Good morning, welcome to the PPL Corporation First Quarter 2016 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 0. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then 1 on your touch-tone phone. To withdraw your question, please press star, then 2. Please note, this event is being recorded. I would now like to turn the conference over to Joe Bergstein, Vice President of Investor Relations. Please go ahead.
Thank you. Good morning, everyone, thank you for joining the PPL conference call on first quarter results and our general business outlook. We're 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 for ongoing earnings, a non-GAAP measure on this call. For reconciliations to the GAAP measure, 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'd like to turn the call over to William Spence, PPL Chairman, President, and CEO.
Thank you, Joe. Good morning, everyone. We're pleased that you've joined us this morning. With me on the call today are Vince Sorgi, PPL's Chief Financial Officer, and the presidents of our U.S. and U.K. utility businesses. Moving to slide three, our agenda this morning starts with a discussion of our 2016 ongoing earnings forecast, an overview of our first quarter 2016 earnings results, and an operational overview. Following my remarks, Robert Symons, Chief Executive of our Western Power Distribution subsidiary, will provide an update on expected U.K. incentive revenues for 2017 and 2018, which we are increasing today. Robert will also provide a general update on the completion of our first year under RIIO-ED1. Vince will review our segment financials and provide a more detailed financial overview. Let's move to slide four for discussion of our 2016 earnings forecast.
As we note on this slide, we're reaffirming our 2016 forecast of $2.25-$2.45 per share. The midpoint of this range, $2.35 per share, represents growth of 6.3% compared to 2015 earnings from ongoing operations. Our first quarter results were in line with our expectations, we remain on track to deliver on this forecast, despite the warmer than normal weather we experienced across our service territories to start this year. The significant investments we continue to make to build tomorrow's energy infrastructure, coupled with our ability to begin recovering more than 80% of that investment in near real time, will drive our long-term sustainable growth. We expect to achieve compound annual EPS growth through 2018 of 5%-6% off of our adjusted 2014 earnings from ongoing operations of $2.03 per share.
We continue to expect strong EPS growth of 11%-13% through 2018 from our U.S. operations, with 1%-3% growth expected in the U.K. Turning to slide five. Today, we announced first quarter 2016 reported earnings of $0.71 per share, compared with $0.96 per share from our first quarter 2015 results. Adjusting for special items, first quarter 2016 earnings from ongoing operations were $0.67 per share, compared with $0.77 per share a year ago. As expected, we saw a decline in earnings from ongoing operations in the first quarter as a result of lower earnings in the U.K. This stemmed from lower revenues due to the new price control period that began on April 1st of 2015. Higher domestic margins from rate increases at our Kentucky and Pennsylvania businesses were partially offset by lower sales volumes due to milder winter weather.
Vince will go into greater detail on first quarter results a little later in the call, including a discussion of the timing of our U.K. earnings. As Vince will discuss, we did expect variability between quarters, with increased earnings weighted towards the back half of this year. Let's move to slide six for an update on our utility operations. This month, PPL Electric Utilities energized its Northeast-Pocono transmission line a year ahead of schedule. The project includes 60 miles of new transmission lines, three new substations, and additional improvements focused on making the grid more reliable, resilient, and secure. We're confident this line will deliver significant benefits for our customers. Completing major transmission projects like this one or like the Susquehanna-Roseland line we completed last spring, takes expertise in construction and project management. It also requires working closely with the public and coordinating with various permitting agencies.
We've shown our ability to excel in these areas and deliver successful outcomes for our customers and our share owners. Turning to Kentucky, Louisville Gas & Electric and Kentucky Utilities continue to invest in environmental upgrades at existing generation facilities while strengthening the diversity of our generation fleet. In late January, we filed environmental compliance and cost recovery plans with the Kentucky Public Service Commission, seeking approval and environmental cost recovery for $1 billion in upcoming environmental improvement projects. These projects are largely aimed at ensuring compliance with the EPA's new Coal Combustion Residuals rule, which took effect last year. The projects will involve capping and closing remaining ash ponds at our coal-fired power plants, building process water facilities, and completing the second phase of a dry storage landfill project at our E.W. Brown generating station.
