**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

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

 

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

 

**OR**

 

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

 

**Commission File No. 1-13603**

 

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**TEProducts Pipeline Company, Limited Partnership**

(Exact name of Registrant as specifiedin its charter)

 
| **Delaware**            | ** ** | **76-0329620**         |
|-------------------------|------------|------------------------|
| (State of Incorporation |       | (I.R.S. Employer       |
| or Organization)        |       | Identification Number) |

 

**2929 Allen Parkway**

**P.O. Box 2521**

**Houston, Texas 77252-2521**

(Address of principal executive offices, including zip code)

 

**(713) 759-3636**

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

Yes ý   No o

 

Indicate by check mark whether theregistrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).  

Yes o   No ý

 

 

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**TEPRODUCTS PIPELINE COMPANY, LIMITED PARTNERSHIP**

 

**TABLE OFCONTENTS**

 
| **PART I.  FINANCIAL INFORMATION**                                                                                   | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                | ** ** |
| **Item 1. Financial  Statements**                                                                                         | ** ** |
| **Consolidated Balance Sheets  as of June 30, 2005 (unaudited) and December 31, 2004**                          | ** ** |
| ** **                                                                                                                | ** ** |
| **Consolidated  Statements of Income for the three months and six months ended June 30,  2005 and 2004 (unaudited)** | ** ** |
| ** **                                                                                                                | ** ** |
| **Consolidated  Statements of Cash Flows for the six months ended June 30, 2005 and 2004  (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**

 

**TE PRODUCTS PIPELINE COMPANY,LIMITED PARTNERSHIP**

 

**CONSOLIDATED BALANCE SHEETS**

**(in thousands)**

 
| ** **                                                                                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                          | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| ** **                                                                                                          | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
|                                                                                                                |       |              |       |                  |       |
| **ASSETS**                                                                                                          |       |              |       |                  |       |
| ** **                                                                                                          |       |              |       |                  |       |
| Current assets:                                                                                                     |       |              |       |                  |       |
| Cash and cash equivalents                                                                                           |       | $                 | 14         |                  | $          | — |   |
| Accounts receivable, trade (net of allowance for  doubtful accounts of $56 and $56)                                 |       | 15,712            |       | 21,090                |       |
| Accounts receivable, related parties                                                                                |       | 2,915             |       | 3,455                 |       |
| Inventories                                                                                                         |       | 11,045            |       | 10,093                |       |
| Other                                                                                                               |       | 13,061            |       | 12,143                |       |
| Total current assets                                                                                                |       | 42,747            |       | 46,781                |       |
| Property, plant and equipment, at cost (net of  accumulated depreciation and amortization of $328,189 and $311,197) |       | 729,413           |       | 722,334               |       |
| Equity investments                                                                                                  |       | 166,432           |       | 169,873               |       |
| Other assets                                                                                                        |       | 19,781            |       | 16,156                |       |
| Total assets                                                                                                        |       | $                 | 958,373    |                  | $          | 955,144 |   |
|                                                                                                                |       |              |       |                  |       |
| **LIABILITIES AND PARTNERS’ CAPITAL**                                                                          |       |              |       |                  |       |
|                                                                                                                |       |              |       |                  |       |
| Current liabilities:                                                                                                |       |              |       |                  |       |
| Accounts payable and accrued liabilities                                                                            |       | $                 | 7,689      |                  | $          | 10,211 |   |
| Accounts payable, related parties                                                                                   |       | 45,331            |       | 66,451                |       |
| Accrued interest                                                                                                    |       | 15,818            |       | 17,063                |       |
| Other accrued taxes                                                                                                 |       | 5,971             |       | 5,605                 |       |
| Other                                                                                                               |       | 7,007             |       | 9,339                 |       |
| Total current liabilities                                                                                           |       | 81,816            |       | 108,669               |       |
| Senior Notes                                                                                                        |       | 397,370           |       | 393,317               |       |
| Note Payable, Parent Partnership                                                                                    |       | 62,543            |       | 301,686               |       |
| Other liabilities and deferred credits                                                                              |       | 9,694             |       | 9,980                 |       |
| Commitments and contingencies                                                                                       |       |              |       |                  |       |
| Partners’ capital:                                                                                             |       |              |       |                  |       |
| General partner’s interest                                                                                     |       | 4                 |       | 2                     |       |
| Limited partner’s interest                                                                                     |       | 406,946           |       | 141,490               |       |
| Total partners’ capital                                                                                        |       | 406,950           |       | 141,492               |       |
| Total liabilities and partners’ capital                                                                        |       | $                 | 958,373    |                  | $          | 955,144 |   |

 

See accompanying Notes to ConsolidatedFinancial Statements.

 

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**TE PRODUCTS PIPELINE COMPANY,LIMITED PARTNERSHIP**

 

**CONSOLIDATED STATEMENTS OF INCOME**

**(Unaudited)**

**(in thousands)**

 
| ** **                             | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                             | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Operating revenues:                    |       |                                  |       |                                |       |   |   |   |   |
| Transportation – Refined products |       | $                                     | 37,834     |                                | $          | 38,937 |   | $ | 72,799 |   | $ | 69,908 |   |
| Transportation – LPGs             |       | 14,470                                |       | 13,721                              |       | 46,701 |   | 42,501 |   |
| Other                                  |       | 10,217                                |       | 8,559                               |       | 20,037 |   | 22,470 |   |
| Total operating revenues               |       | 62,521                                |       | 61,217                              |       | 139,537 |   | 134,879 |   |
|                                   |       |                                  |       |                                |       |   |   |   |   |
| Costs and expenses:                    |       |                                  |       |                                |       |   |   |   |   |
| Operating, general and administrative  |       | 28,150                                |       | 28,731                              |       | 54,655 |   | 57,779 |   |
| Operating fuel and power               |       | 7,926                                 |       | 7,192                               |       | 15,555 |   | 15,241 |   |
| Depreciation and amortization          |       | 9,537                                 |       | 8,998                               |       | 18,835 |   | 17,636 |   |
| Taxes – other than income taxes   |       | 2,440                                 |       | 2,492                               |       | 5,348 |   | 5,335 |   |
| Gains on sales of assets               |       | (15                                   | )          | (17                                 | )          | (107 | ) | (17 | ) |
| Total costs and expenses               |       | 48,038                                |       | 47,396                              |       | 94,286 |   | 95,974 |   |
|                                   |       |                                  |       |                                |       |   |   |   |   |
| Operating income                       |       | 14,483                                |       | 13,821                              |       | 45,251 |   | 38,905 |   |
|                                   |       |                                  |       |                                |       |   |   |   |   |
| Interest expense – net            |       | (7,594                                | )          | (6,581                              | )          | (15,553 | ) | (13,490 | ) |
| Equity earnings (losses)               |       | 892                                   |       | (509                                | )          | 50 |   | (1,747 | ) |
| Other income – net                |       | 121                                   |       | 173                                 |       | 270 |   | 445 |   |
|                                   |       |                                  |       |                                |       |   |   |   |   |
| Net income                             |       | $                                     | 7,902      |                                | $          | 6,904 |   | $ | 30,018 |   | $ | 24,113 |   |

 

See accompanying Notes to ConsolidatedFinancial Statements.

 

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**TE PRODUCTS PIPELINE COMPANY,LIMITED PARTNERSHIP**

 

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(Unaudited)**

**(in thousands)**

 
| ** **                                                                     | ** ** | **Six Months Ended   June 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                     | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| Cash flows from operating activities:                                          |       |                                 |       |   |   |
| Net income                                                                     |       | $                                    | 30,018     |   | $ | 24,113 |   |
| Adjustments to reconcile net income to cash provided  by operating activities: |       |                                 |       |   |   |
| Depreciation and amortization                                                  |       | 18,835                               |       | 17,636 |   |
| Earnings (losses) in equity investments, net of distributions                  |       | 7,250                                |       | 6,697 |   |
| Non-cash portion of interest expense                                           |       | 136                                  |       | 15 |   |
| Gains on sales of assets                                                       |       | (107                                 | )          | (17 | ) |
| Decrease in accounts receivable                                                |       | 5,378                                |       | 9,332 |   |
| (Increase) decrease in inventories                                             |       | (952                                 | )          | 1,543 |   |
| (Increase) decrease in other current assets                                    |       | (918                                 | )          | 1,883 |   |
| Decrease in accounts payable and accrued expenses                              |       | (3,162                               | )          | (3,813 | ) |
| Other                                                                          |       | (24,627                              | )          | 10,867 |   |
| Net cash provided by operating activities                                      |       | 31,851                               |       | 68,256 |   |
|                                                                           |       |                                 |       |   |   |
| Cash flows from investing activities:                                          |       |                                 |       |   |   |
| Investment in Mont Belvieu Storage Partners, L.P                               |       | (1,109                               | )          | (17,211 | ) |
| Purchase of assets                                                             |       | —                               |       | (1,962 | ) |
| Investment in Centennial Pipeline LLC                                          |       | —                               |       | (1,500 | ) |
| Capital expenditures                                                           |       | (27,025                              | )          | (24,640 | ) |
| Net cash used in investing activities                                          |       | (28,134                              | )          | (45,313 | ) |
|                                                                           |       |                                 |       |   |   |
| Cash flows from financing activities:                                          |       |                                 |       |   |   |
| Proceeds from note payable, Parent Partnership                                 |       | 58,481                               |       | 70,087 |   |
| Repayments of note payable, Parent Partnership                                 |       | (297,624                             | )          | (34,633 | ) |
| Equity contributions – Parent Partnership                                 |       | 294,822                              |       | — |   |
| Distributions paid                                                             |       | (59,382                              | )          | (58,585 | ) |
| Net cash used in financing activities                                          |       | (3,703                               | )          | (23,131 | ) |
|                                                                           |       |                                 |       |   |   |
| Net increase (decrease) in cash and cash equivalents                           |       | 14                                   |       | (188 | ) |
|                                                                           |       |                                 |       |   |   |
| Cash and cash equivalents at beginning of period                               |       | —                               |       | 188 |   |
| Cash and cash equivalents at end of period                                     |       | $                                    | 14         |   | $ | — |   |
|                                                                           |       |                                 |       |   |   |
| **Supplemental disclosure of cash flows:**                                     |       |                                 |       |   |   |
| Cash paid for interest (net of amounts capitalized)                            |       | $                                    | 16,006     |   | $ | 12,881 |   |

 

See accompanying Notes to ConsolidatedFinancial Statements.

 

3

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** **

**TE PRODUCTS PIPELINE COMPANY,LIMITED PARTNERSHIP**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

** **

**NOTE1.  ORGANIZATION AND BASIS OFPRESENTATION**

** **

TE Products PipelineCompany, Limited Partnership (the “Partnership”), a Delaware limitedpartnership, was formed in March 1990. TEPPCO Partners, L.P. (the “Parent Partnership”) owns a 99.999% interestin us as the sole limited partner. TEPPCO GP, Inc. (“TEPPCO GP” or “General Partner”), a wholly ownedsubsidiary of the Parent Partnership, holds a 0.001% general partner interestin us.  Texas Eastern Products PipelineCompany, LLC (the “Company”), a Delaware limited liability company, serves asthe general partner of our Parent Partnership. Through February 23, 2005, the Company was an indirect wholly ownedsubsidiary of Duke Energy Field Services, LLC (“DEFS”), a joint venture betweenDuke Energy Corporation (“Duke Energy”) and ConocoPhillips.  Through February 23, 2005, Duke Energy heldan interest of approximately 70% in DEFS, and ConocoPhillips held the remaininginterest of approximately 30%.  On February 24,2005, the Company was acquired by DFI GP Holdings L.P. (formerly Enterprise GPHoldings L.P.) (“DFI”), an affiliate of EPCO, Inc. (“EPCO”), a privatelyheld company controlled by Dan L. Duncan, for approximately $1.1 billion.  As a result of the transaction, DFI owns andcontrols the 2% general partner interest in our Parent Partnership and has theright to receive the incentive distribution rights associated with the generalpartner interest.

