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Executives

Tony Somma – Treasurer

Mark Ruelle – Executive Vice President and Chief Financial Officer

Bill Moore – President and Chief Executive Officer

Doug Sterbenz – Chief Operating Officer

Greg Greenwood – Vice President Generation Construction

Kelly Harrison – Vice President Transmission

Jim Ludwig – Executive Vice President

Analysts

Steve Cambata – Longbow Capital

Greg Gordon – City Investment Research

Michael Lapides – Goldman Sachs

Ted Hayne – Catapult Capital

Neil Kalton – Wachovia

Westar Energy Inc (WR) Q4 2008 Earnings Call February 27, 2009 10:00 AM ET

Operator

Welcome to the Westar Energy fourth quarter 2008 earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s conference, Mr. Tony Somma, Treasurer. Please proceed.

Tony Somma

I am Tony Somma, Treasurer of Westar Energy. Welcome to our fourth quarter and year end 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 our 2008 Form 10-K was filed and we posted the earnings release and supplemental materials on our website at westarenergy.com.

The supplemental materials include information intended to assist investors in their analysis of our financial release. They can be found under investor presentations within the investor section of our website. The applicable Safe Harbor disclosures are presented at the end of the release. As is our custom, joining me this morning is Bill Moore President and CEO, Doug Sterbenz Chief Operating Officer, Mark Ruelle CFO, and a number of our senior management team. After our prepared comments we would be pleased to take your questions.

We have a lot to talk about this morning, so we’ll not repeat what we provided in print. We will instead use the time to share with you more details about our business, including what we know must be on everyone’s mind, the economy. We’ll also discuss our investment plans and upcoming regulatory events.

Of course, we’ll spend a few minutes on financial highlights, our dividend increase, and ’09 guidance as well. We’ll begin with Bill sharing his thoughts with respect to the economy of our service territory, I’ll cover the 2008 results, then Mark will address our regulatory milestones this year, our CapEx plan and earnings guidance.

With that, I’ll turn things over to Bill Moore.

Bill Moore

I know all of you are as interested as we are to find out what the present economic conditions mean for sales, our business plans and earnings. Let me start by reminding you about some of the attributes of the areas we serve because not all utilities in the region are exposed to the same economic drivers. We don’t believe it would be accurate to simply extrapolate the experience of other utilities and assume the same for us.

Our retail kilowatt hour sales are divided fairly evenly among residential, commercial and industrial customers with industrial representing a slightly smaller slice at 29%. The economy of our service territory provides diversity with contributions from aerospace manufacturing in Wichita, chemicals, agriculture and food processing, oil and gas refining and pumping, three major military installations, higher education and state government. This diversity has served us well in the past and we hope that that will continue.

Real estate is not a particularly powerful driver for us. We didn’t enjoy a boom in real estate and we hope that bodes well for avoiding a bust in the future. For example, you can still purchase a new 2,000 square foot three-bedroom two bath home in a good neighborhood in Topeka or Wichita for about $180,000. This price wouldn’t have been much higher two years ago, and the foreclosure rate last year in Kansas was less than a third of what it was nationally.

One of the advantages of serving in the heartland is that most folks can pay and will pay their bills. We expect uncollectibles to be a bit higher this year, but still only about one-third of 1% of revenues. So far we haven’t seen any evidence of it mushrooming, but we are watching it closely.

Of course we’re not immune to the global economic slowdown just shielded a bit from it. We made adjustments to our 2009 sales budget to take into account the present economy. We are monitoring sales and business activity closely. January sales were slightly favorable to our expectations. February sales are running a bit softer but that takes into account unusually warm 60 and 70 degree weather this month.

What keeps us on edge are the announced layoffs mostly in Wichita among the aerospace and consumer products manufacturers. We’re monitoring sales to these customers closely and communicating with them frequently to discern any downward trends in production not already reflected in our projections.

Not surprisingly, there is evidence of a slowdown in orders for aircrafts similar to what we saw post 9/11.

This fact, more so than the layoffs, is contributing to reduced energy sales. Our customer relations employees are in regular contact with our top 125 customers, and our projections for electric usage for our major customers reflect both our customers and our own people’s current thinking on the affect of the economy on these businesses.

Significant to the strength of our service territory, we serve several manufacturing plants viewed as flagship facilities for their operations. For example, we serve one of the world’s largest low cost frozen food manufacturing facilities, one of the few foundries making large parts for the heavy equipment industry, plus a very large aftermarket automotive battery plant and a large fluorescent lighting facility.

None of these operations produce luxury goods, but typically make low cost products that individuals consume or use in their homes, which in some cases we think will mean increased demand in an economic downturn.

During the past 12 months, we have had a couple of our industrial customers shut their doors, a meat packing plant last summer and a truck wheel manufacturer in the fourth quarter. But we also see growth from existing customers and the addition of new customers. A major pet food manufacturer will open a new facility later this year.

And over a slightly longer development schedule, a major pipeline company has a project underway that will add four large pipeline pumping stations. That pipeline project remains on schedule, although we don’t expect to see the new demand until next year and into 2011. We expect these new facilities will help offset the ill effects of the economy generally and demonstrate pockets of good news exist also.

