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Westar Energy, Inc. (NYSE:WR)

Q2 2012 Earnings Call

August 8, 2012 9:00 a.m. ET

Executives

Bruce Burns – Director, IR

Tony Somma - CFO

Mark Ruelle – CEO

Doug Sterbenz - EVP and COO

Analysts

Sarah Acres - Wells Fargo

Shahriar Pourezza - Citigroup

Andy Levy – Avon Capital

Travis Miller - Morningstar

Mike Bates – D.A. Davidson

Operator

Good day, ladies and gentlemen, and welcome to the Westar Energy second quarter earnings conference call. My name is Pam, and I will be your operator for today. At this time, all participants are in listen-only mode. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

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

Bruce Burns

Good morning. And welcome to our second quarter conference 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 Investors section.

Some of our remarks will be forward-looking, so I will remind you of uncertainties inherent in our comments or that we may have included in materials that supplement the release. Commenting this morning will be Tony Somma, CFO; and Mark Ruelle, CEO. Other members of our senior management team are available to answer your questions.

Tony will offer highlights on the quarter, provide an updated on major projects and comment on financing activities and earnings guidance. Mark will comment on regulatory activities, and share a few observations on our operations and business trends.

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

Tony Somma

Thanks Bruce. Good morning. We had a very good second-quarter with the growth in earnings resulting largely from recent price adjustments, warm weather and COLI income. Net income was $61 million compared to $44 million last year. EPS were $0.48, up $0.10 from last year.

Keep in mind when comparing the two periods that last year included about $0.03, a one-time legal expenses while this quarter reflects about 10% more shares outstanding to fund utility plants. Gross margin was up $37 million or 11% due largely to higher prices and a 3% increase in retail sales.

As measured by cooling degree days, weather for the quarter was significantly warmer than normal and about 20% warmer than last year although a good portion of that was in April and May which doesn’t have the same effect on sales as hot summer weather does. .

On the expense side, combined O&M and SG&A was up about $22 million or 14%, excluding a $10 million increase in SPP transmission cost, most of which has a revenue offset. Also excluded from this increase was $6 million of one-time legal expenses incurred last year.

Principal reasons for higher expenses most of which are already reflected in the recently authorized revenue requirement price adjustments were: $11 million more for pension employee benefit costs, $3 million for increased tree trimming and related line maintenance, a $3 million increase in property taxes, which has a revenue offset and $2 million for increased maintenance at our coastal plant.

Depreciation was $5 million lower than last year due primarily to the adaption of lower depreciation rates as part of the recent rate order. We recorded $3 million of COLI income which was the primary driver of the increase in other income.

During the quarter, we priced 1.1 million common shares which we intend to settle late next year. Our 2012 plans for equity haven't changed. We don't intend to increase our shares outstanding this year other than a few from our dividend reinvestment plan.

In May, we issued an additional $300 million of 30-year first mortgage bonds at a rate of just over 4%. We accomplished this through a reopen of the bonds we issued in March. Some of those proceeds were used to redeem $150 million of higher cost first mortgage bonds. All total to the second quarter we've issued $550 million of first mortgage bonds and redeemed $220 million of higher cost debt. We also recently redeemed our outstanding preferred stock. This refinancing activity should provide about $3.5 million of annual savings.

Turning to CapEx, I am pleased to report that all of our large projects remain on schedule and on or better than budget. Here's a quick summary. Air quality equipment for our unit four at Lawrence Energy Center remains on schedule for completion in the four quarter. We completed the large unit five project earlier this spring. The entire Lawrence project has come in well below original budget as we shared with you earlier.

Our major environmental projects at the Jeffrey and LaCygne energy centers remain both on schedule and on budget. While not included in Westar’s CapEx table are Prairie Wind joint-venture is coming along nicely. We’ve acquired the majority of the rights away clearing the start of the couple of months ago.

Final engineering on the line is complete and the project targeted completion late 2014 is now coming in at a much lower cost than SPP’s planning estimate about $180 million, down from the earlier $225 million. The two wind projects being developed to meet our state’s RPS are also coming along accordingly to plan. I wish we should be fully operational by the end of this month and Post Rock is targeted for completion in the fourth quarter.

