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Westar Energy, Inc. (NYSE:WR)

Q4 2012 Earnings Conference Call

March 1, 2013 10:00 AM ET

Executives

Bruce Burns - Director Investor Relations

Tony Somma - Senior Vice President, Chief Financial Officer and Treasurer

Mark Ruelle - President and Chief Executive Officer

Analysts

Greg Gordon - ISI Group

Travis Miller – Morningstar

Brian Russo – Ladenburg Thalmann

Sarah Akers – Wells Fargo

Operator

Good day ladies and gentlemen and welcome to the Q4 2012 Westar Energy Earnings Conference Call. My name is Andrew and I will be your operator for today.

At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I would like to turn the call over to Mr. Bruce Burns, Director of Investor Relations. Please proceed, sir.

Bruce Burns

Thank you. Good morning and welcome to our fourth quarter and year-end 2012 conference call. Last night, we filed our 10-K, it’s on our website westarenergy.com along with the earnings release and supplemental materials under the Investor section. Some of our remarks will be forward looking, so I remind you of uncertainties inherent in our comments or that we may have included in materials that supplement the release. We encourage you to read the full disclosure and GAAP reconciliations on our website and in our investor materials.

Commenting this morning will be Tony Somma, CFO; and Mark Ruelle, CEO. Other members of our senior management team are available to answer questions.

Tony will offer highlights on the quarter, introduce three-year CapEx, comment on 2013 financing potential, and our earnings guidance. Mark will address planned regulatory activities, share a few observations on our operations and address the dividend.

With that, I will turn the call over to Tony.

Tony Somma

Thanks, Bruce. Good morning, everyone. We had a strong fourth quarter with earnings of $46 million, or $0.36 per share, well above the $0.16 per share reported in 2011. Our gross margin increased $36 million, or 11%, largely from price adjustments to improve reliability and infrastructure. Retail sales volumes for the quarter were up 1% due to higher industrial sales. Weather, well, not a big driver this time of the year, was mild in both fourth quarter 2011 and normal and was a principal reason for the decline in residential and commercial sales compared with 2011. Stronger industrial sales resulted largely from oil refining, general manufacturing, and aerospace.

On the expense side, operating expenses excluding fuel and purchased power were up $9 million, or 3%. Principal reasons for the increase include $9 million for SPP transmission expense, which has a revenue offset, $6 million for higher pension and employee benefit costs, pursuant to the April rate order, and $3.5 million for contribution to our charitable foundation, the first contribution in several years. Partially offsetting those items were a $3 million decrease at Wolf Creek and a $6 million decrease in depreciation expenses reflecting lower depreciation rates, which were also part of the rate order.

Other income increased $4 million reflecting higher COLI proceeds. Total COLI proceeds in 2012 were more than $17 million, $3 million more than what we had in our guidance.

Interest expense was $3 million higher for the quarter, as a result of our having issued $550 million of long-term debt last year at very favorable rates. Like many of you I never thought we would see a low full handle on a 30-year money. We obviously took full advantage of it and refinanced almost $0.250 billion, a higher coupon debt and preferred stock.

Now turning to CapEx. Our three-year CapEx plan represents an investment of $2.3 billion, with just over half of it for environmental and transmission projects. A major portion of environmental investments will be finishing big air-quality projects at Jeffrey and La Cygne. Both projects remain on schedule and on budget. Jeffrey should be complete by the end of next year and La Cygne about six months later by mid-2015. There has been no change as far as our plans for transmission. Though substantial at over $200 million, none of these are controversial or complex projects. They represent a number of small projects to improve reliability, enable firm transmission within the SPP, and then serve new customers like Mars Chocolate, and expansions for current customers like Enbridge Pipelines. We project our transmission assets will contribute almost 25% to 2013 earnings, up from 15% this five years ago.

A major transmission project that is not included in our CapEx is $180 million, 345 kV Prairie Wind joint venture. As a joint venture, the investment isn’t included in our rate base and a return will be recorded in investment earnings rather than our revenues. Westar is in charge of the construction and financing on behalf of our partner. In that roll, just last December we completed a favorable agreement for $125 million of project financings. Westar’s net direct investment into JV will only be about $35 million. The project remains on track to be completed late next year and we expect Prairie Wind to contribute about $0.03 per share this year as we have SEWIP authority for the project.

