Westar Energy Inc. (NYSE:WR)
Q3 2008 Earnings Call
November 7, 2008 10 00 am ET
Tony Somma - Treasurer
Bill Moore - President and CEO
Mark Ruelle - EVP and CFO
Doug Sterbenz - EVP and COO
Michael Lapides - Goldman Sachs
Good day, ladies and gentlemen, and welcome to the third quarter 2008 Westar Energy Earnings Call. My name is Stacy, and I will be your conference moderator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. (Operator Instructions). As a reminder this conference is being recorded for replay purposes.
I would now like to turn the presentation over to your host for today's call, Mr. Tony Somma, Treasurer. Please proceed.
Good morning. I am Tony Somma, Treasurer of Westar Energy. Welcome to our third quarter 2008 earnings conference call. Some of our remarks will be forward-looking and as such I remind you of uncertainties inherent in our comments during this call or that may be contained in our materials that supplement the release. This morning we posted the earnings release and supplemental materials on our website at weststarenergy.com.
The supplemental materials include information intended to assist investors in their analysis of our financial release. They can be found on our investor presentations within the investor section of our website. The applicable Safe Harbor disclosures are presented at the end of the release. We filed our 2008 third quarter form 10-Q this morning.
With that I want to introduce Mark Ruelle, our Executive Vice President and Chief Financial Officer.
Good morning and thank you for joining us. On the call with me today in addition to Tony are Bill Moore, our President and CEO; Doug Sterbenz, our Chief Operating Officer, and other members of our senior management team.
In addition to commenting on the third quarter, I will provide updates on our 2008 earnings guidance and comment on our rate case and regulatory developments. Tony will then provide more in-depth discussion of financing activities and plans and details about the quarter and then Bill will finish with an update on our principal construction projects and planning initiatives, giving due consideration to the present markets and economic circumstances that we know must be forefront on your minds, too. After that we would be happy to take your questions.
Following our October 2nd, call I doubt you're surprise to do learn that today we reported third quarter 2008 earnings of $0.81 per share, some $0.18 lower than 2007 earnings of $0.99 per share. As we indicated would be the case in October, weather was a significant contributor to the lower result. Cooling degree days for the quarter were 14% below normal and 26% below last year, what started out as a cool summer only got cooler throughout August and September.
Energy marketing has improved somewhat from the second quarter but it certainly hasn't returned to the conditions we enjoyed last year and in recent prior years. We're not sure precisely what all the reasons are, but the key suspects are the liquidity of the trading community and more RTO based transactions so planting negotiated by lateral deals.
As we said before, we don't intend to change our risk profile in an attempt to chase down and overcome these prevailing market dynamics. If these conditions persist, energy marketing margins will become a smaller percentage of our bottom line.
Accordingly, based on year-to-date results and expected trends, we expect energy marketing margins or what some of you know as our non-asset activities, could be as much as 40% below the full year 2007 level of $37 million. This is a further degradation to the 30% reduction in these margins we suggested might occur on our Q2 call.
With regard to off system sales made from our units or what we record as market-based wholesale or asset based transactions, the amounted we credit back to retail customers this year is still fixed. Our outlook for these sales is about in line with the $52 million that we must refund to customers.
As outlined in the pending rate case settlement, this historical credit based on a three-year average will only continue until new rates become effective early next year, likely by early to mid February. After that we will simply refund the same amount we earned, doing so through our fuel clause with an annual true-up. This eliminates the risk of having to provide larger credits than the margins we actually produce.
All of this considered we are affirming the 2008 guidance answer we issued October 2nd of $1.35 to $1.45 per share. Our guidance excludes the positive adjustment of about $0.38 per share stemming from the favorable tax adjustment we recorded in the first quarter. As a result, our reported earnings per share are still expected to be significantly favorable to our guidance, as our guidance excludes the tax benefit.
As you know, our ability to achieve earnings in accordance with guidance is depended on a number of variables including weather, operating regenerating plants, prices in fuel and wholesale power markets, conditions in capital markets, COLE income and the funding of our planned capital program among other factors.
As a further note to-date we have received about $6 million of COLE income compared to an actuarially budgeted basis of $10 million for the full year. The full $10 million is still assumed in our guidance.
Now let me turn to regulatory matters. In May we filed a retail rate case requesting and annual increase of approximately $178 million or just under 15%. But the case was so straight forward is the primary reason we were able to reach a unanimous settlement on October 27th. Subject to the approval by the Kansas Corporation Commission it calls for a $130 million or 11% annual increase in rates.