The application review process before the Kentucky Public Service Commission is proceeding as we would expect. We expect to begin investments in these environmental improvements in the second half of 2016, and those will continue through 2023. In addition, we are on track to complete the final bag house installation at our Mill Creek generating station by June. This follows previous installations of bag houses at our Ghent, Trimble County, and E.W. Brown generating stations. We also expect to complete Kentucky's largest solar facility in June. The 10 MW facility under construction at our E.W. Brown generating facility represents a cost-effective way to extend the benefits of solar to all customers. While portions of the project continue, we began generating our first solar power from the facility on April the 14th.
Moving to the U.K., we continue to achieve strong performance against our RIIO-ED1 incentive targets, and Robert will now discuss that in more detail. Robert?
Many thanks, Bill, and good morning. Moving to Slide seven. March the 31st, 2016, marked the end of the first full regulatory year under RIIO-ED1, and we are pleased to be providing an update on our full-year performance against the RIIO-ED1 incentive targets. Before I go into the details, I would like to review a few key points of the incentive framework. The primary incentive mechanisms that contribute to incentive revenues include the interruption incentive schemes and the broad measure of customer satisfaction. Interruption incentive schemes include customer interruptions and customer minutes lost. The broad measure of customer satisfaction measures the performance of customer satisfaction on a scale from one to 10 against the targets Ofgem has established for customers experiencing interruptions, requesting a connection, or making a general inquiry.
Both of these incentive mechanisms are designed to encourage DNOs to invest and operate their networks so as to reduce both the frequency and duration of power outages. Turning to Slide eight. On this slide, you will find our full-year results against the performance targets set by Ofgem for regulatory year 2015 to 2016. WPD has improved customer minutes lost and customer interruptions performance metrics by approximately 8% over the 2014-15 regulatory year, which resulted in earning 77% of the maximum potential payout. This year, our operational efforts contributing to the success included several major asset replacement projects, significant rural network automation, and outperforming previous years' reliability performance. As it relates to broad measure of customer satisfaction, WPD has also received reaccreditation to the U.K. government-sponsored Customer Service Excellence Standard and has once again achieved the highest level of compliance, which further demonstrates our continued commitment to excellent customer service.
As shown back on slide 7 and based on our better-than-expected performance for quality of service and customer satisfaction, we now expect to achieve $115 million in total incentive revenue in calendar year 2017, above our prior range of $90 million-$110 million for 2017. As a reminder, these incentive revenues, while earned during the 2015-2016 regulatory year, will be received in the 2017-2018 regulatory year. These amounts are internal estimates until final determination is received from Ofgem in November 2016. We expect these favorable results to continue into the next regulatory year. Even with targets that get progressively tougher, we are increasing our guidance range from $75 million-$105 million in incentive revenues in calendar year 2018 to $85 million-$115 million. Overall, the first year of RIIO-ED1 is broadly in line with our published business plan as accepted by Ofgem.
We are focused on delivering excellent customer service, achieving the outputs and incentives while delivering safe, reliable, and sustainable network service. We have been also recognized by Ofgem for our innovative work on providing quicker and alternative network connections for solar, and we continue to hold stakeholder workshops reviewing our results from the first year of RIIO-ED1 while planning for the future by discussing long-term strategic priorities such as reporting smart networks and affordability. Vince will now walk you through a more detailed look at segment earnings. Vince?
Thank you, Robert, and good morning, everyone. Let's move to slide 10. Our first quarter regulated utility earnings from ongoing operations decreased from last year, driven primarily by expected lower U.K.-regulated segment earnings as a result of the April 1, 2015, price decrease, as we began our first year under the RIIO-ED1 framework and the effects of foreign currency, offset by an improvement in the Pennsylvania regulated segment, while the Kentucky regulated segment and corporate and other remained flat compared to a year ago. Let's briefly discuss domestic weather for the first quarter compared to last year and compared to plan. Mild temperatures during the first quarter of 2016 had an unfavorable impact for our domestic segment, a total of $0.04 compared to the prior year, with $0.02 in Pennsylvania and $0.02 in Kentucky.
