**UNITED STATES**

**SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-Q**

 

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

 

**For the quarterly period ended September 30, 2005**

 

**OR**

 

o**TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**

**SECURITIESEXCHANGE 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 markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes ý   No o

 

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

 

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

 

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date.  Limited PartnerUnits outstanding as of October 28, 2005:  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 September 30, 2005 (unaudited) and December 31, 2004**                                     | ** ** |
| ** **                                                                                                                      | ** ** |
| **Consolidated  Statements of Income for the three months and nine months ended September 30,  2005 and 2004 (unaudited)** | ** ** |
| ** **                                                                                                                      | ** ** |
| **Consolidated  Statements of Cash Flows for the nine months ended September 30, 2005 and 2004 (unaudited)**               | ** ** |
| ** **                                                                                                                      | ** ** |
| **Consolidated  Statement of Partners’ Capital for the nine months ended September 30, 2005 (unaudited)**             | ** ** |
| ** **                                                                                                                      | ** ** |
| **Notes  to the Consolidated Financial Statements (unaudited)**                                                                 | ** ** |
| ** **                                                                                                                      | ** ** |
| **Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations**                         | ** ** |
| ** **                                                                                                                      | ** ** |
| **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  6. Exhibits**                                                                                                           | ** ** |
| ** **                                                                                                                      | ** ** |
| **Signatures**                                                                                                                  | ** ** |

** **

** **

**i**

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** **

**PART I. FINANCIAL INFORMATION**

**Item 1. Financial Statements**

**TEPPCO PARTNERS,  L.P.**

** **

**CONSOLIDATED BALANCE SHEETS**

**(in thousands)**

** **
| ** **                                                                                                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                                          | ** ** | **2005**          | ** ** | **2004**         | ** ** |
| ** **                                                                                                          | ** ** | **(Unaudited)**   | ** ** | ** **       | ** ** |
| **ASSETS**                                                                                                          |       |
| Current assets:                                                                                                     |       |              |       |             |       |
| Cash and cash equivalents                                                                                           |       | $                 | 72         |             | $          | 16,422 |   |
| Accounts receivable, trade (net of allowance for  doubtful accounts of $287 and $112)                               |       | 849,968           |       | 553,628          |       |
| Accounts receivable, related parties                                                                                |       | 5,322             |       | 11,845           |       |
| Inventories                                                                                                         |       | 139,005           |       | 19,521           |       |
| Other                                                                                                               |       | 63,483            |       | 42,138           |       |
| Total current assets                                                                                                |       | 1,057,850         |       | 643,554          |       |
| Property, plant and equipment, at cost (net of  accumulated depreciation and amortization of $454,787 and $407,670) |       | 1,907,840         |       | 1,703,702        |       |
| Equity investments                                                                                                  |       | 374,531           |       | 373,652          |       |
| Intangible assets                                                                                                   |       | 385,119           |       | 407,358          |       |
| Goodwill                                                                                                            |       | 16,944            |       | 16,944           |       |
| Other assets                                                                                                        |       | 60,212            |       | 51,419           |       |
| Total assets                                                                                                        |       | $                 | 3,802,496  |             | $          | 3,196,629 |   |
|                                                                                                                |       |              |       |             |       |
| **LIABILITIES  AND PARTNERS’ CAPITAL**                                                                         |       |
| Current liabilities:                                                                                                |       |              |       |             |       |
| Accounts payable and accrued liabilities                                                                            |       | $                 | 851,206    |             | $          | 564,464 |   |
| Accounts payable, related parties                                                                                   |       | 9,858             |       | 24,654           |       |
| Accrued interest                                                                                                    |       | 13,501            |       | 32,292           |       |
| Other accrued taxes                                                                                                 |       | 18,736            |       | 13,309           |       |
| Other                                                                                                               |       | 71,043            |       | 46,593           |       |
| Total current liabilities                                                                                           |       | 964,344           |       | 681,312          |       |
| Senior Notes                                                                                                        |       | 1,122,317         |       | 1,127,226        |       |
| Other long-term debt                                                                                                |       | 460,500           |       | 353,000          |       |
| Other liabilities and deferred credits                                                                              |       | 17,494            |       | 13,643           |       |
| Commitments and contingencies                                                                                       |       |              |       |             |       |
| Partners’ capital:                                                                                             |       |              |       |             |       |
| Accumulated other comprehensive income                                                                              |       | 35                |       | —           |       |
| General partner’s interest                                                                                     |       | (50,889           | )          | (33,006          | )          |
| Limited partners’ interests                                                                                    |       | 1,288,695         |       | 1,054,454        |       |
| Total partners’ capital                                                                                        |       | 1,237,841         |       | 1,021,448        |       |
| Total liabilities and partners’ capital                                                                        |       | $                 | 3,802,496  |             | $          | 3,196,629 |   |
|                                                                                                                     |            |                   |            |                  |            |  |  |  |  |

 

Seeaccompanying Notes to Consolidated Financial Statements.

 

1

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** **

**TEPPCO PARTNERS, L.P.**

** **

**CONSOLIDATED STATEMENTS OF INCOME**

**(Unaudited)**

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

** **
| ** **                               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                               | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Operating revenues:                      |       |                                  |       |                                 |       |   |   |   |   |
| Sales of petroleum products              |       | $                                     | 2,370,710  |                                 | $          | 1,359,954 |   | $ | 5,721,536 |   | $ | 3,774,874 |   |
| Transportation—Refined products     |       | 38,240                                |       | 43,386                               |       | 111,039 |   | 113,294 |   |
| Transportation—LPGs                 |       | 16,519                                |       | 16,071                               |       | 63,220 |   | 58,572 |   |
| Transportation—Crude oil            |       | 10,001                                |       | 9,288                                |       | 28,215 |   | 28,164 |   |
| Transportation—NGLs                 |       | 11,829                                |       | 10,430                               |       | 33,435 |   | 31,022 |   |
| Gathering—Natural gas               |       | 38,833                                |       | 35,515                               |       | 112,349 |   | 104,444 |   |
| Other                                    |       | 17,664                                |       | 15,366                               |       | 50,987 |   | 52,265 |   |
| Total operating revenues                 |       | 2,503,796                             |       | 1,490,010                            |       | 6,120,781 |   | 4,162,635 |   |
|                                     |       |                                  |       |                                 |       |   |   |   |   |
| Costs and expenses:                      |       |                                  |       |                                 |       |   |   |   |   |
| Purchases of petroleum products          |       | 2,352,542                             |       | 1,345,677                            |       | 5,668,698 |   | 3,730,330 |   |
| Operating, general and administrative    |       | 57,763                                |       | 60,492                               |       | 157,760 |   | 164,935 |   |
| Operating fuel and power                 |       | 12,538                                |       | 13,464                               |       | 35,154 |   | 36,459 |   |
| Depreciation and amortization            |       | 30,960                                |       | 30,277                               |       | 83,015 |   | 84,508 |   |
| Taxes—other than income taxes       |       | 5,954                                 |       | 3,868                                |       | 15,662 |   | 13,993 |   |
| Gains on sales of assets                 |       | (31                                   | )          | (849                                 | )          | (597 | ) | (973 | ) |
| Total costs and expenses                 |       | 2,459,726                             |       | 1,452,929                            |       | 5,959,692 |   | 4,029,252 |   |
|                                     |       |                                  |       |                                 |       |   |   |   |   |
| Operating income                         |       | 44,070                                |       | 37,081                               |       | 161,089 |   | 133,383 |   |
|                                     |       |                                  |       |                                 |       |   |   |   |   |
| Interest expense—net                |       | (19,726                               | )          | (17,131                              | )          | (60,640 | ) | (53,190 | ) |
| Equity earnings                          |       | 6,095                                 |       | 5,621                                |       | 20,403 |   | 22,854 |   |
| Other income—net                    |       | 484                                   |       | 284                                  |       | 885 |   | 1,000 |   |
|                                     |       |                                  |       |                                 |       |   |   |   |   |
| Net income                               |       | $                                     | 30,923     |                                 | $          | 25,855 |   | $ | 121,737 |   | $ | 104,047 |   |
|                                     |       |                                  |       |                                 |       |   |   |   |   |
| Net Income Allocation:                   |       |                                  |       |                                 |       |   |   |   |   |
| Limited Partner Unitholders              |       | $                                     | 21,872     |                                 | $          | 18,396 |   | $ | 86,105 |   | $ | 74,032 |   |
| General Partner                          |       | 9,051                                 |       | 7,459                                |       | 35,632 |   | 30,015 |   |
| Total net income allocated               |       | $                                     | 30,923     |                                 | $          | 25,855 |   | $ | 121,737 |   | $ | 104,047 |   |
|                                     |       |                                  |       |                                 |       |   |   |   |   |
| Basic and diluted net income per Limited |       |                                  |       |                                 |       |   |   |   |   |
| Partner Unit                             |       | $                                     | 0.31       |                                 | $          | 0.29 |   | $ | 1.29 |   | $ | 1.18 |   |
|                                     |       |                                  |       |                                 |       |   |   |   |   |
| Weighted average Limited Partner         |       |                                  |       |                                 |       |   |   |   |   |
| Units outstanding                        |       | 69,964                                |       | 62,999                               |       | 66,533 |   | 62,999 |   |
|                                     |       |                                  |       |                                 |       |   |   |   |   |
|                                          |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |

 

Seeaccompanying Notes to Consolidated Financial Statements.

 

2

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**TEPPCO PARTNERS, L.P.**

** **

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(Unaudited)**

**(in thousands)**

 
| ** **                                                                     | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                     | ** ** | **September 30,**     | ** ** |
| ** **                                                                     | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Cash flows from operating activities:                                          |       |                  |       |   |   |
| Net income                                                                     |       | $                     | 121,737    |   | $ | 104,047 |   |
| Adjustments to reconcile net income to cash provided  by operating activities: |       |                  |       |   |   |
| Depreciation and amortization                                                  |       | 83,015                |       | 84,508 |   |
| Earnings in equity investments, net of distributions                           |       | 7,775                 |       | 16,571 |   |
| Gains on sales of assets                                                       |       | (597                  | )          | (973 | ) |
| Non-cash portion of interest expense                                           |       | 1,214                 |       | 177 |   |
| Increase in accounts receivable                                                |       | (296,340              | )          | (139,808 | ) |
| (Increase) decrease in accounts receivable, related  parties                   |       | 6,523                 |       | (15,129 | ) |
| Increase in inventories                                                        |       | (111,094              | )          | (13,124 | ) |
| Increase in other current assets                                               |       | (21,002               | )          | (2,855 | ) |
| Increase in accounts payable and accrued expenses                              |       | 289,130               |       | 135,446 |   |
| Increase (decrease) in accounts payable, related  parties                      |       | (14,796               | )          | 1,882 |   |
| Other                                                                          |       | (21,617               | )          | 3,191 |   |
| Net cash provided by operating activities                                      |       | 43,948                |       | 173,933 |   |
|                                                                           |       |                  |       |   |   |
| Cash flows from investing activities:                                          |       |                  |       |   |   |
| Proceeds from the sales of assets                                              |       | 510                   |       | 1,202 |   |
| Purchase of assets                                                             |       | (112,231              | )          | (3,421 | ) |
| Investment in Centennial Pipeline LLC                                          |       | —                |       | (1,500 | ) |
| Investment in Mont Belvieu Storage Partners, L.P.                              |       | (2,635                | )          | (20,161 | ) |
| Capital expenditures                                                           |       | (148,063              | )          | (110,998 | ) |
| Net cash used in investing activities                                          |       | (262,419              | )          | (134,878 | ) |
|                                                                           |       |                  |       |   |   |
| Cash flows from financing activities:                                          |       |                  |       |   |   |
| Proceeds from revolving credit facility                                        |       | 549,657               |       | 256,300 |   |
| Repayments on revolving credit facility                                        |       | (442,157              | )          | (140,800 | ) |
| Issuance of Limited Partner Units, net                                         |       | 278,830               |       | — |   |
| Distributions paid                                                             |       | (184,209              | )          | (174,399 | ) |
| Net cash provided by (used in) financing activities                            |       | 202,121               |       | (58,899 | ) |
|                                                                           |       |                  |       |   |   |
| Net decrease in cash and cash equivalents                                      |       | (16,350               | )          | (19,844 | ) |
|                                                                           |       |                  |       |   |   |
| Cash and cash equivalents at beginning of period                               |       | 16,422                |       | 29,469 |   |
| Cash and cash equivalents at end of period                                     |       | $                     | 72         |   | $ | 9,625 |   |
|                                                                           |       |                  |       |   |   |
| **Non-cash investing activities:**                                             |       |                  |       |   |   |
| Net assets transferred to Mont Belvieu Storage  Partners, L.P.                 |       | $                     | 1,429      |   | $ | — |   |
|                                                                           |       |                  |       |   |   |
| **Supplemental disclosure of cash flows:**                                     |       |                  |       |   |   |
| Cash paid for interest (net of amounts capitalized)                            |       | $                     | 78,504     |   | $ | 75,498 |   |

 

Seeaccompanying Notes to Consolidated Financial Statements.

 

3

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**TEPPCO PARTNERS, L.P.**

** **

**CONSOLIDATEDSTATEMENT OF PARTNERS’ 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, 2004  |       | 62,998,554      |       | $                  | (33,006    | )                  | $          | 1,054,454         |       | $          | —     |   | $ | 1,021,448 |   |
| Issuance of Limited Partner Units, net       |       | 6,965,000       |       | —             |       | 278,830            |       | —            |       | 278,830    |       |
| Net income allocation                        |       | —          |       | 35,632             |       | 86,105             |       | —            |       | 121,737    |       |
| Change in fair value of crude oil hedge      |       | —          |       | —             |       | —             |       | 35                |       | 35         |       |
| Cash distributions                           |       | —          |       | (53,515            | )          | (130,694           | )          | —            |       | (184,209   | )          |
|                                         |       |            |       |               |       |               |       |              |       |       |       |
| Partners’ capital at September 30, 2005 |       | 69,963,554      |       | $                  | (50,889    | )                  | $          | 1,288,695         |       | $          | 35         |   | $ | 1,237,841 |   |
|                                              |            |                 |            |                    |            |                    |            |                   |            |            |            |  |  |  |  |  |

 

Seeaccompanying Notes to Consolidated Financial Statements.

 

4

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**TEPPCOPARTNERS, L.P.**

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 1.  ORGANIZATIONAND BASIS OF PRESENTATION**

 

TEPPCO Partners, L.P.(the “Partnership”), a Delaware limited partnership, is a master limitedpartnership 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 TEPPCOMidstream are referred to as the “Operating Partnerships.”  TEPPCO GP, Inc. (“TEPPCO GP”), our whollyowned subsidiary, is the general partner of our Operating Partnerships.  We hold a 99.999% limited partner interest inthe Operating Partnerships, and TEPPCO GP holds a 0.001% general partnerinterest.  Texas Eastern ProductsPipeline Company, LLC (the “Company” or “General Partner”), a Delaware limitedliability company, serves as our general partner and owns a 2% general partnerinterest in us.  Through February 23,2005, the General Partner was an indirect wholly owned subsidiary of Duke EnergyField Services, LLC (“DEFS”), a joint venture between Duke Energy Corporation (“DukeEnergy”) and ConocoPhillips.  ThroughFebruary 23, 2005, Duke Energy held an interest of approximately 70% in DEFS,and ConocoPhillips held the remaining interest of approximately 30%.  On February 24, 2005, the General Partner wasacquired by DFI GP Holdings L.P. (formerly Enterprise GP Holdings L.P.) (“DFI”),an affiliate of EPCO, Inc. (“EPCO”), a privately held company controlled by DanL. Duncan, for approximately $1.1 billion. 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.

EPCO performs allmanagement and operating functions required for us, and we reimburse EPCO forall direct and indirect expenses that have been incurred in managing us.  As a result of the sale of our General Partner,DEFS and Duke Energy will continue to provide some administrative services forus for a period of time until we assume these services.  In connection with us assuming the operationsof certain of the TEPPCO Midstream assets from DEFS, certain DEFS employeesbecame employees of EPCO effective June 1, 2005.

In connection with ourformation in 1990, the Company received 2,500,000 Deferred ParticipationInterests (“DPIs”).  Effective April 1,1994, the DPIs began participating in distributions of cash and allocations ofprofit and loss in a manner identical to Limited Partner Units and are treatedas Limited Partner Units for purposes of this Report.  These DPIs were assigned to Duke Energy whenownership of the Company was transferred from Duke Energy to DEFS in 2000.  On February 24, 2005, DFI entered into an LPUnit Purchase and Sale Agreement with Duke Energy and purchased these 2,500,000DPIs for approximately $100.0 million.

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.

                The accompanying unaudited consolidatedfinancial statements reflect all adjustments that are, in the opinion of ourmanagement, of a normal and recurring nature and necessary for a fair statementof our financial position as of September 30, 2005, and the results of ouroperations and cash flows for the periods presented.  The results of operations for the threemonths and nine months ended September 30, 2005, are not necessarily indicativeof results of our operations for the full year 2005.  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, 2004.  Wehave reclassified certain amounts from prior periods to conform to the currentpresentation.

 

                We operate and report in threebusiness segments: transportation and storage of refined products,  liquefied petroleum gases (“LPGs”) andpetrochemicals (“Downstream Segment”); gathering, transportation, marketing andstorage 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”).

 

 

5

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Ourreportable segments offer different products and services and are managedseparately because each requires different business strategies.

 

                Our interstate transportationoperations, including rates charged to customers, are subject to regulationsprescribed by the Federal 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 LimitedPartner Unit (“Unit” or “Units”) is computed by dividing our net income, afterdeduction of the General Partner’s interest, by the weighted average number ofUnits outstanding (a total of 70.0 million and 66.5 million Units for the threemonths and nine months ended September 30, 2005, respectively, and 63.0 millionUnits for the three months and nine months ended September 30, 2004).  The General Partner’s percentage interest inour net income is based on its percentage of cash distributions from AvailableCash for each period (see Note 9. Partners’ Capital and Distributions).  The General Partner was allocated $9.1million (representing 29.27%) and $7.5 million (representing 28.85%) of our netincome for the three months ended September 30, 2005 and 2004, respectively,and $35.6 million (representing 29.27%) and $30.0 million (representing 28.85%)of our net income for the nine months ended September 30, 2005 and 2004,respectively.  The General Partner’spercentage interest in our net income increases as cash distributions paid perUnit increase, in accordance with our limited partnership agreement.

 

                Diluted net income per Unitequaled basic net income per Unit for each of the three-month and nine-month periodsended September 30, 2005 and 2004, as there were no dilutive instrumentsoutstanding.

 

**New Accounting Pronouncements**

** **

**               **In December 2004, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards (“SFAS”) No. 123(R), *Share-BasedPayment*.  SFAS 123(R) requirescompensation costs related to share-based payment transactions to be recognizedin the financial statements.  Withlimited exceptions, the amount of the compensation cost is to be measured basedon the grant-date fair value of the equity or liability instrumentsissued.  In addition, liability awardsare to be re-measured each reporting period. Compensation cost will be recognized over the period that an employeeprovides service in exchange for the award. SFAS 123(R) is a revision of SFASNo. 123, *Accounting for Stock-BasedCompensation*, as amended by SFAS No. 148,*Accounting for Stock-Based Compensation — Transition and Disclosure*and supersedes Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees*.  SFAS 123(R) is effective for public companiesas of the first interim or annual reporting period of the first fiscal yearbeginning after June 15, 2005.  TheSecurities and Exchange Commission amended the implementation date of SFAS 123(R)to begin with the first interim or annual reporting period of the company’sfirst fiscal year beginning on or after June 15, 1005.  As such, we will adopt SFAS 123(R) in thefirst quarter of 2006.  Companies arepermitted to adopt SFAS 123(R) prior to the extended date.  All public companies that adopted thefair-value-based method of accounting must use the modified prospectivetransition method and may elect to use the modified retrospective transitionmethod.  We do not believe that theadoption of SFAS 123(R) will have a material effect on our financial position,results of operations or cash flows.

** **

**                In November 2004, the EmergingIssues Task Force (“EITF”) reached consensus in EITF 03-13, *Applying the Conditions in Paragraph 42 of FASB Statement No. 144, Accounting for Impairment or Disposal ofLong-Lived Assets, in Determining Whether to Report DiscontinuedOperations*, to clarify whether a component of an enterprise that is eitherdisposed of or classified as held for sale qualifies for income statementpresentation as discontinued operations. The FASB ratified the consensus on November 30, 2004.  The consensus is to be applied prospectivelywith regard to a component of an enterprise that is either disposed of orclassified as held for sale in reporting**

** **

** **

**6**

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** **

**periods beginningafter December 15, 2004.  The consensusmay be applied retrospectively for previously reported operating resultsrelated to disposal transactions initiated within an enterprise’s reportingperiod that included the date that this consensus was ratified. The adoption ofEITF 03-13 did not have an effect on our financial position, results ofoperations or cash flows.**

** **

**                In March 2005, the FASB issuedFASB Interpretation No. 47, *Accounting forConditional Asset Retirement Obligations, an interpretation of FASB StatementNo. 143* (“FIN 47”).  FIN 47clarifies that the term, conditional asset retirement obligation as used inSFAS No. 143, *Accounting for Asset Retirement Obligations*,refers to a legal obligation to perform an asset retirement activity in whichthe timing and/or method of settlement are conditional upon a future event thatmay or may not be within the control of the entity.  Even though uncertainty about the timingand/or method of settlement exists and may be conditional upon a future event,the obligation to perform the asset retirement activity is unconditional.  Accordingly, an entity is required torecognize a liability for the fair value of a conditional asset retirement obligationif the fair value of the liability can be reasonably estimated.  Uncertainty about the timing and/or method ofsettlement of a conditional asset retirement obligation should be factored intothe measurement of the liability when sufficient information exists.  The fair value of a liability for theconditional asset retirement obligation should be recognized when incurredgenerally upon acquisition, construction, or development or through the normaloperation of the asset.  SFAS 143acknowledges that in some cases, sufficient information may not be available toreasonably estimate the fair value of an asset retirement obligation.  FIN 47 also clarifies when an entity wouldhave sufficient information to reasonably estimate the fair value of an assetretirement obligation.  FIN 47 iseffective no later than the end of reporting periods ending after December 15,2005, and early adoption of FIN 47 is encouraged.  We will adopt FIN 47 in the fourth quarter of2005.  We do not believe that theadoption of FIN 47 will have a material effect on our financial position,results of operations or cash flows.**

** **

                InJune 2005, the EITF reached consensus in EITF 04-5, *Determining Whether a General Partner, or the General Partners as aGroup, Controls a Limited Partnership or Similar Entity When the LimitedPartners Have Certain Rights*, to provide guidance on how generalpartners in a limited partnership should determine whether they control alimited partnership and therefore should consolidate it.  The EITF agreed that the presumption ofgeneral partner control would be overcome only when the limited partners haveeither of two types of rights. The first type, referred to as kick-out rights,is the right to dissolve or liquidate the partnership or otherwise remove thegeneral partner without cause.  Thesecond type, referred to as participating rights, is the right to effectivelyparticipate in significant decisions made in the ordinary course of thepartnership’s business. The kick-out rights and the participating rights mustbe substantive in order to overcome the presumption of general partner control.The consensus is effective for general partners of all new limited partnershipsformed and for existing limited partnerships for which the partnershipagreements are modified subsequent to the date of FASB ratification (June 29,2005).  For existing limited partnershipsthat have not been modified, the guidance in EITF 04-5 is effective no laterthan the beginning of the first reporting period in fiscal years beginningafter December 15, 2005.  We arecurrently evaluating what impact EITF 04-5 will have on our financialstatements, but at this time we do not believe that the adoption of EITF 04-5 willhave a material effect on our financial position, results of operations or cashflows.

 

InDecember 2004, the FASB issued SFAS No. 153, *Exchanges ofNonmonetary Assets, an amendment of APB Opinion 29*.   SFAS 153 amends APB Opinion No. 29, *Accounting for Nonmonetary Exchanges,*to eliminate theexception for nonmonetary exchanges of similar productive assets and replacesit with a general exception for exchanges of nonmonetary assets that do nothave commercial substance.  A nonmonetaryexchange has commercial substance if the future cash flows of the entity areexpected to change significantly as a result of the exchange.  SFAS 153 is effective for nonmonetary assetexchanges occurring in fiscal periods beginning after June 15, 2005.  We adopted SFAS 153 during the second quarterof 2005.  The adoption of SFAS 153 didnot have a material effect on our financial position, results of operations orcash flows.

 

 

7

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                InMay 2005, the FASB issued SFAS No. 154, *AccountingChanges and Error Corrections*. SFAS 154 establishes new standards on accounting for changes inaccounting principles.  All such changesmust be accounted for by retrospective application to the financial statementsof prior periods unless it is impracticable to do so.  SFAS 154 completely replaces APB Opinion No.20, *Accounting Changes,*and SFASNo. 3, *Reporting Accounting Changes inInterim Periods*.  However, itcarries forward the guidance in those pronouncements with respect to accountingfor changes in estimates, changes in the reporting entity, and the correction oferrors.  SFAS 154 is effective foraccounting changes and error corrections made in fiscal years beginning afterDecember 15, 2005, with early adoption permitted for changes and correctionsmade in years beginning after June 1, 2005. The application of SFAS 154 doesnot affect the transition provisions of any existing pronouncements, includingthose that are in the transition phase as of the effective date of SFAS154.  We do not believe that the adoptionof SFAS 154 will have a material effect on our financial position, results ofoperations or cash flows.