With 2013 CapEx of almost $900 million, we will need to access the capital markets. The majority of the funding will be with debt and a small amount of equity would be the $2 million or so shares we have already priced before the sale agreement that we plan to settle late this year.

In our release last night, we issued 2013 earnings guidance of $2.00 to $2.15 per share. Guidance is conditioned on typical factors including such things as weather, the economy, COLI proceeds, and other factors we can’t control, all of which we detail on our supplemental materials. About $0.11 of COLI proceeds is included in our guidance. Also reflected in guidance is a contribution from the cost saving initiatives we announced on our third quarter call.

With that, let me turn things over to Mark.

Mark Ruelle

Thanks, Tony and good morning. Let me begin with our regulatory plans. We will update our transmission, environmental, property tax and energy efficiency tariffs to reflect recent investments and higher related costs.

We have already filed the transmission rider to pick up an additional $9 million of annual revenue. We expect the decision and time to update retail prices in April. We will file the environmental rider this month, still finalizing the update but the current estimate is about $31 million, reflecting an additional $200 million of 2012 investment in air-quality controls.

This year’s update will also full reflect our nearly $290 million Lawrence Energy Center project and since it’s now in service the adjustment will pick up depreciation as well. We anticipate a June effective date on the rider.

In addition to these regular tariff updates, we are preparing to file by mid-April an abbreviated rate case to recover CapEx for the La Cygne air-quality retrofit. We seek to begin reflecting about $350 million, or a little more than half our share of the upgrades at the plant. As a reminder, this case will have a limited scope with revenue requirement items limited to just the CapEx for La Cygne and terminating an ice storm amortization that will be fully recovered. In the abbreviated filing, capital structure, ROE, and other items are already established based on the levels approved in the general rate case last year. We expect we will file a follow-on general rate case for the balance of La Cygne sometime in 2015.

As part of the abbreviated case, we will adjust rate design to move our rates more in line with economic development and growth. You might have seen last month how Kansas was feature amongst states on the leading edge of creating a more business friendly climate and we are pleased to be a part of that.

Early last month Wolf Creek began its planned refuel and maintenance outage closing out a solid continues run since last March when it returned to service after an unplanned outage. The scope of this outage is one of the largest in plant history. It’s scheduled for about 8 weeks to implement several major modifications, including an additional diesel generator, a port auxiliary feed water pump, a new reactor coolant pump seals. We will also do quite a bit of pipe replacement as we prepare the plant to operate for another three decades given our already extended license.

As far as a long term operation of the plant, you might recall we are considering whether to align with a fleet operator. We are in the middle of reviewing proposals so nothing yet to report other than that the process continues. There is no deadline but we are thinking the owners will reach a decision whether or not to go this route by mid-year.

Regarding our long term power supply, we continue to believe in all of the above approach and we mean it. We are certainly taking advantage of lower gas prices but not so much that we forget that any commodity, ebbs and flows, and we are in this for the long term with long life assets. Though everything we brought online in the last 25 years has been gas or renewable, our customer still benefit from a base load generation. Our delivered cost of low sulfur coal is still half the price of gas and we don’t expect new rail agreements this year to change that. And almost all of it goes through scrub units with NOx controls. In our materials, you can see just how much we have done to reduce emissions and yet not take away diversity out of our long term supply plan as so many others have or are contemplating doing.

Last year, we brought in more renewals as well, which puts us a little ahead of statutory mandates. The cost of these was just a little over $0.03 per kilowatt hour under long term fixed price agreements.

As I mentioned earlier, Kansas is expressing great resolve about make our state an even better place to do business. We are seeing that in our state income taxes, with top individual rates down significantly, and the elimination of income taxes on almost all small businesses. The Kansas economy was improving even before the effects of these recent implemented tax changes. Unemployment is just 5.4%, a full point better than a year ago, and further pulling away from the national average which is 2 points worse.

