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The healing has yet to begin at battered

El Paso



Two months after a nasty proxy fight that left the incumbent board bruised but intact, El Paso reported a steep quarterly loss to investors who had been hoping for signs of recovery.

The giant pipeline operator, still reeling from a disastrous foray into energy trading, posted a second-quarter loss of $1.2 billion, or $1.99 a share, that easily dwarfed the modest loss from a year ago. Even pro forma math -- which excludes "extraordinary" items and often leaves the company with an operating profit -- was not enough to push El Paso into the black this time around. The company, expected by Wall Street to deliver operating profits of 13 cents a share, instead posted a 1-cent loss. It also issued full-year guidance of 15 cents to 45 cents a share that fell well short of the 78 cents analysts had been anticipating.

El Paso shares slipped 6.9% to $6.89 on the news.

The company blamed the disappointing quarter on its once-powerful trading division, which weathered a $95 million loss -- down from $132 million a year ago -- as it continues to wind down. But even its "core" businesses suffered a downturn as massive asset sales dried up former profit streams.

Nevertheless, El Paso Chairman Ronald Kuehn promised better times ahead.

"We believe that the actions we are taking will position us for further debt reduction and earnings growth in 2004," Kuehn said. "We are making steady progress on our asset sale program, simplifying our balance sheet, reducing our total obligations senior to common stock and continuing the liquidation of our trading book. All of these are important components of our concerted efforts to strengthen the company."

As one of the highlights of the first half, El Paso listed a reduction in "consolidated obligations senior to common stock by $1.5 billion, net of non-recourse project finance debt." But deeper into the quarterly update, El Paso blamed a hike in interest expense -- which jumped to $479 million from $347 million a year ago -- on "higher average debt balances in 2003" and the consolidation of some off balance sheet vehicles.

In his attempt to dislodge El Paso's leadership, dissident holder Selim Zilkha had accused the company of selling off mainly core businesses supposedly to pay off a huge debt load that was actually on the rise. Since then, asset sales have clearly cut into El Paso's earnings power. In every core business -- pipeline, production and field services -- El Paso pointed to reduced assets as a reason for declining pro forma profits. Losses in the company's fading energy trading unit, $50 million higher than expected, went on to drag quarterly results into the red.

"The punch-line is, this is a tough business," merchant energy director Bob Baker said of energy trading. But "we're on target to exit this business by the end of 2004."

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By then, Doug Foshee -- who takes the reins from Kuehn on Sept. 2 -- will have more than a year of experience as the company's turnaround CEO. And Zilkha's camp will be closely monitoring Foshee's performance.

Foshee, best-known for his work on a



asbestos settlement that may now fall through, snagged the same $900,000 base salary suggested by the dissidents,but far more generous benefits and perks. Despite that disparity, the dissidents -- who nearly toppled El Paso's entire board by promoting strong corporate governance -- are willing to give Foshee a chance.

"We understand from various sources that he is a good financial man," Zilkha said in a recent letter to Kuehn. "Our preference would have been a leader skilled in operations, an area where we believe El Paso is deeply lacking. ...

But if he can genuinely change the culture at El Paso and restore value to its investors, he will have earned the compensation he has been promised."

Zilkha was far less generous with Kuehn himself. The dissidents have attacked both Kuehn's track record in the industry and his rich compensation for serving as nonexecutive chairman of El Paso. Kuehn is collecting a $300,000 salary -- more than triple the dissidents' suggestion -- for chairing the company.

"Our chairman-designate would have received $80,000 -- all in stock," Zilkha reminded Kuehn. "I trust that you will no longer need a free company apartment at the Four Seasons Hotel in Houston, or need to be shuttled back and forth to Birmingham by private jet, at the expense of El Paso shareholders."

El Paso itself has promised to slash unnecessary expenses. Through its "Clean Slate" initiative, the company has identified $445 million worth of cost-saving opportunities that it expects to realize by the end of next year. Much of the savings will come from reduced headcount as El Paso exits merchant-related businesses. But the company -- known for its generous spending in the past -- has pledged to be more frugal going forward.

"This initiative has created a culture change," El Paso executive Bob Phillips said, adding that it should eliminate the "bloating" of years past.

For now, El Paso promised that big charges -- which have dogged the company for years -- are at least temporarily behind it. The company has included no extraordinary charges in its forecast of a full-year net loss of $2.35 to $2.65 a share. And while it acknowledges that impairments could arise "out in the future," it is projecting that cash flow -- which nearly doubled in the first half to $1 billion -- will continue to grow and that earnings will recover sometime next year.

"As we look to 2004, we certainly expect a much better earnings picture," Kuehn told analysts Wednesday. "We are very optimistic ...

about getting El Paso back on track."