 

                InSeptember 2005, the EITF reached consensus in EITF 04-13, *Accountingfor Purchases and Sales of Inventory with the Same Counterparty*, todefine when a purchase and a sale of inventory with the same party thatoperates in the same line of business should be considered a single nonmonetarytransaction subject to APB Opinion No. 29, *Accounting for NonmonetaryTransactions*.  Two or moreinventory transactions with the same party should be combined if they areentered into in contemplation of one another. The consensus also requires entities to account for exchanges ofinventory in the same line of business at fair value or recorded amounts basedon inventory classification.  Theguidance in EITF 04-13 is effective for new inventory arrangements entered intoin reporting periods beginning after March 15, 2006.  We are currently evaluating what impact EITF 04-13will have on our financial statements, but at this time we do not believe thatthe adoption of EITF 04-13 will have a material effect on our financialposition, results of operations or cash flows.

** **

** **

**NOTE 2.  GOODWILL ANDOTHER INTANGIBLE ASSETS**

 

**Goodwill**

 

Goodwill represents theexcess of purchase price over fair value of net assets acquired and ispresented on the consolidated balance sheets net of accumulatedamortization.  We account for goodwillunder SFAS No. 142, *Goodwill and OtherIntangible Assets,*which was issued by the FASB in July 2001.  SFAS 142 prohibits amortization of goodwilland intangible assets with indefinite useful lives, but instead requirestesting for impairment at least annually. We test goodwill and intangible assets for impairment annually atDecember 31.

To perform an impairmenttest of goodwill, we have identified our reporting units and have determinedthe carrying value of each reporting unit by assigning the assets andliabilities, including the existing goodwill and intangible assets, to thosereporting units.  We then determine thefair value of each reporting unit and compare it to the carrying value of thereporting unit.  We will continue tocompare the fair value of each reporting unit to its carrying value on anannual basis to determine if an impairment loss has occurred.   There have been no goodwill impairmentlosses recorded since the adoption of SFAS 142.

                At September 30, 2005, andDecember 31, 2004, we have $16.9 million of unamortized goodwill and $25.5million of excess investment in our equity investment in Seaway Crude PipelineCompany (equity method goodwill).  Theexcess investment is included in our equity investments account at September30, 2005.  The following table presentsthe carrying amount of goodwill and equity method goodwill at September 30,2005, and December 31, 2004, by business segment (in thousands):

 

 

8

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| ** **             | ** ** | **Downstream  Segment** | ** ** | **Midstream  Segment** | ** ** | **Upstream  Segment** | ** ** | **Segments  Total** | ** ** |
|------------------------|------------|-------------------------|------------|------------------------|------------|-----------------------|------------|---------------------|------------|
| ** **             | ** ** | ** **              | ** ** | ** **             | ** ** | ** **            | ** ** | ** **          | ** ** |
| Goodwill               |       | $                       | —     |                   | $          | 2,777                 |       | $                   | 14,167     |   | $ | 16,944 |   |
| Equity method goodwill |       | —                  |       | —                 |       | 25,502                |       | 25,502              |       |
|                        |            |                         |            |                        |            |                       |            |                     |            |  |  |  |  |

 

**Other Intangible Assets**

 

                The following table reflects thecomponents of intangible assets being amortized at September 30, 2005, andDecember 31, 2004 (in thousands):

 
| ** **                              | ** ** | **September 30, 2005**     | ** ** | **December 31, 2004**         | ** ** |
|-----------------------------------------|------------|----------------------------|------------|-------------------------------|------------|
| ** **                              | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
|                                    |       |                       |       |                          |       |   |   |   |   |
| Intangible assets being amortized:      |       |                       |       |                          |       |   |   |   |   |
| Gathering and transportation agreements |       | $                          | 464,337    |                          | $          | (111,367 | ) | $ | 464,337 |   | $ | (91,262 | ) |
| Fractionation agreement                 |       | 38,000                     |       | (14,250                       | )          | 38,000 |   | (12,825 | ) |
| Other                                   |       | 10,226                     |       | (1,827                        | )          | 12,262 |   | (3,154 | ) |
| Total                                   |       | $                          | 512,563    |                          | $          | (127,444 | ) | $ | 514,599 |   | $ | (107,241 | ) |
|                                         |            |                            |            |                               |            |  |  |  |  |  |  |  |  |  |  |

 

                SFAS 142 requires thatintangible assets with finite useful lives be amortized over their respectiveestimated useful lives.  If an intangibleasset has a finite useful life, but the precise length of that life is notknown, that intangible asset shall be amortized over the best estimate of itsuseful life.  At a minimum, we willassess the useful lives and residual values of all intangible assets on anannual basis to determine if adjustments are required.  Amortization expense on intangible assets was$8.2 million and $8.6 million for the three months ended September 30, 2005 and2004, respectively, and $22.3 million and $25.0 million for the nine monthsended September 30, 2005 and 2004, respectively.

 

                The values assigned to ourintangible assets for natural gas gathering contracts on the Jonah GasGathering Company (“Jonah”) and the Val Verde Gas Gathering Company (“Val Verde”)systems are amortized on a unit-of-production basis, based upon the actualthroughput of the systems over the expected total throughput for the lives ofthe contracts.  On a quarterly basis, wemay obtain limited production forecasts and updated throughput estimates fromsome of the producers on the systems, and as a result, we evaluate theremaining expected useful lives of the contract assets based on the bestavailable information.  During the fourthquarter of 2004 and the first and second quarters of 2005, certain limitedproduction forecasts were obtained from some of the producers on the Jonahsystem related to future expansions of the system, and as a result, weincreased our best estimate of future throughput on the system, which resultedin extensions in the remaining lives of the intangible assets.  During the fourth quarter of 2004 and thethird quarter of 2005, certain limited coal bed methane production forecastswere obtained from some of the producers on the Val Verde system whosecontracts are included in the intangible assets.  These forecasts indicated lower coal bedmethane production estimates over the contract periods, and as a result, we decreasedour best estimate of future throughput on the Val Verde system, which resultedin increases to amortization expense on the intangible assets.  Further revisions to these estimates mayoccur as 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 fractionationagreement with DEFS is being amortized over its contract period of 20years.  The amortization periods for ourother intangible assets, which include non-compete and other agreements, rangefrom 3 years to 15 years.  The valuesassigned to our crude supply and transportation intangible customer contractsare being amortized on a unit-of-production basis.

 

 

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                At September 30, 2005, we have$33.4 million of excess investment in our equity investment in CentennialPipeline LLC, which was created upon its formation.  The excess investment is included in ourequity investments account at September 30, 2005.  This excess investment is accounted for as anintangible asset with an indefinite life. We assess the intangible asset for impairment on an annual basis.

 

                The following table sets forththe estimated amortization expense of intangible assets for the years endingDecember 31 (in thousands):

 

| 2005 |   | $      | 29,573 |   |
|------|--------|--------|--------|--------|
| 2006 |   | 29,621 |   |
| 2007 |   | 33,109 |   |
| 2008 |   | 33,219 |   |
| 2009 |   | 31,213 |   |

 

 

**NOTE 3. PROPERTY, PLANT AND EQUIPMENT**

** **

                We evaluate impairment oflong-lived assets in accordance with SFAS No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*.  Long-lived assets are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Recoverability of the carrying amount of assets to be held and used ismeasured by a comparison of the carrying amount of the asset to future net cashflows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to berecognized is measured by the amount by which the carrying amount of the assetsexceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carryingamount or fair value less costs to sell.

 

                During the third quarterof 2005, our Upstream Segment was notified by a connecting carrier that theflow of its pipeline system would be reversed, which would directly impact theviability of one of our pipeline systems. This system, located in East Texas, consists of approximately 45 miles ofpipeline, six tanks of various sizes and other equipment and asset costs.  As a result of changes to the connectingcarrier, we performed an impairment test of the system and recorded a $1.8million non-cash impairment charge, included in depreciation and amortizationexpense in our consolidated statements of income, for the excess carrying valueover the fair value of the system.

 

                During the third quarter of2005, we completed an evaluation of a crude oil system included in our UpstreamSegment.  The system, located inOklahoma, consists of approximately six miles of pipelines, tanks and otherequipment and asset costs.  The usage ofthe system has declined in recent months as a result of shifting crude oilproduction into areas not supported by the system, and as such, it has becomemore economical to transport barrels by truck to our other pipelinesystems.  As a result, we performed animpairment test on the system and recorded a $0.8 million non-cash impairmentcharge, included in depreciation and amortization expense in our consolidatedstatements of income, for the excess carrying value over the fair value of thesystem.

 

                In September 2005, our Todhunterfacility, near Middletown, Ohio, experienced a propane release and fire at adehydration unit within the storage facility. The facility is included in our Downstream Segment.  The dehydration unit was destroyed due to thepropane release and fire, and as a result, we wrote off the remaining bookvalue of the asset of $0.8 million to depreciation and amortization expenseduring the third quarter of 2005.

 

                During the third quarter of2004, we completed an evaluation of our marine terminal facility in theBeaumont, Texas, area.  The facilityconsists primarily of a barge dock, a ship dock, four storage tanks and varioussegments of connecting pipelines and is included in our DownstreamSegment.  The evaluation indicated thatthe

 

 

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docks andother assets at the facility needed extensive work to continue to becommercially operational.  As a result,we performed an impairment test on the entire marine facility and recorded a$4.4 million non-cash impairment charge, included in depreciation andamortization expense in our consolidated statements of income, for the excesscarrying value over the fair value of the facility.

 

 

**NOTE 4. INTEREST RATE SWAPS**

** **

In July 2000, we enteredinto an interest rate swap agreement to hedge our exposure to increases in thebenchmark interest rate underlying our variable rate revolving creditfacility.  This interest rate swapmatured in April 2004.  We designatedthis swap agreement, which hedged exposure to variability in expected futurecash flows attributed to changes in interest rates, as a cash flow hedge.  The swap agreement was based on a notionalamount of $250.0 million.  Under the swapagreement, we paid a fixed rate of interest of 6.955% and received a floatingrate based on a three-month U.S. Dollar LIBOR rate.  Because this swap was designated as a cashflow hedge, the changes in fair value, to the extent the swap was effective,were recognized in other comprehensive income until the hedged interest costswere recognized in earnings.  FromJanuary 2004 through April 2004, we recognized an increase in interest expenseof $2.9 million related to the difference between the fixed rate and the floatingrate of interest on the interest rate swap.

In October 2001, TEProducts entered into an interest rate swap agreement to hedge its exposure tochanges in the fair value of its fixed rate 7.51% Senior Notes due 2028.  We designated this swap agreement as a fairvalue hedge.  The swap agreement has anotional 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, and receives a fixed rate of interest of 7.51%.  During the nine months ended September 30,2005 and 2004, we recognized reductions in interest expense of $4.6 million and$7.5 million, respectively, related to the difference between the fixed rateand the floating rate of interest on the interest rate swap.  During the quarter ended September 30, 2005,we measured the hedge effectiveness of this interest rate swap and noted thatno gain or loss from ineffectiveness was required to be recognized.  The fair value of this interest rate swap wasa gain of approximately $1.3 million and $3.4 million at September 30, 2005,and December 31, 2004, respectively.

**                During 2002, we entered intointerest rate swap agreements, designated as fair value hedges, to hedge ourexposure to changes in the fair value of our fixed rate 7.625% Senior Notes due2012.  The swap agreements had a combinednotional amount of $500.0 million and matured in 2012 to match the principaland maturity of the Senior Notes.  Underthe swap agreements, we paid a floating rate of interest based on a U.S. DollarLIBOR rate, plus a spread, and received a fixed rate of interest of 7.625%.  These swap agreements were later terminatedin 2002 resulting in gains of $44.9 million. The gains realized from the swap terminations have been deferred asadjustments to the carrying value of the Senior Notes and are being amortizedusing the effective interest method as reductions to future interest expense overthe remaining term of the Senior Notes. At September 30, 2005, the unamortized balance of the deferred gains was$33.5 million.  In the event of earlyextinguishment of the Senior Notes, any remaining unamortized gains would berecognized in the consolidated statement of income at the time ofextinguishment.**

** **

**                During May 2005, we executed atreasury rate lock agreement with a notional amount of $200.0 million to hedgeour exposure to increases in the treasury rate that was to be used to establishthe fixed interest rate for a debt offering that was proposed to occur in thesecond quarter of 2005.  During June2005, the proposed debt offering was cancelled, and the treasury lock wasterminated with a realized loss of $2.0 million.  The realized loss was recorded as a componentof interest expense in the consolidated statements of income in June 2005.**

** **

** **

**11**

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** **

**NOTE 5.  ACQUISITIONSAND DISPOSITIONS**

 

**Rancho Pipeline**

 

                In connection with ouracquisition of crude oil assets in 2000, we acquired an approximate 23.5%undivided joint interest in the Rancho Pipeline, which was a crude oil pipelinesystem from West Texas to Houston, Texas. In March 2003, the Rancho Pipeline ceased operations, and segments ofthe pipeline were sold to certain of the owners that previously held undividedinterests in the pipeline.  We acquired241 miles of the pipeline in exchange for cash of $5.5 million and ourinterests in other portions of the Rancho Pipeline.  We sold 183 miles of the segment we acquiredto other entities for cash and assets valued at approximately $8.5million.  We recorded a net gain of $3.9million on the transactions in the second quarter of 2003.  During the third quarter of 2004, we sold ourremaining interest in the original Rancho Pipeline system for a net gain of$0.4 million. These gains are included in the gains on sales of assets in ourconsolidated statements of income in the 2004 period.

 

**MexiaPipeline**

On March 31, 2005, we purchased crude oil pipeline assets for $7.1million from BP Pipelines (North America) Inc. (“BP”).  The assets include approximately 158 miles ofpipeline, which extend from Mexia, Texas, to the Houston, Texas, area and twostations in south Houston with connections to a BP pipeline that originates insouth Houston.  We funded the purchasethrough borrowings under our revolving credit facility.  We allocated the purchase price to property,plant and equipment, and we accounted for the acquisition of these assets underthe purchase method of accounting.  We areintegrating these assets into our South Texas pipeline system, included in ourUpstream Segment, which will allow us to realize synergies within our existingasset base and will provide future growth opportunities.

 

**Crude OilStorage and Terminaling Assets**

On April 1, 2005, we purchased crude oil storage and terminaling assetsin Cushing, Oklahoma, from Koch Supply & Trading, L.P. for $35.4million.  The assets consist of eightstorage tanks with 945,000 barrels of storage capacity, receipt and deliverymanifolds, interconnections to several pipelines, crude oil inventory andapproximately 70 acres of land.  Wefunded the purchase through borrowings under our revolving creditfacility.  We allocated the purchaseprice to property, plant and equipment and inventory, and we accounted for theacquisition of these assets under the purchase method of accounting.  The storage and terminaling assets willcomplement our existing infrastructure in Cushing and strengthen our gatheringand marketing business in our Upstream Segment.

 

**RefinedProducts Terminal and Truck Rack**

                OnJuly 12, 2005, we purchased a refined products terminal and two-bay truck loadingrack in North Little Rock, Arkansas, for $6.8 million from Exxon MobilCorporation.  The assets include threestorage tanks and a two-bay truck loading rack. We funded the purchase through borrowings under our revolving creditfacility.  We allocated the purchase priceto property, plant and equipment and inventory, and we accounted for the acquisitionof these assets under the purchase method of accounting.  The terminal serves the central Arkansasrefined products market and complements our existing Downstream Segmentinfrastructure in North Little Rock, Arkansas.

 

**Genco Assets**

 

On July 15, 2005, we acquired from Texas Genco LLC (“Genco”) all of itsinterests in certain companies that own a 90-mile pipeline system and 5.5million barrels of storage capacity for $62.1 million.  We funded the purchase through borrowingsunder our revolving credit facility.  Weallocated the purchase price to property, plant

 

 

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and equipment, and we accounted for the acquisition ofthese assets under the purchase method of accounting.  This acquisition was made as part of anexpansion of our refined products origin capabilities in the Houston, Texas,and Texas City, Texas, areas.  The assetsof the purchased companies will be integrated into our Downstream Segmentorigin infrastructure in Texas City and Baytown, Texas.  The integration and other system enhancementsshould be in service by the fourth quarter of 2006, at an estimated cost of$45.0 million.  The strategic location ofthese assets, with refined products interconnections to major exchangeterminals in the Houston area, will provide significant long-term value to ourcustomers and the Texas Gulf Coast refining and logistics system.

 

 

**NOTE 6.  INVENTORIES**

 

**               **Inventories are valued at the lower of cost (based onweighted average cost method) or market. The costs of inventories did not exceed market values at September 30,2005, and December 31, 2004.  The majorcomponents of inventories were as follows (in thousands):

 
| ** **                                | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| Crude oil (1)                             |       | $                       | 114,407    |                   | $          | 3,690 |   |
| Refined products                          |       | 7,335                   |       | 5,665                  |       |
| LPGs                                      |       | 2,511                   |       | —                 |       |
| Lubrication oils and  specialty chemicals |       | 5,015                   |       | 4,002                  |       |
| Materials and supplies                    |       | 6,774                   |       | 6,135                  |       |
| Other                                     |       | 2,963                   |       | 29                     |       |
| Total                                     |       | $                       | 139,005    |                   | $          | 19,521 |   |
|                                           |            |                         |            |                        |            |  |  |  |  |

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**(1) At September 30, 2005, substantially all of our crude oil inventory wassubject 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”).  The remaining 50% interest is owned byConocoPhillips.  Seaway owns a pipelinethat carries mostly imported crude oil from a marine terminal at Freeport,Texas, to Cushing, Oklahoma, and from a marine terminal at Texas City, Texas,to refineries in the Texas City and Houston, Texas, areas.  The Seaway Crude Pipeline Company PartnershipAgreement provides for varying participation ratios throughout the life of theSeaway partnership.  From June 2002through May 2006, we receive 60% of revenue and expense of Seaway.  Thereafter, we will receive 40% of revenueand expense of Seaway.   During the ninemonths ended September 30, 2005 and 2004, we received distributions from Seawayof $17.5 million and $30.9 million, respectively.

 

                TE Products owns a 50% ownershipinterest in Centennial Pipeline Company LLC (“Centennial”), and MarathonPetroleum Company LLC (“Marathon”) owns the remaining 50% interest. Centennialowns an interstate refined petroleum products pipeline extending from the upperTexas Gulf Coast to central Illinois. During the nine months ended September 30, 2005, TE Products has notinvested any additional funds in Centennial. During the nine months ended September30, 2004, TE Products invested an additional $1.5 million in Centennial, whichis included in the equity investment balance at September 30, 2005.  TE Products has not received anydistributions from Centennial since its formation.

 

On January 1, 2003, TEProducts and Louis Dreyfus Energy Services L.P. (“Louis Dreyfus”) formed MontBelvieu Storage Partners, L.P. (“MB Storage”). TE Products and Louis Dreyfus each own a 50% ownership interest

 

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in MBStorage.  MB Storage owns storagecapacity at the Mont Belvieu fractionation and storage complex and a short haultransportation shuttle system that ties Mont Belvieu, Texas, to the upper TexasGulf Coast energy marketplace.  MBStorage is a service-oriented, fee-based venture serving the fractionation,refining and petrochemical industries with transportation, terminaling andstorage.  MB Storage has no commodity tradingactivity.   TE Products operates thefacilities for MB Storage.

For the year endedDecember 31, 2005, TE Products will receive the first $1.7 million per quarter(or $6.78 million on an annual basis) of MB Storage’s income beforedepreciation expense, as defined in the operating agreement.  For the year ended December 31, 2004, TEProducts received the first $1.8 million per quarter (or $7.15 million on anannual basis) of MB Storage’s income before depreciation expense.  TE Products’ share of MB Storage’s earningsis adjusted annually by the partners of MB Storage.  Any amount of MB Storage’s annual incomebefore depreciation expense in excess of $6.78 million for 2005 and $7.15million for 2004 is allocated evenly between TE Products and LouisDreyfus.  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 assets contributed.  Depreciation expense on assets constructed oracquired by MB Storage subsequent to formation is allocated evenly between TEProducts and Louis Dreyfus. For the nine months ended September 30, 2005 and2004, TE Products’ sharing ratio in the earnings of MB Storage wasapproximately 64.3% and 72.3%, respectively. During the nine months ended September 30, 2005, TE Products receiveddistributions of $10.7 million from MB Storage and contributed $4.0 million toMB Storage, which includes a combination of non-cash asset transfers of $1.4 millionand cash contributions of $2.6 million. During the nine months ended September 30, 2004, TE Products receiveddistributions of $8.5 million from MB Storage and contributed $20.2 million toMB Storage, of which $16.5 million was used to acquire storage assets in April2004.

We use the equity method of accounting to account for our investmentsin Seaway, Centennial and MB Storage. Summarized combined financial information for Seaway, Centennial and MBStorage for the nine months ended September 30, 2005 and 2004, is presentedbelow (in thousands):

 

| ** ** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------|------------|--------------------------------------|------------|
| ** ** | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| Revenues   |       | $                                    | 123,224    |   | $ | 115,843 |   |
| Net income |       | 39,896                               |       | 44,344 |   |
|            |            |                                      |            |  |  |  |  |

 

Summarized combined balance sheet information for Seaway, Centennialand MB Storage as of September 30, 2005, and December 31, 2004, is presentedbelow (in thousands):

 

| ** **             | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|------------------------|------------|-----------------------------|------------|----------------------------|------------|
| Current assets         |       | $                           | 74,863     |                       | $          | 59,314 |   |
| Noncurrent assets      |       | 629,143                     |       | 633,222                    |       |
| Current liabilities    |       | 52,805                      |       | 41,209                     |       |
| Long-term debt         |       | 140,000                     |       | 140,000                    |       |
| Noncurrent liabilities |       | 18,952                      |       | 20,440                     |       |
| Partners’ capital |       | 492,249                     |       | 490,887                    |       |
|                        |            |                             |            |                            |            |  |  |

** **

** **

**14**

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** **

**NOTE 8.  DEBT**

## ** **

## **Senior Notes**

## ** **

On January 27, 1998, TEProducts completed the issuance of $180.0 million principal amount of 6.45%Senior Notes due 2008, and $210.0 million principal amount of 7.51% SeniorNotes due 2028 (collectively the “TE Products Senior Notes”).  The 6.45% TE Products Senior Notes wereissued at a discount of $0.3 million and are being accreted to their face valueover the term of the notes.  The 6.45% TEProducts Senior Notes due 2008 are not subject to redemption prior to January15, 2008.  The 7.51% TE Products SeniorNotes due 2028, issued at par, may be redeemed at any time after January 15,2008, at the option of TE Products, in whole or in part, at a premium.

The TE Products SeniorNotes do not have sinking fund requirements. Interest on the TE Products Senior Notes is payable semiannually inarrears on January 15 and July 15 of each year. The TE Products Senior Notes are unsecured obligations of TE Productsand rank pari passu with all other unsecured and unsubordinated indebtedness ofTE Products.  The indenture governing theTE Products Senior Notes contains covenants, including, but not limited to,covenants limiting the creation of liens securing indebtedness and sale andleaseback transactions.  However, theindenture does not limit our ability to incur additional indebtedness.  As of September 30, 2005, TE Products was incompliance with the covenants of the TE Products Senior Notes.

On February 20, 2002, wecompleted the issuance of $500.0 million principal amount of 7.625% SeniorNotes due 2012.  The 7.625% Senior Noteswere issued at a discount of $2.2 million and are being accreted to their facevalue over the term of the notes.  TheSenior Notes may be redeemed at any time at our option with the payment ofaccrued interest and a make-whole premium determined by discounting remaininginterest and principal payments using a discount rate equal to the rate of theUnited States Treasury securities of comparable remaining maturity plus 35basis points.  The indenture governingour 7.625% Senior Notes contains covenants, including, but not limited to,covenants limiting the creation of liens securing indebtedness and sale andleaseback transactions.  However, theindenture does not limit our ability to incur additional indebtedness.  As of September 30, 2005, we were incompliance with the covenants of these Senior Notes.

On January 30, 2003, wecompleted the issuance of $200.0 million principal amount of 6.125% SeniorNotes due 2013.  The 6.125% Senior Noteswere issued at a discount of $1.4 million and are being accreted to their face valueover the term of the notes.  The SeniorNotes may be redeemed at any time at our option with the payment of accruedinterest and a make-whole premium determined by discounting remaining interestand principal payments using a discount rate equal to the rate of the UnitedStates Treasury securities of comparable remaining maturity plus 35 basispoints.  The indenture governing our6.125% Senior Notes contains covenants including, but not limited to, covenantslimiting the creation of liens securing indebtedness and sale and leasebacktransactions.  However, the indenturedoes not limit our ability to incur additional indebtedness.  As of September 30, 2005, we were incompliance with the covenants of these Senior Notes.

The following table summarizes the estimated fair values of the SeniorNotes as of September 30, 2005, and December 31, 2004 (in millions):

 
| ** **                                        | ** ** | ** **     | ** ** | **Fair Value**         | ** ** |
|---------------------------------------------------|------------|----------------|------------|------------------------|------------|
| ** **                                        | ** ** | **Face Value** | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|                                              |       |           |       |                   |       |   |   |
| 6.45% TE Products  Senior Notes, due January 2008 |       | $              | 180.0      |                   | $          | 185.0 |   | $ | 187.1 |   |
| 7.625% Senior Notes,  due February 2012           |       | 500.0          |       | 555.3                  |       | 569.6 |   |
| 6.125% Senior Notes,  due February 2013           |       | 200.0          |       | 206.3                  |       | 210.2 |   |
| 7.51% TE Products  Senior Notes, due January 2028 |       | 210.0          |       | 223.9                  |       | 225.6 |   |
|                                                   |            |                |            |                        |            |  |  |  |  |  |

 

 

15

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We have entered into interest rate swap agreements to hedge ourexposure to changes in the fair value on a portion of the Senior Notesdiscussed above (see Note 4.  InterestRate Swaps).