 

 TEPPCO GP, as our general partner, performsall of the management and operating functions required for us in accordancewith the Agreement of Limited Partnership of TE Products Pipeline Company,Limited Partnership (the “Partnership Agreement”).  We reimburse our General Partner and theCompany for all reasonable direct and indirect expenses that they incur inmanaging us.

 

As used in this Report, “we,”“us,”  and “our” means TE ProductsPipeline Company, Limited Partnership.

 

The accompanyingunaudited consolidated financial statements reflect all adjustments that are,in the opinion of our management, of a normal and recurring nature andnecessary for a fair statement of our financial position as of June 30,2005, and the results of our operations and cash flows for the periodspresented.  The results of operations forthe three months and six months ended June 30, 2005, are not necessarilyindicative of 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 TE Products Pipeline Company, Limited PartnershipAnnual Report on Form 10-K for the year ended December 31, 2004.  We have reclassified certain amounts fromprior periods to conform to the current presentation.

 

We operate and report inone business segment: transportation and storage of refined products, liquefiedpetroleum gases (“LPGs”) and petrochemicals. Our interstate transportation operations, including rates charged tocustomers, are subject to regulations prescribed by the Federal EnergyRegulatory Commission (“FERC”).  We referto refined products, LPGs and petrochemicals in this Report, collectively, as “petroleumproducts” or “products.”

 

At June 30, 2005, andDecember 31, 2004, we had working capital deficits of $39.1 million and $61.9million, respectively.  Cash generatedfrom operations and from our Parent Partnership’s credit facilities and debtand equity offerings are our primary sources of liquidity.  Working capital deficits occur primarily fromthe timing of operating cash receipts from customers, payment of cashdistributions and the payment of normal operating expenses and capitalexpenditures.  Our Parent Partnership hashistorically made capital contributions, loans or otherwise provided liquidityto us as needed, but the Parent Partnership has no contractual obligation to doso.  At June 30, 2005, our Parent Partnershiphad $278.6 million in available borrowing capacity under its revolving creditfacility and agreed to cover any of our working capital needs, if required.

 

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**NewAccounting Pronouncements**

** **

**In December 2004, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“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 SFAS No. 123,*Accounting for Stock-Based Compensation*,as amended by SFAS No. 148,*Accountingfor Stock-Based Compensation – Transition and Disclosure* andsupersedes 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 on or after June 15, 2005. As such, we will adopt SFAS 123(R) in the first quarter of 2006.  Companies are permitted to adopt SFAS 123(R)prior to the extended date.  All publiccompanies that adopted the fair-value-based method of accounting must use themodified prospective transition method and may elect to use the modifiedretrospective transition method.  We donot believe that the adoption of SFAS 123(R) will have a material effect on ourfinancial position, results of operations or cash flows.**

** **

**In November 2004,the Emerging Issues Task Force (“EITF”) reached consensus in EITF 03-13, *Applying the Conditions in Paragraph 42 of FASB Statement No. 144,Accounting for Impairment orDisposal of Long-Lived Assets, in Determining Whether to ReportDiscontinued Operations*, to clarify whether a component of an enterprisethat is either disposed of or classified as held for sale qualifies for incomestatement presentation 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 periods beginning after December 15,2004.  The consensus may be appliedretrospectively for previously reported operating results related to disposaltransactions initiated within an enterprise’s reporting period that includedthe date that this consensus was ratified. The adoption of EITF 03-13 did nothave an effect on our financial position, results of operations or cash flows.**

** **

**In March 2005,the FASB issued FASB Interpretation No. 47, *Accounting for Conditional Asset Retirement Obligations, aninterpretation of FASB Statement No. 143* (“FIN 47”).  FIN 47 clarifies that the term, conditionalasset retirement obligation as used in SFAS No. 143, *Accountingfor Asset Retirement Obligations*, refers to a legal obligation toperform an asset retirement activity in which the timing and/or method ofsettlement are conditional upon a future event that may or may not be withinthe control of the entity.  Even thoughuncertainty about the timing and/or method of settlement exists and may beconditional upon a future event, the obligation to perform the asset retirementactivity is unconditional.  Accordingly,an entity is required to recognize a liability for the fair value of aconditional asset retirement obligation if the fair value of the liability canbe reasonably estimated.  Uncertaintyabout the timing and/or method of settlement of a conditional asset retirementobligation should be factored into the measurement of the liability whensufficient information exists.  The fairvalue of a liability for the conditional asset retirement obligation should berecognized when incurred generally upon acquisition, construction, ordevelopment or through the normal operation of the asset.  SFAS 143 acknowledges that in some cases,sufficient information may not be available to reasonably estimate the fairvalue of an asset retirement obligation. FIN 47 also clarifies when an entity would have sufficient informationto reasonably estimate the fair value of an asset retirement obligation.  FIN 47 is effective no later than the end ofreporting periods ending after December 15, 2005.  As such, we will adopt FIN 47 in the fourthquarter of 2005.  Retrospectiveapplication for interim financial information is permitted but is notrequired.  Early adoption of FIN 47 isencouraged.  We do not believe that theadoption of FIN 47 will have a material effect on our financial position,results of operations or cash flows.**

** **

In June 2005, theEITF reached consensus in EITF 04-5, *DeterminingWhether a General Partner, or the General Partners as a Group, Controls aLimited Partnership or Similar Entity When the Limited Partners Have*

 

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*Certain Rights*, toprovide guidance on how general partners in a limited partnership shoulddetermine whether they control a limited partnership and therefore shouldconsolidate it.  The EITF agreed that thepresumption of general partner control would be overcome only when the limitedpartners have either of two types of rights. The first type, referred to askick-out rights, is the right to dissolve or liquidate the partnership orotherwise remove the general partner without cause.  The second type, referred to as participatingrights, is the right to effectively participate in significant decisions madein the ordinary course of the partnership’s business. The kick-out rights andthe participating rights must be substantive in order to overcome thepresumption of general partner control. The consensus is effective for generalpartners of all new limited partnerships formed and for existing limitedpartnerships for which the partnership agreements are modified subsequent tothe date of FASB ratification (June 29, 2005).  The guidance in this EITF is effective forexisting partnerships no later than the beginning of the first reporting periodin fiscal years beginning after December 15, 2005.  We are currently evaluating what impact thisEITF will have on our financial statements, but at this time, we do not believethat the adoption of this EITF will have a material effect on our financialposition, results of operations or cash flows.

 

**NOTE2.  INTANGIBLE ASSETS**

** **

**We account for ourintangible assets under SFAS No. 142, *Goodwill and OtherIntangible Assets*,**which wasissued by the FASB in July 2001. SFAS 142 prohibits amortization of goodwill and intangible assets withindefinite useful lives, but instead requires testing for impairment at leastannually.  SFAS 142 requires thatintangible assets with definite 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.**

** **

The following table reflectsthe components of intangible assets being amortized, included in other assetson the consolidated balance sheets at June 30, 2005, and December 31,2004 (in thousands):

 
| ** **                         | ** ** | **June 30, 2005**     | ** ** | **December 31, 2004**    | ** ** |
|------------------------------------|------------|----------------------------|------------|-------------------------------|------------|
| ** **                         | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
|                               |       |                       |       |                          |       |   |   |   |   |
| Intangible assets being amortized: |       |                       |       |                          |       |   |   |   |   |
| Transportation agreements          |       | $                          | 1,328      |                          | $          | (294 | ) | $ | 1,328 |   | $ | (260 | ) |
|                                    |            |                            |            |                               |            |  |  |  |  |  |  |  |  |

** **

**At June 30,2005, we had $33.4 million of excess investment in our equity investment inCentennial Pipeline LLC, which was created upon formation of the company.  The excess investment is included in ourequity investments account at June 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.**

** **

**Amortizationexpense on intangible assets was $16,603 for each of the three-month periodsended June 30, 2005 and 2004, and $33,205 for each of the six-monthperiods ended June 30, 2005 and 2004.**

** **

Estimated amortizationexpense on intangible assets will be $0.1 million for each of the years ending December 31,2005 through 2009.

 

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**NOTE3.  INTEREST RATE SWAP**

** **

In October 2001, weentered into an interest rate swap agreement to hedge our exposure to changesin the fair value of our 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 of the 7.51% Senior Notes. Under the swap agreement, we pay a floating rate of interest based on athree-month U.S. Dollar LIBOR rate, plus a spread, and receive a fixed rate ofinterest of 7.51%.  During the six monthsended June 30, 2005 and 2004, we recognized reductions in interest expenseof $3.3 million and $5.1 million, respectively, related to the differencebetween the fixed rate and the floating rate of interest on the interest rateswap.  During the quarter ended June 30,2005, we measured the hedge effectiveness of this interest rate swap and notedthat no gain or loss from ineffectiveness was required to be recognized.  The fair value of this interest rate swap wasa gain of approximately $7.4 million and $3.4 million at June 30, 2005,and December 31, 2004, respectively.

 

**NOTE 4.  INVENTORIES**

** **

Inventories are valued atthe lower of cost (based on weighted average cost method) or market.  The costs of inventories did not exceedmarket values at June 30, 2005, and December 31, 2004. The majorcomponents of inventories were as follows (in thousands):

 
| ** **             | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------|------------|-------------------------|------------|-----------------------------|------------|
| Refined products       |       | $                       | 1,440      |                        | $          | 5,665 |   |
| LPGs                   |       | 5,048                   |       | —                      |       |
| Materials and supplies |       | 4,557                   |       | 4,428                       |       |
| Total                  |       | $                       | 11,045     |                        | $          | 10,093 |   |

** **

**NOTE5.  EQUITY INVESTMENTS**

** **

We own a 50% ownershipinterest in Centennial Pipeline Company LLC (“Centennial”), and MarathonAshland Petroleum 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 six months ended June 30, 2005, we have not invested anyadditional funds in Centennial.  Duringthe six months ended June 30, 2004, we invested an additional $1.5 millionin Centennial, which is included in the equity investment balance at June 30,2005.  We have not received anydistributions from Centennial since its formation.

 

On January 1, 2003,we and Louis Dreyfus Energy Services L.P. (“Louis Dreyfus”) formed Mont BelvieuStorage Partners, L.P. (“MB Storage”). We and Louis Dreyfus each own a 50% ownership interest 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 trading activity.  We operate the facilities for MB Storage.

 

For the year ended December 31,2005, we will receive the first $1.7 million per quarter (or $6.78 million onan annual basis) of MB Storage’s income before depreciation expense, as definedin the operating agreement.  For the yearended December 31, 2004, we received the first $1.8 million per quarter(or $7.15 million on an annual basis) of MB Storage’s income beforedepreciation expense.  Our share of MBStorage’s earnings is adjusted 

 

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annually by the partnersof MB Storage.  Any amount of MB Storage’sannual income before depreciation expense in excess of $6.78 million for 2005and $7.15 million for 2004 is allocated evenly between us and LouisDreyfus.  Depreciation expense on assetseach party originally contributed to MB Storage is allocated between us andLouis 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 usand Louis Dreyfus. For the six months ended June 30, 2005 and 2004, oursharing ratio in the earnings of MB Storage was approximately 62.6% and 70.2%,respectively.  During the six monthsended June 30, 2005, we received distributions of $7.3 million from MBStorage and contributed $1.1 million to MB Storage.  During the six months ended June 30,2004, we received distributions of $5.0 million from MB Storage and contributed$17.2 million to MB Storage, of which $16.5 million was used to acquire storageassets in April 2004.