In Kansas, we ended 2008 at an unemployment rate of 5.2%, a full two points better than the national average. We won’t have state numbers for January until later today. However, BLS reports that in Kansas initial unemployment claims in January fell by 69% compared to December countered to the national data.

It’s clear when you examine the data closely that this economy is having the greatest impact on the east and west coasts. This is evidenced by the fact that Kansas was one of the 17 states, mostly in the Midwest, where initial unemployment claims fell. Obviously, we’re watching all of this very loosely as it affects not just industrial sales, but all retail sales.

In putting together our 2009 budget, we made significant adjustments to our former plans. When we look at total retail sales to date, we’re about where we thought we’d be. Only time and the economy will tell whether these revised projections are enough.

Before I turn the call back to Tony, let me say a few words about our dividend. I hope you noticed our board’s action on Wednesday. Based on our dividend payout guidelines and business expectations and taking into consideration present economic conditions, we concluded a 3.4% increase in our dividend was in order. We hope this helps you share in our confidence about how our business is positioned for the future, even if present economic conditions guided us to a more modest increase this year

Now Tony will comment on results and update you on our financial position.

Tony Somma

We reported 2008 EPS of $1.70 per share. We had some very positive developments in the form of income tax matters that offset what was clearly a disappointing year in terms of energy marketing and weather influence retail kilowatt hour sales.

Let me address retail sales first. Fourth quarter retail kilowatt hour sales were down about 3% compared to 2007 with the most significant decline coming from industrial customers. The impact was primarily from a handful of our large customers.

Weather for the fourth quarter was milder. We estimate it reduces our retail margins by $7 million for the quarter, and for the full year 2008 compared to 2007, we estimate weather reduced our margins by approximately $20 million.

We saw further disappointment in energy marketing results. The softness in what we sometimes refer to as our non-asset wholesale activity continued. We shared with you on both our second and third quarter calls that those activities have been negatively affected by structural changes in this business.

We think the lack of liquidity of some of our trading partners, the soft economy and an increasing number of these transactions being completed through RTO real-time markets, rather than between individual parties, are the causes.

These factors reduced our ability to profit from real-time and short-term trading, which due to how we mange our risk profile, is where we prefer to trade. We’re hopeful of some change here, but as we said before, we don’t intend to chase these trends if it means adopting a riskier profile.

In addition in Q4, we along with many other participants in MISO, received the unwelcome news that MISO has again asked the FERC to re-price some historical transactions. Our Q4 results included a $3 million charge related to this potential refund obligation. We and others have filed protest at FERC challenging this re-pricing.

Not withstanding results from energy marketing, we were pleased with market-based wholesale activities or what we sometimes refer to as asset sales. Recall that under the regulatory protocol in place last year, we were required to refund to customers $52 million related to such sales. In fact, we produced greater than that amount, which helped offset the results in energy marketing.

The cost of the large investments in generating facilities that was not yet reflected in last year’s rates, we let you know that we viewed ’08 as being a transitional year. When coupled with milder weather, extended planned outages and energy marketing results, it was even more so. This made the KCC January order authorizing $130 million price increase a necessary and welcome event.

A bright spot last year was in the area of income taxes. Like many utilities, we had an open issue with the IRS regarding capitalized overheads and other matters. We were able to settle the matter favorably. We recorded a $0.38 per share benefit in the first quarter last year eliminating a tax reserve and related accrued interest

Also in Q4, we have secured significant state tax benefits related to investments and job creation under the Kansas High Performance Incentive Program. This turned out more favorably than expected producing a tax benefit of almost $15 million with commensurate cash benefits expected to be received this year.

To continue on the tax front, we already had a large favorable event this year. Those of you who have owned us for a while know that earlier this decade we divested non-regulated business at a large loss. I won’t get into all the reasons for it, but at the time of the sale there was uncertainty about the ultimate tax treatment of the loss so we recorded loss principally as a capital loss. Because the ability to use capital losses is limited, we had a valuation adjustment against that taxed asset.

We have consistently shared with you that managing our tax expense is as important to us as managing other aspects of our business. One of our objectives was to try to realize as much value as possible from that unregulated capital loss provided that we could do so without altering our risk strategy or profile.

In January of this year, we reached a settlement with the IRS that allows us to re-characterize a significant portion of that capital loss to an operating loss. We expect this will result in a gain in discontinued operations of approximately $0.30 per share in Q1 ’09 with more than half the cash benefit likely coming in later this year or next with the balance over time.

Before turning things over to Mark, I’d like to update you on our liquidity position. In November, we sold $300 million of first mortgage bonds. That, in conjunction with our reduced capital budget, which Mark will address momentarily, will sharply reduce our external funding needs this year. As of February 18th, we’ve had almost $500 million of available liquidity under a credit facility that continues into 2012.

Now I’ll turn things over to Mark.

Mark Ruelle

Let me start by briefly recapping some recent regulatory events and letting you know what you might look forward to in terms of regulatory activity this year. With regard to base rates, the KCC approved on January 21st the unanimous stipulation and agreement we entered into in October. We implemented those new rates on February 3rd.

Recall that the settlement resulted in a $130 million or about 11% annual increase in base rates. The order also approved our long sought changes to simplify how we credit wholesale margins back to customers. Starting in March, we will provide credits for the asset-based margins equal to what we produce, no more no less.