 

## **Revolving Credit Facility**

 

On June 27, 2003, weentered into a $550.0 million unsecured revolving credit facility with a three-yearterm, including the issuance of letters of credit of up to $20.0 million (“RevolvingCredit Facility”).  The interest rate isbased, at our option, on either the lender’s base rate plus a spread, or LIBORplus a spread in effect at the time of the borrowings.  The credit agreement for the Revolving CreditFacility contains certain restrictive financial covenant ratios.  Restrictive covenants in the Revolving CreditFacility limit our ability to, among other things, incur additionalindebtedness, make distributions in excess of Available Cash (see Note 9.Partners’ Capital and Distributions) and complete mergers, acquisitions andsales of assets.  On October 21, 2004, weamended our Revolving Credit Facility to (i) increase the facility size to$600.0 million, (ii) extend the term to October 21, 2009, (iii) remove certainrestrictive covenants, (iv) increase the available amount for the issuance ofletters of credit up to $100.0 million and (v) decrease the LIBOR rate spreadcharged at the time of each borrowing. On February 23, 2005, we again amended our Revolving Credit Facility toremove the requirement that DEFS must at all times own, directly or indirectly,100% of our General Partner, to allow for its acquisition by DFI (see Note 1.Organization and Basis of Presentation). During the second quarter of 2005, we used a portion of the proceedsfrom the equity offering in May 2005 to repay a portion of the Revolving CreditFacility (see Note 9.  Partners’ Capitaland Distributions).  At September 30,2005, $460.5 million was outstanding under the Revolving Credit Facility at aweighted average interest rate of 4.6%. At September 30, 2005, we were in compliance with the covenants of thiscredit agreement.

The following table summarizes the principal amounts outstanding underall of our credit facilities as of September 30, 2005, and December 31, 2004(in thousands):

 
| ** **                                                         | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
|                                                               |       |                    |       |                   |       |
| Credit Facilities:                                                 |       |                    |       |                   |       |
| Revolving Credit  Facility, due October 2009                       |       | $                       | 460,500    |                   | $          | 353,000 |   |
| 6.45% TE Products  Senior Notes, due January 2008                  |       | 179,929                 |       | 179,906                |       |
| 7.625% Senior Notes,  due February 2012                            |       | 498,604                 |       | 498,438                |       |
| 6.125% Senior Notes,  due February 2013                            |       | 198,952                 |       | 198,845                |       |
| 7.51% TE Products  Senior Notes, due January 2028                  |       | 210,000                 |       | 210,000                |       |
| Total borrowings                                                   |       | 1,547,985               |       | 1,440,189              |       |
| Adjustment to carrying  value associated with hedges of fair value |       | 34,832                  |       | 40,037                 |       |
| Total Credit Facilities                                            |       | $                       | 1,582,817  |                   | $          | 1,480,226 |   |
|                                                                    |            |                         |            |                        |            |  |  |  |  |

 

 

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

 

**Equity Offering**

 

                On May 5, 2005, we sold in an underwrittenpublic offering 6.1 million Units at $41.75 per Unit.  The proceeds from the offering, net ofunderwriting discount, totaled approximately $244.5 million.  On June 8, 2005, 865,000 Units were sold uponexercise of the underwriters’ over-allotment option granted in connection withthe offering on May 5, 2005.  Proceedsfrom the over-allotment sale, net of underwriting discount, totaled $34.7 million.

 

 

16

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Theproceeds were used to reduce indebtedness under our Revolving Credit Facility,to fund revenue generating and system upgrade capital expenditures and forgeneral partnership purposes.

 

 

## **Quarterly Distributions of Available Cash**

 

We make quarterly cash distributions of all of our Available Cash,generally defined as consolidated cash receipts less consolidated cashdisbursements and cash reserves established by the General Partner in its solediscretion.  Pursuant to the PartnershipAgreement, the Company receives incremental incentive cash distributions when unitholders’cash distributions exceed certain 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 total distributions paidduring the nine months ended September 30, 2005 and 2004 (in thousands, exceptper Unit amounts):

 
| ** **                              | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------|------------|------------------------------------------|------------|
| ** **                              | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| Limited Partner Units                   |       | $                                        | 130,694    |   | $ | 124,422 |   |
| General Partner  Ownership Interest     |       | 2,667                                    |       | 2,539 |   |
| General Partner  Incentive              |       | 50,848                                   |       | 47,438 |   |
| Total Cash  Distributions Paid          |       | $                                        | 184,209    |   | $ | 174,399 |   |
| Total Cash  Distributions Paid Per Unit |       | $                                        | 2.00       |   | $ | 1.975 |   |
|                                         |            |                                          |            |  |  |  |  |  |  |

 

                On November 7, 2005, we will paya cash distribution of $0.675 per Unit for the quarter ended September 30,2005.  The third quarter 2005 cashdistribution will total $66.9 million.

 

**General Partner’sInterest**

 

As of September 30, 2005, and December 31, 2004, we haddeficit balances of $50.9 million and $33.0 million, respectively, in ourGeneral Partner’s equity account.  Thesenegative balances do not represent assets to us and do not representobligations of the General Partner to contribute cash or other property tous.  The General Partner’s equity accountgenerally 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 ninemonths ended September 30, 2005, the General Partner was allocated $35.6million (representing 29.27%) of our net income and received $53.5 million incash distributions.

Capital Accounts, as defined under our PartnershipAgreement, are maintained for our General Partner and our limitedpartners.  The Capital Account provisionsof our Partnership Agreement incorporate principles established for U.S.federal income tax purposes and are not comparable to the equity accountsreflected under accounting principles generally accepted in the United Statesin our financial statements.  Under ourPartnership Agreement, the General Partner is required to make additional capitalcontributions to us upon the issuance of any additional Units if necessary tomaintain a Capital Account balance equal to 1.999999% of the total Capital 

 

17

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Accountsof all partners.  At September 30, 2005,and December 31, 2004, the General Partner’s Capital Account balancesubstantially exceeded this requirement.

                Net income is allocated betweenthe General Partner and the limited partners in the same proportion asaggregate cash distributions made to the General Partner and the limited partnersduring the period.  This is generallyconsistent with the manner of allocating net income under our PartnershipAgreement.  Net income determined underour Partnership Agreement, however, incorporates principles established forU.S. federal income tax purposes and is not comparable to net income reflectedunder accounting principles generally accepted in the United States in ourfinancial statements.

Cash distributions that we make during a period may exceedour net income for the period.  We makequarterly cash distributions of all of our Available Cash, generally defined asconsolidated cash receipts less consolidated cash disbursements and cashreserves established by the General Partner in its sole discretion.  Cash distributions in excess of net incomeallocations and capital contributions during the year ended December 31, 2004,and the nine months ended September 30, 2005, resulted in deficits in theGeneral Partner’s equity account at December 31, 2004, and September 30,2005.  Future cash distributions thatexceed net income will result in an increase in the deficit balance in theGeneral Partner’s equity account.

                According to the PartnershipAgreement, in the event of our dissolution, after satisfying our liabilities,our remaining assets would be divided among our limited partners and theGeneral Partner generally in the same proportion as Available Cash butcalculated on a cumulative basis over the life of the Partnership.  If a deficit balance still remains in theGeneral Partner’s equity account after all allocations are made between thepartners, the General Partner would not be required to make whole any suchdeficit.

 

 

**NOTE 10. EMPLOYEE BENEFIT PLANS**

 

## **Retirement Plans**

## ** **

The TEPPCO Retirement Cash Balance Plan (“TEPPCO RCBP”) is a non-contributory,trustee-administered pension plan.  Inaddition, the TEPPCO Supplemental Benefit Plan (“TEPPCO SBP”) is anon-contributory, nonqualified, defined benefit retirement plan, in whichcertain executive officers participate. The TEPPCO SBP was established to restore benefit reductions caused bythe maximum benefit limitations that apply to qualified plans.  The benefit formula for all eligibleemployees is a cash balance formula. Under a cash balance formula, a plan participant accumulates a retirementbenefit based upon pay credits and current interest credits.  The pay credits are based on a participant’ssalary, age and service.  We use aDecember 31 measurement date for these plans.

 

On May 27, 2005, the TEPPCO RCBP and the TEPPCO SBP were amended.  Effective May 31, 2005, participation in theTEPPCO RCBP was frozen, and no new participants were eligible to be covered bythe plan after that date.  EffectiveDecember 31, 2005, all plan benefits accrued will be frozen, participants willnot receive additional pay credits after that date, and all plan participantswill be 100% vested regardless of their years of service.  The TEPPCO RCBP plan will be terminatedeffective December 31, 2005, and plan participants will have the option toreceive their benefits either through a lump sum payment in 2006 or through anannuity.  For those plan participants whoelect to receive an annuity, we will purchase an annuity contract from aninsurance company in which the plan participant will own the annuity, absolvingus of any future obligation to the participant. Participants in the TEPPCO SBP will receive pay credits through November30, 2005, and will receive lump sum benefit payments in December 2005.  Both the RCBP and SBP benefit payments arediscussed below.

 

 

18

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In June 2005, we recorded a curtailment charge of $0.1 million inaccordance 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, thefollowing assumptions were changed for purposes of determining the net periodicbenefit costs for the remainder of 2005: the discount rate, the long-term rateof return on plan assets, and the assumed mortality table.  The discount rate was decreased from 5.75% to5.00% to reflect rates of returns on bonds currently available to settle theliability.   The expected long-term rateof return on plan assets was changed from 8% to 2% due to the movement of planfunds from equity investments into short-term money market funds.  The mortality table was changed to reflectoverall improvements in mortality experienced by the general population.  The curtailment charge arose due to theaccelerated recognition of the unrecognized prior service costs.  We expect to record additional settlementcharges of approximately $0.2 million in the fourth quarter of 2005 relating tothe TEPPCO SBP and approximately $3.2 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 the TEPPCO RCBP andthe TEPPCO SBP for the three months and nine months ended September 30, 2005and 2004, were as follows (in thousands):

 
| ** **                                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                     | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost benefit  earned during the period |       | $                                     | 1,147      |                                 | $          | 913 |   | $ | 3,246 |   | $ | 2,739 |   |
| Interest cost on  projected benefit obligation |       | 233                                   |       | 180                                  |       | 701 |   | 540 |   |
| Expected return on plan  assets                |       | (76                                   | )          | (220                                 | )          | (595 | ) | (660 | ) |
| Amortization of prior  service cost            |       | 1                                     |       | 2                                    |       | 4 |   | 6 |   |
| Recognized net  actuarial loss                 |       | 37                                    |       | 14                                   |       | 92 |   | 42 |   |
| SFAS 88 curtailment  charge                    |       | —                                |       | —                               |       | 50 |   | — |   |
| Net pension benefits  costs                    |       | $                                     | 1,342      |                                 | $          | 889 |   | $ | 3,498 |   | $ | 2,667 |   |

## ** **

## **Other Postretirement Benefits**

## ** **

We provide certain health care and life insurance benefits for retiredemployees on a contributory and non-contributory basis (“TEPPCO OPB”).  Employees become eligible for these benefitsif they meet certain age and service requirements at retirement, as defined inthe plans.  We provide a fixed dollarcontribution, which does not increase from year to year, towards retiredemployee medical costs.  The retiree paysall health care cost increases due to medical inflation.  We use a December 31 measurement date forthis plan.

 

In May 2005, benefits provided to employees under the TEPPCO OPB werechanged.  Employees eligible for thesebenefits will receive them through December 31, 2005, however, effective December31, 2005, these benefits will be terminated. In June 2005, as a result of this change in benefits and in accordancewith SFAS No. 106, *Employers’ Accounting forPostretirement Benefits Other Than Pensions*, we recorded acurtailment credit of approximately $2.6 million in our accumulatedpostretirement obligation, partially offset by a curtailment charge ofapproximately $1.0 million related to the accelerated recognition of theunrecognized prior service costs.  Thenet effect of these curtailment adjustments was to reduce our accumulatedpostretirement obligation to the total of the expected remaining 2005 paymentsunder the TEPPCO OPB.  The current employeesparticipating in this plan were transferred to DEFS, who will continue toprovide postretirement benefits to these retirees.  We recorded a one-time settlement to DEFS inthe third quarter of 2005 of $0.4 million for the remaining postretirementbenefits.

 

 

19

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The components of net postretirement benefits cost for the TEPPCO OPBfor the three and nine months ended September 30, 2005 and 2004, were asfollows (in thousands):

 
| ** **                                                      | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost benefit  earned during the period                  |       | $                                     | —     |                                 | $          | 41 |   | $ | 81 |   | $ | 123 |   |
| Interest cost on  accumulated postretirement benefit obligation |       | —                                |       | 38                                   |       | 69 |   | 114 |   |
| Amortization of prior  service cost                             |       | —                                |       | 32                                   |       | 53 |   | 96 |   |
| Recognized net  actuarial loss                                  |       | —                                |       | —                               |       | 4 |   | — |   |
| SFAS 106 curtailment  credit                                    |       | —                                |       | —                               |       | (1,676 | ) | — |   |
| Net postretirement  benefits costs                              |       | $                                     | —     |                                 | $          | 111 |   | $ | (1,469 | ) | $ | 333 |   |

 

Effective June 1, 2005, the payroll functions performed by DEFS for ourGeneral Partner were transferred from DEFS to EPCO.  For those employees who were receivingcertain other postretirement benefits at the time of the acquisition of ourGeneral Partner by DFI, DEFS will continue to provide these benefits to thoseemployees.  Effective June 1, 2005, EPCO beganproviding certain other postretirement benefits to those employees who becameeligible for the benefits after June 1, 2005, and will charge those benefitrelated costs to us.  As a result ofthese changes, we recorded a $1.2 million reduction in our other postretirementobligation in June 2005.

 

## **Estimated Future Benefit Contributions**

## ** **

We expect to contribute approximately $1.1 million to our retirementplans and other postretirement benefit plans in 2005.

 

 

**NOTE 11. SEGMENT INFORMATION**

 

We have three reportingsegments:

•                  transportation and storage of refinedproducts, LPGs and petrochemicals, which operates as the Downstream Segment;

•                  gathering, transportation, marketingand storage of crude oil and distribution of lubrication oils and specialtychemicals, which operates as the Upstream Segment; and

 

•                  gathering of natural gas,fractionation of NGLs and transportation of NGLs, which operates as theMidstream Segment.

The amounts indicatedbelow as “Partnership and Other” relate primarily to intersegment eliminationsand assets that we hold that have not been allocated to any of our reportingsegments.

Our Downstream Segmentrevenues are earned from transportation and storage of refined products andLPGs, intrastate transportation of petrochemicals, sale of product inventoryand other ancillary services. The two largest operating expense items of theDownstream Segment are labor and electric power.  We generally realize higher revenues duringthe first 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 are generally higher from November throughMarch

 

20

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due to higherdemand in the Northeast for propane, a major fuel for residential heating.  Our Downstream Segment also includes theresults of operations of the northern portion of the Dean Pipeline, whichtransports refinery grade propylene from Mont Belvieu to Point Comfort,Texas.  Our Downstream Segment alsoincludes our equity investments in Centennial and MB Storage (see Note 7.  Equity Investments).

Our Upstream Segmentrevenues are earned from gathering, transportation, marketing and storage ofcrude oil and distribution of lubrication oils and specialty chemicals,principally in Oklahoma, 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 of the crude oil to local refineries, marketers or other end users.  Our Upstream Segment also includes our equityinvestment in Seaway (see Note 7. Equity Investments).  Seaway consists of large diameter pipelinesthat transport crude oil from Seaway’s marine terminals on the U.S. Gulf Coastto Cushing, Oklahoma, a crude oil distribution point for the central UnitedStates, and to refineries in the Texas City and Houston areas.

Our Midstream Segmentrevenues are earned from the fractionation of NGLs in Colorado, transportationof NGLs from two trunkline NGL pipelines in South Texas, two NGL pipelines inEast Texas and a pipeline system (Chaparral) from West Texas and New Mexico toMont Belvieu; the gathering of natural gas in the Green River Basin insouthwestern Wyoming, through Jonah, and the gathering of coal bed methane (“CBM”)and conventional natural gas in the San Juan Basin in New Mexico and Colorado,through Val Verde.

                The table below includesfinancial information by reporting segment for the three months and nine monthsended September 30, 2005 and 2004 (in thousands):

 
| ** **                             | ** ** | **Three Months Ended September  30, 2005** | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|
| ** **                             | ** ** | **Downstream Segment**                     | ** ** | **Upstream  Segment** | ** ** | **Midstream Segment** | ** ** | **Segments  Total** | ** ** | **Partnership and Other** | ** ** | **Consolidated** | ** ** |
| ** **                             | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales of petroleum  products           |       | $                                          | —     |   | $ | 2,367,984 |   | $ | 2,880 |   | $ | 2,370,864 |   | $ | (154 | ) | $ | 2,370,710 |   |
| Operating revenues                     |       | 66,094                                     |       | 12,750 |   | 54,430 |   | 133,274 |   | (188 | ) | 133,086 |   |
| Purchases of petroleum  products       |       | —                                     |       | 2,350,107 |   | 2,623 |   | 2,352,730 |   | (188 | ) | 2,352,542 |   |
| Operating expenses,  including power   |       | 41,405                                     |       | 18,956 |   | 16,048 |   | 76,409 |   | (154 | ) | 76,255 |   |
| Depreciation and  amortization expense |       | 10,098                                     |       | 6,471 |   | 14,391 |   | 30,960 |   | — |   | 30,960 |   |
| Gains on sales of  assets              |       | (24                                        | )          | (7 | ) | — |   | (31 | ) | — |   | (31 | ) |
| Operating income                       |       | 14,615                                     |       | 5,207 |   | 24,248 |   | 44,070 |   | — |   | 44,070 |   |
| Equity earnings                        |       | 524                                        |       | 5,571 |   | — |   | 6,095 |   | — |   | 6,095 |   |
| Other income, net                      |       | 306                                        |       | 103 |   | 75 |   | 484 |   | — |   | 484 |   |
| Earnings before  interest              |       | $                                          | 15,445     |   | $ | 10,881 |   | $ | 24,323 |   | $ | 50,649 |   | $ | — |   | $ | 50,649 |   |
|                                        |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

 

21

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| ** **                             | ** ** | **Three Months Ended September  30, 2004** | ** ** |
|----------------------------------------|------------|--------------------------------------------|------------|
| ** **                             | ** ** | **Downstream Segment**                     | ** ** | **Upstream  Segment** | ** ** | **Midstream Segment** | ** ** | **Segments  Total** | ** ** | **Partnership and Other** | ** ** | **Consolidated** | ** ** |
| ** **                             | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales of petroleum  products           |       | $                                          | —     |   | $ | 1,358,220 |   | $ | 1,734 |   | $ | 1,359,954 |   | $ | — |   | $ | 1,359,954 |   |
| Operating revenues                     |       | 68,546                                     |       | 11,866 |   | 49,961 |   | 130,373 |   | (317 | ) | 130,056 |   |
| Purchases of petroleum  products       |       | —                                     |       | 1,344,613 |   | 1,381 |   | 1,345,994 |   | (317 | ) | 1,345,677 |   |
| Operating expenses,  including power   |       | 43,419                                     |       | 17,804 |   | 16,601 |   | 77,824 |   | — |   | 77,824 |   |
| Depreciation and  amortization expense |       | 12,818                                     |       | 3,268 |   | 14,191 |   | 30,277 |   | — |   | 30,277 |   |
| Gains on sales of  assets              |       | (472                                       | )          | (377 | ) | — |   | (849 | ) | — |   | (849 | ) |
| Operating income                       |       | 12,781                                     |       | 4,778 |   | 19,522 |   | 37,081 |   | — |   | 37,081 |   |
| Equity earnings  (losses)              |       | (322                                       | )          | 5,943 |   | — |   | 5,621 |   | — |   | 5,621 |   |
| Other income, net                      |       | 203                                        |       | 60 |   | 21 |   | 284 |   | — |   | 284 |   |
| Earnings before  interest              |       | $                                          | 12,662     |   | $ | 10,781 |   | $ | 19,543 |   | $ | 42,986 |   | $ | — |   | $ | 42,986 |   |
|                                        |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                             | ** ** | **Nine Months Ended September 30,  2005** | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **Downstream Segment**                    | ** ** | **Upstream  Segment** | ** ** | **Midstream Segment** | ** ** | **Segments  Total** | ** ** | **Partnership and Other** | ** ** | **Consolidated** | ** ** |
| ** **                             | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales of petroleum  products           |       | $                                         | —     |   | $ | 5,714,353 |   | $ | 7,337 |   | $ | 5,721,690 |   | $ | (154 | ) | $ | 5,721,536 |   |
| Operating revenues                     |       | 207,699                                   |       | 36,161 |   | 157,622 |   | 401,482 |   | (2,237 | ) | 399,245 |   |
| Purchases of petroleum  products       |       | —                                    |       | 5,665,136 |   | 5,799 |   | 5,670,935 |   | (2,237 | ) | 5,668,698 |   |
| Operating expenses,  including power   |       | 117,271                                   |       | 49,615 |   | 41,844 |   | 208,730 |   | (154 | ) | 208,576 |   |
| Depreciation and  amortization expense |       | 29,460                                    |       | 13,623 |   | 39,932 |   | 83,015 |   | — |   | 83,015 |   |
| Gains on sales of  assets              |       | (131                                      | )          | (59 | ) | (407 | ) | (597 | ) | — |   | (597 | ) |
| Operating income                       |       | 61,099                                    |       | 22,199 |   | 77,791 |   | 161,089 |   | — |   | 161,089 |   |
| Equity earnings                        |       | 574                                       |       | 19,829 |   | — |   | 20,403 |   | — |   | 20,403 |   |
| Other income, net                      |       | 576                                       |       | 132 |   | 177 |   | 885 |   | — |   | 885 |   |
| Earnings before  interest              |       | $                                         | 62,249     |   | $ | 42,160 |   | $ | 77,968 |   | $ | 182,377 |   | $ | — |   | $ | 182,377 |   |
|                                        |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

22

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| ** **                             | ** ** | **Nine Months Ended September 30,  2004** | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **Downstream Segment**                    | ** ** | **Upstream  Segment** | ** ** | **Midstream Segment** | ** ** | **Segments  Total** | ** ** | **Partnership and Other** | ** ** | **Consolidated** | ** ** |
| ** **                             | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales of petroleum  products           |       | $                                         | —     |   | $ | 3,770,006 |   | $ | 4,868 |   | $ | 3,774,874 |   | $ | — |   | $ | 3,774,874 |   |
| Operating revenues                     |       | 205,719                                   |       | 37,430 |   | 146,994 |   | 390,143 |   | (2,382 | ) | 387,761 |   |
| Purchases of petroleum  products       |       | —                                    |       | 3,728,345 |   | 4,367 |   | 3,732,712 |   | (2,382 | ) | 3,730,330 |   |
| Operating expenses,  including power   |       | 122,020                                   |       | 46,880 |   | 46,487 |   | 215,387 |   | — |   | 215,387 |   |
| Depreciation and  amortization expense |       | 31,106                                    |       | 9,381 |   | 44,021 |   | 84,508 |   | — |   | 84,508 |   |
| Gains on sales of  assets              |       | (489                                      | )          | (484 | ) | — |   | (973 | ) | — |   | (973 | ) |
| Operating income                       |       | 53,082                                    |       | 23,314 |   | 56,987 |   | 133,383 |   | — |   | 133,383 |   |
| Equity earnings  (losses)              |       | (2,069                                    | )          | 24,923 |   | — |   | 22,854 |   | — |   | 22,854 |   |
| Other income, net                      |       | 648                                       |       | 257 |   | 95 |   | 1,000 |   | — |   | 1,000 |   |
| Earnings before  interest              |       | $                                         | 51,661     |   | $ | 48,494 |   | $ | 57,082 |   | $ | 157,237 |   | $ | — |   | $ | 157,237 |   |
|                                        |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

                The following table shows totalassets, capital expenditures and non-cash investing activities for each segmentas of and for the periods ended September 30, 2005, and December 31, 2004 (inthousands):

 
| ** **                     | ** ** | **Downstream Segment** | ** ** | **Upstream  Segment** | ** ** | **Midstream Segment** | ** ** | **Segments  Total** | ** ** | **Partnership and Other** | ** ** | **Consolidated** | ** ** |
|--------------------------------|------------|------------------------|------------|-----------------------|------------|-----------------------|------------|---------------------|------------|---------------------------|------------|------------------|------------|
| ** **                     | ** ** | ** **             | ** ** | ** **            | ** ** | ** **            | ** ** | ** **          | ** ** | ** **                | ** ** | ** **       | ** ** |
| September 30, 2005:            |       |                   |       |                  |       |                  |       |                |       |                      |       |             |       |
| Total assets                   |       | $                      | 1,052,883  |                  | $          | 1,514,351             |       | $                   | 1,241,780  |                      | $          | 3,809,014        |       | $ | (6,518 | ) | $ | 3,802,496 |   |
| Capital expenditures           |       | 38,617                 |       | 30,677                |       | 78,089                |       | 147,383             |       | 680                       |       | 148,063          |       |
| Non-cash investing  activities |       | 1,429                  |       | —                |       | —                |       | 1,429               |       | —                    |       | 1,429            |       |
| ** **                     | ** ** | ** **             | ** ** | ** **            | ** ** | ** **            | ** ** | ** **          | ** ** | ** **                | ** ** | ** **       | ** ** |
| December 31, 2004:             |       |                   |       |                  |       |                  |       |                |       |                      |       |             |       |
| Total assets                   |       | $                      | 967,917    |                  | $          | 1,070,477             |       | $                   | 1,184,184  |                      | $          | 3,222,578        |       | $ | (25,949 | ) | $ | 3,196,629 |   |
| Capital expenditures           |       | 80,930                 |       | 37,448                |       | 45,075                |       | 163,453             |       | 694                       |       | 164,147          |       |
|                                |            |                        |            |                       |            |                       |            |                     |            |                           |            |                  |            |  |  |  |  |  |  |  |

 

                The following table reconcilesthe segments’ total earnings before interest to consolidated net income for thethree months and nine months ended September 30, 2005 and 2004 (in thousands):

 
| ** **                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Earnings before  interest |       | $                                     | 50,649     |                                 | $          | 42,986 |   | $ | 182,377 |   | $ | 157,237 |   |
| Interest expense—net |       | (19,726                               | )          | (17,131                              | )          | (60,640 | ) | (53,190 | ) |
| Net income                |       | $                                     | 30,923     |                                 | $          | 25,855 |   | $ | 121,737 |   | $ | 104,047 |   |
|                           |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |

 

 

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**NOTE 12.  COMMITMENTS AND CONTINGENCIES**

** **

**Litigation**

 

In the fall of 1999 andon December 1, 2000, the General Partner and the Partnership were named asdefendants in two separate lawsuits in Jackson County Circuit Court, JacksonCounty, Indiana, styled *Ryan E. McCleery andMarcia S. McCleery, et al. v. Texas Eastern Corporation, et al.*(includingthe General Partner and Partnership) and*Gilbert Richards and JeanRichards v. Texas Eastern Corporation, et al.*(including the GeneralPartner and Partnership).* *In both cases, the plaintiffscontend, among other things, that we and other defendants stored and disposedof toxic and hazardous substances and hazardous wastes in a manner that causedthe materials to be released into the air, soil and water.  They further contend that the release causeddamages to the plaintiffs.  In theircomplaints, the plaintiffs allege strict liability for both personal injury andproperty damage together with gross negligence, continuing nuisance, trespass,criminal mischief and loss of consortium. The plaintiffs are seekingcompensatory, punitive and treble damages. On January 27, 2005, we entered into Release and Settlement Agreementswith the McCleery plaintiffs and the Richards plaintiffs dismissing all ofthese plaintiffs’ claims.  The settlementterms included a $2.0 million payment to the plaintiffs, which was accrued atDecember 31, 2004.