 

  We use the equity method of accounting toaccount for our investments in Centennial and MB Storage.  Summarized combined financial information forCentennial and MB Storage for the six months ended June 30, 2005 and 2004,is presented below (in thousands): 

 
| ** **        | ** ** | **Six Months Ended   June 30,** | ** ** |
|-------------------|------------|--------------------------------------|------------|
| ** **        | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| Revenues          |       | $                                    | 36,719     |   | $ | 28,508 |   |
| Net income (loss) |       | 3,847                                |       | (907 | ) |
|                   |            |                                      |            |  |  |  |  |

 

Summarized combined balancesheet data for Centennial and MB Storage as of June 30, 2005, and December 31,2004, is presented below (in thousands):

 
| ** **             | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **             | ** ** | **2005**          | ** ** | **2004**              | ** ** |
| Current assets         |       | $                 | 39,882     |                  | $          | 39,228 |   |
| Noncurrent assets      |       | 371,638           |       | 377,924               |       |
| Current liabilities    |       | 36,116            |       | 36,015                |       |
| Long-term debt         |       | 140,000           |       | 140,000               |       |
| Noncurrent liabilities |       | 22,183            |       | 20,383                |       |
| Partners’ capital |       | 213,221           |       | 220,754               |       |
|                        |            |                   |            |                       |            |  |  |

** **

**NOTE6.  DEBT**

** **

**SeniorNotes**

** **

On January 27, 1998,we completed the issuance of $180.0 million principal amount of 6.45% SeniorNotes due 2008, and $210.0 million principal amount of 7.51% Senior Notes due2028 (collectively the “Senior Notes”). The 6.45% Senior Notes were issued at a discount of $0.3 million and arebeing accreted to their face value over the term of the notes.  The 6.45% Senior Notes due 2008 are notsubject to redemption prior to January 15, 2008.  The 7.51% Senior Notes due 2028, issued atpar, may be redeemed at any time after January 15, 2008, at our option inwhole or in part, at a premium.

 

The Senior Notes do nothave sinking fund requirements.  Intereston the Senior Notes is payable semiannually in arrears on January 15 and July 15of each year.  The Senior Notes due 2008are unsecured obligations and rank pari passu with all of our other unsecuredand unsubordinated indebtedness.  Theindenture governing the Senior Notes contains covenants, including, but notlimited to, covenants limiting the creation of liens 

 

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securingindebtedness and sale and leaseback transactions.  However, the indenture does not limit ourability to incur additional indebtedness. As of June 30, 2005, we were in compliance with the covenants ofthe Senior Notes.

 

We have entered into aninterest rate swap agreement to hedge our exposure to changes in the fair valueon a portion of the Senior Notes discussed above.  At June 30, 2005, and December 31, 2004,the Senior Notes include the fair value of our interest rate swap of $7.4million and $3.4 million, respectively (see Note 3. Interest Rate Swap).

 

The following tablesummarizes the estimated fair values of the Senior Notes as of June 30,2005, and December 31, 2004 (in millions):

 
| ** **                                | ** ** | ** **      | ** ** | **Fair Value**          | ** ** |
|-------------------------------------------|------------|-----------------|------------|-------------------------|------------|
| ** **                                | ** ** | **Face  Value** | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|                                      |       |            |       |                    |       |   |   |
| 6.45% Senior Notes, due January 2008 |       | $               | 180.0      |                    | $          | 188.5 |   | $ | 187.1 |   |
| 7.51% Senior Notes, due January 2028 |       | 210.0           |       | 224.1                   |       | 225.6 |   |
|                                           |            |                 |            |                         |            |  |  |  |  |  |

** **

**OtherLong Term Debt and Credit Facilities**

** **

We currently utilize debtfinancing available from our Parent Partnership through intercompany notes. Theterms of the intercompany notes generally match the principal and interestpayment dates under the Parent Partnership’s credit agreements.  The interest rates charged by the ParentPartnership include the stated interest rate of the Parent Partnership, plus apremium to cover debt issuance costs. The interest rate is also decreased or increased to cover gains andlosses, respectively, on any interest rate swaps that the Parent Partnershipmay have in place on its respective credit agreements.  These credit facilities of the ParentPartnership are described below.

 

On February 20,2002, our Parent Partnership issued $500.0 million principal amount of 7.625%Senior Notes due 2012.  The 7.625% SeniorNotes were issued at a discount of $2.2 million and are being accreted to theirface value over the term of the notes. The Senior Notes may be redeemed at any time at our Parent Partnership’soption with the payment of accrued interest and a make-whole premium determinedby discounting remaining interest and principal payments using a discount rateequal to the rate of the United States Treasury securities of comparableremaining maturity plus 35 basis points. The indenture governing these 7.625% Senior Notes contains covenants,including, but not limited to, covenants limiting the creation of lienssecuring indebtedness and sale and leaseback transactions.  However, the indenture does not limit ourParent Partnership’s ability to incur additional indebtedness.

 

On January 30, 2003,our Parent Partnership issued $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 facevalue over the term of the notes.  TheSenior Notes may be redeemed at any time at our Parent Partnership’s optionwith the payment of accrued interest and a make-whole premium determined bydiscounting remaining interest and principal payments using a discount rateequal to the rate of the United States Treasury securities of comparableremaining maturity plus 35 basis points. The indenture governing the 6.125% Senior Notes contains covenants,including, but not limited to, covenants limiting the creation of lienssecuring indebtedness and sale and leaseback transactions.  However, the indenture does not limit theParent Partnership’s ability to incur additional indebtedness.

 

On June 27, 2003,our Parent Partnership entered into a $550.0 million revolving credit facilitywith a three-year term, including the issuance of letters of credit of up to$20.0 million (“Revolving Credit Facility”). The interest rate is based, at our Parent Partnership’s option, oneither the lender’s base rate plus a spread, or LIBOR plus a spread in effectat the time of the borrowings.  Thecredit agreement for the Revolving Credit Facility contains 

 

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certainrestrictive financial covenant ratios. On October 21, 2004, our Parent Partnership amended the RevolvingCredit Facility to (i) increase the facility size to $600.0 million, (ii) extendthe term to October 21, 2009, (iii) remove certain restrictivecovenants, (iv) increase the available amount for the issuance of lettersof credit up to $100.0 million and (v) decrease the LIBOR rate spreadcharged at the time of each borrowing.  OnFebruary 23, 2005, the Parent Partnership again amended its RevolvingCredit Facility to remove the requirement that DEFS must at all times own,directly or indirectly, 100% of the Company, to allow for its acquisition byDFI (see Note 1. Organization and Basis of Presentation). During the secondquarter of 2005, the Parent Partnership used a portion of the proceeds fromequity offerings in May 2005 and June 2005 to repay a portion of theRevolving Credit Facility. On June 30, 2005, $278.0 million wasoutstanding under the Revolving Credit Facility at a weighted average interestrate of 4.3%.

 

As of June 30, 2005,and December 31, 2004, we had intercompany notes payable to our ParentPartnership of $62.5 million and $301.7 million, respectively, whichrepresented borrowings under the Parent Partnership’s Revolving CreditFacility, 7.625% Senior Notes and 6.125% Senior Notes. The weighted averageinterest rate on the note payable to the Parent Partnership at June 30,2005, was 5.5%.  At June 30, 2005,accrued interest includes $3.2 million due to our Parent Partnership.  For the six months ended June 30, 2005and 2004, interest costs incurred on the note payable to our Parent Partnershiptotaled $5.1 million and $6.1 million, respectively.

 

**NOTE7.  QUARTERLY DISTRIBUTONS OF AVAILABLECASH**

** **

We make quarterly cashdistributions of all of our Available Cash, generally defined as consolidatedcash receipts less consolidated cash disbursements and cash reserves establishedby the General Partner in its sole discretion. We pay distributions of 99.999% to the Parent Partnership and 0.001% tothe General Partner.

 

During the six monthsended June 30, 2005 and 2004, we paid cash distributions to our ParentPartnership totaling $59.4 million and $58.6 million, respectively.  On August 5, 2005, we will pay a cashdistribution to our Parent Partnership of $32.5 million for the quarter ended June 30,2005.

 

**NOTE8.  EMPLOYEE BENEFIT PLANS**

** **

**Retirement Plans**

 

The Parent Partnershiphas adopted the TEPPCO Retirement Cash Balance Plan (“TEPPCO RCBP”), which is anon-contributory, trustee-administered pension plan.  In addition, certain executive officersparticipate in the TEPPCO Supplemental Benefit Plan (“TEPPCO SBP”), which is anon-contributory, nonqualified, defined benefit retirement plan.  The TEPPCO SBP was established to restorebenefit reductions caused by the maximum benefit limitations that apply toqualified plans.  The benefit formula forall eligible employees is a cash balance formula.  Under a cash balance formula, a planparticipant accumulates a retirement benefit based upon pay credits and currentinterest credits.  The pay credits arebased on a participant’s salary, age and service.  The Parent Partnership uses a December 31measurement date for these plans.

 

On May 27, 2005, theTEPPCO RCBP and the TEPPCO SBP were amended. Effective May 31, 2005, participation in the TEPPCO RCBP was frozenand no new participants were eligible to be covered by the plan after thatdate.  Effective December 31, 2005,all plan benefits accrued will be frozen and participants will not receiveadditional pay credits after that date. In addition, all plan participants will be 100% vested regardless oftheir years of service.  Effective January 1,2006, the TEPPCO RCBP plan will be terminated and plan participants willreceive lump sum benefit payments in 2006. Participants in the TEPPCO SBP will receive pay credits through November30, 2005,

 

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and will receivelump sum benefit payments in December 2005.  Both lump sum benefit payments are discussedbelow.

 

In June 2005, theParent Partnership recorded a curtailment charge of $0.1 million in accordancewith 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.  A portion of the charge wasallocated to us.  As of May 31,2005, the following assumptions were changed for purposes of determining thenet periodic benefit costs for the remainder of 2005: the discount rate, thelong-term rate of 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.  The Parent Partnership expects to record additionalsettlement charges of approximately $0.2 million in the fourth quarter of 2005relating to the TEPPCO SBP and approximately $3.2 million in 2006 relating tothe TEPPCO RCBP for any existing unrecognized losses upon the plan terminationand final distribution of the assets to the plan participants. We expect to beallocated a share of these charges.

 

The components of netpension benefits costs allocated to us for the TEPPCO RCBP and the TEPPCO SBP forthe three and six months ended June 30, 2005 and 2004, were as follows (inthousands):

 
| ** **                                    | ** ** | **Three Months Ended   June 30,** | ** ** | **Six Months Ended   June 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                    | ** ** | **2005**                               | ** ** | **2004**                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost benefit earned during the period |       | $                                      | 589        |                                 | $          | 635 |   | $ | 1,154 |   | $ | 1,271 |   |
| Interest cost on projected benefit obligation |       | 131                                    |       | 120                                  |       | 257 |   | 241 |   |
| Expected return on plan assets                |       | (146                                   | )          | (157                                 | )          | (286 | ) | (315 | ) |
| Amortization of prior service cost            |       | 1                                      |       | 2                                    |       | 2 |   | 4 |   |
| Recognized net actuarial loss                 |       | 16                                     |       | 3                                    |       | 31 |   | 7 |   |
| SFAS 88 curtailment charge                    |       | 14                                     |       | —                               |       | 28 |   | — |   |
| Net pension benefits costs                    |       | $                                      | 605        |                                 | $          | 603 |   | $ | 1,186 |   | $ | 1,208 |   |

 

**Other Postretirement Benefits**

 

Effective January 1,2001, the Parent Partnership provides certain health care and life insurancebenefits for retired employees on a contributory and non-contributory basis (“TEPPCOOPB”).  Employees become eligible forthese benefits if they meet certain age and service requirements at retirement,as defined in the plans.  The ParentPartnership provides a fixed dollar contribution, which does not increase fromyear to year, towards retired employee medical costs.  The retiree pays all health care cost increasesdue to medical inflation. The Parent Partnership uses a December 31measurement date for this plan.

