ALLETE Inc (ALE) 2015 Q2 法說會逐字稿

Good day and welcome to ALLETE second-quarter 2015 financial results call. Today's call is being recorded.

Certain statements contained in this conference call that are not descriptions of historical facts are forward-looking statements, such as terms defined in the Private Securities Litigation Reform Act of 1995. Because such statements can include risk and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements.

Factors that could cause results to differ materially from those expressed or implied by such forward-looking statements include, but are not limited to, those discussed in filings made by the Company with the Securities and Exchange Commission. Many of the factors that will determine the Company's future results are beyond the ability of management to control or predict.

Listeners should not place undue reliance on forward-looking statements which reflect management's views only as of the date hereof. The Company undertakes no obligation to revise or update any forward-looking statements or to make any other forward-looking statements, whether as a result of new information, future events, or otherwise.

For opening remarks and introductions I'd now like to turn the conference over to ALLETE President and Chief Executive Officer, Alan R. Hodnik.

Good morning, everyone, and thanks for joining us today. With me on today's call is Steve DeVinck, ALLETE's Chief Financial Officer.

This morning we reported our second-quarter financial results. Quarterly earnings were $0.46 per share, which included acquisition-related fees of $0.02 per share. Second-quarter operating revenue increased by 24% over last year, primarily due to results from the U.S. Water Services and ALLETE Clean Energy, as well as increased cost recovery rider revenue at Minnesota Power.

I am pleased with our second-quarter financial and operational performance. During the quarter we had success and challenges on different fronts. Our operating businesses, however, delivered and remain on course to provide sustainable value to our shareholders. We are pleased that our energy infrastructure and related services businesses are already benefiting our strategy.

Taking everything into account, we are adjusting our 2015 full-year guidance to a range of $3.20 to $3.40 per share to reflect higher earnings at ALLETE Clean Energy due to the recently approved sale of a wind energy facility under construction to Montana-Dakota Utilities. Steve will go through the financial details in just a moment.

Let us talk first about our successes. During the quarter, Minnesota Power's Great Northern Transmission Line project was granted a certificate of need by the Minnesota Public Utilities Commission. This was a significant milestone for the project. We expect construction of the Great Northern Transmission Line to begin during 2016 and be completed in 2020.

Total project cost on the United States portion of the line, including substation work, is estimated to be between $560 million and $710 million, depending on the final route of the line. Minnesota Power will have majority ownership of the new line and anticipates an investment opportunity of $345 million.

In early July, Minnesota Power publicly announced its plans to further reduce carbon emissions as part of its Energy Forward strategy. Minnesota Power's Energy Forward strategy is already answering our nation's call to transform its energy sector to be less carbon-intense and more sustainable. This -- relative to President Obama's Clean Power Plan.

Beyond Minnesota Power's 500 megawatt Bison Wind Energy addition and its Great Northern Transmission initiative, Energy Forward contemplates adding natural gas to further balance overall power supply. As the transition continues, some smaller coal units in the Minnesota Power fleet will cease operations.

Energy Forward effectively balances reliability, affordability, and stewardship, and Minnesota Power intends to recommend next steps with Energy Forward in an integrated resource plan to be filed with the Minnesota Public Utilities Commission by September 1, 2015.

ALLETE's energy infrastructure and related services businesses continue to move forward with their strategies. ALLETE Clean Energy reported two significant events related to its strategy execution.

In early July, ALLETE Clean Energy closed on the purchase of a 100 megawatt Armenia wind energy facility in Pennsylvania. This facility began commercial operations in 2009 and has power purchase agreements in place for the entire output through 2025. The addition of this facility gives ALLETE Clean Energy an attractive entry into the Eastern US market for renewable energy. ACE now owns and operates more than 500 megawatts of wind generation with an expanded footprint to meet the nation's demand for renewable energy.

Additionally, ALLETE Clean Energy continues construction of a 107-megawatt wind facility project for its customer, Montana-Dakota Utilities. The project is expected to be completed in 2015. This transaction is a great example of how the Company is leveraging its reputation as an accomplished owner and operator that can also effectively manage the construction of these projects.