Although we did notsettle with all 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 not believe that theoutcome of these remaining claims will have a material adverse effect on ourfinancial position, results of operations or cash flows.

On December 21, 2001, TEProducts was named as a defendant in a lawsuit in the 10th Judicial District,Natchitoches Parish, Louisiana, styled *Rebecca L. Grisham et al.v. TE Products Pipeline Company, Limited Partnership*.  In this case, the plaintiffs contend that ourpipeline, which crosses the plaintiffs’ property, leaked toxic products ontotheir property and, consequently caused damages to them.  We have filed an answer to the plaintiffs’petition denying the allegations, and we are defending ourselves vigorouslyagainst the lawsuit.  The plaintiffs havenot stipulated the amount of damages they are seeking in the suit; however,this case is covered by insurance.  We donot believe that the outcome of this lawsuit will have a material adverseeffect on our financial position, results of operations or cash flows.

In May 2003, the GeneralPartner was named as a defendant in a lawsuit styled *John R.James, et al. v. J Graves Insulation Company, et al.* as filed in thefirst Judicial District Court, Caddo Parish, Louisiana.  There are numerous plaintiffs identified inthe action that are alleged to have suffered damages as a result of allegedexposure to asbestos-containing products and materials.  According to the petition and as a result ofa preliminary investigation, the General Partner believes that the only claimasserted against it results from one individual for the period from July 1971through June 1972, who is alleged to have worked on a facility owned by theGeneral 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 claims involve numerousemployers and alleged job sites.  TheGeneral Partner has been unable to confirm involvement by the General Partneror its predecessors with the alleged location, and it is uncertain at this timewhether this case is covered by insurance. Discovery is planned, and theGeneral Partner intends to defend itself vigorously against this lawsuit.  The plaintiffs have not stipulated the amountof damages that they are seeking in this suit. We are obligated to reimburse the General Partner for any costs itincurs related to this lawsuit.  Wecannot estimate the loss, if any, associated with this pending lawsuit.  We do not believe that the outcome of thislawsuit will have a material adverse effect on our financial position, resultsof operations or cash flows.

On August 5, 2005, we werenamed as a third-party defendant in a matter styled *ConocoPhillips,et al. v. BP Amoco Seaway Products Pipeline Company as filed in the 55thJudicial District of Harris County, Texas*.  

 

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ConocoPhillipsalleges a right to indemnity from BP Amoco Seaway Products Pipeline Company (“BPAmoco”) for tax liability incurred by ConocoPhillips as a result of the reversemerger of Seaway Pipeline Company (the “Original Seaway Partnership”).  The reverse merger of the Original SeawayPartnership was undertaken in preparation for our purchase of ARCO Pipe LineCompany pursuant to the Amended and Restated Purchase Agreement (the “PurchaseAgreement”) dated May 10, 2000, between us and Atlantic Richfield Company. BPAmoco has claimed a right to indemnity from us under the Purchase Agreementshould BP Amoco have any indemnity liability to ConocoPhillips.  ConocoPhillips alleges the income taxliability to be approximately $4.0 million. Our discovery is at an early stage in this matter.  While we cannot predict the ultimate outcome,we do not believe that the outcome of this lawsuit will have a material adverseeffect on our financial position, results of operations or cash flows.

In addition to thelitigation discussed above, we have been, in the ordinary course of business, adefendant in various lawsuits and a party to various other legal proceedings,some of which are covered in whole or in part by insurance. We believe that theoutcome of these lawsuits and other proceedings will not individually or in theaggregate have a future material adverse effect on our consolidated financialposition, results of operations or cash flows.

**RegulatoryMatters**

Our operations aresubject to federal, state and local laws and regulations governing thedischarge of materials into the environment. Failure to comply with these lawsand regulations may result in the assessment of administrative, civil andcriminal penalties, imposition of injunctions delaying or prohibiting certainactivities and the need to perform investigatory and remedial activities.  Although we believe our operations are inmaterial compliance with applicable environmental laws and regulations, risksof significant costs and liabilities are inherent in pipeline operations, andwe cannot assure you that significant costs and liabilities will not beincurred. Moreover, it is possible that other developments, such asincreasingly strict environmental laws and regulations and enforcement policiesthereunder, and claims for damages to property or persons resulting from ouroperations, could result in substantial costs and liabilities to us.  We believe that changes in environmental lawsand regulations will not have a material adverse effect on our financialposition, results of operations or cash flows in the near term.

On March 26, 2004, aninitial decision in *ARCO Products Co., et al.v. SFPP*, Docket OR96-2-000, was issued by the FERC, which madeseveral significant determinations with respect to finding “changedcircumstances” under the Energy Policy Act of 1992 (“EP Act”).  The decision largely clarifies, but does notfully quantify, the standard required for a complainant to demonstrate that anoil pipeline’s rates are no longer subject to the rate protection of the EP Actby demonstrating that a substantial change in circumstances has occurred since1992 with respect to the basis 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.  Theelements identified in the decision are volume changes, allowed total returnand total cost-of-service (including major cost elements  such as rate base, tax rates and taxallowances, among others).  The FERC didreject, however, the use of changes in tax rates and income tax allowances asstandalone factors.  Judicial review ofthat decision, which has been sought by a number of parties to the case, iscurrently pending before the U.S. Court of Appeals for the District of ColumbiaCircuit.  We have not yet determined theimpact, if any, that the decision, if it is ultimately upheld, would have onour rates if they were reviewed under the criteria of this decision.

On July 20, 2004, theDistrict of Columbia Circuit issued an opinion in *BP WestCoast Products LLC v. FERC*. In reviewing a series of orders involving SFPP, L.P., the court heldamong other things that the FERC had not adequately justified its policy ofproviding an oil pipeline limited partnership with an income tax allowanceequal to the proportion of its income attributable to partnership interestsowned by corporate partners.  Under theFERC’s initial ruling, SFPP, L.P. was permitted an income tax allowance on itscost-of-service filing for the percentage of its net operating (pre-tax) incomeattributable to partnership units held by corporations, and was denied anincome tax

 

25

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allowance equal tothe percentage attributable to partnership units held by non-corporatepartners.  The court remanded the caseback to the FERC for further review.  Asa result of the court’s remand, on December 2, 2004, the FERC issued a Requestfor Comments seeking comments on whether the court’s ruling applies only to thespecific facts of the SFPP, L.P. proceeding or also extends to other capitalstructures involving partnerships and other forms of ownership.  On May 4, 2005, the FERC issued its PolicyStatement on Income Tax Allowances, which permits regulated partnerships,limited liability companies and other pass-through entities an income taxallowance on their income attributable to any owner that has an actual orpotential income tax liability on that income, regardless whether the owner isan individual or corporation.  If thereis more than one level of pass-through entities, the regulated company incomemust be traced to where the ultimate tax liability lies.  The Policy Statement is to be applied inindividual cases, and the regulated entity bears the burden of proof toestablish the tax status of its owners. On June 1, 2005, the FERC issued an Order on Remand in the SFPP, L.P.proceedings holding the Policy Statement would apply in that case andrequesting briefs on whether additional evidence was necessary to applyit.  Briefs have been filed but the FERChas not yet acted on them.  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 oncost-of-service methodology.  However,the outcome of the income tax allowance would become relevant to us should we(i) elect in the future to use cost-of-service to support our rates, or (ii) berequired to use such methodology to defend our indexed rates.

In 1994, the LouisianaDepartment of Environmental Quality (“LDEQ”) issued a compliance order forenvironmental contamination at our 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 an access agreement with an adjacentindustrial landowner who is located upgradient of the Arcadia facility.  This agreement enables the landowner toproceed with remediation activities at our Arcadia facility for which it hasaccepted shared responsibility.  AtSeptember 30, 2005, we have an accrued liability of $0.2 million forremediation costs at our Arcadia facility. We do not expect that the completion of the remediation program proposedto the LDEQ will have a future material adverse effect on our financialposition, results of operations or cash flows.

OnMarch 17, 2003, we experienced a release of 511 barrels of jet fuel from astorage tank at our Blue Island terminal located in Cook County, Illinois.  As a result of the release, we have enteredinto an Agreed Order with the State of Illinois, which required us to conductan environmental investigation.  At thistime, we have complied with the terms of the Agreed Order, and the results ofthe environmental investigation indicated there were no soil or groundwaterimpacts from the release.  On August 30,2005, a final settlement was reached with the State of Illinois.  The settlement included the payment of acivil penalty of $0.1 million and the requirement that we make certainmodifications to the equipment of the facility, none of which are expected tohave a material adverse effect on our financial position, results of operationsor cash flows.

OnJuly 27, 2004, we received notice from the United States Department of Justice(“DOJ”) of its intent to seek a civil penalty against us related to ourNovember 21, 2001, release of approximately 2,575 barrels of jet fuel from our14-inch diameter pipeline located in Orange County, Texas.  The DOJ, at the request of the EnvironmentalProtection Agency, is seeking a civil penalty against us for alleged violationsof the Clean Water Act (“CWA”) arising out of this release.  We are in discussions with the DOJ regardingthis matter and have responded to its request for additional information.  The maximum statutory penalty proposed by theDOJ for this alleged violation of the CWA is $2.1 million.  We do not expect any civil penalty to have amaterial adverse effect on our financial position, results of operations orcash flows.

At September 30, 2005, wehave an accrued liability of $4.0 million related to various sites requiringenvironmental remediation activities.  Wedo not expect that the completion of remediation programs associated with our activitieswill have a future material adverse effect on our financial position, resultsof operations or cash flows.

 

26

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**Other**

Centennial entered into credit facilities totaling $150.0 million, andas of September 30, 2005, $150.0 million was outstanding under those creditfacilities.  TE Products and Marathonhave each guaranteed one-half of the repayment of Centennial’s outstanding debtbalance under a long-term credit agreement, which expires in 2024, and ashort-term credit agreement, which expires in 2007.  The guarantees arose in order for Centennialto obtain adequate financing, and the proceeds of the credit agreements wereused to fund construction and conversion costs of its pipeline system.  Prior to the expiration of the long-termcredit agreement, TE Products could be relinquished from responsibility underthe guarantee should Centennial meet certain financial tests.  If Centennial defaults on its outstandingbalance, the estimated maximum potential amount of future payments for TEProducts and Marathon is $75.0 million each at September 30, 2005.

 

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 million each.  As a result of the catastrophic eventguarantee, TE Products has recorded a $4.7 million obligation, which representsthe present value of the estimated amount that we would have to pay under theguarantee.  In the event that acatastrophic event occurred and we were required to contribute cash to Centennial,contributions exceeding our deductible may be covered by our insurance.

 

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 the Partnership.  On March 11, 2005, the Bureau of Competitionof the Federal Trade Commission (“FTC”) delivered written notice to DFI’s legaladvisor that it was conducting a non-public investigation to determine whetherDFI’s acquisition of the General Partner may substantially lessencompetition.  The FTC has contacted theGeneral Partner requesting data.  TheGeneral Partner intends to cooperate fully with any such investigations andinquiries requested by the FTC or any other regulatory authorities.

 

 

**NOTE 13.COMPREHENSIVE INCOME**

 

SFAS No. 130, *Reporting Comprehensive Income* requires certain items suchas foreign currency translation adjustments, minimum pension liabilityadjustments and unrealized gains and losses on certain investments to bereported in a financial statement.  As ofand for the nine months ended September 30, 2005, the component ofcomprehensive income was due to a crude oil hedge.  The crude oil hedge matures in December2006.  While the crude oil hedge is ineffect, changes in the fair value of the crude oil hedge, to the extent thehedge is effective, are recognized in other comprehensive income until they arerecognized in net income in future periods. As of and for the nine months ended September 30, 2004, the component ofcomprehensive income were due to the interest rate swap related to our variablerate revolving credit facility, which was designated as a cash flow hedge.  The interest rate swap matured in April2004.  While the interest rate swap wasin effect, changes in the fair value of the cash flow hedge, to the extent thehedge was effective, were recognized in other comprehensive income until thehedge interest costs were recognized in net income.

The table belowreconciles reported net income to total comprehensive income for the threemonths and nine months ended September 30, 2005 and 2004 (in thousands):

 

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| ** **                      | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net income                      |       | $                                     | 30,923     |                                 | $          | 25,855 |   | $ | 121,737 |   | $ | 104,047 |   |
| Net income on cash flow  hedges |       | 35                                    |       | —                               |       | 35 |   | 2,902 |   |
| Total comprehensive  income     |       | $                                     | 30,958     |                                 | $          | 25,855 |   | $ | 121,772 |   | $ | 106,949 |   |
|                                 |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |

 

                The accumulated balance of othercomprehensive income related to our crude oil cash flow hedge is as follows (inthousands):

 

| Balance at December 31,  2004                      |   | $  | — |   |
|----------------------------------------------------|--------|----|--------|--------|
| Change in fair value of  crude oil cash flow hedge |   | 35 |   |
| Balance at September  30, 2005                     |   | $  | 35     |   |

** **

** **

**NOTE 14.  SUPPLEMENTALCONDENSED CONSOLIDATING FINANCIAL INFORMATION**

 

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

The followingsupplemental condensed consolidating financial information reflects ourseparate accounts, the combined accounts of the Guarantor Subsidiaries, thecombined accounts of our other non-guarantor subsidiaries, the combinedconsolidating adjustments and eliminations and our consolidated accounts forthe dates and periods indicated.  Forpurposes of the following consolidating information, our investments in oursubsidiaries and the Guarantor Subsidiaries’ investments in their subsidiariesare accounted for under the equity method of accounting.

 

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| ** **                                    | ** ** | **September 30, 2005**          | ** ** |
|-----------------------------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | **TEPPCO  Partners, L .P.**     | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **TEPPCO  Partners, L.P.  Consolidated** | ** ** |
| ** **                                    | ** ** | **(in thousands)**              | ** ** |
| Assets                                        |       |                            |       |   |   |   |   |   |   |   |   |
| Current assets                                |       | $                               | 25,988     |   | $ | 76,609 |   | $ | 978,222 |   | $ | (22,969 | ) | $ | 1,057,850 |   |
| Property, plant and  equipment—net       |       | —                          |       | 1,294,104 |   | 613,736 |   | — |   | 1,907,840 |   |
| Equity investments                            |       | 1,237,834                       |       | 475,539 |   | 206,538 |   | (1,545,380 | ) | 374,531 |   |
| Intercompany notes  receivable                |       | 1,189,428                       |       | — |   | — |   | (1,189,428 | ) | — |   |
| Intangible assets                             |       | —                          |       | 352,548 |   | 32,571 |   | — |   | 385,119 |   |
| Other assets                                  |       | 5,237                           |       | 24,064 |   | 47,855 |   | — |   | 77,156 |   |
| Total assets                                  |       | $                               | 2,458,487  |   | $ | 2,222,864 |   | $ | 1,878,922 |   | $ | (2,757,777 | ) | $ | 3,802,496 |   |
| Liabilities and  partners’ capital       |       |                            |       |   |   |   |   |   |   |   |   |
| Current liabilities                           |       | $                               | 27,683     |   | $ | 110,933 |   | $ | 849,608 |   | $ | (23,880 | ) | $ | 964,344 |   |
| Long-term debt                                |       | 1,191,557                       |       | 391,260 |   | — |   | — |   | 1,582,817 |   |
| Intercompany notes  payable                   |       | —                          |       | 581,150 |   | 608,279 |   | (1,189,429 | ) | — |   |
| Other long term  liabilities                  |       | 1,441                           |       | 14,843 |   | 1,210 |   | — |   | 17,494 |   |
| Total partners’ capital                  |       | 1,237,806                       |       | 1,124,678 |   | 419,825 |   | (1,544,468 | ) | 1,237,841 |   |
| Total liabilities and  partners’ capital |       | $                               | 2,458,487  |   | $ | 2,222,864 |   | $ | 1,878,922 |   | $ | (2,757,777 | ) | $ | 3,802,496 |   |
|                                          |       |                            |       |   |   |   |   |   |   |   |   |
|                                          | ** ** | **December 31, 2004**           |       |
| ** **                                    | ** ** | **TEPPCO  Partners, L.P.** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **TEPPCO  Partners, L.P.  Consolidated** | ** ** |
|                                          | ** ** | **(in thousands**)              |       |
| Assets                                        |       |                            |       |   |   |   |   |   |   |   |   |
| Current assets                                |       | $                               | 44,125     |   | $ | 85,992 |   | $ | 576,365 |   | $ | (62,928 | ) | $ | 643,554 |   |
| Property, plant and  equipment—net       |       | —                          |       | 1,211,312 |   | 492,390 |   | — |   | 1,703,702 |   |
| Equity investments                            |       | 1,021,476                       |       | 430,688 |   | 203,796 |   | (1,282,308 | ) | 373,652 |   |
| Intercompany notes  receivable                |       | 1,084,034                       |       | — |   | — |   | (1,084,034 | ) | — |   |
| Intangible assets                             |       | —                          |       | 372,621 |   | 34,737 |   | — |   | 407,358 |   |
| Other assets                                  |       | 5,980                           |       | 22,183 |   | 40,200 |   | — |   | 68,363 |   |
| Total assets                                  |       | $                               | 2,155,615  |   | $ | 2,122,796 |   | $ | 1,347,488 |   | $ | (2,429,270 | ) | $ | 3,196,629 |   |
| Liabilities and  partners’ capital       |       |                            |       |   |   |   |   |   |   |   |   |
| Current liabilities                           |       | $                               | 45,255     |   | $ | 142,513 |   | $ | 556,474 |   | $ | (62,930 | ) | $ | 681,312 |   |
| Long-term debt                                |       | 1,086,909                       |       | 393,317 |   | — |   | — |   | 1,480,226 |   |
| Intercompany notes  payable                   |       | —                          |       | 676,993 |   | 407,040 |   | (1,084,033 | ) | — |   |
| Other long term  liabilities                  |       | 2,003                           |       | 9,980 |   | 1,660 |   | — |   | 13,643 |   |
| Total partners’ capital                  |       | 1,021,448                       |       | 899,993 |   | 382,314 |   | (1,282,307 | ) | 1,021,448 |   |
| Total liabilities and  partners’ capital |       | $                               | 2,155,615  |   | $ | 2,122,796 |   | $ | 1,347,488 |   | $ | (2,429,270 | ) | $ | 3,196,629 |   |
|                                          |       |                            |       |   |   |   |   |   |   |   |   |
|                                               |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

29

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| ** **                | ** ** | **Three Months Ended September  30, 2005** | ** ** |
|---------------------------|------------|--------------------------------------------|------------|
| ** **                | ** ** | **TEPPCO Partners, L.P.**                  | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **TEPPCO Partners, L.P.  Consolidated** | ** ** |
| ** **                | ** ** | **(in thousands)**                         | ** ** |
| Operating revenues        |       | $                                          | —     |   | $ | 107,728 |   | $ | 2,396,410 |   | $ | (342 | ) | $ | 2,503,796 |   |
| Costs and expenses        |       | —                                     |       | 77,759 |   | 2,382,340 |   | (342 | ) | 2,459,757 |   |
| Gains on sales of  assets |       | —                                     |       | (24 | ) | (7 | ) | — |   | (31 | ) |
| Operating income          |       | —                                     |       | 29,993 |   | 14,077 |   | — |   | 44,070 |   |
| Interest expense—net |       | —                                     |       | (12,476 | ) | (7,250 | ) | — |   | (19,726 | ) |
| Equity earnings           |       | 30,923                                     |       | 13,071 |   | 5,571 |   | (43,470 | ) | 6,095 |   |
| Other income—net     |       | —                                     |       | 335 |   | 149 |   | — |   | 484 |   |
| Net income                |       | $                                          | 30,923     |   | $ | 30,923 |   | $ | 12,547 |   | $ | (43,470 | ) | $ | 30,923 |   |
|                      |       |                                       |       |   |   |   |   |   |   |   |   |

 
| ** **                | ** ** | **Three Months Ended September  30, 2004** | ** ** |
|---------------------------|------------|--------------------------------------------|------------|
| ** **                | ** ** | **TEPPCO Partners, L.P.**                  | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **TEPPCO Partners, L.P.  Consolidated** | ** ** |
| ** **                | ** ** | **(in thousands)**                         | ** ** |
| Operating revenues        |       | $                                          | —     |   | $ | 106,776 |   | $ | 1,383,551 |   | $ | (317 | ) | $ | 1,490,010 |   |
| Costs and expenses        |       | —                                     |       | 81,291 |   | 1,372,804 |   | (317 | ) | 1,453,778 |   |
| Gains on sales of  assets |       | —                                     |       | (472 | ) | (377 | ) | — |   | (849 | ) |
| Operating income          |       | —                                     |       | 25,957 |   | 11,124 |   | — |   | 37,081 |   |
| Interest expense—net |       | —                                     |       | (11,625 | ) | (5,506 | ) | — |   | (17,131 | ) |
| Equity earnings           |       | 25,855                                     |       | 11,304 |   | 5,943 |   | (37,481 | ) | 5,621 |   |
| Other income—net     |       | —                                     |       | 219 |   | 65 |   | — |   | 284 |   |
| Net income                |       | $                                          | 25,855     |   | $ | 25,855 |   | $ | 11,626 |   | $ | (37,481 | ) | $ | 25,855 |   |
|                      |       |                                       |       |   |   |   |   |   |   |   |   |

 

 

30

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| ** **                | ** ** | **Nine Months Ended September 30,  2005** | ** ** |
|---------------------------|------------|-------------------------------------------|------------|
| ** **                | ** ** | **TEPPCO Partners, L.P.**                 | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **TEPPCO Partners, L.P.  Consolidated** | ** ** |
| ** **                | ** ** | **(in thousands)**                        | ** ** |
| Operating revenues        |       | $                                         | —     |   | $ | 329,310 |   | $ | 5,793,862 |   | $ | (2,391 | ) | $ | 6,120,781 |   |
| Costs and expenses        |       | —                                    |       | 214,807 |   | 5,747,873 |   | (2,391 | ) | 5,960,289 |   |
| Gains on sales of  assets |       | —                                    |       | (538 | ) | (59 | ) | — |   | (597 | ) |
| Operating income          |       | —                                    |       | 115,041 |   | 46,048 |   | — |   | 161,089 |   |
| Interest expense—net |       | —                                    |       | (39,751 | ) | (20,889 | ) | — |   | (60,640 | ) |
| Equity earnings           |       | 121,737                                   |       | 45,767 |   | 19,829 |   | (166,930 | ) | 20,403 |   |
| Other income—net     |       | —                                    |       | 680 |   | 205 |   | — |   | 885 |   |
| Net income                |       | $                                         | 121,737    |   | $ | 121,737 |   | $ | 45,193 |   | $ | (166,930 | ) | $ | 121,737 |   |
|                      |       |                                      |       |   |   |   |   |   |   |   |   |
|                           |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                | ** ** | **Nine Months Ended September 30,  2004** | ** ** |
|---------------------------|------------|-------------------------------------------|------------|
| ** **                | ** ** | **TEPPCO Partners, L.P.**                 | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor Subsidiaries** | ** ** | **Consolidating Adjustments** | ** ** | **TEPPCO Partners, L.P.  Consolidated** | ** ** |
| ** **                | ** ** | **(in thousands)**                        | ** ** |
| Operating revenues        |       | $                                         | —     |   | $ | 317,477 |   | $ | 3,847,540 |   | $ | (2,382 | ) | $ | 4,162,635 |   |
| Costs and expenses        |       | —                                    |       | 226,138 |   | 3,806,469 |   | (2,382 | ) | 4,030,225 |   |
| Gains on sales of  assets |       | —                                    |       | (489 | ) | (484 | ) | — |   | (973 | ) |
| Operating income          |       | —                                    |       | 91,828 |   | 41,555 |   | — |   | 133,383 |   |
| Interest expense—net |       | —                                    |       | (35,636 | ) | (17,554 | ) | — |   | (53,190 | ) |
| Equity earnings           |       | 104,047                                   |       | 47,144 |   | 24,923 |   | (153,260 | ) | 22,854 |   |
| Other income—net     |       | —                                    |       | 711 |   | 289 |   | — |   | 1,000 |   |
| Net income                |       | $                                         | 104,047    |   | $ | 104,047 |   | $ | 49,213 |   | $ | (153,260 | ) | $ | 104,047 |   |
|                      |       |                                      |       |   |   |   |   |   |   |   |   |
|                           |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

