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Executives

Bruce Burns - Director, IR

Tony Somma - CFO

Mark Ruelle - CEO

Doug Sterbenz - COO

Mike Lennen - VP, Regulatory Affairs

Analysts

Michael Lapides - Goldman Sachs

Andrew Levi - Caris

Sarah Akers - Wells Fargo

Westar Energy Inc. (WR) Q2 2011 Earnings Call August 5, 2011 10:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the second quarter Westar Energy Incorporated earnings conference call. (Operator Instructions)

I would now like to turn the conference over to your host, Mr. Bruce Burns, Director of Investor Relations.

Bruce Burns

Good morning. I am Bruce Burns, Director of Investor Relations for Westar Energy. Welcome to our second quarter conference call.

Last night, we filed our 10-Q and posted it along with the earnings release and supplemental materials on our website at westarenergy.com. They can be found under Supplemental Materials within the Investors section.

Some of our remarks will be forward-looking. So I remind you of uncertainties inherent in our comments during this call or that we may have included in materials in the supplemental release.

Making the remarks this morning are Tony Somma, CFO; and Mark Ruelle, CEO. We also have a number of our senior management team with us to answer questions.

Tony will offer some highlights on the quarter, comment on guidance and major projects. Then Mark will update you on regulatory activities and comment about EPA regulations that have been so much in the news recently. He'll also share some perspective on the Kansas economy and comment on a few organizational changes.

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

Tony Somma

Thanks, Bruce. Good morning, everyone. Earnings per share for the quarter were $0.38 compared with $0.47 last year. For the quarter, gross margin increased $10 million or 3% due mostly to higher prices. Weather in the quarter, as measured by cooling degree days, was almost the same as last year.

Turning to the expense side, O&M for the quarter increased about $12 million or 13% excluding a $4 million increase in SPP transmission cost, most of which had a favorable revenue offset. It should be noted, last year we reversed a liability associated with assets we sold in the 1990s, thus reducing 2010 O&M by $5 million.

Current year increases include the following: $4 million of Wolf Creek, half of which was for regulatory compliance and the balance due to increased expenses for this year's refueling and maintenance outage; $2 million on our distribution system for tree-trimming where we're seeing value and a more sophisticated approach to optimize electrical reliability with more targeted expenditures, this program will be a component of our upcoming rate case as we like to expand it; and $2 million increase on property taxes which was also offset with higher revenues.

Partially offsetting the increases were the $2 million reduction in storm amortization expense, something that will continue through the remainder of the year.

SG&A expenses increased $8 million due primarily to higher legal fees related to the arbitration of two former executives and the amortization of deferred energy efficiency program cost with the latter also having a corresponding revenue offset. Last, depreciation expense increased $4 million due largely to planned additions for environmental and transmission projects completed last year.

Now, turning to our financing plans for the year, through June we settled 3.1 million shares priced last year on a forward contract, receiving about $66 million. We still have 9.7 million shares priced last year, reflecting about $226 million of available equity that we plan on selling this quarter or early next. Beyond this, we don't have plans to sell additional equity this year.

The available forward equity combined with $0.5 billion available under our credit lines gives us $0.75 billion of liquidity before including internally-generated cash. With respect to our credit lines, we will likely renegotiate our larger credit facility which comes due in March 2012 later this year.

While summer temps have been strong so far, as evidenced by a record peak demand last week, summer is not over. We're pleased with year-to-date results and happy to affirm earnings guidance for 2011 of $1.65 to $1.80 per share, which excludes an additional $0.11 per share will record as a result of settling arbitration of the two former executives and reversing related reserves.

Guidance is conditioned on typical factors, including such things as weather, the economy, COLI proceeds, which none have been received so far this year, and other factors we can't control, all of which we detailed on our supplemental materials.

Now, before turning the call over to Mark, here is a quick update on our major construction projects, all of which are going well. Our $100 million multiyear 345 kV line from Wichita to Oklahoma is trending favorable with respect to both budget and schedule. Right now, it's trending about 10% favorable on cost and a couple of months ahead of schedule.

The 20 or so smaller transmission projects totaling about $125 million, this year are progressing according to plan with respect to both schedule and budget.

As planned, the KCC approved the route for Prairie Wind, a 345 kV joint venture line running west from Wichita. Now that we have the route, we're gearing up to acquire right of way and start detailed engineering.

We anticipate construction in the field to begin by the middle of next year with a target completion by late 2014. Prior to detailed design, we've estimated the project cost to be about $225 million with Westar's investment to be out $50 million to $60 million. Even though construction has yet to begin, the FERC has already approved Prairie Winds transmission formula rate. This allows us to begin recovering this quarter deferred startup cost.

