Great Plains Energy CEO Discusses Q3 2010 Results – Earnings Call Transcript

Executives

Mike Cline – VP, IR & Treasurer and Corporate Secretary

Mike Chesser – Chairman and CEO

Bill Downey – President and COO

Jim Shay – SVP, Finance and Strategic Planning and CFO

Terry Bassham – EVP, Utility Operations

Analysts

Mike Hahn - Bryn Mawr Capital Management

Michael Lapides – Goldman Sachs

Steven Gambuzza – Longbow Capital

Great Plains Energy, Inc. (GXP) Q3 2010 Earnings Conference Call October 29, 2010 9:00 AM ET

Operator

Good morning. My name is Amanda and I will be your conference operator for today. At this time I would like to welcome everyone to the Great Plains Energy Q3 2010 Earnings Conference Call. (Operator Instructions). I would now like to turn the call over to Michael Cline, Vice President, Investor Relations and Treasurer. You may begin.

Michael Cline

Thank you, Amanda, and good morning. Welcome to Great Plain Energy’s Q3 2010 earnings conference call. Our senior executives presenting this morning are Mike Chesser, Chairman and CEO, Bill Downey, President and COO, and Jim Shay, Senior Vice President and CFO. Also joining us on the call today is Terry Bassham, Executive Vice President Utility Operations, who will be available for questions.

I must remind you of the inherent uncertainties in any forward-looking statements in our discussion this morning. Slide 2 and the disclosure in our SEC filings contain a list of some of the factors that could cause future results to differ materially from our expectations. Before I had the call to Mike I wanted to remind everyone that we issued our earnings release and 10Q for the Q3 after the market closed yesterday. They are available along with supplemental financial information regarding the quarter and today’s webcast slides on the main page of our website at http://www.greatplainsenergy.com.

I also wanted to mention that after nearly three years in investor relations at Great Plains Energy, Ellen Fairchild has been promoted to the role of Vice President, Corporate Secretary and Chief Compliance Officer effective immediately. Tony Carino, most recently a Director in our Regulatory Affairs Group, will be replacing Ellen in investor relations. In addition to his regulatory background, Tony brings a wealth of accounting and corporate finance experience to investor relations from his past positions at both Great Plains Energy and Hallmark. I’d like to take this opportunity to publicly welcome Tony to investor relations as well as thank Ellen for her excellent contributions over the past few years and wish her the best in her new role.

Tony and Ellen will be accompanying Mike, Bill, Terry, Jim, and me to the Edison Electric Institute financial conference in California next week and we look forward to seeing you then. For those of you not attending EEI, the company’s presentation will be webcast beginning at 11:15 am Pacific Time on Tuesday, November 2^nd. Please see the Great Plains Energy website for more information. With that it’s not my pleasure to introduce Mike Chesser.

Mike Chesser

Thanks, Michael, and good morning everyone. I’d like to add my congratulations to Ellen for her well-deserved promotion and welcome Tony to the investor relations team. I know you’ll all enjoy getting to know him and working with him.

I also noted, there’s a great deal of earnings related activity in the industry this morning, in advance of the EEI conference, so we do appreciate you joining us. And I hope you’ve had the opportunity to read the press release that we issued yesterday afternoon. We announced a very solid Q3 with earnings that were well above consensus, and as it has been all year weather was a key factor in the quarter and accounted for all the sales volume growth we experienced compared to last year. As we’ve discussed many times on these calls, the summer cooling season is extremely important to our full year earnings. With that season behind us we are both raising and narrowing our EPS guidance range, and Jim will cover this further in his comments.

We were very pleased to announce in late August that in the company’s view, the Iatan 2 coal plant has successfully satisfied it’s in service criteria. This was consistent with our initial target of summer 2010 under the comprehensive energy plan, and well ahead of the projected Q4 date that we communicated earlier this year. This great result would not have been possible without the incredible commitment, focus, and hard work by our startup team, the many KCP&L employees who supported that team, our key contractors and countless others. I could not be prouder of their efforts and would like to take this opportunity to publicly thank them for a job very well done.

While Iatan 2 coming online represents the last construction step in our comprehensive energy plan, we still have one key element of the CEP to complete – the rate cases in Kansas and Missouri that will bring the state of the art asset into our rate base. These proceedings are extremely important to the company’s financial and credit positions and our ability to capitalize on strategic opportunities going forward. We’ve concluded our regulatory hearings in Kansas and expect an order from the commission in late November with the new rates effective on December 1^st. In Missouri, our proceedings will become very active over the next few months, and Bill will provide additional details on the process and timelines in his remarks.