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| ** **                                                                                   | ** ** | **Nine Months Ended September 30,  2005** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                   | ** ** | **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                                                                                   |       | $                                         | 121,737    |   | $ | 121,737 |   | $ | 45,193 |   | $ | (166,930 | ) | $ | 121,737 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |       |                                      |       |   |   |   |   |   |   |   |   |
| Depreciation and  amortization                                                               |       | —                                    |       | 61,573 |   | 21,442 |   | — |   | 83,015 |   |
| Earnings (losses) in  equity investments, net of distributions                               |       | 62,471                                    |       | 2,731 |   | (2,339 | ) | (55,088 | ) | 7,775 |   |
| Gains on sales of  assets                                                                    |       | —                                    |       | (538 | ) | (59 | ) | — |   | (597 | ) |
| Changes in assets and  liabilities and other                                                 |       | (108,054                                  | )          | (52,386 | ) | (113,346 | ) | 105,804 |   | (167,982 | ) |
| Net cash provided by  (used in) operating activities                                         |       | 76,154                                    |       | 133,117 |   | (49,109 | ) | (116,214 | ) | 43,948 |   |
|                                                                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Cash flows from  investing activities                                                        |       | (278,830                                  | )          | (21,909 | ) | (144,749 | ) | 183,069 |   | (262,419 | ) |
| Cash flows from  financing activities                                                        |       | 202,121                                   |       | (124,614 | ) | 191,061 |   | (66,447 | ) | 202,121 |   |
| Net decrease in cash  and cash equivalents                                                   |       | (555                                      | )          | (13,406 | ) | (2,797 | ) | 408 |   | (16,350 | ) |
| 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                                                  |       | $                                         | 3,561      |   | $ | 190 |   | $ | 29 |   | $ | (3,708 | ) | $ | 72 |   |
|                                                                                         |       |                                      |       |   |   |   |   |   |   |   |   |
|                                                                                         | ** ** | **Nine Months Ended September 30, 2004**  |       |
| ** **                                                                                   | ** ** | **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                                                                                   |       | $                                         | 104,047    |   | $ | 104,047 |   | $ | 49,213 |   | $ | (153,260 | ) | $ | 104,047 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:           |       |                                      |       |   |   |   |   |   |   |   |   |
| Depreciation and  amortization                                                               |       | —                                    |       | 67,784 |   | 16,724 |   | — |   | 84,508 |   |
| Earnings (losses) in  equity investments, net of distributions                               |       | 71,149                                    |       | (4,236 | ) | 5,977 |   | (56,319 | ) | 16,571 |   |
| Gains on sales of  assets                                                                    |       | —                                    |       | (489 | ) | (484 | ) | — |   | (973 | ) |
| Changes in assets and  liabilities and other                                                 |       | (133,125                                  | )          | 4,060 |   | (27,902 | ) | 126,747 |   | (30,220 | ) |
| Net cash provided by  operating activities                                                   |       | 42,071                                    |       | 171,166 |   | 43,528 |   | (82,832 | ) | 173,933 |   |
|                                                                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Cash flows from  investing activities                                                        |       | (699                                      | )          | (17,928 | ) | (29,888 | ) | (86,363 | ) | (134,878 | ) |
| Cash flows from  financing activities                                                        |       | (58,899                                   | )          | (165,268 | ) | (16,898 | ) | 182,166 |   | (58,899 | ) |
| Net decrease in cash  and cash equivalents                                                   |       | (17,527                                   | )          | (12,030 | ) | (3,258 | ) | 12,971 |   | (19,844 | ) |
| Cash and cash  equivalents at beginning of period                                            |       | 19,744                                    |       | 19,243 |   | 5,670 |   | (15,188 | ) | 29,469 |   |
| Cash and cash  equivalents at end of period                                                  |       | $                                         | 2,217      |   | $ | 7,213 |   | $ | 2,412 |   | $ | (2,217 | ) | $ | 9,625 |   |
|                                                                                              |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

** **

** **

**32**

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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 financial position andresults of operations in conjunction with our Consolidated Financial Statementsand the notes thereto.  Materialperiod-to-period variances in the consolidated statements of income arediscussed under “Results of Operations.” The “Financial Condition and Liquidity” section analyzes our cash flowsand financial position.  “OtherConsiderations” addresses trends, future plans and contingencies that arereasonably likely to materially affect our future liquidity or earnings.  The Consolidated Financial Statements shouldbe read in conjunction with the financial statements and related notes,together with our discussion and analysis of financial position and results ofoperations included in our Annual Report on Form 10-K for the year endedDecember 31, 2004.

 

**Forward-Looking Statements**

 

                The matters discussed in thisReport include “forward-looking statements” within the meaning of Section 27A ofthe Securities Act of 1933 and Section 21E of the Securities Exchange Act of1934.  All statements that expressbelief, expectation, estimates or intentions, as well as those that are not statementsof historical facts are forward-looking statements.  The words “proposed”, “anticipates”, “potential”,“may”, “will”, “could”, “should”, “expect”, “estimate”, “believe”, “intend” andsimilar expressions are intended 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 ourperception of historical trends, current conditions and expected futuredevelopments as well as other factors we believe are appropriate under thecircumstances.  While we believe ourexpectations reflected in these forward-looking statements are reasonable, whetheractual results and developments will conform with our expectations and predictionsis subject to a number of risks and uncertainties, including general economic,market or business conditions, the opportunities (or lack thereof) that may bepresented to and pursued by us, competitive actions by other pipelinecompanies, changes in laws or regulations and other factors, many of which arebeyond our control.  For example, thedemand for refined products is dependent upon the price, prevailing economicconditions and demographic changes in the markets served, trucking and railroadfreight, agricultural usage and military usage; the demand for propane issensitive to the weather and prevailing economic conditions; the demand forpetrochemicals is dependent upon prices for products produced frompetrochemicals; the demand for crude oil and petroleum products is dependentupon the price of crude oil and the products produced from the refining ofcrude oil; and the demand for natural gas is dependent upon the price ofnatural gas and the locations in which natural gas is drilled.  We are also subject to regulatory factorssuch as the amounts we are allowed to charge our customers for the services weprovide on our regulated pipeline systems. Consequently, all of theforward-looking statements made in this document are qualified by these cautionarystatements, and we cannot assure you that actual results or developments thatwe anticipate will be realized or, even if substantially realized, will havethe expected consequences to or effect on us or our business oroperations.  For additional discussion ofsuch risks and uncertainties, see our Annual Report on Form 10-K for the yearended December 31, 2004, and other filings we have made with the Securities andExchange Commission (“SEC”).

 

**CriticalAccounting Policies and Estimates**

 

A summary of thesignificant accounting policies we have adopted and followed in the preparationof our consolidated financial statements is detailed in our consolidatedfinancial statements for the year ended December 31, 2004, included in ourAnnual Report on Form 10-K. Certain of these accounting policies requirethe use of estimates.  The followingestimates, in our opinion, are subjective in nature, require the exercise ofjudgment and

 

 

33

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involve complex analysis: revenue and expenseaccruals, including accruals for power costs, property taxes and crude oilmargins; environmental costs; asset impairment analysis related to property,plant and equipment; and amortization expense and asset impairment analysisrelated to goodwill and other intangible assets.  These estimates are based on our knowledgeand understanding of current conditions and actions we may take in thefuture.  Changes in these estimates willoccur as a result of the passage of time and the occurrence of futureevents.  Subsequent changes in theseestimates may have a significant impact on our financial condition and resultsof operations.

## ** **

## ****Management Overview of the Three Months and Nine Months Ended September30, 2005****

## ** **

## ****                Wereported net income of $30.9 million, or $0.31 per Limited Partner Unit (“Unit”or “Units”), for the three months ended September 30, 2005, compared with netincome of $25.9 million, or $0.29 per Unit, for the three months ended September30, 2004.  Net income was $121.7 million,or $1.29 per Unit, for the nine months ended September 30, 2005, compared withnet income of $104.1 million, or $1.18 per Unit, for the nine months ended September30, 2004.  The weighted average number ofUnits outstanding was 70.0 million and 63.0 million for the three months ended September30, 2005 and 2004, respectively, and 66.5 million and 63.0 million for the ninemonths ended September 30, 2005 and 2004, respectively.****

## ** **

## ****Our Downstream Segment’s operating income for the three monthsended September 30, 2005, increased compared with the prior year period primarilydue to lower depreciation expense attributable to a $4.4 million assetimpairment charge in the 2004 period (see Note 3.  Property, Plant and Equipment), a $4.0million decrease in pipeline integrity costs, increased margins on productinventory sales and decreased product measurement losses.  These increases to operating income werepartially offset by the recognition in the 2004 period of $4.1 million ofdeferred revenue related to the expiration of two customer transportationagreements, $1.3 million of regulatory penalties for past incidents, theimpacts of Hurricanes Katrina and Rita in the third quarter of 2005 whichreduced revenues by an estimated $1.5 million, the impact of a propane releaseand fire at an LPG storage facility in Ohio, which reduced revenues by anestimated $0.3 million, increased pipeline operating expense, higher propertytaxes, higher depreciation expense primarily due to asset acquisitions and theretirement of assets in the current period, increased environmental remediationand assessment costs and transition expenses related to the change in controlof our general partner.****

## ** **

## ****For the nine months ended September 30, 2005, operating incomefor the Downstream Segment increased compared with the prior year period primarilydue to a $9.7 million decrease in pipeline integrity costs, lower depreciationexpense attributable to an asset impairment charge in the 2004 period,increased refined products and LPG transportation revenues and volumes anddecreased product measurement losses.  Weanticipate that our pipeline integrity expenses for our Downstream Segment for2005 will be approximately $15.1 million lower than our 2004 expenses primarilydue to the completion of pipeline inspections and repairs under our integritymanagement program.  These increases tooperating income were partially offset by the recognition of $4.1 million ofdeferred revenue in the 2004 period, $1.8 million of regulatory penalties forpast incidents, the impact of the hurricanes in the third quarter of 2005 andthe propane release and fire at a storage facility in Ohio, increased pipelineoperating expenses, higher property taxes, higher depreciation expenseprimarily due to asset acquisitions and the retirement of assets in the currentperiod, transition expenses related to the change in control of our generalpartner and increased environmental remediation and assessment costs.****

## ** **

## ****Our Upstream Segment’s operating income for the three monthsended September 30, 2005, increased compared with the prior year periodprimarily due to a $3.4 million increase in marketing margins related to assetacquisitions, lower pipeline integrity costs and increased transportationrevenues on the South Texas and West Texas systems.  These increases to operating income werepartially offset by a $2.6 million non-cash asset impairment charge related totwo of our crude oil systems and higher property taxes, depreciation expenseand operating expenses related to acquisitions earlier this year (see Note5.  Acquisitions and Dispositions).  For the nine months ended September 30, 2005,operating income for the Upstream Segment decreased compared with the prioryear period primarily due to the non-cash impairment charge, increasedoperating expenses of acquired assets and higher insurance and laborexpenses.  These decreases to operatingincome were partially offset by a $4.1 million increase in transportationrevenues primarily on the South Texas and West Texas systems, a $3.4 million increasein****

## **** ****

## **** ****

## ****34****

## ****

## **** ****

## ****marketing margins, lower pipeline integrity costs, lowerproduct measurement losses and lower environmental remediation and assessmentcosts.  Pipeline integrity expensesdecreased $1.5 million and $1.8 million for the three months and nine monthsended September 30, 2005, respectively, compared with the prior yearperiods.  We anticipate that our 2005pipeline integrity expenses for our Upstream Segment will be approximately $2.1million lower than our 2004 expenses due to the completion of pipelineinspections and repairs under our integrity management program.  Equity earnings from Seaway Crude PipelineCompany (“Seaway”) decreased for the three months and nine months endedSeptember 30, 2005, compared with the prior year periods primarily due tohigher operating, general and administrative expenses primarily related to apipeline release in May 2005 and a gain recognized on an inventory settlementin 2004, partially offset by increased transportation volumes in the 2005periods.****

## ** **

## ****Our Midstream Segment’s operating income for the three monthsand nine months ended September 30, 2005, increased compared to the prior yearperiods primarily due to increased revenues and volumes on Jonah Gas GatheringCompany (“Jonah”), resulting from our 2003 Phase III expansion and theinstallation of additional capacity during the fourth quarter of 2004.  Revenues on Val Verde Gas Gathering Company (“ValVerde”) increased due to new connections made to the system in May and December2004, partially offset by the impact of reduced revenues related to the naturaldecline of coal bed methane (“CBM”) production from existing wells.  Additionally, our operating and gassettlement expenses decreased compared with the prior year period.  Transportation revenues on the Panola andChaparral Pipelines increased from the prior year periods.  Pipeline integrity expenses decreased $0.7million for the nine months ended September 30, 2005, compared with the prioryear period.  These increases tooperating income were partially offset by lower gathering rates on the newconnections at Val Verde, on which the gathering rates are lower than existingaverage rates on the system.****

## ** **

Certainfactors are key to our business segments as discussed in this Report.  These include the safe, reliable andefficient operation of the pipelines and facilities that we own or operatewhile meeting increased regulations that govern the operation of our assets andthe costs associated with such regulations. We are also focused on our continued growth through expansion of theassets that we own and through the acquisition of assets that complement ourcurrent operations.

 

        We believe that our current strategy andfocus will provide continued growth in earnings and cash distributions.  This growth potential is based on:

 

•                 Continued strong performance in ourUpstream Segment, as we build on our existing asset base and concentrate onacquisitions in our core operating areas;

•                 Continued development of the Jonahsystem, which serves the Jonah and Pinedale fields;

•                 Gathering of volumes from infilldrilling of CBM by producers and new connections of conventional gas in the SanJuan Basin, where our Val Verde system is located; and

•                  Growth in our Downstream Segment,resulting from our recent capacity expansion, grass roots facility investments,acquisitions and growing demand for Gulf Coast sourced products.

 

On March 31, 2005, we purchased crude oil pipeline assets for $7.1million from BP Pipelines (North America) Inc. (“BP”).  The assets include approximately 158 miles ofpipeline, which extend from Mexia, Texas, to the Houston, Texas, area and twostations in south Houston with connections to a BP pipeline that originates insouth Houston.  We are integrating theseassets into our South Texas pipeline system, included in our Upstream Segment,which will allow us to realize synergies within our existing asset base andwill provide future growth opportunities.

 

On April 1, 2005, we purchased crude oil storage and terminaling assetsin Cushing, Oklahoma, from Koch Supply & Trading, L.P. for $35.4million.  The assets consist of eightstorage tanks with 945,000 barrels of storage capacity, receipt and deliverymanifolds, interconnections to several pipelines, crude oil inventory andapproximately 70 acres of land.  Thestorage and terminaling assets will complement our existing infrastructure inCushing and strengthen our gathering and marketing business in our UpstreamSegment.

 

 

35

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On July 12, 2005, we purchased a refined products terminal and two-bay truckloading rack in North Little Rock, Arkansas, for $6.8 million from Exxon MobilCorporation.  The assets include threestorage tanks and a two-bay truck loading rack. The terminal serves the central Arkansas refined products market andcomplements our existing Downstream Segment infrastructure in North LittleRock, Arkansas.

 

On July 15, 2005, we acquired from Texas Genco LLC (“Genco”) all of itsinterests in certain companies that own a 90-mile pipeline system and 5.5million barrels of storage capacity for $62.1 million.  This acquisition was made as part of anexpansion of our refined products origin capabilities in the Houston, Texas,and Texas City, Texas, areas.  The assetsof the purchased companies will be integrated into our Downstream Segmentorigin infrastructure in Texas City and Baytown, Texas.  The integration and other system enhancementsshould be in service by the fourth quarter of 2006, at an estimated cost of$45.0 million.  The strategic location ofthese assets, with refined products interconnections to major exchangeterminals in the Houston area, will provide significant long-term value to ourcustomers and the Texas Gulf Coast refining and logistics system.

 

Consistent with ourbusiness strategy, we continuously evaluate possible acquisitions of assetsthat would complement our current operations, including assets which, ifacquired, would have a material effect on our financial position, results ofoperations or cash flows****.****

## ****Our Business****

 

TEPPCO Partners, L.P.(the “Partnership”), a Delaware limited partnership, is a master limitedpartnership 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 TEPPCOMidstream are referred to as the “Operating Partnerships.”  TEPPCO GP, Inc. (“TEPPCO GP”), our whollyowned subsidiary, is the general partner of our Operating Partnerships.  We hold a 99.999% limited partner interest inthe Operating Partnerships, and TEPPCO GP holds a 0.001% general partnerinterest.  Texas Eastern ProductsPipeline Company, LLC (the “Company” or “General Partner”), a Delaware limitedliability company, serves as our general partner and owns a 2% general partnerinterest in us.  Through February 23,2005, the General Partner was an indirect wholly owned subsidiary of Duke EnergyField Services, LLC (“DEFS”), a joint venture between Duke Energy Corporation (“DukeEnergy”) and ConocoPhillips.  ThroughFebruary 23, 2005, Duke Energy held an interest of approximately 70% in DEFS,and ConocoPhillips held the remaining interest of approximately 30%.  On February 24, 2005, the General Partner wasacquired by DFI GP Holdings L.P. (formerly Enterprise GP Holdings L.P.) (“DFI”),an affiliate of EPCO, Inc. (“EPCO”), a privately held company controlled by DanL. Duncan, for approximately $1.1 billion. 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.

EPCO performs allmanagement and operating functions required for us, and we reimburse EPCO forall direct and indirect expenses that have been incurred in managing us.  As a result of the sale of our General Partner,DEFS and Duke Energy will continue to provide some administrative services forus for a period of time until we assume these services.  In connection with us assuming the operationsof certain of the TEPPCO Midstream assets from DEFS, certain DEFS employeesbecame employees of EPCO effective June 1, 2005.

In connection with our formation in 1990, the Company received2,500,000 Deferred Participation Interests (“DPIs”).  Effective April 1, 1994, the DPIs beganparticipating in distributions of cash and allocations of profit and loss in amanner identical to Limited Partner Units and are treated as Limited Partner Unitsfor purposes of this Report.  These DPIswere assigned to Duke Energy when ownership of the Company was transferred fromDuke Energy to DEFS in 2000.  On February24, 2005, DFI entered into an LP Unit Purchase and Sale Agreement with DukeEnergy and purchased these 2,500,000 DPIs for approximately $100.0 million.

 

We operate and report in three business segments:

 

 

36

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•                  Downstream Segment — transportationand storage of refined products, liquefied petroleum gases (“LPGs”) andpetrochemicals;

•                  Upstream Segment — gathering,transportation, marketing and storage of crude oil and distribution oflubrication oils and specialty chemicals; and

•                  Midstream Segment — gathering ofnatural gas, transportation of natural gas liquids (“NGLs”) and fractionationof NGLs.

Our reportable segmentsoffer different products and services and are managed separately because eachrequires different business strategies. TEPPCO GP, our wholly owned subsidiary, acts as managing general partnerof our Operating Partnerships, with a 0.001% general partner interest andmanages our subsidiaries.

Our Downstream Segmentrevenues are earned from transportation and storage of refined products andLPGs, intrastate transportation of petrochemicals, sale of product inventoryand other ancillary services.  The twolargest operating expense items of the Downstream Segment are labor andelectric power.  We generally realizehigher revenues during the first and fourth quarters of each year since ouroperations are somewhat seasonal. 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 in theNortheast for propane, a major fuel for residential heating.  Our Downstream Segment also includes theresults of operations of the northern portion of the Dean Pipeline, whichtransports refinery grade propylene from Mont Belvieu to Point Comfort,Texas.  Our Downstream Segment alsoincludes our equity investments in Centennial Pipeline LLC (“Centennial”) andMont Belvieu Storage Partners, L.P. (“MB Storage”) (see Note 7.  Equity Investments).

                Our Upstream Segment revenuesare earned from gathering, transportation, marketing and storage of crude oiland distribution 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 of the crude oil to local refineries, marketers or other endusers.  Our Upstream Segment alsoincludes our equity investment in Seaway (see Note 7.  Equity Investments).  Seaway consists of large diameter pipelinesthat transport crude oil from Seaway’s marine terminals on the U.S. Gulf Coastto Cushing, Oklahoma, a crude oil distribution point for the central UnitedStates, and to refineries in the Texas City and Houston areas.

 

Our Midstream Segment revenues are earned from the fractionation ofNGLs in Colorado, transportation of NGLs from two trunkline NGL pipelines inSouth Texas, two NGL pipelines in East Texas and a pipeline system (Chaparral)from West Texas and New Mexico to Mont Belvieu; the gathering of natural gas inthe Green River Basin in southwestern Wyoming, through Jonah, and the gatheringof CBM and conventional natural gas in the San Juan Basin in New Mexico andColorado, through Val Verde.

 

 

37

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**Results of Operations**

 

                The following table summarizesfinancial information by business segment for the three months and nine monthsended September 30, 2005 and 2004 (in thousands):

 
| ** **                      | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------|------------|---------------------------------------|------------|------------------------------------------|------------|
| ** **                      | ** ** | **2005**                              | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| Operating revenues:             |       |                                  |       |                                     |       |   |   |   |   |
| Downstream Segment              |       | $                                     | 66,094     |                                     | $          | 68,546 |   | $ | 207,699 |   | $ | 205,719 |   |
| Upstream Segment                |       | 2,380,734                             |       | 1,370,086                                |       | 5,750,514 |   | 3,807,436 |   |
| Midstream Segment               |       | 57,310                                |       | 51,695                                   |       | 164,959 |   | 151,862 |   |
| Intersegment  eliminations      |       | (342                                  | )          | (317                                     | )          | (2,391 | ) | (2,382 | ) |
| Total operating  revenues       |       | 2,503,796                             |       | 1,490,010                                |       | 6,120,781 |   | 4,162,635 |   |
|                            |       |                                  |       |                                     |       |   |   |   |   |
| Operating income:               |       |                                  |       |                                     |       |   |   |   |   |
| Downstream Segment              |       | 14,615                                |       | 12,781                                   |       | 61,099 |   | 53,082 |   |
| Upstream Segment                |       | 5,207                                 |       | 4,778                                    |       | 22,199 |   | 23,314 |   |
| Midstream Segment               |       | 24,248                                |       | 19,522                                   |       | 77,791 |   | 56,987 |   |
| Total operating income          |       | 44,070                                |       | 37,081                                   |       | 161,089 |   | 133,383 |   |
|                            |       |                                  |       |                                     |       |   |   |   |   |
| Earnings before  interest:      |       |                                  |       |                                     |       |   |   |   |   |
| Downstream Segment              |       | 15,445                                |       | 12,662                                   |       | 62,249 |   | 51,661 |   |
| Upstream Segment                |       | 10,881                                |       | 10,781                                   |       | 42,160 |   | 48,494 |   |
| Midstream Segment               |       | 24,323                                |       | 19,543                                   |       | 77,968 |   | 57,082 |   |
| Total earnings before  interest |       | 50,649                                |       | 42,986                                   |       | 182,377 |   | 157,237 |   |
|                            |       |                                  |       |                                     |       |   |   |   |   |
| Interest expense                |       | (22,033                               | )          | (18,495                                  | )          | (65,202 | ) | (57,002 | ) |
| Interest capitalized            |       | 2,307                                 |       | 1,364                                    |       | 4,562 |   | 3,812 |   |
| Net income                      |       | $                                     | 30,923     |                                     | $          | 25,855 |   | $ | 121,737 |   | $ | 104,047 |   |

 

                The following is a detailedanalysis of the results of operations, including reasons for changes inresults, by each of our operating segments.