This should simplify your analysis of our business, as it should make our earnings a little more predicable. The KCC order also authorized us to file an abbreviated rate case to realizing rates remaining investments and operating expenses associated with our wind and Emporia generating facilities.

Much of the cost of service for these new investments was already captured in the recent increase, but the full amount couldn’t be included until the plants were completed and in operations. With them now complete, or very nearly so, we expect to file the abbreviated case later this spring. We estimate the increase in our cost of service to be between $15 and $20 million.

We’re presently looking at some of the tax provisions of the stimulus bill, which could affect the final amount of the request in the abbreviated case. If the commission takes the full statutory period allowed for base rate adjustments, we would expect this increase to take effect early next year.

On January 1st, we implemented FERC-approved adjustments to our transmission formula rate. The portion of those revenues applicable to wholesale customers, about 12% of the total, reflects an increase of about $4 million annually. To capture the retail portion, or about 88% of the total, in January we filed with the KCC a request to adjust our retail transmission delivery charge.

The KCC staff memo recommending approval was advanced to the commission just yesterday, according to our plan. Our request is for an annualized increase of just under $32 million, which we expect will be effective about mid-March.

With respect to investment and environmental projects, recall that regulators recognize between general rate cases investments we make in pollution control facilities through a rider. That rider is presently set to zero with the prior rider balance having been rolled into our new base rates.

We expect to file in March for an adjustment to the economic cost recovery rider to address the cost of service associated with almost a quarter billion dollars of environmental investments we made last year. We expect the adjustment to the ECRR to be approximately $30 million effective June 1.

Let me shift gears now and talk about our capital budget and projects. As you are aware, we’ve outlined a large multiyear capital investment plan to address environmental requirements, new transmission investments and our commitment to renewable energy, among other things.

As a function of good planning or good luck, we are finishing up the first round of those projects but haven’t yet started on the second round. Accordingly, we’ve exercised the flexibility in our strategy to significantly modify our 2009 capital budget from our earlier forecast.

We know many other utilities have also adjusted downward their capital budgets. It’s our observation that our reduction is significantly larger than what’s been typical for our industry. In last year’s 10-K and investor materials, we estimated that we would invest more than $820 million this year.

In fact, our approved 2009 budget is only about $500 million, an adjustment of almost 40%. These adjustments include some belt tightening, but mostly are comprised of rescheduling projects we still intend to construct.

Let me address a few of the big projects we have underway. Greg Greenwood here with us today is managing our large generation and environmental projects. He and his team just fired up the seventh and final unit at Emporia Energy Center with the second phase of this project placed in service yesterday.

I’m delighted to report that the project was completed two months ahead of schedule, under budget and within the amount pre-approved by the KCC and with more megawatt output than expected. In fact, the cost per kilowatt result was only $470, about 9% better than we planned.

Two of our three wind projects are now complete and the third should be fully operational before the end of March. With these wind projects, we will own about half of the turbines and we’ll purchase the output from the other half through power purchase agreements. We budgeted $282 million for the parts we own consisted with the amount pre-approved by the KCC. I’m happy to report that we expect these projects too to come in under budget.

With the growing pressures to focus on renewable energy, you might have seen that we just issued another RFP to give us a look at perhaps adding some more renewable resources, likely wind. We have about 300 megawatts today. If we and our regulators agree that it makes sense to do more, 200 additional megawatts would have us meeting our governors goal of renewables comprising 10% of retail peak by 2010.

We also see a growing probability for a federal renewable mandate that might require even more. Accordingly in our RFP, we have sought to take a look at a total of up to 500 additional megawatts. Our large and complex environmental project at our flagship Jeffrey Energy Center is in its final stage. In fact, we’re preparing for the tie-in outage for the last of those three new scrubbers in a couple of weeks.

The total project looks to be coming in about 20% more than planned, but it is on schedule. We had earlier estimated the total project cost to be about $360 million. Our present outlook has it at about $435 million, our share being 92% of those figures.

Turning to transmission, we completed and energized in December Kansas first major 345KV addition in many years with our Wichita to Hutchinson segment. It cost about $100 million and is already reflected in our formula rate with incentives.

We are now turning our attention to the northern segment, running from Hutchinson north to Salina. Kelly Harrison and his team expect to finish the northern segment by mid-2010, evidenced that once we have in hand the necessary approvals for a project, we’ll act swiftly to bring major transmission projects to fruition. The entire Wichita to Salina 345KV project we now estimate will run just over $200 million.

We continue to be excited about our Prairie Wind Transmission JV and its proposed 765KV line west of Wichita. We’ve already received FERC authority for incentives, and we continue working on the protocols to establish a formula rate for it. Prairie Wind has filed with the KCC for its utility certificate. Assuming the KCC grants Prairie Wind’s utility certificate, the next major regulatory step in Kansas will be citing authority from the KCC.

Many of you know that there’s competition for this project. The KCC is busy sorting this out and we are confident that the commission will appreciate the merits of what Prairie Wind brings to the table. Those of you interested in these proceedings, we would direct you to recent orders and testimony in the KCC dockets posted on its website.

