Driven by pipeline earnings within its master limited partnership (MLP) and a solid performance from fee-based assets, Kinder Morgan Inc. (KMI) reported a 29% increase in second quarter earnings on Wednesday. The company also announced major changes to its executive compensation policies to more closely align with what the CEO called shareholder interests.

CEO Rich Kinder reviewed the quarterly results with analysts during a conference call Wednesday afternoon, noting that KMI had a “terrific” quarter. For the period, net income was $94.2 million (76 cents a share), up from $72.5 million (59 cents) in Q202. The CEO noted that KMI already has reduced debt this year by more than $280 million, including $120 million in the second quarter, thereby lowering its debt-to-capital ratio to approximately 44% from 48% at the end of 2002.

By segment, KMI’s interest in its MLP, Kinder Morgan Energy Partners (KMP), contributed $97.8 million of pre-tax earnings in the second quarter, a 20% increase over $81.5 million for the comparable period a year ago. The results are consistent with KMI’s published budget target of 16% annual growth from its KMP interest, and the CEO said the cash flow increase was boosted mostly by internal growth in its pipeline and internal assets.

Natural Gas Pipeline Company of America (NGPL) reported second quarter segment earnings of $84.3 million, up slightly from $84.0 million for the same quarter last year. NGPL also remains on target to meet its published annual budget of nearly 5% annual growth, according to the company.

“We continue to successfully re-contract firm transportation capacity on NGPL,” said the CEO. “Firm capacity on the pipeline is virtually sold out through October of 2003 and 95% contracted for through March of 2004.”

TransColorado, in which KMI owns a 50% interest, reported segment earnings of $5.3 million for the quarter, versus the $2.1 million a year ago. Throughput on TransColorado increased by about 7% in the quarter and 23% over the first six months of the year. It is fully subscribed into 2004.

“TransColorado continues to exceed the expectations that we had when we increased our ownership in this pipeline to 100% in October of 2002,” said Kinder. “While we have already achieved 78% of this segment’s $16 million published annual budget and are certainly on a pace to surpass it, keep in mind that the rate provisions under a few of TransColorado’s contracts vary with basis differentials and they may not remain as favorable in the second half of the year as they were in the first two quarters.”

Segment earnings for Retail in the second quarter were $6.3 million, up slightly from $6.1 million in Q202. The increase primarily reflects reduced expenses, and KMI said the unit is on target to “achieve slightly more” than its published annual budget of $65.3 million.

Power, which is expected to account for about 2% of KMI’s total segment income in 2003, recorded earnings of $10.8 million compared to $5.9 million last year. Approximately $2 million of the increase reflects increased contributions from tolled power plants in Colorado and Michigan, and about $2.8 million of the increase is attributable to an increase in net plant development fees. KMI noted that the second quarter was the final one in which this segment expects to recognize power development fees. It has already achieved 71% of its target for the year.

Following the board meeting Wednesday, KMI announced a change to its compensation policies “to more closely align senior management compensation with the long-term interests of its shareholders and unitholders.”

Kinder, who also chairs the company, will continue to receive $1 per year in salary with no bonuses, options, grants of restricted stock or other compensation. The 10 most senior executives (excluding the CEO) will continue to have their base salaries capped at $200,000 per year and will continue to be eligible for annual bonuses when KMI and KMP meet their annual earnings per share and distributions per unit targets.

In addition, these senior executives will no longer be eligible for options and have received grants of restricted stock, which will vest 25% after three years and the remaining 75% after five years. It is expected that executives will receive no further equity compensation during the five-year life of these restrictions. In total, 575,000 shares of restricted KMI shares have been issued under a shareholder approved plan.

As a result if the changes, KMI and KMP will each expense $3.5 million annually. All other employees will be eligible for annual grants of options, which will fully vest after three years. Fewer than 700,000 options to purchase KMI shares are expected to be issued annually. Other than restricted stock, executives will continue to have only those benefits which are available to every KMI employee, the company said.

Under the changes, CFO C. Park Shaper plans to sell 37,000 KMI shares and 82,000 KMP units to repay a $5 million personal loan that was guaranteed by the shares and units under a previously disclosed retention agreement that was effective Jan. 17, 2002. Under terms of the agreement, Shaper was required to purchase common stock of both KMI and KMP in the open market with the loan proceeds. On the fifth anniversary date of the agreement, provided he was still employed by KMI, the company would have assumed Shaper’s obligations under the loan.

“Because the Sarbanes-Oxley Act of 2002 does not allow companies to issue or guarantee new loans to executives, Shaper and Kinder Morgan have agreed that it would be prudent for Shaper to repay the loan now,” the company said in a statement. “Even though the continuation of our agreement was allowed by the Sarbanes-Oxley Act, the Kinder Morgan management team, including Park, believes that it is appropriate in today’s business environment to eliminate the previous retention agreement,” said the CEO. “Shaper will repay the loan in its entirety, and instead will participate in the restricted stock plan with other senior executives.”

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