 

 

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**Downstream Segment**

 

The following table provides financialinformation for the Downstream Segment for the three months and nine monthsended September 30, 2005 and 2004 (in thousands):

 
| ** **                            | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | **Nine Months Ended** | ** ** | ** **   | ** ** |
|---------------------------------------|------------|------------------------|------------|--------------|------------|-----------------------|------------|--------------|------------|
| ** **                            | ** ** | **September 30,**      | ** ** | **Increase** | ** ** | **September 30,**     | ** ** | **Increase** | ** ** |
| ** **                            | ** ** | **2005**               | ** ** | **2004**     | ** ** | **(Decrease)**        | ** ** | **2005**     | ** ** | **2004** | ** ** | **(Decrease)** | ** ** |
|                                  |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Transportation—Refined  products |       | $                      | 38,240     |         | $          | 43,386                |       | $            | (5,146     | ) | $ | 111,039 |   | $ | 113,294 |   | $ | (2,255 | ) |
| Transportation—LPGs              |       | 16,519                 |       | 16,071       |       | 448                   |       | 63,220       |       | 58,572 |   | 4,648 |   |
| Other                                 |       | 11,335                 |       | 9,089        |       | 2,246                 |       | 33,440       |       | 33,853 |   | (413 | ) |
| Total operating  revenues             |       | 66,094                 |       | 68,546       |       | (2,452                | )          | 207,699      |       | 205,719 |   | 1,980 |   |
|                                  |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Operating, general and administrative |       | 30,219                 |       | 32,905       |       | (2,686                | )          | 85,115       |       | 90,924 |   | (5,809 | ) |
| Operating fuel and  power             |       | 8,170                  |       | 8,533        |       | (363                  | )          | 23,787       |       | 23,776 |   | 11 |   |
| Depreciation and  amortization        |       | 10,098                 |       | 12,818       |       | (2,720                | )          | 29,460       |       | 31,106 |   | (1,646 | ) |
| Taxes—other than income  taxes   |       | 3,016                  |       | 1,981        |       | 1,035                 |       | 8,369        |       | 7,320 |   | 1,049 |   |
| Gains on sales of  assets             |       | (24                    | )          | (472         | )          | 448                   |       | (131         | )          | (489 | ) | 358 |   |
| Total costs and  expenses             |       | 51,479                 |       | 55,765       |       | (4,286                | )          | 146,600      |       | 152,637 |   | (6,037 | ) |
|                                  |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Operating income                      |       | 14,615                 |       | 12,781       |       | 1,834                 |       | 61,099       |       | 53,082 |   | 8,017 |   |
|                                  |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Equity earnings  (losses)             |       | 524                    |       | (322         | )          | 846                   |       | 574          |       | (2,069 | ) | 2,643 |   |
| Other income—net                 |       | 306                    |       | 203          |       | 103                   |       | 576          |       | 648 |   | (72 | ) |
|                                  |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Earnings before  interest             |       | $                      | 15,445     |         | $          | 12,662                |       | $            | 2,783      |   | $ | 62,249 |   | $ | 51,661 |   | $ | 10,588 |   |
|                                       |            |                        |            |              |            |                       |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The following table presents volumes deliveredin barrels and average tariff per barrel for the three months and nine monthsended September 30, 2005 and 2004 (in thousands, except tariff information):
| ** **                        | ** ** | **Three Months Ended** | ** ** | **Percentage** | ** ** | **Nine Months Ended** | ** ** | **Percentage** | ** ** |
|-----------------------------------|------------|------------------------|------------|----------------|------------|-----------------------|------------|----------------|------------|
| ** **                        | ** ** | **September 30,**      | ** ** | **Increase**   | ** ** | **September 30,**     | ** ** | **Increase**   | ** ** |
| ** **                        | ** ** | **2005**               | ** ** | **2004**       | ** ** | **(Decrease)**        | ** ** | **2005**       | ** ** | **2004** | ** ** | **(Decrease)** | ** ** |
| **Volumes  Delivered:**           |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Refined products                  |       | 43,067                 |       | 41,726         |       | 3                     | %          | 123,759        |       | 116,184 |   | 7 | % |
| LPGs                              |       | 8,646                  |       | 9,107          |       | (5                    | )%         | 31,303         |       | 31,109 |   | 1 | % |
| Total                             |       | 51,713                 |       | 50,833         |       | 2                     | %          | 155,062        |       | 147,293 |   | 5 | % |
|                              |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| **Average  Tariff per Barrel:**   |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Refined products (1)              |       | $                      | 0.89       |           | $          | 1.04                  |       | (14            | )%         | $ | 0.90 |   | $ | 0.98 |   | (8 | )% |
| LPGs                              |       | 1.91                   |       | 1.76           |       | 9                     | %          | 2.02           |       | 1.88 |   | 7 | % |
| Average system tariff  per barrel |       | $                      | 1.06       |           | $          | 1.17                  |       | (9             | )%         | $ | 1.12 |   | $ | 1.17 |   | (4 | )% |
|                                   |            |                        |            |                |            |                       |            |                |            |  |  |  |  |  |  |  |  |  |

----

(1)          The 2004 periods include $4.1 million of deferred revenue related to theexpiration of two customer transportation agreements.

 

 

*Three Months Ended September 30,2005 Compared with Three Months Ended September 30, 2004*

 

                Revenues from refined productstransportation decreased $5.1 million for the three months ended September 30,2005, compared with the three months ended September 30, 2004, primarily due tothe recognition in the 2004 period of $4.1 million of deferred revenue relatedto the expiration of two customer transportation agreements.  The $4.1 million of deferred revenueincreased the refined products average tariff for the third quarter of 2004 by$0.10 per barrel, or 11%.  Excluding theeffect of the deferred revenue recognized in the 2004 period, the refinedproducts average tariff per barrel decreased 5% from the prior year periodprimarily due to the impact of

 

 

39

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greatergrowth in the volume of products delivered under a Centennial tariff comparedwith the growth in deliveries under a TEPPCO tariff, which resulted in anincreased proportion of lower tariff barrels transported on our system.  Prior to the construction of Centennial, deliverieson 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, our previously constrained system has expanded deliveries inmarkets both south and north of Creal Springs, Illinois.  In February 2003, we entered into a leaseagreement with Centennial that increased our flexibility to deliver refinedproducts to our market areas.  Centennialhas provided our system with additional pipeline capacity for movement ofproducts originating in the U.S. Gulf Coast area.  The overall increase in refined productsvolumes was primarily due to increased demand and market share for productssupplied from the U.S. Gulf Coast into Midwest markets.

 

                Revenues from LPGstransportation increased $0.4 million for the three months ended September 30,2005, compared with the three months ended September 30, 2004, due to higherdeliveries of isobutane in the upper Midwest market areas, partially offset bylower deliveries of propane.   The LPGsaverage rate per barrel increased from the prior period primarily as a resultof decreased short-haul deliveries during the three months ended September 30,2005, and an increase in tariff rates which went into effect in July 2005.  Our propane revenues also decreased due to apropane release and fire at a dehydration unit in September 2005 at ourTodhunter storage facility, near Middletown, Ohio.  As a result of the propane release and fire,our LPG loading facilities at Todhunter were shut down for approximately threeweeks.  We estimate that the reduction topropane revenues for this occurrence was approximately $0.3 million for thethird quarter of 2005.  The propane releaseand fire will also reduce fourth quarter 2005 propane revenues by an estimated $0.3million.

 

                Revenues from refined productsand LPGs for the current period were also impacted by Hurricane Katrina andHurricane Rita, which affected the U.S. Gulf Coast in August and September2005, respectively.  Hurricane Katrinadisrupted refineries and other pipeline systems in the central U.S. Gulf Coast,which provided us with additional deliveries at Shreveport and Arcadia,Louisiana, as shippers used alternative sources to supply product to areaswhere normal distribution patterns were disrupted.  Hurricane Katrina also resulted in higherprices of refined products and LPGs, which had a negative impact on the currentdemand for the products.

 

                Hurricane Rita disruptedproduction at western U.S. Gulf Coast refineries, many of which directly supplyus with product.  Hurricane Rita alsodisrupted power to our Beaumont terminal, which resulted in the mainline beingshut down for four days and Centennial being shut down for ten days.  Our mainline system was reopened, but hasbeen operating at reduced rates as a result of Hurricane Rita.  At September 30, 2005, our 230,000 barrel perday capacity, 20-inch diameter mainline system, which primarily delivers LPGsand gasoline from the Texas Gulf Coast to the Midwest, was pumping from MBStorage’s facility at approximately 60% of normal operating capacity.  Our 110,000 barrel per day capacity, 14-inchand 16-inch diameter pipelines, which primarily deliver distillates andgasoline from the Texas Gulf Coast to the Midwest, were pumping atapproximately 75% of normal operating capacity from our Baytown, Texas,terminal.  We installed generators at ourBeaumont, Texas, facility, which enabled receipt and delivery of refinedproducts out of tankage at the terminal. Commercial power was restored to the Beaumont terminal and the Newton,Texas, pump station in mid-October and full operations were resumed.  Centennial resumed operating at its normalcapacity on October 1, 2005.  For thequarter ended September 30, 2005, we estimate that the hurricanes reducedrefined products and propane revenues by approximately $1.2 million and $0.3million, respectively.  The impact tooperating expenses for the period was less than $0.1 million through September30, 2005.  We expect the impact ofHurricane Rita to reduce our fourth quarter 2005 revenues as well, resulting inestimated losses in that period of approximately $4.0 million of refinedproducts revenues and $0.5 million of LPG revenues.  The estimated impact to operating expensesfor the fourth quarter of 2005 is an increase of approximately $1.2 million.

 

                Other operating revenuesincreased $2.2 million for the three months ended September 30, 2005, comparedwith the three months ended September 30, 2004, primarily due to increasedmargins on product inventory sales and higher refined products additive and tender deduction revenue.

 

 

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                Costs and expenses decreased $4.3million for the three months ended September 30, 2005, compared with the threemonths ended September 30, 2004, due to decreased operating, general andadministrative expenses, decreased depreciation and amortization expense anddecreased operating fuel and power, partially offset by increased taxes — otherthan income taxes and lower gains on the sales of assets in the 2005 period.  Operating, general and administrativeexpenses decreased $2.7 million primarily due to a $4.0 million decrease inpipeline inspection and repair costs associated with our integrity managementprogram, a $0.6 million decrease in product losses, a $0.6 million decrease inlabor and benefits expenses related to the vesting of certain of ourcompensation plans in the first quarter of 2005 as a result of changes incontrol of our General Partner, a $0.6 million decrease in rental expense fromthe Centennial pipeline capacity lease agreement and a $0.5 million decrease inrental expense on a lease agreement with a third-party pipeline.

 

                These decreases to costs andexpenses were partially offset by a $1.3 million increase attributable to regulatorypenalties for past incidents, a $0.7 million increase in pipeline operating andmaintenance expenses, a $0.4 million increase in labor and benefits expenserelated to retirement plan settlements with DEFS, a $0.4 million increaserelated to transition costs due to the changes in control of our GeneralPartner, a $0.4 million increase in environmental assessment and remediationexpenses and an increase in insurance expense. Depreciation expense increased $2.7 million primarily due to a $0.8million write-off of assets related to the propane release and fire at astorage facility in Ohio and assets retired to depreciation expense during thequarter, partially offset by a $4.4 million non-cash impairment charge in thethird quarter of 2004 (see Note 3. Property, Plant and Equipment). Operating fuel and power decreased $0.4 million primarily due to adjustmentsto power accruals, partially offset by increased mainline throughput.  Taxes — other than income taxes increased $1.0million primarily due to increases in property tax accruals and a higher assetbase in the 2005 period.  During thethree months ended September 30, 2004, we recognized net gains of $0.5 millionfrom the sales of various assets in the Downstream Segment.

 

                Net earnings from equityinvestments increased for the three months ended September 30, 2005, comparedwith the three months ended September 30, 2004, as shown below (in thousands):

 

| ** **                      | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** |
|---------------------------------|------------|------------------------|------------|------------|------------|
| ** **                      | ** ** | **September 30,**      | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **2005**               | ** ** | **2004**   | ** ** | **Increase** | ** ** |
| ** **                      | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Centennial                      |       | $                      | (1,216     | )          | $          | (1,839 | ) | $ | 623 |   |
| MB Storage                      |       | 1,728                  |       | 1,530      |       | 198 |   |
| Other                           |       | 12                     |       | (13        | )          | 25 |   |
| Total equity earnings  (losses) |       | $                      | 524        |       | $          | (322 | ) | $ | 846 |   |

 

                Equity losses in Centennialdecreased $0.6 million for the three months ended September 30, 2005, comparedwith the three months ended September 30, 2004, primarily due to highertransportation revenues, decreased operating expenses and lower productmeasurement losses during the 2005 period. Equity earnings in MB Storage increased $0.2 million for the threemonths ended September 30, 2005, compared with the three months ended September30, 2004, primarily due to increased tender deduction and lease line revenueson the MB Storage system.  As a result ofHurricane Rita, MB Storage’s revenues were reduced by approximately $0.2million during the three months ended September 30, 2005.  We expect the impact of Hurricane Rita toreduce MB Storage’s fourth quarter 2005 revenues by an estimated $0.1 millionand increase operating expenses by an estimated $0.4 million.

 

*Nine Months Ended September 30, 2005Compared with Nine Months Ended September 30, 2004*

 

                Revenues from refined productstransportation decreased $2.3 million for the nine months ended September 30,2005, compared with the nine months ended September 30, 2004, primarily due tothe recognition of $4.1 million of deferred revenue in the 2004 period relatedto the expiration of two customer transportation agreements, and the effects ofHurricanes Katrina and Rita in August and September 2005 as discussed above,partially offset by an overall increase in the refined products volumesdelivered.  This increase was primarilydue to deliveries of products moved on Centennial.  Volume increases were due to increased demandand market share for products

 

 

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suppliedfrom the U.S. Gulf Coast into Midwest markets. The refined products averagerate per barrel decreased from the prior year period primarily due to theimpact of greater growth in the volume of products delivered under a Centennialtariff compared with the growth in deliveries under a TEPPCO tariff, whichresulted in an increased proportion of lower tariff barrels transported on oursystem.

 

                Revenues from LPGstransportation increased $4.7 million for the nine months ended September 30,2005, compared with the nine months ended September 30, 2004, due to higherdeliveries of propane in the upper Midwest and Northeast market areas primarilyresulting from cold weather in March 2005. Prior year LPG transportation revenues were negatively impacted by aprice spike in the Mont Belvieu propane price in late February 2004, whichresulted in TEPPCO sourced propane being less competitive than propane fromother source points.  Our propane revenueswere also affected by Hurricane Rita and the propane release and fire at a storagefacility in September 2005 as discussed above.

 

                Otheroperating revenues decreased $0.4 million for the nine months ended September30, 2005, compared with the nine months ended September 30, 2004, primarily dueto lower propane inventory fees in the 2005 period, partially offset by higherrefined products tender deduction and loading revenues and increased margins onproduct inventory sales.

 

                Costs and expenses decreased $6.0million for the nine months ended September 30, 2005, compared with the ninemonths ended September 30, 2004, due to decreased operating, general andadministrative expenses and decreased depreciation and amortization expense,partially offset by increased taxes — other than income taxes and lower gainson the sales of assets in the 2005 period. Operating, general and administrative expenses decreased $5.8 millionprimarily due to a $9.7 million decrease in pipeline inspection and repaircosts associated with our integrity management program, a $2.0 million decreasein postretirement benefit accruals related to plan amendments (see Note 10.Employee Benefit Plans), a $1.1 million decrease in consulting servicesprimarily related to acquisition related activities in the 2004 period and a$0.7 million decrease in product losses.

 

                These decreases to costs andexpenses were partially offset by a $1.8 million increase in labor and benefitsexpenses associated with vesting provisions in certain of our compensationplans as a result of changes in control of our General Partner resulting in higherincentive compensation expenses compared to the prior year period, a $1.8million increase attributable to regulatory penalties for past incidents, a$1.4 million increase in pipeline operating and maintenance expense, a $0.6million increase related to transition costs due to the changes in control ofour General Partner, a $0.4 million increase in environmental assessment andremediation expenses, a $0.4 million increase in labor and benefits expenserelated to retirement plan settlements with DEFS and an increase in insuranceexpense.  Depreciation expense decreased$1.6 million primarily due to a $4.4 million non-cash impairment charge in thethird quarter of 2004, partially offset by a $0.8 million write-off of assetsrelated to the propane release and fire at a storage facility in Ohio (see Note3.  Property Plant, and Equipment),assets placed into service and assets retired to depreciation expense in the 2005period.  Taxes — other than income taxesincreased $1.0 million primarily due to asset acquisitions and a higher taxbase in the 2005 period.  During the ninemonths ended September 30, 2004, we recognized net gains of $0.5 million fromthe sales of various assets in the Downstream Segment.

 

                Net earnings from equityinvestments increased for the nine months ended September 30, 2005, comparedwith the nine months ended September 30, 2004, as shown below (in thousands):

 

| ** **                      | ** ** | **Nine Months Ended** | ** ** | ** **   | ** ** |
|---------------------------------|------------|-----------------------|------------|--------------|------------|
| ** **                      | ** ** | **September 30,**     | ** ** | **Increase** | ** ** |
| ** **                      | ** ** | **2005**              | ** ** | **2004**     | ** ** | **(Decrease)** | ** ** |
| ** **                      | ** ** | ** **            | ** ** | ** **   | ** ** | ** ** | ** ** |
| Centennial                      |       | $                     | (5,184     | )            | $          | (7,982 | ) | $ | 2,798 |   |
| MB Storage                      |       | 5,727                 |       | 5,944        |       | (217 | ) |
| Other                           |       | 31                    |       | (31          | )          | 62 |   |
| Total equity earnings  (losses) |       | $                     | 574        |         | $          | (2,069 | ) | $ | 2,643 |   |

 

 

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                Equity losses in Centennialdecreased $2.8 million for the nine months ended September 30, 2005, comparedwith the nine months ended September 30, 2004, primarily due to highertransportation revenues and volumes and lower transmix related productreplacement costs and product measurement losses during the 2005 period.  Equity earnings in MB Storage decreased $0.2million for the nine months ended September 30, 2005, compared with the ninemonths ended September 30, 2004, primarily due to increased depreciation andamortization expense and higher general and administrative expenses, partiallyoffset by higher rental and storage revenues and volumes.  MB Storage’s revenues were also impacted byHurricane Rita as discussed above.  In April2004, MB Storage acquired storage and pipeline assets and contracts forapproximately $35.0 million, of which TE Products contributed $16.5million.  Increases in storage revenue,shuttle revenue, rental revenue and depreciation and amortization expense forthe nine months ended September 30, 2005, compared with the nine months endedSeptember 30, 2004, are primarily related to the acquired storage assets andcontracts.

** **

**Upstream Segment**

 

                The following table providesfinancial information for the Upstream Segment for the three months and ninemonths ended September 30, 2005 and 2004 (in thousands):

 
| ** **                             | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | **Nine Months Ended** | ** ** | ** **   | ** ** |
|----------------------------------------|------------|------------------------|------------|--------------|------------|-----------------------|------------|--------------|------------|
| ** **                             | ** ** | **September 30,**      | ** ** | **Increase** | ** ** | **September 30,**     | ** ** | **Increase** | ** ** |
| ** **                             | ** ** | **2005**               | ** ** | **2004**     | ** ** | **(Decrease)**        | ** ** | **2005**     | ** ** | **2004** | ** ** | **(Decrease)** | ** ** |
|                                   |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Sales of petroleum  products           |       | $                      | 2,367,984  |         | $          | 1,358,220             |       | $            | 1,009,764  |   | $ | 5,714,353 |   | $ | 3,770,006 |   | $ | 1,944,347 |   |
| Transportation—Crude  oil         |       | 10,001                 |       | 9,288        |       | 713                   |       | 28,215       |       | 28,164 |   | 51 |   |
| Other                                  |       | 2,749                  |       | 2,578        |       | 171                   |       | 7,946        |       | 9,266 |   | (1,320 | ) |
| Total operating  revenues              |       | 2,380,734              |       | 1,370,086    |       | 1,010,648             |       | 5,750,514    |       | 3,807,436 |   | 1,943,078 |   |
|                                   |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Purchases of petroleum  products       |       | 2,350,107              |       | 1,344,613    |       | 1,005,494             |       | 5,665,136    |       | 3,728,345 |   | 1,936,791 |   |
| Operating, general and  administrative |       | 15,972                 |       | 15,412       |       | 560                   |       | 41,700       |       | 39,279 |   | 2,421 |   |
| Operating fuel and  power              |       | 1,247                  |       | 1,240        |       | 7                     |       | 3,709        |       | 4,373 |   | (664 | ) |
| Depreciation and  amortization         |       | 6,471                  |       | 3,268        |       | 3,203                 |       | 13,623       |       | 9,381 |   | 4,242 |   |
| Taxes—other than income  taxes    |       | 1,737                  |       | 1,152        |       | 585                   |       | 4,206        |       | 3,228 |   | 978 |   |
| Gains on sales of  assets              |       | (7                     | )          | (377         | )          | 370                   |       | (59          | )          | (484 | ) | 425 |   |
| Total costs and  expenses              |       | 2,375,527              |       | 1,365,308    |       | 1,010,219             |       | 5,728,315    |       | 3,784,122 |   | 1,944,193 |   |
|                                   |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Operating income                       |       | 5,207                  |       | 4,778        |       | 429                   |       | 22,199       |       | 23,314 |   | (1,115 | ) |
|                                   |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Equity earnings                        |       | 5,571                  |       | 5,943        |       | (372                  | )          | 19,829       |       | 24,923 |   | (5,094 | ) |
| Other income—net                  |       | 103                    |       | 60           |       | 43                    |       | 132          |       | 257 |   | (125 | ) |
|                                   |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Earnings before  interest              |       | $                      | 10,881     |         | $          | 10,781                |       | $            | 100        |   | $ | 42,160 |   | $ | 48,494 |   | $ | (6,334 | ) |
|                                        |            |                        |            |              |            |                       |            |              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

                Information presented in thefollowing table includes the margin of the Upstream Segment, which may beviewed as a non-GAAP (Generally Accepted Accounting Principles) financialmeasure under the rules of the SEC.  Wecalculate the margin of the Upstream Segment as revenues generated from thesale of crude oil and lubrication oil, and transportation of crude oil, lessthe costs of purchases of crude oil and lubrication oil.  We believe that margin is a more meaningfulmeasure of financial performance than sales and purchases of crude oil andlubrication oil due to the significant fluctuations in sales and purchasescaused by variations in the level of volumes marketed and prices for productsmarketed.  Additionally, we use margin internallyto evaluate the financial performance of the Upstream Segment as we believemargin is 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 and nine months ended September 30, 2005 and 2004 is presented below (inthousands, except per barrel and per gallon amounts):

 

 

43

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| ** **                              | ** ** | **Three Months Ended** | ** ** | **Percentage** | ** ** | **Nine Months Ended** | ** ** | **Percentage** | ** ** |
|-----------------------------------------|------------|------------------------|------------|----------------|------------|-----------------------|------------|----------------|------------|
| ** **                              | ** ** | **September 30,**      | ** ** | **Increase**   | ** ** | **September 30,**     | ** ** | **Increase**   | ** ** |
| ** **                              | ** ** | **2005**               | ** ** | **2004**       | ** ** | **(Decrease)**        | ** ** | **2005**       | ** ** | **2004** | ** ** | **(Decrease)** | ** ** |
|                                    |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Margins: (1)                            |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Crude oil  transportation               |       | $                      | 15,626     |           | $          | 14,485                |       | 8              | %          | $ | 44,982 |   | $ | 40,860 |   | 10 | % |
| Crude oil marketing                     |       | 7,750                  |       | 4,327          |       | 79                    | %          | 20,282         |       | 16,920 |   | 20 | % |
| Crude oil terminaling                   |       | 2,552                  |       | 2,426          |       | 5                     | %          | 6,785          |       | 7,392 |   | (8 | )% |
| Lubrication oil sales                   |       | 1,950                  |       | 1,657          |       | 18                    | %          | 5,383          |       | 4,653 |   | 16 | % |
| Total margin                            |       | $                      | 27,878     |           | $          | 22,895                |       | 22             | %          | $ | 77,432 |   | $ | 69,825 |   | 11 | % |
|                                    |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Total barrels:                          |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Crude oil  transportation               |       | 23,659                 |       | 25,093         |       | (6                    | )%         | 71,181         |       | 75,941 |   | (6 | )% |
| Crude oil marketing                     |       | 54,747                 |       | 43,284         |       | 26                    | %          | 147,905        |       | 131,208 |   | 13 | % |
| Crude oil terminaling                   |       | 28,528                 |       | 28,889         |       | (1                    | )%         | 76,934         |       | 89,777 |   | (14 | )% |
|                                    |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Lubrication oil volume  (total gallons) |       | 3,573                  |       | 3,346          |       | 7                     | %          | 10,898         |       | 9,765 |   | 12 | % |
|                                    |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Margin per barrel:                      |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Crude oil  transportation               |       | $                      | 0.660      |           | $          | 0.577                 |       | 14             | %          | $ | 0.632 |   | $ | 0.538 |   | 17 | % |
| Crude oil marketing                     |       | 0.142                  |       | 0.100          |       | 42                    | %          | 0.137          |       | 0.129 |   | 6 | % |
| Crude oil terminaling                   |       | 0.089                  |       | 0.084          |       | 7                     | %          | 0.088          |       | 0.082 |   | 7 | % |
|                                    |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Lubrication oil margin  (per gallon)    |       | 0.546                  |       | 0.495          |       | 10                    | %          | 0.494          |       | 0.476 |   | 4 | % |
|                                         |            |                        |            |                |            |                       |            |                |            |  |  |  |  |  |  |  |  |  |  |

----

(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.

 

               The following table reconcilesthe Upstream Segment margin to the consolidated statements of income using theinformation presented in the consolidated statements of income and thestatements of income in Note 11.  SegmentInformation (in thousands):

 
| ** **                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                             | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Sales of petroleum  products           |       | $                      | 2,367,984  |                  | $          | 1,358,220 |   | $ | 5,714,353 |   | $ | 3,770,006 |   |
| Transportation — Crude  oil       |       | 10,001                 |       | 9,288                 |       | 28,215 |   | 28,164 |   |
| Less: Purchases of  petroleum products |       | (2,350,107             | )          | (1,344,613            | )          | (5,665,136 | ) | (3,728,345 | ) |
| Total margin                           |       | 27,878                 |       | 22,895                |       | 77,432 |   | 69,825 |   |
| Other operating  revenues              |       | 2,749                  |       | 2,578                 |       | 7,946 |   | 9,266 |   |
| Net operating revenues                 |       | 30,627                 |       | 25,473                |       | 85,378 |   | 79,091 |   |
| Operating, general and  administrative |       | 15,972                 |       | 15,412                |       | 41,700 |   | 39,279 |   |
| Operating fuel and  power              |       | 1,247                  |       | 1,240                 |       | 3,709 |   | 4,373 |   |
| Depreciation and  amortization         |       | 6,471                  |       | 3,268                 |       | 13,623 |   | 9,381 |   |
| Taxes—other than income  taxes    |       | 1,737                  |       | 1,152                 |       | 4,206 |   | 3,228 |   |
| Gains on sales of  assets              |       | (7                     | )          | (377                  | )          | (59 | ) | (484 | ) |
| Operating income                       |       | $                      | 5,207      |                  | $          | 4,778 |   | $ | 22,199 |   | $ | 23,314 |   |
|                                        |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |

 

*Three Months Ended September 30,2005 Compared with Three Months Ended September 30, 2004*

 

               Our margin increased $5.0 millionfor the three months ended September 30, 2005, compared with the three monthsended September 30, 2004.  Crude oilmarketing margin increased $3.4 million primarily due to an increase in volumesmarketed primarily due to asset acquisitions, partially offset by unrealizedlosses of $1.2 million related

 

 

44

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tomarking crude oil grade and location swap contracts to current market value andincreased transportation costs.  Crudeoil transportation margin increased $1.2 million primarily due to increasedtransportation volumes and revenues on our South Texas and West Texas systems,partially offset by decreased transportation volumes on our Red River and Basinsystems.  Lubrication oil sales marginincreased $0.3 million due to increased sales of chemical volumes and theacquisitions of lubrication oil distributors in Casper, Wyoming, in August2004, and in Dumas, Texas, in July 2005. Crude oil terminaling margin increased $0.1 million as a result of anincrease in pumpover volumes at Cushing, Oklahoma, partially offset by adecrease in pumpover volumes at Midland, Texas.