Utility costs are part of the economic solution. We have a significant rate advantage of almost 20% compared to the nation as a whole, but not quite as favorable comparison with our large business customers. We are jealously protective of what affordable energy means for the Kansas economy. So, as I mentioned, we hope to improve that even further with some rate design changes which should make Kansas even more jobs friendly. Reaching other ways to help our smaller customers manage their energy costs. Our small and medium customers for example now have more tools to work with and those same tools help us with our operating cost as well by not having to roll so many trucks for things like basic service calls. This is a real plus around the KU campus migration each May and August.

Pickup about any industry publication these days and you will find an article about slumping or stagnant electricity sales. Some hope that that’s just a flat trend and a symptom of a still tepid economy and it will bounce back with recovery, just as it had after past recessions. Others speculate that flattening electricity sales is the new normal and a way of life. Most of you know, though we don’t claim being fortune tellers, and instead focus on what we need to do no matter what the future brings.

As a result, we disciplined O&M spending last year through a combination of workforce reductions and productivity gains. Our year-end staffing was down about 5%. Our demographics held, in the next few years about half of our workforce will be eligible to retire. So this means our early to mid-current employees have great development opportunities and our late current employees have a chance to leave a legacy, a company even better than they founded.

Before taking your questions, I would like to comment on the recent winter storms, our safety and our dividend. We got flamed this past week two back to back winter storms that dumped as much as two feet of wet sticky snow with some high winds to boost. While we remain humbled by what mother nature could send her way, we were gratified with this latest set of challenges, we had no impact for about 95% of our customers, and with all but a couple of dozen of those affected back on within 36 hours. Thanks to our proactive reliability in tree trimming program approved by the KCC last year, our system held up pretty well and our preparedness paid off.

With regard to safety, we had our best year ever. With 600 or so people operating our power plants avoiding even a single injury. If you have ever visited a large base load plant, you will appreciate just how remarkable that accomplishment is. Our entire workforce experienced just 13 injuries, still too many in our view, but few of them enough to put us in the top of industry performers. This kind of focus and attention not only keeps our people safe, but it keeps them sharper in all aspects of their jobs.

Finally, I am happy to report that last night we announced a 3% in our dividend. This results in an indicated annual rate of $1.36 per share and consistent with our long standing policy of paying out 60% to 70% of earnings. Our Board recognizes that Westar shareholders continue to value dividends as part of the total value proposition we offer.

We are now ready for questions from the financial community. Members of the media, we invite you to contact Erin La Row at 785-575-6060 if you have questions. Andrew, would you please open the lines for questions?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Greg Gordon, ISI Group, please proceed.

Greg Gordon - ISI Group

Thanks, good morning.

Mark Ruelle

Good morning, Greg.

Greg Gordon - ISI Group

Thank you for the very concise disclosure on drivers for 2013 earnings, we appreciate that.

Mark Ruelle

You are welcome.

Greg Gordon - ISI Group

Good work getting back from the storms so quickly. I don’t know if I had mentioned this last time we had a call, but I did see a Westar Energy truck here in New York during our storm and we must appreciate your help there as well.

Mark Ruelle

You are welcome, we are happy to do it.

Greg Gordon - ISI Group

A couple of questions. I just want to clear, if we are trying to model unrecoverable O&M escalations. I think you’ve made it very clear that the third bullet in your planning assumptions is, all things equal net of riders. Overall O&M should be down 1%?

Mark Ruelle

That’s correct Greg.

Greg Gordon - ISI Group

If we think about the opportunity for you to go with the fleet operator for Wolf Creek, so what are key sort of underlying metrics you’re looking at in that decision? Should one of them we think about be the ability to continue to hold the line on O&M costs, still say moving up in the rankings in terms of operating performance and safety?

Mark Ruelle

Well. I won’t comment on the process because of course we are in the middle of that, but yes our objective is not a short term look at that, it’s recognizing that we got a good asset and it’s got 33 years more of operating license. And there seem to be advantages in terms of the long term structural cost trends, whether you’re maybe aligned with the fleet or not, and so we’re taking a hard look at that.