We continue to take steps that reflect our commitment to sound environmental stewardship. During the quarter we began construction of 48 megawatts of wind adjacent to our existing 100 megawatt Spearville facility. In addition, we’ve issued RFPs related to environmental retrofits at our Lacine (ph) units that would bring these units into compliance with BARTS, or best available retrofit technology standards, by mid-2015. We also are evaluating environmental control alternatives at our Cibri 3 (ph), Lake Road, and Montour units.

Environmental issues continue to be at the forefront of our industry, and while we’re supportive of the long-term objectives of reducing emissions we continue to work with others in the industry to raise awareness of the need for an appropriate and responsible transition period. This is going to be essential to minimize the near-term impacts on our customers and our shareholders. As we have clarity on environmental regulations and cost recovery mechanisms we’ll also make decisions related to the best resource options for compliance at each of our generating facilities.

And finally I’d like to update you on a key transmission opportunity. As expected during the quarter we formally accepted the SPP’s notification to construct a 345 kv transmission line in GMO service territory. The cost for our 170-mile portion of the line is estimated at around $380 million and most expenditures are expected to be made over the 2012 to 2017 period. In accepting this obligation we’re responsible for ensuring the completion of the project, either by constructing it ourselves, partnering with other entities, or transferring the obligation to a qualified transmission owner. We’re evaluating these alternatives and as always we’ll keep you posted on our progress.

So with that I’d like to introduce Bill.

Bill Downey

Thank you, Mike, and good morning everyone. In my comments this morning I’ll provide an update on Iatan 2, describe the current status of our rate cases in Kansas and Missouri, provide an update on legislative and political developments in our two states, and highlight our continued strong sleep performance in the Q3.

I’ll start with the significant accomplishments during the quarter at Iatan 2. As Mike mentioned, we were pleased to announce that Iatan 2 successfully completed it’s in service testing on October 26^th. The Kansas Corporation Commission has confirmed our assessment of the in service date, and we anticipate that the Missouri Public Service Commission staff will communicate its position in the next few weeks. The staff’s view will then be subject to final confirmation by the Commission during our pending rate cases.

I’d like to echo Mike’s thanks and congratulations to the hundreds of KCP&L employees, our key contractors and vendors, and the many others who have been instrumental in taking Iatan 2 from the design phase to the finished product that has been generating low-cost energy for our customers. From the July 21^st fly around (inaudible) through the end of the quarter, KCP&L’s and GMO’s combined share of Iatan 2’s production was about 382,000 megawatt hours, which represented over 6% of our total coal fire generation during the quarter. I simply could not be more pleased with how the startup of this plant progressed. It represents yet another example of the excellent execution we have exhibited throughout the CEP.

As Mike indicated, the construction phase of Iatan 2 is complete. We are now in what we call the fine tuning and finish work phase. As a standard during this phase, the unit has experienced occasional outages to address various issues that have been identified. There has been nothing out of the ordinary in that regard. We expect to move into the performance testing stage late next month and are targeting wrap up of that phase by the end of the year.

You will recall that we issued both a revised schedule and cost estimate for Iatan 2 earlier this year. As I have outlined we have exceeded our expectations on the scheduling front and now we’ll be turning to the determination of the final cost of the project. At this point we see no indication that final cost will be outside the range we disclosed in April. As we have said repeatedly, we continue to believe that the cost of Iatan 2 will be competitive with other similar plants put into service in roughly the same timeframe. While the physical construction of Iatan 2 has been successfully completed, we cannot claim success for the overall project until our investment in the unit – the largest in our company’s history in nominal dollar terms – is adequately captured in our rate base.

I will turn next to an update on our current rate cases. The chart on slide 8 contains several of the key elements of our pending rate cases. In Kansas we are very close to a decision in the case that KCP&L filed last December. Following a three week evidentiary hearing in August and the customary briefing phase that followed, the next major milestone is the issuance of the KCC’s order, which is expected by November 22^nd. New rates are projected to be in effect December 1. As you may recall from our last call, the major contributors to the difference between our initial requested annual increase of about $55 million and the staff’s recommended decrease of about $9 million were first of all cost of capital and specifically ROE; secondly, the staff’s recommended disallowance of about $231 million of Iatan 2 project costs; and finally, depreciation. Though we cannot predict the outcome, we believe we presented and supported strong and compelling positions with respect to these items along with a number of other issues through the entire evidentiary phase of the case.

In Missouri we filed two cases in June requesting a total annual increase of $190 million across three jurisdictions. Procedurally the MPSC’s staff’s report related to Iatan 2 prudency is due on November 3^rd. The staff and other parties to the case will file direct testimony regarding revenue requirements on November 10 for KCP&L and November 17 for GMO. If needed, hearings for KCP&L are scheduled for three weeks in late January to early February and for one week in mid-February for GMO. New rates are expected to go into effect in early May, 2011, for KCP&L, and early June, 2011, for GMO.