While the two competing firms are still awaiting their respective utility certificates related to the proposed project, we don’t view the KCC as the holdup. It's a lack of a regional cost allocation process that’s keeping such large scale projects from being completed more quickly.

We’re participating in the Southwest Power Pool’s effort to establish a regional postage stamp rate authority to help this process along. Once that’s resolved, our best guess is that the project could be in its heavy construction phase in 2011 and 2012, with an in-service date late in 2013.

Let me now turn to our outlook for ’09. We issued this morning earnings guidance in the range of $1.65 to $1.90 per share. Those figures do not include the $0.30 per share tax benefit we expect to recognize this quarter.

We widened the range a bit, compared to when we issued 2008 guidance in light of the economic uncertainty. But of course guidance is conditioned on a number of factors, including such things as the weather, the economy, COLI results and other factors we can’t control, as detailed in the supplemental materials.

Before we take your questions, let me share some additional thoughts on our dividend. With the very items we shared with you today being the backdrop, we concluded that an increase in our dividend was in order. We’ve been steadfast in our discussion about dividend policy.

This action is consistent with those sentiments, as well as our view of our business expectations, albeit with a bit of caution given the larger economic influences. We continue to believe that a target payout ratio of 60% to 75% of earnings is an attractive and responsible goal.

We’re now ready for questions from the financial community. Members of the media, we invite you to contact Erin La Roe at 316-261-7429 if you have questions. Operator, would you please open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Greg Gordon – City Investment Research.

Greg Gordon – City Investment Research

A couple questions, when you look at the revised capital budget and as you look at your liquidity and your expected operating cash flow for the year do you think you’ll be coming to the market for common equity this fiscal year?

Mark Ruelle

Well as we said at our EEI presentation in November, we haven’t ruled out, but any requirement for new equity this year would be very modest, if any.

Greg Gordon – City Investment Research

So you think you could accomplish that through normal sort of 401(k) and DRIP?

Mark Ruelle

Well, we’d be flexible as to how we would do it. But the amounts if any that we have in mind could be fully satisfied with, for example, what’s remaining in our dribble.

Greg Gordon – City Investment Research

Second question, give us a little bit more guidance vis-à-vis what you’re expecting in terms of a range of gross margin targets in your wholesale business, and give us a sense of what the strategic landscape is, how it’s evolved, as MISO becomes more integrated into the flow of power in the region and that impact on the future of that business.

Doug Sterbenz

This is Doug Sterbenz. Let me refer back to 2008. Remember that we have been talking about two internal factors that have really led to the decline in these non-asset margins, and that is our staff spending considerable time dealing with our asset business in 2008, and that was driven by a couple of things.

First, we had some large capital projects, namely scrubber installations, at our large coal plants that we had to go out and, in essence, buy a bunch of power to replace. And so the same people that do the non-asset business are tied up doing that. In addition to that, we had some highly favorable gas basis in the Midwest here in the Q4 of last year, and that, recall, made a bunch of sales and so we’re out buying gas and selling off our assets.

Second, we are still adjusting to these marketing changes with these MISOs. SPP also went through some major changes a year ago as well. So we’re seeing some major changes where people are now dealing directly with the ISOs or they’re not doing bilateral transactions with folks like us.

Now with that said, going forward we do believe that we’re seeing more increased physical activity by some players who were historical financial players. That is a positive thing for us because this gives us more counterparties to do transactions with.

We’re also seeing some companies that are reducing staff and market exposure to trading, therefore, creating new opportunities for us, and we think we’re going to be able to capitalize on those opportunities in 2009. First let’s remember that the asset business is doing fine in 2009, and so now we can concentrate more efforts on the non-asset business.

Mark Ruelle

Greg, I’d also remind you that in 2008 we had pretty significant refund obligation we made to a customer and then also took a charge for the potential refund obligation on the MISO matter in ’08.

Tony Somma

Greg, this is Tony. What’s in our guidance range is an increase of ’08 margins on the energy marketing side of around 90% to 110%.

Greg Gordon – City Investment Research

What were they in ’08?

Tony Somma

Fourteen and some change, $14.5 million.

Greg Gordon – City Investment Research

Okay so an increase off of $14.5 million.

Doug Sterbenz

And the 14 was net, or did include the refund. So we actually did better than that, but we’re required to refund business. When we add up the various business segments that comprise the non-asset margins where in essence we think we can return, not quite to the historic levels, but within about 20% of what we budgeted in 2008.

Greg Gordon – City Investment Research

So between $25 and $30 million.

Doug Sterbenz

Yes.

Greg Gordon – City Investment Research

When you talk about the opportunities that are being created by the shifting landscape, is this requiring you to put more capital behind the business or increase your evaluate risk?

Doug Sterbenz

Not more capital. It’s more just reshuffling efforts within that department, redeploying people.

Mark Ruelle

Greg, I would actually say if anything, it’s been less, for a couple of reasons. One, we’re actually one of the few companies that has enjoyed a credit rating upgrade from two of the agencies in the last six months. And then secondly, I think the place it may be affecting the business is not our capital but the fact that some other folks that maybe aren’t as well capitalized, just don’t have the liquidity that they used to have so they’re maybe not trading as much.

Operator

Your next question comes from Michael Lapides – Goldman Sachs.

