999, our Arcadia facility and adjacentterminals were directed by the Remediation Services Division of the LDEQ topursue remediation of this contamination. Effective March 2004, we executed anaccess agreement with an adjacent industrial landowner who is locatedupgradient of the Arcadia facility. This agreement enables the landowner toproceed with remediation activities at our Arcadia facility for which it hasaccepted shared responsibility. At March 31, 2006, we have an accrued liabilityof $0.2 million for remediation costs at our Arcadia facility. We do not expectthat the completion of the remediation program proposed to the LDEQ will have afuture material adverse effect on our financial position, results of operationsor cash flows.

 

On July 27, 2004, wereceived notice from the United States Department of Justice (“DOJ”) of itsintent to seek a civil penalty against us related to our November 21, 2001,release of approximately 2,575 barrels of jet fuel from our 14-inch diameterpipeline located in Orange County, Texas. The DOJ, at the request of theEnvironmental Protection Agency, is seeking a civil penalty against us foralleged violations of the Clean Water Act (“CWA”) arising out of this release,as well as three smaller spills at other locations in 2004 and 2005. We are indiscussions with the DOJ regarding these matters. The settlement penaltyproposed by the DOJ for these alleged violations of the CWA is a $3.0 million penalty,along with our commitment to implement additional spill prevention measures. Wedo not expect this settlement to have a material adverse effect on ourfinancial position, results of operations or cash flows.

 

One of the spillsencompassed in our current settlement discussion with the DOJ involved a37,450-gallon release from Seaway on May 13, 2005 at Colbert, Oklahoma. Thisrelease was remediated under the supervision of the Oklahoma CorporationCommission, but has resulted in claims by neighboring landowners, for which weanticipate a financial settlement in the range of $0.7 million to $0.8 million.In addition, the release resulted in a Corrective Action Order by the U.S.Department of Transportation. Among other requirements of this Order, we arerequired to reduce the operating pressure of Seaway by 20% until the completionof required corrective actions. We have a 50% ownership interest in Seaway, andany settlement should be covered by our insurance. We do not expect thecompletion of our obligations relating to the Colbert release to have amaterial adverse effect on our financial position, results of operations orcash flows.

 

On September 18, 2005, a propane release and fireoccurred at our Todhunter facility, near Middletown, Ohio. The incidentresulted in the death of one of our employees; there were no other injuries. Repairsto the impacted facilities have been completed. On March 17, 2006, we receiveda citation from the Occupational Safety and Health Administration (“OSHA”) arisingout of this incident with a proposed penalty of less than $0.2 million. We arein settlement negotiations with OSHA representatives regarding this matter. We donot expect any settlement, fine or penalty to have a material adverse effect onour financial position, results of operations or cash flows.

 

**Other**

 

Centennial entered into credit facilities totaling$150.0 million, and as of March 31, 2006, $150.0 million was outstanding underthose credit facilities, of which $140.0 million expires in 2024, and $10.0million expires in April 2007. TE Products and Marathon have each guaranteedone-half of the repayment of Centennial’s outstanding debt balance (plusinterest) under these credit facilities. The guarantees arose in order forCentennial to obtain adequate financing, and the proceeds of the credit facilitieswere used to fund construction and conversion costs of its pipeline system. Priorto the expiration of the long-term credit facility, TE Products could berelinquished from responsibility under the guarantee should Centennial meetcertain financial tests. If Centennial defaults on its outstanding balance, theestimated maximum potential amount of future payments for TE Products andMarathon is $75.0 million each at March 31, 2006.

 

TE Products, Marathon and Centennial have entered into a limited cashcall agreement, which allows each member to contribute cash in lieu ofCentennial procuring separate insurance in the event of a third-party liabilityarising from a catastrophic event.  Thereis an indefinite term for the agreement and each member is to contribute cashin proportion to its ownership interest, up to a maximum of $50.0 millioneach.  As a result of the catastrophicevent guarantee, TE Products has recorded a $4.6 million obligation, whichrepresents the present value of the estimated amount that we would have to payunder the guarantee.  If a catastrophicevent were to occur and we were required to contribute cash to Centennial,contributions exceeding our deductible might be covered by our insurance.  

 

One of our subsidiaries, TEPPCO Crude Oil, L.P.(“TCO”), has entered into master equipment lease agreements with financecompanies for the use of various equipment. We have guaranteed the full and timely 

 

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payment and performance ofTCO’s obligations under the agreements. Generally, events of default would trigger our performance under theguarantee.  The maximum potential amount offuture payments under the guarantee is not estimable, but would include baserental payments for both current and future equipment, stipulated loss paymentsin the event any equipment is stolen, damaged, or destroyed and any futureindemnity payments.  We carry insurancecoverage that may offset any payments required under the guarantees.

 

On February 24, 2005, the General Partner was acquired from DEFS byDFI.  The General Partner owns a 2%general partner interest in us and is the general partner of thePartnership.  On March 11, 2005, theBureau of Competition of the Federal Trade Commission (“FTC”) delivered writtennotice to DFI’s legal advisor that it was conducting a non-public investigationto determine whether DFI’s acquisition of the General Partner may substantiallylessen competition.  The General Partneris cooperating fully with this investigation.

** **

**NOTE 14.COMPREHENSIVE INCOME**

 

SFAS No. 130, *Reporting ComprehensiveIncome* requires certain items such as foreign currency translationadjustments, minimum pension liability adjustments and unrealized gains andlosses on certain investments to be reported in a financial statement.  As of and for the three months ended March31, 2006, the components of accumulated other comprehensive income reflected onour consolidated balance sheets were composed of crude oil hedges and interestrate swaps.  The crude oil hedges maturein December 2006.  While the crude oilhedges are in effect, changes in their fair values, to the extent the hedgesare effective, are recognized in accumulated other comprehensive income untilthey are recognized in net income in future periods.  The interest rate swaps mature in January2008, are related to our variable rate revolving credit facility, and aredesignated as cash flow hedges.  Whilethe interest rate swaps are in effect, changes in the fair values of the cashflow hedges, to the extent the hedges are effective, are recognized inaccumulated other comprehensive income until the hedged interest costs arerecognized in net income in future periods.

 

The accumulated balance of othercomprehensive income related to our cash flow hedges are as follows (inthousands):

 
| Balance at December 31, 2005                              |   | $     | 11     |   |
|-----------------------------------------------------------|--------|-------|--------|--------|
| Changes in fair values of crude oil cash  flow hedges     |   | 236   |   |
| Changes in fair values of interest rate  cash flow hedges |   | 1,671 |   |
| Balance at March 31, 2006                                 |   | $     | 1,918  |   |

 

**NOTE15.  SUPPLEMENTAL CONDENSED CONSOLIDATINGFINANCIAL INFORMATION**

** **

TE Products Pipeline Company, Limited Partnership,TCTM, L.P., TEPPCO Midstream Companies, L.P., Jonah Gas Gathering Company andVal Verde Gas Gathering Company, L.P., have issued guarantees of our debtsecurities.  The guarantees are full,unconditional, and joint and several.  Thesesignificant subsidiaries, TE Products Pipeline Company, Limited Partnership,TCTM, L.P., TEPPCO Midstream Companies, L.P., Jonah Gas Gathering Company andVal Verde Gas Gathering Company, L.P., are collectively referred to as the“Guarantor Subsidiaries.”

 

The following supplemental condensed consolidatingfinancial information reflects our separate accounts, the combined accounts ofthe Guarantor Subsidiaries, the combined accounts of our other non-guarantorsubsidiaries, the combined consolidating adjustments and eliminations and ourconsolidated accounts for the dates and periods indicated.  For purposes of the following consolidatinginformation, our investments in our subsidiaries and the GuarantorSubsidiaries’ investments in their subsidiaries are accounted for under theequity method of accounting.

 

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| ** **                                   | ** ** | **March 31, 2006**          | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                   | ** ** | **TEPPCO   Partners, L.P.** | ** ** | **Guarantor   Subsidiaries** | ** ** | **Non-Guarantor   Subsidiaries** | ** ** | **Consolidating   Adjustments** | ** ** | **TEPPCO   Partners, L.P.  Consolidated** | ** ** |
| ** **                                   | ** ** | **(in thousands)**               | ** ** |
| Assets                                       |       |                                  |       |   |   |   |   |   |   |   |   |
| Current assets                               |       | $                                     | 19,323     |   | $ | 77,696 |   | $ | 995,790 |   | $ | (17,859 | ) | $ | 1,074,950 |   |
| Property, plant and equipment – net     |       | —                                |       | 1,308,022 |   | 628,733 |   | — |   | 1,936,755 |   |
| Equity investments                           |       | 1,197,369                             |       | 451,909 |   | 196,523 |   | (1,498,425 | ) | 347,376 |   |
| Intercompany notes receivable                |       | 1,162,479                             |       | — |   | — |   | (1,162,479 | ) | — |   |
| Intangible assets                            |       | —                                |       | 337,388 |   | 31,242 |   | — |   | 368,630 |   |
| Other assets                                 |       | 6,947                                 |       | 23,008 |   | 56,916 |   | — |   | 86,871 |   |
| Total assets                                 |       | $                                     | 2,386,118  |   | $ | 2,198,023 |   | $ | 1,909,204 |   | $ | (2,678,763 | ) | $ | 3,814,582 |   |
| Liabilities and partners’ capital       |       |                                  |       |   |   |   |   |   |   |   |   |
| Current liabilities                          |       | $                                     | 21,629     |   | $ | 69,771 |   | $ | 973,854 |   | $ | (19,662 | ) | $ | 1,045,592 |   |
| Long-term debt                               |       | 1,164,072                             |       | 382,982 |   | — |   | — |   | 1,547,054 |   |
| Intercompany notes payable                   |       | —                                |       | 637,079 |   | 525,401 |   | (1,162,480 | ) | — |   |
| Other long term liabilities                  |       | 1,405                                 |       | 20,326 |   | 946 |   | — |   | 22,677 |   |
| Total partners’ capital                 |       | 1,199,012                             |       | 1,087,865 |   | 409,003 |   | (1,496,621 | ) | 1,199,259 |   |
| Total liabilities and partners’ capital |       | $                                     | 2,386,118  |   | $ | 2,198,023 |   | $ | 1,909,204 |   | $ | (2,678,763 | ) | $ | 3,814,582 |   |

 
| ** **                                   | ** ** | **December 31, 2005**       | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                   | ** ** | **TEPPCO   Partners, L.P.** | ** ** | **Guarantor   Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **TEPPCO   Partners, L.P.   Consolidated** | ** ** |
| ** **                                   | ** ** | **(in thousands)**               | ** ** |
| Assets                                       |       |                                  |       |   |   |   |   |   |   |   |   |
| Current assets                               |       | $                                     | 40,977     |   | $ | 107,692 |   | $ | 789,486 |   | $ | (39,026 | ) | $ | 899,129 |   |
| Property, plant and equipment – net     |       | —                                |       | 1,335,724 |   | 624,344 |   | — |   | 1,960,068 |   |
| Equity investments                           |       | 1,201,388                             |       | 461,741 |   | 202,343 |   | (1,505,816 | ) | 359,656 |   |
| Intercompany notes receivable                |       | 1,134,093                             |       | — |   | — |   | (1,134,093 | ) | — |   |
| Intangible assets                            |       | —                                |       | 345,005 |   | 31,903 |   | — |   | 376,908 |   |
| Other assets                                 |       | 5,532                                 |       | 22,170 |   | 57,075 |   | — |   | 84,777 |   |
| Total assets                                 |       | $                                     | 2,381,990  |   | $ | 2,272,332 |   | $ | 1,705,151 |   | $ | (2,678,935 | ) | $ | 3,680,538 |   |
| Liabilities and partners’ capital       |       |                                  |       |   |   |   |   |   |   |   |   |
| Current liabilities                          |       | $                                     | 43,236     |   | $ | 140,743 |   | $ | 793,683 |   | $ | (40,451 | ) | $ | 937,211 |   |
| Long-term debt                               |       | 1,135,973                             |       | 389,048 |   | — |   | — |   | 1,525,021 |   |
| Intercompany notes payable                   |       | —                                |       | 635,263 |   | 498,832 |   | (1,134,095 | ) | — |   |
| Other long term liabilities                  |       | 1,422                                 |       | 14,564 |   | 950 |   | — |   | 16,936 |   |
| Total partners’ capital                 |       | 1,201,359                             |       | 1,092,714 |   | 411,686 |   | (1,504,389 | ) | 1,201,370 |   |
| Total liabilities and partners’ capital |       | $                                     | 2,381,990  |   | $ | 2,272,332 |   | $ | 1,705,151 |   | $ | (2,678,935 | ) | $ | 3,680,538 |   |

 

