PPL Corporation (PPL) Q3 2011 Earnings Report, Transcript and Summary

Good morning. My name is Tequila, and I will be your conference operator today. At this time, I would like to welcome everyone to the PPL Corporation Third Quarter Conference Call. [Operator Instructions] Mr. Joe Bergstein, you may begin.

Thank you. Good morning. Thank you for joining the PPL conference call on third 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 provision 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 vary is contained in the appendix to this presentation and in the company's SEC filings. At this time, I'd like to turn the call over to Jim Miller, PPL Chairman and CEO.

Thanks, Joe. Good morning, everyone. I'll just make a few general business comments, and then I'll turn it over to Paul Farr, Chief Financial Officer, who will provide a much more detail financial overview. And then Bill Spencer, President and Chief Operating Officer, for an operations -- in-depth operations overview, and then we'll go to questions. Today, we announced reported third quarter earnings of $0.76 per share, an increase of $0.25 from the same period a year ago. For the first 9 months of the year our reported earnings are $1.91 per share compared to $1.40 through the first 3 quarters of 2010. Ongoing earnings for the third quarter were also $0.76 per share versus $0.74 in the third quarter of '10, and ongoing earnings through the 3 quarters of 2011 are $2.02 per share compared with $2.29 a year ago. We noted in our release this morning that per share ongoing earnings for both periods were affected by the issuance of common stock to fund our recent acquisitions in Kentucky and the U.K. During the quarter, our solid performance from our newly acquired businesses in Kentucky and the United Kingdom helped overcome earnings pressure on our competitive Supply business and our Pennsylvania Delivery business, and we remain highly confident in our ability to achieve the economic performance we projected for the expanded U.K. business. Through the first 9 months of the year, earnings performance was driven by the contribution of our Kentucky regulated segment, strong international segment performance and by the PPL Electric Utilities' distribution rate increase that took effect January 1. The improvements were offset by lower energy margins in our Supply segment driven by higher-priced hedges rolling off, unplanned outages to replace turbine blades and our Susquehanna nuclear units and higher storm restorations expenses in Pennsylvania and…

Thanks, Jim and, good morning, everyone. Let's start with Slide 6 to review our third quarter results. Third quarter earnings from ongoing operations were higher than last year primarily due to the performance of our newly acquired utility. These positive drivers were significantly offset by dilution resulting from the common stock issued in April of this year to fund our central networks acquisition, lower margins on our Supply segment and higher storm restoration expenses in our Pennsylvania regulated segment. While there's no comparator for 2010 performance for Kentucky, because that acquisition didn't close until November 1 of last year, I'd like to remind everyone that the Kentucky segment earnings include the operating results of KU and LG&E, holding company cost of LKE, interest expense associated with the 2010 equity unit issuance and dilution of $0.03 per share. Let's now move to the international segment earnings drivers on Slide 7. Our international regulated segment earned $0.22 per share in the third quarter, a $0.10 increase over last year. This increase was due to the operating results of the Midlands utilities, including interest expense of $0.02 per share associated with 2011 equity unit issuance, higher earnings in WPD's legacy businesses resulting from higher Delivery revenues primarily due to higher prices, partially offset by higher pension and other operating expenses, higher income taxes and dilution of $0.04 per share. Moving to Slide 8. Our Pennsylvania regulated segment earned $0.05 per share in the third quarter of 2011, a $0.03 decline from last year. The decrease was the net result of higher delivery margins primarily due to the distribution base rate increase that went into effect on January 1, higher O&M primarily due to higher storm restoration expenses and dilution of $0.01 per share. Turning now to Slide 9, for supply. This segment earned…