Michael Lapides – Goldman Sachs

I apologize I actually have a couple of questions here. One, when you look out to 2009, can you talk about whether you have a view on whether you’re likely to over or under earn this year. And if you can’t kind of talk directly to that, talk about the factors that could potentially drive any under earning in 2009.

Mark Ruelle

Well I guess in one respect, we’ve already said that we expect that because we intend to file the abbreviated rate case to pick up the portions of our wind investment, the portions of Emporia, and then basically the depreciation that wasn’t reflected in the CWIP that’s already in rate.

So clearly we see a need for higher prices which, implicit in that is that we are not earning our cost by filing the abbreviated rate case, obviously we're filing for an increase in our environmental cost and in our transmission cost.

So our cost of service is going up, so we've been able to reduce the regulatory lag significantly, but it's not eliminated. And I think it's fair to say, there is probably a little lag in there and yes, we'll under earn and that's why we have to raise our prices.

Michael Lapides – Goldman Sachs

During the course, if I look at the capitalization sheet at the back of one of your releases and all of the tranches of long-term debt, one or two of those stand out a little bit. The 8.625's due in 2018, and maybe one other tranche, just trying to think about that. Is that already embedded in your cost of debt that was settled upon in your last rate case, just given that's a slightly higher interest rate compared to what the rest of your debt is.

Mark Ruelle

No. That's the one we just did in November. You guys all know what the markets were like in November, but we felt it important to mange our business affairs in such a way to keep us plenty liquid through tough markets. We were pleased with it in terms of the rate, but we were not concerned about it either.

First of all in a weighted average basis, changes it ever so slightly. And secondly our rates are set kind of on a yield to maturity basis. So if you simply look at what was authorized in the rate case versus what a weighted average coupon is, we're still probably right at or even maybe slightly advantaged to that rate.

Michael Lapides – Goldman Sachs

Okay. Last question, you have a good amount of rate based growth coming via environmental projects and you've got a really good tracker on cost recovery on that. Can you talk about over the next four or five years, kind of the big picture, what are the projects you have to do, meaning that you are required by either the state or the EPA to do on the environmental front, and roughly what kind of the costs of some of those big components?

Mark Ruelle

Greg's with us, so I'm going to turn it over to him because, obviously, that's his business.

Greg Greenwood

Michael, the projects that we have coming up at our power plants are going to be things just like low NOx burners, precip rebuilds and then on the bigger projects in my group will be primarily at our coal station in Lawrence, and we'll be putting in fabric filters for particulate control on two units there, and also rebuilding the internal parts of the scrubber systems.

Those are projects that are scheduled to be done by the end of 2012 and they're required to be done and operating at 100% efficiency by the first day of '14.

Mark Ruelle

All of those of course are air quality projects, that are eligible for the cost recovery rate.

Greg Greenwood

And required by the Clean Air Act.

Michael Lapides – Goldman Sachs

Right. So if I look at your 2011, 10 and 11, CapEx for environmental purposes that are outlined in the 10-K, and it's really the 2010 and '11 numbers, where you go a pretty low number this year, wise to kind of push it out to $235, $236 million in 2010, and then $400 plus million in '11.

At the end of '11, does this assume you have completed all of that, or if you're actually modeling this past 2011, what's the run rate for the next year or so after that when we think about major CapEx on those type of projects you've just described?

Mark Ruelle

Well, maybe we'll tag team this answer. First of all, I think you're pretty aware and follow Great Plains so some of it depends on what they do at Lassen, and we own half of that plan. But they're the operators of it, so they probably have a little bit more influence on the schedule than we do.

Secondly, I think all of us know a lot of it just depends on the new administration and on the outcome of the litigation that we have had underway for awhile with regard to new source issues. So it's really kind of hard to speculate about that in the out years regarding the new source issue.

With regard to the near-term projects we know about Greg, anything to add to that?

Greg Greenwood

No. I think once we get out beyond '11, I think from an environment spend standpoint, you'll see it kind of remain at those levels or maybe slightly down until the projects at Lassen are done, and then beyond those projects and the first part of 2014, it really depends probably primarily on how the laws change between now and then and any outcome related to the new source review issue.

Operator

Your next questions from the line of Ted Hayne – Catapult Capital

Ted Hayne – Catapult Capital

First, just a quick housekeeping question on the, I think, Tony you mentioned a tax gain in the fourth quarter, can you just refresh me, how big was that and was that pulled out of the $0.21 number in the quarter?

Tony Somma

The state tax?

Ted Hayne – Catapult Capital

Yes.

Tony Somma

That's a program that we've used before in the early 2000 timeframe, and we have to have taxable income to use it. It was a little bit less than $15 million for 2008.

Mark Ruelle

It was not pulled out, Ted, because it was something that we do periodically. It was obviously better than we expected.

Ted Hayne – Catapult Capital

So if you adjusted, the fourth quarter was more like $0.07 or something like that versus $0.15 last year, is that right?

Tony Somma

If you're going to pull that out, yes.

Ted Hayne – Catapult Capital

So, what were the pressures that were just the general volume contractions and stuff like that that was pressuring it?

Tony Somma

It was certainly energy marketing, as Doug discussed.