Although our coal capacity is almost 85% scrubbed, complying with changing environment mandates by installing more air quality controls, it'll continue to be a largest component of our CapEx program for a few more years. Our project Lawrence Energy Center, where we're upgrading existing scrubbers as well as adding new controls, continues on schedule for a completion by late next year. It is also running about $20 million or 6% favorable to budget.

The installation of selective catalytic reduction on one unit at Jeffrey Energy Center remains on plan to be in operation by the end of 2014. Obviously, this is not in time to meet the recently issued dictate of January 1 of next year, under the new cross-state rule, a point Mark will comment on in a minute.

Our most significant environmental project is at on the jointly-owned LaCygne Station managed by Great Plains Energy. This is big project that includes scrubbers, backhouses and a common chimney for both units, and SCR and low NOx burners for unit two. Unit one already has an SCR. Our share is estimated at $615 million, excluding AFUDC, with the completion date expected by summer 2015.

GXP filed a request with KCC for predetermination, but until they issue their decision, very limited work will take place. We joined their case of pointing the need for the project and we, (inaudible) the KCC staff and their consultants agree that retrofitting the units is the right thing to do for Kansas. We expect a decision by the KCC later this month.

With that, let me turn the call over to Mark.

Mark Ruelle

Thanks Tony, and good morning. I'll begin by commenting on our active regulatory agenda. Of significant interest to us in the LaCygne predetermination docket beyond the KCC's finding whether the retrofitting of the plant is the right thing to do for our customers is the KCC's clarification whether or not we may continue to use our environmental rider to recover our share of the cost. Using the rider reduces regulatory lag and reduces the overall cost for our customers, something important given the size of this project.

In addition to participating in the LaCygne case, we've completed a number of other dockets so far this year. In April, the KCC approved the request for a $17 million increase due to transmission delivery charge to recover increased transmission costs to serve our Kansas retail customers.

We received from the KCC in May an order approving predetermination to purchase an additional 370 megawatt of wind energy, taking the advantage of what looked to us to be favorable market conditions with the all-in 20-year fixed price below $35 per megawatt hour. This is to satisfy the renewable portfolio requirement under Kansas law.

Also in May, the KCC approved our annual update of the environmental rider, reflecting cost recovery for investments made last year. The increase was $10 million. Last month, we also filed our request to update the energy efficiency rider, seeking to recover about $10 million of deferred cost for energy efficiency programs. We expect that decision by November.

We plan to file a general rate case by the end of this month, as without line the drivers for the case is straightforward, lower kilowatt hour sales and higher cost since the time of our last test year almost four years ago.

Wolf Creek returned to service after a longer than typical refueling and maintenance outage where we upgraded the turbine to increase its capacity. The replacement of the turbine required a longer outage. With that, we scheduled some through inspections which gave us an opportunity to rehab other equipment while things were opened up. In addition, some startup issues resulting from the longer outage delayed the plant's ramp up to full power. It returned to 100% power early in July and has operated at that level since.

We amortized the cost of outages over an 18-month refuel cycle, which will be about 1 million a month higher than last year, most of which we had already anticipated in our 2011 plans and guidance. As Tony mentioned, this was one of the contributing items for the higher O&M.

As you're aware, EPA issued its Cross-State Air Pollution Rule last month aimed at further limiting the emissions of SO2 and NOx. Some of you know that the final rule differs significantly from the proposed rule released last year and has taken a number of utilities and states by surprise, particularly as to the dramatic reduction in the number of allowances that will exist starting next year.

In the past, such rules have allowed adequate time for companies to modify their plans and operating practices to comply. This rule provides no such construction window. We already have a state-approved plan that keeps us in compliance by 2015 and with the reasonable construction window. We're now looking at various options to comply with this new rule on January 1 that include re-dispatch of our units, purchasing allowances and possibly purchasing some power from others, any of which unfortunately increase cost to our customers.

Accordingly, our view is that a more balanced approach to compliance is the one that shows greater regard for customers' energy cost in a fair U.S. economy seems to be in order.

Speaking on the economy, at least in Kansas, it continues to get better. Unemployment through June is 6.6%, which has improved since the beginning of the year and remains significantly favorable to the national rate, which unfortunately we know is sideways at best.

Most of our Kansas industrial sectors continue to show improvements. Manufacturing customers are leading the way, plus we had two significant announcements for new manufacturing facilities. One particular sweet one was the announcement that Mars Chocolate plans to crank out M&Ms and Snickers bars from a brand new facility here in Topeka. This will be the first major Mars Chocolate site built in the U.S. in 35 years.

