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Westar Energy, Inc. (NYSE:WR)

Q1 2013 Earnings Call

May 9, 2013 10:00 AM ET

Executives

Bruce Burns – Director, IR

Tony Somma – SVP, CFO and Treasurer

Mark Ruelle – President and CEO

Greg Greenwood – SVP, Strategy

Analysts

Michael Lapides – Goldman Sachs

Moses – UBS

Travis Miller – Morningstar

Andy Levi – Avon Capital

David Paz – Wolfe Research

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2013 Conference Call. My name is Sean and I’ll be your operator for today. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

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

Bruce Burns

Thank you, Sean. Good morning. Welcome to our first quarter call. Last night we filed our 10-Q, 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’ll 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 also available to answer questions. Tony will offer highlights on the quarter, provide an update on 2013 financing plans, CapEx progress and comment on the earnings guidance. Mark will address our regulatory activities, share a few observations on the economy and comment on operations.

With that, I’ll turn the call over to Tony.

Tony Somma

Thanks, Bruce. Good morning. Our remarks will be brief this morning as our business is operating according to plan and there isn’t anything unusual to report or that we think requires a lot of explanation.

We had a strong first quarter with earnings of $51 million or $0.40 per share, well above the $0.21 a share last year. Gross margin increased $42 million or 14% largely from price adjustments related to capital investment to improve reliability and infrastructure. Retail sales in the quarter were up 3% due primarily to weather, which was slightly cooler than normal and much cooler than last year’s warm first quarter. We estimate weather added about $0.04 a share compared with last year.

You may have noticed industrial sales are down 3.5%, principally from just two large customers: one a chemical manufacturer and the other a foundry. Their performance is not reflective of the Kansas economy so much as they both saw soft global and national markets with their products. Even as industrial sales are lower, we’re pleased to see residential and commercial come in a little stronger than expected. Overall we’re still comfortable with our kilowatt hours sales guidance.

On the expense side, operating expenses excluding fuel and purchased power were down $2 million, or just under 1%. Principal reasons for the decrease include: a $7 million decrease at Wolf Creek due to the unplanned outage last year; and a $6 million decrease in depreciation expenses reflecting lower depreciation rates which are part of the rate order we implemented last May. Partially offsetting those items were increases of $5 million for property taxes which has a revenue offset; $4 million for SPP transmission expense which also has a revenue offset; and $2 million for a combination of higher pension expense reflected in last year’s rate order and lower employee cost.

Other income decreased $10 million reflecting no COLI proceeds this year versus our having received $9 million last year. Interest expense was $2 million higher for the quarter, the result of our having issued additional long-term debt last year at very favorable rates. As indicated on our March call and in our guidance, we’ll fund CapEx this year principally with debt. At the end of March we issued $250 million of 30-year first origin bonds with a coupon of 4.1%. With rates at current levels we’ll call $100 million of PCBs next month, providing about $2 million of annual interest savings.

Since February we apprised an additional million shares of common equity through forward sale agreements. We have indicated we’ll sell about 2 million shares late this year that have been priced through February.

Now as far as our CapEx, about half of the planned $900 million we’ll invest this year is for air quality controls and transmission projects. No surprises here, as all of the projects remain on schedule and on budget.

We filed last week with the KCC a sudden request for the 30-mile, 345-kV line going north out of Salina on the northwest corner of our system. We plan to complete the $7 million project in late 2016.

In our release last night we affirmed 2013 earnings guidance of $2 to $2.15 per share. Guidance is conditioned on the typical factors including such things as weather, the economy, COLI proceeds and other factors we can’t control, all of which we detail in our supplemental materials. Recall we include $0.11 of COLI proceeds in our annual guidance.

With that, let me turn things over to Mark.

Mark Ruelle

Thanks, Tony, and good morning. I’ll start with our regulatory plans.

We filed updates to our transmission and environmental tariffs to reflect more than $300 million of plan investment made last year. We implemented the transmission rider in April, adding $9 million of annual revenue; we expect final approval of it by mid-year.