 

                Other operating revenuesincreased $0.2 million for the three months ended September 30, 2005, comparedwith the three months ended September 30, 2004, primarily due increasedrevenues from documentation and other services to support customers’ tradingactivity at Midland and Cushing.

 

                Costs and expenses, excludingexpenses associated with purchases of crude oil and lubrication oil, increased$4.8 million for the three months ended September 30, 2005, compared with thethree months ended September 30, 2004, primarily due to increased depreciationand amortization expense, increased operating, general and administrativeexpenses, increased taxes — other than income taxes and lower gains on sales ofassets in the 2005 period.  Depreciationand amortization expense increased $3.2 million as a result of a $2.6 millionnon-cash impairment charge in the third quarter of 2005, resulting from theimpairment of two crude oil systems (see Note 3.  Property, Plant and Equipment).  Depreciation expense also increased as aresult of assets placed into service in the 2005 period related to acquisitionsand assets retired to depreciation expense during the period.  Operating, general and administrativeexpenses increased $0.6 million from the prior year period primarily due to a$1.1 million increase in pipeline operating and maintenance expense, a $0.4million increase in insurance expense, a $0.3 million increase in labor andbenefits expense relating to plan amendments (see Note 10.  Employee Benefit Plans) and a $0.2 millionincrease in transition expenses related to changes in control of our GeneralPartner.  These increases were partiallyoffset by a $1.5 million decrease in pipeline inspection and repair costsassociated with our integrity management program and a $0.2 million decrease inlabor and benefits expense related to the vesting of certain of ourcompensation plans in the first quarter of 2005 as a result of changes incontrol of our General Partner.  Taxes —other than income taxes increased $0.6 million primarily as a result of ahigher asset base in the 2005 period primarily due to acquisitions ofassets.  During the three months endedSeptember 30, 2004, we recognized a gain of $0.4 million from the sale of ourremaining interest in the original Rancho Pipeline system (see Note 5.  Acquisitions and Dispositions).

 

       Equityearnings from our investment in Seaway decreased $0.4 million for the threemonths ended September 30, 2005, compared with the three months ended September30, 2004, primarily due to higheroperating, general and administrative expenses related to a pipeline release inMay 2005 and decreased gains on inventory sales, partially offset by increasedlong-haul transportation volumes.

 

                After Seaway’s pipeline release in May 2005, themaximum operating pressure on the pipeline system was reduced by 20% until thecause of the failure is determined and any required corrective measures areimplemented.  A study of the failed pipewas performed by independent, metallurgical experts who determined that thepipe failed due to damage that occurred during rail shipment associated withits installation thirty years ago.  Thecorrective actions include running a very sophisticated, high definitioninspection tool through the pipe to determine if there are any other sectionsof pipe that have similar damage.   Thisapproach is consistent with directives from the United States Department ofTransportation’s Office of Pipeline Safety in past failures of this type.  We are in the initial stages of evaluating approximately300 miles of Seaway’s pipeline that have similar vintage pipe.  Because of the complexity of the inspectiontool being used, we expect that it will take several months to complete theanalysis of the data, as well as complete any additional repairs that areidentified from the analysis.  Based onthese projections, we expect Seaway to be operating at reduced maximumpressures through the first quarter of 2006. As a result of operating at reduced maximum pressures, during the thirdquarter of 2005, we began using a drag reducing agent to increase the flow ofproduct through the pipeline system.  Thedrag reducing agent allowed us to maintain the higher volumes transported, butalso increased our operating costs.  Atthis time, we do not believe the reduced pressures will have a material adverseeffect on our financial position, results of operations or cash flows.

 

 

45

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*Nine Months Ended September 30,2005 Compared with Nine Months Ended September 30, 2004*

 

               Our margin increased $7.6 millionfor the nine months ended September 30, 2005, compared with the nine monthsended September 30, 2004.  Crude oiltransportation margin increased $4.1 million primarily due to increasedtransportation volumes and revenues on our South Texas system and higherrevenues on our Basin and West Texas systems related to movements on highertariff segments, partially offset by decreases in transportation volumes on ourRed River system and on lower tariff segments of our Basin system.  Crude oil marketing margin increased $3.4million primarily due to increased volumes marketed as a result of assetacquisitions, partially offset by increased transportation costs and unrealizedlosses of $0.4 million related to marking crude oil grade and location swapcontracts to current market value. Lubrication oil sales margin increased $0.7 million due to increasedsales of chemical volumes and the acquisitions of lubrication oil distributorsin Casper, Wyoming, in August 2004, and in Dumas, Texas, in July 2005.  Crude oil terminaling margin decreased $0.6million as a result of a decrease in pumpover volumes at Midland, Texas, andCushing, Oklahoma.

 

                Other operating revenuesdecreased $1.3 million for the nine months ended September 30, 2005, comparedwith the nine months ended September 30, 2004, primarily due to a $1.4 millionfavorable settlement of inventory imbalances in the first quarter of 2004 and lowerrevenues from documentation and other services to support customers’ tradingactivity at Midland and Cushing in the first nine months of 2005.

 

                Costs and expenses, excludingexpenses associated with purchases of crude oil and lubrication oil, increased$7.4 million for the nine months ended September 30, 2005, compared with thenine months ended September 30, 2004, due to increased depreciation andamortization expense, increased operating, general and administrative expenses,increased taxes — other than income taxes and lower gains on sales of assets inthe 2005 period, partially offset by decreased operating fuel and power.  Depreciation and amortization expenseincreased $4.4 million primarily as a result of a $2.6 million non-cashimpairment charge (see Note 3.  Property,Plant and Equipment).  Depreciationexpense also increased as a result of assets placed in service and assetsretired to depreciation expense during the period.  Operating, general and administrativeexpenses increased $2.4 million from the prior year period.  This increase was primarily due to a $2.6million increase in pipeline operating and maintenance expense, a $2.4 millionincrease in labor and benefits expense related to vesting provisions in certainof our compensation plans as a result of changes in control of our GeneralPartner and an increase in the number of employees between periods and a $0.7million increase in insurance expense. These increases were partially offset by a $0.6 million decrease inpostretirement benefit accruals related to plan amendments (see Note 10.Employee Benefit Plans), a $1.8 million decrease in pipeline inspection andrepair costs associated with our integrity management program, a $1.4 milliondecrease in environmental assessment and remediation costs and a $1.4 milliondecrease in product measurement losses. Taxes — other than income taxes increased $1.0 million due to increasesin property tax accruals and a higher asset base in the 2005 period.  During the nine months ended September 30,2004, we recognized a gain of $0.4 million from the sale of our remaininginterest in the original Rancho Pipeline system (see Note 5.  Acquisitions and Dispositions).  Operating fuel and power decreased $0.7million primarily as a result of lower transportation volumes in the 2005period.

 

       Equityearnings from our investment in Seaway decreased $5.1 million for the ninemonths ended September 30, 2005, compared with the nine months ended September30, 2004, primarily due to higheroperating, general and administrative expenses related to a pipeline release inMay 2005 as discussed above, decreased gains on inventory sales, higher depreciation expense  and a favorable settlement in the firstquarter of 2004 with a former owner of Seaway’s crude oil assets regardinginventory imbalances that were not acquired by us, partially offset by higherlong-haul transportation volumes.

** **

**Midstream Segment**

 

                The following table providesfinancial information for the Midstream Segment for the three months and ninemonths ended September 30, 2005 and 2004 (in thousands):

 

 

46

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| ****                                   | ** ** | **Three Months Ended** | ** ** | ** **   | ** ** | **Nine Months Ended** | ** ** | ** **   | ** ** |
|----------------------------------------|------------|------------------------|------------|--------------|------------|-----------------------|------------|--------------|------------|
| ** **                             | ** ** | **September 30,**      | ** ** | **Increase** | ** ** | **September 30,**     | ** ** | **Increase** | ** ** |
| ** **                             | ** ** | **2005**               | ** ** | **2004**     | ** ** | **(Decrease)**        | ** ** | **2005**     | ** ** | **2004** | ** ** | **(Decrease)** | ** ** |
|                                   |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Sales of petroleum  products           |       | $                      | 2,880      |         | $          | 1,734                 |       | $            | 1,146      |   | $ | 7,337 |   | $ | 4,868 |   | $ | 2,469 |   |
| Gathering—Natural Gas             |       | 38,833                 |       | 35,515       |       | 3,318                 |       | 112,349      |       | 104,444 |   | 7,905 |   |
| Transportation—NGLs               |       | 11,829                 |       | 10,430       |       | 1,399                 |       | 33,435       |       | 31,022 |   | 2,413 |   |
| Other                                  |       | 3,768                  |       | 4,016        |       | (248                  | )          | 11,838       |       | 11,528 |   | 310 |   |
| Total operating  revenues              |       | 57,310                 |       | 51,695       |       | 5,615                 |       | 164,959      |       | 151,862 |   | 13,097 |   |
|                                   |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Purchases of petroleum  products       |       | 2,623                  |       | 1,381        |       | 1,242                 |       | 5,799        |       | 4,367 |   | 1,432 |   |
| Operating, general and  administrative |       | 11,726                 |       | 12,175       |       | (449                  | )          | 31,099       |       | 34,732 |   | (3,633 | ) |
| Operating fuel and  power              |       | 3,121                  |       | 3,691        |       | (570                  | )          | 7,658        |       | 8,310 |   | (652 | ) |
| Depreciation and  amortization         |       | 14,391                 |       | 14,191       |       | 200                   |       | 39,932       |       | 44,021 |   | (4,089 | ) |
| Taxes—other than income  taxes    |       | 1,201                  |       | 735          |       | 466                   |       | 3,087        |       | 3,445 |   | (358 | ) |
| Gains on sales of  assets              |       | —                 |       | —       |       | —                |       | (407         | )          | — |   | (407 | ) |
| Total costs and  expenses              |       | 33,062                 |       | 32,173       |       | 889                   |       | 87,168       |       | 94,875 |   | (7,707 | ) |
|                                   |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Operating income                       |       | 24,248                 |       | 19,522       |       | 4,726                 |       | 77,791       |       | 56,987 |   | 20,804 |   |
|                                   |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Other income—net                  |       | 75                     |       | 21           |       | 54                    |       | 177          |       | 95 |   | 82 |   |
|                                   |       |                   |       |         |       |                  |       |         |       |   |   |   |   |
| Earnings before  interest              |       | $                      | 24,323     |         | $          | 19,543                |       | $            | 4,780      |   | $ | 77,968 |   | $ | 57,082 |   | $ | 20,886 |   |
|                                        |            |                        |            |              |            |                       |            |              |            |  |  |  |  |  |  |  |  |  |  |  |

 

                The following table presentsvolume and average rate information for the three months and nine months ended September30, 2005 and 2004:

 
| ** **                                                        | ** ** | **Three Months Ended** | ** ** | **Percentage** | ** ** | **Nine Months Ended** | ** ** | **Percentage** | ** ** |
|-------------------------------------------------------------------|------------|------------------------|------------|----------------|------------|-----------------------|------------|----------------|------------|
| ** **                                                        | ** ** | **September 30,**      | ** ** | **Increase**   | ** ** | **September 30,**     | ** ** | **Increase**   | ** ** |
| ** **                                                        | ** ** | **2005**               | ** ** | **2004**       | ** ** | **(Decrease)**        | ** ** | **2005**       | ** ** | **2004** | ** ** | **(Decrease)** | ** ** |
| Gathering—Natural Gas—Jonah:                            |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Million cubic feet  (“MMcf”)                            |       | 105,993                |       | 90,005         |       | 18                    | %          | 302,388        |       | 257,402 |   | 17 | % |
| Billion British thermal  units (“MMmbtu”)               |       | 117,006                |       | 99,531         |       | 18                    | %          | 333,823        |       | 284,858 |   | 17 | % |
| Average fee per Million  British thermal unit (“MMBtu”) |       | $                      | 0.185      |           | $          | 0.191                 |       | (4             | )%         | $ | 0.187 |   | $ | 0.195 |   | (4 | )% |
|                                                              |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Gathering—Natural Gas—Val  Verde:                       |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| MMcf                                                              |       | 46,273                 |       | 36,733         |       | 26                    | %          | 131,646        |       | 108,213 |   | 22 | % |
| MMmbtu                                                            |       | 40,881                 |       | 31,294         |       | 31                    | %          | 115,685        |       | 91,459 |   | 26 | % |
| Average fee per MMBtu                                             |       | $                      | 0.422      |           | $          | 0.527                 |       | (20            | )%         | $ | 0.430 |   | $ | 0.533 |   | (19 | )% |
|                                                              |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Transportation—NGLs:                                         |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Thousand barrels                                                  |       | 16,332                 |       | 15,064         |       | 8                     | %          | 45,708         |       | 45,209 |   | 1 | % |
| Average rate per barrel                                           |       | $                      | 0.724      |           | $          | 0.692                 |       | 5              | %          | $ | 0.731 |   | $ | 0.686 |   | 7 | % |
|                                                              |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Fractionation—NGLs:                                          |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Thousand barrels                                                  |       | 1,068                  |       | 994            |       | 7                     | %          | 3,294          |       | 3,064 |   | 7 | % |
| Average rate per barrel                                           |       | $                      | 1.768      |           | $          | 1.866                 |       | (6             | )%         | $ | 1.744 |   | $ | 1.802 |   | (3 | )% |
|                                                              |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Sales—Condensate:                                            |       |                   |       |           |       |                  |       |           |       |   |   |   |   |
| Thousand barrels                                                  |       | 3.4                    |       | 7.3            |       | (54                   | )%         | 44.6           |       | 67.0 |   | (33 | )% |
| Average rate per barrel                                           |       | $                      | 55.60      |           | $          | 43.54                 |       | 28             | %          | $ | 50.21 |   | $ | 35.58 |   | 41 | % |
|                                                                   |            |                        |            |                |            |                       |            |                |            |  |  |  |  |  |  |  |  |  |  |  |

 

 

47

----

 

               The following table reconciles theMidstream Segment margin to operating income in the consolidated statements ofincome using the information presented in the tables above, in the consolidatedstatements of income and in the statements of income in Note 11.  Segment Information (in thousands):

 
| ** **                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                             | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Sales of petroleum  products           |       | $                      | 2,880      |                  | $          | 1,734 |   | $ | 7,337 |   | $ | 4,868 |   |
| Less: Purchases of  petroleum products |       | (2,623                 | )          | (1,381                | )          | (5,799 | ) | (4,367 | ) |
| Total margin                           |       | 257                    |       | 353                   |       | 1,538 |   | 501 |   |
| Gathering—Natural Gas             |       | 38,833                 |       | 35,515                |       | 112,349 |   | 104,444 |   |
| Transportation—NGLs               |       | 11,829                 |       | 10,430                |       | 33,435 |   | 31,022 |   |
| Other operating  revenues              |       | 3,768                  |       | 4,016                 |       | 11,838 |   | 11,528 |   |
| Net operating revenues                 |       | 54,687                 |       | 50,314                |       | 159,160 |   | 147,495 |   |
| Operating, general and  administrative |       | 11,726                 |       | 12,175                |       | 31,099 |   | 34,732 |   |
| Operating fuel and  power              |       | 3,121                  |       | 3,691                 |       | 7,658 |   | 8,310 |   |
| Depreciation and  amortization         |       | 14,391                 |       | 14,191                |       | 39,932 |   | 44,021 |   |
| Taxes—other than income  taxes    |       | 1,201                  |       | 735                   |       | 3,087 |   | 3,445 |   |
| Gains on sales of  assets              |       | —                 |       | —                |       | (407 | ) | — |   |
| Operating income                       |       | $                      | 24,248     |                  | $          | 19,522 |   | $ | 77,791 |   | $ | 56,987 |   |
|                                        |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |

 

*Three Months Ended September 30,2005 Compared with Three Months Ended September 30, 2004*

 

                Revenues from the gathering ofnatural gas increased $3.3 million for the three months ended September 30,2005, compared with the three months ended September 30, 2004.  Natural gas gathering revenues from the Jonahsystem increased $2.5 million and volumes gathered increased 16.0 billion cubicfeet (“Bcf”) for the three months ended September 30, 2005, primarily due tothe expansion of the Jonah system in 2004. Installation of additional capacity of 100 million cubic feet per daywas completed during the fourth quarter of 2004.  Jonah’s average natural gas gathering rateper MMcf decreased due to higher system wellhead pressures. Natural gasgathering revenues from the Val Verde system increased $0.8 million and volumesgathered increased 7.0 Bcf for the three months ended September 30, 2005,primarily due to increased volumes from two new connections made to the ValVerde system in May and December 2004, partially offset by the natural declineof CBM production, slower than anticipated completion and connection of infillwells andless volume from infill wells than was anticipated.  Val Verde’saverage natural gas gathering rate per MMcf decreased due to contracts enteredinto relating to the new connections, which have lower rates than the existingVal Verde system’s average rates.

 

                Revenues from the transportationof NGLs increased $1.4 million for the three months ended September 30, 2005,compared with the three months ended September 30, 2004, primarily due toincreases in volumes transported on the Panola and Chaparral Pipelines,partially offset by decreases in volumes transported on the Dean and WilcoxPipelines.  The increase in the NGLtransportation average rate per barrel resulted from higher average rates perbarrel on volumes transported on the Panola and Chaparral Pipelines.

 

                Other operating revenuesdecreased $0.3 million for the three months ended September 30, 2005, comparedwith the three months ended September 30, 2004. The decrease was due to various miscellaneous revenue items.

 

                Costs and expenses (excludingpurchases of petroleum products) decreased $0.4 million for the three monthsended September 30, 2005, compared with the three months ended September 30,2004, due to decreases in operating, general and administrative expenses andoperating fuel and power, partially offset by increases in taxes — other thanincome taxes and depreciation and amortization expense.  Operating, general and administrativeexpenses decreased $0.5 million primarily due to a $1.3 million decrease in gassettlement expenses and a decrease in consulting and contract services relatedto compliance with the Sarbanes-Oxley Act of 2002, partially offset by a

 

 

48

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$0.9million increase in labor and benefits expenses associated with certain of ourcompensation plans and a $0.4 million increase in transition expenses as aresult of changes in control of our General Partner.  Operating fuel and power decreased $0.6million compared to the prior year period due to adjustments to the fuel andpower accrual in the prior year period, partially offset by increased expensesin the 2005 period related to higher transportation volumes.  Taxes — other than income taxes increased$0.5 million as a result of adjustments to property tax accruals primarilyrelated to the expansion of the Jonah system. Depreciation expense increased$0.4 million primarily due to a $0.4 million increase on Val Verde as a resultof assets placed into service in 2004 and an increase on Panola due to assetsretired to depreciation expense, partially offset by a $0.2 million decrease onJonah as a result of increases to the estimated lives of Jonah’s assets.  Amortization expense on the Jonah systemdecreased $1.0 million primarily due to a $1.3 million decrease related torevisions to the estimated life of intangible assets under theunits-of-production method, partially offset by a $0.3 million increase as aresult of higher volumes on the Jonah system in the 2005 period.  Amortization expense on the Val Verde systemincreased $0.8 million primarily due to at $1.3 million increase related torevisions to the estimated life of intangible assets under theunits-of-production method, partially offset by a $0.5 million decrease as aresult of lower volumes in the 2005 period on contracts included in theintangible assets, resulting from the natural decline in CBM production.  From time to time, updated productionforecasts are obtained from some of the producers on the Jonah and Val Verdesystems, and as a result, we revise our best estimate of future throughput onthe these systems (see Note 2.  Goodwilland Other Intangible Assets).

 

*Nine Months Ended September 30,2005 Compared with Nine Months Ended September 30, 2004*

 

                Revenues from the gathering ofnatural gas increased $7.9 million for the nine months ended September 30,2005, compared with the nine months ended September 30, 2004.  Natural gas gathering revenues from the Jonahsystem increased $6.9 million and volumes gathered increased 45.0 Bcf for thenine months ended September 30, 2005, primarily due to the expansion of theJonah system in 2004.  Installation ofadditional capacity of 100 million cubic feet per day was completed during thefourth quarter of 2004.  Jonah’s averagenatural gas gathering rate per MMcf decreased due to higher system wellheadpressures. Natural gas gathering revenues from the Val Verde system increased$1.0 million and volumes gathered increased 23.4 Bcf for the nine months endedSeptember 30, 2005, primarily due to increased volumes from two new connectionsmade to the Val Verde system in May and December 2004, partially offset by thenatural decline of CBM production, slower than anticipated completion andconnection of infill wells and less volume from infill wells than was anticipated.  Val Verde’saverage natural gas gathering rate per MMcf decreased due to contracts enteredinto relating to the new connections, which have lower rates than the existingVal Verde system’s average rates.

 

                Margin (sales of petroleumproducts less purchases of petroleum products) resulting from the processingarrangements at the Jonah Pioneer plant increased $1.0 million for the ninemonths ended September 30, 2005, compared with the nine months ended September30, 2004, primarily due to increased volumes and higher NGL prices.  Jonah’s Pioneer gas processing plant wascompleted during the first quarter of 2004, as a part of the Phase IIIexpansion to increase the processing capacity in southwestern Wyoming.  Pioneer’s processing agreements allow theproducers to elect annually whether to be charged under a fee-based arrangementor a fee plus keep-whole arrangement. Under the fee-based election, Jonah receives a fee for its processingservices.  Under the fee plus keep-wholeelection, Jonah receives a lower fee for its processing services, retains andsells the NGLs extracted during the process and delivers to producers theresidue gas equivalent in energy to the natural gas received from theproducers.  Jonah sells the NGLs itretains and purchases gas to replace the equivalent energy removed in theliquids.  For the 2004 and 2005 periods,the producers elected the fee plus keep-whole arrangement.

 

                Revenues from the transportationof NGLs increased $2.4 million for the nine months ended September 30, 2005,compared with the nine months ended September 30, 2004, primarily due toincreases in volumes transported on the Panola and Chaparral Pipelines,partially offset by decreases in volumes transported on the Dean and WilcoxPipelines.  The increase in the NGL transportationaverage rate per barrel resulted from higher average rates per barrel onvolumes transported on the Panola and Chaparral Pipelines.

 

 

49

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                Other operating revenuesincreased $0.3 million for the nine months ended September 30, 2005, comparedwith the nine months ended September 30, 2004. This increase was primarily due to a $0.2 million increase in NGLfractionation revenues as a result of higher volumes.

 

                Costs and expenses (excludingpurchases of petroleum products) decreased $9.1 million for the nine monthsended September 30, 2005, compared with the nine months ended September 30,2004, due to decreases in depreciation and amortization expense, operating,general and administrative expenses, operating fuel and power and taxes — otherthan income taxes and a net gain recorded on the sale of an asset.  Amortization expense on the Jonah systemdecreased $2.7 million primarily due to a $3.7 million decrease related torevisions to the estimated life of intangible assets under theunits-of-production method, partially offset by a $1.0 million increase as aresult of higher volumes in the 2005 period. Amortization expense on the Val Verde system increased $0.3 millionprimarily due to a $1.4 million increase related to revisions to the estimatedlife of intangible assets under the units-of-production method, partiallyoffset by a $1.1 million decrease as a result of lower volumes in the 2005period on contracts included in the intangible assets, resulting from thenatural decline in CBM production.  Depreciationexpense decreased $1.7 million primarily due to a $3.7 million decrease onJonah as a result of increases to the estimated lives of Jonah’s assets,partially offset by a $1.7 million increase on Val Verde and a $0.3 millionincrease on Panola as a result of assets placed into service in 2004.  Operating, general and administrativeexpenses decreased $3.6 million primarily due to a $4.8 million decrease in gassettlement expenses, a $0.7 million decrease in inspection and repair costsassociated with our integrity management program and a decrease in consultingand contract services related to compliance with the Sarbanes-Oxley Act of 2002.  These decreases were partially offset by a$2.1 million increase in labor and benefits expense primarily associated withvesting provisions in certain of our compensation plans and with certain DEFSemployees becoming employees of EPCO and a $0.7 million increase in transitionexpenses as a result of changes in control of our General Partner.  Operating fuel and power decreased $0.7million compared to the prior year period due to adjustments to the fuel andpower accrual in the prior year period, partially offset by increased expensesin the 2005 period related to higher transportation volumes. Taxes — other thanincome taxes decreased $0.3 million as a result of adjustments to property taxaccruals.  A net gain of $0.4 million wasrecognized on the sale of equipment in the current period.

 

**Interest Expenseand Capitalized Interest**

 

*Three Months Ended September 30,2005 Compared with Three Months Ended September 30, 2004*

 

                Interest expense increased $3.5million for the three months ended September 30, 2005, compared with the threemonths ended September 30, 2004, primarily due to higher short term floatinginterest rates on our revolving credit facility and higher outstanding debtbalances.

 

                Capitalized interest increased $0.9million for the three months ended September 30, 2005, compared with the threemonths ended September 30, 2004, due to higher construction work-in-progressbalances in the 2005 period.

 

*Nine Months Ended September 30,2005 Compared with Nine Months Ended September 30, 2004*

 

                Interest expense increased $8.2million for the nine months ended September 30, 2005, compared with the ninemonths ended September 30, 2004, primarily due to higher outstanding borrowingsand higher short term floating interest rates on our revolving credit facilityand $2.0 million of expense related to the termination of a treasury lock (seeNote 4.  Interest Rate Swaps).  These increases were partially offset by ahigher percentage of fixed interest rate debt during the nine months ended September30, 2004, that carried a higher rate of interest as compared with floatinginterest rate debt.  The higherpercentage of fixed interest rate debt resulted from an interest rate swap thatexpired in April 2004 (see Note 4. Interest Rate Swaps).