I am pleased to report that U.S. Water Services is profitable and will undoubtedly be a noteworthy contributor to our financial results in the not-too-distant future. As you may recall, near-term results are impacted by a purchase accounting allocation. We believe strongly in the nexus of energy and water and related growth prospects driven by water scarcity, conservation, and tightening water use regulations.

As a point of interest, U.S. Water now has customers in excess of 4,000, an increase of 20% since the beginning of the year. ALLETE's energy infrastructure and related services businesses are well-positioned to complement the core regulated utility, balance exposure to business cycles and changing demand, and provide long-term earnings growth.

I will comment briefly on recent challenges as well. We continue to monitor the domestic steel industry and its impact on iron ore production by our customers. As you have read in the press, the steel makers are pushing elected officials to take action against unfair trade practices to slow the pace of imports. Progress on this front has been made, so more work needs to be done, as there are still high levels of imports creating difficulties for our steel markets.

Several steel companies have announced second-quarter financial results and they are reporting that market conditions in the first half of the year were very challenging, to say the least. But they do anticipate improvement in the second half of the year. Recently, Cliffs Natural Resources announced plans to temporarily idle their United Taconite mine in northeastern Minnesota. Cliffs stated that the idling of production at the plant will be initiated as soon as feasible, returning to production as soon as demand from customers return.

On the positive side, Cliffs also stated that the idling offers a chance to invest and start reengineering the plant to produce a fully fluxed taconite pellet. That new product will replace the fluxed pellet now made at Cliffs Empire mine operation in Michigan, which is scheduled to shut down at the end of 2016.

In the second quarter of 2015, United States Steel Corporation temporarily idled its Minnesota ore operation's Keetac plant in Keewatin, Minnesota, and a portion of its Minnesota ore operations' Minntac plant in Mountain Iron, Minnesota. These actions were due to its current inventory levels and ongoing adjustment of its steel-producing operations throughout North America.

I am pleased to report that Minnesota Power received near full demand nominations for October through December 2015 from United States Steel Corporation. In summary, Minnesota Power's large power taconite customers nominated at approximately 80% of full demand levels for September and approximately 90% of full demand levels for October to December of 2015.

All of our energy businesses carry unique strengths and opportunities. We are especially focused on improving our earned ROE at Minnesota Power and on complementary growth at U.S. Water Services and ALLETE Clean Energy. We like our portfolio of companies and are confident that their respective positioning will provide future shareholder value.

I will make some additional comments after Steve takes you through the quarterly financial results. Steve?

Thanks, Al, and good morning, everyone. I would like to remind you that we filed our 10-Q this morning and I encourage you to refer to it for more details on the quarter.

Today we reported second-quarter 2015 earnings of $0.46 per share on net income of $22.5 million and operating revenue of $323.3 million. Earnings for the second quarter of 2014 were $0.40 per share on net income of $16.8 million and operating revenue of $260.7 million. This marks the 12th consecutive quarter of quarter-over-quarter consolidated revenue growth.

This year's quarterly results included acquisition transaction fees amounting to $0.02 per share. Included in last year's second-quarter results was a $0.06 per share non-recurring charge associated with a settlement agreement with the Environmental Protection Agency. Earnings per share for the second quarter of 2015 were diluted by $0.07 due to an increase in the number of shares outstanding.

Earnings from ALLETE's regulated operations statement, which includes Minnesota Power, Superior Water Light & Power, and our investment in the American Transmission Company were $23.6 million, an increase of $6.1 million over 2014 second-quarter net income. This year's results reflect increases in cost recovery rider revenue, production tax credits, and power marketing sales, partially offset by increased depreciation and interest expense.