Let me summarize a few of the specific components addressed by the agreement. We expect an order by late January with new rates in effect by mid February. We will modify our fuel adjustment clause to adjust it quarterly rather than monthly. This should mitigate some of the month-to-month pricing volatility the consumer advocate was concerned about, but doesn't change the tariff's overall mechanics.
We will simplify the crediting of market based wholesale margins to customers through the fuel adjustment clause. Beginning with new rates the amount to be credited will be based on our quarterly projection of margins from these sales with an annual true-up. Historical margins will no longer have any bearing.
Energy marketing or non-asset margin will remain outside of the cost of service. The deferred 2007 ice storm costs will be included in rate base and amortized over five years instead of the four years that we had proposed in our application. We have agreed to forego an incentive return on the wind generation that's currently under construction.
The transmission delivery charge and environmental cost recovery rider increases recently granted by the commission remain separate from the $130 million increase. However, we will roll the ECRR revenues into base rates and reset that rider to zero. We will increase depreciation expense for steam generating plant by $7.6 million.
If the parties agree we may use a statutorily permitted method of an abbreviated rate proceeding to recover the portion of revenue requirements for Emporia Energy Center wind projects not reflected in the present rate settlement. We expect this will address about $120 million of investment not yet in CWIP, in addition to picking up the operating costs and depreciation expenses associated with Emporia Phase II and the wind investment.
This should avoid the complexities of a full blown rate case, because the abbreviated proceedings will not require the parties to relitigate all of the other issues typically comprising a general rate case.
The capital structure includes 51% equity on a rate base of about $3.1 billion. There are two other components of Westar's total rate base, the FERC regulated transmission rate base of $315 million and the rate base associated with the pollution control investment of about $233 million that are not included in that $3.1 billion figure.
Though an ROE was not stated in the agreement generally for regulatory accounting purposes such as the ECRR and AFUDC calculations as well as the abbreviated rate proceeding, the parties have agreed to use a 10.4% ROE.
As for other regulatory matters, let me address developments with respect to a couple of other tariffs. In March the FERC approved an increase to the ROE in our transmission formula rate, but set an important remaining matter for settlement discussions. The other matter, deals with changing the rate formula to reflect a forecasted test year with a subsequent true-up.
On September 26th we filed an uncontested settlement agreement on this matter and that agreement has been forwarded to the FERC with a recommendation for approval. We expect the FERC to rule on this matter in December, and if approved, the new rates would go into effect at the wholesale level on January 1st and we would expect to update our companion retail transmission rider thereafter.
I hope by now everyone understands the portfolio of approaches that our regulators use to set our prices. We think this holds advantageous for both our customers and our investors. It allows greater transparency into our present and predicted prices. It allows smaller price adjustments and ultimately yields lower prices for customers while still providing investors confidence about our business plan.
Now let me turn things back to Tony to share with you an update on our financing plans and a few more details about the quarter. Given everyone's appropriate preoccupation with matters of the market and liquidity he'll update you on that as well.
Thanks, Mark. Let me address liquidity first. We consider ourselves fortunate to have negotiated earlier this year a 50% increase in our multi-year revolving credit facility that runs through March 2012. After adjusting for the $20 million reduction associated with Lehman Brothers failed participation, we have a $730 million facility. As of November 4th, we had approximately $370 million available after taking into consideration present usage.
Additionally, I am happy to report that as of Wednesday all of Westar senior unsecured credit ratings are now rated investment grade by all three major rating agencies. This reduces our need to post letters of credit which also gives us more flexibility.
Considering our outstanding revolver balance and remaining capital required to finish up the first phase of our large construction program, expect us to issue debt most likely first mortgage bonds either later this year or early next year.
Now with respect to equity, you should expect us to scale back those needs commensurate with our '09 capital budget in terms of both timing and amount. It's hard today to see us raising much equity 2009.
Our thoughts about how we finance our business haven't changed. We continue to target a capitalization of 50% debt and 50% equity with a bias of an equity ratio slightly north of 50%. As Mark said our rate settlement is consistent with this as it reflects 51% equity.
A business plan that assumes capital will always be cheap and available isn't much of a business plan. The flexibility in this respect that we built into our planning couldn't be more useful than it is right now. By basing our gross plan on smaller more scalable investment across asset classes, this leaves us with more flexibility to adjust our construction program and to align it with capital market conditions.
We're busy doing our '09 budget right now. You should plan to see a capital budget below what was in our earlier forecast with a financing plan to match. Bill, will discuss this in more detail in a few minutes.