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| ** **                              | ** ** | **Three Months Ended March 31, 2006** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                              | ** ** | **TEPPCO   Partners, L.P.**                          | ** ** | **Guarantor   Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating   Adjustments** | ** ** | **TEPPCO   Partners, L.P.  Consolidated** | ** ** |
| ** **                              | ** ** | **(in thousands)**                                        | ** ** |
| Operating revenues                      |       | $                                                              | —     |   | $ | 115,060 |   | $ | 2,426,966 |   | $ | (5,657 | ) | $ | 2,536,369 |   |
| Costs and expenses                      |       | —                                                         |       | 75,764 |   | 2,405,002 |   | (5,657 | ) | 2,475,109 |   |
| Gains on sales of assets                |       | —                                                         |       | (1,378 | ) | — |   | — |   | (1,378 | ) |
| Operating income                        |       | —                                                         |       | 40,674 |   | 21,964 |   | — |   | 62,638 |   |
| Interest expense – net             |       | —                                                         |       | (14,377 | ) | (6,766 | ) | — |   | (21,143 | ) |
| Equity earnings                         |       | 62,874                                                         |       | 16,263 |   | 2,255 |   | (80,403 | ) | 989 |   |
| Other income – net                 |       | —                                                         |       | 823 |   | 76 |   | — |   | 899 |   |
| Income from continuing operations       |       | 62,874                                                         |       | 43,383 |   | 17,529 |   | (80,403 | ) | 43,383 |   |
| Income from discontinued operations     |       | —                                                         |       | 1,607 |   | — |   | — |   | 1,607 |   |
| Gain on sale of discontinued operations |       | —                                                         |       | 17,884 |   | — |   | — |   | 17,884 |   |
| Net income                              |       | $                                                              | 62,874     |   | $ | 62,874 |   | $ | 17,529 |   | $ | (80,403 | ) | $ | 62,874 |   |

 
| ** **                          | ** ** | **Three Months Ended March 31, 2005 (as restated)** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                          | ** ** | **TEPPCO   Partners, L.P.**                                                  | ** ** | **Guarantor   Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating   Adjustments** | ** ** | **TEPPCO   Partners, L.P.  Consolidated** | ** ** |
| ** **                          | ** ** | **(in thousands)**                                                                | ** ** |
| Operating revenues                  |       | $                                                                                      | —     |   | $ | 115,111 |   | $ | 1,410,020 |   | $ | (1,340 | ) | $ | 1,523,791 |   |
| Costs and expenses                  |       | —                                                                                 |       | 66,089 |   | 1,398,308 |   | (1,340 | ) | 1,463,057 |   |
| (Gains) losses on sales of assets   |       | —                                                                                 |       | (499 | ) | 1 |   | — |   | (498 | ) |
| Operating income                    |       | —                                                                                 |       | 49,521 |   | 11,711 |   | — |   | 61,232 |   |
| Interest expense – net         |       | —                                                                                 |       | (13,018 | ) | (6,269 | ) | — |   | (19,287 | ) |
| Equity earnings                     |       | 47,429                                                                                 |       | 9,619 |   | 5,915 |   | (58,869 | ) | 4,094 |   |
| Other income – net             |       | —                                                                                 |       | 183 |   | 83 |   | — |   | 266 |   |
| Income from continuing operations   |       | 47,429                                                                                 |       | 46,305 |   | 11,440 |   | (58,869 | ) | 46,305 |   |
| Income from discontinued operations |       | —                                                                                 |       | 1,124 |   | — |   | — |   | 1,124 |   |
| Net income                          |       | $                                                                                      | 47,429     |   | $ | 47,429 |   | $ | 11,440 |   | $ | (58,869 | ) | $ | 47,429 |   |

 

31

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| ** **                                                                         | ** ** | **Three Months Ended March 31, 2006** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **TEPPCO   Partners, L.P.**                          | ** ** | **Guarantor   Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **TEPPCO   Partners, L.P.  Consolidated** | ** ** |
| ** **                                                                         | ** ** | **(in thousands)**                                        | ** ** |
| Cash flows from operating activities                                               |       |                                                           |       |   |   |   |   |   |   |   |   |
| Net income from continuing operations                                              |       | $                                                              | 62,874     |   | $ | 43,383 |   | $ | 17,529 |   | $ | (80,403 | ) | $ | 43,383 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities: |       |                                                           |       |   |   |   |   |   |   |   |   |
| Depreciation and amortization                                                      |       | —                                                         |       | 22,701 |   | 6,056 |   | — |   | 28,757 |   |
| Earnings in equity investments, net of distributions                               |       | 4,018                                                          |       | 11,644 |   | 6,202 |   | (6,556 | ) | 15,308 |   |
| Gains on sales of assets                                                           |       | —                                                         |       | (1,378 | ) | — |   | — |   | (1,378 | ) |
| Changes in assets and liabilities and other                                        |       | (25,236                                                        | )          | (22,609 | ) | (26,347 | ) | 25,215 |   | (48,977 | ) |
| Net cash provided by operating activities from continuing operations               |       | 41,656                                                         |       | 53,741 |   | 3,440 |   | (61,744 | ) | 37,093 |   |
| Cash flows from discontinued operations                                            |       | —                                                         |       | 1,631 |   | — |   | — |   | 1,631 |   |
| Net cash provided by operating activities                                          |       | 41,656                                                         |       | 55,372 |   | 3,440 |   | (61,744 | ) | 38,724 |   |
|                                                                               |       |                                                           |       |   |   |   |   |   |   |   |   |
| Cash flows from investing activities                                               |       | —                                                         |       | 59,377 |   | (10,176 | ) | (50,163 | ) | (962 | ) |
| Cash flows from financing activities                                               |       | (37,792                                                        | )          | (114,811 | ) | 6,769 |   | 108,042 |   | (37,792 | ) |
| Net increase (decrease) in cash and cash equivalents                               |       | 3,864                                                          |       | (62 | ) | 33 |   | (3,865 | ) | (30 | ) |
| Cash and cash equivalents at beginning of period                                   |       | 1,978                                                          |       | 62 |   | 45 |   | (1,966 | ) | 119 |   |
| Cash and cash equivalents at end of period                                         |       | $                                                              | 5,842      |   | $ | — |   | $ | 78 |   | $ | (5,831 | ) | $ | 89 |   |

 

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| ** **                                                                                   | ** ** | **Three Months Ended March 31, 2005 (as restated)** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **TEPPCO   Partners, L.P.**                                                  | ** ** | **Guarantor   Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **TEPPCO   Partners, L.P.  Consolidated** | ** ** |
| ** **                                                                                   | ** ** | **(in thousands)**                                                                | ** ** |
| Cash flows from operating activities                                                         |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Net income from continuing operations                                                        |       | $                                                                                      | 47,429     |   | $ | 46,305 |   | $ | 11,440 |   | $ | (58,869 | ) | $ | 46,305 |   |
| Adjustments to reconcile net income to net cash provided by (used in)  operating activities: |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Depreciation and amortization                                                                |       | —                                                                                 |       | 19,577 |   | 6,034 |   | — |   | 25,611 |   |
| Earnings (losses) in equity investments, net of distributions                                |       | 11,229                                                                                 |       | 2,213 |   | (1,196 | ) | (11,621 | ) | 625 |   |
| (Gains) losses on sales of assets                                                            |       | —                                                                                 |       | (499 | ) | 1 |   | — |   | (498 | ) |
| Changes in assets and liabilities and other                                                  |       | (55,364                                                                                | )          | (28,814 | ) | (45,981 | ) | 72,642 |   | (57,517 | ) |
| Net cash provided by (used in) operating activities from continuing  operations              |       | 3,294                                                                                  |       | 38,782 |   | (29,702 | ) | 2,152 |   | 14,526 |   |
| Cash flows from discontinued operations                                                      |       | —                                                                                 |       | 1,277 |   | — |   | — |   | 1,277 |   |
| Net cash provided by (used in) operatingactivities                                           |       | 3,294                                                                                  |       | 40,059 |   | (29,702 | ) | 2,152 |   | 15,803 |   |
| Cash flows from investing activities                                                         |       | —                                                                                 |       | 9,088 |   | (14,301 | ) | (28,967 | ) | (34,180 | ) |
| Cash flows from financing activities                                                         |       | 20,342                                                                                 |       | (62,243 | ) | 41,452 |   | 20,791 |   | 20,342 |   |
| Net increase (decrease) in cash and cash equivalents                                         |       | 23,636                                                                                 |       | (13,096 | ) | (2,551 | ) | (6,024 | ) | 1,965 |   |
| Cash and cash equivalents at beginning of period                                             |       | 4,116                                                                                  |       | 13,596 |   | 2,826 |   | (4,116 | ) | 16,422 |   |
| Cash and cash equivalents at end of period                                                   |       | $                                                                                      | 27,752     |   | $ | 500 |   | $ | 275 |   | $ | (10,140 | ) | $ | 18,387 |   |

 

**NOTE 16. RESTATEMENT OFCONSOLIDATED FINANCIAL STATEMENTS**

 

In the fourthquarter of 2005, we determined that our method of accounting for the $33.4million excess investment in Centennial, previously described as an intangibleasset with an indefinite life, and the $27.1 million excess investment inSeaway, previously described as equity method goodwill, was incorrect.  Through our accounting for these excessinvestments in Centennial and Seaway as intangible assets with indefinite livesand equity method goodwill, respectively, we had been testing the amounts forimpairment on an annual basis as opposed to amortizing them over a determinablelife.  We determined that it would bemore appropriate to account for these excess investments as intangible assetswith determinable lives.  As a result, wemade non-cash adjustments that reduced the net value of the excess investmentsin Centennial and Seaway, and increased amortization expense allocated to ourequity earnings.  We restated previouslyreported consolidated financial statements for the fiscal years ended December31, 2003 and 2004 in our Annual Report on Form 10-K for the year ended December31, 2005.  The effect of this restatementcaused a $1.2 million reduction to net income as previously reported for thethree months ended March 31, 2005.  As aresult, we are restating our previously reported consolidated financialstatements for the three months ended March 31, 2005.

 

While webelieve the impacts of these non-cash adjustments are not material to anypreviously issued financial statements, we determined that the cumulativeadjustment for these non-cash items was too material to record in the fourthquarter of 2005, and therefore it was most appropriate to restate priorperiods’ results.  These non-cashadjustments had no effect on our operating income, compensation expense, debtbalances or ability to meet all requirements related to our debtinstruments.  The restatement had noimpact on total cash flows from operating activities, investing activities orfinancing activities.  All amounts in theaccompanying consolidated financial statements have been adjusted for thisrestatement.

 

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We will continue to amortize the $30.0 million excessinvestment in Centennial related to a contract using units-of-productionmethodology over a 10-year life.  Theremaining $3.4 million related to a pipeline will continue to be amortized on astraight-line basis over 35 years.  Wewill continue to amortize the $27.1 million excess investment in Seaway on astraight-line basis over a 39-year life related primarily to a pipeline.

 

The following tables summarize the impact of therestatement adjustment on previously reported income statement amounts and cashflow amounts for the three months ended March 31, 2005 (in thousands):

 

**Income Statement Amounts:**

 
| ** **                                             | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                             | ** ** | **As Previously  Reported**                           | ** ** | **Adjustment** | ** ** | **As Restated** | ** ** |
| ** **                                             | ** ** | ** **                                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Equity earnings                                        |       | $                                                          | 5,246      |   | $ | (1,152 | ) | $ | 4,094 |   |
| Net income                                             |       | 48,581                                                     |       | (1,152 | ) | 47,429 |   |
|                                                   |       |                                                       |       |   |   |   |   |
| Net Income Allocation:                                 |       |                                                       |       |   |   |   |   |
| Limited Partner Unitholders                            |       | $                                                          | 34,566     |   | $ | (819 | ) | $ | 33,747 |   |
| General Partner                                        |       | 14,015                                                     |       | (333 | ) | 13,682 |   |
| Total net income allocated                             |       | $                                                          | 48,581     |   | $ | (1,152 | ) | $ | 47,429 |   |
| Basic and diluted net income per Limited  Partner Unit |       | $                                                          | 0.55       |   | $ | (0.01 | ) | $ | 0.54 |   |

 

**Cash Flow Amounts:**

 
| ** **                            | ** ** | **Three Months Ended   March 31, 2005** | ** ** |
|---------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                            | ** ** | **As Previously  Reported**                                 | ** ** | **Adjustment** | ** ** | **As Restated** | ** ** |
| ** **                            | ** ** | ** **                                                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash flows from operating activities: |       |                                                             |       |   |   |   |   |
| Net income                            |       | $                                                                | 48,581     |   | $ | (1,152 | ) | $ | 47,429 |   |
| Earnings in equity investments        |       | (5,246                                                           | )          | 1,152 |   | (4,094 | ) |
|                                       |            |                                                                  |            |  |  |  |  |  |  |  |

 

**NOTE 17. SUBSEQUENT EVENT**

 

On April 20, 2006, EPCO submitted a proposal to theAudit and Conflicts Committee of our General Partner’s Board of Directors toeliminate the General Partner’s incentive distribution right to receive 50% oftotal cash distributions with respect to that portion of our quarterlydistribution to limited partners that exceeds $0.45 per Unit.  Under the terms of the proposal, the GeneralPartner’s incentive distribution rights would be capped at 25% of the totalcash distributions with respect to that portion of our quarterly cashdistribution to partners that exceeds $0.325 per Unit.  In exchange for the agreement to eliminate the50% incentive distribution right, our General Partner would receive a number ofnewly-issued Units whose distributions would approximate the amount of actualcash distributions foregone by the General Partner from eliminating the 50%incentive distribution right at the time such change, if any, in the incentivedistribution right is instituted.  Basedon the amount of cash distributions being received by the General Partner as ofthe date of the filing of this Report, the number of newly-issued Units issuedto the General Partner would be approximately 13.0 million.  The proposal, which includes other amendmentsto certain provisions of our Partnership Agreement, is subject to the approvalof the Board of Directors upon the recommendation of the Audit and ConflictsCommittee and, to the extent required under our Partnership Agreement or by therules of the New York Stock Exchange, by our limited partners.

 

34

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**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

** **

**General**

 

You should read the following review of our financialposition and results of operations in conjunction with our ConsolidatedFinancial Statements and the notes thereto. The Consolidated Financial Statements should be read in conjunction withthe financial statements and related notes, together with our discussion andanalysis of financial position and results of operations included in our AnnualReport on Form 10-K for the year ended December 31, 2005.  Our discussion and analysis includes thefollowing:

 

•      CautionaryNote Regarding Forward-Looking Statements.

 

•      Overviewof Critical Accounting Policies and Estimates.

 

•      Overviewof Business.

 

•      Restatementof Consolidated Financial Statements.

 

•      Resultsof Operations – Discusses material period-to-period variances in theconsolidated statements of income.

 

•      FinancialCondition and Liquidity – Analyzes cash flows and financial position.

 

•      OtherConsiderations – Addresses available sources of liquidity, trends, future plansand contingencies that are reasonably likely to materially affect futureliquidity or earnings.

