Good day, and welcome to the PPL Corporation third quarter earnings conference call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to Joe Bergstein, Vice President of Investor Relations and Treasurer. Please go ahead.
Thank you. Good morning, everyone. Thank you for joining the PPL conference call on third quarter results and our general business outlook. We are providing slides of this presentation on our website at www.pplweb.com. Any statements made in this presentation about future operating results or other future events are forward-looking statements under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from such forward-looking statements. A discussion of factors that could cause actual results or events to differ is contained in the appendix to this presentation and in the company's SEC filings. We will refer to earnings from ongoing operations or ongoing earnings, a non-GAAP measure on this call. For reconciliations to the GAAP measures, you should refer to the press release, which has been posted on our website and has been filed with the SEC.
At this time, I would like to turn the call over to Bill Spence, PPL Chairman, President, and CEO.
Thank you, Joe, and good morning, everyone. We appreciate you joining us for today's call. With me are Vince Sorgi, PPL's Chief Financial Officer, as well as the presidents of our U.S. and U.K. utility businesses. Starting with slide three, our agenda this morning begins with an overview of our quarterly and year-to-date 2016 earnings results. Following that, I'll address our 2016 and 2017 earnings forecast as we are raising the midpoint of our 2016 forecast and reaffirming our 2017 guidance. I'll provide a brief operational overview as well as an update on our U.K. currency hedging. Following my remarks, Vince will review our segment results and provide a more detailed financial overview. As always, we'll leave time to answer your questions. Turning to slide four.
Today, we announced third quarter 2016 reported earnings of $0.69 per share, compared with reported earnings of $0.58 per share in the third quarter of 2015. Year-to-date through the third quarter, reported earnings were $2.11 per share, compared with $0.42 per share through the same period a year ago. Reported earnings for the first nine months of 2015 reflected a loss from discontinued operations of $1.36 per share, which resulted primarily from the spinoff of our competitive generation business. Adjusting for special items, third quarter 2016 earnings from ongoing operations were $0.63 per share, compared with $0.51 per share a year ago. That represents a 23% increase on a per-share basis.
The increase was driven largely by an April 1st, 2016 price increase in the U.K., higher base electricity rates, and higher transmission earnings from additional transmission capital investments in Pennsylvania, and higher sales volumes due to favorable weather in Kentucky. Through the first nine months of 2016, earnings from ongoing operations were $1.86 per share, compared with $1.77 per share a year ago. Higher earnings year-to-date were primarily driven by higher base rates in Kentucky and Pennsylvania and returns on additional capital investments. Vince will go into greater detail on third quarter results a little later in the call, but we're pleased with the strong results across our business units. Moving to slide five.
Based on our strong performance year-to-date, we've narrowed our guidance range from the previous $2.25-$2.45 per share to $2.30-$2.45 per share, increasing the midpoint of our 2016 ongoing earnings forecast from $2.35-$2.38 per share. Vince will provide a walk on the drivers contributing to this 2016 increased performance later in his remarks. As we discussed on our October 12th call, we took steps to significantly reduce our exposure to foreign currency risk by restriking our remaining in-the-money 2016 hedges. The impact to 2016 ongoing earnings was a negative $0.06. Because of our strong business line results, we're increasing our 2016 earnings guidance, even as we've leveraged the strength of our 2016 performance to minimize future currency risk.
We also discussed on the October 12th call the opportunity to further leverage 2017 hedge gains, targeting no more than $0.05 of EPS exposure for 2019, even at an exchange rate of $1.15 per GBP. As of today, we've completed all the restrikes for 2016 and 2017, and we've achieved our targeted hedge levels. Vince will provide the details of our updated hedge positions in his remarks. The higher than projected earnings in 2017 that enabled us to restrike a portion of our 2017 hedges was partially driven by lower than anticipated U.K. property taxes. In the revised earnings guidance we provided on the second quarter call, we were expecting fairly significant property tax increases starting next year and continuing through 2020. Based on the property tax valuation recently completed by the U.K. government, our property tax increases are lower compared to our previous expectation.