 

                Capitalized interest increased $0.7million for the nine months ended September 30, 2005, compared with the ninemonths ended September 30, 2004, due to higher construction work-in-progressbalances in the 2005 period.

 

 

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** **

**FinancialCondition and Liquidity**

Cash generated from operations, credit facilities and debt and equityofferings are our primary sources of liquidity. At September 30, 2005, we had a working capital surplus of $93.5million, while at December 31, 2004, we had a working capital deficit of $37.8million.  At September 30, 2005, we hadapproximately $139.5 million in available borrowing capacity under ourrevolving credit facility.  Cash flowsfor the nine months ended September 30, 2005 and 2004 were as follows (inmillions):

 

| ** **                   | ** ** | **Nine Months Ended** | ** ** |
|------------------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **September 30,**     | ** ** |
| ** **                   | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Cash provided by (used  in): |       |                  |       |   |   |
| Operating activities         |       | $                     | 44.0       |   | $ | 173.9 |   |
| Investing activities         |       | (262.4                | )          | (134.9 | ) |
| Financing activities         |       | 202.1                 |       | (58.9 | ) |
|                              |            |                       |            |  |  |  |  |

 

*        OperatingActivities*

Net cash from operating activities for the nine months ended September30, 2005 and 2004, was comprised of the following (in millions):

 

| ** **                              | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **September 30,**     | ** ** |
| ** **                              | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                              | ** ** | ** **            | ** ** | ** ** | ** ** |
| Net income                              |       | $                     | 121.7      |   | $ | 104.1 |   |
| Depreciation and  amortization          |       | 83.0                  |       | 84.5 |   |
| Earnings in equity  investments         |       | (20.4                 | )          | (22.9 | ) |
| Distributions from  equity investments  |       | 28.2                  |       | 39.5 |   |
| Gains on sales of  assets               |       | (0.6                  | )          | (1.0 | ) |
| Non-cash portion of  interest expense   |       | 1.2                   |       | 0.2 |   |
| Cash used in working  capital and other |       | (169.1                | )          | (30.5 | ) |
|                                    |       |                  |       |   |   |
| Net  cash from operating activities     |       | $                     | 44.0       |   | $ | 173.9 |   |
|                                         |            |                       |            |  |  |  |  |  |

 

For a discussion of changes in earnings before interest, depreciationand amortization, equity earnings, gain on sales of assets by segment andconsolidated interest expense — net, see “— Results of Operations for theDownstream Segment, Upstream Segment and Midstream Segment.”  Cash provided by operating activitiesdecreased $129.9 million for the nine months ended September 30, 2005, comparedwith the nine months ended September 30, 2004, primarily due to the timing ofcash disbursements and cash receipts for crude oil inventory and other workingcapital components and an $11.3 million decrease in distributions received fromour equity investments during the nine months ended September 30, 2005,partially offset by higher net income and lower depreciation and amortizationexpense in the 2005 period.

 

 During the second and third quartersof 2005, we purchased crude oil and simultaneously entered into offsettingsales contracts for physical delivery during the fourth quarter of 2005.  The purpose of these contracts was to lock ina margin on the crude oil while it is stored in our facilities.  These purchases had a negative impact on cashfrom operating activities when the invoices for the purchase of the crude oilwere paid.  We utilized borrowings underour revolving credit facility to fund a large portion of the crude oilpurchases.  These borrowings on our revolvingcredit facility are shown as financing activities in the statement of cashflows.  Until we deliver the crude oil inthe fourth quarter of 2005 and subsequently receive payment from our customers,cash from operating activities will be negatively impacted by this activity.

 

 

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Net cash from operatingactivities for the nine months ended September 30, 2005 and 2004, includedinterest payments, net of amounts capitalized, of $78.5 million and $75.5million, respectively.  Excluding theeffects of hedging activities and interest capitalized during the year endedDecember 31, 2005, we expect interest payments on our fixed rate Senior Notesto be approximately $77.8 million.  Weexpect to pay our interest payments with cash flows from operating activities.

*        InvestingActivities*

Cash flows used ininvesting activities totaled $262.4 million for the nine months ended September30, 2005, and were comprised of $148.1 million of capital expenditures, $68.9million for the acquisition of Downstream Segment assets, $43.3 million for theacquisition of Upstream Segment assets and $2.6 million of cash contributionsfor TE Products’ ownership interest in MB Storage for capital expenditures,partially offset by $0.5 million in net cash proceeds from an asset sale in ourMidstream Segment.  Cash flows used ininvesting activities totaled $134.9 million for the nine months ended September30, 2004, and were comprised of $111.0 million of capital expenditures, $1.5million of cash contributions for TE Products’ ownership interest in Centennialto cover operating needs and capital expenditures, $20.2 million of cashcontributions for TE Products’ ownership interest in MB Storage, of which $16.5million was used to acquire storage assets, and $3.4 million for theacquisition of assets during the nine months ended September 30, 2004,partially offset by $1.2 million in net cash proceeds from the sales of variousassets in our Upstream and Downstream Segments.

*        FinancingActivities*

Cash flows provided byfinancing activities totaled $202.1 million for the nine months ended September30, 2005, and were comprised of $278.8 million of net proceeds received fromthe issuance of 7.0 million Units in May and June 2005 and $107.5 million inborrowings, net of repayments, on our revolving credit facility, partially offsetby $184.2 million of distributions paid to unitholders.  Cash flows used in financing activitiestotaled $58.9 million for the nine months ended September 30, 2004, and werecomprised of $174.4 million of distributions paid to unitholders, partiallyoffset by $115.5 million in borrowings, net of repayments, on our revolvingcredit facility.

We paid cash distributions of $184.2 million ($2.00 per Unit) and$174.4 million ($1.975 per Unit) during the nine months ended September 30,2005 and 2004, respectively. Additionally, we declared a cash distribution of $0.675 per Unit for thequarter ended September 30, 2005. We will pay the distribution of $66.9 millionon November 7, 2005, to unitholders of record on October 31, 2005.

 

                On May 5, 2005, we sold in anunderwritten public offering 6.1 million Units at $41.75 per Unit.  The proceeds from the offering, net ofunderwriting discount, totaled approximately $244.5 million.  On June 8, 2005, 865,000 Units were sold uponexercise of the underwriters’ over-allotment option granted in connection withthe offering on May 5, 2005.  Proceedsfrom the over-allotment sale, net of underwriting discount, totaled $34.7million.  The proceeds were used toreduce indebtedness under our revolving credit facility, to fund revenuegenerating and system upgrade capital expenditures and for general partnershippurposes.

 

***Universal Shelf***

** **

**                We have filed with the SEC auniversal shelf registration statement that, subject to agreement on terms atthe time of use and appropriate supplementation, allows us to issue, in one ormore offerings, up to an aggregate of $2.0 billion of equity securities, debtsecurities or a combination thereof.  In theMay 2005 equity offering, we issued $279.2 million of equity securities.  At September 30, 2005, we had $1.7 billion remainingunder this shelf registration, subject to customary marketing terms andconditions.**

 

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* *

*Credit Facilities*

 

                We have in place anunsecured revolving credit facility for up to $600.0 million (“Revolving CreditFacility”), including the issuance of letters of credit of up to $100.0million.  Interest is payable at anapplicable margin above either the lender’s base rate or LIBOR.  At September 30, 2005, $460.5 million was outstandingunder the facility, and we had $139.5 million of availability.  Restrictive covenants in the credit agreementlimit our ability to, among other things, incur additional indebtedness, makedistributions in excess of Available Cash (see Note 9.  Partners’ Capital and Distributions), and completemergers, acquisitions and sales of assets. In addition, the credit agreement requires us to maintain certainfinancial ratios, which we were in compliance with at September 30, 2005.

 

Centennialentered into credit facilities totaling $150.0 million, and as of September 30,2005, $150.0 million was outstanding under those credit facilities.  TE Products and Marathon Petroleum Company LLC(“Marathon”) have each guaranteed one-half of the repayment of Centennial’soutstanding debt balance (plus interest) under a long-term credit agreement,which expires in 2024, and a short-term credit agreement, which expires in2007.  The guarantees arose in order forCentennial to obtain adequate financing, and the proceeds of the creditagreements were used to fund construction and conversion costs of its pipelinesystem.  Prior to the expiration of thelong-term credit agreement, 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 September 30, 2005.

 

*2005 Capital Expenditures*

 

We estimate that capitalexpenditures, excluding acquisitions, for 2005 will be approximately $239.0million (including $7.0 million of capitalized interest).  We expect to spend approximately $176.6million for revenue generating projects and facility improvements.  Capital spending on revenue generatingprojects and facility improvements will include approximately $17.5 million forthe expansion of our Downstream Segment facilities.  We expect to spend $18.8 million to expandour Upstream Segment pipelines and facilities in West Texas and Oklahoma andapproximately $140.3 million to expand our Midstream Segment assets, withfurther expansions on our Jonah system. We expect to spend approximately $36.2 million to sustain existingoperations, including life-cycle replacements for equipment at variousfacilities and pipeline and tank replacements among all of our businesssegments.  We expect to spendapproximately $19.2 million to improve operational efficiencies and reducecosts among all of our business segments. During the remainder of 2005, TE Products may be required to contributecash to Centennial to cover capital expenditures, acquisitions or otheroperating needs and to MB Storage to cover significant capital expenditures oradditional acquisitions.  We continuallyreview and evaluate potential capital improvements and expansions that would becomplementary to our present business operations.  These expenditures can vary greatly dependingon the magnitude of our transactions.

        *Liquidity Outlook*

 

We believe that we will continue to have adequate liquidity to fundfuture recurring operating and investing activities.  Our primary cash requirements consist ofnormal operating expenses, capital expenditures to sustain existing operationsand revenue generating expenditures, interest payments on our Senior Notes and RevolvingCredit Facility, distributions to our General Partner and unitholders andacquisitions of new assets or businesses. Our cash requirements for the remainder of 2005 and 2006, such asoperating expenses, capital expenditures to sustain existing operations andquarterly distributions to our General Partner and unitholders, are expected tobe funded through operating cash flows.  Long-term cash requirements forexpansion projects, acquisitions and debt repayments are expected to be fundedby several sources, including cash flows from operating activities, borrowingsunder credit facilities, and possibly the issuance of additional equity anddebt securities.  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.

 

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        *Off-BalanceSheet Arrangements*

We do not rely on off-balancesheet borrowings to fund our acquisitions. We have no off-balance sheet commitments for indebtedness other than thelimited guaranty of Centennial debt, the limited guaranty of Centennialcatastrophic events and leases covering assets utilized in several areas of ouroperations.

        *ContractualObligations*

The following table summarizes our debt repayment obligations andmaterial contractual commitments as of September 30, 2005 (in millions): 

 
| ** **                                  | ** ** | **Amount of Commitment Expiration  Per Period** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                  | ** ** | **Total**                                       | ** ** | **Less than  1 Year** | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **After 5  Years** | ** ** |
|                                        |       |                                            |       |   |   |   |   |   |   |   |   |
| Revolving Credit  Facility                  |       | $                                               | 460.5      |   | $ | — |   | $ | — |   | $ | 460.5 |   | $ | — |   |
| 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 |   |
| Debt subtotal                               |       | 1,550.5                                         |       | — |   | 180.0 |   | 460.5 |   | 910.0 |   |
|                                        |       |                                            |       |   |   |   |   |   |   |   |   |
| Operating leases (3)                        |       | 79.7                                            |       | 18.9 |   | 30.2 |   | 15.1 |   | 15.5 |   |
| Capital expenditure  obligations (4)        |       | 24.7                                            |       | 24.7 |   | — |   | — |   | — |   |
| Other liabilities and  deferred credits (5) |       | 8.5                                             |       | — |   | 3.5 |   | 1.0 |   | 4.0 |   |
|                                        |       |                                            |       |   |   |   |   |   |   |   |   |
| Total                                       |       | $                                               | 1,663.4    |   | $ | 43.6 |   | $ | 213.7 |   | $ | 476.6 |   | $ | 929.5 |   |
|                                             |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          Obligations of TE Products.

(2)          Our TE Products subsidiary entered into an interest rate swapagreement to hedge its exposure to changes in the fair value of its 7.51%Senior Notes due 2028.  At September 30,2005, the 7.51% Senior Notes include an adjustment to increase the fair valueof the debt by $1.3 million related to this interest rate swap agreement.  We also entered into interest rate swapagreements to hedge our exposure to changes in the fair value of our 7.625%Senior Notes due 2012.  At September 30,2005, the 7.625% Senior Notes include a deferred gain, net of amortization,from previous interest rate swap terminations of $33.5 million.  At September 30, 2005, our 6.45% SeniorNotes, our 7.625% Senior Notes and our 6.125% Senior Notes include $2.5 millionof unamortized debt discounts.  The fairvalue adjustments, the deferred gain adjustment and the unamortized debtdiscounts are excluded from this table.

 

(3)          Includes a pipeline capacity lease with Centennial.  In January 2003, TE Products entered into apipeline capacity lease agreement with Centennial for a period of five yearsthat contains a minimum throughput requirement. For the year ended December 31, 2004, TE Products exceeded the minimumthroughput requirements on the lease agreement.

 

(4)          Includes accruals for costs incurred but not yet paid relatingto capital projects.

 

(5)          Excludes approximately $9.0 million of long-term deferredrevenue payments, which are being transferred to income over the term of therespective revenue contracts.  The amountof commitment by year is our best estimate of projected payments of theselong-term liabilities.

 

 

We expect to repay thelong-term, senior unsecured obligations and bank debt through the issuance ofadditional long-term senior unsecured debt at the time the 2008, 2012, 2013 and2028 debt matures, issuance of additional equity, with proceeds fromdispositions of assets, cash flow from operations or any combination of theabove items.

 

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TEProducts, Marathon and Centennial have entered into a limited cash callagreement, which allows each member to contribute cash in lieu of Centennialprocuring separate insurance in the event of a third-party liability arisingfrom a catastrophic event.  There is anindefinite term for the agreement and each member is to contribute cash inproportion to its ownership interest, up to a maximum of $50.0 millioneach.  As a result of the catastrophicevent guarantee, TE Products has recorded a $4.7 million obligation, whichrepresents the present value of the estimated amount that we would have to payunder the guarantee.  In the event that acatastrophic event occurred and we were required to contribute cash toCentennial, contributions exceeding our deductible may be covered by our insurance.

 

In addition to the itemsin the table above, we have entered into various operational commitments andagreements related to pipeline operations and to the marketing, transportation,terminaling and storage of crude oil. The majority of contractual commitments for the purchase of crude oilthat are made range in term from a thirty-day evergreen to three years.  A substantial portion of the contracts forthe purchase of crude oil that extend beyond thirty days include cancellationprovisions that allow us to cancel the contract with thirty days writtennotice.  During the nine months ended September30, 2005, crude oil purchases averaged approximately $629.5 million per month.

Our senior unsecured debt is rated BBB- by Standard and 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. The senior unsecured debt of our subsidiary, TE Products, is also ratedBBB- by S&P and Baa3 by Moody’s.  Bothratings are with a stable outlook.

** **

****Other Considerations****

** **

Our operations aresubject to federal, state and local laws and regulations governing thedischarge of materials into the environment. Failure to comply with these lawsand regulations may result in the assessment of administrative, civil andcriminal penalties, imposition of injunctions delaying or prohibiting certainactivities and the need to perform investigatory and remedial activities.  Although we believe our operations are inmaterial compliance with applicable environmental laws and regulations, risksof significant costs and liabilities are inherent in pipeline operations, andwe cannot assure you that significant costs and liabilities will not beincurred.  Moreover, it is possible thatother developments, such as increasingly strict environmental laws andregulations and enforcement policies thereunder, and claims for damages toproperty or persons resulting from our operations, could result in substantialcosts and liabilities to us.  We believethat changes in environmental laws and regulations will not have a materialadverse effect on our financial position, results of operations or cash flowsin the near term.

*Recent Accounting Pronouncements*

* *

**               **See discussion of new accountingpronouncements in Note 1.  Organizationand Basis of Presentation - New Accounting Pronouncements in the accompanyingconsolidated financial statements.

** **

** **

**Item 3. Quantitative and Qualitative Disclosures About MarketRisk**

 

We may be exposed tomarket risk through changes in crude oil commodity prices and interestrates.  We do not have foreign exchangerisks.  Our Risk Management Committee hasestablished policies to monitor and control these market risks.  The Risk Management Committee is comprised,in part, of senior executives of the Company.

We seek to maintain aposition that is substantially balanced between crude oil purchases and salesand future delivery obligations.  On themajority of our crude oil derivative contracts, we take the normal purchase andnormal sale exclusion in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 133, 

 

55

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*Accountingfor Derivative Instruments and Hedging Activities*, and SFASNo. 138, *Accounting for Certain Derivative Instruments andCertain Hedging Activities, an amendment of FASB Statement No. 133*.  At September 30, 2005, we have $108.7 millionof crude oil inventory for which we have entered into forward crude sales contractsto mitigate the risk of price volatility.

Occasionally, customersrequire pricing terms that do not allow us to balance our position.  Additionally, certain pricing terms mayexpose us to movements in margin.  On asmall portion of our crude oil marketing business, we enter into derivativecontracts such as swaps and other business hedging devices for which we cannottake the normal purchase and normal sale exclusion and for which we do notelect hedge accounting.  The terms ofthese contracts are less than one year. The purpose is to balance our position or lock in a margin and, as such,do not expose us to any additional significant market risk.  We mark these transactions to market and thechanges in the fair value are recognized in current earnings.  This results in some financial statementvariability during quarterly periods; however, any unrealized gains and lossesreflected in the financial statements related to marking these transactions tomarket are offset by realized gains and losses in different quarterly periodswhen the transactions are settled.

At September 30, 2005, wehad $460.5 million outstanding under our variable interest rate revolvingcredit facility.  The interest rate isbased, at our option, on either the lender’s base rate plus a spread or LIBORplus a spread in effect at the time of the borrowings and is adjusted monthly,bimonthly, quarterly or semiannually. Utilizing the balances of our variable interest rate debt outstanding atSeptember 30, 2005, and assuming market interest rates increase 100 basispoints, the potential annual increase in interest expense would be $4.6million.

At September 30, 2005, TEProducts had outstanding $180.0 million principal amount of 6.45% Senior Notesdue 2008 and $210.0 million principal amount of 7.51% Senior Notes due 2028(collectively, the “TE Products Senior Notes”). At September 30, 2005, the estimated fair value of the TE ProductsSenior Notes was approximately $408.9 million. At September 30, 2005, we had outstanding $500.0 million principalamount of 7.625% Senior Notes due 2012 and $200.0 million principal amount of6.125% Senior Notes due 2013.  At September30, 2005, the estimated fair value of the $500.0 million 7.625% Senior Notesand the $200.0 million 6.125% Senior Notes was approximately $555.3 million and$206.3 million, respectively.

We have utilized andexpect to continue to utilize interest rate swap agreements to hedge a portionof our cash flow and fair value risks. Interest rate swap agreements are used to manage the fixed and floatinginterest rate mix of our total 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.

In October 2001, TEProducts entered into an interest rate swap agreement to hedge its exposure tochanges in the fair value of its fixed rate 7.51% Senior Notes due 2028. Wedesignated this swap agreement as a fair value hedge.  The swap agreement has a notional amount of$210.0 million and matures in January 2028 to match the principal and maturityof the TE Products Senior Notes.  Underthe swap agreement, TE Products pays a floating rate of interest based on athree-month U.S. Dollar LIBOR rate, plus a spread, and receives a fixed rate ofinterest of 7.51%.  During the ninemonths ended September 30, 2005, and 2004, we recognized reductions in interestexpense of $4.6 million and $7.5 million, respectively, related to thedifference between the fixed rate and the floating rate of interest on theinterest rate swap.  During the quarter endedSeptember 30, 2005, we measured the hedge effectiveness of this interest rateswap and noted that no gain or loss from ineffectiveness was required to be recognized.  The fair value of this interest rate swap wasa gain of approximately $1.3 million and $3.4 million at September 30, 2005,and December 31, 2004, respectively. Utilizing the balance of the 7.51% TE Products Senior Notes outstandingat September 30, 2005 and including the effects of hedging activities, assumingmarket interest rates increase 100 basis points, the potential annual increasein interest expense is $2.1 million.

 

 

56

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In July 2000, we enteredinto an interest rate swap agreement to hedge our exposure to increases in thebenchmark interest rate underlying our variable rate revolving creditfacility.  This interest rate swapmatured in April 2004.  We designatedthis swap agreement, which hedged exposure to variability in expected futurecash flows attributed to changes in interest rates, as a cash flow hedge. Theswap agreement was based on a notional amount of $250.0 million.  Under the swap agreement, we paid a fixedrate of interest of 6.955% and received a floating rate based on a three-monthU.S. Dollar LIBOR rate.  Because thisswap was designated as a cash flow hedge, the changes in fair value, to theextent the swap was effective, were recognized in other comprehensive incomeuntil the hedged interest costs were recognized in earnings.  From January 2004 through April 2004, werecognized an increase in interest expense of $2.9 million related to thedifference between the fixed rate and the floating rate of interest on theinterest rate swap.

                During 2002, we entered intointerest rate swap agreements, designated as fair value hedges, to hedge ourexposure to changes in the fair value of our fixed rate 7.625% Senior Notes due2012.  The swap agreements had a combinednotional amount of $500.0 million and matured in 2012 to match the principaland maturity of the Senior Notes.  Underthe swap agreements, we paid a floating rate of interest based on a U.S. DollarLIBOR rate, plus a spread, and received a fixed rate of interest of 7.625%.  These swap agreements were later terminated in2002 resulting in gains of $44.9 million. The gains realized from the swap terminations have been deferred asadjustments to the carrying value of the Senior Notes and are being amortizedusing the effective interest method as reductions to future interest expenseover the remaining term of the Senior Notes. At September 30, 2005, the unamortized balance of the deferred gains was$33.5 million.  In the event of earlyextinguishment of the Senior Notes, any remaining unamortized gains would berecognized in the consolidated statement of income at the time ofextinguishment.

 

**               **During May 2005, we executed a treasury rate lockagreement with a notional amount of $200.0 million to hedge our exposure toincreases in the treasury rate that was to be used to establish the fixedinterest rate for a debt offering that was proposed to occur in the secondquarter of 2005.  During June 2005, the proposeddebt offering was cancelled, and the treasury lock was terminated with arealized loss of $2.0 million.  Therealized loss was recorded as a component of interest expense in theconsolidated statements of income.

 

 

**Item 4.  Controls andProcedures**

 

                As of the end of the periodcovered by this report, our management carried out an evaluation, with theparticipation of our principal executive officer (the “CEO”) and our principalfinancial officer (the “CFO”), of the effectiveness of our disclosure controlsand procedures pursuant to Rule 13a-15 of the Securities Exchange Act of1934.  Based on those evaluations, as ofSeptember 30, 2005, the CEO and CFO concluded:

 

(i)             that ourdisclosure 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)          that ourdisclosure controls and procedures are effective.

 

        *Changes in InternalControl over Financial Reporting*

 

**                Through February 23, 2005, ourGeneral Partner was an indirect subsidiary of Duke Energy, and Duke Energy’sAudit Services Department provided our internal audit functions.  On February 24, 2005, the General Partner wasacquired by DFI, an affiliate of EPCO.** EPCO, using its own personnel and third partyproviders, will provide us with internal audit services.  The transition of internal audit functionswas completed in the third quarter of 2005. This change is not expected to adversely affect our internal auditprocess.

 

 

57

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                There has been no change in ourinternal control over financial reporting during the third quarter of 2005 thathas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

 

 

**PART II.  OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

**               **We have been, in the ordinary course of business, adefendant in various lawsuits and a party to various other legal proceedings,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 12.  Commitments andContingencies in the accompanying consolidated financial statements.

 

 

**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).                                                                                                                                         |
| 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). |

 

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| 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   |   | Third Amended and Restated Administrative Services  Agreement by and among EPCO, Inc., Enterprise Products Partners L.P.,  Enterprise Products Operating L.P., Enterprise Products GP, LLC and  Enterprise Products OLPGP, Inc., Enterprise GP Holdings L.P., EPE Holdings,  LLC, TEPPCO Partners, L.P., Texas Eastern Products Pipeline Company, LLC, TE  Products Pipeline Company, Limited Partnership, TEPPCO Midstream Companies,  L.P., TCTM, L.P. and TEPPCO GP, Inc. dated August 15, 2005, but effective as  of February 24, 2005 (Filed as Exhibit 99.1 to Form 8-K of TEPPCO Partners,  L.P. (Commission File No. 1-10403) dated August 19, 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  Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange  Act of 1934, as amended.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 31.2*  |   | Certification of Chief Financial Officer pursuant to  Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange  Act of 1934, as amended.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 32.1** |   | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 32.2** |   | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |

 

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*              Filed herewith.

**           Furnished herewith pursuant to Item601(b)-(32) of Regulation S-K.

 

 

**SIGNATURES**

 

                Pursuant to the requirements ofthe Securities Exchange Act of 1934, the Registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 

TEPPCO Partners, L.P.

 
|  Date: October 31, 2005 | By:    | /s/ BARRY R. PEARL                                                                                                           |
|------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------|
|                         |   | Barry R. Pearl,President and  Chief Executive Officer of Texas Eastern Products Pipeline Company, LLC, General  Partner |
|                         |   |                                                                                                                         |
|  Date: October 31, 2005 | By:    | /s/ TRACY E. OHMART                                                                                                          |
|                         |   | Tracy E. Ohmart,Chief Financial  Officer of Texas  Eastern Products Pipeline Company, LLC, General Partner              |
|                         |   |                                                                                                                         |

 

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