Okay. Thank you, Paul, and good morning, everyone. Let's turn now to Slide 13, start with an operational review of the third quarter. Overall, as Paul noted, we had another very good quarter of financial performance. In Pennsylvania, we had a couple of major regulatory developments this past month in both the Distribution and Transmission businesses. On October 4, the Pennsylvania House of Representatives passed House Bill 1294 with strong bipartisan support by a vote of 183 to 18. This bill is intended to clarify the authority of the Pennsylvania PUC to approve a request for alternative rate-making mechanisms by regulated utilities such as PPL. We strongly support the bill in its current form, as we believe that it will help reduce regulatory lag currently experienced on certain distribution-related capital expenditures and add meaningful benefits for our customers. House Bill 1294 has been referred to the State Senate, where it will work through a similar process as the House. We're hopeful the bill will pass the Senate this year and will be sent to the governor for the signature. With respect to Pennsylvania transmission, on October 5, President Obama announced the initial list of projects under the newly formed federal rapid response team for transmission. PPL's Susquehanna-Roseland power lines was named to this initial list. The rapid response team is expected to accelerate review and permitting of Transmission Line projects to increase reliability and save consumers' money by modernizing the grid. Susquehanna-Roseland remains under review by the National Park Service, which is performing an environmental impact statement. We look forward to working with the rapid response team, as we have been with the National Park Service, to ensure a thorough and comprehensive review in a timely manner that will support availability of the new line by early 2015. The fact…

All right, operator, would you please open the call for Q&A?

[Operator Instructions] Your first question comes from the line of Dan Eggers with Credit Suisse. Kevin Cole - Crédit Suisse AG, Research Division: This is actually Kevin. I guess on your comments on supply you indicated that you're looking at being more optimistic on the hedging program in 2014. Can you give us a flavor on really what that means? And then on the Rail side, I realize you're in negotiations, but can you just kind of point me in the right direction of will it kind of be in line with the current contract or a little below?

Well, it's hard on the coal contract, rail contract first, really hard to predict at the moment. We are, as you pointed out, in negotiation. So I really prefer not to comment on that. But on the hedges for 2014, we do have an open book for 2014. I think we're going to wait and see how that CSAPR regulations really translate into market prices, as well as keep a close eye on natural gas prices, and I think we'll have a better feel for that, of course, once we get into early 2012. Kevin Cole - Crédit Suisse AG, Research Division: Okay. I guess maybe changing focus a little bit. So on Kentucky, can you kind of offer a little more color on what's going on there, and just kind of what the dialogue is on the ground? And are they looking at maybe considering less retrofits in favor of new gas? Or to maybe do a little more purchase power versus rate pacing?

No, I think, Kevin, the plan that we filed both with respect to the certificate that Bill mentioned for the gas-fired generation, when you combine that filing with the IRP and with the ECR, everything that we've contemplated in that consolidated set of filings brings together the lease costs compliance program for the consumer. If we were to retire more generation on an NPB basis, that would result, in our view, in a much higher cost for the consumer. And that last plant that cleared the hurdle, if you will, in terms of making retrofits, again on an NPB basis, would not result in the most economic decision on the behalf of the customers. So I think we're in good shape there. So as it relates to the consumer end of it, it's the right decision and we're simply going through that ECR filing, we'll get the certificate in April of next year. But the ECR should be done by mid-December this year. And that -- those hearings are going to take place in the next couple of days here, that 2-day hearing starting on the 9th of November fully as expected. So that's pretty much by way an update. Kevin Cole - Crédit Suisse AG, Research Division: Will the ultimate level of the ECR ROE be subject to this filing, or is that a different process?

I mean, the ROE is susceptible to being addressed. But again, as we look at where the movements have gone, both with respect to the GRC ROEs and the ECR ROEs, they've moved on a modest basis over past cycles. And we wouldn't expect anything different here.

Your next question comes from the line of Kit Konolige with Ticonderoga.

Can you give us any sense in the U.K. what the bonus revenue situation is looking like for 2012?