Recall these projects aren't in our CapEx plans as it will take 100% of the output under long-term fixed-price power purchase agreements. In our release last night we affirmed 2012 earnings guidance of $1.85 to $2 per share with a bias toward the upper end of the range. In affirming guidance we’ve also adjusted our outlook for weather adjusted retail sales to flat, down from an earlier estimate of 1% growth for the year.

As is always the case, guidance is conditioned on the typical factors, including such things as weather, economy, COLI proceeds, and so far this year we’ve received about 90% of the full year estimate built in the guidance, and other factors we can’t control all of which we detailed in our supplemental materials.

With that, let me turn things over to Mark.

Mark Ruelle

Thank you, Tony. On the regulatory front, with the general rate case behind us things are pretty quiet, but we have implemented a number of necessary price adjustments to fund required utility plant investment. A $37 million increase through our transmission rider in April, an increase of $19 million through the environmental rider approved in June and we just initiated a $1 million update to the energy efficiency rider which is targeted for adjustment in November, all according to plan.

With respect to Kansas Commission, Commissioner Lloyd’s term expired in March. Governor Brownback has since appointed Shari Albrecht to fill the open position. She is an attorney who’s worked for 20 years at the Kansas department of health and environment. Our environmental team is working through in that capacity and we expect she’d be thoughtful commissioner. She awaits confirmation by the Kansas Senate, which we think will take place late-summer.

On the nuclear front, we see a continuing increase in demand for resources at Wolf Creek stemming from increased regulation generally coupled with increased regulatory oversight following the unplanned outage earlier this year. We expected these combined effects will lead to incrementally trending higher costs. The plant’s had a very good history over its life but lengthy outages the last couple of years have been disappointing. We and our co-owners are doing what we should to get the plant back to its customary level of very high performance.

Unemployment in the region remained at 6%, unchanged since the beginning of the year. Most our large customers expressed optimism for steady or better performance with a number of expansions planned to be in place next year.

Aerospace remains mixed as Boeing military continues its ramp down and we expect Spirit to offset some of that with increased commercial (indiscernible) production. New home construction remained slow but positive with new customer connects following the same trend.

Notwithstanding the Kansas Spirit better than most, in reviewing the overall economic picture and considering our best estimate of weather normalized sales, as Tony said we’ve revised our outlook for retail sales this year to flat, down from about 1% growth included when we issued guidance last February. Like most in the industry it’s hard to peg this on just one or two factors. We’ve come to conclude that some mix of the still soft economy, psychological belt-tightening energy efficiency and price elasticity.

Of course, we are adapting to softer sales by addressing our expenses. We are in the middle of some modest efficiency and organizational effectiveness adjustment that we will have more to say about when we recap the third quarter.

With that, we are 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. So operator, please open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Sarah Acres with Wells Fargo.

Sarah Acres - Wells Fargo

Can you remind us of your current thought process around the timing of the next base rate case and kind of what level of regulatory lag would trigger the need to file a case?

Mark Ruelle

We really haven’t put a date on that, Sarah. If you look at how we’ve operated in the past, we are pretty transparent. You can see how much capital we are adding, how much of that is adjusted to trackers and the portion of that does not adjusted to trackers. We have, recall that as part of the GRC we just finished, as part of that agreement we will file an abbreviated general rate case to pick the essentially the capital investments associated with our La Cygne project and by rule, we will file that abbreviated case within one year of the order we just received. So that says we file that case probably early spring. Last date we could file that I think the end of April. And that will pick up a good part of the La Cygne case and then the follow-on to that will mean a general rate case down the road.

Tony Somma

Exactly right. Sarah, we probably have to do another GRC as the La Cygne spend winds down to pick those costs.

Sarah Acres - Wells Fargo

And as that might be a few years out, how does that impact the timing of equity? Is it likely that you kind of wait until the capital structure needs to be trued-up for rate making purposes or might there be something in between?

Tony Somma

We have been pretty open about and transparent how we finance the business. We target 50:50 cap structure and we are not going to create too big of a bow wave in which (indiscernible) to issue equity. I think so you should look to what we have done in the past as to how kind of dollar cost to average our equity issuances. But in all likelihood we are going to wait to issue shares till or close to the rate case timing.