Included in last year's quarterly results was the previously mentioned non-recurring charge related to a settlement agreement with the EPA. Operating revenue from this segment was similar to 2014 as higher cost recovery rider revenues and kilowatt hour sales were offset by lower fuel adjustment clause recoveries, transmission revenue, and gas sales. Cost recovery rider revenue increased $7.6 million, mainly due to higher capital expenditures for our Bison Wind Energy Center and the Boswell Unit 4 environmental upgrade.

Revenue from regulated operations increased $7.6 million due to increased kilowatt hour sales. Total regulated utility kilowatt hours sold were 7.3% higher than 2014, primarily due to increased power marketing sales as the Minnkota Power sales agreement commenced in June 2014. Sales to residential, commercial, and municipal customers were down 4.5%, mainly because of unseasonably cold temperatures during the second quarter of 2014.

Industrial sales decreased 12% due to reduced taconite production. Please keep in mind that although industrial kilowatt hour sales decreased for the second quarter of this year, revenue from our taconite customers was comparable to 2014 as these customers nominated at full demand levels through August.

Fuel clause recoveries were down $8.7 million due to lower fuel and purchase power costs attributable to our retail and municipal customers. Transmission revenue was down $3.8 million, largely due to a reserve recorded in the second quarter of 2015 for a MISO return on equity complaint. Please note that our overall reserve for the MISO complaint also includes a reserve for an estimated refund of MISO transmission expense, resulting in a pretax net reserve of $1.9 million. $1.5 million was attributable to prior years.

Gas sales at Superior Water Light & Power were down $3.7 million compared to the second quarter of last year, due to unseasonably cold weather in 2014. On the expense side, fuel and purchase power expense decreased $3.5 million, primarily due to lower purchase power prices in 2015. Transmission expense increased by $800,000 over 2014, primarily due to higher MISO-related expenses offset by the estimated refund of the MISO transmission expense I mentioned earlier.

Cost of sales decreased $3.3 million compared to 2014, due to less gas purchased by Superior Water Light & Power. Operating and maintenance expense decreased $5.8 million compared to last year, primarily due to the $4.2 million expense that was recorded in the second quarter of 2014 to reflect the EPA settlement. Salary and wage expense was also lower in 2015.

Depreciation and amortization expense increased $4.1 million, or 14%, from 2014, reflecting additional property, plant, and equipment and service. Taxes other than income taxes increased $1.5 million, or 14%, over last year, due to higher taxable plant and rates in 2015. Interest expense rose by $1.9 million, or 17%, over last year, primarily due to higher average long-term debt balances.

Income tax expense declined by $3.2 million in the second quarter of 2015 compared to the same quarter last year, mostly due to higher federal production tax credits with the completion of the Bison 4 Wind Energy Center in December of 2014.

Equity earnings in ATC decreased $500,000 primarily due to reserves recorded for the FERC ROE complaints. Year-to-date we have recorded $1.7 million in lower net income from ATC related to the FERC ROE complaints, of which $1.1 million is attributable to prior years.

The investments and other segment is comprised primarily of our energy infrastructure and related services companies: ALLETE Clean Energy, U.S. Water Services, and BNI Coal. It also includes other miscellaneous corporate income and expenses as well as ALLETE Properties.

This segment reported a net loss of $1.1 million compared to a second quarter 2014 net loss of $700,000. Operating results from the companies in this segment were as expected. The net loss for the second quarter of 2015 included the acquisition transaction fees of $900,000 after tax and higher interest and income taxes.

Revenue from this segment increased $62.2 million, or 200%, compared to the same period last year, primarily due to U.S. Water Services, which was acquired on February 10. ALLETE Clean Energy also contributed to the increase, reflecting revenue from recently acquired facilities and the recognition of revenue under percentage of completion accounting for the MDU transaction.

Cost of sales increased $36.7 million and operating and maintenance expense increased $16.9 million, primarily due to the recent acquisitions of U.S. Water Services and ALLETE Clean Energy wind acquisitions. Cost of sales also includes construction costs recognized under percentage of completion accounting for the MDU transaction.