Yes, we got the results signed off by Ofgem in September. And on a consolidated U.K. basis, it's approximately $30 million that will begin to be collected April 1 of next year through 3/31 of 2013, slightly ahead for both the WPD legacy component, as well as the acquired utility as to what we thought would be our -- then again, recognize that we got a substantial amount, I believe it was almost GBP 50 million of upfront revenue bonus for the legacy WPD property in the filing for accepting tougher in the press control review decision by accepting tougher targets. So it'll be you have to combine, for legacy WPD, both the upfront award and the interim bonus to be able to get the total award, if you will.

Just to be clear on that, so the legacy award is already in place. So that's showing up in current earnings and then there'll be another 30?

Well, for both utilities, we [indiscernible] signed off on in September of last year is being earned April 1 this year to 3/31 of '12. That will fall away then, and then the bonus outcome that was awarded or determined, if you will, in the September sign-off this year will kick in and will begin to earn those revenue bonuses. We actually have a chart where you'll see the revenue bonuses for legacy and for Midlands that goes back over the past, I think it's 6 or 7 years.

Very good, okay. And just -- I'm being dense on this, I know. So is the change in next April when the next round kicks in, is that a negative delta at that point?

No, it should be a positive delta because the outcome at WPD legacy, net-net decrease was, I believe, offset by the increase that we saw at Midlands. Midlands saw improved performance from the prior owner that we inherited as this outcome.

Your next question comes from the line of Paul Ridzon with KeyBanc.

When you upped your midpoint guidance, does that incorporate the impact of the recent storms? Or are you going to carve that out as a special item?

It's included in the results for Q3. There was $0.01 or $0.02 of impact in EU within the quarter that was again in excess of -- from an expense perspective, in excess of the insurance limits under the policy that we got for that program. So we would expect to carve out that, plus the impact that we're going to experience here in Q4 within Q4. And again, we'd expect to defer the cost. In fact, there was a filing already made for the Irene cost, and we'll be making likely a subsequent filing for deferral for the Halloween storm.

And if HB 1294 were to pass in this present form, can you kind of give us a sense of what the impact would be from a lag standpoint?

Well, I think, it's hard to tell. But we like the current form. I think it's in good shape for what we had hoped to achieve. And I think our expectation would be to get something that looked more like [indiscernible] formula rate-type mechanism in place. But until we see the final bill and it's approved by the governor’s office, we'll make subsequent filings and adjust as we need to.

We wouldn't expect, Paul, that we have a material adjustment to our forecast of the CapEx until we get out until at least '13 or early '14, just given the amount of activity that's currently going on in transmission work both with respect to Susquehanna-Roseland, as well as several other material projects like -- I wouldn't expect in terms of the impact on the lag that we'd see that; one until we get it approved as part of a filing next year for our D rate case, and then two, until we adjust the actual CapEx spending plan.

And then, what are the drivers you indicated? Supply was improved, trading and marketing? Can you kind of give us bookends as to how much that improved?

Sure. As we mentioned on the previous call, we had planned about $40 million in the marketing and trading arena and we were slightly ahead of that coming out of the second quarter. We added to that probably another $10 million to $20 million during the third quarter. So the favorable market conditions gave us some opportunities, particularly around our mid-merit assets. As Paul mentioned in his opening remarks, the low-volume contracts that we had performed better than expected, even though they're fairly small compared to -- and we have had very positive experience with our retail book. You may recall that we started more aggressively selling in the PPL and other Pennsylvania territories locally here to mass-market as well as C&I customers.

And as much as a federal rapid response is an oxymoron, how incrementally positive do you think Susquehanna-Roseland being added to that is?

Well, I think it does add a considerable amount of weight behind our project. And there's just a few projects that are included on that list and we're happy that ours is one of them. But I think it illustrates the importance of that line to the regions. So we feel good about it, and think it is a real positive.

You have a high degree of confidence in the spring of '15?

We do.

Your next question comes from the line Bill Appicelli with ISI Group.

Just a question regarding the organizational structure and rework cost, the $102 million pretax. You made some commentary that things are going better there. How does that number stack up with what you guys had thought back in April?