 

•      RecentAccounting Pronouncements.

 

**CautionaryNote Regarding Forward-Looking Statements**

** **

The matters discussed in this Quarterly Report on Form10-Q (this “Report”) include “forward-looking statements” within the meaning ofSection 27A of the Securities Act of 1933 and Section 21E of the SecuritiesExchange Act of 1934.  All statementsthat express belief, expectation, estimates or intentions, as well as thosethat are not statements of historical facts are forward-lookingstatements.  The words “proposed”,“anticipate”, “potential”, “may”, “will”, “could”, “should”, “expect”,“estimate”, “believe”, “intend”, “plan”, “seek” and similar expressions areintended to identify forward-looking statements.  Without limiting the broader description offorward-looking statements above, we specifically note that statements includedin this document that address activities, events or developments that we expector anticipate will or may occur in the future, including such things asestimated future capital expenditures (including the amount and naturethereof), business strategy and measures to implement strategy, competitivestrengths, goals, expansion and growth of our business and operations, plans,references to future success, references to intentions as to future matters andother such matters are forward-looking statements.  These statements are based on certainassumptions and analyses made by us in light of our experience and our perceptionof historical trends, current conditions and expected future developments aswell as other factors we believe are appropriate under the circumstances.  While we believe our expectations reflectedin these forward-looking statements are reasonable, whether actual results anddevelopments will conform with our expectations and predictions is subject to anumber of risks and uncertainties, including general economic, market orbusiness conditions, the opportunities (or lack thereof) that may be presentedto and pursued by us, competitive actions by other pipeline companies, changesin laws or regulations and other factors, many of which are beyond ourcontrol.  For example, the demand forrefined products is dependent upon the price, prevailing economic conditionsand demographic changes in the markets served, trucking and railroad freight,agricultural usage and military usage; the demand for propane is sensitive tothe weather and prevailing economic conditions; the demand for petrochemicalsis dependent upon prices for products produced from petrochemicals; the demandfor crude oil and petroleum products 

 

35

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is dependent upon the price ofcrude oil and the products produced from the refining of crude oil; and thedemand for natural gas is dependent upon the price of natural gas and thelocations in which natural gas is drilled. We are also subject to regulatory factors such as the amounts we areallowed to charge our customers for the services we provide on our regulatedpipeline systems.  Consequently, all ofthe forward-looking statements made in this document are qualified by thesecautionary statements, and we cannot assure you that actual results or developmentsthat we anticipate will be realized or, even if substantially realized, willhave the expected consequences to or effect on us or our business oroperations.  Also note that we provide acautionary discussion of risks and uncertainties under the captions“Management’s Discussion and Analysis of Financial Condition and Results ofOperations” and elsewhere in this Form 10-Q, as well as under the captions“Risk Factors”, “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” and elsewhere in our Annual Report on Form 10-K forthe year ended December 31, 2005.

 

The forward-looking statements contained in thisReport speak only as of the date hereof. Except as required by the federal and state securities laws, weundertake no obligation to publicly update or revise any forward-lookingstatements, whether as a result of new information, future events or any otherreason.  All forward-looking statementsattributable to TEPPCO Partners, L.P. or any person acting on its behalf areexpressly qualified in their entirety by the cautionary statements contained orreferred to in this Quarterly Report on Form 10-Q and in our future periodicreports filed with the Securities and Exchange Commission (“SEC”).  In light of these risks, uncertainties andassumptions, the forward-looking events discussed in this Report may notoccur.  For additional discussion of such risks anduncertainties, see our Annual Report on Form 10-K for the year ended December31, 2005, and other filings we have made with the SEC.

 

**Overviewof Critical Accounting Policies and Estimates**

 

A summary of the significant accounting policies wehave adopted and followed in the preparation of our consolidated financialstatements is included in our Annual Report on Form 10-K for the yearended December 31, 2005.  Certain ofthese accounting policies require the use of estimates.  As more fully described therein, thefollowing estimates, in our opinion, are subjective in nature, require theexercise of judgment and involve complex analysis: revenue and expense accruals,including accruals for power costs, property taxes and crude oil margins;environmental costs; asset impairment analysis related to property, plant andequipment; and amortization expense and asset impairment analysis related togoodwill and other intangible assets. These estimates are based on our knowledge and understanding of currentconditions and actions we may take in the future.  Changes in these estimates will occur as aresult of the passage of time and the occurrence of future events.  Subsequent changes in these estimates mayhave a significant impact on our financial position and results of operations.

## **** ****

## ****Overview of Business****

## **** ****

Our corporate business strategy is to grow sustainablecash flow and cash distributions to our unitholders.  The key elements of our strategy are to focuson internal growth prospects in order to increase pipeline system and terminalthroughput, expand and upgrade existing assets and services and construct newpipelines, terminals and facilities; to target accretive and complementaryacquisitions and expansion opportunities that provide attractive growthpotential; to maintain an appropriate mix of assets; and to operate in a safe,efficient and environmentally responsible manner.

 

Certain factors are keyto our operations.  These include thesafe, reliable and efficient operation of the pipelines and facilities that weown or operate while meeting the regulations that govern the operation of ourassets and the costs associated with such regulations.  We are also focused on our continued growththrough expansion of the assets that we own and through the acquisition ofassets that complement our current operations. We operate and report in three business segments:

 

•      OurDownstream Segment, which is engaged in the transportation and storage ofrefined products, LPGs and petrochemicals;

 

36

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•      OurUpstream Segment, which is engaged in the gathering, transportation, marketingand storage of crude oil and distribution of lubrication oils and specialtychemicals; and

 

•      OurMidstream Segment, which is engaged in the gathering of natural gas,transportation of NGLs and fractionation of NGLs.

 

Our Downstream Segment revenues are earned fromtransportation and storage of refined products and LPGs, intrastatetransportation of petrochemicals, sale of product inventory and other ancillaryservices.  The two largest operatingexpense items of the Downstream Segment are labor and electric power.  We generally realize higher revenues during thefirst and fourth quarters of each year since our operations are somewhatseasonal. Refined products volumes are generally higher during the second andthird quarters because of greater demand for gasolines during the spring andsummer driving seasons.  LPGs volumes aregenerally higher from November through March due to higher demand for propane,a major fuel for residential heating. Our Downstream Segment also includes the results of operations of thenorthern portion of the Dean Pipeline, which transports refinery gradepropylene from Mont Belvieu to Point Comfort, Texas.  Our Downstream Segment also includes ourequity investments in Centennial and MB Storage (see Note 7 in the Notes to theConsolidated Financial Statements).

 

Our Upstream Segment revenues areearned from gathering, transportation, marketing and storage of crude oil anddistribution of lubrication oils and specialty chemicals, principally inOklahoma, Texas, New Mexico and the Rocky Mountain region.  Marketing operations consist primarily ofaggregating purchased crude oil along our pipeline systems, or from third partypipeline systems, and arranging the necessary transportation logistics for theultimate sale or delivery of the crude oil to local refineries, marketers orother end users.  Our Upstream Segmentalso includes our equity investment in Seaway (see Note 7 in the Notes to theConsolidated Financial Statements). Seaway consists of large diameter pipelines that transport crude oilfrom Seaway’s marine terminals on the U.S. Gulf Coast to Cushing, Oklahoma, acrude oil distribution point for the central United States, and to refineriesin the Texas City and Houston areas.

 

Our Midstream Segment revenues areearned from the gathering of natural gas in the Green River Basin in southwesternWyoming, through Jonah, and the gathering of coal bed methane and conventionalnatural gas in the San Juan Basin in New Mexico and Colorado, through ValVerde; transportation of NGLs from two trunkline NGL pipelines in South Texas,two NGL pipelines in East Texas and a pipeline system (Chaparral) from WestTexas and New Mexico to Mont Belvieu; and the fractionation of NGLs inColorado.

 

We continue to build a base for long-term growth by pursuing newbusiness opportunities, increasing throughputon our pipeline systems, constructing new pipeline and gathering systems, andexpanding and upgrading our existing infrastructure.  We remain confident that our businessstrategy will provide continued growth in earnings and cash distributions.  This growth potential is based on, amongother things:

 

•       Continued development andexpansion of the Jonah system which serves the Jonah and Pinedale fields in ourMidstream Segment.  Through an additionalJonah expansion, which should be completed in the fourth quarter of 2006, weexpect to increase the capacity to 2 billion cubic feet per day.

•      Expandingour Downstream Segment gathering capacity of refined products along the upperTexas Gulf Coast.

•      Utilizingavailable Downstream Segment system capacity of Centennial to move refinedproducts to Midwest market areas.

•      Expandingour Downstream Segment system delivery capability of gasoline and diesel fuelin the Indianapolis and Chicago market areas.

•      Integrating2005 acquisitions by our Upstream Segment into our existing asset base.

•      Expandingour West Texas system and storage capacity at Cushing in our Upstream Segment.

•      Addingnew volumes and improving the operating efficiency of the Val Verde system inour Midstream Segment in New Mexico’s San Juan Basin, through new connectionsof conventional and Colorado coal seam gas.

 

37

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•      Increasingthroughput on our Midstream Segment NGL systems.

•      Pursuingacquisitions or organic growth projects in any of our business segments thatwould complement our current operations.

 

For a discussion of importantfactors that could affect our growth, please read “-Cautionary Note RegardingForward-Looking Statements” in this Report and “Risk Factors” in this Reportand our Annual Report on Form 10-K for the year ended December 31, 2005.

 

Our Upstream Segment’sperformance for 2006 will be impacted by a decrease in our participation ratioin the revenue and expense of Seaway, in accordance with the Seaway CrudePipeline Company Partnership Agreement. From June 2002 through May 2006, we receive 60% of revenue and expenseof Seaway.  Thereafter, we will receive40% of revenue and expense of Seaway.  Ourshare of revenue and expense of Seaway is 47% for 2006 (see Note 7 in the Notesto the Consolidated Financial Statements).

 

On March 31, 2006, we sold our ownership interest inthe Jonah Pioneer silica gel natural gas processing plant located near Opal,Wyoming, together with Jonah’s rights to process natural gas originating fromthe Jonah and Pinedale fields, located in southwest Wyoming to an affiliate ofEnterprise for $38.0 million.  ThePioneer plant was not an integral part of our Midstream Segment operations, andnatural gas processing is not a core business. The sales proceeds will be used to fund organic growth projects, retiredebt and for other general partnership purposes.  The margin of the Midstream Segment,calculated as revenues generated from the processing arrangements at thePioneer plant, less purchases of gas, will be reduced in 2006 as a result ofthe sale of the Pioneer plant (see Note 5 in the Notes to the ConsolidatedFinancial Statements).  Operating resultsof the Pioneer plant for all periods presented are shown as discontinuedoperations.

 

We expect to further expand the Jonah system. InFebruary 2006, we entered into a letter of intent with an affiliate ofEnterprise related to the formation of a joint venture for the construction andfinancing of the expansion of the Jonah system. The letter of intent stipulates that Enterprise will be responsible forall activities related to the construction of the Jonah expansion, includingadvancing all amounts necessary to plan, engineer and construct the Jonahexpansion.  We anticipate that the totalfunds needed for this expansion project will be approximately $200.0 million,and that the expanded assets will be placed in service in late 2006.  The amounts Enterprise advances to theproject will constitute a subscription for an equity interest in the proposedjoint venture.  We have the option toreturn to Enterprise up to 100% of the amount of the subscription.  If we return any portion of the subscriptionto Enterprise, our relative interests in the proposed joint venture will beadjusted accordingly.  The proposed jointventure will terminate without liability to either party if we return 100% ofthe subscription (including carrying costs and expenses).

 

Consistent with our business strategy, we continuouslyevaluate possible acquisitions of assets that would complement our currentoperations, including assets which, if acquired, would have a material effecton our financial position, results of operations or cash flows.

 

*Changes inLeadership*

 

On April 5, 2006, the Board of Directors of ourGeneral Partner elected Jerry E. Thompson as President, Chief Executive Officerand a director of the Company, effective April 11, 2006.  Mr. Thompson, age 56, was previously chiefoperating officer of CITGO Petroleum Corporation (“CITGO”) from 2003 to March2006, when he retired.  Mr. Thompsonjoined CITGO in 1971 and advanced from a process engineer to positions ofincreasing responsibilities in the operations, supply and logistics, businessdevelopment, planning and financial aspects of CITGO.  He was elected vice president of CITGO’srefining business in 1987 and as its senior vice president in 1998.  Mr. Thompson will serve as the principalexecutive officer of the Company.

 

38

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*EPCO Proposal*

 

On April 20, 2006, EPCO submitted a proposal to theAudit and Conflicts Committee of our General Partner’s Board of Directors toeliminate the General Partner’s incentive distribution right to receive 50% oftotal cash distributions with respect to that portion of our quarterlydistribution to limited partners that exceeds $0.45 per Unit, among otherthings. For additional information regarding this proposal, please read Note 17in the Notes to the Consolidated Financial Statements.

**** ****

****Restatement of Consolidated Financial Statements****

**** ****

In the fourthquarter of 2005, we determined that our method of accounting for the $33.4million excess investment in Centennial, previously described as an intangibleasset with an indefinite life, and the $27.1 million excess investment inSeaway, previously described as equity method goodwill, was incorrect.  Through our accounting for these excessinvestments in Centennial and Seaway as intangible assets with indefinite livesand equity method goodwill, respectively, we had been testing the amounts forimpairment on an annual basis as opposed to amortizing them over a determinablelife.  We determined that it would bemore appropriate to account for these excess investments as intangible assetswith determinable lives.  As a result, wemade non-cash adjustments that reduced the net value of the excess investmentsin Centennial and Seaway, and increased amortization expense allocated to ourequity earnings.  We restated previouslyreported consolidated financial statements for the fiscal years ended December31, 2003 and 2004 in our Annual Report on Form 10-K for the year ended December31, 2005.  The effect of this restatementcaused a $1.2 million reduction to net income as previously reported for thethree months ended March 31, 2005.  As aresult, we are restating our previously reported consolidated financialstatements for the three months ended March 31, 2005 (see Note 16 in the Notesto the Consolidated Financial Statements).