Operating and maintenance expenses includes acquisition transaction fees of $1.6 million. Depreciation and amortization expense increased $3.3 million over 2014, reflecting additional property plant and equipment as well as amortization of intangible assets related to the recent acquisitions.

Income tax expense increased $4.7 million over the same quarter last year. Accounting rules require the recognition of quarterly income tax expense at the estimated effective annual effective tax rates. The estimated annual effective tax rate could differ from what a quarterly effective tax rate would otherwise be on a stand-alone basis, and this may cause quarter-to-quarter differences in the timing of income taxes.

During the second quarter, we reflected additional income tax expense in our investment and other segment of $2.5 million to reflect total tax expense at our estimated annual consolidated effective tax rate of 16.8%. Of this amount, $1.2 million was related to the first quarter as we increased our estimated annual effective tax rate during the second quarter to 16.8% from 13.5% at March 31, 2015.

Year-to-date, ALLETE's cash flow from operating activities was $182.3 million and we carried a 44% debt-to-capital ratio as of June 30, 2015. As Al mentioned, ALLETE's full-year earnings guidance has been adjusted to a range of between $3.20 and $3.40 to include higher earnings at ALLETE Clean Energy due to the expected development fee from the MDU transaction. We estimate the development fee to be between $20 million and $25 million pretax.

Based on demand nominations we received on July 31, Minnesota Power's large power taconite customers nominated at approximately 90% of full demand levels for October through December of 2015. ALLETE's full-year earnings guidance includes the impact of these large power nominations and excludes acquisition-related transaction fees. Al?

Thank you, Steve. Let me provide you with a few additional updates and observations before Steve and I take your questions.

The Essar Steel Minnesota project continues, with ongoing construction activity ramping up, as evidenced by statements from Essar and regional media stories that they now have 550 building and trades workers on site. Essar has stated that it has spent $1.3 billion on the expected $1.9 billion project and it expects to continue to achieve or expects to receive full production capability by 2016.

The new Essar facility will result in up to 110 megawatts of new load once the facility reaches full production.

PolyMet's proposed copper nickel and precious metal mining operation continues to advance. The Minnesota Department of Natural Resources has indicated they would likely have the final environmental impact statement, or FEIS, out in November of this year and shortly after that PolyMet will file key permits with the state of Minnesota. Minnesota Power has a contract with PolyMet and it could begin to supply between 45 to 50 megawatts of new load beginning upon start up of mining operations as early as 2017.

I would now like to ask the operator to open up the lines so that Steve and I can take your questions.

(Operator Instructions) Paul Ridzon, KeyBanc.

Just wondering kind of what your reaction was to the nominations and what visibility you might have at this point with regards to the December 1 nominations.

Well, I feel pretty good about the demand nominations; given the amount of buffeting that the industry has taken throughout the early part of the year. So we feel very good about the nominations at this point.

With respect to going off into the winter, Paul, I don't have any additional reconnaissance with regards to that. We do work closely with our industrial customers in their operations with our engineers and the like. We watch market signals as well.

I feel pretty good about domestic fuel consumption in autos. Down there in the Great Lakes where most of this fuel goes, there's no sign of weakness there at all. And so I am hopeful that they will have weathered this sort of glut of iron ore, if you will, and also steel importation illegally that the Federal Trade Commission is getting on now. We've won a few of those battles up here and ultimately that they can get on with their operations and getting them back to normal.

I am also encouraged that they are looking at sort of taking that technology and looking at investments where they can to improve their pellet quality and products that they use.

What do you see as the calendar for tariffs coming?

For the tariff remediation?

Yes.

I don't know. Those are long-winded, Paul, in nature. Each one is individual in nature. Each complaint that gets filed has its own runway that it goes on, so some of the complaints that have been resolved here more recently were from a year and a half or more ago. Some are going to get resolved sometime during the winter months.

The Trade Commission works on an individual basis on each one of those and it's very difficult to predict how they will map out on a runway basis.

Okay, thank you for the update.

Chris Turnure, JPMorgan.