Sarah Acres - Wells Fargo

And then lastly, are you able to quantify the impact of weather year-to-date versus normal?

Tony Somma

Sure. Our estimate for weather kind of for the quarter added about $0.05 to $0.06 and as far as versus normal year-to-date it’s probably about a wash as we had a pretty warm as you know first-quarter which hurt our earnings in the second quarter which is warmer. So net, net they pretty much wash each other out.

Sarah Acres - Wells Fargo

So then with the upper or the bias towards the upper end of the range on guidance, does that more reflect hot July weather?

Tony Somma

Well, it’s a couple of things. We have issued some pretty cheap debt. We’ve refinanced some higher cost debt. So we’ve got a tick up on our interest expense lower. We received 90% of our COLI proceeds and to your point, we’ve had relatively warm July.

Operator

And the next question comes from the line of Shahriar Pourezza with Citigroup.

Shahriar Pourezza - Citigroup

Just a general question on the macro-economic environment down there, are we seeing any benefit in your service towards – with some of the oil drilling we are seeing down there? I mean I think Sandwich estimates 15 billion barrels of oil in Southern Kansas and areas like Harper County are seeing no vacancies in their hotels where historically they gave you a tax break to stay in the town. Are we seeing any kind of a benefit down there for some of the oil drilling?

Mark Ruelle

Well, I think you pegged it right, which is the activity we're seeing is preliminary activity and all positive. But I think most people would say it’s too early to claim victory on it. We share the optimism that some of the drillers have and we’re well aware of what is meeting for land values and mineral values, and as you just indicated the buzz of activity in that area. But I don’t think we would say that we’re yet seeing that economic flow from royalties or something. I just don’t think there is meaningful production yet out of that.

Operator

And the next question comes from the line of Andy Levy with Avon Capital.

Andy Levy – Avon Capital

First question doesn’t have anything to do with your earnings but just curious one of the things you talked about on your earnings release was lower wholesale sales, I assume margins as well. Can you just give us a little color on that again? I know you are not sensitive earnings wise, kind of have just motivation on it, but is that just more weather related where you had to allocate other resources towards your retail business or is there something else going on?

Doug Sterbenz

This is Doug Sterbenz. Primarily what we are seeing in the markets is low gas prices. And while low gas prices are prevalent, it doesn’t give our coal fleet the advantage that sometimes it has under higher gas prices. And so the markets that we normally would sell off of our assets into, they are providing their own generation off those combined cycle units. It’s just lowering our opportunity in the marketplace. And again as you’ve pointed out, recall that those margins that were missed in this year are returned to our customers in the way of lower fuel cost.

Now our customers all in all are net benefit to that because we also are taking advantage of those low fuel prices and low purchase power prices and passing those savings on to our customers through lower fuel bid.

Andy Levy – Avon Capital

Which I am sure the customers are happy about. How does that compare to the first quarter with what you saw in the first quarter?

Doug Sterbenz

Our wholesale sales were actually up a little bit in the second quarter. Remember though in the first quarter, we throttled our plants back because of the potential regulations.

Andy Levy – Avon Capital

How about pricing? What did you see as far as pricing first quarter versus second quarter?

Doug Sterbenz

Gas prices are a little higher in the second-quarter than they were in the first. And demand is up a little bit in the second-quarter over the first is because of our weather patterns here.

Andy Levy – Avon Capital

And separately on your sales sensitivity, you mentioned that you are assuming flat sales now, is that for the remainder of the year or that’s for the entire year?

Tony Somma

So what we've said is sales are flat and that's weather normalized for the entire year.

Andy Levy – Avon Capital

And that's weather normalized. And can you give us some type of sensitivity as far as I don’t know on an earnings per share basis or gross margin basis?

Tony Somma

Sure. If you look at our basket of sales, our retail sales, that 1% equates to about $0.05 to $0.06 a share.

Andy Levy – Avon Capital

So that's what you have to do breakout this year and even maybe next year on the O&M side, for modeling purposes that’s kind of where we should kind of offset –

Tony Somma

Haven’t given any guidance for 2013 yet.