 

In May 2005,benefits provided to employees under the TEPPCO OPB were changed.  Employees eligible for these benefits willreceive them through December 31, 2005, however, effective January 1,2006, these benefits will be terminated. In June 2005, as a result of this change in benefits and inaccordance with SFAS 106, *Employers’ Accounting forPostretirement Benefits Other Than Pensions*, the Parent Partnership recordeda curtailment credit of approximately $2.6 million in its 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 its accumulatedpostretirement 

 

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obligation to thetotal of the expected remaining 2005 payments under the TEPPCO OPB.  A portion of these charges was allocated to us.

 

The components of netpostretirement benefits cost allocated to us for the TEPPCO OPB for the threemonths and six months ended June 30, 2005 and 2004, were as follows (inthousands):

 
| ** **                                                      | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Service cost benefit earned during the period                   |       | $                                     | 23         |                                | $          | 29 |   | $ | 45 |   | $ | 58 |   |
| Interest cost on accumulated postretirement benefit  obligation |       | 19                                    |       | 33                                  |       | 38 |   | 65 |   |
| Amortization of prior service cost                              |       | 15                                    |       | 28                                  |       | 29 |   | 56 |   |
| Recognized net actuarial loss                                   |       | 1                                     |       | —                              |       | 2 |   | 1 |   |
| SFAS 106 curtailment credit                                     |       | (470                                  | )          | —                              |       | (922 | ) | — |   |
| Net postretirement benefits costs                               |       | $                                     | (412       | )                                   | $          | 90 |   | $ | (808 | ) | $ | 180 |   |

## ** **

EffectiveJune 1, 2005, the payroll functions performed by DEFS for the Company weretransferred from DEFS to EPCO.  For thoseemployees who were receiving certain other postretirement benefits at the timeof the acquisition of the Company by DFI, DEFS will continue to provide thesebenefits to those employees.  Effective June 1,2005, EPCO began providing certain other postretirement benefits to thoseemployees who became eligible for the benefits after June 1, 2005, andwill charge those benefit related costs to our Parent Partnership.  As a result of these changes, the ParentPartnership recorded a $1.2 million reduction in its other postretirementobligation in June 2005.  A portionof the reduction was allocated to us.

 

## **Estimated Future BenefitContributions**

## ** **

The Parent Partnershipexpects to contribute approximately $1.1 million to its retirement plans andother postretirement benefit plans in 2005. We expect to be allocated a share of these contributions.

 

**NOTE9.  COMMITMENTS AND CONTINGENCIES**

** **

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 seeking compensatory,punitive and treble damages.  On January 27,2005, we entered into Release and Settlement Agreements with the McCleeryplaintiffs and the Richards plaintiffs dismissing all of these plaintiffs’claims.  The settlement terms included a$2.0 million payment to the plaintiffs, which was accrued at December 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 

 

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these remainingclaims will have a material adverse effect on our financial position, resultsof operations or cash flows.

 

On December 21, 2001,we were 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, theCompany 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 Company believes that the only claim assertedagainst it results from one individual for the period from July 1971through June 1972, who is alleged to have worked on a facility owned bythe Company’s predecessor.  This periodrepresents a small portion of the total alleged exposure period from January 1964through December 2001 for this individual. The individual’s claims involve numerous employers and alleged jobsites.  The Company has been unable toconfirm involvement by the Company or its predecessors with the allegedlocation, and it is uncertain at this time whether this case is covered byinsurance. Discovery is planned, and the Company intends to defend itselfvigorously against this lawsuit.  Theplaintiffs have not stipulated the amount of damages that they are seeking inthis suit.  We are obligated to reimbursethe Company for any costs it incurs related to this lawsuit.  We cannot estimate the loss, if any,associated with this pending lawsuit.  Wedo not believe that the outcome of this lawsuit will have a material adverseeffect on our financial position, results of operations or cash flows.

 

On April 2, 2003,Centennial was served with a petition in a matter styled *Adams, et al.v. Centennial Pipeline Company LLC, et al*.  This matter involves approximately 2,000plaintiffs who allege that over 200 defendants, including Centennial,generated, transported, and/or disposed of hazardous and toxic waste at twosites in Bayou Sorrell, Louisiana, an underground injection well and alandfill.  The plaintiffs allege personalinjuries, allergies, birth defects, cancer and death.  The underground injection well has been inoperation since May 1976.  Basedupon current information, Centennial appears to be a *de minimis*contributor, having used the disposal site during the two month time period of December 2001to January 2002.  Marathon has beenhandling this matter for Centennial under its operating agreement withCentennial.  We have a 50% ownershipinterest in Centennial.  On November 30,2004, the court approved a class settlement, which included an $80,000 paymentby Centennial.  The time period forparties to appeal this settlement expired in March 2005, and the classsettlement became final.  The terms ofthe settlement did not have a material adverse effect on our financialposition, results of operations or cash flows.

 

On February 4, 2005,we received a letter notifying us of a claim for approximately $1.45 million indamages allegedly due to a shipper being delivered off-specification gasolineduring November 2004.  We arecontesting liability for this matter, and to the extent there may be liability,we would seek reimbursement from the third party refiner who supplied thegasoline into our pipeline system.  We donot believe that the outcome of this matter will have a future 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 the

 

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aggregate have afuture material adverse effect on our consolidated financial position, resultsof operations or cash flows.

 

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 certain activitiesand 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,an initial decision in *ARCO Products Co., et al.v. SFPP*, Docket OR96-2-000, et al. was issued by the FERC, whichmade several 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, taxrates and tax allowances, among others). The FERC did reject, however, the use of changes in tax rates and incometax allowances as standalone factors. Judicial review of that decision, which has been sought by a number ofparties to the case, is currently pending before the U.S. Court of Appeals forthe District of Columbia Circuit.  Wehave not yet determined the impact, if any, that the decision, if it isultimately upheld, would have on our rates if they were reviewed under thecriteria of this decision.

 

On July 20, 2004,the District 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 allowance equal to the percentage attributable to partnership unitsheld by non-corporate partners.  Thecourt remanded the case back to the FERC for further review.  As a result of the court’s remand, on December 2,2004, the FERC issued a Request for Comments seeking comments on whether thecourt’s ruling applies only to the specific facts of the SFPP, L.P. proceeding oralso extends to other capital structures involving partnerships and other formsof ownership.  On May 4, 2005, theFERC issued its Policy Statement on Income Tax Allowances, which permitsregulated partnerships, limited liability companies and other pass-throughentities an income tax allowance on their income attributable to any owner thathas an actual or potential income tax liability on that income, regardlesswhether the owner is an individual or corporation.  If there is more than one level of pass-throughentities, the regulated company income must be traced to where the ultimate taxliability lies.  The Policy Statement isto be applied in individual cases, and the regulated entity bears the burden ofproof to establish the tax status of its owners.  On June 1, 2005, the FERC issued anOrder on Remand in the SFPP, L.P. proceedings holding the Policy Statementwould apply in that case and requesting briefs on whether additional evidencewas necessary to apply it.  Briefs havebeen filed but the FERC has not yet acted on them.  The ultimate outcome of the FERC’s inquiry onincome tax allowance should not affect our current rates and rate structurebecause our rates are not based on cost-of-service methodology.  However, the outcome of the income tax allowancewould become relevant to us 

 

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should we (i) electin 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. At June 30, 2005, we have an accrued liability of $0.2 million forremediation costs at our Arcadia facility. Effective March 2004, we executed an access agreement with anadjacent industrial landowner who is located upgradient of the Arcadiafacility.  This agreement enables thelandowner to proceed with remediation activities at our Arcadia facility forwhich it has accepted shared responsibility. 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 conduct anenvironmental 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.  We are in theprocess of negotiating a final settlement with the State of Illinois, and wedo not expect that compliance with the settlement will have a future materialadverse effect on our financial position, results of operations or cash flows.

 

OnJuly 22, 2004, we experienced a release of approximately 12 barrels of jetfuel from a sump at our Lebanon, Ohio, terminal.  The released jet fuel was contained within astorm water retention pond located on the terminal property.  Six migratory waterfowl were affected by thejet fuel and were subsequently euthanized by or at the request of the UnitedStates Fish and Wildlife Service (“USFWS”). On October 1, 2004, the USFWS served us with a Notice of Violation,alleging that we violated 16 USC 703 of the Migratory Bird Treaty Act for the “take[ing]of migratory birds by illegal methods.” On February 7, 2005, we entered into a Memorandum of Understanding(“MOU”) with the USFWS, and on June 23, 2005, we notified the USFWS thatwe had completed all requirements under the MOU, thus terminating the agreementand settling all aspects of this matter. The terms of this settlement did nothave a material effect on our financial position, results of operations or cashflows.

 

OnJuly 27, 2004, we received notice from the United States Department ofJustice (“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 fromour 14-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.  The maximum statutory penalty calculated forthis alleged violation of the CWA is $2.8 million.  We are in discussions with the DOJ regardingthis matter and have responded to its request for additional information.  We do not expect a civil penalty, if any, tohave a material adverse effect on our financial position, results of operationsor cash flows.

 

At June 30, 2005, wehave an accrued liability of $1.5 million related to sites requiringenvironmental remediation activities.  Wedo not expect that the completion of remediation programs associated theseactivities will have a future material adverse effect on our financialposition, results of operations or cash flows.

 

Centennial entered intocredit facilities totaling $150.0 million, and as of June 30, 2005, $150.0million was outstanding under those credit facilities.  The proceeds were used to fund constructionand conversion costs of its pipeline system. We and Marathon have each guaranteed one-half of Centennial’s debt, upto a maximum amount of $75.0 million each.

 

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On February 24,2005, the Company was acquired from DEFS by DFI.  The Company owns a 2% general partnerinterest in Parent Partnership and is the general partner of the ParentPartnership.  On March 11, 2005, theBureau of Competition of the Federal Trade Commission (“FTC”) delivered writtennotice to DFI’s legal advisor that it was conducting a non-public investigationto determine whether DFI’s acquisition of the Company may substantially lessencompetition.  The FTC has contacted theCompany requesting data.  The Companyintends to cooperate fully with any such investigations and inquiries requestedby the FTC or any other regulatory authorities.

 

**NOTE10.  SUBSEQUENT EVENTS**

** **

On July 12, 2005, we purchased a refined productsterminal and truck rack in North Little Rock, Arkansas for $6.8 million fromExxon Mobil Corporation.  The assetsinclude three storage tanks and a two-bay truck loading rack.  We funded the purchase through borrowingsunder our revolving credit facility.  Theterminal serves the central Arkansas refined products market and complementsour existing infrastructure in North Little Rock, Arkansas.

 

We have initiated an expansion of our refined productsorigin capabilities in the Houston, Texas, and Texas City, Texas areas.  As part of that project, on July 15,2005, we acquired from Texas Genco LLC (“Genco”) all of its interests incertain companies that own a 90-mile pipeline system and 5.5 million barrels ofstorage capacity for $70.6 million (including $8.6 million for the estimatedvalue of inventory).  According to theterms of the purchase and sale agreement with Genco, we will sell the acquiredinventory (anticipated to occur in the third quarter of 2005) and use theproceeds from the sale to offset the purchase price of the inventory, includingcosts incurred to consummate the sale. To the extent the proceeds from the inventory sale, including costsincurred to consummate the sale, are greater than or less than the estimatedamount previously paid to Genco, a final settlement payment will occur betweenGenco and us, resulting in no gain or loss being recognized by us on the saleof the inventory.  We funded the purchasethrough borrowings under our revolving credit facility.  The assets of the purchased companies will beintegrated into our origin infrastructure in Texas City and Baytown,Texas.  The integration and other systemenhancements should be in service by the fourth quarter of 2006, at anestimated cost of $45.0 million.  Thestrategic location of these assets, with refined products interconnections tomajor exchange terminals in the Houston area, will provide significantlong-term value to our customers and the Texas Gulf Coast refining andlogistics system.