In March we filed our environmental rider to pick up $27 million of annual revenue to recover almost $200 million of investment in air quality controls made last year. The KCC status report affirms our request and we again expect a decision in time to implement by June.

As planned, we filed in mid-April the follow-on case to recover about half of our La Cygne air quality retrofit. It reflects planned investment of about $335 million through mid-year. It also includes two other components of note: an adjustment to revenue requirements to reduce revenues about $10 million, reflecting deferred ice storms costs we’ve now recovered; and a cost allocation rate design to ensure rates are fair and reflect the cost of providing service to each class of customers. The last item is revenue neutral.

Bottom line our net request is for $32 million, an increase of less than 2%. In this abbreviated filing, capital structure, ROE and all the other items are already established based on levels approved in last year’s GRC. After this, we shouldn’t see base rates change again for a couple years, late 2015 at the earliest, when we’ll seek to pick up the balance of La Cygne in our next GRC.

In mid-April, Wolf Creek competed it’s refuel and maintenance outage. We made several major modifications to improve performance and regulatory margin, including prepping for additional diesel generator, which we’ll tie in shortly, and a four-speed water pump and quite a bit of additional pipe replacement that will help position the plant for long-term operations.

Recall we already have a license extension in hand. You may have noticed Wolf Creek is currently off line. It’s the major conditioning equipment that they expect to have repaired and back in a few days. The co-owners continue evaluating the possibility of aligning Wolf Creek with a fleet operator. Not much new to report here other than we still expect to make a decision sometimes in the Q3.

Overall we feel pretty good about the Kansas economy. Unemployment is just 5.6%, half a point better than last year at this time and two points better than the national rate. A lot of discussion continues around potential expansion from existing customers, and there’s a fair amount of activity from firms looking maybe to locate here as well. Utility costs are part of the picture.

We have a significant rate advantage compared to the nation as a whole, but that advantage for our largest customers isn’t as pronounced, and that’s the reason we’re looking to realign our rates and in the process further improve our competitive advantage for Kansas.

As Tony mentioned, the decline in industrial sales was driven largely by just two customers, but refining, pipelines and construction and general manufacturing all continue relatively strong. We continue to watch the Keystone Pipeline and remain cautiously optimistic it’ll be approved.

If it does, and it stays on track, it could be one of our largest customers. And for those of you watching your waistlines, I regret to inform you that Kansas is back in the Twinkie business. A reconstituted Hostess will be firing up a plant here with nearly 300 employees.

Another bright spot is the resurgence in apartment construction, and though Wichita isn’t Phoenix, we’re also seeing growth in new single family homes that look like green shoots for housing, even though the housing recession here was more of a lull than a crash like in other places.

As far as operations, I’m happy to report it’s business as usual. Our generation team has now done more than 2 million man hours accident free. Let me put that in perspective. That’s 600 employees working almost two years without a single injury in a highly industrialized and complex environment. So why do investors care?

Well, though safety is one of our core values, we believe this attention to detail also illustrates the quality of our workforce engaged in the right things under good plant and field leadership. This same focus helps us be more efficient. We’re still seeing a lot of retirements, given our demographics, and with that we’re able to get our work done with about 5% fewer employees this year compared to last year.

After lighting last year for no good reason in our view, we’re pleased to see our shares trading a little more in line with our peers. I think this reflects a good story, clarity about it and a solid dividend policy. 2013 is off to a good start. We’ll continue to focus on the fundamentals of our business, believing that the best way to take care of investors is to focus on our customers.

With that, we’re now ready for questions from the financial community.

Members of the media, if you have questions we invite you to contact Gina Penzig at 785-575-8089. Sean, would you please open the line?

Question-and-Answer Session

Operator

Certainly. (Operator Instructions). Your first question comes from the line of Michael Lapides of Goldman Sachs. Please proceed.

Michael Lapides – Goldman Sachs

Hey, Mark, Tony. Congrats on a great quarter. And maybe more importantly, congrats on the Twinkie factory. I think that’s great. I look forward to visiting.