Compared to our plan, weather had a negative $0.02 impact, with a $0.01 impact in each of the domestic segments. Heating degree days were about 11% lower than normal in the first quarter 2016 for both Kentucky and Pennsylvania. While weather in the U.K. was also unfavorable to plan and the prior year, with Q1 being the mildest winter in recorded history for the U.K., it was not a primary driver of our results for the U.K. segment. As Bill mentioned in his remarks, despite this unfavorable weather for Q1, we remain confident that we will continue to meet our 2016 earnings guidance of $2.25-$2.45 per share. Let's move to a more detailed review of the first quarter segment earnings drivers, starting with the Pennsylvania results on slide 11.
Our Pennsylvania regulated segment earned $0.14 per share in the first quarter of 2016, a $0.01 increase compared to the same period last year. This increase was due to higher gross margins due to higher distribution margins as a result of the 2015 rate case that became effective January 1, 2016, and higher transmission margins due to additional capital investments, partially offset by lower volumes due to unfavorable weather. Higher margins were partially offset by higher O&M, primarily due to higher support costs and maintenance-related work, mostly attributable to timing. Moving to slide 12. Our Kentucky regulated segment earned $0.16 per share in the first quarter of 2016, flat compared to a year ago.
This result was due to lower O&M, primarily due to the closure of the Cane Run and Green River coal stations in 2015, offset by higher financing costs due to higher debt balances to fund CapEx. Higher gross margins from higher base rates that went into effect July 1 of last year were offset by lower sales volumes, primarily due to the less favorable weather. Turning to slide 13. Our U.K.-regulated segment earned GBP 0.39 per share in the first quarter 2016, a GBP 0.11 decrease compared to last year, primarily driven by lower prices in RIIO-ED1 and the effects of foreign currency. In our plan, we had expected about a GBP 0.10 decrease year-over-year for Q1, so the actual results are consistent with our expectations. I'll provide additional details on the shape of our 2016 U.K. earnings forecast after I walk through the quarter compared to last quarter's results.
The quarter-on-quarter decrease was due to lower gross margins resulting from lower prices as we transitioned to RIIO-ED1 on April 1, 2015, of about GBP 0.08 per share, and unfavorable effects of foreign currency of about GBP 0.03 per share, which included some 2016 restrikes executed during the quarter to hedge 2018 earnings. The other variances for the U.K. were not significant and offset each other. Taking a closer look at our full-year U.K. segment forecast. As noted on our year-end earnings call and the 2016 ongoing earnings update that Bill just provided, we are projecting a GBP 0.01 decrease in U.K. segment earnings year-over-year. However, there is significant variability between the quarters, with lower earnings in Q1 and Q2 and higher earnings in Q3 and Q4. We expect lower margins in the first half of the year as a result of the RIIO-ED1 revenue reset.
That revenue reset occurred at the beginning of the regulatory year on April 1, 2015. Since we report WPD on a one-month lag, we will still see some effect of that revenue reset continue into the second quarter, an additional GBP 0.02 per share above the GBP 0.08 for Q1. This decrease is expected to be primarily offset by the price increase beginning April 1, 2016, in allowed revenues under the RIIO-ED1 framework and from the recovery of prior customer rebates beginning April 1, 2016 through March 31, 2017, which will positively impact 2016 earnings by about GBP 0.05. We also expect this revenue recovery to positively affect 2017 earnings by another GBP 0.02-GBP 0.03. In addition, we are projecting lower O&M expenses in the back half of the year, primarily related to higher vegetation management in Q4 of last year and lower expected pension expense in 2016.
All of these factors contribute to the shaping of our earnings for the U.K. this year compared to last year. Moving to slide 14. On this slide, we provide an update to our GBP hedging status for 2016, 2017, and 2018, including sensitivities for a $0.05, $0.10, and $0.15 downward movement in the exchange rate compared to our budgeted rate of $1.60 on open positions. First, we are 92% hedged for the remainder of 2016 at an average rate of $1.54. For 2017, we're still hedged at 89% at an average rate of $1.58. For 2018, we've continued to layer on hedges during the quarter and have increased our hedge percentage from 20% at year-end to 41% today at an average rate of $1.56.
You can see from the sensitivity table that there's minimal exposure in 2016 and 2017, and about $0.03 of exposure in 2018 for every $0.05 below our budgeted rate of $1.60. As I mentioned during our year-end call, our business plan provided enough capacity to hedge about 50% of our 2018 U.K. earnings exposure through restrikes. However, at this point, we will refrain from adding additional 2018 hedges until after the U.K. referendum vote on June 23rd. Moving to slide 15. On this slide, we are providing an update on RPI. Now that 2015-2016 regulatory year has concluded, the final RPI rate was 1.1% and was based on the Office for National Statistics average RPI index from April 2015 through March 2016.