 

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

 

**General**

** **

You should read thefollowing review of our financial position and results of operations inconjunction with our Consolidated Financial Statements.  Material period-to-period variances in theconsolidated statements of income are discussed under “Results of Operations.”  The “Financial Condition and Liquidity” section analyzesour cash flows and financial position.  “OtherConsiderations” addresses trends, future plans and contingencies that arereasonably likely to materially affect 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 ended December 31,2004.

 

**Critical Accounting Policies and Estimates**

 

A summary of the significant accounting policies wehave adopted and followed in the preparation of our consolidated financialstatements is detailed in our consolidated financial statements for the yearended December 31, 2004, included in our Annual Report on Form 10-K.Certain of these accounting policies require the use of estimates.  The following estimates, in our opinion, aresubjective in nature, require the exercise of judgment and involve complexanalysis: revenue and expense accruals, including accruals for power costs,property taxes and crude oil margins; environmental costs; asset impairmentanalysis related to property, plant and equipment; and amortization expense andasset impairment analysis related 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.

 

## ****ManagementOverview of the Three Months and Six Months Ended June 30, 2005****

## ** **

## ****We reported net income of $30.0million for the six months ended June 30, 2005, compared with net incomeof $24.1 million for the six months ended June 30, 2004, and net income of$7.9 million for the three months ended June 30, 2005, compared with netincome of $6.9 million for the three months ended June 30, 2004.****

## ** **

## ****Our results for the three monthsended June 30, 2005, were impacted by increased LPG transportationrevenues and long-haul volumes delivered, increased refined products tenderdeduction revenues and increased revenues from product location exchanges.  These increases were partially offset bydecreased refined products transportation revenues, increased power costs,increased pipeline operating expenses and increased rental expense from our CentennialPipeline LLC (“Centennial”) capacity lease agreement.****

## ** **

## ****The results for the six monthsended June 30, 2005, were impacted by increased refined products and LPGtransportation revenues and volumes, partially offset by lower propaneinventory fee revenues, increased pipeline operating expenses, increased rentalexpense from our Centennial capacity lease agreement and increasedenvironmental assessment and remediation expenses.  Additionally, pipeline integrity expensesdecreased $1.4 million and $5.7 million for the three months and six monthsended June 30, 2005, respectively, compared with the prior yearperiods.  We anticipate that our pipelineintegrity expenses for 2005 will be approximately $15.2 million lower than our2004 expenses primarily due to the completion of projects.****

## ** **

We focus on thesafe, reliable and efficient operation of the pipelines and facilities that weown or operate while meeting increased regulations that govern the operation ofour assets and the costs associated with such regulations.  We are also focused on our continued growththrough expansion of the assets that we own and through acquisition of assetsthat complement our current operations. We remain confident that our current strategy and focus will providecontinued growth in earnings and cash distributions.  These opportunities include continued 

 

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growth, resulting from our recent capacity expansion and grass rootsfacility investments and growing demand for Gulf Coast sourced products.

 

On July 12, 2005, wepurchased a refined products terminal and truck rack in North Little Rock,Arkansas for $6.8 million from Exxon Mobil Corporation.  The assets include three storage tanks and atwo-bay truck loading rack.  The terminalserves the central Arkansas refined products market and complements ourexisting infrastructure in North Little Rock, Arkansas.

 

We have initiated anexpansion of our refined products origin capabilities in the Houston, Texas,and Texas City, Texas areas.  As part ofthat project, on July 15, 2005, we acquired from Texas Genco LLC (“Genco”)all of its interests in certain companies that own a 90-mile pipeline systemand 5.5 million barrels of storage capacity for $70.6 million (including $8.6million for the estimated value of inventory). According to the terms of the purchase and sale agreement with Genco, wewill sell the acquired inventory (anticipated to occur in the third quarter of2005) and use the proceeds from the sale to offset the purchase price of theinventory, including costs incurred to consummate the sale.  To the extent the proceeds from the inventorysale, including costs incurred to consummate the sale, are greater than or lessthan the estimated amount previously paid to Genco, a final settlement paymentwill occur between Genco and us, resulting in no gain or loss being recognizedby us on the sale of the inventory.  Theassets of the purchased companies will be integrated into our origininfrastructure 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.

 

We are subject toeconomic and other factors that affect our industry.  The demand for refined products is dependentupon the price, prevailing economic conditions and demographic changes in themarkets served, trucking and railroad freight, agricultural usage and militaryusage; the demand for propane is sensitive to the weather and prevailingeconomic conditions; and the demand for petrochemicals is dependent upon pricesfor products produced from petrochemicals. We are also subject to regulatoryfactors such as the amounts we are allowed to charge our customers for theservices we provide on our regulated pipeline systems.

 

Consistent with ourbusiness strategy, we continuously evaluate possible acquisitions of assetsthat would complement our current operations. Such acquisition efforts involve participation by us in processes thathave been made public and involve a number of potential buyers, as well assituations in which we believe we are the only party or one of a very limitednumber of potential buyers in negotiations with the potential seller.  These acquisition efforts often involveassets which, if acquired, would have a material effect on our financial position,results of operations or cash flows****.****

 

# **Our Business**

# ** **

TE Products PipelineCompany, Limited Partnership (the “Partnership”), a Delaware limitedpartnership, was formed in March 1990. TEPPCO Partners, L.P. (the “Parent Partnership”) owns a 99.999% interestin us as the sole limited partner. TEPPCO GP, Inc. (“TEPPCO GP” or “General Partner”), a wholly ownedsubsidiary of the Parent Partnership, holds a 0.001% general partner interestin us.  Texas Eastern Products PipelineCompany, LLC (the “Company”), a Delaware limited liability company, serves asthe general partner of our Parent Partnership. Through February 23, 2005, the Company was an indirect wholly ownedsubsidiary of Duke Energy Field Services, LLC (“DEFS”), a joint venture betweenDuke Energy Corporation (“Duke Energy”) and ConocoPhillips. Through February 23,2005, Duke Energy held an interest of approximately 70% in DEFS, andConocoPhillips held the remaining interest of approximately 30%.  On February 24, 2005, the Company wasacquired by DFI GP Holdings L.P. (formerly Enterprise GP Holdings L.P.) (“DFI”),an affiliate of EPCO, Inc. (“EPCO”), a privately held company controlledby Dan L. Duncan, for approximately $1.1 billion.  As a result of the transaction, DFI owns andcontrols the 2% general partner interest in our Parent Partnership and has theright to receive the incentive distribution rights associated with the generalpartner interest.

 

TEPPCO GP, as our generalpartner, performs all of the management and operating functions required for usin accordance with the Agreement of Limited Partnership of TE Products PipelineCompany, Limited Partnership 

 

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(the “PartnershipAgreement”).  We reimburse our GeneralPartner and the Company for all reasonable direct and indirect expenses thatthey incur in managing us.

 

We operate and report inone business segment:  transportation andstorage of refined products, LPGs and petrochemicals.  Revenues are earned from transportation andstorage of refined products and LPGs, intrastate transportation ofpetrochemicals, sales of product inventory and other ancillary services.  Our two largest operating expense items arelabor and electric power.  We generallyrealize higher revenues during the first and fourth quarters of each year sinceour operations 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 are generally higher from November throughMarch due to higher demand in the Northeast for propane, a major fuel forresidential heating.  Our results alsoinclude our equity investments in Centennial and Mont Belvieu Storage Partners,L.P. (“MB Storage”) (see Note 5.  EquityInvestments).

 

We areone of three operating subsidiaries of our Parent Partnership.  Our Parent Partnership is managed by itsgeneral partner, the Company.  EPCO hasapproximately 1,200 employees dedicated to the operations and management of ourParent Partnership operating subsidiaries. Our Parent Partnership allocatesoperating, general and administrative expenses to us for legal, insurance,financial, communication and other administrative services based upon theestimated level of effort devoted to our various operations.  We believe that the methods for allocatingcorporate operating, general and administrative expenses to us are reasonable.

 

**Resultsof Operations**

** **

The following table presents volumesdelivered in barrels and average tariff per barrel for the three months and sixmonths ended June 30, 2005 and 2004 (in thousands, except tariffinformation):

 
| ** **                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Percentage  Increase** | ** ** | **Six Months Ended  June 30,** | ** ** | **Percentage  Increase** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|--------------------------|------------|-------------------------------------|------------|--------------------------|------------|
| ** **                       | ** ** | **2005**                              | ** ** | **2004**                 | ** ** | **(Decrease)**                      | ** ** | **2005**                 | ** ** | **2004** | ** ** | **(Decrease)** | ** ** |
| ** **                       | ** ** | ** **                            | ** ** | ** **               | ** ** | ** **                          | ** ** | ** **               | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Volumes Delivered**            |       |                                  |       |                     |       |                                |       |                     |       |   |   |   |   |
| Refined products                 |       | 42,097                                |       | 41,936                   |       | 1                                   | %          | 80,692                   |       | 74,458 |   | 8 | % |
| LPGs                             |       | 7,855                                 |       | 8,794                    |       | (11                                 | )%         | 22,657                   |       | 22,002 |   | 3 | % |
| Total                            |       | 49,952                                |       | 50,730                   |       | (2                                  | )%         | 103,349                  |       | 96,460 |   | 7 | % |
|                             |       |                                  |       |                     |       |                                |       |                     |       |   |   |   |   |
| **Average Tariff per Barrel**    |       |                                  |       |                     |       |                                |       |                     |       |   |   |   |   |
| Refined products                 |       | $                                     | 0.90       |                     | $          | 0.93                                |       | (3                       | )%         | $ | 0.90 |   | $ | 0.94 |   | (4 | )% |
| LPGs                             |       | 1.84                                  |       | 1.56                     |       | 18                                  | %          | 2.06                     |       | 1.93 |   | 7 | % |
| Average system tariff per barrel |       | $                                     | 1.05       |                     | $          | 1.04                                |       | 1                        | %          | $ | 1.16 |   | $ | 1.17 |   | (1 | )% |

 

*Three MonthsEnded June 30, 2005 Compared with Three Months Ended June 30, 2004*

 

Revenues from refinedproducts transportation decreased $1.1 million for the three months ended June 30,2005, compared with the three months ended June 30, 2004, primarily due toa decrease in distillate volumes transported and a decrease in the refinedproducts average rate per barrel, partially offset by an overall increase inthe refined products volume delivered. The decrease in distillate volumes was a result of low distillate pricedifferentials.  The decrease in therefined products average rate per barrel from the prior year period wasprimarily due to the impact of greater growth in the volume of productsdelivered under a Centennial tariff compared with the growth in deliveriesunder our tariff, which resulted in an increased proportion of lower tariffbarrels transported on our system.  Priorto the construction of Centennial, deliveries on our pipeline system werelimited by our pipeline capacity, and transportation services for our customerswere allocated in accordance with a proration policy.  With this incremental pipeline capacity, ourpreviously constrained system has expanded deliveries in markets both south andnorth of Creal Springs, Illinois.  In February 2003,we entered into a lease agreement with Centennial that increased ourflexibility to deliver refined products to our market areas.  Centennial has provided our system with 

 

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additionalpipeline capacity for movement of products originating in the U.S. Gulf Coastarea.  The overall increase in refinedproducts volume was primarily due to increased demand and market share forproducts supplied from the U.S. Gulf Coast into Midwest markets.

 

Revenues from LPGstransportation increased $0.7 million for the three months ended June 30,2005, compared with the three months ended June 30, 2004, due to higherdeliveries of propane in the upper Midwest and Northeast market areas.  The LPGs average rate per barrel increasedfrom the prior period primarily as a result of decreased short-haul deliveriesduring the three months ended June 30, 2005.