The other announcement was by New Millennium Wind Energy, a company that will build vertical axis wind turbines. We've been pleased to see the development of what looks like a developing wind technology cluster around the aerospace expertise in the state.

Both of these are positive indicators for the Kansas economy and demonstrate that our value preposition as the electric provider here contributes to the attractive business climate for our state and the region.

Traditional aerospace is one of the sectors where results are more mixed. While the military and commercial aircraft continue on a favorable trend, it continues to be a struggle for private aviation.

As Tony referenced earlier, we close the final chapter in a nearly decade-long dispute with two former executives. We're thankful to have settled the matter for significantly less than we had reserved, which will benefit our bottomline in the third quarter. Settling this also provides a relief for what have been elevated legal expenditures and which have not been recoverable in our utility rates.

With all the flooding this summer affecting some utilities, let me share with you our situation. None of our plants have been in harm's way. We went into summer with strong coal inventory at our largest plant, Jeffrey, and are operating there with no concerns or restrictions about coal.

As to LaCygne and two smaller coal plants, the diversions have resulted in longer training cycle time, though not as severe as in '05 and '06. We are taking some modest coal conservation measures at those other plants.

Before we take your questions, let me say a few words about our strategy and some changes to our organization. I along with Bill Moore and Jim Haines and a couple of others returned to Westar about eight years ago. We set about shaping a common vision and continue to believe in that vision and the merits of remaining a basic regulated utility. With Bill's retirement, I don't expect any significant change to the strategy we mapped out eight years ago.

We'll continue to focus on taking care of our customers, operating with discipline and efficiency and working constructively with regulators and officials to help us address significant policy mandates, while working to keep prices affordable and providing investors fair returns and carefully manage risk exposures.

Nevertheless, a change in the CEO's office presents a natural opportunity for us to grow our people through new assignments and to refocus on changing imperatives. Other than being down one executive with Bill's retirement, I'm pleased to share that our entire executive team remains in place, but with some changes in responsibilities. Let me share just a couple of them.

Tony Somma is now Senior vice President, Chief Financial Officer and Treasurer. Greg Greenwood has become Senior Vice President, Strategy. He will head up what we referred as our newly formed strategic imperatives organization, which recognizes the emerging nexus among regulatory affairs, environmental services and major construction. Alighting these three functions to bring the collective leadership and expertise to bear should help us navigate successfully.

We're now ready for questions from the financial community. Members of the media, we invite you to contact Gina Penzig at 785-575-8089 if you have questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question today comes from the line of Michael Lapides with Goldman Sachs.

Michael Lapides - Goldman Sachs

First of all, thinking about the revenue increases that will come in during the course of 2011, the transmission piece, the$17 million that was granted in April, that basically was just the state passing trough the FERC-approved transmission revenue increase, correct?

Tony Somma

Correct.

Michael Lapides - Goldman Sachs

The ECR, how much did you recognize in the second quarter, meaning the $10 million granted in May?

Tony Somma

It would have been, Michael, just rough and dirty probably one month of the $10 million. You take $10 million divided by 12 times one month.

Mark Ruelle

Effective June 1.

Michael Lapides - Goldman Sachs

And the energy efficiency rider of $10 million, when does that go into effect?

Mark Ruelle

November 1.

Michael Lapides - Goldman Sachs

On the cost side, when you at things like the legal costs and Wolf Creek, how much do you think of those is kind of basically abnormal? If I were to look at a year or two years from now, those costs wouldn't be in the O&M or SG&A line?

Tony Somma

Certainly the legal costs were elevated due to the arbitration. And we would expect that number to come down pretty much commensurate with what we said the additional arbitration expenses contributed.

With respect to O&M, I'll just refer to our guidance drivers that we updated last night. We are looking at roughly maybe a 3% increase on our O&M over the last year. Our O&M spending last year was heavier in the fourth quarter than it will be this year. This year, we're a little heavier and slated towards first and second quarter.

Operator

Your next question comes from the line of Andrew Levi with Caris.

Andrew Levi - Caris

On the plant outages relative to the coal delivery, can you just give us a little more detail on that and more I guess as far as timing, when we may feel these plants will be able to run at full capacity? What your thinking is?

Doug Sterbenz

First of all, there was no flooding impact on our second quarter earnings. But where the flooding has negatively impact is the delivery times at a few of our plants. First, our Jeffrey Energy Center remains completely unimpacted. We started out with a very high coal pile and we do not expect any impact on that plant. Even though it is having longer cycle times with trains, we are not going to have any problems with coal there.