Doug Sterbenz

It was energy marketing Ted, weather cost us compared to last year about $0.04 in the quarter, and energy marketing costs us $0.03 to $0.04 as well and those were the bigger numbers.

Tony Somma

Needless to say we were pretty anxious to get that rate settlement in place because we had invested a ton of money that hadn't yet been reflected in the rates at that point.

Ted Hayne – Catapult Capital

Then the other question that I have was just more on the volume growth assumptions, you're assuming your '09 guidance, its looks like you're assuming 0.5% to 1.5% of volume growth. It seems a little bit higher than what kind of comparable companies in your area have been projecting, and I think Bill walked through some of the benefits of diversity. But can you just contrast that with the fourth quarter where it looked like industrial was down a big amount it was down 3% I think, on a total basis, and industrial was down 9%.

Tony Somma

Ted, part of that is going to be just normalizing weather. As Bill shared with you, a lot of our industrial customers, you know we have a diverse mix of industrial customers and we're in contact with them, taking their pulse with respect to how they view the economy and how they think they're going to be running their facilities.

Doug Sterbenz

Things just haven't fallen off the desk here Ted, that doesn't mean they won't, and obviously we're as attuned to it as anybody, but as Bill cited, when you look at the unemployment claims for example, by state, this is not an even recession.

Ted Hayne – Catapult Capital

I guess the weather could probably explain in the fourth quarter, the residential, but it seemed like the industrial of 9% was a pretty big hit, and I think you mentioned maybe there was like a tire manufacturer that went off line. Can you just kind of comment on how you think industrial is versus the rest of the volume mix going forward.

Mark Ruelle

We've got Jim Ludwig here as well, and he's one of our executive vice presidents, probably closest to our customers, and the people that talk to our customers report to him, I'll let him address it.

Jim Ludwig

The only thing I would add to what Tony mentioned was that our aerospace customers typically trail down in production during the holiday period from Thanksgiving to December historically they slow down in production. So I think that's a bit of what you're seeing as well. That's a historical trend.

Operator

Your next question comes from Neil Kalton – Wachovia.

Neil Kalton – Wachovia

Just a question of sort of a rate case cycle going forward, and I think we tend to think about it as sort of every two or three years from a general rate case perspective, and I wondered if I can get your thoughts and given obviously there are some pressures this year. Has anything that's happened over the last six, twelve months with the economy does that change your thinking on your timing of your next rate case going forward?

Mark Ruelle

Well, it certainly changes our thinking about requiring a rate case, but it doesn't really change our thinking about whether or not we go in if we need one. And by that I mean, obviously we've rescheduled and postponed some of our capital expenditures.

And it's nice to have a flexibility to do that because obviously we don't want to raise our prices to our customers at a time when maybe they're not as able to pay it, but our rates are already very low and very attractive.

We work every day to try to keep them that way, but of course you've got to balance that with making sure we take care of our investors. So if we need rate relief we will seek rate relief, but obviously by changing our capital spending plan and deferring some things that defers the need to see additional rate relief.

Now fortunately we’ve got base rates that have just been adjusted the means to make a modest adjustment to our base rates due to this abbreviated process I mentioned in my comments and then obviously we have the ability to recognize our environmental and our transmission costs on a more timely basis.

Beyond the abbreviated case that we intend to file this spring, it’s sort of too soon to guess as to when we would need to file a new base rate case. But if we needed to file one, we would.

Neil Kalton – Wachovia

So it wouldn’t be out of the realm of possibility that you might go back in again later this year and file for another rate case then?

Mark Ruelle

I think I’ll just leave the comments where I made them. We try to be pretty transparent and I think if we were deviating our course of action, we probably would have signaled that to you, as well as our regulators.

Operator

Your next question comes from Steve Cambata – Longbow Capital.

Steve Cambata – Longbow Capital

I just wanted to clarify. You said the guidance for energy marketing was roughly $20 to $25 million of gross margin in 2009?

Tony Somma

Yes. It’s in that range.

Steve Cambata – Longbow Capital

What was the amount of the refund in 2008 that led to the $14.5 million of gross margin in 2008?

Tony Somma

We had a couple of charges, I think. One was in $3 million and another $3 million charge approximately. So energy marketing, if you were to normalize it, kind of would have been in the $20 million margin range.

Steve Cambata – Longbow Capital

You spoke of these structural issues you’re dealing with but you think that the structural issues are not going to present the headwind next year.

Doug Sterbenz

It’s a challenge for us. This business has constantly evolved since I’ve been involved with it since 1997 it was sort of created and we’ve had to come up with different ways to do our business every year since then. This is not different.

I think this was a little different because it was coupled with some internal things that were going on inside of Westar that made it more difficult for us to concentrate on that business. With that behind us, for the most part, we clearly see what we have to do to bring this business back to where it was.

Steve Cambata – Longbow Capital

I guess, when I saw the guidance range for the company my initial reaction was it was fairly wide range and that it would encompass a fairly large level of uncertainty around this business, which tends to be a little more volatile than the core utility business. But a $5 million pre-tax range is approximately $0.03 of earnings. So is it fair to say your guidance kind of embeds not a lot of volatility around this $20 to $25 million.