 

  Other operating revenuesincreased $1.7 million for the three months ended June 30, 2005, comparedwith the three months ended June 30, 2004, primarily due to higher refinedproducts additive and tender deduction revenue and increased margins on productinventory sales.

 

Costs and expensesincreased $0.6 million for the three months ended June 30, 2005, comparedwith the three months ended June 30, 2004, due to increased operating fueland power and increased depreciation and amortization expense, partially offsetby decreased operating, general and administrative expenses and decreased taxes– other than income.  Operating fuel andpower increased $0.7 million primarily due to increased mainline throughput andadjustments to power accruals. Depreciation expense increased $0.5 million primarily due to assetsplaced into service in 2005.  Operating,general and administrative expenses decreased $0.6 million primarily due to a$1.4 million decrease in pipeline inspection and repair costs associated withour integrity management program and a $0.4 million decrease in consultingservices and supplies primarily related to acquisition activities in 2004.  These decreases were partially offset by a$0.7 million increase in pipeline operating and maintenance expenses, a $0.3million increase in rental expense from the Centennial pipeline capacity leaseagreement and a $0.2 million increase in insurance expense. Increased labor andbenefits expenses associated with vesting provisions in certain of ourcompensation plans as a result of changes in control of our General Partner higherincentive compensation expenses compared to the prior year period were offsetby a $1.6 million decrease in postretirement benefit accruals related to planamendments (see Note 8. Employee Benefit Plans).

 

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

 

| ** **          | ** ** | **Three Months Ended   June  30,** | ** ** | **Increase** | ** ** |
|---------------------|------------|-----------------------------------------|------------|--------------|------------|
| ** **          | ** ** | **2005**                                | ** ** | **2004**     | ** ** | **(Decrease)** | ** ** |
| ** **          | ** ** | ** **                              | ** ** | ** **   | ** ** | ** ** | ** ** |
| Centennial          |       | $                                       | (496       | )            | $          | (2,286 | ) | $ | 1,790 |   |
| MB Storage          |       | 1,365                                   |       | 1,785        |       | (420 | ) |
| Other               |       | 23                                      |       | (8           | )          | 31 |   |
| Total equity losses |       | $                                       | 892        |         | $          | (509 | ) | $ | 1,401 |   |

 

Equity losses inCentennial decreased $1.8 million for the three months ended June 30,2005, compared with the three months ended June 30, 2004, primarily due tohigher transportation revenues and volumes, partially offset by higher transmixrelated product replacement costs and product measurement losses during the2005 period.  Equity earnings in MBStorage decreased $0.4 million for the three months ended June 30, 2005,compared with the three months ended June 30, 2004, primarily due tohigher pipeline rehabilitation expenses on the MB Storage system.

 

*Six Months Ended June 30,2005 Compared with Six Months Ended June 30, 2004*

 

Revenuesfrom refined products transportation increased $2.9 million for the six monthsended June 30, 2005, compared with the six months ended June 30,2004, due to an overall increase in the refined products volumes delivered.This increase was primarily due to deliveries of products moved on Centennial.

 

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Volume increases were dueto increased demand and market share for products supplied from the U.S. GulfCoast into Midwest markets. The refined products average rate per barreldecreased from the prior year period primarily due to the impact of greatergrowth in the volume of products delivered under a Centennial tariff comparedwith the growth in deliveries under our tariff, which resulted in an increasedproportion of lower tariff barrels transported on our system.

 

Revenuesfrom LPGs transportation increased $4.2 million for the six months ended June 30,2005, compared with the six months ended June 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 our sourced propane being less competitive than propane from othersource points.

 

Other operating revenues decreased $2.4 million forthe six months ended June 30, 2005, compared with the six months ended June 30,2004, primarily due to lower propane inventory fees in 2005 and lower volume ofproduct inventory sales, partially offset by higher refined products tenderdeduction and loading revenues.

 

Costsand expenses decreased $1.7 million for the six months ended June 30,2005, compared with the six months ended June 30, 2004, due to decreasedoperating, general and administrative expenses, partially offset by increaseddepreciation and amortization expense and increased operating fuel andpower.  Operating, general andadministrative expenses decreased $3.1 million, primarily due to a $5.7 milliondecrease in pipeline inspection and repair costs associated with our integritymanagement program, and a $1.6 million decrease in postretirement benefitaccruals related to plan amendments (see Note 8. Employee Benefit Plans) and a $0.3million decrease in consulting services and supplies primarily related toacquisition related activities in 2004. These decreases were partially offset by a $2.4 million increase inlabor and benefits expenses associated with vesting provisions in certain ofour compensation plans as a result of changes in control of our General Partnerand higher incentive compensation expenses compared to the prior year period, a$1.0 million increase in rental expense from the Centennial pipeline capacitylease agreement, a $0.6 million increase in environmental remediation andassessment costs and a $0.6 million increase in pipeline operating andmaintenance expense.  Depreciationexpense increased $1.2 million primarily due to assets placed into service andassets retired to depreciation expense in 2005. Operating fuel and power increased $0.3 million primarily due toincreased mainline throughput and adjustments to power accruals.

 

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

 

| ** **          | ** ** | **Six Months Ended   June  30,** | ** ** | **Increase** | ** ** |
|---------------------|------------|---------------------------------------|------------|--------------|------------|
| ** **          | ** ** | **2005**                              | ** ** | **2004**     | ** ** | **(Decrease)** | ** ** |
| ** **          | ** ** | ** **                            | ** ** | ** **   | ** ** | ** ** | ** ** |
| Centennial          |       | $                                     | (3,967     | )            | $          | (6,143 | ) | $ | 2,176 |   |
| MB Storage          |       | 3,998                                 |       | 4,414        |       | (416 | ) |
| Other               |       | 19                                    |       | (18          | )          | 37 |   |
| Total equity losses |       | $                                     | 50         |         | $          | (1,747 | ) | $ | 1,797 |   |

 

Equity losses inCentennial decreased $2.2 million for the six months ended June 30, 2005,compared with the six months ended June 30, 2004, primarily due to highertransportation revenues and volumes, partially offset by higher transmixrelated product replacement costs and product measurement losses during the2005 period.  Equity earnings in MBStorage decreased $0.4 million for the six months ended June 30, 2005,compared with the six months ended June 30, 2004, primarily due toincreased depreciation and amortization expense, higher pipeline rehabilitationexpenses and higher general and administrative expenses, partially offset byhigher revenues and volumes.  In April 2004,MB Storage acquired storage and pipeline assets and contracts for approximately$34.0 million, of which we contributed $16.5 million.  Increases in storage revenue, shuttlerevenue, rental revenue and 

 

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depreciation andamortization expense for the six months ended June 30, 2005, compared withthe six months ended June 30, 2004, are primarily related to the acquiredstorage assets and contracts.

 

**FinancialCondition and Liquidity**

** **

Cash flows for the sixmonths ended June 30, 2005 and 2004, were as follows (in thousands):

 
| ** **                  | ** ** | **Six Months Ended   June 30,** | ** ** |
|-----------------------------|------------|--------------------------------------|------------|
| ** **                  | ** ** | **2005**                             | ** ** | **2004** | ** ** |
|                        |       |                                 |       |   |   |
| Cash provided by (used in): |       |                                 |       |   |   |
| Operating activities        |       | $                                    | 31,851     |   | $ | 68,256 |   |
| Investing activities        |       | (28,134                              | )          | (45,313 | ) |
| Financing activities        |       | (3,703                               | )          | (23,131 | ) |
|                             |            |                                      |            |  |  |  |  |

 

*OperatingActivities*

 

Net cash from operatingactivities for the six months ended June 30, 2005 and 2004, were comprisedof the following (in thousands):

 
| ** **                                           | ** ** | **Six Months Ended   June 30,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                           | ** ** | **2005**                             | ** ** | **2004** | ** ** |
|                                                 |       |                                 |       |   |   |
| Net income                                           |       | $                                    | 30,018     |   | $ | 24,113 |   |
| Depreciation and amortization                        |       | 18,835                               |       | 17,636 |   |
| Earnings (losses) in equity investments              |       | (50                                  | )          | 1,747 |   |
| Distributions from equity investments                |       | 7,300                                |       | 4,950 |   |
| Non-cash portion of interest expense                 |       | 136                                  |       | 15 |   |
| Gains on sales of assets                             |       | (107                                 | )          | (17 | ) |
| Cash provided by (used in) working capital and other |       | (24,281                              | )          | 19,812 |   |
| Net cash from operating  activities                  |       | $                                    | 31,851     |   | $ | 68,256 |   |

 

For a discussion ofchanges in net income, depreciation and amortization and equity earnings, seeResults of Operations in Item 2. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations.  Cash provided byoperating activities decreased $36.4 million for the six months ended June 30,2005, compared with the six months ended June 30, 2004, primarily due tothe timing of cash disbursements and cash receipts for working capitalcomponents partially offset by higher net income and depreciation andamortization in the 2005 period.

 

We believe that we willcontinue to have adequate liquidity to fund future recurring operating andinvesting activities.  Our primary cashrequirements consist of normal operating expenses, capital expenditures tosustain existing operations and revenue generating expenditures, interestpayments on our Senior Notes and on borrowings under our Parent Partnership’scredit facilities and distributions to our Parent Partnership.  Short-term cash requirements, such asoperating expenses, capital expenditures to sustain existing operations andquarterly distributions to our Parent Partnership, are expected to be fundedthrough operating cash flows.  Long-term cash requirements for expansionprojects are expected to be funded by several sources, including cash flowsfrom operating activities, borrowings under our Parent Partnership’s creditfacilities and the issuance by our Parent Partnership of additional equity anddebt securities.  The timing of any debtor offerings by our Parent Partnership will depend on various factors,including prevailing market conditions, interest rates and our ParentPartnership’s financial condition and credit rating at the time.

 

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At June 30, 2005, andDecember 31, 2004, we had working capital deficits of $39.1 million and$61.9 million, respectively.  Cashgenerated from operations and from our Parent Partnership’s credit facilitiesand debt and equity offerings are our primary sources of liquidity.  Working capital deficits can occur primarilydue to the timing of operating cash receipts from customers, payment of cashdistributions and the payment of normal operating expenses and capitalexpenditures.  We are a wholly ownedsubsidiary of the Parent Partnership.  Weexpect that our Parent Partnership will make capital contributions, loans orotherwise provide liquidity to us as needed, but the Parent Partnership has nocontractual obligation to do so.  Weanticipate that the Parent Partnership will provide the necessary liquidity toprotect its investment in us.  At June 30,2005, our Parent Partnership had $278.6 million in available borrowing capacityunder its revolving credit facility to cover any working capital needs, andexpects that cash flows from operating activities, the sale of additional debtor equity offerings will provide necessary liquidity to us.

 

*InvestingActivities*

 

Cash flows used in investingactivities totaled $28.1 million for the six months ended June 30, 2005,and were comprised of $27.0 million of capital expenditures and $1.1 million ofcash contributions for our ownership interest in MB Storage.  Cash flows used in investing activitiestotaled $45.3 million for the six months ended June 30, 2004, and werecomprised of $24.6 million of capital expenditures, $17.2 million of cashcontributions for our ownership interest in MB Storage, $2.0 million for theacquisition of assets and $1.5 million of cash contributions for our ownershipinterest in Centennial.