**** ****

While we believe the impacts of these non-cashadjustments are not material to any previously issued financial statements, wedetermined that the cumulative adjustment for these non-cash items was toomaterial to record in the fourth quarter of 2005, and therefore it was mostappropriate to restate prior periods’ results. These non-cash adjustments had no effect on our operating income,compensation expense, debt balances or ability to meet all requirements relatedto our debt instruments.  The restatementhad no impact on total cash flows from operating activities, investingactivities or financing activities.  Allamounts in the accompanying consolidated financial statements have beenadjusted for this restatement.

 

We will continue to amortize the $30.0 million excessinvestment in Centennial related to a contract using units-of-production methodologyover a 10-year life.  The remaining $3.4million related to a pipeline will continue to be amortized on a straight-linebasis over 35 years.  We will continue toamortize the $27.1 million excess investment in Seaway on a straight-line basisover a 39-year life related primarily to a pipeline.

 

39

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**Results of Operations**

 

Thefollowing table summarizes financial information by business segment for thethree months ended March 31, 2006 and 2005 (in thousands):

 
| ** **                        | ** ** | **Three Months Ended   March 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                               | ** ** | **2005** | ** ** |
| ** **                        | ** ** | ** **                                             | ** ** | **(as restated)** | ** ** |
| Operating revenues:               |       |                                                   |       |   |   |
| Downstream Segment                |       | $                                                      | 74,067     |   | $ | 78,167 |   |
| Upstream Segment                  |       | 2,411,582                                              |       | 1,396,780 |   |
| Midstream Segment                 |       | 56,377                                                 |       | 50,184 |   |
| Intercompany eliminations         |       | (5,657                                                 | )          | (1,340 | ) |
| Total operating revenues          |       | 2,536,369                                              |       | 1,523,791 |   |
|                              |       |                                                   |       |   |   |
| Operating income:                 |       |                                                   |       |   |   |
| Downstream Segment                |       | 23,281                                                 |       | 31,512 |   |
| Upstream Segment                  |       | 13,306                                                 |       | 5,403 |   |
| Midstream Segment                 |       | 26,051                                                 |       | 24,317 |   |
| Total operating income            |       | 62,638                                                 |       | 61,232 |   |
|                              |       |                                                   |       |   |   |
| Earnings before interest:         |       |                                                   |       |   |   |
| Downstream Segment                |       | 22,794                                                 |       | 29,840 |   |
| Upstream Segment                  |       | 15,605                                                 |       | 11,393 |   |
| Midstream Segment                 |       | 26,127                                                 |       | 24,359 |   |
|                              |       |                                                   |       |   |   |
| Interest expense                  |       | (24,402                                                | )          | (20,389 | ) |
| Interest capitalized              |       | 3,259                                                  |       | 1,102 |   |
| Income from continuing operations |       | 43,383                                                 |       | 46,305 |   |
| Discontinued operations           |       | 19,491                                                 |       | 1,124 |   |
| Net income                        |       | $                                                      | 62,874     |   | $ | 47,429 |   |

 

Below is a detailed analysis of theresults of operations, including reasons for changes in results, for each ofour operating segments.

 

40

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**DownstreamSegment**

 

The followingtable provides financial information for the Downstream Segment for the threemonths ended March 31, 2006 and 2005 (in thousands):

 
| ** **                             | ** ** | **Three Months Ended   March 31,** | ** ** | **Increase** | ** ** |
|----------------------------------------|------------|--------------------------------------------------------|------------|--------------|------------|
| ** **                             | ** ** | **2006**                                               | ** ** | **2005**     | ** ** | **(Decrease)** | ** ** |
| ** **                             | ** ** | **(as restated)**                                 | ** ** |
| Revenues:                              |       |                                                   |       |         |       |   |   |
| Transportation – Refined products |       | $                                                      | 31,799     |         | $          | 34,965 |   | $ | (3,166 | ) |
| Transportation – LPGs             |       | 29,421                                                 |       | 32,231       |       | (2,810 | ) |
| Other                                  |       | 12,847                                                 |       | 10,971       |       | 1,876 |   |
| Total operating revenues               |       | 74,067                                                 |       | 78,167       |       | (4,100 | ) |
|                                   |       |                                                   |       |         |       |   |   |
| Costs and Expenses:                    |       |                                                   |       |         |       |   |   |
| Operating, general and administrative  |       | 28,596                                                 |       | 26,615       |       | 1,981 |   |
| Operating fuel and power               |       | 9,305                                                  |       | 7,660        |       | 1,645 |   |
| Depreciation and amortization          |       | 10,297                                                 |       | 9,561        |       | 736 |   |
| Taxes – other than income taxes   |       | 2,595                                                  |       | 2,911        |       | (316 | ) |
| Gains on sales of assets               |       | (7                                                     | )          | (92          | )          | 85 |   |
| Total costs and expenses               |       | 50,786                                                 |       | 46,655       |       | 4,131 |   |
|                                   |       |                                                   |       |         |       |   |   |
| Operating income                       |       | 23,281                                                 |       | 31,512       |       | (8,231 | ) |
|                                   |       |                                                   |       |         |       |   |   |
| Equity losses                          |       | (1,266                                                 | )          | (1,821       | )          | 555 |   |
| Other income – net                |       | 779                                                    |       | 149          |       | 630 |   |
|                                   |       |                                                   |       |         |       |   |   |
| Earnings before interest               |       | $                                                      | 22,794     |         | $          | 29,840 |   | $ | (7,046 | ) |

 

The followingtable presents volumes delivered in barrels and average tariff per barrel forthe three months ended March 31, 2006 and 2005 (in thousands, except tariffinformation):

 
| ** **                       | ** ** | **Three Months Ended** | ** ** | **Percentage** | ** ** |
|----------------------------------|------------|----------------------------------|------------|----------------|------------|
| ** **                       | ** ** | **March 31,**               | ** ** | **Increase**   | ** ** |
| ** **                       | ** ** | **2006**                         | ** ** | **2005**       | ** ** | **(Decrease)** | ** ** |
| Volumes Delivered:               |       |                             |       |           |       |   |   |
| Refined products                 |       | 35,808                           |       | 38,595         |       | (7 | )% |
| LPGs                             |       | 12,840                           |       | 14,801         |       | (13 | )% |
| Total                            |       | 48,648                           |       | 53,396         |       | (9 | )% |
|                             |       |                             |       |           |       |   |   |
| Average Tariff per Barrel:       |       |                             |       |           |       |   |   |
| Refined products                 |       | $                                | 0.89       |           | $          | 0.91 |   | (2 | )% |
| LPGs                             |       | 2.29                             |       | 2.18           |       | 5 | % |
| Average system tariff per barrel |       | $                                | 1.26       |           | $          | 1.26 |   | — |   |

 

*Three Months Ended March 31, 2006 Compared with Three Months EndedMarch 31, 2005*

 

Revenues from refined products transportation decreased $3.2 millionfor the three months ended March 31, 2006, compared with the three months endedMarch 31, 2005, due to an overall decrease of 7% in the refined productsvolumes delivered.  Volume decreases weredue to decreased demand for products supplied from the U.S. Gulf Coast intoMidwest markets compared with unusually high demand in the first quarter of2005 due to refinery downtime in Chicago, Illinois. Refined products volumeswere impacted by unfavorable differentials for motor fuels and lower jet fueldemand during the three months ended March 31, 2006, compared with the threemonths ended March 31, 2005. The decrease in demand for U.S. Gulf Coast sourceproducts also resulted in lower deliveries of products on Centennial.  In February 2003, we entered into a leaseagreement with Centennial that increased our flexibility to deliver refinedproducts to our market areas.  As aresult, Centennial has provided our system with additional pipeline capacityfor movement of products originating in the U.S. Gulf Coast area.  Prior to 

 

41

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the construction of Centennial,deliveries on our pipeline system were limited by our pipeline capacity, andtransportation services for our customers were allocated in accordance with aproration policy.  With this incrementalpipeline capacity and our supporting lease of pipeline capacity, our previouslyconstrained system has expanded deliveries in markets both south and north ofCreal Springs, Illinois.  Movement ofTEPPCO product via the Centennial lease to the north end of our system permitsexpanded supply capability on the TEPPCO system for delivery to the south endof our system.  Increased movements ofrefined products on Centennial has resulted in a decrease in the refinedproducts average rate per barrel; however, utilizing Centennial for refinedproducts movements allows us to increase movements of long-haul propanevolumes.

 

Revenues from LPGs transportationdecreased $2.8 million for the three months ended March 31, 2006, compared withthe three months ended March 31, 2005, due to lower deliveries of propane inthe upper Midwest and Northeast market areas as a result of warmer than normalwinter weather and decreased short-haul propane deliveries to U.S. Gulf Coastpetrochemical customers in the first quarter of 2006.

 

Other operating revenues increased$1.9 million for the three months ended March 31, 2006, compared with the threemonths ended March 31, 2005, primarily due to increased rental revenues fromleasing storage capacity on pipeline assets acquired in July 2005, and higherrefined products excess inventory fees, partially offset by lower volumes ofproduct inventory sales.

 

Costs and expenses increased $4.1million for the three months ended March 31, 2006, compared with the threemonths ended March 31, 2005, due to increased operating, general andadministrative expenses, increased operating fuel and power, increaseddepreciation and amortization expense and lower gains on the sales of assets inthe current period, partially offset by decreased taxes – other than incometaxes.  Operating, general andadministrative expenses increased primarily due to a $1.4 million increase inpipeline operating costs primarily as a result of asset acquisitions in 2005, a$1.2 million increase related to the retirement of an executive in February2006, as well as higher insurance premiums, product measurement and settlementlosses and transition costs.  These increaseswere partially offset by a $1.9 million decrease in pipeline inspection andrepair costs associated with our integrity management program and a $0.5million decrease in rental expense from the Centennial pipeline capacity leaseagreement.  Operating fuel and powerincreased $1.6 million primarily due to adjustments to power accruals andhigher power rates.  Depreciation andamortization expense increased $0.7 million primarily due to a higher assetbase in the 2006 period.  Taxes – otherthan income taxes decreased due to decreases in property tax accruals.

 

Net losses from equity investmentsdecreased for the three months ended March 31, 2006, compared with the threemonths ended March 31, 2005, as shown below (in thousands):

 
| ** **          | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** |
|---------------------|------------|----------------------------------|------------|--------------|------------|
| ** **          | ** ** | **March 31,**               | ** ** | **Increase** | ** ** |
| ** **          | ** ** | **2006**                         | ** ** | **2005**     | ** ** | **(Decrease)** | ** ** |
| ** **          | ** ** | **(as restated)**           | ** ** |
| Centennial          |       | $                                | (3,913     | )            | $          | (4,450 | ) | $ | 537 |   |
| MB Storage          |       | 2,651                            |       | 2,634        |       | 17 |   |
| Other               |       | (4                               | )          | (5           | )          | 1 |   |
| Total equity losses |       | $                                | (1,266     | )            | $          | (1,821 | ) | $ | 555 |   |

 

Equity losses in Centennial decreased $0.5 million forthe three months ended March 31, 2006, compared with the three months endedMarch 31, 2005, primarily due to lower amortization expense on the portion ofTE Products’ excess investment in Centennial resulting from lowertransportation volumes in the current period, partially offset by lowertransportation revenues and volumes primarily due to warmer than normal winterweather in the Northeast.  Equityearnings in MB Storage were virtually unchanged for the three months endedMarch 31, 2006, compared with the three months ended March 31, 2005, withhigher revenues offset by higher operating costs.

** **

**Other income – netincreased $0.6 million for the three months ended March 31, 2006, compared withthe three months ended March 31, 2005, primarily due to higher interest incomeearned on a capital lease.**

 

42

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**UpstreamSegment**

 

The followingtable provides financial information for the Upstream Segment for the threemonths ended March 31, 2006 and 2005 (in thousands):

 
| ** **                            | ** ** | **Three Months Ended   March 31,** | ** ** | **Increase** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------|------------|--------------|------------|
| ** **                            | ** ** | **2006**                                               | ** ** | **2005**     | ** ** | **(Decrease)** | ** ** |
| ** **                            | ** ** | **(as restated)**                                 | ** ** |
| Revenues:                             |       |                                                   |       |         |       |   |   |
| Sales of petroleum products           |       | $                                                      | 2,400,436  |         | $          | 1,385,067 |   | $ | 1,015,369 |   |
| Transportation – Crude oil       |       | 8,923                                                  |       | 9,172        |       | (249 | ) |
| Other                                 |       | 2,223                                                  |       | 2,541        |       | (318 | ) |
| Total operating revenues              |       | 2,411,582                                              |       | 1,396,780    |       | 1,014,802 |   |
|                                  |       |                                                   |       |         |       |   |   |
| Costs and Expenses:                   |       |                                                   |       |         |       |   |   |
| Purchases of petroleum products       |       | 2,376,396                                              |       | 1,372,430    |       | 1,003,966 |   |
| Operating, general and administrative |       | 14,951                                                 |       | 12,816       |       | 2,135 |   |
| Operating fuel and power              |       | 2,193                                                  |       | 1,228        |       | 965 |   |
| Depreciation and amortization         |       | 3,271                                                  |       | 3,501        |       | (230 | ) |
| Taxes – other than income taxes  |       | 1,465                                                  |       | 1,401        |       | 64 |   |
| Losses on sales of assets             |       | —                                                 |       | 1            |       | (1 | ) |
| Total costs and expenses              |       | 2,398,276                                              |       | 1,391,377    |       | 1,006,899 |   |
|                                  |       |                                                   |       |         |       |   |   |
| Operating income                      |       | 13,306                                                 |       | 5,403        |       | 7,903 |   |
|                                  |       |                                                   |       |         |       |   |   |
| Equity earnings                       |       | 2,255                                                  |       | 5,915        |       | (3,660 | ) |
| Other income – net               |       | 44                                                     |       | 75           |       | (31 | ) |
|                                  |       |                                                   |       |         |       |   |   |
| Earnings before interest              |       | $                                                      | 15,605     |         | $          | 11,393 |   | $ | 4,212 |   |

