KINDER MORGAN, INC. quarterly report, Q3 FY2014

Kinder Morgan, Inc. — 2014 Third-Quarter Form 10-Q

Reporting period: Three and nine months ended September 30, 2014; balance-sheet comparisons are with December 31, 2013. Amounts are in millions of dollars except per-share data, volumes, and percentages. The consolidated statements include KMP, EPB, and KMR, so consolidated earnings include substantial noncontrolling interests.

Business context and key financial results

Kinder Morgan described itself as a North American midstream energy company with approximately 80,000 miles of pipelines and 180 terminals. Its operations include natural gas pipelines, CO₂ production and transportation, products pipelines, terminals, and Canadian pipelines.

Metric	Q3 2014	Q3 2013	Nine months 2014	Nine months 2013
Total revenue	$4,291	$3,756	$12,275	$10,198
Operating income	$1,332	$1,041	$3,492	$2,830
Operating margin	31.0%	27.7%	28.4%	27.7%
Income from continuing operations	$779	$551	$1,877	$1,990
Net income attributable to KMI	$329	$286	$900	$855
Basic and diluted EPS	$0.32	$0.27	$0.87	$0.82
Dividends declared per share	$0.44	$0.41	$1.29	$1.19

Q3 operating margin is calculated as operating income divided by revenue. The filing reports consolidated net income of $779 million for Q3 and $1,877 million for the nine-month period; $450 million and $977 million, respectively, was attributable to noncontrolling interests.

Cash flow, capital spending, debt, and liquidity

• Cash flow: Nine-month operating cash flow was $3,492, up from $2,792 in 2013. Investing cash outflow was $4,020, compared with $2,053; financing cash inflow was $411, versus an outflow of $625. Cash and cash equivalents ended at $472, down from $598 at year-end 2013.
• Capital spending: Nine-month capital expenditures were $2,678. The company reported $353 of sustaining capital expenditures and $2,703 of discretionary capital expenditures for the period; the latter category includes acquisitions and contributions to unconsolidated ventures as described in the filing. It expected full-year 2014 sustaining spending of $522 and discretionary spending of $4,024.
• Debt: Balance-sheet debt, including debt fair-value adjustments, was $37,943 at September 30, 2014. The filing separately reports $35,010 of consolidated debt excluding fair-value adjustments, including current maturities and the preferred interest in KMP’s general partner. Debt excluding fair-value adjustments increased from $33,062 at year-end 2013.
• Liquidity: Working-capital deficit was $2,599, compared with $2,207 at year-end. Available borrowing capacity was approximately $825 for KMI, $2,355 for KMP, and $1,000 for EPB. KMI reported compliance with its financial covenants; KMP and EPB had no revolver borrowings, though KMP had $135 of commercial paper outstanding.
• Dividend cash measure: Management’s non-GAAP cash available to pay dividends was $435, or $0.42 per average share, in Q3 against a declared $0.44 dividend; for nine months it was $1,340, or $1.29 per share, against $1.29 declared. The filing cautions that this measure is not GAAP and should not be considered in isolation.

Material changes and operating trends

• Revenue rose 14% in Q3 and 20% for nine months. Operating income increased 28% and 23%, respectively. KMI-attributable net income rose 15% in Q3 and 5% for nine months.
• Nine-month income from continuing operations declined 6%, despite higher revenue and operating income, reflecting higher interest expense and the comparison with significant 2013 gains. The prior-year period included a $558 gain on remeasurement of the Eagle Ford investment and a $224 gain on the sale of Express pipeline investments.
• Segment EBDA, a company-defined non-GAAP measure, increased 19% in Q3 and 3% for nine months. Management said that, excluding identified certain items, income from continuing operations before unallocable taxes increased 11% for Q3 and 12% for the nine-month comparison.
• Growth contributors included natural gas pipelines, products pipelines, and terminals. The terminals business benefited from acquired marine assets, expansions, and the BOSTCO terminal beginning operations in October 2013. Natural gas pipeline results also included a $198 increase from early termination of a long-term transportation contract.
• CO₂ segment revenue and earnings benefited from higher CO₂ contract prices and volumes. Reported crude oil realizations were lower year over year, and management noted that the Midland-to-Cushing price differential reduced net prices relative to KMP’s Q3 budget.

Outlook, merger plans, and notable items

• Proposed mergers: Agreements signed August 9, 2014 would have KMI acquire the remaining public interests in KMP, KMR, and EPB. Completion of each transaction was contingent on the other two and subject to shareholder and unitholder votes and other conditions. The company expected closing in Q4 2014. Proxy materials had been mailed and special meetings were set for November 20, 2014.
• Merger financing: KMI arranged a $5.0 billion bridge facility and a $4.0 billion replacement revolver, expandable to $5.0 billion subject to conditions. Management expected to finance the cash consideration and transaction expenses primarily through debt securities, with bridge borrowing available if needed. The filing estimated approximately $4.2 billion of additional debt associated with the transactions and pro forma consolidated debt of approximately $39.3 billion, based on June 30, 2014 figures. The planned post-merger structure included cross-guarantees of debt among KMI, KMP, EPB, and substantially all debt-bearing wholly owned subsidiaries.
• Dividend outlook: KMI expected to exceed its published 2014 budget dividend of $1.72 per share, citing continued strong performance at KMP and EPB. The board declared a Q3 dividend of $0.44 per share, payable November 17, 2014. The filing emphasizes that dividends are discretionary and depend importantly on distributions from KMP and EPB.
• Rate-case settlement: After quarter-end, SFPP and shippers executed a proposed global settlement of California proceedings providing for $319 of refunds, consistent with established reserves, and a three-year moratorium on new rate filings or complaints. CPUC approval was anticipated before year-end; the company expected the payment not to adversely affect KMP’s Q4 results or 2014 distribution outlook.
• Contingencies: Legal reserves were $723 at September 30, up from $624 at year-end; environmental reserves were $347, down from $378. Significant matters include pipeline rate proceedings, railroad easement and relocation disputes, environmental remediation, and litigation challenging the proposed mergers. The filing states that ultimate outcomes cannot be predicted and that estimates may change.
• Merger risks and costs: The mergers could fail or be delayed, and litigation sought to enjoin votes. Specified termination scenarios could require fees of $817 to KMP or $311 to KMR. Estimated transaction costs were approximately $90, excluding potentially substantial financing expenses. Added debt, floating-rate exposure, cross-guarantees, and constraints on future financing or dividends were identified risks.
• Other risks and controls: Commodity prices, interest rates, counterparty performance, environmental and safety obligations, and access to debt and equity markets could affect results. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

• Whether all three proposed mergers received the required approvals, closed on the anticipated timetable, and were financed on terms consistent with the company’s expectations.
• Post-merger debt, cross-guarantees, credit ratings, covenant headroom, and the effect of financing costs on cash available for dividends.
• Whether the $319 SFPP settlement received regulatory approval and was paid as expected, and whether the recorded legal and environmental reserves remain adequate.
• The sustainability of dividend coverage, particularly the Q3 non-GAAP cash-available figure of $0.42 per share compared with the $0.44 declared dividend, and the company’s reliance on KMP and EPB distributions.
• Underlying segment performance after separating acquisition effects and unusual items, including the $198 contract-termination benefit and the significant Eagle Ford and Express gains in the 2013 comparison.