Tony Somma

Thank you.

Michael Lapides – Goldman Sachs

A couple of minor questions. First of all, SG&A and O&M, strong cost control in the quarter. Just curious, anything we should be thinking about directionally during the quarters of 2013 in terms of just trends? Meaning was the year-over-year change in SG&A or O&M something that may have been unusual and year-over-year changes for the rest of the quarters in 2013 could be different from what we saw in the first quarter?

Tony Somma

Michael, this is Tony. Not all of our costs are level, so there’s some lumpiness. We’ll stand by with what we issued in our earnings drivers. Overall O&M and SG&A will go up about 5%, but our O&M and SG&A that’s not covered by trackers or riders will go down 1%. So it’s a little front loaded this quarter. You should expect that to kind of smooth out as the year progresses.

Michael Lapides – Goldman Sachs

Got it. Second, the storm deferral, the $10 million in terms of the revenue reduction, does that drop to the bottom line? Or is there an offsetting cost, whether in fuel, purchased power, somewhere else?

Mark Ruelle

No, it was actually negotiated as part of our GRC settlement last year. This is an ice storm from a few years ago and basically is fully recovered, so as part of our settlement last year we said when we filed the abbreviated case we’d zero that out. So the expense goes away, so does the revenue unfortunately.

Michael Lapides – Goldman Sachs

Got it. And what line item – where did the expense show up?

Mark Ruelle

I’m going to look at the accounts for that one.

Tony Somma

It goes in O&M.

Michael Lapides – Goldman Sachs

Okay. Got it. Finally, just given through the Q there’s some commentary in terms of capital formation regarding forward sale up to about $500 million, just want to confirm that amount, the timeframe for when you’re thinking about making that draw down, and whether pricing – whether you’ve been guaranteed a price with that $500 million of equity or whether that’s still kind of market exposed, et cetera?

Tony Somma

Yeah, Michael, that was a – an agreement that we refreshed when we refreshed our S3. And it doesn’t mean we’ll issue $500 million of equity through what we’re going to call the ATM program, we were just refreshing the program and we can dribble out up to that amount; but chances are we will not dribble up to that amount, we do not need $500 million of equity. And we’d probably want to come with a follow-on offering here sometime.

Mark Ruelle

But in terms of how we raise money, you should look for us to continue the tactics and the strategy that worked very well for this company in the past, which is some forward, some marketed, some aftermarket and just kind of dollar cost averaging.

Michael Lapides – Goldman Sachs

Right. And the goal is strictly try and stay as close to 50/50 as you can over time.

Mark Ruelle

Yeah. With the understanding that we have to be conscious of the costs of our capital and make sure that’s reflected in the prices that our customers pay for our products. So you’ll see that bounce around a little bit, in and around the rate-making schedule, in and around the equity issuance schedule.

Michael Lapides – Goldman Sachs

Got it. Thanks, guys. Congrats on a good quarter.

Mark Ruelle

Thank you.

Operator

Thank you. Your next question comes from the line of Julien Dumoulin-Smith of UBS. Please proceed.

Moses – UBS

Moses for Julien. Just had a quick question on kind of CapEx and how you see kind of CapEx prospectively, you’re in kind of the new and collage updates from EPA?

Greg Greenwood

This is Greg, Greg Greenwood. I’ll take a shot at that. You know we had the effluent guidelines that came out recently, they would indicate that EPA is headed toward categorizing solid waste as non-hazardous, which will make it much more economical for us and other utilities to handle, so I think that’s a good sign. I think our capital plans as we lay them out there are sufficient to pay for the projects to take care of those matters.

Moses – UBS

Got it. Okay. And switching to just industrial sales, can you give us any insight into what growth would have looked like without those two customers this quarter?

Mark Ruelle

They were probably around flat without those two customers.

Moses – UBS

Okay. Thanks.

Greg Greenwood

You’re welcome.

Operator

Thank you. Your next question comes from the line of Travis Miller of Morningstar. Please proceed, sir.