Additionally, some of the earnings strength we are experiencing in 2016, as a result of lower O&M in the U.K., is expected to continue into 2017. These positive factors provide us with the confidence to reaffirm our 2017 earnings forecast of $2.05-$2.25 per share, with a midpoint of $2.15 per share, despite executing about $0.06 of 2017 hedge restrikes. Lastly, we remain confident in our ability to deliver on our long-term growth projections. We expect to achieve 5%-6% compound annual earnings growth from 2017 to 2020 and are targeting annual dividend growth of about 4% over the same period. Let's move to slide six. Kentucky Utilities and Louisville Gas & Electric are announcing today that they intend to file rate requests on November 23rd with the Kentucky Public Service Commission.
KU and LG&E expect to seek revenue increases of $103 million and $93 million, respectively, through adjustments to annual base electric rates. LG&E, meanwhile, anticipates seeking a revenue increase of $14 million in annual base natural gas rates. In total, we're expecting to seek a revenue increase of approximately $210 million. The requested increases are driven by additional capital investments that are focused on enhancing our reliability programs across the operational groups, along with technology and infrastructure investments in our customer service areas. This will allow us to continue to provide safe, reliable electric and gas service to customers while meeting federal regulations. Even with the increases, it's anticipated that LG&E and KU rates will remain well below national averages. If approved by the commission, the increases would take effect in July of 2017. Now let's turn to slide seven for some additional operational highlights.
In Kentucky, KU and LG&E will be seeking approval to invest in an advanced metering system and a distribution automation program as part of their rate case proceeding. They will include applications for certificates of public convenience and necessity for implementing these new initiatives, which focus on enhancing service offerings to customers with a continued emphasis on our reliability. In recognition of continued efforts to focus on the customer experience, LG&E ranked highest among mid-sized gas utilities in the Midwest in J.D. Power's 2016 survey of residential customer satisfaction. This J.D. Power Award is the third by a PPL utility this year and the 41st overall for PPL companies, demonstrating our commitment to provide customers with the highest level of service. As we highlighted on our second quarter call, both PPL Electric Utilities and Kentucky Utilities earned J.D. Power Awards in July.
In Pennsylvania, PPL Electric Utilities is on track to execute more than $1 billion in capital improvements to modernize the grid and strengthen reliability for our customers. The company's automated power restoration system has now restored within minutes more than 58,000 customers since that system became fully operational this past June. We also continue to add new smart devices to extend these benefits and improve grid resiliency even more. The company is also completing preparations to replace 1.4 million meters in Pennsylvania with new smart meters. The meter replacements are expected to begin before the end of the year, and the full $471 million project is expected to be completed by 2019. Transmission expansion also continues, with additional investments focused on reinforcing, expanding, and hardening the bulk power system, adding redundancy and making the grid more secure.
In the U.K., we continue to execute on our plans, and while there is still considerable time left in the current regulatory year, we're on pace to achieve our projected performance against the 2016-2017 incentive targets for customer minutes loss and customer interruptions. In addition, we're on pace to be at or near the maximum reward levels for customer satisfaction. We provided updates to our incentive revenue performance in slides 20 to 22 of the appendix. Also in the U.K., we're leading the way, according to the regulator Ofgem, in connecting renewable generation to local distribution networks. To date, we've connected or offered to connect almost 20 gigawatts of renewable power. We've already connected approximately 200,000 private solar installations, along with 7,500 commercial distributed generation facilities.
The company has also launched what we believe to be the world's largest electric vehicle trial to explore charging patterns and the ability of markets to influence those patterns. The trial, involving up to 700 vehicles, will inform future network planning. Finally, as I've already discussed, we have taken steps to reduce our 2018 and 2019 exposure to foreign currency. Vince will now walk you through a more detailed look at earnings and our hedging strategy. Vince?