Mark Ruelle

Well, obviously it’s a wider guidance than we’ve done in the past and we try to take all of the business into consideration when we said it. But I think the uncertainties in the broader economy that we’re all hearing about on CNN or reading about it in the New York Times and everything are probably the reason for widening it more than this.

Steve Cambata – Longbow Capital

Does it feel like there’s a potential wider band of uncertainty around your ability to do $20 to $25 million than there is around your expectations around the core business?

Mark Ruelle

Well, there’s always a wider range on the energy marketing. Anyone that follows us we’ve been pretty honest about the fact that this is the toughest piece of our business to predict. So, Doug’s telling you how he’s viewing the business but he’s not telling you that it’s a narrow range and that it’s either tighter or more loose than it was last year when we talked about it.

Steve Cambata – Longbow Capital

On your financing plan, given the significantly reduced CapEx, could you give a sense for what the operating cash flow you’d expect to generate would be around the midpoint of your guidance range?

Tony Somma

Just round numbers, if you look at our outstanding shares and take maybe the middle of the EPS range, let’s call it $1.80, $1.82 that gets you about $200 million of debt income. And then our historical depreciation and amortization has been about 205, 210. I would expect that to go up this year probably closer to the 250 number because of the wind that we’re adding this year and just the additional plant additions that we’re making.

Steve Cambata – Longbow Capital

Is there bonus depreciation? Like, is there going to be a big deferred tax benefit that hits and drives your cash flow up?

Tony Somma

Well, obviously that affects it.

Steve Cambata – Longbow Capital

It seems like it could be rather significant for you guys given the amount of plant going in service in 2009.

Mark Ruelle

And that was part of my comment when I said there’s uncertainty about the size of the abbreviated case because some of that depends on the stimulus bill and how you treat tax and such with that.

Tony Somma

So round numbers I’d say we’re going to throw in the 450 range cash flow from operations and subtract off 120ish for a preferred and common dividends and you’ll be left in that sort of 330 ballpark number after dividends.

Steve Cambata – Longbow Capital

Do you expect to issue long-term debt in 2009?

Tony Somma

Sure.

Steve Cambata – Longbow Capital

The comments you made around transmission and the need to figure out kind of regional cost recover, I was wondering if you could just expand upon what the status of those initiatives are in SPP and whether you’re optimistic it’s something you could get figured out in the near-term on this issue?

Kelly Harrison

This is Kelly Harrison, I’m responsible for transmission. I’m pretty active at the Southwest Power Pool. We’ve been working on this regional cost allocation for some time right now. If I was to be willing to guess, it would be about a year before we can get that pushed through.

There seems to be a little more inertia behind it now because of some of the comments that have come out of the Obama Administration in terms of what the national perspective would be on transmission.

Steve Cambata – Longbow Capital

Meaning that RTO is more reluctant to move forward feeling they’re going to be kind of made less relevant by some national policy that’s going to define things?

Kelly Harrison

Well, the comment we received from one of the FERC staff folks at one of our meetings was that he encouraged us to be proactive and stay ahead of the curve.

Steve Cambata – Longbow Capital

Wouldn’t that suggest a quicker resolution rather than a slower resolution?

Kelly Harrison

That’s why I say there’s a little more impetus and inertia on getting this pushed through now. But I still think it would take maybe up to a year. The thing to remember at the Southwest Power Pool, the Southwest Power Pool does not determine the cost allocation. It’s the regional state committee, which is made up of a commissioner from each state and the Southwest Power Pool. So we’re dealing with several state commissions trying to come to resolution.

Steve Cambata – Longbow Capital

Is adding Nebraska slowing us down?

Kelly Harrison

No. I don’t believe adding Nebraska would slow it down.

Steve Cambata – Longbow Capital

Can you say what the COLI net income was in 2008 and whether there’s any COLI net income included in 2009 guidance?

Tony Somma

Yes to both of those questions. We had $5.8 million in 2008 of COLI net income, which is about probably $0.03 to $0.04 less than actuarially what we would have had in the ’08 guidance. And there’s probably a $10, $10.5 million number in the ’09 guidance as well.

Steve Cambata – Longbow Capital

That’s a net income number or per-tax number?

Tony Somma

That is a net income after tax number. So I’m talking about the debt proceeds.

Steve Cambata – Longbow Capital

You’ll have $10.5 million in 2009?

Tony Somma

It’s 10.5 to 11 in that range.

Steve Cambata – Longbow Capital

Do you have a sense for what you would expect O&M growth to be this year?

Tony Somma

I think it would be consist with inflationary trends and obviously increases in wages and salaries.

Kelly Harrison

Obviously, with adjustments for our big projects. Steve, if you look at our O&M you’re going to have to do a little bit of forensic work because for example our transmission O&M will likely go up but most of that comes back to us in the form of revenue.

Steve Cambata – Longbow Capital

If you’re successful, when will that rider go into place?

Kelly Harrison

Sort of irrespective of the rider, what happens with transmission is we actually pay the Southwest Power Pool to use our own transmission, as well as others transmission. And then of course we get money back when anybody, including us, uses their transmission.

So when you see a big increase in O&M you have to sort out and say well wait a minute is that transmission or not because if it’s transmission most of it’s coming back in the top line as well. Also you’re going to see some increased thrown in for two new power plants, which is Emporia and the wind project.