Greg Gordon - ISI Group

Okay, and one of these things I often hear when I talk to investors about Westar is, there is lack of familiarity about the underlying economy in Kansas and there is a sense that somehow the Kansas economic picture is sort of below average relative to national trends and people often focus on your exposure to aerospace. Can you talk a little bit more about what you’re seeing in Topeka and Wichita in terms of underlying economic development, job growth, job loss etc.

Mark Ruelle

Sure. They need to come visit because it’s not like Detroit and autos of the 1980’s. Aerospace is actually commercial aerospace, which is largely related to spirit, it’s doing quite well. Now it is true that the small private aircraft and the small jets are not doing well and they haven’t done well since the crash back in ’08, and that’s not a big part of our business. In fact if you look at aerospace overall, I can’t remember the right percentage. Bruce, do you remember how much aerospace is even as a percent of our revenues?

Bruce Burns

Not as percent of revenues, but it’s roughly 16% to 17% of industrial revenues, of just the industrial component.

Mark Ruelle

So, it’s single digit on our revenues. The Kansas economy is actually pretty diverse. One of the best performing sectors we just had was general manufacturing, so car batteries, prepared foods, frozen pizzas, dog food, light bulbs. We’re in the process of building a very large chocolate factory in Topeka that will come on line next year, actually maybe in later this year. I can’t remember the schedule. They are going to M&M and Snicker bars, for example. More pipeline loadings and then of course we still have a pretty large military presence here and we serve all the major universities. So, we’re not tired in any particular sector, in fact, that’s one of the nice things about our economy in our view.

Greg Gordon - ISI Group

Great and looking at -- I didn’t see, I don’t think you put out a fully updated slide deck for the call, but should we still assume that your CapEx plan is consistent with the CapEx guidance that you laid out at the EI with rate base going from 5.5 billion at year-end ’12 close to 7 billion by ’16? That’s still accurate?

Mark Ruelle

Greg, there is on the back of our earnings package the last page does show our updated capital CapEx plans for the year, and as 2013 is still in line with what we were planning for the last year for ’13.

Greg Gordon - ISI Group

Great, thanks guys. Great 2012 and good outlook for ’13, take care.

Mark Ruelle

Appreciate that, thanks.

Operator

Thank you. Your next question comes from Travis Miller, Morningstar, please proceed.

Travis Miller – Morningstar

Good morning guys.

Mark Ruelle

Good morning.

Travis Miller – Morningstar

Wonder if you could detail what happened between November when you last reaffirmed your guidance for the year, and what you guys ended up at? If am correct, there is about a $0.10 change would be looked at high ends 205 to the 215?

Tony Somma

Yes Travis, this is Tony. We had some COLI proceeds come in of about almost $5 million in the quarter. We also had some gains on a Rabbi Trust, and so those two items gave us let’s say $0.05 to $0.06, and then the balance came from kind of lower O&M throughout the organization and throughout our co-owned units as well.

Mark Ruelle

Including the Wolf Creek.

Tony Somma

Yes.

Travis Miller – Morningstar

Is that sustainable? Lower O&M or just one-off?

Tony Somma

What is sustainable is in our guidance for 2013, in range that we gave $2.0 and $2.15 a share.

Travis Miller – Morningstar

Okay, great and then one other question on the CapEx. When we look out to 2015 what you guys announced here, is that more of a run rate number, even if we take off some of that environmental expense, is $600 million roughly where you’re ending up on a run rate or there are one-time projects in there?

Tony Somma

They are likely to get lower if we go on beyond 2015. As we said, as the environmental projects unwind in our CapEx will ramp down when you stay in that 2015, and then if you want to look out beyond that, I would suggest that you’ll still see a pretty good spend on transmission and that $200 million year range and the other CapEx for the business units were probably where they were historically.

Travis Miller – Morningstar

Okay great, thanks a lot.

Operator

Thank you. The next question comes from Brian Russo, Ladenburg Thalmann, please proceed.

Brian Russo – Ladenburg Thalmann

Hi good morning. Just you mentioned $200 million run rate on transmission kind of post 2015, any specific project that you can discuss?

Mark Ruelle

Let me introduce Kelly Harrison, he is our Vice President of transmission and he can give a little more color on that.