At the beginning of the quarter we had about $272 million of issued and outstanding variable rate tax exempt bonds. The rates for these bonds are set via periodic auctions like most of our auctions have failed with recent index based failure reset rates as low as 2% and as high as 14%.
As the reset rates began to rise we elected refund and term out some of the issues at fixed rates and in late August we refunded $50 million at a fixed rate of 5.6% and in early October of all times we were still able to refund another $50 million at a fixed rate of 6%.
We continue to monitor and review our options with respect to the remaining $172 million of auction rate bonds. In the meantime we're pleased to see that in the season which fare rates are based have dropped significantly. Our most recent reset resulted in a rate of only 3.2%.
Like many companies, we're keenly interested in what this market means for our pension funding given lower asset values and changing discount rates. We measure our plan at year end, so it is too early to tell what impact recent market events will have. We plan to address that as part of the discussion of our '09 budget and guidance early next year.
Mark discussed the principal drivers for the quarter, but I will provide a few more details you might find of interest. Total sales increased $26 million driven largely by increased retail sales. Mostly this was due to higher prices resulting from higher fuel recovery costs.
Offsetting the higher prices were lower kilowatt hour sales volumes, which were down 7% compared to last year due to cooler weather. Fuel and purchase power expense increased $37 million or 21% primarily to reflect the amortization of last year's under collection through the fuel adjustment clause.
Our current period cost of fuel and purchase power was virtually unchanged from last year. At the end of September we had about $15 million of under collections still to be recovered.
Operating and maintenance expense decreased $13.5 million compared to last year. This was due primarily to $6.2 million of lower maintenance costs at our power plants in our electric distribution system and $7.6 million decrease in SPP network transmission costs. The latter of which is largely offset by lower transmission revenues.
Other income increased by $7.7 million compared with last year primarily from $5.7 million of corporate owned life insurance proceeds.
Now let me turn things over to Bill Moore.
Thanks Tony, and thanks all of you for joining us today. Before taking your questions, let me update you on several of our major construction projects and then discuss our plans to respond to capital market conditions.
Our growth plan is in place not only to meet our customer's needs, but also to grow the value of our business. If capital market conditions in the economy are not conducive to meeting those two important goals, then obviously we will adjust our plans accordingly. We didn't predict this particular set of events, but as Tony said, our business plan certainly leaves room for surprises and accordingly we have built flexibility into our plans.
Progress on our large scrubber project at Jeffrey Energy Center continues. The first unit went into operation in July and is operating as planned. Installation of the second unit is underway right now and should be in service by the end of the month. Current plans call for the third and final unit to be completed next spring.
Let me remind you that the first phase of Emporia Energy Center, our new 610 megawatt gas fired peeking station went in service in June and performed very well over the summer. In fact, some favorable dislocation in the gas markets allowed us to run these low heat rate units even in October.
The two turbine generators comprising the remaining 300 megawatts are already on their foundations and slightly ahead of their scheduled in-service date next spring. This project cost remains on track with its original estimate of $318 million.
The rate settlement includes about $280 million of this total. This is split about $200 million for Phase I as plant in-service and about $80 million for Phase II as CWIP. The remaining portions of Emporia's revenue requirements can be included in the abbreviated case Mark mentioned.
Our three wind projects totaling almost 200 megawatts are expected to begin commercial operation by year end. Towers and generators are presently being installed and we're taking test power from a few units.
Recall that we will own half of these wind turbines and purchase power from the other half through contracts. We expect our investment to be about $285 million, a $5 million decrease from what we shared with you in August.
About $200 million of this investment measured through September is already reflected in the present rate settlement as CWIP. The balance plus depreciation and operating expenses can be included in our abbreviated rate proceeding contemplated in the rate settlement.
By year end we expect to energize the first leg, the 40-mile section running from Wichita to Hutchinson of our new 100-mile 345 KV transmission line. We already have acquired the rights of way and are ready to begin construction on the second leg from Salina South to Hutchinson. But we will manage the construction schedule in accordance with our view of customer demand and economic conditions.
In the meantime we're pleased to see steel prices falling. Recall that this is the project for which the FERC authorized incentives of a 12.3% ROE and a 15-year book depreciation recovery.
We have siding authority for our second large 345 KV project, the 50-mile line from Wichita South to Oklahoma. We are prepared to begin acquiring rights of way for this line, but again we have timing flexibility, and are taking advantage of it in light of economic conditions.
In May we announced the formation of Prairie Wind Transmission LLC. Our 50% owned joint venture that plans to construct and operate approximately 230-miles of 765 KV transmission, that would run from Wichita to Western Kansas with a spur to Oklahoma.