Doug Sterbenz

This is Doug Sterbenz. For all of operations, excluding the new plants and the scrubbers, which obviously require a little more O&M, our O&M was very modest. It was less than 2%.

Steve Cambata – Longbow Capital

So it sounds like there’s going to be certain significant cost pressures on O&M that are going to be captured in revenues essentially. Is it fair to say there’s going to be some inflationary pressure call it 2% to 3% that might not be captures in revenues just given normal regulatory lag.

Tony Somma

That’s correct. And also the new wind farms we’re putting online will be incremental above that.

Steve Cambata – Longbow Capital

That should be captured, right? The O&M associated with that should be captured and the renewable tariff.

Mark Ruelle

No. That’s captured in the abbreviated rate case. So that won’t take effect until early ’10.

Steve Cambata – Longbow Capital

That lag is reflected in your guidance.

Mark Ruelle

Yes. And pension expense, of course, will be going up.

Steve Cambata – Longbow Capital

How much will pension go up?

Mark Ruelle

$15 million.

Steve Cambata – Longbow Capital

And what will you fund to the plan in 2009?

Tony Somma

Right now as we said in our K we’ll plan to fund about a little more than 60 when you look at both us and Wolf Creek.

Steve Cambata – Longbow Capital

Final question, you talked about some opportunities to invest in renewables in the future. I just wanted to get your sense in terms of how you’re looking at running the business right now and what management’s appetite is to go ahead and issue equity at these prices to fund to invest in rate-based initiatives or whether you just prefer to sign PTAs.

Mark Ruelle

I’ll talk about our share price and then maybe I’ll let Bill or Greg talk about the renewable process and what’s going on there because obviously that’s a lot of pressures from all places in the present administration and elsewhere.

In terms of issuing equity, obviously, we’re keenly aware of where we’re trading and we’re keenly aware of at what prices utility returns are accretive or dilutive vis-à-vis the share price. For us you need to do a little bit of forensic work.

If you look at our book value per share on a GAAP basis, that’s probably not the more meaningful number because there’s some basically, for lack of a better word, some non-earning equity from years past. But if you look at it on a regulatory basis, our GAAP equity per share is probably 17 and change, Tony?

Tony Somma

Yes.

Steve Cambata – Longbow Capital

On a regulatory basis.

Mark Ruelle

Yes. So we’re not far below sort of that hinge point.

Steve Cambata – Longbow Capital

If you have a mandate do you have to add renewables?

Mark Ruelle

We don’t have to do it one way or the other and the last time we did it, we did it 50/50. Going forward, Greg’s issued this RFP and he’s already had some meetings with some of the potential bidders and I’m sure there were some that will want to sell us under power agreements. Some that will want to sell us projects that we’ll own and maybe some of each and we’ll look at all of it and make our determination based on, among other factors, what our share price is.

Operator

Your next question is a follow-up from Michael Lapides – Goldman Sachs.

Michael Lapides – Goldman Sachs

When the KCC looks at your capital structure, how is short-term debt or things like commercial paper treated?

Mark Ruelle

It’s typically excluded and it was in the last case too and we think that’s the right way to do it because it’s such a transitional balance.

Michael Lapides – Goldman Sachs

Okay. And what’s your target level of short-term debt, or what’s the level where you kind of wouldn’t want to go over in terms of short-term debt on the balance sheet.

Tony Somma

We like to keep floating rate debt exposure pretty small. So we have a $730 million credit facility. We kind of work from the other end, which is what is remaining liquidity. And when we feel that that’s either tighter or would potentially get us in a corner if things continued for four or six months you look for us to fund. That’s why we funded in November.

We weren’t up against a wall in November but we said things aren’t looking so great and by about February of ’09, we’ll wish we had a little more liquidity. Should we come now or should be just play the market and see if it gets better. Well, we’ve got very attractive coupons on our portfolio short-term debt.

We said we could probably tolerate coming with an issuance of bonds in November if we did $300 million, a higher coupon that we wanted but on a weighted average basis doesn’t hurt us that much and it allowed us to sleep over the holidays and not have to worry bout whether we were going to be able to fund our plan this year. The fact is we’ve got $500 million of liquidity and a construction budget at $500 million. That feels pretty good.

Michael Lapides – Goldman Sachs

Last question, when looking at the income statement in the K and for the quarter, the investment loss in the forth quarter, is that all pension, is some of that nuclear decom trust as well or is it other items?

Mark Ruelle

That investment loss is really due to non-qualified plans. Some rabbi trust Surf programs. I think it was $12 million and some change that we took a loss on.

Bill Moore

Michael, you’ll appreciate that in the old days there were some non-qualified plans that none of us presently are the beneficiaries of to that extent and that’s what it was.

Operator

That concludes the question and answer session. I’ll now turn it back to Mr. Bill Moore for closing remarks.

Bill Moore

Thank you all for joining us this morning. We appreciate your interest in Westar and listening to our story. I think we have a unique story. We talk about being flexible and nimble and I think this demonstrates what we’re doing. So thank you for joining us today. If you have additional questions, call Bruce Burns. Many of you know Bruce is our director of investor relations at 785-575-8227. Thanks for joining us.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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Source: Westar Energy Inc Q4 2008 Earnings Call Transcript
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