 

*FinancingActivities*

 

Cash flows used infinancing activities totaled $3.7 million for the six months ended June 30,2005, and were comprised of $239.1 million of repayments on the note payable toour Parent Partnership, net of borrowings, and $59.4 million of distributionspaid to our Parent Partnership, partially offset by $294.8 million ofcontributions from our Parent Partnership. The contributions received from the Parent Partnership during 2005 wereprimarily used to reduce the level of indebtedness owed to our ParentPartnership.  Cash flows used infinancing activities totaled $23.1 million for the six months ended June 30,2004, and were comprised of $58.6 million of distributions paid to our ParentPartnership, partially offset by $35.5 million of proceeds received from ournote payable to our Parent Partnership.

 

Centennial entered intocredit facilities totaling $150.0 million and, as of June 30, 2005, $150.0million was outstanding under those credit facilities. The proceeds were usedto fund construction and conversion costs of Centennial’s pipeline system.  We and Marathon Ashland Petroleum LLC haveeach guaranteed one-half of Centennial’s debt, up to a maximum of $75.0 millioneach.

 

*ParentPartnership Credit Facilities*

 

We currently utilize debtfinancing available from our Parent Partnership through intercompany notes. Theterms of the intercompany notes generally match the principal and interestpayment dates under the Parent Partnership’s credit agreements.  The interest rates charged by the ParentPartnership include the stated interest rate of the Parent Partnership, plus apremium to cover debt issuance costs. The interest rate is also decreased or increased to cover gains andlosses, respectively, on any interest rate swaps that the Parent Partnershipmay have in place on its respective credit agreements.  These credit facilities of the ParentPartnership are described below.

 

On June 27, 2003,our Parent Partnership entered into a $550.0 million revolving credit facilitywith a three-year term, including the issuance of letters of credit of up to$20.0 million (“Revolving Credit Facility”). The interest rate is based, at our Parent Partnership’s option, on eitherthe lender’s base rate plus a spread, or LIBOR plus a spread in effect at thetime of the borrowings.  The creditagreement for the Revolving Credit Facility contains certain restrictivefinancial covenant ratios.  On October 21,2004, our Parent Partnership amended the Revolving Credit Facility to (i) increasethe facility size to $600.0 million, (ii) extend the term to October 21,2009, (iii) remove certain restrictive covenants, (iv) increase theavailable amount for the issuance of letters of credit up to $100.0 million and(v) decrease the LIBOR rate spread charged at the time of eachborrowing.  On February 23, 2005,the 

 

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Parent Partnershipagain amended its Revolving Credit Facility to remove the requirement that DEFSmust at all times own, directly or indirectly, 100% of the Company, to allowfor its acquisition by DFI (see Note 1. Organization and Basis ofPresentation).  During the second quarterof 2005, the Parent Partnership used a portion of the proceeds from equityofferings in May 2005 and June 2005 to repay a portion of the RevolvingCredit Facility. On June 30, 2005, $278.0 million was outstanding underthe Revolving Credit Facility at a weighted average interest rate of 4.3%.

 

On January 30, 2003,our Parent Partnership issued $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 facevalue over the term of the notes.  TheSenior Notes may be redeemed at any time at our Parent Partnership’s optionwith the payment of accrued interest and a make-whole premium determined bydiscounting remaining interest and principal payments using a discount rateequal to the rate of the United States Treasury securities of comparableremaining maturity plus 35 basis points. The indenture governing the 6.125% Senior Notes contains covenants,including, but not limited to, covenants limiting the creation of lienssecuring indebtedness and sale and leaseback transactions.  However, the indenture does not limit theParent Partnership’s ability to incur additional indebtedness.

 

As of June 30, 2005,and December 31, 2004, we had intercompany notes payable to our ParentPartnership of $62.5 million and $301.7 million, respectively, whichrepresented borrowings under the Parent Partnership’s Revolving CreditFacility, 7.625% Senior Notes and 6.125% Senior Notes. The weighted averageinterest rate on the note payable to the Parent Partnership at June 30,2005, was 5.5%.  At June 30, 2005,accrued interest includes $3.2 million due to our Parent Partnership.  For the six months ended June 30, 2005and 2004, interest costs incurred on the note payable to our Parent Partnershiptotaled $5.1 million and $6.1 million, respectively.

 

### *Cash Distributions*

### * *

During the six monthsended June 30, 2005 and 2004, we paid cash distributions to our ParentPartnership totaling $59.4 million and $58.6 million, respectively.  On August 5, 2005, we will pay a cash distributionto our Parent Partnership of $32.5 million for the quarter ended June 30,2005.

 

### *FutureCapital Needs and Commitments*

### * *

We estimate that capitalexpenditures, excluding acquisitions, for 2005 will be approximately $88.4million (which includes $2.5 million of capitalized interest). We expect tospend approximately $43.8 million for revenue generating projects and facilityimprovements.  We expect to spendapproximately $20.4 million to sustain existing operations, includinglife-cycle replacements for equipment at various facilities and pipeline andtank replacements and $21.7 million for various system upgrade projects.  We continually review and evaluate potentialcapital improvements and expansions that would be complementary to our presentsystem.  These expenditures can varygreatly depending on the magnitude of our transactions.  We may finance capital expenditures throughinternally generated funds, debt or capital contributions from our ParentPartnership or any combination thereof.

 

Our debt repaymentobligations consist of payments for principal and interest on (i) our $62.5million principal amount due to the Parent Partnership related to our share ofthe Parent Partnership’s Revolving Credit Facility due in October 2009,7.625% Senior Notes due in February 2012 and 6.125% Senior Notes due in February 2013,(ii) our $210.0 million 7.51% Senior Notes due January 15, 2028, and (iii) our$180.0 million 6.45% Senior Notes due January 15, 2008.

 

We are also contingentlyliable as guarantor for the lesser of one half or $75.0 million principalamount (plus interest) of the borrowings of Centennial. In January 2003,we entered into a pipeline capacity lease agreement with Centennial for aperiod of five years that contains a minimum throughput requirement.  For the year ended December 31, 2004, weexceeded the minimum throughput requirements on the lease agreement.  We are also contingently liable as guarantorfor $500.0 million principal amount of 7.625% Senior Notes due 2012 issued in February 2002and for $200.0 million principal amount of 6.125% Senior Notes due 2013 issuedin January 2003 by our Parent Partnership.

 

24

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During the six monthsended June 30, 2005, we contributed $1.1 million to MB Storage.  No amounts were contributed to Centennialduring the six months ended June 30, 2005. During the six months ended June 30, 2004, we contributed $1.5million to Centennial to cover operating needs and capital expenditures and$17.2 million to MB Storage, of which $16.5 million was used to acquire storageassets in April 2004.  During theremainder of 2005, we may be required to contribute cash to Centennial to covercapital expenditures, acquisitions or other operating needs and to MB Storageto cover significant capital expenditures or additional acquisitions.

 

### *Off-BalanceSheet Arrangements*

### * *

We do not rely onoff-balance sheet borrowings to fund our acquisitions. We have no off-balancesheet commitments for indebtedness other than the limited guaranty of the Centennialdebt, the Parent Partnership debt and leases covering assets utilized inseveral areas of our operations.

 

### *ContractualObligations*

 

The following tablesummarizes our debt repayment obligations and material contractual commitmentsas of June 30, 2005 (in millions):

 
| ** **                                 | ** ** | **Amount of Commitment Expiration  Per Period** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                 | ** ** | **Total**                                       | ** ** | **Less than 1   Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **After 5   Years** | ** ** |
|                                       |       |                                            |       |   |   |   |   |   |   |   |   |
| Note payable, Parent Partnership           |       | $                                               | 62.5       |   | $ | — |   | $ | — |   | $ | 62.5 |   | $ | — |   |
| 6.45% Senior Notes due 2008 (1)            |       | 180.0                                           |       | — |   | 180.0 |   | — |   | — |   |
| 7.51% Senior Notes due 2028 (1)            |       | 210.0                                           |       | — |   | — |   | — |   | 210.0 |   |
| Debt subtotal                              |       | 452.5                                           |       | — |   | 180.0 |   | 62.5 |   | 210.0 |   |
|                                       |       |                                            |       |   |   |   |   |   |   |   |   |
| Operating leases                           |       | 56.4                                            |       | 12.4 |   | 21.1 |   | 9.1 |   | 13.8 |   |
| Capital expenditure obligations (2)        |       | 0.3                                             |       | 0.3 |   | — |   | — |   | — |   |
| Other liabilities and deferred credits (3) |       | 0.7                                             |       | — |   | 0.6 |   | 0.1 |   | — |   |
|                                       |       |                                            |       |   |   |   |   |   |   |   |   |
| Total                                      |       | $                                               | 509.9      |   | $ | 12.7 |   | $ | 201.7 |   | $ | 71.7 |   | $ | 223.8 |   |

 

----

| (1)    |   | We entered into an interest rate swap agreement to hedge our exposure  to changes in the fair value of our 7.51% Senior Notes due 2028. At  June 30, 2005, the 7.51% Senior Notes include an adjustment to increase  the fair value of the debt by $7.4 million related to this interest rate swap  agreement. At June 30, 2005, our 6.45% Senior Notes include less than  $0.1 million of unamortized debt discount. The fair value adjustment and  unamortized debt discount are excluded from this table. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (2)    |   | Includes  accruals of cost incurred but not yet paid relating to capital projects.                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| (3)    |   | Excludes  approximately $9.1 million of long-term deferred revenue payments, which are  being transferred to income over the term of the respective revenue  contracts. The amount of commitment by year is our best estimate of projected  payments of these long-term liabilities.                                                                                                                                                                                                                                   |

 

Weexpect to repay the long-term, senior unsecured obligations and note payable toour Parent Partnership through the issuance of additional long-term seniorunsecured debt at the time the 2008 and 2028 debts mature, with proceeds fromthe dispositions of assets, cash flows from operations, and contributions fromour Parent Partnership or any combination of the above items.

 

* Sources of Future Capital*

 

We expect that our cashflow from operating activities will be adequate to fund cash distributions andcapital additions necessary to sustain existing operations.  However, expansionary capital projects andacquisitions may require additional capital contributions from our ParentPartnership.  The Parent Partnership hasfunded its capital commitments from operating cash flow, borrowings under bankcredit facilities, the issuance of long term 

 

25

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debt in capitalmarkets and the public offering of Limited Partner Units.  We expect future capital needs will besimilarly funded.

 

Our Parent Partnershiphas filed with the Securities and Exchange Commission a universal shelfregistration statement that, subject to agreement on terms at the time of useand appropriate supplementation, allows it to issue, in one or more offerings,up to an aggregate of $2.0 billion of equity securities, debt securities or a combinationthereof. During the three months ended June 30, 2005, our ParentPartnership issued $279.2 million of equity securities.  At June 30, 2005, our Parent Partnershiphad $1.7 billion remaining under this shelf registration, subject to customarymarketing terms and conditions.

 

 Our Parent Partnership’s senior unsecured debtis rated BBB- by Standard and Poors (“S&P”) and Baa3 by Moody’s Investors Service(“Moody’s”).  S&P assigned thisrating on June 14, 2005, following its review of the ownership structure,corporate governance issues, and proposed funding after the acquisition of theCompany by DFI.  Both ratings are with astable outlook.  A rating reflects onlythe view of a rating agency and is not a recommendation to buy, sell or holdany indebtedness.  Any rating can berevised upward or downward or withdrawn at any time by a rating agency if itdetermines that the circumstances warrant such a change.  The senior unsecured debt of our rating isalso rated BBB- by S&P and Baa3 by Moody’s. Both ratings are with a stable outlook.

 

# **Other Considerations**

# ** **

Our operations aresubject to federal, state and local laws and regulations governing the dischargeof materials into the environment. Failure to comply with these laws andregulations may result in the assessment of administrative, civil and criminalpenalties, imposition of injunctions delaying or prohibiting certain activitiesand 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.

 

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. At June 30, 2005, we have an accrued liability of $0.2 million forremediation costs at our Arcadia facility. Effective in March 2004, we executed an access agreement with anadjacent industrial landowner who is located upgradient of the Arcadiafacility.  This agreement enables thelandowner to proceed with remediation activities at our Arcadia facility forwhich it has accepted shared responsibility. 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.  We are in theprocess of negotiating a final settlement with the State of Illinois, and wedo not expect that compliance with the settlement will have a future materialadverse effect on our financial position, results of operations or cash flows.

 

OnJuly 22, 2004, we experienced a release of approximately 12 barrels of jetfuel from a sump at our Lebanon, Ohio, terminal.  The released jet fuel was contained within astorm water retention pond located on the terminal property.  Six migratory waterfowl were affected by thejet fuel and were subsequently euthanized by or at the request of the UnitedStates Fish and Wildlife Service (“USFWS”). On October 1, 2004, the USFWS served us 

 

26

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with a Notice of Violation, alleging that we violated 16 USC 703 of theMigratory Bird Treaty Act for the “take[ing] of migratory birds by illegalmethods.”  On February 7, 2005, weentered into a Memorandum of Understanding (“MOU”) with the USFWS, and on June 23,2005, we notified the USFWS that we had completed all requirements under theMOU, thus terminating the agreement and settling all aspects of this matter.The terms of this settlement did not have a material effect on our financialposition, results of operations or 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 our November 21,2001, release of approximately 2,575 barrels of jet fuel from our 14-inchdiameter pipeline located in Orange County, Texas.  The DOJ, at the request of the EnvironmentalProtection Agency, is seeking acivil penalty against us for alleged violations of the Clean Water Act (“CWA”)arising out of this release.  The maximumstatutory penalty calculated for this alleged violation of the CWA is $2.8million.  We are in discussions with theDOJ regarding this matter and have responded to its request for additionalinformation.  We do not expect a civilpenalty, if any, to have a material adverse effect on our financial position,results of operations or cash flows.

 

At June 30, 2005, wehave an accrued liability of $1.5 million related to various sites requiringenvironmental remediation activities.  Wedo not expect that the completion of remediation programs associated with theseactivities will have a future material adverse effect on our financialposition, results of operations or cash flows.

 

*Recent AccountingPronouncements*

* *

**See discussion ofnew accounting pronouncements in Note 1. Organization and Basis of Presentation - New Accounting Pronouncementsin the accompanying consolidated financial statements.**

** **

*Retirement andElection of Officers*

* *

OnJuly 12, 2005, we announced that Charles H. Leonard elected to retireeffective July 8, 2005, as Senior Vice President and Chief FinancialOfficer of the Company.  Tracy E. Ohmart,Controller of the Company, became the acting Chief Financial Officer.

 

Mr. Ohmart, age 37,has served as Controller of the Company since May 2002.  Mr. Ohmart joined the Company in January 2001and has held various positions within the Company until he became AssistantController in May 2001.  Prior tohis employment with the Company, Mr. Ohmart spent 12 years in variouspositions at ARCO Pipe Line Company, most recently serving as supervisor ofgeneral accounting and policy.

 

# **Forward-Looking Statements**

# ** **

The matters discussedherein include “forward-looking statements” within the meaning of variousprovisions of the Securities Act of 1933 and the Securities Exchange Act of1934.  All statements, other thanstatements of historical facts, included in this document that addressactivities, events or developments that we expect or anticipate will or mayoccur in the future, including such things as estimated future capitalexpenditures (including the amount and nature thereof), business strategy andmeasures to implement strategy, competitive strengths, goals, expansion andgrowth of our business and operations, plans, references to future success,references to intentions as to future matters and other such matters areforward-looking statements.  These statementsare based on certain assumptions and analyses made by us in light of ourexperience and our perception of historical trends, current conditions andexpected future developments as well as other factors we believe areappropriate under the circumstances. However, whether actual results and developments will conform with ourexpectations and predictions is subject to a number of risks and uncertainties,including general economic, market or business conditions, the opportunities(or lack thereof) that may be presented to and pursued by us, competitiveactions by other pipeline companies, changes in laws or regulations, and otherfactors, many of which are beyond our control. Consequently, all of the forward-looking statements made in thisdocument are qualified by these cautionary statements and we cannot assure youthat actual results or developments that we anticipate will be realized or,even if substantially realized, that they will have the expected consequencesto or effect on us or our business or 

 

27

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operations.  For additional discussion of such risks anduncertainties, see our Annual Report on Form 10-K for the year ended December 31,2004, and other filings we have made with the Securities and ExchangeCommission.

 

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

** **

We may be exposed tomarket risk through changes in commodity prices and interest rates.  We do not have foreign exchange risks.  Our Risk Management Committee has establishedpolicies to monitor and control these market risks. The Risk ManagementCommittee is comprised, in part, of senior executives of the Company.

 

We have utilized andexpect to continue to utilize interest rate swap agreements to hedge a portionof our fair value risks.  Interest rateswap agreements are used to manage the fixed interest rate mix of our debtportfolio and overall cost of borrowing. The interest rate swap related to our fair value risk is intended toreduce our exposure to changes in the fair value of our fixed rate SeniorNotes.  The interest rate swap agreementinvolves the periodic exchange of payments without the exchange of the notionalamount upon which the payments are based. The related amount payable to orreceivable from counterparties is included as an adjustment to accruedinterest.

 

At June 30, 2005, wehad outstanding $180.0 million principal amount of 6.45% Senior Notes due 2008and $210.0 million principal amount of 7.51% Senior Notes due 2028.  At June 30, 2005, the estimated fairvalue of the 6.45% Senior Notes and 7.51% Senior Notes were approximately $188.5million and $224.1 million, respectively.

 

In October 2001, weentered into an interest rate swap agreement to hedge our exposure to changesin the fair value of our fixed rate 7.51% Senior Notes due 2028. We designatedthis swap agreement as a fair value hedge. The swap agreement has a notional amount of $210.0 million and maturesin January 2028 to match the principal and maturity of the Senior Notes.  Under the swap agreement, we pay a floatingrate of interest based on a three-month U.S. Dollar LIBOR rate, plus a spread,and receive a fixed rate of interest of 7.51%. During the six months ended June 30, 2005, and 2004, we recognizedreductions in interest expense of $3.3 million and $5.1 million, respectively,related to the difference between the fixed rate and the floating rate ofinterest on the interest rate swap. During the quarter ended June 30, 2005, we measured the hedgeeffectiveness of this interest rate swap and noted that no gain or loss fromineffectiveness was required to be recognized. The fair value of this interest rate swap was a gain of approximately $7.4million and $3.4 million at June 30, 2005, and December 31, 2004,respectively.  Utilizing the balance ofthe 7.51% Senior Notes outstanding at June 30, 2005, and including theeffects of hedging activities, assuming market interest rates increase 100basis points, the potential annual increase in interest expense is $2.7million.

 

As of June 30, 2005,and December 31, 2004, we had intercompany notes payable to our ParentPartnership of $62.5 million and $301.7 million, respectively, whichrepresented borrowings under the Parent Partnership’s Revolving CreditFacility, 7.625% Senior Notes and 6.125% Senior Notes. The weighted averageinterest rate on the note payable to the Parent Partnership at June 30,2005, was 5.5%.  At June 30, 2005,accrued interest includes $3.2 million due to our Parent Partnership.  For the six months ended June 30, 2005and 2004, interest costs incurred on the note payable to our Parent Partnershiptotaled $5.1 million and $6.1 million, respectively.

 

**Item4.  Controls and Procedures**

** **

The principal executiveofficer and principal financial officer of our General Partner, afterevaluating the effectiveness of our disclosure controls and procedures (asdefined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of June 30,2005, have concluded that, as of such date, our disclosure controls andprocedures are adequate and effective to ensure that material informationrelating to us and our consolidated subsidiaries would be made known to them byothers within those entities.

 

28

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*Changesin Internal Control over Financial Reporting*

 

There has been no changein our internal control over financial reporting during the second quarter of2005 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.  As a result, no corrective actions wererequired or undertaken.

 

**PART II.  OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

We have been, in theordinary course of business, a defendant in various lawsuits and a party tovarious other legal proceedings, some of which are covered in whole or in partby insurance.  We believe that theoutcome of these lawsuits and other proceedings will not individually or in theaggregate have a material adverse effect on our consolidated financial position,results of operations or cash flows.  Seediscussion of legal proceedings in Note 9. Commitments and Contingencies in the accompanying consolidated financialstatements.

 

**Item 6. Exhibits**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
|-------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 3.1         |       | Second Amended and Restated  Agreement of Limited Partnership of TE Products Pipeline Company, Limited  Partnership, effective September 21, 2001 (Filed as Exhibit 3.8 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 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).                                                                                                                                                                                                                                                                             |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 4.2         |       | 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).                                                                                                                                               |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 4.3         |       | 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).                                                                                                                                          |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 4.4         |       | Second Supplemental Indenture, dated  as of June 27, 2002, among TEPPCO Partners, L.P., as issuer, TE Products  Pipeline Company, Limited Partnership, TCTM, L.P., TEPPCO Midstream  Companies, L.P., and Jonah Gas Gathering Company, as Initial Subsidiary Guarantors,  and Val Verde Gas Gathering Company, L.P., as New Subsidiary Guarantor, and  Wachovia Bank, National Association, formerly known as First Union National  Bank, as trustee (Filed as Exhibit 4.6 to Form 10-Q of TEPPCO  Partners, L.P. (Commission File No. 1-10403) for the quarter ended June 30,  2002 and incorporated herein by reference). |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
| 4.5         |       | 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                                                                                                                                                                                                                                                                                                                                                                                                     |

 

29

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|   |   | 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   |   | Amendments to the TEPPCO Retirement  Cash Balance Plan and the TEPPCO Supplemental Benefit Plan dated as May 27,  2005 (Filed as Exhibit 10.1 to Form 10-Q of TEPPCO Partners, L.P.  (Commission File No. 1-10403) for the quarter ended June 30, 2005,  and incorporated herein by reference).        |
|   |   |                                                                                                                                                                                                                                                                                                                            |
| 10.2   |   | Agreement and Release between Charles H. Leonard and  Texas Eastern Products Pipeline Company, LLC dated as of July 11, 2005  (Filed as Exhibit 10.2 to Form 10-Q of TEPPCO Partners, L.P.  (Commission File No. 1-10403) for the quarter ended June 30, 2005,  and incorporated herein by reference). |
|   |   |                                                                                                                                                                                                                                                                                                                            |
| 31.1*  |   | Certification of Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                            |
| 31.2*  |   | Certification of Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                            |
| 32.1** |   | Certification of Chief  Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                            |
| 32.2** |   | Certification of Chief  Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                      |

 

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* Filed herewith.

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

+ Amanagement contract or compensation plan or arrangement.

 

 

**SIGNATURES**

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|                       | TE Products Pipeline  Company, Limited Partnership |                                 |
|----------------------------|----------------------------------------------------|--------------------------------------|
|                       | (Registrant)                                       |                                 |
|                       | (A Delaware Limited Partnership)                   |                                 |
|                       |                                               |
|                       |                                               |
|                       | By:                                                | TEPPCO GP, Inc.,                |
|                       |                                               | as General Partner                   |
|                       |                                               |
|                       |                                               |
|                       | By:                                                | /s/   BARRY  R. PEARL |   |
|                       |                                               | Barry R. Pearl,                      |   |
|                       |                                               | President, Chief Executive           |   |
|                       |                                               | Officer and Director                 |   |
|                       |                                               |
|                       |                                               |
|                       | By:                                                | /s/ TRACY E. OHMART                  |   |
|                       |                                               | Tracy E. Ohmart                      |   |
|                       |                                               | Chief Financial Officer              |   |
|                       |                                               |                                 |
|                       |                                               |
| Date: August 2,  2005 |                                               |
|                            |                                                    |                                      |  |  |  |  |  |  |  |

 

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