We had thought back in April, I think the numbers we outlined was $109 million of cost this year and $36 million next year. So it's going to be around $145 million. 85% of that number was going to be roughly be redundancy cost, and the balance will be basically IT infrastructure spending plus a few other items. And as Jim mentioned, I think we'll come in at modestly below the cost expectation for both this year and next. And that I would expect that we would be able to slightly or modestly outperform some of the synergy numbers that we outlined, given that the amount of cost that we're taking out is slightly ahead of plan as well.

Okay. But you still feel comfortable with the net income targets that you gave back in the roadshow that those are achievable? And if not, maybe some upside?

Yes, very. And again, I think you need to factor in the comments that I made back and it was -- might have been Kit that asked. I forget who that -- we did not embed the $40 million pretax of revenue bonus for the '13, '14 fiscal year in those numbers. And then again, yes, we're going to be slightly outperforming on a cost basis. Now we do at the local entity levels end up capitalizing quite a bit of cost for construction-related activity, so it doesn't all fall to the bottom line. But there should be some tailwind to those numbers that we provided.

And then just switching gears, it looks like the hedging profile to the East, amount of -- the volumes hedged in 2012 came down a bit. Is that right? And can you give us some color behind that?

Yes, we did lower just slightly by about 6% overall. That just really reflects minor adjustments that reflect our view on market and dispatch conditions. Nothing really more than that.

And to profile, I guess we'd expect to likely close out by the end of the year. We did open up the book a bit to take advantage what we see as an opportunity for some improvement in '12 pricing.

And as I mentioned in my opening remarks, and Paul reiterated, we would expect to be close to 100% by the end of the year.

Your next question comes from the line of Ashar Khan with Visium Asset Management.

Paul, just based on your hedges and capacity prices and everything, is it fair to say that the generation earnings will have their, I guess, their low point next year, and from there it should be a positive trajectory?

Yes, when you look at the effective gas prices that the hedges are at, I would think that's reasonable. Obviously, total margins are dependent upon power and that curve is in contango. And as Bill mentioned, we're pretty much fully opened in the East from '14 and beyond. So generally, I would expect that just marking it to a curve and with what we think will happen and what we've already booked in terms of added outcomes and capacity auctions, I think that's pretty accurate.

If you look at the energy-only, setting aside capacity for a moment, the energy-only and the average hedge prices for '12 and '13 are pretty consistent. So energy-only would be, if these prices hold, would be relatively flat, and then you're left with capacity price increase.

And then does Midlands -- can I ask you, so how much of accretion should we expect this year? I mean, there was a pretty strong accretion in the third quarter. What is accretion level expected this year, can I ask?

When announced the transaction, it was $0.10 to $0.15. I think we're probably moving slightly ahead of that, the midpoint of that figure at this point. But I would expect that range to hold. We're maybe at the upper end, but that's the range.

Okay. And then finally if I can ask, Paul, how are you all taking the currency risk? Are you -- for next year, could you just go over how you're hedging your currency going forward?

Yes, very consistent with what we've done in the past. And that is as we approach the end of the year and get into the beginning of a year, we try to be approximately 75% hedged on translating that year's earnings, so we can provide a narrower guidance range. We're basically at those levels already for next year. We've done a decent amount of color. If we mark those all at the floors of the colors, probably in the -- what we have hedged in the $1.59-ish type range for next year on that 75%, we use $1.60 for sterling in the net income numbers for '12 that we gave in the roadshow materials. So pretty much right on top of that. You can see where we sit today at a $1.60, $1.61 where we stand from a frontline basis. So we're right in line with those numbers.

[Operator Instructions] There are no further questions in queue.

Okay. Well, I thank you all for joining us this morning. I know there's a number of calls this morning. So we feel very good about a strong quarter and working towards finalizing this year's earnings. And we're very pleased with our status of our acquisitions. And as well, we're very pleased with the potential we see in the U.K. for our bonus situation. So thanks again, and see you at EEI.

This does conclude today's conference call. You may now disconnect.