Already Prairie Wind has taken several steps to move the project forward. We have one filed with the KCC for a certificate of public convenience and authority, the first step necessary to build transmission facilities in Kansas. Two, develop preliminary routes for the line; three, applied at FERC to request a formula rate with incentives, and; four, are working with the SPP to obtain regional funding for cost recovery.
We estimate that it could take about a year or more to obtain regulatory clarity on this project. Our current CapEx forecast does not yet include this investment as we don't anticipate any meaningful spend prior to 2011 with a target in service date in 2013.
Well, there is never a good time for liquidity crisis, and conditions in the capital market and the economy are capturing our interest as much as anyone's. However, I am pleased with the flexibility we have built into our business plan is reaping benefits.
Our decision to avoid huge commitments to single assets or one type of asset is being validated. The scalability and diversity of our capital program gives us flexibility that some of our peers may not have.
Moreover, by good fortune we find ourselves at a convenience inflection point. We're at the very end of our first phase of large construction projects, but have not yet to commence the second phase. This flexibility is consistent with our commitment to the value proposition of being a basic vertically integrated rate regulated electric utility.
We certainly couldn't have predicted recent economic events, but these very attributes of our strategic approach suit us well to deal with them. We will continue to keep you apprised of the progress in our capital expansion plan and the companion regulatory processes.
We're now ready for questions from the financial community, members of the media we invite to you contact Karla Olson at 888-613-0003 if you have questions. Operator, would you please open the lines for questions?
(Operator Instructions) Your first question comes from the line of Michael Lapides with Goldman Sachs. Please proceed.
Michael Lapides - Goldman Sachs
Hey, guys, look forward to seeing you next week in Arizona at EEI. Quick question for you. How does the KCC treat short-term debt, whether its commercial papers or letters of credit or anything else, in terms of dealing with the regulatory authorized capital structure in rates and revenue requirements?
It has typically and traditionally and this settlement has been excluded from the capital structure.
Michael Lapides - Goldman Sachs
So you could issue some short-term debt necessary to finance it and then eventually either term it out as your equity layer grows with retained earnings or just eliminate it with equity?
Sure. We view short-term debt as simply a transitional form of financing and that our long-term capital structure should be appropriately balanced with our rate base.
Michael Lapides - Goldman Sachs
Understood. Question a little bit on when we think about the '09 capital budgets. When I look at kind of your publicly disclosed CapEx plan and the supply plan, trying to think about what are the items that are most flexible. You laid it out in pretty decent detail. I didn't know if there were items whether its in the transmission bucket or whether it is in the $130 million-$140 million of refurbishment and other generation work where you have the most flexibility?
I tell you, Michael, obviously we are pretty condensed business, we operate in a single state. The officers of the company sit around the same table every Monday morning and the whole team is looking at just that question right now. So its certainly includes what may be people would call the sort of the run of the mill maintenance kind of capital and it also includes some of the larger projects. Doug, do you want to shed any light on that?
Sure. This is Doug Sterbenz. I would say we have a great deal of flexibility. Certainly our growth plan that outlined in our comprehensive energy plan calls for very large projects. We're looking right now at scaling some of those back as needed. Also, our plan shows for a pretty large capital maintenance budget. Things that we would like to do to ensure good quality service going into the future but there is certainly other ways to handle that in the short run and we're having to looking at all those options right now.
And more importantly everyone is so focused on just the capital market. It is an important consideration but it's not the only consideration. We don't want to get ahead of our customers, either the demand for the facilities or their ability to pay for facilities. So in looking at this, sure, we look at the capital markets in what we think the market wants to see us invest. But just as important to that as we're looking around to see what our customers maybe can afford to what they want to pay for. And so it is really those two things that work into our capital planning. Sorry we don't have more information right now, but you should expect as Tony indicated that our capital budget for '09 will be smaller than what our forecast showed for '09 based on the present economic circumstances.
Michael Lapides - Goldman Sachs
Got it. Okay, thank you guys.
(Operator Instructions). With no further questions in the queue, I would like to turn the call over to Mr. Bill Moore for closing remarks.
Well, thank you for joining us this morning. Members of the Westar management team as Michael said will be at the EEI Financial Conference next week. We look forward to seeing many of you there. If you have follow-up questions, please contact Bruce Burns, our Director of Investor Relations at 785-575-8227. Thank you again for joining us this morning.
Thank you for your participation in today's conference. This does conclude your presentation. You may now disconnect and have a great day.
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