From regulatory I’ll transition to a very brief update of the political landscape. As you might imagine with the midterm elections looming we are closely monitoring a number of key races in our two states. In Kansas, incumbent Governor democrat Mark Parkinson announced in 2009 that he would not be a candidate in 2010. Republican US Senator Sam Brownback is running against democratic state Senator Tom Holland for the position. Republican Congressional Representative Jerry Moran is running against democratic nominee Lisa Johnson for the US Senate seat vacated by Senator Brownback. In terms of the Kansas Corporation Commission, the only commissioner whose term expires next year is Commissioner Joseph Harkins. Commissioner Lloyd’s and Commissioner Wright’s terms expire in 2012 and 2014 respectively.

In Missouri there is no gubernatorial election in 2010. The most visible race in the state is for the US Senate, where republican Congressional Representative Roy Blount is running against Missouri Secretary of State Robin Carnahan, a democrat, for the seat vacated by the four-term republican Kip Bond. With regards to the Missouri Public Service Commission there are no commissioners whose terms expire in 2011, and Commissioner Davis is the only expiring term in 2012.

Turning now to slide 9 I will close with a few comments on generation fleet operations. Our coal plants delivered a solid performance during the Q3. The overall equivalent availability factor, or EAF, for the coal units was 85%, just slightly below the 87% level registered in the same period of 2009. The gap between EAF and the capacity factor, however, narrowed by two points, which indicates that our units responded very well to the demands from the extremely hot summer in our region.

Wolf Creek ran extremely well during the Q3 with an EAF of 100% compared to 93% for the same period in 2009. As you may have seen, Wolf Creek was down earlier this month for about 15 days when an underground pipe leak developed on an essential service water system. The necessary repairs were completed and the unit has run at full load since its return to service. We are seeing current and projected upward pressure on operations and maintenance costs at Wolf Creek related to a number of factors, including increased maintenance as the unit continues to age, and higher security and reliability related compliance costs. We have incorporated increased O&M at Wolf Creek into the revised 2010 guidance range which Jim will discuss in a few minutes, and are evaluating 2011 impacts as part of our budgeting and planning process.

Also, with regard to Wolf Creek, I wanted to remind you that the next scheduled outage is in the spring of 2011. In addition to normal course refueling we have several major projects scheduled during that outage, including the replacement of all four turbine rotors. As I discussed on the August earnings call, our Lacine 1 unit is scheduled for a planned outage beginning the third week of November. It is expected to last about three and a half months. During this shutdown we plan to replace all 18 cyclones in the boiler, overhaul the turbine, inspect the selective catalytic reduction system, and replace a number of other components. The planned outages in the coming months at Wolf Creek and Lacine are prime examples of our focus on optimizing the scope and duration of planned outages. We are confident these capital investments will result in improved performance for the units going forward.

That concludes my comments. Jim is next on the agenda with a review of the financials.

Jim Shay

Thank you, Bill, and good morning everyone. My comments this morning will focus on our quarterly and year to date results as well as our change in 2010 guidance. As Mike mentioned earlier, the benefits of the warm weather we experienced in our service territory this summer are a big piece of the story.

I’ll start with a few comments on our financial results for the quarter and the first nine months of 2010 compared with the same periods last year. As shown on slide 11, Great Plains Energy’s earnings for the Q3 were just under $132 million, or $0.96 per share, compared with 2009 Q3 earnings of about $79 million, or $0.58 per share. The increase was driven by improved results in our electric utilities segment, which I’ll discuss in a moment. As shown on slide 12 for the first nine months of 2010, Great Plains Energy’s earnings were roughly $215 million, or $1.57 per share. This compares with earnings of about $133 million, or $1.04 per share, for the same period in 2009. An increase in electric utilities segment’s net income was again the key driver of the increase.

Comparative results were also impacted by our Other category, which includes mainly unallocated corporate charges and GMO’s non-utility operations. This category included a loss of approximately $17 million or $0.13 per share for year to date 2010 compared to income of $1.5 million, or $0.01 per share in 2009. The main driver of the difference was a $16 million benefit from a GMO tax audit settlement in the 2009 period which we’ve discussed in prior calls.