 

Information presented in the followingtable includes the margin of the Upstream Segment, which may be viewed as anon-GAAP (Generally Accepted Accounting Principles) financial measure under therules of the SEC.  We calculate themargin of the Upstream Segment as revenues generated from the sale of crude oiland lubrication oil, and transportation of crude oil, less the costs ofpurchases of crude oil and lubrication oil. We believe that margin is a more meaningful measure of financialperformance than sales and purchases of crude oil and lubrication oil due tothe significant fluctuations in sales and purchases caused by variations in thelevel of volumes marketed and prices for products marketed.  Additionally, we use margin internally toevaluate the financial performance of the Upstream Segment as we believe marginis a better indicator of performance than operating income, as operating,general and administrative expenses, operating fuel and power and depreciationexpense are not directly related to the margin activities.  Margin and volume information for the threemonths ended March 31, 2006 and 2005 is presented below (in thousands, exceptper barrel and per gallon amounts):

 

43

----

 
| ** **                             | ** ** | **Three Months Ended** | ** ** | **Percentage** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|----------------|------------|
| ** **                             | ** ** | **March 31,**               | ** ** | **Increase**   | ** ** |
| ** **                             | ** ** | **2006**                         | ** ** | **2005**       | ** ** | **(Decrease)** | ** ** |
| ** **                             | ** ** | ** **                       | ** ** | ** **     | ** ** | ** ** | ** ** |
| Margins: (1)                           |       |                             |       |           |       |   |   |
| Crude oil transportation               |       | $                                | 15,768     |           | $          | 14,153 |   | 11 | % |
| Crude oil marketing                    |       | 12,786                           |       | 3,476          |       | 268 | % |
| Crude oil terminaling                  |       | 2,278                            |       | 2,423          |       | (6 | )% |
| Lubrication oil sales                  |       | 2,131                            |       | 1,757          |       | 21 | % |
| Total margin                           |       | $                                | 32,963     |           | $          | 21,809 |   | 51 | % |
|                                   |       |                             |       |           |       |   |   |
| Total barrels:                         |       |                             |       |           |       |   |   |
| Crude oil transportation               |       | 22,328                           |       | 23,754         |       | (6 | )% |
| Crude oil marketing                    |       | 52,941                           |       | 44,294         |       | 20 | % |
| Crude oil terminaling                  |       | 24,443                           |       | 27,119         |       | (10 | )% |
|                                   |       |                             |       |           |       |   |   |
| Lubrication oil volume (total gallons) |       | 3,855                            |       | 4,172          |       | (8 | )% |
|                                   |       |                             |       |           |       |   |   |
| Margin per barrel:                     |       |                             |       |           |       |   |   |
| Crude oil transportation               |       | $                                | 0.706      |           | $          | 0.596 |   | 19 | % |
| Crude oil marketing                    |       | 0.242                            |       | 0.078          |       | 208 | % |
| Crude oil terminaling                  |       | 0.093                            |       | 0.089          |       | 4 | % |
|                                   |       |                             |       |           |       |   |   |
| Lubrication oil margin (per gallon)    |       | 0.553                            |       | 0.421          |       | 31 | % |

 

----

(1)     Margins in this table arepresented prior to the elimination of intercompany sales, revenues andpurchases between TEPPCO Crude Oil, L.P. and TEPPCO Crude Pipeline, L.P.

 

Thefollowing table reconciles the Upstream Segment margin to operating income inthe consolidated statements of income using the information presented in thetables above, in the consolidated statements of income and in the statements ofincome in Note 12 in the Notes to the Consolidated Financial Statements (inthousands):

 
| ** **                            | ** ** | **Three Months Ended   March 31,** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                               | ** ** | **2005** | ** ** |
| Sales of petroleum products           |       | $                                                      | 2,400,436  |   | $ | 1,385,067 |   |
| Transportation – Crude oil       |       | 8,923                                                  |       | 9,172 |   |
| Less: Purchases of petroleum products |       | (2,376,396                                             | )          | (1,372,430 | ) |
| Total margin                          |       | 32,963                                                 |       | 21,809 |   |
| Other operating revenues              |       | 2,223                                                  |       | 2,541 |   |
| Net operating revenues                |       | 35,186                                                 |       | 24,350 |   |
| Operating, general and administrative |       | 14,951                                                 |       | 12,816 |   |
| Operating fuel and power              |       | 2,193                                                  |       | 1,228 |   |
| Depreciation and amortization         |       | 3,271                                                  |       | 3,501 |   |
| Taxes – other than income taxes  |       | 1,465                                                  |       | 1,401 |   |
| Losses on sales of assets             |       | —                                                 |       | 1 |   |
| Operating income                      |       | $                                                      | 13,306     |   | $ | 5,403 |   |

 

*Three Months Ended March 31, 2006 Compared with Three Months EndedMarch 31, 2005*

 

Ourmargin increased $11.2 million for the three months ended March 31, 2006,compared with the three months ended March 31, 2005.  Crude oil marketing margin increased $9.3million primarily due to a 20% increase in volumes marketed primarily resultingfrom the acquisitions of assets in April 2005, favorable market conditions andlower unrealized losses related to marking crude oil physical swaps to marketcompared to the 2005 period.  Crude oiltransportation margin increased $1.6 million primarily due to increased transportationvolumes on our 

 

44

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South Texas system due to theacquisition of crude oil pipeline assets in April 2005, and increased revenueson our Red River system as a result of increased movements on higher tariffsegments, partially offset by a decrease in low margin transportation volumeson the Red River system and other crude oil transportation systems.  Lubrication oil sales margin increased $0.4million due to an increase in the margin per gallon on product sales, partiallyoffset by slightly lower volumes.

 

Other operating revenues of theUpstream Segment decreased $0.3 million for the three months ended March 31,2006, compared with the three months ended March 31, 2005, primarily due tolower revenues from documentation and other services to support customers’trading activity at Midland, Texas, and Cushing, Oklahoma, in the first quarterof 2006 as a result of consolidations of trading companies.

 

Costs and expenses, excluding expensesassociated with purchases of crude oil and lubrication oil, increased $3.0million for the three months ended March 31, 2006, compared with the threemonths ended March 31, 2005, due to increased operating, general andadministrative expenses, increased operating fuel and power and increased taxes– other than income taxes, partially offset by decreased depreciation andamortization expense.  Operating, generaland administrative expenses increased $2.1 million from the prior year periodprimarily due to a $1.4 million increase in pipeline operating and maintenanceexpense as a result of acquisitions and the continued integration of Genesisassets into our system, a $0.5 million increase in environmental assessment andremediation costs, a $0.4 million increase in insurance premiums and a $0.4million increase in general and administrative consulting services and suppliesand expenses.   These increases werepartially offset by a $0.6 million decrease in product measurement losses.  Operating fuel and power increased $1.0 millionprimarily as a result of higher power rates, partially offset by lowertransportation volumes.  Taxes – otherthan income taxes increased $0.1 million due to increases in property taxaccruals and a higher asset base in 2006. Depreciation and amortization expense decreased $0.2 million as a resultof assets retired to depreciation expense during the 2005 period.

 

**Equity earningsfrom our investment in Seaway decreased $3.7 million for the three months endedMarch 31, 2006, compared with the three months ended March 31, 2005. Our equity earnings in Seaway were reduced by adecrease in our participation ratio in the revenue and expense of Seaway. Oursharing ratio for 2005 was 60%, while for the full year of 2006, it is 47% ofthe revenue and expense of Seaway (see Note 7 in the Notes to the ConsolidatedFinancial Statements). Equity earnings from our investment in Seaway alsodecreased due to higher pipelineinspection and repair costs, higher power costs and higher operatingcosts attributable to a pipeline release in May 2005, partially offset byhigher long-haul transportation volumes.**

** **

**After Seaway’s pipeline release inMay 2005, the maximum operating pressure on the pipeline system has beenreduced by 20% until the cause of the failure was determined and any requiredcorrective measures are implemented.  Astudy of the failed pipe was performed by independent metallurgical experts whodetermined that the pipe failed due to damage that occurred during rail shipmentassociated with its installation thirty years ago.  The corrective actions include running a highdefinition inspection tool through the pipe to determine if there are any othersections of pipe that have similar damage. This approach is consistent with directives from the United States Departmentof Transportation’s Office of Pipeline Safety in past failures of thistype.  The inspection tool has been runand the resulting data is currently being analyzed.  We expect Seaway to be operating at reducedmaximum pressure through the second quarter of 2006.  As a result of operating at reduced maximumpressure, during the third quarter of 2005, we began using a drag reducingagent to increase the flow of product through the pipeline system.  The drag reducing agent allowed us tomaintain the higher volumes transported, but also increased our operatingcosts.  At this time, we do not believethe reduced pressure will have a material adverse effect on our financialposition, results of operations or cash flows.**

 

45

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**MidstreamSegment**

 

The followingtable provides financial information for the Midstream Segment for the threemonths ended March 31, 2006 and 2005 (in thousands):

 
| ** **                                           | ** ** | **Three Months Ended   March 31,** | ** ** | **Increase** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------|------------|--------------|------------|
| ** **                                           | ** ** | **2006**                                               | ** ** | **2005**     | ** ** | **(Decrease)** | ** ** |
|                                                 |       |                                                   |       |         |       |   |   |
| Revenues:                                            |       |                                                   |       |         |       |   |   |
| Sales of petroleum products                          |       | $                                                      | —     |         | $          | — |   | $ | — |   |
| Gathering – Natural Gas                         |       | 41,375                                                 |       | 36,560       |       | 4,815 |   |
| Transportation – NGLs                           |       | 10,653                                                 |       | 10,219       |       | 434 |   |
| Other                                                |       | 4,349                                                  |       | 3,405        |       | 944 |   |
| Total operating revenues                             |       | 56,377                                                 |       | 50,184       |       | 6,193 |   |
|                                                 |       |                                                   |       |         |       |   |   |
| Costs and Expenses:                                  |       |                                                   |       |         |       |   |   |
| Purchases of petroleum products                      |       | 125                                                    |       | —       |       | 125 |   |
| Operating, general and administrative                |       | 12,333                                                 |       | 10,449       |       | 1,884 |   |
| Operating fuel and power                             |       | 2,799                                                  |       | 2,182        |       | 617 |   |
| Depreciation and amortization                        |       | 15,189                                                 |       | 12,549       |       | 2,640 |   |
| Taxes – other than income taxes                 |       | 1,251                                                  |       | 1,094        |       | 157 |   |
| Gains on sales of assets                             |       | (1,371                                                 | )          | (407         | )          | (964 | ) |
| Total costs and expenses                             |       | 30,326                                                 |       | 25,867       |       | 4,459 |   |
|                                                 |       |                                                   |       |         |       |   |   |
| Operating income                                     |       | 26,051                                                 |       | 24,317       |       | 1,734 |   |
|                                                 |       |                                                   |       |         |       |   |   |
| Other income – net                              |       | 76                                                     |       | 42           |       | 34 |   |
|                                                 |       |                                                   |       |         |       |   |   |
| Earnings before interest from continuing  operations |       | 26,127                                                 |       | 24,359       |       | 1,768 |   |
|                                                 |       |                                                   |       |         |       |   |   |
| Income from discontinued operations                  |       | 1,607                                                  |       | 1,124        |       | 483 |   |
| Gain on sale of discontinued operations              |       | 17,884                                                 |       | —       |       | 17,884 |   |
|                                                 |       |                                                   |       |         |       |   |   |
| Earnings before interest                             |       | $                                                      | 45,618     |         | $          | 25,483 |   | $ | 20,135 |   |

 

The following table presents volumeand average rate information for the three months ended March 31, 2006 and 2005(in thousands, except average fee and average rate amounts):

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** | **Percentage** | ** ** |
|---------------------------------------------------|------------|----------------------------------|------------|----------------|------------|
| ** **                                        | ** ** | **March 31,**               | ** ** | **Increase**   | ** ** |
| ** **                                        | ** ** | **2006**                         | ** ** | **2005**       | ** ** | **(Decrease)** | ** ** |
| Gathering – Natural Gas – Jonah:        |       |                             |       |           |       |   |   |
| Million cubic feet (“MMcf”)             |       | 108,669                          |       | 97,350         |       | 12 | % |
| Million British thermal units (“MMBtu”) |       | 120,007                          |       | 107,300        |       | 12 | % |
| Average fee per MMBtu                             |       | $                                | 0.206      |           | $          | 0.189 |   | 9 | % |
|                                              |       |                             |       |           |       |   |   |
| Gathering – Natural Gas – Val Verde:    |       |                             |       |           |       |   |   |
| MMcf                                              |       | 45,350                           |       | 43,325         |       | 5 | % |
| MMBtu                                             |       | 39,392                           |       | 38,088         |       | 5 | % |
| Average fee per MMBtu                             |       | $                                | 0.418      |           | $          | 0.428 |   | (2 | )% |
|                                              |       |                             |       |           |       |   |   |
| Transportation – NGLs:                       |       |                             |       |           |       |   |   |
| Thousand barrels                                  |       | 15,866                           |       | 13,836         |       | 15 | % |
| Average rate per barrel                           |       | $                                | 0.671      |           | $          | 0.739 |   | (9 | )% |
|                                              |       |                             |       |           |       |   |   |
| Fractionation – NGLs:                        |       |                             |       |           |       |   |   |
| Thousand barrels                                  |       | 1,153                            |       | 1,139          |       | 1 | % |
| Average rate per barrel                           |       | $                                | 1.486      |           | $          | 1.647 |   | (10 | )% |
|                                              |       |                             |       |           |       |   |   |
| Sales – Condensate:                          |       |                             |       |           |       |   |   |
| Thousand barrels                                  |       | 24.7                             |       | 27.9           |       | (11 | )% |
| Average rate per barrel                           |       | $                                | 63.54      |           | $          | 48.11 |   | 32 | % |

 

46

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*Three Months Ended March 31, 2006 Compared with Three MonthsEnded March 31, 2005*

 

Revenuesfrom the gathering of natural gas increased $4.8 million for the three monthsended March 31, 2006, compared with the three months ended March 31, 2005.  Natural gas gathering revenues from the Jonahsystem increased $4.4 million and volumes gathered increased 11.3 billion cubicfeet (“Bcf”) for the three months ended March 31, 2006, primarily due to theexpansion of the Jonah system in 2005. The Phase IV expansion project on Jonah was completed in February 2006.  The expansion increased the system capacityof Jonah to 1.5 Bcf per day with the addition of 33,000 horsepower ofcompression and approximately 50 miles of pipeline.  Jonah’s average natural gas gathering rateincreased primarily due to lower system wellhead pressures.  Natural gas gathering revenues from the ValVerde system increased $0.4 million and volumes gathered increased 2.0 Bcf forthe three months ended March 31, 2006, primarily due to increased volumes froma natural gas connection on the Val Verde system, better performance from coalseam infill wells and increased volumes from temporary interconnects with thirdparty gatherers.  Val Verde’s averagenatural gas gathering rate decreased due to contracts entered into relating tothe new connections, which have lower rates than the existing Val Verde system’saverage rates.