If you recall, in the third quarter of 2015, we had incorporated a 1.3% RPI rate in our 2015-2016 planning assumptions compared to the 2.6% included in our tariffs. That true-up will flow through allowed revenues in 2017 and 2018, and has already been incorporated in our earnings growth projections. The additional downside from our budgeted 1.3% rate will not have a material impact on earnings in either 2017 or 2018. Our planning assumptions for 2016-2017, 2017-2018, and 2018-2019 have not changed since our year-end update. As you can see, the current forecast from the HM Treasury for all periods are in line with our current assumptions. That concludes my prepared remarks, and I'll turn the call back over to Bill for the question and answer period.
Great. Thank you, Vince, and thanks for everyone's participation on today's call. I'd like to first summarize by saying that we remain confident in where we're headed. We're solidly on track to deliver on our earnings forecast for 2016, and we expect to deliver compound annual EPS growth of 5%-6% through 2018. We're pleased the WPD team has had such a successful first year under RIIO-ED1 and have outperformed incentive expectations. As Robert mentioned earlier, we are raising our expectations for incentive revenues from $90 million-$110 million to $115 million for 2017, and from $75 million-$105 million to $85 million-$115 million for 2018. This level of performance is consistent with WPD's long history of operational excellence.
Across all of our businesses, we continue to invest in tomorrow's energy infrastructure to strengthen the diversity of our generation fleet and to drive continuous improvements aimed at exceeding customer expectations and delivering power safely, reliably, and affordably. As I stated in my recent message to shareowners in the annual report, I am convinced that our best days are ahead, and I'm very excited about our future. With that, operator, let's open the call to questions, please.
Thank you. 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. At this time, we will pause momentarily to assemble our roster. Our first question will come from Paul Zimbardo of UBS. Please go ahead.
Hi. Good morning.
Morning, Paul.
First, I just wanted to confirm that the U.K. environmental spending you discussed on the prepared remarks is included in the CapEx plan?
In the CapEx plan that we have for U.K., there's very little that I would classify as environmental spending.
Sorry, I meant KU, Kentucky.
Oh, I'm sorry. Yeah. Within Kentucky Utilities, yes. The environmental spending for the plans as articulated really deal with the MATS rule and a lot of the combustion ash disposal costs that we need to incur. It does not include any Clean Power Plan CapEx spending, which would be incremental should that come back into play. With the stay at the Supreme Court level of the CPP, we're not anticipating to update the capital at this time.
The $1 billion that we filed is in the plan.
Yes.
Okay, great. Turning to Compass. Could you give a brief update on kind of the initial segment? With respect to future segments, should we expect that in-service on those is ahead of this one with 2023 or longer dated?
Okay. I'll ask Greg Dudkin, president of our electric utilities group in Pennsylvania, to address that.
Yeah. Where we are in Compass, we put together an interconnection request for the New York ISO on the 95-mile segment, I guess we call it mini-Compass. What we're waiting for is for the ISO to come back with an approval that all the specifications and reliability impact is positive, then we proceed with what's called an Article VII, which is a siting application, basically. That's where we are there. We're still for that portion, 2021 to 2023 timeframe. We're continuing to look at the other components of Compass, at this point, it wouldn't be before 2021 or 2023. It would be during that time or maybe a little after.
Okay, great. Thank you very much.
Thanks, Paul.
Our next question will come from Anthony Crowdell of Jefferies. Please go ahead. Mr. Crowdell?
Morning, Anthony.
Your line is open, Mr. Crowdell. It may be muted. Mr. Crowdell, your line is open.
Okay, operator, we'll move on if there are any other questions in the queue.
Okay, thank you. At this time, I am not showing any further questions in the queue.
Okay. As far as you can tell, operator, the lines are all open and available for questions, correct?
Yes, that is correct.
Okay. I just wanted to verify.
Okay.
Okay. Well, since there are no further questions, we'll assume that everything was crystal clear, and that we'll look forward to the second quarter earnings call. Thanks for joining us today on the call. Thank you, operator.
Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines.