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FORM 10-Q SECURITIES AND EXCHANGE COMMISSION x For the quarterly period ended June 30, 2003 o For the transition period from _____________to_____________ Kansas 48-0290000 (State or Other Jurisdiction of (I.R.S. Employer 500
Dallas Street, Suite 1000, Houston, Texas 77002 (Address of Principal Executive Offices, Including Zip
Code) (713)
369-9000 (Registrant's Telephone Number, Including Area Code) (Former Name, Former Address and Former Fiscal Year, if
Changed Since Last Report) Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x No o Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes x No o The number of shares outstanding of the registrant's common stock, $5
par value, as of July 31, 2003 was 123,291,645 shares. KINDER MORGAN, INC. AND SUBSIDIARIES Page Consolidated Balance
Sheets 3-4 Consolidated
Statements of Operations 5 Consolidated
Statements of Cash Flows 6 Notes to Consolidated
Financial Statements 7-26 Management's Discussion and Analysis of
Financial Condition and Results
of Operations 27-42 Quantitative and Qualitative
Disclosures About Market Risk 42 Controls and Procedures 42 OTHER INFORMATION Legal Proceedings 43 Changes in Securities and Use of
Proceeds 43 Defaults Upon Senior Securities 43 Submission of Matters to a Vote of
Security Holders 43-44 Other Information 44 Exhibits and Reports on Form 8-K 45 46 2 PART I. - FINANCIAL INFORMATION Item 1. Financial Statements. CONSOLIDATED BALANCE SHEETS (Unaudited) June 30, December 31, 2003 2002 (In
thousands) $ 29,932 $ 35,653 2,047 2,783 58,496 82,258 1,324 48,054 27,248 62,760 50,043 32,033 143,606 157,454 312,696 420,995 2,089,443 2,034,160 969,443 990,878 291,180 285,883 3,350,066 3,310,921 6,548,167 6,544,418 (546,409) (496,311) 6,001,758 6,048,107 298,503 322,727 $ 9,963,023 $10,102,750 =========== =========== The accompanying notes are an integral part of these statements. 3 CONSOLIDATED BALANCE SHEETS (Unaudited) June 30, December 31, 2003 2002 (In thousands
except shares) $ - $ 501,267 221,500 - 32,485 88,227 2,657 50 68,539 80,158 31,483 49,580 34,568 27,355 41,225 50,394 69,505 69,501 501,962 866,532 2,485,964 2,435,780 147,975 210,869 2,633,939 2,646,649 2,842,440 2,852,181 185,623 139,589 3,028,063 2,991,770 275,000 275,000 983,346 967,802 654,263 649,308 1,698,253 1,681,042 654,718 486,062 (410,999) (406,630) (8,214) (10,066) (47,308) (44,719) 2,540,713 2,354,997 $ 9,963,023 $10,102,750 =========== =========== The accompanying notes are an integral part of these statements. 4 CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended June 30, Six Months Ended June 30, 2003 2002 2003 2002 (In thousands
except per share amounts) $ 162,974 $ 143,410 $ 345,827 $ 296,816 70,490 54,291 193,489 175,067 18,401 16,033 31,417 33,252 251,865 213,734 570,733 505,135 79,852 53,310 192,807 154,557 31,549 33,225 61,450 62,305 18,786 17,108 35,194 36,658 29,047 25,994 58,672 51,998 7,383 7,226 14,557 14,391 166,617 136,863 362,680 319,909 85,248 76,871 208,053 185,226 113,732 93,394 225,227 183,485 2,719 4,056 5,202 6,428 (31,314) (39,810) (71,288) (79,358) (15,476) (12,824) (31,397) (25,601) (874) 1,477 122 5,050 68,787 46,293 127,866 90,004 154,035 123,164 335,919 275,230 59,841 50,712 130,655 114,390 $ 94,194 $ 72,452 $ 205,264 $ 160,840 $ 0.77 $ 0.59 $ 1.68 $ 1.31 122,218 122,015 122,048 122,703 $ 0.76 $ 0.59 $ 1.66 $ 1.30 123,474 123,230 123,285 124,026 $ 0.15 $ 0.05 $ 0.30 $ 0.10 The accompanying notes are an integral part of these statements. 5 CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Six Months Ended June 30, 2003 2002 (In
thousands) $ 205,264 $ 160,840 58,672 51,998 56,502 28,916 (225,227) (183,485) 177,316 148,591 (5,202) (6,428) 20,441 14,645 (11,339) 3,921 4,297 (2,567) (2,917) - - (22,050) - (18,772) 66,852 (17,503) (64,330) 27,765 28,147 - (10,832) (4,434) 297,644 181,437 (807) (5,136) 296,837 176,301 (47,827) (77,720) (1,764) - (8,677) (167,085) 2,627 - 6,421 4,941 (49,220) (239,864) 221,500 230,227 (511,083) (636) 24,545 12,314 49,337 (24,727) 2,622 - (928) - (2,478) (139,875) (36,608) (12,302) (245) (216) (253,338) 64,785 (5,721) 1,222 35,653 16,134 $ 29,932 $ 17,356 =========== =========== For supplemental cash flow information, see Note 5. 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Summary of Significant Accounting Policies Stock-Based Compensation SFAS No. 123, Accounting for Stock-Based Compensation,
encourages, but does not require, entities to adopt the fair value method of accounting
for stock-based compensation plans. As allowed under SFAS No. 123, we continue to apply
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees.
Accordingly, compensation expense is not recognized for stock options unless the options
are granted at an exercise price lower than the market price on the grant date. Had
compensation cost for these plans been determined consistent with SFAS No. 123, net income
and diluted earnings per share would have been reduced to the pro forma amounts shown in
the table below. Because the SFAS No. 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years. Additionally, the pro forma
amounts include approximately $253,000 and $290,000 for the three months ended June 30,
2003 and 2002, respectively and $500,000 and $568,000 for the six months ended June 30,
2003 and 2002, respectively, related to the purchase discount offered under the employee
stock purchase plan. Three Months Ended Six Months Ended 2003 2002 2003 2002 $ 94,194 $ 72,452 $ 205,264 $ 160,840 234 223 474 446 (3,875) (3,703) (7,881) (7,896) $ 90,553 $ 68,972 $ 197,857 $ 153,390 ========= ========= ========= ========= $ 0.77 $ 0.59 $ 1.68 $ 1.31 ========= ========= ========= ========= $ 0.74 $ 0.57 $ 1.62 $ 1.25 ========= ========= ========= ========= $ 0.76 $ 0.59 $ 1.66 $ 1.30 ========= ========= ========= ========= $ 0.73 $ 0.56 $ 1.60 $ 1.24 ========= ========= ========= ========= 2. General We are a provider of energy and related services and have operations in
the Rocky Mountain and mid-continent regions of the United States, with principal
operations in Arkansas, Colorado, Illinois, Iowa, Kansas, Nebraska, Oklahoma, Texas and
Wyoming. We have both regulated and nonregulated operations. Our business activities
include: (i) storing, transporting and selling natural gas, (ii) providing retail natural
gas distribution services and (iii) operating and, in previous periods, constructing,
natural gas-fired electric generation facilities. In addition, we own the general partner
interest, as well as significant limited partner interests, in Kinder Morgan Energy
Partners, L.P., a publicly traded pipeline master limited partnership, referred to in
these Notes as "Kinder Morgan Energy Partners," and receive a 7 substantial portion of our earnings from returns on these investments.
Our common stock is traded on the New York Stock Exchange under the symbol
"KMI." We have prepared the accompanying unaudited interim consolidated
financial statements under the rules and regulations of the Securities and Exchange
Commission. Under such rules and regulations, we have condensed or omitted certain
information and notes normally included in financial statements prepared in conformity
with accounting principles generally accepted in the United States of America. We believe,
however, that our disclosures are adequate to make the information presented not
misleading. The consolidated financial statements reflect all adjustments that are, in the
opinion of management, necessary for a fair presentation of our financial results for the
interim periods presented. You should read these interim consolidated financial statements
in conjunction with our consolidated financial statements and related notes included in
our Annual Report on Form 10-K for the year ended December 31, 2002 ("2002 Form
10-K"). Certain prior period amounts have been reclassified to conform to the current
presentation. Unless the context requires otherwise, references to "we,"
"us," "our," or the "Company" are intended to mean Kinder
Morgan, Inc. and its consolidated subsidiaries. 3. Earnings Per Share Basic earnings per common share is computed based on the
weighted-average number of common shares outstanding during each period. In recent
periods, we have repurchased a significant number of our outstanding shares, see Note 13.
Diluted earnings per common share is computed based on the weighted-average number of
common shares outstanding during each period, increased by the assumed exercise or
conversion of securities (stock options are currently the only such securities
outstanding) convertible into common stock, for which the effect of conversion or exercise
using the treasury stock method would be dilutive. Three Months Ended Six Months Ended 2003 2002 2003 2002 (In
thousands) 122,218 122,015 122,048 122,703 1,256 1,215 1,237 1,323 123,474 123,230 123,285 124,026 ======== ======== ======== ======== Weighted-average stock options outstanding totaling 2.4 million and 2.6
million for the three months ended June 30, 2003 and 2002, respectively and 2.5 million
and 2.5 million for the six months ended June 30, 2003 and 2002, respectively, were
excluded from the diluted earnings per common share calculation because the effect of
including them would have been antidilutive. 4. Interest
Expense, Net "Interest Expense, Net" as presented in the accompanying
interim Consolidated Statements of Operations is net of the debt component of the
allowance for funds used during construction, which was $0.1 million and $0.5 million for
the three months ended June 30, 2003 and 2002, respectively and $0.4 million and $0.9
million for the six months ended June 30, 2003 and 2002, respectively. 8 5. Cash Flow
Information We consider all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents. Changes in Other Working Capital Items: Six Months Ended 2003 2002 (In
thousands) $ 25,020 $ 58,351 (506) 6,096 (5,294) (19,659) (44,913) (49,516) (38,637) 32,493 $ (64,330) $ 27,765 ========= ========= Supplemental Disclosures of Cash Flow Information: $ 85,038 $ 79,550 ========= ========= $ 10,956 $ 10,956 ========= ========= $ 62,990 $ 61,474 ========= ========= Distributions received by our Kinder Morgan Management subsidiary from
its investment in i-units of Kinder Morgan Energy Partners are in the form of additional
i-units, while distributions made by Kinder Morgan Management to its shareholders are in
the form of additional Kinder Morgan Management shares, see Note 7. "Other, Net"
as presented in the accompanying interim Consolidated Statements of Cash Flows principally
consists of other non-cash increases and decreases to earnings, including amortization of
deferred revenue, amortization of debt discount and expense and amortization of interest
rate swap proceeds previously received upon termination of the swap. For the six months
ended June 30, 2003, this line item also includes approximately $4.1 million attributable
to a reduction in interest expense associated with the final settlement of a regulatory
matter at Natural Gas Pipeline Company of America. 9 6. Comprehensive
Income Our comprehensive income for the three months and six months ended June
30, 2003 and 2002 is as follows: Three Months Ended June 30, Six Months Ended June 30, 2003 2002 2003 2002 (In
thousands) $ 94,194 $ 72,452 $ 205,264 $ 160,840 (9,430) (2,144) (30,534) (12,627) 11,274 (3,051) 30,005 2,181 (4,362) (718) (5,750) (19,963) 2,111 303 3,690 8,311 (407) (5,610) (2,589) (22,098) $ 93,787 $ 66,842 $ 202,675 $ 138,742 ========= ========= ========= ========= The Accumulated Other Comprehensive Loss of $47.3 million at June 30,
2003 consisted of (i) $17.7 million associated with recognition of a minimum pension
liability, (ii) $8.1 million representing our pro rata share of the accumulated other
comprehensive loss of Kinder Morgan Energy Partners and (iii) $21.5 million representing
unrecognized net losses on derivative activities. 7. Kinder Morgan Management, LLC On May 15, 2003, Kinder Morgan Management paid a share distribution of
859,933 of its shares to shareholders of record as of April 30, 2003, based on the $0.64
per common unit distribution declared by Kinder Morgan Energy Partners. On August 14,
2003, Kinder Morgan Management will pay a share distribution of 811,878 of its shares to
shareholders of record as of July 31, 2003, based on the $0.65 per common unit
distribution declared by Kinder Morgan Energy Partners for the second quarter of 2003.
These distributions are paid in the form of additional shares or fractions thereof
calculated by dividing the Kinder Morgan Energy Partners' cash distribution per common
unit by the average market price of a Kinder Morgan Management share determined for a
ten-trading day period ending on the trading day immediately prior to the ex-dividend date
for the shares. Kinder Morgan Management has paid share distributions totaling 1,718,914
shares in the six months ended June 30, 2003. 8. Investments In June 2003, Kinder Morgan Energy Partners issued 4.6 million common
units in a public offering at a price of $39.35 per common unit, receiving total net
proceeds (after underwriting discount) of $173.3 million. We did not acquire any of these
common units. This transaction reduced our percentage ownership of Kinder Morgan Energy
Partners from approximately 19.28% to approximately 18.86% and had the associated effects
of increasing our investment in the net assets of Kinder Morgan Energy Partners by $14.9
million and reducing (i) our equity method goodwill in Kinder Morgan Energy Partners by
$21.4 million, (ii) associated accumulated deferred income taxes by $2.5 million and (iii)
paid-in capital by $4.0 million. In addition, in June 2003, in order to maintain our one
percent general partner interest in Kinder Morgan Energy Partners' operating partnerships
we made a contribution of approximately $1.8 million. 10 On June 30, 2003, we received $3.8 million from the sale of our
interest in Igasamex USA Ltd. We recorded a pre-tax loss of $4.3 million ($2.7 million
after tax) in conjunction with the sale. On March 6, 2000, we received a promissory note from Orcom Solutions,
Inc. as partial consideration for the sale of our enable joint venture, which
note was carried at nominal value due to concerns as to recoverability. On June 30, 2003,
we received $5.2 million in settlement of this note of which $2.6 million was paid to
PacifiCorp reflecting its 50% interest in enable. In conjunction with this
settlement, we recorded a pre-tax gain of $2.9 million ($1.8 million after tax). 9. Summarized
Income Statement Information for Kinder Morgan Energy Partners, L.P. Following is summarized income statement information for Kinder Morgan
Energy Partners, a publicly traded master limited partnership in which we own the general
partner interest. In addition, we own limited partner interests in the form of Kinder
Morgan Energy Partners common units, i-units (indirectly through Kinder Morgan Management)
and Class B limited partner units. This investment, which is accounted for under the
equity method of accounting, is described in more detail in our 2002 Form 10-K. Additional
information on Kinder Morgan Energy Partners' results of operations and financial position
are contained in its Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 and
in its Annual Report on Form 10-K for the year ended December 31, 2002. Three Months Ended June 30, Six Months Ended June 30, 2003 2002 2003 2002 (In
thousands) $ 1,664,447 $ 1,090,936 $ 3,453,285 $ 1,894,001 1,464,885 918,589 3,058,571 1,555,798 $ 199,562 $ 172,347 $ 394,714 $ 338,203 =========== =========== =========== =========== $ 168,957 $ 144,517 $ 339,435 $ 285,950 =========== =========== =========== =========== 10. Discontinued
Operations During 1999, we adopted and implemented a plan to discontinue a number
of lines of business. During 2000, we essentially completed the disposition of these
discontinued operations. The cash flows attributable to discontinued operations included
in the accompanying interim Statements of Consolidated Cash Flows under the caption
"Net Cash Flows Used in Discontinued Operations" result from cash activity
attributable to retained liabilities associated with these discontinued operations. Note 8
of Notes to Consolidated Financial Statements included in our 2002 Form 10-K contains
additional information on these matters. 11. Financing We have available a $445 million 364-day credit facility dated October
15, 2002, and a $355 million three-year revolving credit agreement dated October 15, 2002.
These bank facilities can be used for general corporate purposes, including backup for our
commercial paper program and, as discussed in our 2002 Form 10-K, include covenants that
are common in such arrangements. Under these bank facilities, we are required to pay a
facility fee based on the total commitment, whether used or unused, at a rate that varies
based on our senior debt rating. We had no borrowings under our bank facilities at June
30, 2003. 11 The commercial paper we issue, which is supported by the credit
facilities described above, is comprised of unsecured short-term notes with maturities not
to exceed 270 days from the date of issue. Commercial paper outstanding at June 30, 2003
was $221.5 million. Our weighted-average interest rate on short-term borrowings
outstanding at June 30, 2003 was 1.31 percent. Average short-term borrowings outstanding
during the second quarter of 2003 were $269.1 million and the weighted-average interest
rate was 1.41 percent. Average short-term borrowings outstanding during the first six
months of 2003 were $192.3 million and the weighted-average interest rate was 1.45
percent. On March 3, 2003, our $500 million 6.45% Senior Notes matured and we
paid the holders of the notes. On July 16, 2003, our Board of Directors approved a cash dividend of
$0.40 per common share payable on August 14, 2003 to shareholders of record as of July 31,
2003. 12. Change in
Compensation Policies On July 16, 2003, we announced a change to our compensation policies.
Chairman and Chief Executive Officer Richard D. Kinder will continue to receive $1 per
year in salary with no bonuses, stock options, grants of restricted stock or other
compensation. The ten most senior executives (excluding Mr. Kinder) will continue to have
their base salaries capped at $200,000 per year and will continue to be eligible for
annual bonuses when we and Kinder Morgan Energy Partners meet annual earnings per share
and distributions per unit targets. In addition, these senior executives will no longer be
eligible for future stock option grants and have received grants of restricted stock which
will vest 25 percent after three years and the remaining 75 percent after five years. We
expect that executives will receive no further equity compensation during the five-year
life of these restrictions. In total, 575,000 restricted shares of our common stock have
been issued under a shareholder approved plan. As a result, we and Kinder Morgan Energy
Partners will each expense approximately $3.5 million annually related to the grants of
restricted stock. Other than restricted stock, executives will continue to have only those
benefits which are available to all other employees. All other employees will be eligible
for annual grants of stock options which will vest after three years. On July 16, 2003, we
issued 656,450 options to purchase our common shares for $53.80 (the closing price of our
common shares on that date) to eligible employees. We expect to issue to employees fewer
than 700,000 options to purchase our common shares annually. The reader is directed to Part II, Item 5 for further information
regarding the retention agreement of C. Park Shaper. We and Kinder Morgan Energy Partners have, collectively, agreed to
guarantee potential borrowings under lines of credit available from Wachovia Bank,
National Association, formerly known as First Union National Bank, to Messrs. Thomas
Bannigan, C. Park Shaper and James Street and Ms. Deborah Macdonald. Each of these
officers is primarily liable for any borrowing on his or her line of credit, and if we or
Kinder Morgan Energy Partners makes any payment with respect to an outstanding loan, the
officer on behalf of whom payment is made must surrender a percentage of his or her
options to purchase our common stock. Our and Kinder Morgan Energy Partners' current
obligations under the guaranties generally do not exceed $1.0 million in respect of any
such officer individually and such obligations, in the aggregate, do not exceed $1.9
million. To date, we and Kinder Morgan Energy Partners have made no payment with respect
to these lines of credit. Further, we and Kinder Morgan Energy Partners' involvement in
these lines of credit will expire in October 2003. 12 13. Common Stock
Repurchase Plan On August 14, 2001, we announced a program to repurchase up to $300
million of our outstanding common stock, which program was increased to $400 million and
$450 million at February 5, 2002 and July 17, 2002, respectively. As of June 30, 2003, we
had repurchased a total of approximately $417.2 million (8,361,800 shares) of our
outstanding common stock under the program, of which $1.1 million (22,500 shares) and $2.5
million (53,600 shares) were repurchased in the three months and six months ended June 30,
2003, respectively. 14. Business Segments In accordance with the manner in which we manage our businesses,
including the allocation of capital and evaluation of business segment performance, we
report our operations in the following segments: (1) Natural Gas Pipeline Company of
America and certain affiliates, referred to as Natural Gas Pipeline Company of America, a
major interstate natural gas pipeline and storage system; (2) TransColorado Gas
Transmission Company, referred to as TransColorado Pipeline, an interstate natural gas
pipeline located in western Colorado and northwest New Mexico; (3) Kinder Morgan Retail,
the regulated sale and transportation of natural gas to residential, commercial and
industrial customers (including a small distribution system in Hermosillo, Mexico) and the
non-regulated sales of natural gas to certain utility customers under the Choice Gas
Program and (4) Power, the operation and, in previous periods, construction of natural
gas-fired electric generation facilities. The accounting policies we apply in the generation of business segment
information are generally the same as those described in Note 1 of Notes to Consolidated
Financial Statements included in our 2002 Form 10-K, except that (i) certain items below
the "Operating Income" line are either not allocated to business segments or are
not considered by management in its evaluation of business segment performance and (ii)
equity in earnings of equity method investees, other than Kinder Morgan Energy Partners
and certain insignificant international investees, are included in segment results. These
equity method earnings are included in "Other Income and (Expenses)" in the
accompanying interim Consolidated Statements of Operations. In addition, (i) certain items
included in operating income (such as general and administrative expenses) are not
allocated to individual business segments and (ii) gains and losses from incidental sales
of assets are included in segment earnings. With adjustment for these items, we currently
evaluate business segment performance primarily based on operating income in relation to
the level of capital employed. We account for intersegment sales at market prices, while
we account for asset transfers at either market value or, in some instances, book value. 13 BUSINESS SEGMENT INFORMATION Three Months Ended June 30, 2003 June 30, 2003 Segment Earnings Revenues From Depreciation Segment (In
thousands) $ 84,3353 $ 188,188 $ 23,150 $ 22,133 $5,536,043 5,297 7,615 1,035 172 239,569 6,331 43,323 4,003 5,858 383,006 10,778 12,739 859 184 353,129 106,741 $ 251,865 $ 29,047 $ 28,347 6,511,747 ========== ========== ========== 113,732 2,089,443 (18,786) 969,443 (47,652)3 392,390 $ 154,035 $9,963,023 ========== ========== Three Months Ended June 30, 2002 Segment Earnings Revenues From Depreciation (In
thousands) $ 83,984 $ 157,531 $ 21,637 $ 31,818 2,091 - - - 6,097 46,542 3,583 9,924 5,924 9,661 774 93 98,096 $ 213,734 $ 25,994 $ 41,835 ========== ========== ========== 93,394 (17,108) (51,218) $ 123,164 ========== There were no intersegment
revenues during the periods presented. Includes market value of
derivative instruments (including interest rate swaps) and miscellaneous corporate assets
(such as information technology and telecommunications equipment) not allocated to
individual segments. Natural Gas Pipeline
Company of America's segment results for the three months ended June 30, 2003 do not
include a reduction of $4.1 million in interest expense attributable to the final
settlement of a regulatory matter, which amount is included in "Other Income and
(Expenses)." 14 Six Months Ended June 30, 2003 Segment Earnings Revenues From Depreciation (In
thousands) $ 184,4112 $ 402,256 $ 45,455 $ 36,941 12,557 17,114 2,101 581 37,790 132,312 7,927 7,444 13,698 19,051 3,189 2,861 248,456 $ 570,733 $ 58,672 $ 47,827 ========== ========== ========== 225,227 (35,194) (102,570)2 $ 335,919 ========== Six Months Ended June 30, 2002 Segment Earnings Revenues From Depreciation (In
thousands) $ 179,602 $ 340,620 $ 43,401 $ 49,852 2,184 - - - 30,955 144,169 7,053 10,769 15,664 20,346 1,544 17,099 228,405 $ 505,135 $ 51,998 $ 77,720 ========== ========== ========== 183,485 (36,658) (100,002) $ 275,230 ========== There were no intersegment
revenues during the periods presented. Natural Gas Pipeline
Company of America's segment results for the six months ended June 30, 2003 do not include
a reduction of $4.1 million in interest expense attributable to the final settlement of a
regulatory matter, which amount is included in "Other Income and (Expenses)." GEOGRAPHIC INFORMATION All but an insignificant amount of our assets and operations are
located in the continental United States of America. 15 15. Accounting for Asset
Retirement Obligations We adopted Statement of Financial Accounting Standards
("SFAS") No. 143, Accounting for Asset Retirement Obligations, effective
January 1, 2003. This statement changed the financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated retirement costs. The statement requires that the fair value of a liability for
an asset retirement obligation be recognized in the period in which it is incurred if a
reasonable estimate of fair value can be made. The impact of the adoption of this
statement on us is discussed below by segment. In general, Natural Gas Pipeline Company of America's system is
composed of underground piping, compressor stations and associated facilities, natural gas
storage facilities and certain other facilities and equipment. Except as discussed
following, we have no plans to abandon any of these facilities, the majority of which have
been providing utility service for many years, making it impossible to determine the
timing of any potential retirement expenditures. Notwithstanding our current intentions,
in general, if we were to cease utility operations in total or in any particular area, we
would be permitted to abandon the underground piping in place, but would have to remove
our surface facilities from land belonging to our customers or others. We would generally
have no obligations for removal or remediation with respect to equipment and facilities,
such as compressor stations, located on land we own. Natural Gas Pipeline Company of America has various condensate drips
tanks located throughout the system, storage wells located within the storage fields,
laterals no longer integral to the overall mainline transmission system, compressor
stations which are no longer active, and other miscellaneous facilities, all of which have
been officially abandoned. For these facilities, it is possible to reasonably estimate the
timing of the payment of obligations associated with their retirement. The recognition of
these obligations has resulted in a liability and associated asset of approximately $2.8
million as of January 1, 2003, representing the present value of those future obligations
for which we are able to make reasonable estimations of the current fair value due to, as
discussed above, our ability to estimate the timing of the incurrence of the expenditures.
The remainder of Natural Gas Pipeline Company of America's asset retirement obligations
have not been recorded due to our inability, as discussed above, to reasonably estimate
when they will be settled in cash. We will record liabilities for these obligations when
we are able to reasonably estimate their fair value. In general, our retail natural gas distribution system is composed of
town border stations, regulator stations, underground piping and delivery meters. In
addition, we have (i) certain other associated surface equipment, (ii) gas storage
facilities in Colorado and Wyoming and (iii) one producing gas field in Colorado. Except
as discussed following, we have no plans to abandon any of these facilities, the majority
of which have been providing utility service for many years, making it impossible to
determine the timing of any potential retirement expenditures. Notwithstanding our current
intentions, if we were to cease utility operations in any particular area, we would be
permitted to abandon the underground piping in place, but would have to remove our surface
facilities at customer delivery points. We would be under no obligation to remove town
border stations, odorization or other miscellaneous facilities located on our property. In our Kinder Morgan Retail storage field operations we would, upon
abandonment, be required to plug and abandon the wells and to remove our surface wellhead
equipment and compressors. We currently have two small sites in Wyoming that are no longer
being used as active storage facilities and estimate that, in 2013, we will incur
approximately $200,000 in costs to fulfill these retirement obligations. We have no plans
to cease using any of our other storage facilities as they are expected to, for the
foreseeable future, provide critical deliverability to our customers in severe cold
weather situations. With respect to our small natural gas production field in Colorado, we
will be required, upon cessation 16 of commercial operations, to plug and abandon the natural gas wells,
remove surface equipment and remediate the well sites. We have estimated that this process
will start in 2005 and continue through 2013 for a total cost of $240,000, with
approximately half the total being spent in the final two years. The recognition of these
obligations has resulted in a liability and associated asset of approximately $0.3 million
as of January 1, 2003, representing the present value of those future obligations for
which we are able to make reasonable estimations of the current fair value due to, as
discussed above, our ability to estimate the timing of the incurrence of the expenditures.
The remainder of our asset retirement obligations have not been recorded due to our
inability to reasonably estimate when they will be settled in cash. We will record
liabilities for these obligations when we are able to reasonably estimate their fair
value. The facilities utilized in our power generation activities fall into
two general categories: those that we own and those that we do not own. With respect to
those facilities that we do not own but either operate or maintain a preferred interest
in, principally the Jackson, Michigan and Wrightsville, Arkansas power plants, we have no
obligation for any asset retirement obligation that may exist or arise. With respect to
the Colorado power generation assets that we do own, we have no asset retirement
obligation with respect to those facilities located on land that we also own, and no
direct responsibility for assets in which we own an interest accounted for under the
equity method of accounting. Thus, our power generation activities do not give rise to any
asset retirement obligations. We have not presented prior period information on a pro forma basis to
reflect the implementation of SFAS No. 143 because the impact in total and on each
individual period is immaterial. 16. Accounting for
Derivative Instruments and Hedging Activities Our normal business activities expose us to risks associated with
changes in the market price of natural gas and associated transportation. We engage in
derivative transactions for the purpose of mitigating these risks, which transactions are
accounted for in accordance with SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities and associated amendments. During the three and six month
periods ended June 30, 2003 and 2002, our derivative activities relating to the mitigation
of these risks were designated and qualified as cash flow hedges, and the impact of hedge
ineffectiveness, while included in our net income, was immaterial. As the hedged sales and
purchases take place and we record them into earnings, we also reclassify the gains and
losses included in accumulated other comprehensive income into earnings. We expect to
reclassify into earnings, during the next twelve months, substantially all of our
accumulated other comprehensive loss balance related to these derivatives of $21.5
million, representing unrecognized net losses on derivative activities at June 30, 2003.
During the three months and six months ended June 30, 2003 and 2002, we reclassified no
gains or losses into earnings as a result of the discontinuance of cash flow hedges due to
a determination that the forecasted transactions would no longer occur by the end of the
originally specified time period. In addition, at June 30, 2003, our accumulated other
comprehensive loss included $8.1 million representing our pro rata share of the
accumulated other comprehensive loss of Kinder Morgan Energy Partners. We have outstanding fixed-to-floating interest rate swap agreements
with a notional principal amount of $1.25 billion at June 30, 2003. These agreements
effectively convert the interest expense associated with our 7.25% Debentures due in 2028
and our 6.50% Senior Notes due in 2012 from fixed rates to floating rates based on the
three-month London Interbank Offered Rate ("LIBOR") plus a credit spread. These
swaps have been designated as fair value hedges and we have accounted for them utilizing
the "shortcut" method prescribed for qualifying fair value hedges under SFAS No.
133. Accordingly, the carrying value of the swap is adjusted to its fair value as of the
end of each reporting period, and an offsetting entry is made to adjust the carrying value
of the debt securities whose fair value is being 17 hedged. The carrying value of the swaps at June 30, 2003 was $162.2
million (included in the caption "Deferred Charges and Other Assets" in the
accompanying interim Consolidated Balance Sheet as of June 30, 2003). We record interest
expense equal to the floating rate payments, which is accrued monthly and paid
semi-annually. On March 3, 2003, we terminated the interest rate swap agreements
associated with our 6.65% Senior Notes due in 2005 and received $28.1 million. We are
amortizing this amount (reducing interest expense) over the remaining period the 6.65%
Senior Notes are outstanding. The unamortized balance of $23.5 million at June 30, 2003 is
included in the caption "Value of Interest Rate Swaps" under the heading
"Long-term Debt" in the accompanying interim Consolidated Balance Sheet. 17. Regulatory Matters On July 17, 2000, Natural Gas Pipeline Company of America filed its
compliance plan, including pro forma tariff sheets, pursuant to the Federal Energy
Regulatory Commission's ("FERC") Order Nos. 637 and 637-A. The FERC directed all
interstate pipelines to file pro forma tariff sheets to comply with new regulatory
requirements in the Orders regarding scheduling procedures, capacity segmentation,
imbalance management services and penalty credits, or in the alternative, to explain why
no changes to existing tariff provisions are necessary. On November 21, 2002, the FERC
issued an order approving much of Natural Gas Pipeline Company of America's Order 637
filing, but requiring additional changes. The primary changes related to Natural Gas
Pipeline Company of America's segmentation proposal, the ability of shippers to designate
additional primary points on a segmented release, a shipper's rights to request discounts
at alternate points and Natural Gas Pipeline Company of America's unauthorized overrun
charges. Natural Gas Pipeline Company of America made its compliance filing on December
23, 2002 and filed for rehearing. Other parties have objected to certain aspects of
Natural Gas Pipeline Company of America's compliance filing. On May 14, 2003, the FERC
issued an order accepting most of Natural Gas Pipeline Company of America's compliance
filing, but requiring additional changes, particularly regarding the designation of
additional primary points for a segmented release. This order also established an
effective date for Natural Gas Pipeline Company of America's Order 637 provisions of
December 1, 2003. Natural Gas Pipeline Company of America made its further compliance
filing on June 13, 2003. Limited protests have been filed. That compliance filing is
pending FERC action and the resulting tariff sheets are expected to be effective on
December 1, 2003. The FERC, in a Notice of Proposed Rulemaking in RM02-14-000, has
proposed new regulation of cash management practices, including establishing limits on the
amount of funds that can be swept from a regulated subsidiary to a non-regulated parent
company. Natural Gas Pipeline Company of America filed comments on August 28, 2002. On
June 26, 2003, the FERC issued an interim rule to be effective in August 2003, under which
regulated companies are required to document cash management arrangements and
transactions. The FERC eliminated the proposal that, as a prerequisite to participation in
cash management programs, regulated companies must maintain a 30 percent equity balance
and investment grade credit rating. The FERC seeks additional comment on whether it should
require filing of cash management agreements and notification if a regulated company's
proprietary capital ratio falls below 30 percent. On July 25, 2003, the FERC issued a Modification to Policy Statement
stating that FERC regulated natural gas pipelines will, on a prospective basis, no longer
be permitted to use gas basis differentials to price negotiated rate transactions.
Effectively, we will no longer be permitted to use commodity price indices to structure
transactions on our FERC regulated natural gas pipelines. Negotiated rates based on
commodity price indices in existing contracts will be permitted to remain in effect until
the end of the contract period for which such rates were negotiated. Price indexed
contracts currently constitute an 18 insignificant portion of our negotiated contracts on our FERC regulated
natural gas pipelines; consequently, we do not believe that this Modification to Policy
Statement will have a material impact on our operations, financial results or cash flows. As a part of the settlement of litigation styled, Jack J. Grynberg,
individually and as general partner for the Greater Green River Basin Drilling Program:
72-73 v. Rocky Mountain Natural Gas Company and K N Energy, Inc., Case No. 90-CV-3686,
in early 2002, Mr. Grynberg received $16.825 million from us (including forgiveness of a
$10.4 million obligation owing from Mr. Grynberg) and an additional $15.625 million was
paid into escrow. Rocky Mountain Natural Gas Company agreed to seek to recover these
amounts from its customers/rate payers in a proceeding before the Public Utilities
Commission for the State of Colorado (the "CPUC"). Rocky Mountain Natural Gas
Company and Kinder Morgan, Inc. made regulatory filings with the CPUC on September 30,
2002, proposing recovery of these amounts as part of their annual Gas Cost Adjustment
filing process. We proposed to collect these litigated gas costs, including associated
carrying charges, over a 15-year amortization period. On October 30, 2002, the CPUC
decided, in open meeting, to allow us to place rates in effect and begin recovery of these
costs effective November 1, 2002, subject to refund pending a final determination as to
our ability to recover these costs in our rates. Mr. Grynberg will receive the money in
escrow only to the extent rates allowing us to collect this gas cost are finally approved.
An uncontested Stipulation and Settlement Agreement was filed with the CPUC on June 20,
2003, providing for full rate recovery by Rocky Mountain Natural Gas Company and Kinder
Morgan, Inc. of $30,173,472 of gas cost payments to Mr. Grynberg. It also provided for
$14,451,528 of allowable interest recovery to Rocky Mountain Natural Gas Company and
Kinder Morgan, Inc. The total settlement amount of $44,625,000 will be recovered through a
special rate rider over a fifteen year period which commenced on November 1, 2002. A
hearing was held before the presiding administrative law judge on July 14, 2003, to
determine whether the Stipulation and Settlement Agreement should be approved. At the
conclusion of the hearing, the judge stated from the bench that she would issue a written
decision recommending approval of the Stipulation and Settlement Agreement. Issuance of
the written decision is pending. If no exceptions are filed and no stay or extension is
issued by the CPUC within twenty days after issuance of the recommended decision, it will
become the decision of the CPUC by operation of law. The Wyoming Choice Gas program, under which our customers are permitted
to select their own supplier of natural gas, was reviewed by the Wyoming Public Service
Commission to determine whether the existing program should continue and whether any
program modifications should be made. A hearing was conducted in February 2003 and a
decision was issued on March 11, 2003, authorizing the Choice Gas program to continue with
several modifications. The traditional regulated pass-on rate must continue to be offered
with the Choice Gas program. Customers who do not return a Choice Gas selection form will
be assigned to the pass-on tariff rate. The $1 per month Choice Gas customer charge will
not be applied to pass-on tariff customers. Currently, there are no material proceedings challenging the base rates
on any of our pipeline systems. Nonetheless, shippers on our pipelines do have rights to
challenge the rates we charge under certain circumstances prescribed by applicable
statutes and regulations. There can be no assurance that we will not face challenges to
the rates we receive for services on our pipeline systems in the future. In addition,
since many of our assets are subject to regulation, we are subject to potential future
changes in applicable rules and regulations that may have an adverse effect on our
business, cash flows, financial position or results of operations. See Note 9 of Notes to Consolidated Financial Statements included in
our 2002 Form 10-K for additional information regarding regulatory matters. 19 18. Environmental and
Legal Matters (A) Environmental Matters We are subject to a variety of federal, state and local laws that
regulate permitted activities relating to air and water quality, waste disposal, and other
environmental matters. Additionally, we have established reserves to address known
environmental remediation sites. After consideration of reserves established, we believe
that costs for environmental remediation and ongoing compliance with these regulations
will not have a material adverse effect on our cash flows, financial position or results
of operations or diminish our ability to operate our businesses. However, there can be no
assurances that future events, such as changes in existing laws, the promulgation of new
laws, or the development of new facts or conditions will not cause us to incur significant
costs. See Note 10(A) of Notes to Consolidated Financial Statements included
in our 2002 Form 10-K for additional information regarding environmental matters. (B) Litigation Matters United States of America, ex rel., Jack J. Grynberg v. K N Energy, Civil
Action No. 97-D-1233, filed in the U.S. District Court, District of Colorado. This action
was filed on June 9, 1997 pursuant to the federal False Claims Act and involves
allegations of mismeasurement of natural gas produced from federal and Indian lands. The
Department of Justice has decided not to intervene in support of the action. The complaint
is part of a larger series of similar complaints filed by Mr. Grynberg against 77 natural
gas pipelines (approximately 330 other defendants). An earlier single action making
substantially similar allegations against the pipeline industry was dismissed by Judge
Hogan of the U.S. District Court for the District of Columbia on grounds of improper
joinder and lack of jurisdiction. As a result, Mr. Grynberg filed individual complaints in
various courts throughout the country. In 1999, these cases were consolidated by the
Judicial Panel for Multidistrict Litigation, and transferred to the District of Wyoming.
The MDL case is called In Re Natural Gas Royalties Qui Tam Litigation, Docket No.
1293. Motions to dismiss were filed and an oral argument on the motion to dismiss occurred
on March 17, 2000. On July 20, 2000, the United States of America filed a motion to
dismiss those claims by Grynberg that deal with the manner in which defendants valued gas
produced from federal leases (referred to as valuation claims). Judge Downes denied the
defendant's motion to dismiss on May 18, 2001. The United States' motion to dismiss most
of the plaintiff's valuation claims has been granted by the Court. Mr. Grynberg has
appealed that dismissal to the 10th Circuit, which has requested briefing
regarding its jurisdiction over that appeal. Discovery is now underway to determine issues
related to the Court's subject matter jurisdiction, arising out of the False Claims Act.
On May 7, 2003, Grynberg sought leave to file a Third Amended Complaint, which adds
allegations of undermeasurement related to CO2 production. Defendants have
filed briefs opposing leave to amend. Will Price, et al. v. Gas Pipelines, et al., (f/k/a Quinque
Operating Company et al. v. Gas Pipelines, et al.), Stevens County, Kansas District
Court, Case No. 99 C 30. In May 1999, three plaintiffs, Quinque Operating Company, Tom
Boles and Robert Ditto, filed a purported nationwide class action in the Stevens County,
Kansas District Court against some 250 natural gas pipelines and many of their affiliates.
The petition (recently amended) alleges a conspiracy to underpay royalties, taxes and
producer payments by the defendants' undermeasurement of the volume and heating content of
natural gas produced from nonfederal lands for more than 25 years. The named plaintiffs
purport to adequately represent the interests of unnamed plaintiffs in this action who are
comprised of the nation's gas producers, state taxing agencies and royalty, working and
overriding interest owners. The plaintiffs seek compensatory damages, along with statutory
penalties, treble damages, interest, costs and fees from the 20 defendants, jointly and severally. This action was originally filed
on May 28, 1999 in Kansas State Court in Stevens County, Kansas as a class action against
approximately 245 pipeline companies and their affiliates, including certain Kinder Morgan
entities. Subsequently, one of the defendants removed the action to Kansas Federal
District Court and the case was styled as Quinque Operating Company, et al. v. Gas
Pipelines, et al., Case No. 99-1390-CM, United States District Court for the District
of Kansas. Thereafter, we filed a motion with the Judicial Panel for Multidistrict
Litigation to consolidate this action for pretrial purposes with the Grynberg False Claims
Act cases, because of common factual questions. On April 10, 2000, the MDL Panel ordered
that this case be consolidated with the Grynberg False Claims Act cases. On January 12,
2001, the Federal District Court of Wyoming issued an oral ruling remanding the case back
to the State Court in Stevens County, Kansas. The defendants filed a motion to dismiss on
grounds other than personal jurisdiction, which was denied by the Court in August 2002.
The motion to dismiss for lack of personal jurisdiction of the nonresident defendants has
been briefed and is awaiting decision. Merits discovery has been stayed. The current named
plaintiffs are Will Price, Tom Boles, Cooper Clark Foundation and Stixon Petroleum, Inc.
Quinque Operating Company has been dropped from the action as a named plaintiff. On April
10, 2003, the Court issued its decision denying plaintiffs' motion for class
certification. The plaintiffs moved the Court for permission to amend the complaint. On
July 8, 2003, a hearing was held on the motion to amend. On July 28, 2003, the Court
granted leave to amend the complaint. The amended complaint does not list us or any of our
affiliates as defendants. Additionally, a new complaint was filed but that complaint does
not list us or any of our affiliates as defendants. We will continue to monitor these
matters. K N Energy, Inc., et al. v. James P. Rode and Patrick R. McDonald,
Case No. 99CV1239, filed in the District Court, Jefferson County, Division 8, Colorado.
The case was filed on May 21, 1999. Defendants counterclaimed and filed third party claims
against several of our former officers and/or directors. Messrs. Rode and McDonald are
former principal shareholders of Interenergy Corporation. We acquired Interenergy on
December 19, 1997 pursuant to a merger agreement dated August 25, 1997. Rode and McDonald
allege that K N Energy committed securities fraud, common law fraud and negligent
misrepresentation as well as breach of contract. Rode and McDonald are seeking an
unspecified amount of compensatory damages, greater than $2 million, plus unspecified
exemplary or punitive damages, attorney's fees and their costs. We filed a motion to
dismiss, and on April 21, 2000, the Jefferson County District Court Judge dismissed the
case against the individuals and us with prejudice. On April 6, 2001, the Colorado Court
of Appeals affirmed the dismissal. Rode and McDonald also filed a federal securities fraud
action in the United States District Court for the District of Colorado on January 27,
2000 titled James P. Rode and Patrick R. McDonald v. K N Energy, Inc., et al.,
Civil Action No. 00-N-190. This case initially raised the identical state law claims
contained in the counterclaim and third party complaint in state court. Rode and McDonald
filed an amended complaint, which dropped the state-law claims. On June 20, 2000, the
federal district court dismissed this complaint with prejudice. The district court's
dismissal was subsequently affirmed by the Tenth Circuit Court of Appeals on April 23,
2002. A third related class action case styled, Adams vs. Kinder Morgan, Inc., et al.,
Civil Action No. 00-M-516, in the United States District Court for the District of
Colorado was served on us on April 10, 2000. As of this date no class has been certified.
On February 23, 2001, the federal district court dismissed several claims raised by the
plaintiff, with prejudice, and dismissed the remaining claims, without prejudice. On April
27, 2001, the Adams plaintiffs filed their second amended complaint. On March 29, 2002,
the court dismissed the Adams plaintiffs' second amended complaint with prejudice. On May
2, 2002, the Adams plaintiffs appealed the dismissal. Briefing at the Tenth Circuit Court
of Appeals is complete and oral argument on the appeal was heard on January 13, 2003. Darrell Sargent d/b/a Double D Production v. Parker & Parsley Gas
Processing Co., American Processing, L.P. and Cesell B. Cheatham, et al., Cause No.
878, filed in the 100th Judicial District Court, Carson County, Texas. The plaintiff filed
a purported class action suit in 1999 and amended its 21 petition in late 2002 to assert claims on behalf of over 1,000
producers who process gas through as many as ten gas processing plants formerly owned by
American Processing, L.P. ("American Processing"), a former wholly owned
subsidiary of Kinder Morgan, Inc. in Carson and Gray counties and other surrounding Texas
counties. The plaintiff claims that American Processing (and subsequently, ONEOK, Inc.
("ONEOK"), which purchased American Processing from us in 2000) improperly
allocated liquids and gas proceeds to the producers. In particular, among other claims,
the plaintiff challenges the accuracy of a computer model used at the plants to allocate
liquids and gas proceeds among the producers and processors. The petition asserts claims
for breach of contract and Natural Resources Code violations relating to the period from
1994 to the present. To date, the plaintiff has not made a specific monetary demand nor
produced a specific calculation of alleged damages. The plaintiff has alleged generally in
the petition that damages are "not to exceed $200 million" plus attorney's fees,
costs and interest. The defendants have filed a counterclaim for overpayments made to
producers. Pioneer Natural Resources USA, Inc., formerly known as Parker &
Parsley Gas Processing Company ("Parker & Parsley"), is a co-defendant.
Parker & Parsley has claimed indemnity from American Processing based on its sale of
assets to American Processing on October 4, 1995. We have accepted indemnity and defense
subject to a reservation of rights pending resolution of the suit. The plaintiff has also
named ONEOK as a defendant. We and ONEOK are defending the case pursuant to an agreement
whereby ONEOK is responsible for any damages that may be attributable to the period
following ONEOK's acquisition of American Processing from us in 2000. The purported class has not been certified. The plaintiff filed a
motion for pre-trial conference on class certification issues and sought to establish a
schedule for class discovery. The defendants filed a motion to deny class certification
because of the plaintiff's delay in proceeding with the class action. On March 11, 2003,
the Court ordered that the defendants' motion to deny class certification was premature.
The Court allowed class discovery to proceed. The defendants expect to assert additional
objections to class certification. Manna Petroleum Services, L.P., et al. v. American Processing, L.P. and
Cesell B. Cheatham, et al., Cause No. 31,485, filed in the 223rd Judicial District
Court of Gray County, Texas. The plaintiff filed suit in late 1999 and alleges that
American Processing (and subsequently ONEOK) improperly allocated liquids and gas
proceeds. This suit, which was filed by the same attorney who represents the purported
class in the Sargent case discussed above, involves similar allegations as those
presented in Sargent except this suit is not styled as a class action. See the
discussion of Sargent above for further details. The defendants have filed a
counterclaim for overpayments to the plaintiff. The parties are presently engaged in fact
discovery, with expert discovery and trial presently scheduled to occur in 2003. Energas Company, a Division of Atmos Energy Company v. ONEOK Energy
Marketing and Trading Company, L.P., et al., Cause No. 2001-516,386, filed in the 72nd
District Court of Lubbock County, Texas. The plaintiff is suing several ONEOK entities for
alleged overcharges in connection with gas sales, transportation, and other services, and
alleged misallocations and meter errors, in and around Lubbock, under three different gas
contracts. While the petition is vague, it is broad enough to include claims for the
period before and after March 1, 2000 when the assets in question were conveyed by us to
ONEOK. We and ONEOK are defending the case pursuant to an agreement whereby ONEOK is
responsible for any damages that may be attributable to the period following ONEOK's
acquisition of the assets in question. In an amended petition filed in mid-2002, the
plaintiff alleged damages in excess of $12 million. The defendants have filed a
counterclaim for offsetting damages and accounting corrections under the contracts with
the plaintiff. The parties are currently engaged in an informal dispute resolution process
in an attempt to resolve their accounting and other differences. In the event this process
does not resolve the claims, a scheduling order will be established for completion of fact
22 discovery and trial. We believe that the resolution of the plaintiff's
claims will be for amounts substantially less than the amounts sought. We believe that we have meritorious defenses to all lawsuits and legal
proceedings in which we are defendants and will vigorously defend against them. Based on
our evaluation of the above matters, and after consideration of reserves established, we
believe that the resolution of such matters will not have a material adverse effect on our
business, cash flows, financial position or results of operations. In addition, we are a defendant in various lawsuits arising from the
day-to-day operations of our businesses. Although no assurance can be given, we believe,
based on our investigation and experience to date, that the ultimate resolution of such
items will not have a material adverse impact on our business, cash flows, financial
position or results of operations. 19. Recent Accounting Pronouncements FASB Interpretation No. 46, Consolidation of Variable Interest
Entities In January 2003, the Financial Accounting Standards Board
("FASB") issued Interpretation No. 46, Consolidation of Variable Interest
Entities. This interpretation of Accounting Research Bulletin No. 51, Consolidated
Financial Statements, addresses consolidation by business enterprises of variable
interest entities (some, but not all, of which have been referred to as "special
purpose entities") with certain defined characteristics. One provision of the
interpretation increases the minimum amount of third-party investment required to support
non-consolidation from 3% to 10%. Certain of the disclosure provisions contained in the
interpretation are effective for financial statements issued after January 31, 2003, all
of the provisions are immediately applicable to variable interest entities created after
January 31, 2003 and public entities with variable interests in entities created before
February 1, 2003 are required to apply the provisions (other than the transition
disclosure provisions) to that entity no later than the beginning of the first interim or
annual reporting period beginning after June 15, 2003. The principal impact of this interpretation on us is that, upon
implementation, we expect to begin consolidation of Triton Power Company LLC and its
wholly owned subsidiary, Triton Power Michigan LLC, the lessee of the Jackson, Michigan
power generation facility. We operate the Jackson facility and have a preferred interest
in Triton Power Company LLC, in which the common interest is owned by others. Neither
entity has debt but, as a result of this consolidation, we will include the lease
obligation on the Jackson plant in our consolidated financial statements. We expect to
apply the provisions of the statement beginning with the third quarter of 2003 and, at
that time, the total remaining lease payments will be $553.5 million and will be $21.7
million, $20.3 million, $20.3 million, $20.4 million and $20.6 million for 2004 through
2008, respectively. The difference between the earnings impact under consolidation and
under the currently-applied cost method is not expected to be material. In addition, a preliminary conclusion has been reached that the trusts
which are our wholly owned subsidiaries that issued our trust preferred trust securities
are variable interest entities for purposes of applying this statement and, further, that
upon application of this statement these trusts would no longer be consolidated. Assuming
that this conclusion is not changed, we expect that, upon application of the statement,
(i) an amount equal to the carrying value of the trust preferred securities will be
reported as part of long-term debt in our consolidated balance sheet and (ii) we will
classify future payments made by us in conjunction with the trust preferred securities as
interest expense, rather than minority interest. 23 Statement of Financial Accounting Standards No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging Activities On April 30, 2003, the FASB issued SFAS No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging Activities. This statement amends
and clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS No. 133. The new guidance amends SFAS No. 133 for decisions made: as part of the Derivatives Implementation
Group process that effectively required amendments to SFAS No. 133; in connection with other FASB projects
dealing with financial instruments; and regarding implementation issues raised in
relation to the application of the definition of a derivative, particularly regarding the
meaning of "underlying" and the characteristics of a derivative that contains
financing components. The amendments set forth in SFAS No. 149 require that contracts with
comparable characteristics be accounted for similarly. In particular, this statement
clarifies under what circumstances a contract with an initial net investment meets the
characteristic of a derivative as discussed in SFAS No. 133. In addition, it clarifies
when a derivative contains a financing component that warrants special reporting in the
statement of cash flows. SFAS No. 149 amends certain other existing pronouncements. Those
changes will result in more consistent reporting of contracts that are derivatives in
their entirety or that contain embedded derivatives that warrant separate accounting. The statement is effective for contracts entered into or modified after
June 30, 2003, except as stated below and for hedging relationships designated after June
30, 2003. We will apply this guidance prospectively. We do not expect the impacts of
adopting this statement on our financial position or results of operations to be material. The provisions of this statement that relate to SFAS No. 133
implementation issues that have been effective for fiscal quarters that began prior to
June 15, 2003, should continue to be applied in accordance with their respective effective
dates. In addition, certain provisions relating to forward purchases or sales of
"when-issued" securities or other securities that do not yet exist, should be
applied to existing contracts as well as new contracts entered into after June 30, 2003. 24 Statement of Financial Accounting Standards No. 150, Accounting for
Certain Financial Instruments with Characteristics of Both Liabilities and Equity. In May 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity. This
statement establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It requires
that an issuer classify a financial instrument that is within its scope as a liability (or
an asset in some circumstances). Many of those instruments were previously classified as
equity. SFAS No. 150 requires an issuer to classify the following instruments
as liabilities (or assets in some circumstances): a financial instrument issued in the form
of shares that is mandatorily redeemable - that embodies an unconditional obligation
requiring the issuer to redeem it by transferring its assets at a specified or
determinable date (or dates) or upon an event that is certain to occur; a financial instrument, other than an
outstanding share, that, at inception, embodies an obligation to repurchase the issuer's
equity shares, or is indexed to such an obligation, and that requires or may require the
issuer to settle the obligation by transferring assets (for example, a forward purchase
contract or written put option on the issuer's equity shares that is to be physically
settled or net cash settled); and a financial instrument that embodies an
unconditional obligation, or a financial instrument other than an outstanding share that
embodies a conditional obligation, that the issuer must or may settle by issuing a
variable number of its equity shares, if, at inception, the monetary value of the
obligation is based solely or predominantly on any of the following: a fixed monetary amount known at
inception, for example, a payable settleable with a variable number of the issuer's equity
shares; variations in something other than the
fair value of the issuer's equity shares, for example, a financial instrument indexed to
the Standard & Poor's 500 and settleable with a variable number of the issuer's equity
shares; or variations inversely related to changes in
the fair value of the issuer's equity shares, for example, a written put option that could
be net share settled. The requirements of this statement apply to issuers' classification and
measurement of freestanding financial instruments, including those that comprise more than
one option or forward contract. This statement does not apply to features that are
embedded in a financial instrument that is not a derivative in its entirety. It also does
not affect the classification or measurement of convertible bonds, puttable stock, or
other outstanding shares that are conditionally redeemable. This statement also does not
address certain financial instruments indexed partly to the issuer's equity shares and
partly, but not predominantly, to something else. This statement is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003, except for mandatorily redeemable financial
instruments of nonpublic entities. It is to be implemented by reporting the cumulative
effect of a change in accounting principle for financial instruments created before the
issuance date of the statement and still existing at the beginning of the interim period
of adoption. Restatement is not permitted. In the event that, under the provisions of FASB
Interpretation No. 46, our wholly-owned subsidiary trusts which issued our preferred trust
securities are determined 25 not to be variable interest entities or if they are determined to be
variable interest entities but continued consolidation is determined to be appropriate, we
expect that the provisions of this statement will, upon implementation, result in (i) the
reclassification of our trust preferred securities to the debt portion of our balance
sheet and (ii) the classification of future payments made by us in conjunction with the
trust preferred securities as interest expense, rather than minority interest. 26 Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations. General The following discussion should be read in conjunction with (i) the
accompanying interim Consolidated Financial Statements and related Notes and (ii) the
Consolidated Financial Statements, related Notes and Management's Discussion and Analysis
of Financial Condition and Results of Operations included in our 2002 Form 10-K. Due to
the seasonal variation in energy demand, among other factors, the following interim
results may not be indicative of the results to be expected over the course of an entire
year. In this report Kinder Morgan Energy Partners, L.P., a publicly traded pipeline
master limited partnership in which we own the general partner interest and significant
limited partner interests, is referred to as "Kinder Morgan Energy Partners." Consolidated Financial Results Three Months Ended June 30, Earnings 2003 2002 (Decrease) (In thousands
except per share amounts) $ 251,865 $ 213,734 $ 38,131 (79,852) (53,310) (26,542) (18,786) (17,108) (1,678) (67,979) (66,445) (1,534) 85,248 76,871 8,377 68,787 46,293 22,494 (59,841) (50,712) (9,129) $ 94,194 $ 72,452 $ 21,742 ========== ========== ========== $ 0.76 $ 0.59 $ 0.17 ========== ========== ========== 123,474 123,230 244 ========== ========== ========== Six Months Ended June 30, Earnings 2003 2002 (Decrease) (In thousands
except per share amounts) $ 570,733 $ 505,135 $ 65,598 (192,807) (154,557) (38,250) (35,194) (36,658) 1,464 (134,679) (128,694) (5,985) 208,053 185,226 22,827 127,866 90,004 37,862 (130,655) (114,390) (16,265) $ 205,264 $ 160,840 $ 44,424 ========== ========== ========== $ 1.66 $ 1.30 $ 0.36 ========== ========== ========== 123,285 124,026 (741) ========== ========== ========== Net income increased from $72.5 million in the second quarter of 2002
to $94.2 million in the second quarter of 2003, an increase of $21.7 million (30%). Total
diluted earnings per common share increased from $0.59 in the second quarter of 2002 to
$0.76 in the second quarter of 2003, an increase of 27 $0.17 (29%). Income was positively affected in the second quarter of
2003, relative to 2002, primarily by (i) increased equity in earnings of Kinder Morgan
Energy Partners due, in part, to the strong performance from the assets owned and/or
operated by Kinder Morgan Energy Partners, (ii) increased earnings from each of our
business segments, as discussed in more detail in the individual business segment
discussions following, (iii) reduced interest expense as a result of lower outstanding
debt, lower interest rates and a $4.1 million reduction as a result of the final
settlement of a regulatory matter at Natural Gas Pipeline Company of America, (iv) a lower
effective tax rate in 2003 and (v) a $2.9 million pre-tax gain ($1.8 million after tax)
from recovery of loan principal in excess of our carrying value (see Note 8 of the
accompanying Notes to Consolidated Financial Statements). These positive impacts were
partially offset by (i) increased income tax expense due to the increased pre-tax income,
(ii) a $4.3 million pre-tax loss ($2.7 million after tax) due to the sale of our interest
in the Igasamex joint venture and (iii) increased general and administrative expenses due
principally to higher costs for employee benefits. The number of shares used to calculate
diluted earnings per common share was approximately 0.2 million higher in the second
quarter of 2003 than in the second quarter of 2002, principally due to incremental shares
issued under the employee stock purchase plan and for stock options that were exercised,
partially offset by the impact of share repurchases. Net income increased from $160.8 million in the first six months of
2002 to $205.3 million in the first six months of 2003, an increase of approximately $44.5
million (28%). Total diluted earnings per common share increased from $1.30 in the first
six months of 2002 to $1.66 in the first six months of 2003, an increase of $0.36 (28%).
Income was affected in the first six months of 2003, relative to 2002, principally by the
same factors as previously discussed for the second quarter, except that, on a
year-to-date basis, (i) general and administrative expenses were lower in 2003 due, in
part, to lower legal costs and (ii) earnings from the Power business segment were lower in
2003 (see the Power segment discussion following). The number of shares used to calculate
diluted earnings per common share was approximately 0.7 million lower in the first six
months of 2003 than in the first six months of 2002, principally due to the impact of
share repurchases. Results of Operations The following comparative discussion of our results of operations is by
segment for factors affecting segment earnings, and on a consolidated basis for other
factors. We manage our various businesses by, among other things, allocating
capital and monitoring operating performance. This management process includes dividing
the company into business segments so that performance can be effectively monitored and
reported for a limited number of discrete businesses. Currently, we manage and report our
operations in the following business segments: 28 The accounting policies we apply in the generation of business segment
information are generally the same as those described in Note 1 of Notes to Consolidated
Financial Statements included in our 2002 Form 10-K, except that (i) certain items below
the "Operating Income" line are either not allocated to business segments or are
not considered by management in its evaluation of business segment performance and (ii)
equity in earnings of equity method investees, other than Kinder Morgan Energy Partners
and certain insignificant international investees, are included in segment results. These
equity method earnings are included in "Other Income and (Expenses)" in our
Consolidated Statements of Operations. In addition, (i) certain items included in
operating income (such as general and administrative expenses) are not allocated to
individual business segments and (ii) gains and losses from incidental sales of assets are
included in segment earnings. With adjustment for these items, we currently evaluate
business segment performance primarily based on operating income in relation to the level
of capital employed. We account for intersegment sales at market prices, while we account
for asset transfers at either market value or, in some instances, book value. Following are operating results by individual business segment (before
intersegment eliminations), including explanations of significant variances between the
periods presented. Natural Gas Pipeline Company of America Three Months Ended Increase Six Months Ended 2003 2002 (Decrease) 2003 2002 Increase (In
thousands except systems throughput) $188,188 $157,531 $ 30,657 $402,256 $340,620 $ 61,636 ======== ======== ======== ======== ======== ======== $ 84,335 $ 83,984 $ 351 $184,411 $179,602 $ 4,809 ======== ======== ======== ======== ======== ======== 340.9 353.1 (12.2) 792.0 751.0 41.0 ======== ======== ======== ======== ======== ======== Natural Gas Pipeline Company of America's segment earnings increased by
$0.4 million (0.4%) from the second quarter of 2002 to the second quarter of 2003. The
increase in operating revenues, which was largely offset by a corresponding increase in
cost of sales, was principally due to increased 2003 operational natural gas sales and, to
a lesser extent, increased transportation and storage revenues, largely due to
expansions/extensions as discussed following. Business segment earnings for the second
quarter of 2003 were positively impacted, relative to 2002, by (i) increased margin from
transportation and storage services resulting from expansion and extension projects coming
on line since the end of the second quarter of last year as discussed below and (ii)
increased 2003 operational sales of natural gas. 29 Results were also affected by increased depreciation expense related to
the expansion and extension projects, partially offset by decreased operations and
maintenance expenses for storage operations, compressor power and right-of-way costs.
System throughput decreased by 12.2 trillion Btus (3.5%) from the second quarter of 2002
to the second quarter of 2003 due, in part, to the fact that 2002, as a result of
weather-related factors, was an abnormally high year in terms of system throughput. System
throughput in the second quarter of 2003 exceeded the average second quarter throughput
for the last four years. The decrease in system throughput in 2003 did not have a
significant direct impact on revenues due to the fact that transportation revenues are
derived primarily from "demand" contracts in which shippers pay a fee to reserve
a set amount of system capacity for their use. Natural Gas Pipeline Company of America's
segment results for the second quarter and the six months ended June 30, 2003 do not
include a reduction of $4.1 million in interest expense attributable to the final
settlement of a regulatory matter, which amount is included in "Interest Expense,
Net" as discussed elsewhere herein. Natural Gas Pipeline Company of America's segment earnings increased by
$4.8 million (2.7%) from the first six months of 2002 to the first six months of 2003. The
increase in operating revenues, which was largely offset by a corresponding increase in
cost of sales, was principally due to increased 2003 operational natural gas sales and, to
a lesser extent, increased revenues from transportation and storage revenues. Business
segment earnings for the first six months of 2003 were impacted, relative to 2002,
principally by the same factors affecting the first quarter, as discussed previously,
except that, on a year-to-date basis, (i) taxes other than income taxes were lower in 2003
due, principally, to a state refund received in 2003 and (ii) operations and maintenance
expenses were nearly unchanged in 2003. System throughput increased by 41.0 trillion Btus
(5.5%) from the first six months of 2002 to the first six months of 2003 due, in part, to
colder than normal weather in this segment's principal market areas during the first
quarter of 2003. This increase did not have a significant direct impact on revenues due to
the "demand" structure of transportation contracts as discussed previously. Horizon Pipeline Company, which provides natural gas transportation
capacity to the growing northern Illinois market, began service in the second quarter of
2002. Horizon Pipeline Company is a joint venture with Nicor Inc. Natural Gas Pipeline
Company of America's lateral extension into the eastern portion of the St. Louis
metropolitan area began service in the third quarter of 2002. During April 2003, Natural
Gas Pipeline Company of America began construction of 10.7 Bcf of storage service
expansion at the existing North Lansing storage facility in east Texas, all of which is
fully subscribed under long-term contracts. Although construction on the $35.6 million
project won't be totally completed until early 2004, the service is available at this
time. Please refer to our 2002 Form 10-K for additional information regarding Natural Gas
Pipeline Company of America. TransColorado Pipeline Three Months Ended Six Months Ended 2003 2002 Increase 2003 2002 Increase (In
thousands except systems throughput) $ 7,615 $ - $ 7,615 $ 17,114 $ - $ 17,114 ======== ======== ======== ======== ======== ======== $ 5,297 $ 2,091 $ 3,206 $ 12,557 $ 2,184 $ 10,373 ======== ======== ======== ======== ======== ======== 42.2 39.5 2.7 88.7 72.2 16.5 ======== ======== ======== ======== ======== ========
Washington, DC 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-6446
Kinder Morgan, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Incorporation or Organization)
Identification No.)
FORM 10-Q
QUARTER ENDED JUNE 30, 2003
Contents
Number
PART I.
FINANCIAL INFORMATION
Item 1.
Financial Statements (Unaudited)
Item 2.
Item 3.
Item 4.
PART II.
Item 1.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
SIGNATURE
Kinder Morgan, Inc. and Subsidiaries
ASSETS:
Current Assets:
Cash and Cash Equivalents
Restricted Deposits
Accounts Receivable, Net:
Trade
Related Parties
Inventories
Gas Imbalances
Other
Investments:
Kinder Morgan Energy Partners
Goodwill
Other
Property, Plant and Equipment
Less Accumulated Depreciation and
Amortization
Deferred Charges and Other Assets
Total Assets
Kinder Morgan, Inc. and Subsidiaries
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current Liabilities:
Current Maturities of Long-term Debt
Notes Payable
Accounts Payable:
Trade
Related Parties
Accrued Interest
Accrued Expenses
Accrued Taxes
Gas Imbalances
Other
Other Liabilities and Deferred Credits:
Deferred Income Taxes
Other
Long-term Debt:
Outstanding
Value of Interest Rate Swaps
Kinder Morgan-Obligated Mandatorily
Redeemable Preferred
Capital Trust Securities of
Subsidiary Trusts Holding
Solely Debentures of Kinder
Morgan
Minority Interests in Equity of
Subsidiaries
Stockholders' Equity:
Common Stock-
Authorized - 150,000,000
Shares, Par Value $5 Per Share
Outstanding - 130,852,688 and
129,861,650 Shares,
Respectively,
Before Deducting 8,260,375 and 8,168,241
Shares Held in
Treasury
Additional Paid-in Capital
Retained Earnings
Treasury Stock
Deferred Compensation
Accumulated Other Comprehensive Loss
Total Stockholders' Equity
Total Liabilities and Stockholders'
Equity
Kinder Morgan, Inc. and Subsidiaries
Operating Revenues:
Natural Gas Transportation and Storage
Natural Gas Sales
Other
Total Operating
Revenues
Operating Costs and Expenses:
Gas Purchases and Other Costs of Sales
Operations and Maintenance
General and Administrative
Depreciation and Amortization
Taxes, Other Than Income Taxes
Total Operating
Costs and Expenses
Operating Income
Other Income and (Expenses):
Equity in Earnings of Kinder Morgan Energy
Partners
Equity in Earnings of Other Equity
Investments
Interest Expense, Net
Minority Interests
Other, Net
Total Other Income
and (Expenses)
Income Before Income Taxes
Income Taxes
Net Income
=========
=========
=========
=========
Basic Earnings Per Common Share
=========
=========
=========
=========
Number of Shares Used in Computing Basic
Earnings Per Common
Share
=========
=========
=========
=========
Diluted Earnings Per Common Share
=========
=========
=========
=========
Number of Shares Used in Computing Diluted
Earnings Per Common
Share
=========
=========
=========
=========
Dividends Per Common Share
=========
=========
=========
=========
Kinder Morgan, Inc. and Subsidiaries
Increase (Decrease) in Cash and Cash Equivalents
Cash Flows From Operating Activities:
Net Income
Adjustments to Reconcile Net Income to Net
Cash Flows
from Operating Activities:
Depreciation and
Amortization
Deferred Income
Taxes
Equity in Earnings
of Kinder Morgan Energy Partners
Distributions from
Kinder Morgan Energy Partners
Equity in Earnings
of Other Investments
Minority Interests
in Income of Consolidated Subsidiaries
Deferred Purchased
Gas Costs
Net (Gains) Losses
on Sales of Assets
Gain from
Settlement of Orcom Note
Litigation
Settlement and Escrow Deposit
Pension
Contribution in Excess of Expense
Changes in Gas in
Underground Storage
Changes in Other
Working Capital Items
Proceeds from
Termination of Interest Rate Swap
Other, Net
Net Cash Flows Provided by
Continuing Operations
Net Cash Flows Used in
Discontinued Operations
Net Cash Flows Provided by Operating
Activities
Cash Flows From Investing Activities:
Capital Expenditures
Investment in Kinder Morgan Energy Partners
Other Investments
Proceeds from Settlement of Orcom Note
Proceeds from Sales of Assets
Net Cash Flows Used in Investing
Activities
Cash Flows From Financing Activities:
Short-term Debt, Net
Long-term Debt Retired
Common Stock Issued
Short-term Advances From (To)
Unconsolidated Affiliates
Orcom Proceeds Payable to Pacificorp
Repurchase of Kinder Morgan Management, LLC
Shares
Treasury Stock Acquired
Cash Dividends, Common Stock
Minority Interests, Net
Net Cash Flows (Used in) Provided by
Financing Activities
Net (Decrease) Increase in Cash and Cash
Equivalents
Cash and Cash Equivalents at Beginning of
Period
Cash and Cash Equivalents at End of Period
The accompanying notes are an integral part of these statements.
June 30,
June 30,
Net Income, As Reported
Add: Stock-based Employee
Compensation Expense
Included in Reported Net Income, Net of Related Tax
Effects
Deduct: Total Stock-based
Employee Compensation
Expense Determined under Fair Value Method for
All Awards, Net of Related Tax Effects
Pro Forma Net Income
Basic Earnings Per Common Share:
As Reported
Pro Forma
Diluted Earnings Per Common Share:
As Reported
Pro Forma
June 30,
June 30,
Weighted-average Common Shares Outstanding
Dilutive Common Stock Options
Shares Used to Compute Diluted Earnings Per
Common Share
(Net of Effects of Acquisitions and Sales)
Increase (Decrease) in Cash and Cash Equivalents
June 30,
Accounts Receivable
Materials and Supplies Inventory
Other Current Assets
Accounts Payable
Other Current Liabilities
Cash Paid During the Period for:
Interest, Net of Amount Capitalized
Distribution on Preferred Capital Trust
Securities
Income Taxes Paid
Net Income
Other Comprehensive Income (Loss), Net
of Tax:
Change in Fair Value of
Derivatives Utilized
for Hedging
Purposes, Net of Tax
Reclassification of Change in
Fair Value of
Derivatives to Net
Income, Net of Tax
Equity in Other Comprehensive
Income of
Equity Method
Investees
Minority Interest in Other
Comprehensive
Income of Equity
Method Investees
Other Comprehensive Loss
Comprehensive Income
Operating Revenues
Operating Expenses
Operating Income
Net Income
External
Customers1
And
Amortization
Capital
Expenditures
Assets
Natural Gas Pipeline Company of America
TransColorado Pipeline
Kinder Morgan Retail
Power
Segment Totals
Earnings from Investment in Kinder Morgan
Energy Partners
Investment in Kinder Morgan
Energy Partners
General and Administrative Expenses
Goodwill
Other Income and (Expenses)
Other2
Income Before Income Taxes
Consolidated
External
Customers1
And
Amortization
Capital
Expenditures
Natural Gas Pipeline Company of America
TransColorado Pipeline
Kinder Morgan Retail
Power
Segment Totals
Earnings from Investment in Kinder Morgan
Energy Partners
General and Administrative Expenses
Other Income and (Expenses)
Income Before Income Taxes
1
2
3
External
Customers1
And
Amortization
Capital
Expenditures
Natural Gas Pipeline Company of America
TransColorado Pipeline
Kinder Morgan Retail
Power
Segment Totals
Earnings from Investment in Kinder Morgan
Energy Partners
General and Administrative Expenses
Other Income and (Expenses)
Income Before Income Taxes
External
Customers1
And
Amortization
Capital
Expenditures
Natural Gas Pipeline Company of America
TransColorado Pipeline
Kinder Morgan Retail
Power
Segment Totals
Earnings from Investment in Kinder Morgan
Energy Partners
General and Administrative Expenses
Other Income and (Expenses)
Income Before Income Taxes
1
2
Increase
Operating Revenues
Gas Purchases and Other Costs of Sales
General and Administrative Expenses
Other Operating Expenses
Operating Income
Other Income and (Expenses)
Income Taxes
Net Income
Diluted Earnings Per Common Share
Number of Shares Used in Computing Diluted
Earnings per
Common Share
Increase
Operating Revenues
Gas Purchases and Other Costs of Sales
General and Administrative Expenses
Other Operating Expenses
Operating Income
Other Income and (Expenses)
Income Taxes
Net Income
Diluted Earnings Per Common Share
Number of Shares Used in Computing Diluted
Earnings per
Common Share
Business Segment
Business Conducted
Referred to As:
Natural Gas Pipeline Company of
America and certain affiliates
The ownership and operation of a major interstate natural gas pipeline and storage system
Natural Gas Pipeline Company of America
TransColorado Gas Transmission Company
The ownership and operation of an interstate natural gas pipeline system in Colorado and
New Mexico
TransColorado Pipeline
Retail Natural Gas Distribution
The regulated sale and transportation of natural gas to
residential, commercial and industrial customers (including a small distribution system in
Hermosillo, Mexico) and the non-regulated sales of natural gas to certain utility
customers under the Choice Gas program
Kinder Morgan Retail
Power Generation
The operation and, in previous periods, construction of
natural gas-fired electric generation facilities
Power
June 30,
June 30,
Operating Revenues
Segment Earnings
Systems Throughput (Trillion
Btus)
1 Equity method in 2002, fully
consolidated in 2003, see the textual discussion following.
June 30,
June 30,
Operating Revenues1
Segment Earnings1
Systems Throughput (Trillion
Btus) 2
2 Representing 100% of
pipeline throughput in each period.
30
TransColorado Pipeline's segment earnings increased from $2.1 million in the second quarter of 2002 (representing a 50% equity method interest in earnings) to $5.3 million in the second quarter of 2003 (representing fully consolidated results at the 100% ownership level). During the second quarter of 2002, TransColorado Pipeline was a joint venture in which we shared ownership equally with an affiliate of Questar Corp. We acquired full ownership through a purchase of Questar's interest effective October 2002. Throughput on the system increased 2.7 trillion Btus (6.8%) from the second quarter of 2002 to the second quarter of 2003 as long-haul capacity on TransColorado is now fully subscribed into 2004. In addition, these results reflect the favorable impact of wide basis differentials on certain transportation contracts, which differentials may not remain as wide throughout the year.
TransColorado Pipeline's segment earnings increased from $2.2 million in the first six months of 2002 (representing a 50% equity method interest in earnings) to $12.6 million in the first six months of 2003 (representing fully consolidated results at the 100% ownership level). Results for the first six months of 2003, relative to 2002, were affected by the same factors affecting second quarter results, as discussed above, with the exception that, on a year-to-date basis, system throughput has increased 16.5 trillion Btus (22.9%). Please refer to our 2002 Form 10-K for additional information regarding TransColorado Pipeline, including our previously announced exploration of a potential expansion of the system.
Kinder Morgan Retail
Three Months Ended |
Increase |
Six Months Ended |
Increase |
||||||||
2003 |
2002 |
(Decrease) |
2003 |
2002 |
(Decrease) |
||||||
(In thousands except systems throughput) |
|||||||||||
Operating Revenues | $ 43,323 |
$ 46,542 |
$ (3,219) |
$132,312 |
$144,169 |
$(11,857) |
|||||
======== |
======== |
======== |
======== |
======== |
======== |
||||||
Segment Earnings | $ 6,331 |
$ 6,097 |
$ 234 |
$ 37,790 |
$ 30,955 |
$ 6,835 |
|||||
======== |
======== |
======== |
======== |
======== |
======== |
||||||
Systems Throughput (Trillion Btus)1 |
5.9 |
6.6 |
(0.7) |
23.3 |
20.1 |
3.2 |
|||||
======== |
======== |
======== |
======== |
======== |
======== |
||||||
Kinder Morgan Retail's segment earnings increased by $0.2 million (3.3%) from $6.1 million in the second quarter of 2002 to $6.3 million in the second quarter of 2003. Segment results were positively impacted in 2003, relative to 2002, by (i) lower costs and higher per-unit margins in unregulated businesses and (ii) customer growth in Colorado. These positive impacts were partially offset by (i) increased depreciation expenses resulting from asset additions and (ii) a reduction in system throughput volumes of 0.7 trillion Btus (10.6%), principally due to reduced irrigation demand resulting from increased precipitation during the second quarter of 2003. Our weather hedging program continued to reduce the impact of these weather-related demand fluctuations, thereby contributing to stability in our earnings pattern. Our hedging strategy is discussed in detail in our 2002 Form 10-K.
Kinder Morgan Retail's segment earnings increased by $6.8 million (21.9%) from $31.0 million in the first six months of 2002 to $37.8 million in the first six months of 2003. Segment results were impacted in 2003, relative to 2002, principally by the same factors affecting second quarter results as discussed previously except that (i) on a year-to-date basis, segment results were positively affected in 2003 by a shift in timing of certain items affecting margin by approximately $3 million between the first and fourth quarters of 2003 and (ii) on a year-to-date basis, system throughput increased 3.2 trillion Btus (15.9%) due to increased throughput in the first quarter resulting from increased space-heating demand caused by
31
colder weather in 2003, partially offset by lower irrigation volumes in the second quarter as discussed above.
Kinder Morgan Retail has undertaken two expansion projects in western Colorado that are expected to be drivers of future earnings growth. A mainline project from Gypsum to Dotsero has been completed and is in service. A mainline from near Montrose to Ouray is in progress with completion expected by mid-2004. Please refer to our 2002 Form 10-K for additional information regarding Kinder Morgan Retail.
Power
Three Months Ended |
Six Months Ended |
||||||||||
2003 |
2002 |
Increase |
2003 |
2002 |
Decrease |
||||||
(In thousands) |
|||||||||||
Operating Revenues | $ 12,739 |
$ 9,661 |
$ 3,078 |
$ 19,051 |
$ 20,346 |
$ (1,295) |
|||||
======== |
======== |
======== |
======== |
======== |
======== |
||||||
Segment Earnings | $ 10,778 |
$ 5,924 |
$ 4,854 |
$ 13,698 |
$ 15,664 |
$ (1,966) |
|||||
======== |
======== |
======== |
======== |
======== |
======== |
||||||
Power's segment earnings increased by $4.9 million (83.1%) from $5.9 million in the second quarter of 2002 to $10.8 million in the second quarter of 2003. Segment results were positively impacted in the second quarter of 2003, relative to 2002, by (i) an increase of $2.8 million in net power plant development fees, (ii) an increase of $1.0 million attributable to net operating fees from the Jackson, Michigan plant, which commenced commercial operations in July 2002, and increased earnings from Thermo Cogeneration Partnership, primarily resulting from lower 2003 turbine maintenance and (iii) reduced labor costs. As previously announced, we have ceased power plant development activities. Consequently, we do not anticipate any revenues from power plant development fees after the second quarter of 2003. We currently retain interests in five natural gas-fired power plants.
Power's segment earnings decreased by $2.0 million (12.7%) from $15.7 million in the first six months of 2002 to $13.7 million in the first six months of 2003. Segment results were negatively impacted in the first six months of 2003, relative to 2002, by (i) a decrease of $4.1 million in net power plant development fees and (ii) $1.5 million in depreciation expense in 2003 related to the retirement of gas turbine components that were replaced. These negative impacts were partially offset by (i) an increase of $2.0 million attributable to net operating fees from the Jackson, Michigan plant, which was placed in service in July 2002, (ii) increased earnings from Thermo Cogeneration Partnership and (iii) reduced labor costs. Please refer to our 2002 Form 10-K for additional information regarding Power.
32
Other Income and (Expenses)
Three Months Ended |
Earnings Increase |
||||
2003 |
2002 |
(Decrease) |
|||
(In thousands) |
|||||
Interest Expense, Net | $ (31,314) |
$ (39,810) |
$ 8,496 |
||
Equity in Earnings of Kinder Morgan Energy Partners: | |||||
General Partner Interest | 82,243 |
66,700 |
15,543 |
||
Limited Partner Units | 8,803 |
11,824 |
(3,021) |
||
Limited Partner i-units1 | 22,686 |
14,870 |
7,816 |
||
Equity in Earnings of Power Segment2 | 2,305 |
1,611 |
694 |
||
Equity in Earnings of Horizon Pipeline Company3 | 402 |
415 |
(13) |
||
Equity in Earnings of TransColorado Pipeline4 | - |
2,091 |
(2,091) |
||
Other Equity in Earnings (Losses) | 12 |
(61) |
73 |
||
Minority Interests: | |||||
Trust Preferred Securities | (5,478) |
(5,478) |
- |
||
Kinder Morgan Management, LLC | (9,895) |
(7,237) |
(2,658) |
||
Other | (103) |
(109) |
6 |
||
Other, Net | (874) |
1,477 |
(2,351) |
||
$ 68,787 |
$ 46,293 |
$ 22,494 |
|||
========= |
========= |
========= |
|||
Six Months Ended |
Earnings Increase |
||||
2003 |
2002 |
(Decrease) |
|||
(In thousands) |
|||||
Interest Expense, Net | $ (71,288) |
$ (79,358) |
$ 8,070 |
||
Equity in Earnings of Kinder Morgan Energy Partners: | |||||
General Partner Interest | 160,412 |
129,935 |
30,477 |
||
Limited Partner Units | 18,312 |
23,938 |
(5,626) |
||
Limited Partner i-units1 | 46,503 |
29,612 |
16,891 |
||
Equity in Earnings of Power Segment2 | 4,478 |
3,922 |
556 |
||
Equity in Earnings of Horizon Pipeline Company3 | 731 |
415 |
316 |
||
Equity in Earnings of TransColorado Pipeline4 | - |
2,184 |
(2,184) |
||
Other Equity in Earnings (Losses) | (7) |
(93) |
86 |
||
Minority Interests: | |||||
Trust Preferred Securities | (10,956) |
(10,956) |
- |
||
Kinder Morgan Management, LLC | (20,283) |
(14,365) |
(5,918) |
||
Other | (158) |
(280) |
122 |
||
Other, Net | 122 |
5,050 |
(4,928) |
||
$ 127,866 |
$ 90,004 |
$ 37,862 |
|||
========= |
========= |
========= |
1
Owned by Kinder Morgan Management."Other Income and (Expenses)" was a net increase to earnings of $68.8 million and $46.3 million in the second quarters of 2003 and 2002, respectively. This positive variance of $22.5 million is principally due to (i) an increase of $20.3 million in equity in earnings of Kinder Morgan Energy Partners, which was partially offset by an increase in expense of $2.7 million due principally to additional minority interest in Kinder Morgan Management, (ii) a decrease of $8.5 million in interest expense resulting from lower outstanding debt, lower interest rates and a reduction of $4.1 million in expense as a result of the final settlement of a regulatory matter at Natural Gas Pipeline Company of America and (iii) a $2.9 million pre-tax gain ($1.8 million after tax) from receipt of loan principal in excess of our carrying value
33
(see Note 8 of the accompanying Notes to Consolidated Financial Statements). These positive impacts were partially offset by a $4.3 million pre-tax loss ($2.7 million after tax) due to the sale of our interest in the Igasamex joint venture.
"Other Income and (Expenses)" was a net increase to earnings of $127.9 million and $90.0 million in the first six months of 2003 and 2002, respectively. This positive variance of $37.9 million is principally due to (i) an increase of $41.7 million in equity in earnings of Kinder Morgan Energy Partners, which was partially offset by an increase in expense of $5.8 million, due principally to additional minority interest in Kinder Morgan Management, (ii) a decrease of $8.1 million in interest expense resulting from lower interest rates and a reduction of $4.1 million in expense at Natural Gas Pipeline Company of America as discussed above and (iii) the receipt of loan proceeds in excess of carrying value and the loss on sale of our Igasamex investment as discussed above.
Income Taxes
The increase of $9.1 million in the income tax provision for the second quarter of 2003, relative to the second quarter of 2002, consisted of an increase of $13.0 million resulting from an increase in pre-tax income, partially offset by a decrease of $3.9 million reflecting a reduction in the effective tax rate, largely due to a reduced provision for state income taxes.
The increase of $16.3 million in the income tax provision for the first six months of 2003, relative to the first six months of 2002, consisted of an increase of $26.3 million resulting from an increase in pre-tax income, partially offset by a decrease of $10.0 million reflecting a reduction in the effective tax rate, largely due to a reduced provision for state income taxes.
Discontinued Operations
During 1999, we adopted and implemented a plan to discontinue a number of lines of business. During 2000, we essentially completed the disposition of these discontinued operations. The cash flow impacts associated with discontinued operations are discussed under "Cash Flows" following. Note 10 of the accompanying Notes to Consolidated Financial Statements contains additional information on these matters.
Liquidity and Capital Resources
The following table gives the sources of our invested capital. The balances at December 31, 2001 and thereafter reflect the May 2001 sale of shares of Kinder Morgan Management in its initial public offering. The balances at December 31, 2002 and thereafter also reflect the impact of Kinder Morgan Management's August 2002 public sale of its shares. In addition to our results of operations, which affect the amount of cash we generate internally, financing activities such as (i) retirement of debt securities, (ii) the November 2001 maturity of our premium equity participating security units and (iii) reacquisition of our common stock under our stock repurchase program impact these balances in various periods. Additional information on these matters is contained under "Cash Flows" following and in Notes 11 and 13 of the accompanying Notes to Consolidated Financial Statements.
The discussion under the heading "Liquidity and Capital Resources" in Management's Discussion and Analysis of Financial Condition and Results of Operations included in our 2002 Form 10-K includes a comprehensive discussion of (i) our investments in and obligations to unconsolidated entities, (ii) our contractual obligations and (iii) our contingent liabilities. These disclosures, which reflected balances and contractual arrangements existing as of December 31, 2002, also reflect current balances and
34
contractual arrangements except for changes discussed following. Changes in our long-term debt and commercial paper are discussed under "Net Cash Flows from Financing Activities" following and in Note 11 of the accompanying Notes to Consolidated Financial Statements.
June 30, |
December 31, |
|||||||
2003 |
2002 |
2001 |
2000 |
|||||
(Dollars in thousands) |
||||||||
Long-term Debt: | ||||||||
Outstanding | $2,842,440 |
$2,852,181 |
$2,409,798 |
$2,478,983 |
||||
Value of Interest Rate Swaps1 | 185,623 |
139,589 |
(4,831) |
- |
||||
3,028,063 |
2,991,770 |
2,404,967 |
2,478,983 |
|||||
Minority Interests | 983,346 |
967,802 |
817,513 |
4,910 |
||||
Common Equity | 2,540,713 |
2,354,997 |
2,259,997 |
1,777,624 |
||||
Capital Securities | 275,000 |
275,000 |
275,000 |
275,000 |
||||
6,827,122 |
6,589,569 |
5,757,477 |
4,536,517 |
|||||
Less: Value of Interest Rate Swaps | (185,623) |
(139,589) |
4,831 |
- |
||||
Capitalization | 6,641,499 |
6,449,980 |
5,762,308 |
4,536,517 |
||||
Short-term Debt, Less Cash and Cash Equivalents2 | 191,568 |
465,614 |
613,918 |
766,244 |
||||
Invested Capital | $6,833,067 |
$6,915,594 |
$6,376,226 |
$5,302,761 |
||||
========== |
========== |
========== |
========== |
|||||
Capitalization: | ||||||||
Outstanding Long-term Debt | 42.8% |
44.2% |
41.8% |
54.6% |
||||
Minority Interests | 14.8% |
15.0% |
14.2% |
0.1% |
||||
Common Equity | 38.3% |
36.5% |
39.2% |
39.2% |
||||
Capital Securities | 4.1% |
4.3% |
4.8% |
6.1% |
||||
Invested Capital: | ||||||||
Total Debt (Excluding Interest Rate Swaps) | 44.4% |
48.0% |
47.4% |
61.2% |
||||
Equity,
Including Capital Securities and Minority Interests |
55.6% |
52.0% |
52.6% |
38.8% |
||||
1 | See Note 16 of the accompanying Notes to Consolidated Financial Statements. |
2 | Cash and cash equivalents netted against short-term debt were $29,932, $35,653, $16,134 and $141,923 for June 30, 2003 and December 31, 2002, 2001 and 2000, respectively. |
Certain of our customers are experiencing financial problems that have had a significant impact on their creditworthiness. We are working to implement, to the extent allowable under applicable laws, tariffs and regulations, prepayments and other security requirements such as letters of credit to enhance our credit position relating to amounts owed from these customers. We cannot assure that one or more of our financially distressed customers will not default on their obligations to us or that such a default or defaults will not have a material adverse effect on our business.
On August 14, 2001, we announced a program to repurchase up to $300 million of our outstanding common stock, which program was increased to $400 million and $450 million at February 5, 2002 and July 17, 2002, respectively. As of June 30, 2003, we had repurchased a total of approximately $417.2 million (8,361,800 shares) of our outstanding common stock under the program, of which $1.1 million (22,500 shares) and $2.5 million (53,600 shares) were repurchased in the three months and six months ended June 30, 2003, respectively.
On May 15, 2003, Kinder Morgan Management paid a share distribution of 859,933 of its shares to shareholders of record as of April 30, 2003, based on the $0.64 per common unit distribution declared by Kinder Morgan Energy Partners. On August 14, 2003, Kinder Morgan Management will pay a share distribution of 811,878 of its shares to shareholders of record as of July 31, 2003, based on the $0.65 per
35
common unit distribution declared by Kinder Morgan Energy Partners for the second quarter of 2003. These distributions are paid in the form of additional shares or fractions thereof calculated by dividing the Kinder Morgan Energy Partners' cash distribution per common unit by the average market price of a Kinder Morgan Management share determined for a ten-trading day period ending on the trading day immediately prior to the ex-dividend date for the shares. Kinder Morgan Management has paid share distributions totaling 1,718,914 shares in the six months ended June 30, 2003.
CASH FLOWS
The following discussion of cash flows should be read in conjunction with the accompanying interim Consolidated Statements of Cash Flows and related supplemental disclosures, and the Consolidated Statements of Cash Flows and related supplemental disclosures included in our 2002 Form 10-K.
Net Cash Flows from Operating Activities
"Net Cash Flows Provided by Operating Activities" increased from $176.3 million for the six months ended June 30, 2002 to $296.8 million for the six months ended June 30, 2003, an increase of $120.5 million (68.3%). This positive variance is principally due to (i) an increase of $36.9 million in 2003 earnings before depreciation and amortization expense, deferred income taxes and equity in earnings of Kinder Morgan Energy Partners, (ii) a $28.7 million increase in cash distributions received in 2003 attributable to our interests in Kinder Morgan Energy Partners, (iii) $28.1 million of cash proceeds received in 2003 from termination of an interest rate swap, (iv) an increase of $84.4 million in cash inflows for gas in underground storage during 2003 and (v) the fact that cash flows for the first six months of 2002 included $22.1 million and $18.9 million of cash outflows for a litigation settlement and pension contribution, respectively. These positive impacts were partially offset by (i) an increase of $15.3 million in 2003 cash outflows for deferred purchased gas costs and (ii) an increased 2003 use of cash for miscellaneous working capital of $92.1 million (see Note 5 of the accompanying Notes to Consolidated Financial Statements).
Net Cash Flows from Investing Activities
"Net Cash Flows Used in Investing Activities" decreased from $239.9 million for the six months ended June 30, 2002 to $49.2 million for the six months ended June 30, 2003, a decrease of $190.6 million (79.5%). This decreased use of cash is principally due to the fact that the first six months of 2002 included (i) $15.7 million in capital expenditures for the Natural Gas Pipeline Company of America pipeline extension to East St. Louis, Illinois, (ii) a $137.5 million cash outflow for incremental investments in power plant facilities and (iii) a $16.5 million investment in Horizon Pipeline Company.
Net Cash Flows from Financing Activities
"Net Cash Flows (Used in) Provided by Financing Activities" decreased from a source of $64.8 million for the six months ended June 30, 2002 to a use of $253.3 million for the six months ended June 30, 2003, a decrease of $318.1 million. This decrease is principally due to $500 million of cash used during the six months ended June 30, 2003 to retire our $500 million 6.45% Senior Notes and an increase of $24.3 million paid in 2003 for dividends, principally due to the increased dividends declared per share. Partially offsetting these factors were (i) a $137.4 million decreased use of cash during 2003 to repurchase shares and (ii) a $74.1 million increased source of cash from short-term advances to unconsolidated affiliates during 2003.
36
Our principal sources of short-term liquidity are the commercial paper market and our $800 million of revolving bank facilities, which replaced $900 million of revolving bank facilities on October 15, 2002. At June 30, 2003, we had $221.5 million of commercial paper (which is backed by the bank facilities) issued and outstanding. At July 31, 2003, we had $179.8 million of commercial paper issued and outstanding. After inclusion of applicable letters of credit, the remaining available borrowing capacity under the bank facilities was $547.2 million and $588.9 million at June 30, 2003 and July 31, 2003, respectively. For additional information on utilization of these facilities, see Note 11 of the accompanying Notes to Consolidated Financial Statements.
On March 3, 2003, our $500 million 6.45% Senior Notes matured and we paid the holders of the notes.
Apart from our current maturities of long-term debt and commercial paper outstanding, our current assets exceeded our current liabilities by approximately $32.2 million at June 30, 2003.
As further described in Note 16 of the accompanying Notes to Consolidated Financial Statements, we have outstanding fixed-to-floating interest rate swap agreements with a notional principal amount of $1.25 billion and a fair market value of approximately $162.2 million at June 30, 2003. These swaps are accounted for as hedges under Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities.
Change in Compensation Policies
On July 16, 2003, we announced a change to our compensation policies. Chairman and Chief Executive Officer Richard D. Kinder will continue to receive $1 per year in salary with no bonuses, stock options, grants of restricted stock or other compensation. The ten most senior executives (excluding Mr. Kinder) will continue to have their base salaries capped at $200,000 per year and will continue to be eligible for annual bonuses when we and Kinder Morgan Energy Partners meet annual earnings per share and distributions per unit targets. In addition, these senior executives will no longer be eligible for future stock option grants and have received grants of restricted stock which will vest 25 percent after three years and the remaining 75 percent after five years. We expect that executives will receive no further equity compensation during the five-year life of these restrictions. In total, 575,000 restricted shares of our common stock have been issued under a shareholder approved plan. As a result, we and Kinder Morgan Energy Partners will each expense approximately $3.5 million annually related to the grants of restricted stock. Other than restricted stock, executives will continue to have only those benefits which are available to all other employees. All other employees will be eligible for annual grants of stock options which will vest after three years. On July 16, 2003, we issued 656,450 options to purchase our common shares for $53.80 (the closing price of our common shares on that date) to eligible employees. We expect to issue to employees fewer than 700,000 options to purchase our common shares annually.
The reader is directed to Part II, Item 5 for further information regarding the retention agreement of C. Park Shaper.
We and Kinder Morgan Energy Partners have, collectively, agreed to guarantee potential borrowings under lines of credit available from Wachovia Bank, National Association, formerly known as First Union National Bank, to Messrs. Thomas Bannigan, C. Park Shaper and James Street and Ms. Deborah Macdonald. Each of these officers is primarily liable for any borrowing on his or her line of credit, and if we or Kinder Morgan Energy Partners makes any payment with respect to an outstanding loan, the officer on behalf of whom payment is made must surrender a percentage of his or her options to purchase our common stock. Our and Kinder Morgan Energy Partners' current obligations under the guaranties generally do not exceed $1.0 million in respect of any such officer individually and such
37
obligations, in the aggregate, do not exceed $1.9 million. To date, we and Kinder Morgan Energy Partners have made no payment with respect to these lines of credit. Further, we and Kinder Morgan Energy Partners' involvement in these lines of credit will expire in October 2003.
Recent Accounting Pronouncements
FASB Interpretation No. 46, Consolidation of Variable Interest Entities
In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, Consolidation of Variable Interest Entities. This interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements, addresses consolidation by business enterprises of variable interest entities (some, but not all, of which have been referred to as "special purpose entities") with certain defined characteristics. One provision of the interpretation increases the minimum amount of third-party investment required to support non-consolidation from 3% to 10%. Certain of the disclosure provisions contained in the interpretation are effective for financial statements issued after January 31, 2003, all of the provisions are immediately applicable to variable interest entities created after January 31, 2003 and public entities with variable interests in entities created before February 1, 2003 are required to apply the provisions (other than the transition disclosure provisions) to that entity no later than the beginning of the first interim or annual reporting period beginning after June 15, 2003.
The principal impact of this interpretation on us is that, upon implementation, we expect to begin consolidation of Triton Power Company LLC and its wholly owned subsidiary, Triton Power Michigan LLC, the lessee of the Jackson, Michigan power generation facility. We operate the Jackson facility and have a preferred interest in Triton Power Company LLC, in which the common interest is owned by others. Neither entity has debt but, as a result of this consolidation, we will include the lease obligation on the Jackson plant in our consolidated financial statements. We expect to apply the provisions of the statement beginning with the third quarter of 2003 and, at that time, the total remaining lease payments will be $553.5 million and will be $21.7 million, $20.3 million, $20.3 million, $20.4 million and $20.6 million for 2004 through 2008, respectively. The difference between the earnings impact under consolidation and under the currently-applied cost method is not expected to be material.
In addition, a preliminary conclusion has been reached that the trusts which are our wholly owned subsidiaries that issued our trust preferred trust securities are variable interest entities for purposes of applying this statement and, further, that upon application of this statement these trusts would no longer be consolidated. Assuming that this conclusion is not changed, we expect that, upon application of the statement, (i) an amount equal to the carrying value of the trust preferred securities will be reported as part of long-term debt in our consolidated balance sheet and (ii) we will classify future payments made by us in conjunction with the trust preferred securities as interest expense, rather than minority interest.
Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities
On April 30, 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133.
The new guidance amends SFAS No. 133 for decisions made:
| as part of the Derivatives Implementation Group process that effectively required amendments to SFAS No. 133; |
38
| in connection with other FASB projects dealing with financial instruments; and |
|
| regarding implementation issues raised in relation to the application of the definition of a derivative, particularly regarding the meaning of "underlying" and the characteristics of a derivative that contains financing components. |
The amendments set forth in SFAS No. 149 require that contracts with comparable characteristics be accounted for similarly. In particular, this statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative as discussed in SFAS No. 133. In addition, it clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 amends certain other existing pronouncements. Those changes will result in more consistent reporting of contracts that are derivatives in their entirety or that contain embedded derivatives that warrant separate accounting.
The statement is effective for contracts entered into or modified after June 30, 2003, except as stated below and for hedging relationships designated after June 30, 2003. We will apply this guidance prospectively. We do not expect the impacts of adopting this statement on our financial position or results of operations to be material.
The provisions of this statement that relate to SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. In addition, certain provisions relating to forward purchases or sales of "when-issued" securities or other securities that do not yet exist, should be applied to existing contracts as well as new contracts entered into after June 30, 2003.
Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity.
SFAS No. 150 requires an issuer to classify the following instruments as liabilities (or assets in some circumstances):
| a financial instrument issued in the form of shares that is mandatorily redeemable - that embodies an unconditional obligation requiring the issuer to redeem it by transferring its assets at a specified or determinable date (or dates) or upon an event that is certain to occur; |
|
| a financial instrument, other than an outstanding share, that, at inception, embodies an obligation to repurchase the issuer's equity shares, or is indexed to such an obligation, and that requires or may require the issuer to settle the obligation by transferring assets (for example, a forward purchase contract or written put option on the issuer's equity shares that is to be physically settled or net cash settled); and |
|
| a financial instrument that embodies an unconditional obligation, or a financial instrument other than an outstanding share that embodies a conditional obligation, that the issuer must or may settle by issuing a variable number of its equity shares, if, at inception, the monetary value of the obligation is based solely or predominantly on any of the following: |
39
| a fixed monetary amount known at inception, for example, a payable settleable with a variable number of the issuer's equity shares; |
|
| variations in something other than the fair value of the issuer's equity shares, for example, a financial instrument indexed to the Standard & Poor's 500 and settleable with a variable number of the issuer's equity shares; or |
|
| variations inversely related to changes in the fair value of the issuer's equity shares, for example, a written put option that could be net share settled. |
The requirements of this statement apply to issuers' classification and measurement of freestanding financial instruments, including those that comprise more than one option or forward contract. This statement does not apply to features that are embedded in a financial instrument that is not a derivative in its entirety. It also does not affect the classification or measurement of convertible bonds, puttable stock, or other outstanding shares that are conditionally redeemable. This statement also does not address certain financial instruments indexed partly to the issuer's equity shares and partly, but not predominantly, to something else.
This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of nonpublic entities. It is to be implemented by reporting the cumulative effect of a change in accounting principle for financial instruments created before the issuance date of the statement and still existing at the beginning of the interim period of adoption. Restatement is not permitted. In the event that, under the provisions of FASB Interpretation No. 46, our wholly owned subsidiary trusts which issued our preferred trust securities are determined not to be variable interest entities or if they are determined to be variable interest entities but continued consolidation is determined to be appropriate, we expect that the provisions of this statement will, upon implementation, result in (i) the reclassification of our trust preferred securities to the debt portion of our balance sheet and (ii) the classification of future payments made by us in conjunction with the trust preferred securities as interest expense, rather than minority interest.
Information Regarding Forward-looking Statements
This filing includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are identified as any statement that does not relate strictly to historical or current facts. They use words such as "anticipate," "believe," "intend," "plan," "projection," "forecast," "strategy," "position," "continue," "estimate," "expect," "may," "will," or the negative of those terms or other variations of them or by comparable terminology. In particular, statements, express or implied, concerning future actions, conditions or events, operating results or the ability to generate sales, income or cash flow or to pay dividends are forward-looking statements. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Future actions, conditions or events and future results of operations may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results are beyond our ability to control or predict. Specific factors which could cause actual results to differ from those in the forward-looking statements include but are not limited to the following:
| price trends, stability and overall demand for natural gas and electricity in the United States; |
| economic activity, weather, alternative energy sources, conservation and technological advances that may affect price trends and demand; |
40
| changes in our tariff rates or those of Kinder Morgan Energy Partners implemented by the FERC or another regulatory agency or, with respect to Kinder Morgan Energy Partners, the California Public Utilities Commission; |
| Kinder Morgan Energy Partners' ability to integrate any acquired operations into its existing operations; |
| Kinder Morgan Energy Partners' ability and our ability to acquire new businesses and assets and to make expansions to our respective facilities; |
| difficulties or delays experienced by railroads, barges, trucks, ships or pipelines in delivering products to Kinder Morgan Energy Partners' bulk terminals; |
| Kinder Morgan Energy Partners' ability and our ability to successfully identify and close acquisitions and make cost-saving changes in operations; |
| shut-downs or cutbacks at major refineries, petrochemical or chemical plants, utilities, military bases or other businesses that use or supply our services; |
| changes in laws or regulations, third party relations and approvals, decisions of courts, regulators and governmental bodies may adversely affect our business or our ability to compete; |
| our ability to offer and sell equity securities and debt securities or obtain debt financing in sufficient amounts to implement that portion of our business plan that contemplates growth through acquisitions of operating businesses and assets and expansions of our facilities; |
| our indebtedness could make us vulnerable to general adverse economic and industry conditions, limit our ability to borrow additional funds and/or place us at competitive disadvantages compared to our competitors that have less debt or have other adverse consequences; |
| interruptions of electric power supply to facilities due to natural disasters, power shortages, strikes, riots, terrorism, war or other causes; |
| acts of nature, sabotage, terrorism or other similar acts causing damage greater than our insurance coverage limits; |
| the condition of the capital markets and equity markets in the United States; |
| the political and economic stability of the oil producing nations of the world; |
| national, international, regional and local economic, competitive and regulatory conditions and developments; |
| the ability to achieve cost savings and revenue growth; |
| rates of inflation; |
| interest rates; |
| the pace of deregulation of retail natural gas and electricity; |
| the timing and extent of changes in commodity prices for oil, natural gas, electricity and certain agricultural products; and |
41
| the timing and success of business development efforts. |
You should not put undue reliance on any forward-looking statements.
See Items 1 and 2 "Business and Properties - Risk Factors" of our annual report filed on Form 10-K for the year ended December 31, 2002, for a more detailed description of these and other factors that may affect the forward-looking statements. When considering forward-looking statements, one should keep in mind the risk factors described in our 2002 Form 10-K report. The risk factors could cause our actual results to differ materially from those contained in any forward-looking statement. We disclaim any obligation to update the above list or to announce publicly the result of any revisions to any of the forward-looking statements to reflect future events or developments. Our future results also could be adversely impacted by unfavorable results of litigation and the coming to fruition of contingencies referred to in Notes 17 and 18 of the accompanying Notes to Consolidated Financial Statements.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
There have been no material changes in market risk exposures that would affect the quantitative and qualitative disclosures presented as of December 31, 2002, in the "Risk Management" section of Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our 2002 Form 10-K. See also Note 16 of the accompanying Notes to Consolidated Financial Statements.
Item 4. Controls and Procedures.
As of the end of the quarter ended June 30, 2003, our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the design and operation of our disclosure controls and procedures were effective.
There has been no change in our internal control over financial reporting during the quarter ended June 30, 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
42
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
The reader is directed to Note 18 of the accompanying Notes to Consolidated Financial Statements in Part I, Item 1, which is incorporated herein by reference.
Item 2. Changes in Securities and Use of Proceeds.
During the quarter ended June 30, 2003, we did not sell any equity securities that were not registered under the Securities Act of 1933, as amended.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
a) | The Company held its Annual Meeting of Shareholders on May 8, 2003 (the "Annual Meeting"). |
b) | Proxies for the Annual Meeting were solicited pursuant to Regulation 14A of the Securities Exchange Act of 1934. There was no solicitation in opposition to management's nominees for directors as listed in the Proxy Statement and all such nominees were elected, which included Messrs. Kinder, Austin, Hybl and Gardner. In addition, those directors continuing in office after the meeting included Messrs. Battey, Bliss, Morgan, Randall, Sarofim and True. The number of votes for and withheld for the nominees elected at the meeting were as follows: |
For |
Withheld |
||
Richard D. Kinder | 97,835,239 |
12,493,527 |
|
Edward H. Austin, Jr. | 106,297,595 |
4,031,171 |
|
William J. Hybl | 107,034,616 |
3,294,150 |
|
Ted A. Gardner | 106,943,865 |
3,384,901 |
c) | The following matters were also voted on at the Annual Meeting: |
(1) | A proposal to ratify and approve the selection of PricewaterhouseCoopers LLP as our independent auditors for 2003 was approved and the number of affirmative votes, negative votes, abstentions and broker non-votes with respect to the matter were as follows: |
For | 107,516,377 |
Against | 2,237,023 |
Abstain | 575,366 |
Broker Non-votes | N/A |
43
(2) | A stockholder proposal relating to the adoption of an executive compensation policy requiring the use of indexed stock options was not approved and the number of affirmative votes, negative votes, abstentions and broker non-votes with respect to the matter were as follows: |
For | 5,966,778 |
Against | 85,373,287 |
Abstain | 958,613 |
Broker Non-votes | N/A |
(3) | A stockholder proposal relating to establishing a policy of expensing the costs of all future stock options was not approved and the number of affirmative votes, negative votes, abstentions and broker non-votes with respect to the matter were as follows: |
For | 28,278,890 |
Against | 62,401,564 |
Abstain | 1,618,220 |
Broker Non-votes | N/A |
Item 5. Other Information.
Certain Relationships and Related Transactions
Retention Agreement
Effective January 17, 2002, we entered into a retention agreement with C. Park Shaper, an officer of us, Kinder Morgan G.P., Inc. (the general partner of Kinder Morgan Energy Partners) and its delegate, Kinder Morgan Management. Pursuant to the terms of the agreement, Mr. Shaper obtained a $5 million personal loan guaranteed by Kinder Morgan Energy Partners and us. Mr. Shaper was required to purchase and did purchase our common stock and Kinder Morgan Energy Partners' common units in the open market with the loan proceeds.
The Sarbanes-Oxley Act of 2002 does not allow companies to issue or guarantee new loans to executives, but it "grandfathers" loans that were in existence prior to the act. Regardless, Mr. Shaper and we have agreed that in today's business environment it would be prudent for him to repay the loan. In conjunction with this decision, Mr. Shaper has sold 37,000 of our shares and 82,000 of Kinder Morgan Energy Partner's common units. He used the proceeds to repay the $5 million personal loan guaranteed by Kinder Morgan Energy Partners and us. Kinder Morgan Energy Partners' and our guarantee of this loan has been removed. Mr. Shaper will instead participate in our restricted stock plan with other senior executives.
44
Item 6. Exhibits and Reports on Form 8-K.
(A) Exhibits. |
31.1 31.2 32.1 32.2 |
Section 13a - 14(a) / 15d - 14(a) Certification of Chief
Executive Officer Section 13a - 14(a) / 15d - 14(a) Certification of Chief Financial Officer Section 1350 Certification of Chief Executive Officer Section 1350 Certification of Chief Financial Officer |
(B) Reports on Form 8-K. |
(1) |
Current Report on Form 8-K dated April 1, 2003 was furnished as of April 1, 2003 pursuant to Item 9. of that form. |
|
We announced our intention to make presentations on April 1, 2003 at the 31st Annual Howard Weil Energy Conference to address our strategy and philosophy, the fiscal year 2003 budget and other business information about us, Kinder Morgan Energy Partners, L.P. and Kinder Morgan Management, LLC, and the availability of materials to be presented at the meetings on our website. |
(2) |
Current Report on Form 8-K dated April 16, 2003 was furnished as of April 23, 2003 pursuant to Item 7., Item 9. and Item 12. of that form. |
|
Pursuant to Item 9. of that form (information provided under Item 12.), we disclosed that on April 16, 2003 we issued a press release regarding our financial results for the quarter ended March 31, 2003 and held a webcast conference call discussing those results. Pursuant to Item 7. of that form, we filed our press release issued April 16, 2003 and an unedited transcript of the webcast conference call, prepared by an outside vendor, as exhibits. |
(3) |
Current Report on Form 8-K dated June 9, 2003 was furnished as of June 6, 2003 pursuant to Item 9. of that form. |
|
We announced our intention to make presentations on June 9, 2003 at the Deutsche Bank Conference to investors, analysts and others, in order to address various strategic and financial issues relating to the business plans and objectives of us, Kinder Morgan Energy Partners, L.P. and Kinder Morgan Management, LLC, and the availability of materials to be presented at the meetings on our website. |
(4) |
Current Report on Form 8-K dated August 4, 2003 was furnished as of August 5, 2003 pursuant to Item 9. of that form. |
|
We announced our intention to make presentations on August 5, 2003 and August 6, 2003 at various meetings with investors, analysts and others, in order to discuss the second quarter and year-to-date financial results, business plans and objectives of us, Kinder Morgan Energy Partners, L.P. and Kinder Morgan Management, LLC and the availability of materials to be presented at the meetings on our website. |
45
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
KINDER MORGAN, INC. (Registrant) |
|
August 8, 2003 | /s/ C. Park Shaper |
C. Park Shaper Vice President, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer) |
46
Exhibit 31.1
CERTIFICATION
I, Richard D. Kinder, certify that: | |
1. |
I have reviewed this quarterly report on Form 10-Q of Kinder Morgan, Inc.; |
2. |
|
3. |
|
4. |
|
a) | designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
|
b) |
|
|
c) |
|
5. | The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): |
a) | all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and |
|
b) |
|
Date: August 8, 2003 | ||
/s/ Richard D. Kinder | ||
Richard D. Kinder Chairman and Chief Executive Officer |
Exhibit 31.2
CERTIFICATION
I, C. Park Shaper, certify that: |
1. |
I have reviewed this quarterly report on Form 10-Q of Kinder Morgan, Inc.; |
2. |
|
3. |
|
4. |
|
a) | designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
|
b) |
|
|
c) |
|
5. | The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): |
a) | all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and |
|
b) |
|
Date: August 8, 2003 | |||
/s/ C. Park Shaper | |||
C. Park Shaper Vice President, Treasurer and Chief Financial Officer |
EXHIBIT 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906
OF THE
SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Kinder Morgan, Inc. (the "Company") on Form 10-Q for the quarterly period ended June 30, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned, in the capacity and on the date indicated below, hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
A signed original of this written statement required by Section 906 has been provided
to Kinder Morgan, Inc. and will be retained by Kinder Morgan, Inc. and furnished to the
Securities and Exchange Commission or its staff upon request.
Dated: August 8, 2003 | /s/ Richard D. Kinder | |
Richard D. Kinder Chairman and Chief Executive Officer |
EXHIBIT 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906
OF THE
SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Kinder Morgan, Inc. (the "Company") on Form 10-Q for the quarterly period ended June 30, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned, in the capacity and on the date indicated below, hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
A signed original of this written statement required by Section 906 has been provided
to Kinder Morgan, Inc. and will be retained by Kinder Morgan, Inc. and furnished to the
Securities and Exchange Commission or its staff upon request.
Dated: August 8, 2003 | /s/ C. Park Shaper | ||
C. Park Shaper Vice President, Treasurer and Chief Financial Officer |
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