Travis Miller – Morningstar

The – I want to think longer term about the transmission growth. You guys have identified in the past about a half dozen or so potential projects. I wonder if there’s any status update on those in the last couple of months? And potentially looking forward any kind of mileposts, ruling, et cetera that we could look for?

Mark Ruelle

Sure. Yeah. I guess Tony mentioned one, that 345 line on the northwest corner of our system is actually the first one of those projects that we outlined 18 months ago, a couple years ago Travis, where we said these are projects that are on the preliminary planning addenda for the southwest power pool that we would expect some or all of them to be built by over a pretty long horizon. And the first one is actually already being constructed. We have the authority to do it.

Travis Miller – Morningstar

Great. Any initial cost estimates? Or mileage estimates that we can back into?

Mark Ruelle

Yeah, on that one...

Greg Greenwood

30 miles, sure.

Mark Ruelle

70 million, 30 miles.

Travis Miller – Morningstar

70 miles, 30. Okay. Great. Thanks a lot. I appreciate it.

Mark Ruelle

70 million, 30 miles no I wasn’t sure. We might have transposed that or you might have. I can’t remember.

Operator

Okay. Thank you. The next question we have comes from the line of Andy Levi of Avon Capital. Please proceed.

Mark Ruelle

Good morning, Andy.

Andy Levi – Avon Capital

Hi. How are you? I always like your calls. Very straight to the point; it makes my life easy.

Mark Ruelle

Thank you. That’s why we live, Andy.

Andy Levi – Avon Capital

I don’t have to listen to you pontificate, you know? I’m sure you’re probably good at it. Just a few housekeeping questions; on the sales gross or the sales numbers for the quarter, so $0.04 to $0.05, or $0.04 I guess you said, was weather versus the below normal weather from last year. Is that right?

Mark Ruelle

Yeah. That’s our swag at it.

Andy Levi – Avon Capital

So I think residential sales, I’m trying to do it from memory, I don’t have anything in front of me, but it was up 9% for the quarter. Is that right?

Tony Somma

Yes.

Andy Levi – Avon Capital

So if you not weather normalized it, but you understand, what would be that amount that it was up if you’re trying to on a normal basis, normal to normal?

Greg Greenwood

Yeah. So residential...

Andy Levi – Avon Capital

Commercial too?

Greg Greenwood

Yeah. Our estimate would suggest the financials may be up a point and a half, commercial around 2% if they weren’t normalized.

Andy Levi – Avon Capital

Okay. That’s very helpful.

Tony Somma

Then...

Greg Greenwood

Bottom line on that, the commercial and residential probably came in a little stronger than we were thinking.

Andy Levi – Avon Capital

Right.

Mark Ruelle

It came in a little softer than we were thinking, but net-net, we still feel pretty good about the annual guidance on sale.

Greg Greenwood

I want to clarify that. So weather for the quarter was very close to normal, and slightly cooler. Last quarter as you know was warm. And if you were to normalize both of those quarters and compare them year over year, we’re looking at about 1.5% growth in residential and about 2% in commercial.

Andy Levi – Avon Capital

Okay. And does that include the effects of leap year or not?

Greg Greenwood

Let me think that through, Andy. We did not adjust it for the leap year, the numbers I’m looking at.

Andy Levi – Avon Capital

Okay. So the numbers...

Greg Greenwood

Might be a little bit stronger than that.

Mark Ruelle

So what’s that, 0.28% – 22 8% or something?

Andy Levi – Avon Capital

All right. Okay.

Tony Somma

On total retail, yes.

Andy Levi – Avon Capital

Okay. That’s helpful. And then back on the O&M, which Michael Lapides had asked about, was there any effect in the quarter from weather? And what I mean is not that maybe there were some higher costs, I know you guys got a lot of snow, but were there certain maybe O&M costs, whether it’s tree trimming or something like that, that was deferred second or third quarter cause of snow?

Tony Somma

No.

Andy Levi – Avon Capital

Okay. So it’s all timing?