Thank you, Bill, and good morning, everyone. Let's move to slide 9. Our third quarter earnings from ongoing operations increased by $0.12 per share, driven by $0.05 of higher earnings from the Pennsylvania regulated segment, $0.02 from the Kentucky regulated segment, and $0.06 from the U.K. regulated segment. We should note that for the third quarter, we saw warmer weather compared to last year, and as a result, domestic weather was favorable $0.03 compared to last year, and weather was about $0.02 positive compared to budget. However, with the warmer winter earlier this year, on a year-to-date basis, domestic weather is only positive about $0.01 compared to budget. Year-to-date weather in the U.K. is negative $0.01 compared to the prior year and negative $0.02 compared to budget.
For the company in total, weather has not been a significant driver of our financial performance this year. Let's move to a more detailed review of the second quarter segment earnings drivers, starting with the Pennsylvania results on slide 10. Our Pennsylvania regulated segment earned $0.13 per share in the third quarter of 2016, a $0.05 increase compared to the same period last year. This increase was primarily driven by higher gross margins due to higher distribution margins as a result of new rates going into effect January 1st of this year, higher transmission margins due to additional capital investments, and the favorable effects of weather. Moving to slide 11. Our Kentucky regulated segment earned $0.18 per share in the third quarter of 2016, a $0.02 increase compared to a year ago. This result was primarily due to higher gross margins due to favorable weather.
Turning to slide 12. Our U.K. regulated segment earned $0.35 per share in the third quarter of 2016, a $0.06 increase compared to a year ago. This result was primarily driven by higher gross margins, primarily resulting from higher prices from the April 1st, 2016 price increase, partially offset by lower volumes due to weather and lower O&M expense, including pension expense. Moving to slide 13. As Bill mentioned, strong performance at each of our regulated utilities led to very solid results through the first nine months of the year compared to our plan, enabling us to raise our 2016 guidance. This slide provides a walk from the midpoint of our original 2016 earnings guidance of $2.35 per share to our new forecasted midpoint of $2.38 per share. The $0.03 improvement in the forecast is coming from $0.02 in Pennsylvania and $0.01 in Kentucky.
While we were experiencing better than expected earnings in the U.K. as well, that was fully offset by the $0.06 of 2016 restrikes. The outperformance in the U.K. is driven by higher margins as well as lower operating expenses. In Pennsylvania, we are expecting higher margins from favorable weather and usage, as well as higher transmission margins. In Kentucky, we are expecting slightly lower operating expenses. Additionally, across all the segments, we are seeing lower interest expense from lower interest rates and deferrals of debt issuances, in part due to cashing in $310 million of 2017 and 2018 U.K. earnings hedges. Moving to slide 14. As we discussed on our October 12th call, we took action in early October to restrike our remaining in-the-money 2016 hedges to hedge more of our 2018 exposure.
Since the call, we have taken additional action and have completed the execution of the 2017 restrikes, further increasing our hedge levels for 2018. You can see we are now hedged 94% for 2017 at an average hedge rate of $1.25 per pound. We are well hedged for 2018 as a result of the actions we have taken. The combined results of the 2016 and 2017 restrikes is that we have increased our 2018 hedge levels to 93% at an average hedge rate of $1.42 per pound. This creates the flexibility to restrike about $0.12 of 2018 hedge gains to help hedge 2019 earnings at our budgeted rate of $1.30 per pound. The 2019 hedge attainment table reflects the targeted hedge levels in 2019, assuming we restrike 2018 hedge gains and layer on 2019 hedges at our budgeted rate.
If market rates are around $1.20 per pound when we execute the 2018 restrike, we would be able to hedge 100% of 2019 earnings at our budgeted rate, leaving no additional currency exposure for 2019. If market rates were to drop to $1.15 per pound at the time we execute the 2018 restrikes, we would be able to hedge about 73% of 2019 earnings, leaving about $0.04 of exposure on the remaining open positions. In the bottom right part of the chart, we also show sensitivities on the open position at various market rates from $1.15-$1.45 per pound. To the extent the incremental hedge value that we have created in 2018 is not needed to hedge 2019 earnings, which would be the case if the pound rebounds closer to our budgeted rate, we could use it to hedge 2020 earnings.