 

Revenues from the transportation ofNGLs increased $0.4 million for the three months ended March 31, 2006, comparedwith the three months ended March 31, 2005, primarily due to increases involumes transported on the Chaparral, Panola and Dean Pipelines.  The average NGL transportation rate perbarrel decreased primarily due to an increase in short-haul movements on theChaparral Pipeline and a decrease in long-haul movements on the Panola Pipeline.

 

Other operating revenues increased$0.9 million for the three months ended March 31, 2006, compared with the threemonths ended March 31, 2005, primarily due to a new pipeline capacity lease onthe Chaparral Pipeline, higher revenues on the Panola Pipeline and highercondensate sales on Jonah.

 

Costs and expenses increased $4.4 million for thethree months ended March 31, 2006, compared with the three months ended March31, 2005, due to increased depreciation and amortization expense, increasedoperating, general and administrative expense, increased operating fuel andpower and increased taxes – other than income taxes, partially offset by a netgain recorded on the sale of assets. Depreciation expense increased $1.5 million primarily due to an increaseon Jonah as a result of assets placed into service from the Phase IVexpansion.  Amortization expenseincreased primarily due to an increase of $1.0 million on Val Verde due tohigher volumes on contracts included in the intangible assets in the 2006 period.  Ona quarterly basis, we may obtain limited production forecasts and updatedthroughput estimates from some of the producers on the systems, and as aresult, we evaluate the remaining expected useful lives of the contract assetsbased on the best available information. Revisions to these estimates may occuras additional production information is made available to us.  Operating, general and administrativeexpense increased $1.9 million primarily due to an increase in general andadministrative expenses, transition costs, an increase in insurance expense andimbalance valuations.  Operating fuel andpower increased $0.6 million primarily due to increased volumes and higherpower costs in the 2006 period.  Taxes otherthan income taxes increased $0.2 million primarily due to adjustments toproperty tax accruals and a higher asset base in 2006.  During the three months ended March 31, 2006and 2005, gains of $1.4 million and $0.4 million, respectively, were recognizedon the sales of various equipment at Val Verde.

 

*Discontinued Operations*

 

On March 31, 2006, we sold our ownership interest inthe Pioneer silica gel natural gas processing plant located near Opal, Wyoming,together with Jonah’s rights to process natural gas originating from the Jonahand Pinedale fields, located in southwest Wyoming to an affiliate of Enterprisefor $38.0 million in cash.  The Pioneerplant was not an integral part of our Midstream Segment operations, and naturalgas processing is not a core business. We have no continuing involvement in the operations or results of thisplant. This transaction was reviewed and approved by the Audit and ConflictsCommittee of the board of directors of our General Partner and of the generalpartner of Enterprise, and a fairness opinion was rendered by an independentthird-party. The sales proceeds will be used to fund organic growth projects,retire debt and for other general partnership purposes.  The carrying value of the Pioneer plant atMarch 31, 2006, prior to the sale, was $19.7 million.  Costs associated with the completion of thetransaction are estimated to be approximately $0.4 million.

 

47

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Condensed statements of income for the Pioneer plant,which is classified as discontinued operations, for the three months endedMarch 31, 2006 and 2005, are presented below (in thousands):

 
| ** **                              | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **March 31,**               | ** ** |
| ** **                              | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                    |       |                             |       |   |   |
| Sales of petroleum products             |       | $                                | 3,810      |   | $ | 2,142 |   |
| Other                                   |       | 921                              |       | 672 |   |
| Total operating revenues                |       | 4,731                            |       | 2,814 |   |
| Purchases of petroleum products         |       | 2,861                            |       | 1,370 |   |
| Operating, general and administrative   |       | 182                              |       | 138 |   |
| Depreciation and amortization           |       | 51                               |       | 152 |   |
| Taxes – other than income taxes    |       | 30                               |       | 30 |   |
| Total costs and expenses                |       | 3,124                            |       | 1,690 |   |
| Net income from discontinued operations |       | $                                | 1,607      |   | $ | 1,124 |   |

 

Sales of petroleum products lesspurchases of petroleum products resulting from the processing activities at theJonah Pioneer plant increased $0.2 million for the three months ended March 31,2006, compared with the three months ended March 31, 2005, primarily due toincreased NGL prices.   The Pioneer gasprocessing plant was completed during the first quarter of 2004, as a part ofJonah’s Phase III expansion to increase the processing capacity in southwesternWyoming.  Pioneer’s processing agreementsallowed the producers to elect annually whether to be charged under a fee-basedarrangement or a fee plus keep-whole arrangement.  Under the fee-based election, Jonah receiveda fee for its processing services.  Underthe fee plus keep-whole election, Jonah received a lower fee for its processingservices, retained and sold the NGLs extracted during the process and deliveredto producers the residue gas equivalent in energy to the natural gas receivedfrom the producers.  Jonah sold the NGLsit retained and purchased gas to replace the equivalent energy removed in theliquids.   For the 2005 and 2006 periods,the producers elected the fee plus keep-whole arrangement.

* *

**InterestExpense and Capitalized Interest**

** **

Interest expense increased $4.0 millionfor the three months ended March 31, 2006, compared with the three months endedMarch 31, 2005, primarily due to higher outstanding borrowings and higher shortterm floating interest rates on our revolving credit facility.

 

Capitalized interest increased $2.2million for the three months ended March 31, 2006, compared with the threemonths ended March 31, 2005, due to higher construction work-in-progressbalances in 2006 as compared to the 2005 period.

 

**FinancialCondition and Liquidity**

 

Cash generated from operations, credit facilities anddebt and equity offerings are our primary sources of liquidity.  At March 31, 2006, we had a working capitalsurplus of $29.4 million, while at December 31, 2005, we had a working capitaldeficit of $38.1 million.  At March 31,2006, we had approximately $253.1 million in available borrowing capacity underour revolving credit facility to cover any working capital needs.  Cash flows for the three months ended March31, 2006 and 2005, were as follows (in millions):

 
| ** **                  | ** ** | **Three Months Ended   March 31,** | ** ** |
|-----------------------------|------------|--------------------------------------------------------|------------|
| ** **                  | ** ** | **2006**                                               | ** ** | **2005** | ** ** |
| ** **                  | ** ** | ** **                                             | ** ** | **(as restated)** | ** ** |
| Cash provided by (used in): |       |                                                   |       |   |   |
| Operating activities        |       | $                                                      | 38.7       |   | $ | 15.8 |   |
| Investing activities        |       | (1.0                                                   | )          | (34.2 | ) |
| Financing activities        |       | (37.8                                                  | )          | 20.3 |   |
|                             |            |                                                        |            |  |  |  |  |

 

48

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*Operating Activities*

* *

Net cash provided by operating activities for thethree months ended March 31, 2006 and 2005, was comprised of the following (inmillions):

 
| ** **                                                            | ** ** | **Three Months Ended   March 31,** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                            | ** ** | **2006**                                               | ** ** | **2005** | ** ** |
| ** **                                                            | ** ** | ** **                                             | ** ** | **(as restated)** | ** ** |
| Net income from continuing operations                                 |       | $                                                      | 43.4       |   | $ | 46.3 |   |
| Depreciation and amortization                                         |       | 28.8                                                   |       | 25.6 |   |
| Losses in equity investments                                          |       | (1.0                                                   | )          | (4.1 | ) |
| Distributions from equity investments                                 |       | 16.3                                                   |       | 4.7 |   |
| Gains on sales of assets                                              |       | (1.4                                                   | )          | (0.5 | ) |
| Non-cash portion of interest expense                                  |       | 0.4                                                    |       | 0.4 |   |
| Cash used in working capital and other                                |       | (49.4                                                  | )          | (57.9 | ) |
|                                                                  |       |                                                   |       |   |   |
| Net cash provided by operating  activities from continuing operations |       | 37.1                                                   |       | 14.5 |   |
| Cash flows from discontinued  operations                              |       | 1.6                                                    |       | 1.3 |   |
| Net cash provided by operating  activities                            |       | $                                                      | 38.7       |   | $ | 15.8 |   |

 

Net cash provided by operating activities fromcontinuing operations increased $22.6 million for the three months ended March31, 2006, compared with the three months ended March 31, 2005, primarily due toan increase of $11.6 million in distributions received from our equityinvestments in Seaway and MB Storage, the timing of cash disbursements and cashreceipts for working capital components, higher depreciation and amortizationexpense and decreased losses from equity investments.  For a discussion of changes in earningsbefore interest, depreciation and amortization expense, equity earnings andconsolidated interest expense – net, see Results of Operations for theDownstream Segment, Upstream Segment and Midstream Segment in Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.

 

Net cash from operating activities for the threemonths ended March 31, 2006 and 2005, included interest payments, net ofamounts capitalized, of $38.5 million and $36.8 million, respectively.  Excluding the effects of hedging activitiesand interest capitalized during the year ended December 31, 2006, we expectinterest payments on our fixed rate Senior Notes to be approximately $78.0million.  We expect to pay our interestpayments with cash flows from operating activities.

 

*Investing Activities*

* *

Cash flows used in investing activities totaled $1.0million for the three months ended March 31, 2006, and were comprised of $38.3million of capital expenditures and $1.7 million of cash contributions for TEProducts’ ownership interest in MB Storage for capital expenditures, partiallyoffset by $39.0 million in net cash proceeds from asset sales in our MidstreamSegment, of which $38.0 million related to cash proceeds received from the saleof the Pioneer plant.  Cash flows used ininvesting activities totaled $34.2 million for the three months ended March 31,2005, and were comprised of $27.6 million of capital expenditures and $7.1million for the acquisition of crude oil assets acquired in the first quarterof 2005, partially offset by $0.5 million in net cash proceeds from an assetsale in our Midstream Segment.

 

*Financing Activities*

* *

Cash flows used in financing activities totaled $37.8million for the three months ended March 31, 2006, and were comprised of $66.9million of distributions paid to our General Partner and to unitholders,partially offset by $29.1 million in borrowings, net of repayments, from ourrevolving credit facility.  Cash flowsprovided by financing activities totaled $20.3 million for the three monthsended March 31, 2005, and were comprised of $79.0 

 

49

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million in borrowings, net ofrepayments, from our revolving credit facility, partially offset by $58.7million of distributions paid to our General Partner and to unitholders.

 

We paid cash distributions of $66.9 million ($0.675per Unit) and $58.7 million ($0.6625 per Unit) during each of the three monthsended March 31, 2006 and 2005, respectively. Additionally, we declared a cash distribution of $0.675 per Unit for thequarter ended March 31, 2006.  We willpay the distribution of $66.9 million on May 5, 2006, to unitholders of recordon April 28, 2006.

 

**OtherConsiderations**

 

*Universal Shelf*

 

**We have filed with the SEC a universal shelf registrationstatement that, subject to agreement on terms at the time of use andappropriate supplementation, allows us to issue, in one or more offerings, upto an aggregate of $2.0 billion of equity securities, debt securities or acombination thereof.  In the May 2005equity offering, we issued $279.2 million of equity securities, leaving $1.7billion available under this shelf registration at March 31, 2006, subject tocustomary marketing terms and conditions.**

* *

*Credit Facilities*

 

We have in place an unsecuredrevolving credit facility for up to $700.0 million (“Revolving CreditFacility”), which may be increased up to a maximum of $850.0 million upon ourrequest, subject to lender approval and the satisfaction of certain otherconditions.  The Revolving CreditFacility expires on December 13, 2010. Interest is payable at an applicable margin above either the lender’s baserate or LIBOR.  At March 31, 2006, $435.0million was outstanding under the facility, and we had $253.1 million ofavailable borrowing capacity, which includes $11.9 million of outstandingletters of credit.  Financialcovenants in the Revolving Credit Facility require that we maintain a ratio ofConsolidated Funded Debt to Pro Forma EBITDA (as defined and calculated in thefacility) of less than 4.75 to 1.00 (subject to adjustment for specifiedacquisitions) and a ratio of EBITDA to Interest Expense (as defined andcalculated in the facility) of at least 3.00 to 1.00, in each case with respectto specified twelve month periods.  Other restrictive covenants in the creditagreement limit our ability to, among other things, incur additionalindebtedness, make distributions in excess of Available Cash, incur liens,engage in specified transactions with affiliates and complete mergers,acquisitions and sales of assets.  AtMarch 31, 2006, we were in compliance with the covenants of the RevolvingCredit Facility.