Tony Somma

We actually could have used more snow. We didn’t get all the snow that other people did. We had miserable weather, but unfortunately not much moisture in it.

Andy Levi – Avon Capital

Okay. I just remember talking to the Wells Fargo guys.

Tony Somma

It’s been grey and gloomy out here, but...

Andy Levi – Avon Capital

Not like in Missouri I guess. Okay. And then on the equity, just I want to understand. So stock has kind of done very we’ll, but – and you’ve done a forward sale in the past when again you’ve dribbled it out and you’ve also done a block and you have this rate case in 2015 I think it will be? Is that correct?

Mark Ruelle

Yeah. We filed probably early spring 2015.

Andy Levi – Avon Capital

Right. And then forward sale is what, 18 to 24 months? Or is it 18 months that you’ve got...

Mark Ruelle

You can go on up to 24 months.

Andy Levi – Avon Capital

So should we think your strategy may be similar to the last rate case and kind of forward sale, that type of thinking?

Tony Somma

We’ll do it as I indicated, Andy, we’ve been a serial issuer of equity as we’ve made a lot of infrastructure investment. It’s worked pretty well in the past. You shouldn’t assume we’re changing our plans on that.

Andy Levi – Avon Capital

Okay. And then I also missed at the beginning in I think Tony’s comments, how many shares did you issue in the quarter?

Mark Ruelle

We didn’t issue any shares, we priced about a million more.

Andy Levi – Avon Capital

Oh, priced. Priced. A million more shares.

Mark Ruelle

One million, yeah.

Andy Levi – Avon Capital

Okay. And is that part of the two million that you had planned to do for the year? Or didn’t you sell that down already to two million?

Mark Ruelle

Yeah, we priced...

Andy Levi – Avon Capital

Last year?

Mark Ruelle

A couple million last year, two million, and we priced an additional million first part of this year.

Andy Levi – Avon Capital

Additional million, okay. And what was the average price there? Do you have that? Or dollar.

Mark Ruelle

31 and some change.

Andy Levi – Avon Capital

31 and change, great. Thank you very much guys. Great quarter.

Operator

Okay. Thank you. (Operator Instructions). Your next question comes from the line of David Paz of Wolfe Research. Please proceed.

David Paz – Wolfe Research

Good morning.

Mark Ruelle

Good morning, David.

David Paz – Wolfe Research

I just had a question on Prairie Wind, how much do you guys expect to invest in that project by the end of this year?

Greg Greenwood

This is Greg Greenwood again. The total cost of that project is $180 million, our share. The entity itself would finance half of that with debt, and then the partners would contribute the equity.

David Paz – Wolfe Research

Okay. And how much – I think your guidance assumes about $5 million of earnings from that venture, is that correct?

Tony Somma

In our guidance we have roughly $6 million for the full year of earnings from that project, and that’s about a $4 million increase over last year.

Greg Greenwood

David, let me just clarify something, make sure it was clear; the total cost of Prairie Wind is $180 million. About half of that will be debt at the project level, the other half will be equity, of which we’ll have half of that.

David Paz – Wolfe Research

I see. Okay. Got it. So if we look at the remaining I think you have – beyond 2013 you have about $18 million of I guess that would be equity investment planned for the project, is that correct?

Tony Somma

We’ll lever up a little bit more during the construction period, but once the line goes in service we’ll be about 50% debt 50% equity.

David Paz – Wolfe Research

Okay. And the earned...

Greg Greenwood

So bottom line, we’ll end up with about $45 million of equity in that project.

David Paz – Wolfe Research

And you earn, what’s the ROE on that project again?

Greg Greenwood

12 8.

David Paz – Wolfe Research

12 8. Okay, great. Thank you.

Tony Somma

Thank you.

Operator

Okay. Thank you. Sir, you have no further questions at this time. I would now like to turn the call over to Mark Ruelle, CEO, for closing remarks.

Mark Ruelle

Thanks again, folks, for joining us this morning. If you have follow-up questions, just contact Bruce, 785-575-8227. Have a great day.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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