Next I’ll turn to the electric utilities segment on slide 13. For the quarter, net income rose about $52 million over 2009 levels. Gross margin increased roughly $110 million on the back of a revenue increase of about $141 million. The warm summer in the region where cooling degree days during the quarter were over 70% higher than last year and 19% higher than normal drove most of the increase. Another key driver was the fact that we had a full quarter in 2010 of increased revenues from new retail rates which became effective August 1^st, 2009, in Kansas, and September 1^st, 2009, in Missouri.

As the chart indicates, partial offsets to the higher gross margin included increases in operations and maintenance expense of about $12 million, depreciation and amortization of about $7 million, and non-operating expense also about $7 million. As noted on the slide and as we’ve described in our earnings release, the increase in O&M expense includes a $4 million pretax loss relating to KCP&L’s and GMO’s combined share of the cost of a temporary Ox boiler we installed during the construction of Iatan. KCP&L supported a recommended disallowance of this cost in the post hearing brief we filed in September, 2010, in KCP&L’s Kansas rate case.

Moving to slide 14, year to date earnings for the electric utilities segment were nearly $100 million higher than 2009. The segment’s gross margin increased almost $240 million, again primarily due to new retail rates and the impacts of weather. Improved weather normalized demand, which I will discuss on the next slide, also contributed to the improvement but to a far less significant degree than the two factors I just mentioned. Partially offsetting the impact of higher gross margin was an increase of about $41 million in O&M expense as a result of scheduled planned outages, higher general taxes, and the loss I just mentioned on Iatan 2. Also depreciation and amortization increased about $28 million. Of that, about $17 million was driven by additional regulatory amortization and the rest from depreciation of CEP projects we placed in service in 2009, commencement of depreciation on Iatan 2 for KCP&L Kansas, and normal plant additions. With regard to depreciation, keep in mind that after construction accounting we will defer depreciation on Iatan 2 for KCP&L Missouri and GMO as a regulatory asset until new rates are effective in the Q2 of 2011.

Weather has been a big driver of sales volume increases we have seen in both the quarter and year to date. Total retail megawatt hour sales in the Q3 were about 14% higher this year than in 2009. The entire amount of the increase was attributable to weather. As you can see on the left side of the chart on slide 15, megawatt hour sales adjusted for the effects of weather were essentially flat for the quarter. For the year to date sales, volume rose approximately 8% compared to last year, with slightly over 90% of the increase attributable to weather. Compared to normal conditions, the estimated year to date revenue impact from weather is about $60 million and we estimate that the positive effect on our EPS is about $0.20 per share. Weather normalized retail sales increased about 0.6% over the first nine months of 2009 as shown on the right side of the chart. This created incremental revenue of just under $6 million.

We are still seeing a somewhat mixed story across our three customer segments, which supports our continued view of the economy in our region as stable but improving very slowly. The residential sector has shown stronger than expected growth so far in 2010. This is due in part to a very strong Q1 when we saw increased use of electric heat, but we also saw growth in both number of customers and usage per customer in the Q3. After the worst recession in decades, business conditions for certain of our top tier customers in the industrial segment appear to be stabilizing. Year to date industrial megawatt hour sales are up over 3% compared to last year, as growth in customer usage has more than offset continued decline in the number of customers.

We often receive questions about the outlook for the economy in our region. In general, forecasts are pointing to improvements in a number of key statistics in 2011 and 2012 including gross regional product, employment, personal income, and housing starts to name a few. While these projections are encouraging, whether they will come to fruition and how they will impact our customer segments remains to be seen. We retain a cautiously optimistic view of the local economy for now. As always, we will continue to keep investors apprised of developing economic trends in our service territory.

Turning now to slide 16, the Q3 was an active one for us on the financing front. In August we closed on $1.25 billion of new three-year credit facilities which replace lines totaling $1.4 billion that were set to expire in 2011. The lines were reduced based on lower projected short-term borrowing requirements over the next three years. Also during the quarter we issued $250 million of three year notes of GPE at a coupon rate of 2.75%. Proceeds for the transaction were loaned to GMO on an inter-company basis, which used the funds to repay outstanding short-term debt. This in turn contributed to our strong liquidity position at the end of the quarter when we had approximately $965 million of available capacity on our credit lines.

And finally, I want to wrap up with a few comments on our increase of 2010 guidance and some thoughts on 2011. As Mike indicated earlier, with our most important quarter from an earnings perspective now behind us, we have narrowed and increased our earnings guidance. The new range is $1.52 to $1.62 per share, up from the range of $1.30 to $1.50 we announced on our Q2 call. As slide 17 shows we’ve considered a number of year to date impacts in making this guidance change, the first being weather being the primary driver – as I mentioned earlier we estimated that the year to date favorable EPS impact as compared to normal is roughly $0.20 per share; the other being positive year to date factors including lower than expected fuel costs, which flow directly to the bottom line for KPC&L Missouri, cause there’s no fuel clause in that jurisdiction, and lower transmission costs at GMO.