Our smaller plants, the Tecumseh Energy Center and the Lawrence Energy Center, are in a situation where their coal piles were not able to be as big just due to the space. So we are starting to curtail those units primarily at night. So we are not seeing really any impact. And with the cycle times we are seeing right now, we expect that will just continue on through the fall. But building a coal pile will be a slow process, and we don't expect to have that coal pile built back up to its normal levels until mid-2012.

The LaCygne plant is operated by Kansas City Power & Light, and it's really in the same situation as our Lawrence and Tecumseh plants, slower delivery times. The coal pile is dropping. So therefore, we're curtailing that plant at night, and we don't expect that to be back up to its normal piles until probably the end of 2012.

Mark Ruelle

Basically, Andy, we don't have trouble serving our own mode, but it does reduce the amount of off-system sales we can make at night, which of course ultimately help our customers.

Andrew Levi - Caris

LaCygne, you said 2012 or did you mean 2011?

Mark Ruelle

We don't expect normal coal piles there until the end of 2012. That doesn't mean we're going to be curtailing all that time. It's just going to take a long time to build that reserve back up.

Andrew Levi - Caris

And on LaCygne, when do you think you will be able to run that plant, or do you feel that you will be able to run that plant at full capacity?

Mark Ruelle

Well, we're probably going to take the opportunity during economic times to curtail that unit even all through the fall to try to build that coal pile up ready for next summer.

Andrew Levi - Caris

So you think by end of the year, it should be running full capacity if needed?

Mark Ruelle

It's running full capacity as needed today. The prices are such and our load is such that we can curtail that plant at night with very little harm.

Andrew Levi - Caris

Obviously, you guys have the fuel costs, so there should be no financial issues relating to this, right?

Mark Ruelle

That's correct. We don't anticipate any impact to earnings.

Operator

Your next question comes from the line of (inaudible).

Unidentified Analyst

What is the timing for the rate case? I'm just trying to understand why the delay? Could you just elaborate a little bit more to your strategy for the next rate case?

Mike Lennen

At this point, we're on target to make a filing at the end of this month. And then the commission has 240-day timeframe within which to consider the application and reach a decision in terms of moving from early summer to the late summer for the filing. There are just a number of factors that we looked at, including the first quarter and adjusting a test year a bit for that and then just looking some of the underlying factors that would go into including depreciation expense.

Unidentified Analyst

Could you just give us a little bit better what the rate base could be or something, anything you can share today?

Tony Somma

The rate base is something that we don't normally publish, because there are so many pluses and minuses to it. We have had a long estimate and projection for you for a long time. Of course, the exact number, we don't have.

Operator

Your next question comes from the line of Sarah Akers with Wells Fargo.

Sarah Akers - Wells Fargo

I have a question on transmission. A while ago, you guys put out a press release that kind of had a map on it for Kansas that laid out a number of potential projects. I know the SPP is in the midst of their ITP10, which will be wrapped up I think later this year or early next year. Do you expect that process to give some clarity on which projects you guys are going to move forward with?

Mark Ruelle

Remember those projects were on long-term plans out, as long as 10 years. But it does appear that at least one of those projects is moving forward quicker. So we're encouraged to see that some of those projects that we anticipated being spaced up quite away might actually happen quicker.

Sarah Akers - Wells Fargo

Then also, the FERC just put out their Rule 1000 on the Right of First Refusal. Will that have any impact on your plans in pursuing transmission projects outside of your footprint in Kansas?

Mark Ruelle

No body knows, of course, right now. Recall one of the things in Kansas that's maybe different than in other states is that the Kansas Corporation Commission still has the signing authority. And so there is still a fair amount of state interest to get represented in there irrespective of how the FERC comes out on that rule.

Doug Sterbenz

And I will say that Right of First Refusal I believe applies to new transmission lines. Many of our lines are existing lines that are just simply going to be upgraded along their existing right away. And therefore the Right of First Refusal, we still have. So we would be the builder of that upgraded line.

Operator

Ladies and gentlemen, this concludes the question-and-answer portion of today's event. I'd like to turn the conference back over to Mark Ruelle for closing remarks.

Mark Ruelle

Well, thank you for joining us. For those of you that have follow-up questions, of course you know you can contact Bruce Burns, our Director of Investor Relations. And just to remind you, Bruce's number is 785-575-8227. Thank you for joining us this morning and have a great day.

Operator

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect. Have a great day.

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