Before I turn the call back over to Bill, you will find an update on RPI in the appendix on slide 23. That slide has been updated for the October RPI forecast from HM Treasury and is consistent with our forecasted assumptions. That concludes my prepared remarks, I'll turn it back over to Bill for the question and answer period. Bill?
Thanks, Vince Sorgi. To summarize, we continue to perform very well across all three of our business segments, we're solidly on track to deliver on our increased 2016 earnings guidance. Even with the $0.06 of restrikes we've executed for 2017, we are reaffirming our 2017 earnings guidance. The actions we've taken as part of our foreign currency hedging strategy have substantially minimized foreign currency risk through 2019 and provide greater assurance to our earnings growth targets. We're confident in our ability to achieve competitive earnings growth of 5%-6% a year from 2017 through 2020. The strength of our underlying business plans also provides us with confidence in targeting about 4% annual dividend growth beginning in 2017 and running through 2020. With that, operator, let's open the call for questions.
We will now begin the question and answer session. To ask a question, you may press star then one on your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Our first question comes from Neel Mitra of Tudor, Pickering, Holt & Co. Please go ahead.
Hi, good morning.
Good morning.
I had a question as to how often you plan to file rate cases within the U.S., both in Pennsylvania and Kentucky, now that the capital spending is coming down to some degree, given that transmission in Pennsylvania and the ECR in Kentucky is somewhat coming to an end. How often do you need to file in order to avoid under-earning? What's the criterion which you'll go in for a rate case or what your earned ROE needs to be before you go in to take that risk?
Sure. Let me begin with Pennsylvania. On the transmission side, we're continuing to build out many projects, and those projects are included in our five-year capital spending plan that's included in the appendix of our presentation today. That work will continue on. Relative to Pennsylvania distribution operations, that capital spending is coming down, and we would not expect the need to go in for a rate case in Pennsylvania during our forecast period. In Kentucky, I'll let Vic comment on our plans there.
As we just announced today, we just filed this morning, I suspect I'd like to see the outcome of this case before I speculate on when we would file again. Generally speaking, when we get below 10% or so, we begin to look at whether or not another case is required. I should also point out that given the current status environment of regulations, I still would expect there to be substantial expenditures associated with our ECR, both in terms of the $1 billion that was just recently authorized by the commission to meet some of our coal combustion residual requirements. Also now we have some water issues that are going to require us to file under the ECR. I still think there'll be a lot of money running through the ECR.
Let's get the outcome of this case, generally speaking, when we get below 10%, we begin to look at additional cases.
Thanks, Vic. Just one addition, some of this could be dependent also on the results of the Clean Power Plan and how that may roll out into the future in terms of at least the Kentucky operations.
Could you remind me the rider that you have in place for ECR and how much that covers regarding contemporaneous spend?
Sure. Go ahead, Vic.
Well, under the terms of the statute, we're entitled to recover costs, both capital and O&M, associated with the Clean Air Act. Generally speaking, that handles most of things associated with not only the Clean Power Plan you've discussed, the MATS requirements and all of those types of expenditures. I don't have a breakdown with me of how much is in rates now and how much will be in rates, generally speaking, it pretty broadly addresses almost all of the environmental requirements associated with our coal combustion facilities.
It's near real-time, correct?
It is near real-time. We file it, we recover on a forward-looking basis. I'm sorry, we recover it almost instantaneously, about a 60-day delay.
Got it. The Kentucky rate case that you're filing now, is that more for distribution spend? Is that the way we should look at it?
It's for everything not associated with environmental spend. It would be things not associated with the ECR filing. For example, as Bill pointed out, we're looking for things like additional reliability on distribution system, additional automation on our distribution system, additional rebuild of our transmission systems. It's really driven by bricks and mortars associated with distribution and transmission. There is some capital in there that's not associated necessarily with coal combustion.