Andy Levy – Avon Capital

Just want to give you the benefit of the doubt, that assumption would be that on the O&M side, you got to make up $0.05 to $0.06, is that fair?

Tony Somma

If you want to just look at in terms of the refinancing things we have done as well.

Andy Levy – Avon Capital

And any idea versus plan how much interest expense may save you this year?

Tony Somma

I am sorry, can you repeat the question?

Andy Levy – Avon Capital

Versus your original plan for 2012, how much benefit you are getting on the interest expense side on the refinance?

Tony Somma

The refinancing is about 3.5%. I don’t know versus our plan – I can tell you our plan didn’t have us issuing debt at 4.8%, it was something higher than that. I just don’t recall. And also we have been tapping the commercial paper market because we got upgraded earlier in the year and we’re able to access CP as opposed to pulling down off of our credit facility which is cheaper as well.

Andy Levy – Avon Capital

And then one crazy question I’ve got for you. And that was based on the last question, I guess relative to the oil. You guys don’t have any properties down in that area that may have some benefits to it.

Mark Ruelle

You mean like do we own a bunch of ranch with mineral rights or something?

Andy Levy – Avon Capital

Yes.

Mark Ruelle

Unfortunately no.

Operator

And the next question comes from the line of Travis Miller with Morningstar.

Travis Miller - Morningstar

Want to think about over the next 2 to 3 years on the GRC side, especially the distribution generation stuff, outside of what we have seen, and outside of the environmental control stuff, what kind of spending – are there any kind of big projects coming down the pipe or are we just looking at kind of maintenance level that capital spend?

Mark Ruelle

With the caveat that you never know what the regulations in the future will be, we think we're on the tail end of complying with the wave of regulations we know about with regard to the environmental stuff. You might recall that well much of the industry is pretty twisted up around mass. You haven’t heard Westar express a lot of concern about mass, and the reason for that we got started early. And so we have a good part of that behind us. Really the only major environmental projects that we see in front of us are already in under construction, and that's the La Cygne retrofit which will be concluded in the spring of ‘15 and then FCR project at one of the Jeffrey units, which we expect to conclude the end of next year.

Beyond that on the environmental side, things look a little more manageable than in the past in terms of the -- little more modest in terms of any capital requirement. On the transmission, we continue to see the need for additional transmission, but I don't think you'll see those as big lumpy projects that are difficult to finance, just a nice run rate of very good smaller project additions that maybe 100 or 200 a year of that kind of thing. And right now we don't have any identified needs for new generation other than the wind projects that Tony mentioned that are under development and which are not going to be on our balance sheet but are instead going to be taken under PPAs.

Now the Kansas statutes have another step up in the requirements for renewables that for us I think will hit in ‘16 or ‘17 and we haven’t made any commitments as to whether we might own those or take those under contract. And then with regard to the future generation needs, that’s the thing that our customers dictate more than us. And so we don't have any present plans to on the near-term horizon to build any power plants, but just as the economy falls off, perhaps it can pick up and we’d have to put some plants together pretty quickly and are ready to do that.

Travis Miller - Morningstar

And then distribution is driven by customer growth primarily?

Mark Ruelle

Well, customer growth, and maintaining a system.

Travis Miller - Morningstar

And second question on Prairie Wind, again started this year, do you expect any kind of earnings contribution this year, or most of that is going to fall – will it fall in 2013, 2014?

Tony Somma

It’s going to be relatively benign, Travis just because we are in nascent stages of construction and acquiring the right way.

Mark Ruelle

We get construction work in progress, it’s just such a small amount of money.

Travis Miller - Morningstar

(indiscernible)

Tony Somma

It gets to see – we are getting a return on our start-up costs and cash investment but it’s not a big number that we’re getting a return on.

Operator

And your next question comes from the line of Mike Bates with D.A. Davidson.

Mike Bates – D.A. Davidson

I just wanted to follow up on Sarah’s earlier question. When you talked about the weather benefit in the quarter being $0.05 or $0.06 was that absolute or was that relative to last year?

Tony Somma

That was relative to norm and relative to last year you can probably cut that in half to $0.02 to $0.03 for the quarter.