While we are obviously pleased with improved earnings prospects for the year, the significant impact of weather makes 2010 an inappropriate baseline for 2011. Our results for 2011 will depend to a large degree on the outcomes of our rate cases and the strength of the economic recovery in our services territory, all of which are highly uncertain, as well as the previous factors we discussed in last quarter’s webcast. We will of course be talking with more of you about our view of 2011 and beyond on future calls.

That wraps up my comments, I’m looking forward to meeting many of you at EEI next week, and now we’ll pass the call back to Mike.

Mike Chesser

Thanks very much, Jim. So in summary, bringing Iatan 2 online this summer was a great achievement, and the timing was consistent with what we had promised five years ago when we launched the CEP, and ahead of the target we had disclosed earlier this year. Our focus now is on working diligently to obtain fair and reasonable regulatory treatment on our investment in this plant. This is extremely important to our company’s ability to meet the needs of our shareholders, customers, employees, and the communities that we serve in the year ahead.

So thank you very much for your attention this morning. Bill, Jim, Terry and I will now be happy to take any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions.) Your first question is from Mike Hahn with Bryn Mawr Capital.

Mike Hahn – Bryn Mawr Capital Management

Hi, good morning. I’d like to–

Mike Chesser

Good morning.

Mike Hahn – Bryn Mawr Capital Management

How are you, good morning. I wanted to get a bit more color on Wolf Creek. You talked a little bit about the age and O&M costs there. Could you characterize how much those costs are adding? You mentioned that you reflected that in your guidance. What are those extra costs beyond what you planned and then what do they look like for next year? And then as a follow-up, any- Building on your comments about you can’t use this as a base year because of the weather, maybe you could talk about any other incremental costs that you see coming in 2011, be it fuel or transportation costs for fuel, or any other things like that. Thank you very much.

Jim Shay

Yeah. The financial impact in our Q4 estimate is about $0.02 per share. In terms of the actual factors driving the cost, I’ll turn that over to Mike.

Mike Chesser

This is normal maintenance that all plants this age are facing, and particularly with the increase in regulatory requirements. There isn’t anything unusual with that. We will, for next year when we give our guidance we’ll detail how much if any additional costs associated with Wolf Creek are in there.

Mike Hahn – Bryn Mawr Capital Management

And then in terms of any other incremental costs you see coming in 2011 above and beyond normal growth and line items like pension and things like that. But any other one-time things as we start to think about 2011?

Bill Downey

Well, the largest factor is in our last call we kind of detailed in kind of some great detail some of the larger factors impacting next year, but one of the largest items we wanted folks to consider was the additional O&M with Iatan coming online. But there were a number of factors we detailed in a previous call.

Mike Hahn – Bryn Mawr Capital Management

Okay, thank you.

Operator

(Operator instructions.) Your next question is from Michael Lapides with Goldman Sachs.

Michael Lapides – Goldman Sachs

Hey, guys. I had really a couple of questions. One, can you give us an update on planned financing needs over the next couple of years, as you wrap down Iatan, as you ramp up on the Lacine project, just in terms of both debt and equity?

Jim Shay

The plan is we have a couple of scheduled debt refinancings, and with respect to equity issuances, in 2011 there are none planned at the present time. And our financing plans will really be tied to the capital requirements in the upcoming periods.

Michael Lapides – Goldman Sachs

Okay. When are you going to provide an update on the timing of the environmental CAPEX and then just your broader CAPEX plans?

Mike Chesser

Well, there are a number of variables right now that we’re looking at. Obviously we don’t know what the ultimate environmental requirements are going to be. There’s a lot of work going on between EI and the EPA to try to come up with transitional plans that would make more sense than what the current regulations require. So we have to see how that plays out. But I suspect we’ll get more visibility into that over the next year or two.

Michael Lapides – Goldman Sachs

And I thought you had a dissent decree that had company- or asset-specific requirements for Lacine. Is that incorrect?

Mike Chesser

We do. If we wanted, at this point if we want to operate Lacine past 2015 we have to make a major investment in environmental retrofit there. But again–

Jim Shay

And we’ll be detailing out our view of CAPEX in connection with our 10K filing and the associated scheduling, so we’ll be able to provide a good update at that time.

Michael Lapides – Goldman Sachs

Okay, but you’ve got till 2015 before you actually have to have Lacine implemented.

Mike Chesser

That’s correct.

Michael Lapides – Goldman Sachs

Okay, thank you.

Operator

Your next question is from Steven Gambuzza with Longbow Capital.