 

*Future Capital Needs andCommitments*

 

We estimate that capital expenditures for 2006,excluding acquisitions and capital expenditures related to the proposed jointventure with an affiliate of Enterprise discussed below, will be approximately$231.8 million (including $6.0 million of capitalized interest).  We expect to spend approximately $161.5million for revenue generating projects. Capital spending on revenue generating projects and facilityimprovements will include approximately $74.9 million for the expansion of ourDownstream Segment facilities.  We expectto spend $24.0 million to expand our Upstream Segment pipelines and facilitiesin West Texas and Oklahoma and approximately $62.6 million to expand ourMidstream Segment assets, with further expansions on our Jonah system.  We expect to spend approximately $39.8 millionto sustain existing operations, including life-cycle replacements for equipmentat various facilities and pipeline and tank replacements among all of ourbusiness segments.  We expect to spendapproximately $24.5 million to improve operational efficiencies and reducecosts among all of our business segments. During 2006, TE Products may be required to contribute cash toCentennial to cover capital expenditures, acquisitions or other operating needsand to MB Storage to cover significant capital expenditures or additionalacquisitions.  We continually review andevaluate potential capital improvements and expansions that would becomplementary to our present business operations.  These expenditures can vary greatly dependingon the magnitude of our transactions.  Wemay finance capital expenditures through internally generated funds, debt orthe issuance of additional equity.

 

50

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The construction of the Jonah expansion is expected tobe completed through a proposed joint venture between us and Enterprise,relating to the construction and financing of the Jonah expansion.  In February 2006, we entered into a letter ofintent with an affiliate of Enterprise related to this expansion, which isanticipated to cost approximately $200.0 million.  For additional information, see “-Overview ofBusiness” above.

 

*Liquidity Outlook*

 

We believe that we will continue to have adequateliquidity to fund future recurring operating and investing activities.  Our primary cash requirements consist ofnormal operating expenses, capital expenditures to sustain existing operationsand to complete the Jonah expansion, revenue generating expenditures, interestpayments on our Senior Notes and Revolving Credit Facility, distributions toour General Partner and unitholders and acquisitions of new assets orbusinesses.  Our cash requirements for2006 are expected to be funded through operating cash flows and our arrangementwith an affiliate of Enterprise under the pending joint venture agreementrelated to the Jonah expansion.  Long-term cash requirements for expansion projects, acquisitions anddebt repayments are expected to be funded by several sources, including cashflows from operating activities, borrowings under credit facilities, jointventures and possibly the issuance of additional equity and debtsecurities.  Our ability to completefuture debt and equity offerings and the timing of any such offerings willdepend on various factors, including prevailing market conditions, interestrates, our financial condition and our credit rating at the time.

 

*Off-Balance Sheet Arrangements*

* *

We do not rely on off-balance sheet borrowings to fundour acquisitions.  We have no material off-balancesheet commitments for indebtedness other than the limited guaranty ofCentennial debt, the limited guarantee of Centennial catastropic events asdiscussed below and an outstanding letter of credit. In addition, we haveentered into various leases covering assets utilized in several areas of ouroperations.

 

Centennial entered into credit facilities totaling$150.0 million, and as of March 31, 2006, $150.0 million was outstanding underthose credit facilities, of which $140.0 million expires in 2024, and $10.0million expires in April 2007.  TEProducts and Marathon have each guaranteed one-half of the repayment ofCentennial’s outstanding debt balance (plus interest) under these creditfacilities.  The guarantees arose inorder for Centennial to obtain adequate financing, and the proceeds of thecredit facilities were used to fund construction and conversion costs of itspipeline system.  Prior to the expirationof the long-term credit facility, TE Products could be relinquished fromresponsibility under the guarantee should Centennial meet certain financialtests.  If Centennial defaults on itsoutstanding balance, the estimated maximum potential amount of future paymentsfor TE Products and Marathon is $75.0 million each at March 31, 2006.

 

TE Products, Marathon and Centennial have entered intoa limited cash call agreement, which allows each member to contribute cash inlieu of Centennial procuring separate insurance in the event of a third-partyliability arising from a catastrophic event. There is an indefinite term for the agreement and each member is tocontribute cash in proportion to its ownership interest, up to a maximum of$50.0 million each.  As a result of thecatastrophic event guarantee, TE Products has recorded a $4.6 millionobligation, which represents the present value of the estimated amount that wewould have to pay under the guarantee. If a catastrophic event were to occur and we were required to contributecash to Centennial, contributions exceeding our deductible might be covered byour insurance.

 

One of our subsidiaries, TEPPCO Crude Oil, L.P.(“TCO”), has entered into master equipment lease agreements with financecompanies for the use of various equipment. We have guaranteed the full and timely payment and performance of TCO’sobligations under the agreements. Generally, events of default would trigger our performance under theguarantee.  The maximum potential amountof future payments under the guarantee is not estimable, but would include baserental payments for both current and future equipment, stipulated loss paymentsin the event any equipment is stolen, damaged, or destroyed and any futureindemnity payments.  We carry insurancecoverage that may offset any payments required under the guarantees.

 

51

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*Contractual Obligations*

* *

The following table summarizes our debt repaymentobligations and material contractual commitments as of March 31, 2006 (inmillions):  

 
| ** **                                 | ** ** | **Amount of Commitment Expiration Per Period** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Total**                                                               | ** ** | **Less than   1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **After 5   Years** | ** ** |
|                                       |       |                                                                    |       |   |   |   |   |   |   |   |   |
| Revolving Credit Facility                  |       | $                                                                       | 435.0      |   | $ | — |   | $ | — |   | $ | 435.0 |   | $ | — |   |
| 6.45% Senior Notes due 2008 (1) (2)        |       | 180.0                                                                   |       | — |   | 180.0 |   | — |   | — |   |
| 7.625% Senior Notes due 2012 (2)           |       | 500.0                                                                   |       | — |   | — |   | — |   | 500.0 |   |
| 6.125% Senior Notes due 2013 (2)           |       | 200.0                                                                   |       | — |   | — |   | — |   | 200.0 |   |
| 7.51% Senior Notes due 2028 (1) (2)        |       | 210.0                                                                   |       | — |   | — |   | — |   | 210.0 |   |
| Interest payments (3)                      |       | 791.4                                                                   |       | 100.4 |   | 189.2 |   | 171.0 |   | 330.8 |   |
| Debt and interest subtotal                 |       | 2,316.4                                                                 |       | 100.4 |   | 369.2 |   | 606.0 |   | 1,240.8 |   |
|                                       |       |                                                                    |       |   |   |   |   |   |   |   |   |
| Operating leases (4)                       |       | 82.4                                                                    |       | 18.7 |   | 28.1 |   | 14.1 |   | 21.5 |   |
| Capital expenditure obligations (5)        |       | 3.1                                                                     |       | 3.1 |   | — |   | — |   | — |   |
| Standby letter of credit (6)               |       | 11.9                                                                    |       | 11.9 |   | — |   | — |   | — |   |
| Other liabilities and deferred credits (7) |       | 9.7                                                                     |       | — |   | 9.2 |   | 0.3 |   | 0.2 |   |
|                                       |       |                                                                    |       |   |   |   |   |   |   |   |   |
| Total                                      |       | $                                                                       | 2,423.5    |   | $ | 134.1 |   | $ | 406.5 |   | $ | 620.4 |   | $ | 1,262.5 |   |

 

----

(1)   Obligations of TE Products.

 

(2)   Our TE Products subsidiaryentered into an interest rate swap agreement to hedge its exposure to changesin the fair value of its 7.51% Senior Notes due 2028.  At March 31, 2006, the 7.51% Senior Notesinclude an adjustment to decrease the fair value of the debt by $7.0 millionrelated to this interest rate swap agreement. We also entered into interest rate swap agreements to hedge our exposureto changes in the fair value of our 7.625% Senior Notes due 2012.  At March 31, 2006, the 7.625% Senior Notesinclude a deferred gain, net of amortization, from previous interest rate swapterminations of $31.3 million.  At March31, 2006, our 6.45% Senior Notes, our 7.625% Senior Notes and our 6.125% SeniorNotes include $2.2 million of unamortized debt discounts.  The fair value adjustments, the deferred gainadjustment and the unamortized debt discounts are excluded from this table.

 

(3)   Includes interest payments dueon our Senior Notes and interest payments and commitment fees due on ourRevolving Credit Facility. The interest amount calculated on the RevolvingCredit Facility is based on the assumption that the amount outstanding and theinterest rate charged both remain at their current levels.

 

(4)   Includes a pipeline capacitylease with Centennial.  In January 2003,TE Products entered into a pipeline capacity lease agreement with Centennialfor a period of five years that contains a minimum throughput requirement.  For the three months ended March 31, 2006, TEProducts exceeded the minimum throughput requirements on the lease agreement.

 

(5)   Includes accruals for costsincurred but not yet paid relating to capital projects.

 

(6)   At March 31, 2006, we had outstanding an $11.9million standby letter of credit in connection with crude oil purchased in thefirst quarter of 2006.  This amount isexpected to be paid during the second quarter of 2006.

 

(7)   Excludes approximately $8.7million of long-term deferred revenue payments, which are being transferred toincome over the term of the respective revenue contracts and $4.3 millionrelated to our estimated long-term portion of our obligation under acatastrophic event guarantee for Centennial. The amount of commitment by year is our best estimate of projectedpayments of these long-term liabilities.

 

52

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We expect to repay the long-term, senior unsecuredobligations and bank debt through the issuance of additional long-term seniorunsecured debt at the time the 2008, 2012, 2013 and 2028 debt matures, issuanceof additional equity, with proceeds from dispositions of assets, cash flow fromoperations or any combination of the above items.

 

In addition to the items in the table above, we haveentered into various operational commitments and agreements related to pipelineoperations and to the marketing, transportation, terminaling and storage ofcrude oil.  The majority of contractualcommitments we make for the purchase of crude oil range in term from athirty-day evergreen to one year.  Asubstantial portion of the contracts for the purchase of crude oil that extendbeyond thirty days include cancellation provisions that allow us to cancel thecontract with thirty days written notice. During the three months ended March 31, 2006, crude oil purchasesaveraged approximately $792.1 million per month.

 

Our senior unsecured debt is rated BBB- by Standardand Poors (“S&P”) and Baa3 by Moody’s Investors Service (“Moody’s”).  S&P assigned this rating on June 14,2005, following its review of the ownership structure, corporate governanceissues, and proposed funding after the acquisition of the General Partner byDFI.  Both ratings are with a stableoutlook.  A rating reflects only the viewof a rating agency and is not a recommendation to buy, sell or hold anyindebtedness.  Any rating can be revisedupward or downward or withdrawn at any time by a rating agency if it determinesthat the circumstances warrant such a change and should be evaluatedindependently of any other rating.  Thesenior unsecured debt of our subsidiary, TE Products, is also rated BBB- byS&P and Baa3 by Moody’s.  Bothratings are with a stable outlook and were reaffirmed during the first quarterof 2006.

 

***Recent Accounting Pronouncements***

* *

**See discussion ofnew accounting pronouncements in Note 1 in the Notes to the ConsolidatedFinancial Statements.**

** **

**Item 3.  Quantitativeand Qualitative Disclosures About Market Risk**

 

For additional discussion of ourexposure to market risks, please refer to “Item 7A.  Quantitative and Qualitative DisclosuresAbout Market Risk” in our Annual Report on Form 10-K for the year endedDecember 31, 2005.

 

*Commodity Risk*

 

We may be exposed to market risk through changes incrude oil commodity prices and interest rates. We do not have foreign exchange risks. Our Risk Management Committee has established policies to monitor andcontrol these market risks.  The RiskManagement Committee is comprised, in part, of senior executives of the Company.

 

We seek to maintain a position that is substantiallybalanced between crude oil purchases and sales and future deliveryobligations.  On the majority of ourcrude oil derivative contracts, we take the normal purchase and normal saleexclusion in accordance with SFAS No. 133, *Accounting for DerivativeInstruments and Hedging Activities*, and SFAS No. 138, *Accounting for Certain Derivative Instruments and Certain HedgingActivities, an amendment of FASB Statement No. 133*.

 

On a small portion of our crude oil marketingbusiness, we enter into derivative contracts such as swaps and other businesshedging devices for which we cannot take the normal purchase and normal saleexclusion.  Generally, hedge accountingis elected.  The terms of these contractsare typically one year or less.  Thepurpose is to balance our position or lock in a margin and, as such, thederivative contracts do not expose us to additional significant marketrisk.  For derivatives where hedgeaccounting is elected, the effective portion of changes in fair value arerecorded in other comprehensive income and reclassified into earnings as suchtransactions are settled.  Forderivatives where hedge accounting is not elected, we mark these transactionsto market and the changes in the fair value are recognized in currentearnings.  This results in some financialstatement variability during quarterly 

 

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periods; however, anyunrealized gains and losses reflected in the financial statements related tomarking these transactions to market are offset by realized gains and losses indifferent quarterly periods when the transactions are settled.

 

At March 31, 2006, we had a limited number ofcommodity derivatives that were accounted for as cash flow hedges.  Gains and losses on these derivatives areoffset against corresponding gains or losses of the hedged item and aredeferred through other comprehensive income, thus minimizing exposure to cashflow risk.  The fair value of the openpositions at March 31, 2006, was $0.3 million. Assuming a hypothetical across-the-board 10% price decrease in theapplicable forward curve, the change in fair value of the hedging instrumentwould have been $0.7 million.  The fairvalue of the open positions was based upon both quoted market prices obtainedfrom NYMEX and were estimated based on quoted prices from various sources suchas independent reporting services, industry publications, brokers andmarketers.  The fair values weredetermined based upon the differences by month between the fixed contract priceand the relevant forward price curve, the volumes for the applicable month anda discount rate of 6%.