Kelly Harrison

Yes, Brian, we did have a couple of specific projects out [ph]passed 15/01 and we’re working on a routing for -- right now it’s a 345 KV line, it’s about $67 million our share. There will be a couple or more projects after that, so we think we’ve got a pretty good pipeline out of the STP for a couple of 345 KV projects. There is a standard fair amount of ageing infrastructure and projects for reliability improvements.

Brian Russo – Ladenburg Thalmann

Okay, great. What’s your projections for the Wolf Creek operating expenses in ’13? You mentioned that it was down slightly in the fourth quarter, just curious?

Mark Ruelle

We haven’t broken that out separately Brian. It’s kind of baked into our guidance, the $2.0 to $2.15 a share.

Brian Russo – Ladenburg Thalmann

Okay, and just on the capital market strategy, you mentioned $2 million forward sale shares of equity likely towards the end of the year. Should we kind of assume that you looked to kind of recalibrate your cap structure in that mid 2015 time period when you file your next full GRC?

Mark Ruelle

Yes, we will be in the process of issuing some more equity next couple of years, as our capital structure gets a little thin.

Brian Russo – Ladenburg Thalmann

Okay, great. Thank you very much.

Mark Ruelle

Welcome.

Operator

Thank you ( Operator Instructions ) And the next question we have comes from Sarah Akers, Wells Fargo, please proceed.

Sarah Akers – Wells Fargo

Hey good morning everyone.

Mark Ruelle

Good morning.

Sarah Akers – Wells Fargo

As a follow up to the question on transmission, it sounds like I think I heard that a lot of the post ’15 opportunity is just related to ageing infrastructure. So, how much of that 200 million run rate depends on continued support and in development of renewables in Kansas? Or does that just represent upside to that run rate?

Mark Ruelle

Most of that 200 million is just singles and doubles there. It’s not big, green field stuff that’s got one driver on it, that’s frankly why we like most of the way we’re approaching it. Now, as you know from our investor materials, there are a host of bigger projects that are sort of on the drawing board of the South West Power Pool over the next decade. One of those Kelly just mentioned but they are not what we’re assuming in our next forecast. What we’re assuming in our next forecast is just a bunch of little stuff that has to get done.

Sarah Akers – Wells Fargo

Got it, thank you. And then, what are the things that you talked about at EI was some of the real estate development in your territory. So, this is a follow up to Greg’s question on the economy, what trends are you seeing in the commercial and residential real estate market?

Mark Ruelle

I’ll ask Jim Ludwig, our Executive Price President of Public affairs and consumer services talk about that.

James Ludwig

Yes, good morning. We are seeing a pickup in housing starts, year-over-year we saw about an 11% increase. 2012 over 2011. Admittedly, that’s not back to the levels we had previous session. In the first few months of 2013, our builders and developers are cautiously optimistic that it’s picking up. I think what’s even more important perhaps is that the oversupply of housing, the existing stock is improving, the sales are increasing and the market value is increasing somewhat. Another area wherein, in this coming year we expect maybe a little bit more robust growth is in apartments, multi-housing and also some commercial building. So we’re seeing a little more activity in those areas and seeing some economic improvement.

Mark Ruelle

Sarah, one of the things that sort of sets our place apart is Kansas, right, it’s just not that exciting one way or the other in terms of booms and bust. So, when we have the downturn, we did not have empty houses, we did not have half built homes like so much of the country did. Now, we saw some contraction in pricing, but there was not the freefall. And there hasn’t been the rapid bounce back either as those empty houses get filled. We didn’t have dead meters, the way so many other people did.

Sarah Akers – Wells Fargo

Got it, that’s helpful. Thanks and congrats on the year.

Mark Ruelle

Thanks.

Operator

Thank you. And I would now like to turn the call over to Mark Ruelle for closing remarks.

Mark Ruelle

Well, thanks for joining us this morning. If you have follow up questions, of course you can contact Bruce Burns, Director of Investor Relations and Bruce’s number is 785-575-8227. Thanks and have a good day.

Operator

Thank you for joining today’s conference. This concludes the presentation. You may now disconnect, have a good day.

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