Mike Bates – D.A. Davidson

And then in the prepared remarks you mentioned an expected expansion for some of your larger customers in 2013. Can you give us a little bit more color as far as what type of customers these are and what the expansion could possibly be –

Mark Ruelle

I will give you a couple of illustrations but it’s pretty broad and some of these, and just basic materials, for example, lot of people might not know but Kansas is a pretty significant salt producer. So one of our customers is expanding there. Some basic manufacturing in the automobile supply chain, I don't know that that’s been publicly announced. So I will just leave it at that.

And then with regard to food stuff, everybody love bacon, there is actually a pretty big bacon, precook bacon facility that’s expanding like gang busters. And then we have a big chocolate factory that is being constructed right here in Topeka. I think it’s the first Mars chocolate factory in the U.S. I don’t know 30 years or something and make M&M and Snickers parts. And so that’s kind of an illustration. Of course, you know what’s happening in commercial aviation with the Spirit having a pretty nice expansion on the commercial side of aviation and then about six months ago Boeing said they were ramping down military aviation. So that's why it’s kind of a bit of a wash.

Mike Bates – D.A. Davidson

And then just coming back to the question on the abbreviated rate case tied to that La Cygne, do you have any view as far as the size of the cliff balance you would likely file with when you submit them?

Mark Ruelle

It would be roughly half. So our shares about 600 million, so we are talking around 300 million plus or minus.

Operator

And the next question comes from the line of Dave Pad with Bank of America.

Unidentified Analyst

Just got a question, could you remind me what your weather adjusted sales growth in 2011 was?

Mark Ruelle

About 1% -- a strong one, 1.5%.

Unidentified Analyst

So much of the change really you’ve essentially seen in the last quarter in terms of the – get you guys to change your expectation for the full year?

Mark Ruelle

I am going to put a little bit of context on it Davie. Much of the change, and we are the first to confess that it's really hard to guess the weather. Weather is not linear. So when you get extreme weather it’s hard to attribute that accurately. So when we’re talking about, you know about 1% growth, now saying about flat, I'm not sure there is a lot of change going on.

For example, if you have 85 degree or an 80 degree summer day, that really hurts you on your expected sales. But it hits 105, it’s probably not. The difference between 100 and 105 doesn’t turn on more (indiscernible).

Tony Somma

And just to frame up the weather, the weather in this quarter was a 2.5 standard deviation event. So that’s – as what Mark was saying it’s not perfectly linear. And weather in the first quarter was a 2 plus standard deviation of that going the other way.

Unidentified Analyst

But I guess then how should we view – I know this year O&M growth tied to great relief that you received. But just adjusting for that, going forward in light of what you see for sales growth and the comments you’ve made about ongoing pressures that will creep, how should we kind of think about O&M growth?

Mark Ruelle

Well, you should think about it as just living within our means.

Unidentified Analyst

Is that mean tied to your expected sales growth –

Mark Ruelle

We’re obviously going to manage around our business. And so we don’t treat O&M growth as a constant and sales as random. We manage O&M along with the sales changes. And there are some years you're going to not be able to do everything you want, other years you can do more than you hope you could.

Unidentified Analyst

On Prairie Wind, what – I think you mentioned the CapEx now for the project $180 million.

Mark Ruelle

Yes.

Unidentified Analyst

And what’s your share of that?

Tony Somma

50%, and recall the project itself will raise the debt at that project level. So really we’re talking about a difference of about $10 million of equity contribution from Westar.

Unidentified Analyst

And then you also mentioned changes in the Lawrence the actual spend versus what you had planned, can you quantify what that –

Mark Ruelle

But those are already in this year’s plan. That project was originally estimated at I think $340 million and I think it’s going to come in, in the high 2s.

Unidentified Analyst

And they are totally reflected in there.

Mark Ruelle

Yeah, they are reflected in the plan. And frankly most of that was already reflected in the larger unit that we just already completed in April.

Operator

With no further questions, thank you, I would like to turn the call back over to Mr. Mark Ruelle for closing remarks.

Mark Ruelle

Thanks folks for joining us. If you have follow up questions, please go ahead and give Bruce a call at 785-575-8227. Thanks and have a great day.

Operator

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

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