Got it. Quickly, could you just update us where you are with any Compass approvals and where you are in the progress with that project, just with the first phase?
Sure. I'll ask Greg Dudkin, President of our Pennsylvania utilities, to address that one.
Sure. Yeah. Where we are is we've filed an interconnection request with New York ISO. We're expecting a response shortly on that. For New York transmission projects, you have to go through something called Article 7, which is environmental siting and need process, and we're in the process of starting that up.
I should add that Article 7 process normally takes two to three years.
Got it. Thank you very much.
Okay, thanks.
Again, if you have a question, please press star, then one. Our next question comes from Abe Azar of Deutsche Bank. Please go ahead.
Good morning.
Morning.
When do you expect new rates will be in place for the Kentucky Utilities? Can you remind us what your history is of settling rate cases there?
Sure. The expected rates would go into effect if approved by the commission in July of next year. Our history of settling has been very solid. We operate, we believe, in a very constructive jurisdiction in Kentucky, and I think all of our spending in the past has been well justified, and we've had what I think are fair and balanced outcomes through settlements. That's been the pattern thus far.
Great. That's all I have. Thank you.
Sure. You're welcome.
Again, if you have a question, please press star then one. We will pause momentarily to assemble the roster. Our next question comes from David Paz of Wolfe Research. Please go ahead.
Hey, good morning.
Good morning.
Just heard earlier, someone there mention water issues. I just wanted to make sure I understood. What are the water issues you referenced earlier with respect to capital spending? How much is that, and is that already in your five-year plan?
Yeah, those are water effluent guidelines that have been issued by the EPA, so it is not a new issue. We are looking to see if we have a breakdown of exactly how much that is. We may not have it here at hand, but we can get that to you.
This is Vic Staffieri. I should also comment that we are in the process now of reviewing those regulations. They only recently promulgated. Those regulations and how we are going to comply with them, we are also finalizing those estimates, I suspect we will be in a better position to comment on that at the next call.
Great. Okay. I presume on the next call is when you will update your five-year plan to include, I guess, 2021. Is that fair?
That's correct. Yes.
Okay, great. Then just on the 2019, specifically 2019 hedges, just want to make sure I understand what has changed since the October 12th call?
Just really the fact that we were able to execute the plan that we talked about on the October 12th call. We had outlined what the strategy was, and we had executed some of that plan. Now we've completed the restrikes for 2016 and 2017, and we were able to do that at the rates that are shown on slide 14, which shows, and as Vince commented, that when we get out to 2018, we've got hedges on at a $1.42, well above our $1.30 that's embedded in our earnings expectations, the 5%-6% earnings growth. That gives us $0.12 of potential value that we could move to hedge 2019 if need be.
Got you. Okay. As long as the pound's within $1.15, $1.25, you're relatively protected in 2019. To the extent there's any raises above $1.30 or so, $1.35, that's when you say you can move to 2020 protection?
Well, first off, let me just comment on if the pound stays at, let's just say $1.20 and above, what you can see on this slide is at $1.20, we would effectively be able to use that $0.12 from 2018 and hedge up 100% of the 2019 exposure. To the extent that we don't need 2018 value to hedge 2019, we would look forward to 2020, and we could use some of that value for 2020 if we needed to.
Gotcha. Okay. Perfect. Thank you.
Sure.
Our next question comes from John Barta of Key Banc. Please go ahead.
Hi, good morning, and thanks for taking my questions. Just two quick ones. The AMI in Kentucky, that's going to go through the rate case?
Yes.
Okay. When did you say you were going to be filing the domestic rate cases? Is that today?
Yes. We're announcing, well, actually, the filing would be on November 23rd, I believe it was.
Okay. That's all. Thank you.
Okay. You're welcome. Okay, operator, I think that's all the questions that are in the queue. Let me just close the call by thanking everyone for your participation on today's call. I will note that several members of our senior management team and I will be attending the EEI conference next week, and we look forward to seeing everyone there. Thanks, everyone.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.