 

*Interest Rate Risk*

* *

We have utilized and expect to continue to utilizeinterest rate swap agreements to hedge a portion of our cash flow and fairvalue risks.  Interest rate swapagreements are used to manage the fixed and floating interest rate mix of ourtotal debt portfolio and overall cost of borrowing.  Interest rate swaps that manage our cash flowrisk reduce our exposure to increases in the benchmark interest ratesunderlying variable rate debt.  Interestrate swaps that manage our fair value risks are intended to reduce our exposureto changes in the fair value of the fixed rate debt.  Interest rate swap agreements involve theperiodic exchange of payments without the exchange of the notional amount uponwhich the payments are based.  Therelated amount payable to or receivable from counterparties is included as anadjustment to accrued interest.

 

At March 31, 2006, we had $435.0 million outstandingunder our variable interest rate revolving credit facility.  The interest rate is based, at our option, oneither the lender’s base rate plus a spread or LIBOR plus a spread in effect atthe time of the borrowings and is adjusted monthly, bimonthly, quarterly orsemiannually.  In January 2006, weentered into interest rate swap agreements with a total notional amount of$200.0 million to hedge our exposure to increases in the benchmark interestrate underlying the credit facility. These interest rate swaps mature in January 2008.  We designated these swap agreements as cashflow hedges.  Under the swap agreements,we pay a fixed rate of interest ranging from 4.67% to 4.695% and receive afloating rate based on a three-month U.S. Dollar LIBOR rate.  Because these swaps are designated as cashflow hedges, the changes in fair value, to the extent the swaps are effective,are recognized in other comprehensive income until the hedged interest costsare recognized in earnings.  During thethree months ended March 31, 2006, we recognized increases in interest expenseof $0.1 million related to the difference between the fixed rate and thefloating rate of interest on the interest rate swaps.  During the three months ended March 31, 2006,we measured the hedge effectiveness of these interest rate swaps and noted thatno gain or loss from ineffectiveness was required to be recognized.  The total fair value of the interest rateswap agreements was a gain of approximately $1.7 million at March 31,2006.  Utilizing the balances of ourvariable interest rate debt outstanding at March 31, 2006, and including theeffects of hedging activities, if market interest rates increased 100 basispoints, the annual increase in interest expense would be $2.4 million.

 

The following table summarizes the estimated fairvalues of the Senior Notes as of March 31, 2006 and December 31, 2005 (inmillions):

 
| ** **                                        | ** ** | ** **            | ** ** | **Fair Value**            | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|--------------------------------|------------|
| ** **                                        | ** ** | **Face   Value** | ** ** | **March 31,   2006** | ** ** | **December 31,  2005** | ** ** |
|                                              |       |                  |       |                           |       |   |   |
| 6.45% TE Products Senior Notes, due January  2008 |       | $                     | 180.0      |                           | $          | 182.6 |   | $ | 183.7 |   |
| 7.625% Senior Notes, due February 2012            |       | 500.0                 |       | 537.9                          |       | 552.0 |   |
| 6.125% Senior Notes, due February 2013            |       | 200.0                 |       | 200.0                          |       | 205.6 |   |
| 7.51% TE Products Senior Notes, due January  2028 |       | 210.0                 |       | 223.4                          |       | 224.1 |   |
|                                                   |            |                       |            |                                |            |  |  |  |  |  |

 

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In October 2001, TE Products entered into an interestrate swap agreement to hedge its exposure to changes in the fair value of itsfixed rate 7.51% Senior Notes due 2028. We designated this swap agreement as afair value hedge.  The swap agreement hasa notional amount of $210.0 million and matures in January 2028 to match theprincipal and maturity of the TE Products Senior Notes.  Under the swap agreement, TE Products pays afloating rate of interest based on a three-month U.S. Dollar LIBOR rate, plus aspread of 147 basis points, and receives a fixed rate of interest of7.51%.  During the three months endedMarch 31, 2006, and 2005, we recognized reductions in interest expense of $0.7 millionand $1.8 million, respectively, related to the difference between the fixedrate and the floating rate of interest on the interest rate swap.  During the quarters ended March 31, 2006 and2005, we measured the hedge effectiveness of this interest rate swap and notedthat no gain or loss from ineffectiveness was required to be recognized.  The fair value of this interest rate swap wasa loss of approximately $7.0 million and $0.9 million at March 31, 2006, and December31, 2005, respectively.  Utilizing thebalance of the 7.51% TE Products Senior Notes outstanding at March 31, 2006,and including the effects of hedging activities, if market interest ratesincreased 100 basis points, the annual increase in interest expense would be$2.1 million.

 

**Item 4.  Controls andProcedures**

 

As of the end of the period covered by this report,our management carried out an evaluation, with the participation of ourprincipal executive officer (the “CEO”) and our principal financial officer(the “CFO”), of the effectiveness of our disclosure controls and procedurespursuant to Rule 13a-15 of the Securities Exchange Act of 1934.  Based on those evaluations, as of March 31,2006, the CEO and CFO concluded:

 

(i)    thatour disclosure controls and procedures are designed to ensure that informationrequired to be disclosed by us in the reports that we file or submit under theSecurities Exchange Act of 1934 is recorded, processed, summarized and reportedwithin the time periods specified in the SEC’s rules and forms, and that suchinformation is accumulated and communicated to our management, including theCEO and CFO, as appropriate to allow timely decisions regarding requireddisclosure; and

 

(ii)   thatour disclosure controls and procedures are effective.

 

*Changesin Internal Control over Financial Reporting*

* *

There has been no change in our internal control overfinancial reporting during the first quarter of 2006 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

**PART II.  OTHER INFORMATION**

** **

**Item 1.  Legal Proceedings**

** **

We have been, in the ordinary courseof business, a defendant in various lawsuits and a party to various other legalproceedings, some of which are covered in whole or in part by insurance.  We believe that the outcome of these lawsuitsand other proceedings will not individually or in the aggregate have a materialadverse effect on our consolidated financial position, results of operations orcash flows.  See discussion of legalproceedings in Note 13 in the Notes to the Consolidated Financial Statements,which is incorporated into this item by reference.

 

**Item 1A.  Risk Factors**

** **

Unitholders and potential investors in our Unitsshould carefully consider our risk factors set forth in our Annual Report onForm 10-K for the year ended December 31, 2005, and below, in addition to otherinformation in such Annual Report and this Report.  We are identifying these risk factors asimportant factors that could cause our actual results to differ materially fromthose contained in any written or oral forward-looking statements made by or 

 

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on behalf of us.  We are relying upon the safe-harbor forforward-looking statements, and any such statements made by or on behalf of usare qualified by reference to the risk factors in our Annual Report on Form10-K for the year ended December 31, 2005, and the following cautionarystatements, as well as to those set forth elsewhere in such Annual Report andthis Report.

 

***We depend on the leadership and involvement of our keypersonnel for the success of our business.***

 

We depend on the leadership andinvolvement of our key personnel to identify and develop business opportunitiesand make strategic decisions.  Our presidentand chief executive officer was elected in April 2006, our chief financialofficer was elected in January 2006, and our general counsel was elected inMarch 2006.  Our president and chiefexecutive officer has over 35 years of relevant experience and our chieffinancial officer and general counsel each have approximately 20 years ofrelevant experience.  While retentionplans are in place for certain senior executives, any future unplanneddepartures could have a material adverse effect on our business, financialcondition and results of operations. Legacy senior executives have compensation agreements in place; new officersmay not be party to any compensation agreements.

 

**Item 6.  Exhibits.**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.1         |       | Certificate of Limited Partnership  of TEPPCO Partners, L.P. (Filed as Exhibit 3.2 to the Registration Statement  of TEPPCO Partners, L.P. (Commission File No. 33-32203) and incorporated  herein by reference).                                                                                                                                                                                                                                                                   |
| 3.2         |       | Third Amended and Restated Agreement  of Limited Partnership of TEPPCO Partners, L.P., dated September 21, 2001  (Filed as Exhibit 3.7 to Form 10-Q of TEPPCO Partners, L.P. (Commission File  No. 1-10403) for the quarter ended September 30, 2001 and incorporated herein  by reference).                                                                                                                                                                                        |
| 4.1         |       | Form of Certificate representing  Limited Partner Units (Filed as Exhibit 4.1 to the Registration Statement of  TEPPCO Partners, L.P. (Commission File No. 33-32203) and incorporated herein  by reference).                                                                                                                                                                                                                                                                        |
| 4.2         |       | Form of Indenture between TE  Products Pipeline Company, Limited Partnership and The Bank of New York, as  Trustee, dated as of January 27, 1998 (Filed as Exhibit 4.3 to TE Products  Pipeline Company, Limited Partnership’s Registration Statement on Form S-3  (Commission File No. 333-38473) and incorporated herein by reference).                                                                                                                                      |
| 4.3         |       | Form of Certificate representing  Class B Units (Filed as Exhibit 4.3 to Form 10-K of TEPPCO Partners, L.P.  (Commission File No. 1-10403) for the year ended December 31, 1998 and  incorporated herein by reference).                                                                                                                                                                                                                                                             |
| 4.4         |       | Form of Indenture between TEPPCO  Partners, L.P., as issuer, TE Products Pipeline Company, Limited Partnership,  TCTM, L.P., TEPPCO Midstream Companies, L.P. and Jonah Gas Gathering Company,  as subsidiary guarantors, and First Union National Bank, NA, as trustee,  dated as of February 20, 2002 (Filed as Exhibit 99.2 to Form 8-K of TEPPCO  Partners, L.P. (Commission File No. 1-10403) dated as of February 20, 2002  and incorporated herein by reference).            |
| 4.5         |       | First Supplemental Indenture between  TEPPCO Partners, L.P., as issuer, TE Products Pipeline Company, Limited  Partnership, TCTM, L.P., TEPPCO Midstream Companies, L.P. and Jonah Gas  Gathering Company, as subsidiary guarantors, and First Union National Bank,  NA, as trustee, dated as of February 20, 2002 (Filed as Exhibit 99.3 to Form  8-K of TEPPCO Partners, L.P. (Commission File No. 1-10403) dated as of  February 20, 2002 and incorporated herein by reference). |

 

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| 4.6    |   | Second Supplemental Indenture, dated  as of June 27, 2002, among TEPPCO Partners, L.P., as issuer, TE Products  Pipeline Company, Limited Partnership, TCTM, L.P., TEPPCO Midstream  Companies, L.P., and Jonah Gas Gathering Company, as Initial Subsidiary  Guarantors, and Val Verde Gas Gathering Company, L.P., as New Subsidiary  Guarantor, and Wachovia Bank, National Association, formerly known as First  Union National Bank, as trustee (Filed as Exhibit 4.6 to Form 10-Q of TEPPCO  Partners, L.P. (Commission File No. 1-10403) for the quarter ended June 30,  2002 and incorporated herein by reference). |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.7    |   | Third Supplemental Indenture among  TEPPCO Partners, L.P. as issuer, TE Products Pipeline Company, Limited  Partnership, TCTM, L.P., TEPPCO Midstream Companies, L.P., Jonah Gas  Gathering Company and Val Verde Gas Gathering Company, L.P. as Subsidiary Guarantors,  and Wachovia Bank, National Association, as trustee, dated as of January 30,  2003 (Filed as Exhibit 4.7 to Form 10-K of TEPPCO Partners, L.P. (Commission  File No. 1-10403) for the year ended December 31, 2002 and incorporated  herein by reference).                                                                                         |
| 10.1   |   | Agreement and Release between James  C. Ruth and Texas Eastern Products Pipeline Company, LLC dated as of January  25, 2006 (Filed as Exhibit 10.53 to Form 10-K of TEPPCO Partners, L.P.  (Commission File No. 1-10403) for the year ended December 31, 2005 and  incorporated herein by reference).                                                                                                                                                                                                                                                                                                                       |
| 10.2   |   | Letter of Intent between TEPPCO  Partners, L.P. and Enterprise Products Operating, L.P. dated February 13,  2006 (Filed as Exhibit 99.1 to Form 8-K of TEPPCO Partners, L.P. (Commission  File No. 1-10403) dated February 17, 2006 and incorporated herein by  reference).                                                                                                                                                                                                                                                                                                                                                 |
| 10.3   |   | Waiver of Provisions of the  Conflicts Policies and Procedures of the Third Amended and Restated  Administrative Services Agreement (Filed as Exhibit 10.56 to Form 10-K of  TEPPCO Partners, L.P. (Commission File No. 1-10403) for the year ended  December 31, 2005 and incorporated herein by reference).                                                                                                                                                                                                                                                                                                               |
| 12.1*  |   | Statement of Computation of Ratio of  Earnings to Fixed Charges.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 31.1*  |   | Certification of Chief Executive  Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 31.2*  |   | Certification of Chief Financial  Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 32.1** |   | Certification of Chief Executive  Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 32.2** |   | Certification of Chief Financial  Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |

 

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*  Filed herewith.

**Furnished herewith pursuant to Item 601(b)-(32) of Regulation S-K.

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 
|              |                                                                                                          | TEPPCO Partners, L.P. |
|-------------------|---------------------------------------------------------------------------------------------------------------|-----------------------|
|              |                                                                                                          |
|              | By:                                                                                                           |                  | /s/   JERRY E. THOMPSON |   |
|              | Jerry E. Thompson,                                                                                            |
| Date: May 3, 2006 | President and Chief Executive Officer of

Texas Eastern Products Pipeline Company, LLC, General  Partner      |
|              |                                                                                                          |
|              | By:                                                                                                           |                  | /s/   WILLIAM G. MANIAS |   |
|              | William G. Manias,                                                                                            |
| Date: May 3, 2006 | Vice President and Chief Financial Officer of

Texas Eastern Products Pipeline Company, LLC, General  Partner |
|                   |                                                                                                               |                       |  |  |  |

 

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