Good morning, Al and Steve. I just wanted to get some more color on the steel side of things, or the taconite side of things at least. You talked about both U.S. Steel and Essar.

On the U.S. Steel side I wanted to get a sense of if you knew -- I don't think you mentioned this in your prepared remarks, but if you knew kind of when they were coming back online at each of the two facilities and if you had visibility into that. And how, if so, this downtime compares to prior idlings of these or other taconite facilities in your territories years ago.

And then also on the Essar front, you said that construction is ramping up. Is there or has there been any kind of slower-than-expected progress there versus their original expectations last fall when they resumed the whole process? Or has anything kind of changed over the last six or so months?

I'll take the United States Steel questions first, Chris. We don't have any additional information than what U.S. Steel has released at this point in time about their scheduled return to production with the lines that they idled at U.S. Steel Minntac and at Keetac, but certainly their demand nominations for the fall would signal that they are planning to ramp up here and we feel very good about that.

With respect to how relatable these temporary idlings are to past history, I think you potentially recall the 2009 economic collapse of the US economy, or global economy. In that particular instance, the industry was down from May through the December time period and then it sprung back and recovered nicely.

There are other periods of history where the industry has cycled up and down. This industry produces about 40 million tons per year. They have cycled on average between 35 million and 40 million tons, so it's not a highly irregular cycle at this point in time. The amount of steel dumping, of course, is sort of new in this particular case, so I think that affects their situation more than anything else at this point.

With respect to Essar Steel, construction again with the trades on the ground has reached 550 full-time people working there, that is substantial. That is significant. That really reflects sort of peaking towards peak of construction at this point in time, and so they have really ramped up significantly.

They are going to work right on through the winter at this point in time to finish up the project. Their financing difficulties are behind them as well and we fully expect that they will commence some operation in 2016.

And as I have expressed many times, starting up a taconite facility is not like turning on a light switch in your bedroom. It takes time to ramp up these large pieces of operation and then integrate them all.

So we expect to ramp up in 2016 and ultimately, as they move off into the later year, enhanced or near full production.

Got you. Then you mentioned on the water business seeing a customer account growth of 20% since the beginning of the year. Is that better than you had originally expected? And could you just give us a little bit more color on how that business is performing after the first full quarter that it has been part of you guys?

Good morning, Chris. This is Steve. First, I want to say, as we've kind of indicated, we will be providing more information on U.S. Water Services and ALLETE Clean Energy later this year as they trip the required segment reporting rules.

The customer growth is as we expected, but we had high expectations here. As we indicated, U.S. Water had revenue of about $120 million last year and we expect it to grow organically between 10% and 15%. So it is meeting our expectations. We have high expectations, so they are off to a very good start under our ownership.

Great, thanks.

Brian Russo, Ladenburg Thalmann.

Good morning. Just to follow-up on the roughly 90% demand nomination. That would imply 36 million tons on an annual basis and I believe you've previously disclosed that 1 ton equals $0.03 annually for cost cutting.

So if you do the math, it's probably $0.03 negative impact to the fourth quarter and if it continues at 90% for all of 2016, it would be $0.12. Is that accurate?

Yes. That is a good rule of thumb, that $0.03 per million tons, and the way you have outlined it would fit with that general rule of thumb. And of course, that's before any other cost mitigation, but it is after selling in the wholesale market.

Okay. And if you had any discussions with these customers, it seems like it's more temporary rather than a sustained downturn, so we shouldn't necessarily extrapolate the 90% in the fourth quarter into 2016. Can you give your thoughts on that?

Yes, I think that's a good rule of thumb. I think that our view and I think their view as expressed -- all the steelmakers expressed this -- more temporary than longer lasting. There are some broader macro factors again with iron ore pricing and steel dumping that affect them all. Each of them have their own individual circumstances that they have worked through, but I would say our view and their view is more temporary in nature than long term.

Do you know kind of how many megawatt hours one ton of production equates to?

You know, we have not disclosed that type of detail historically.

Okay. And is there any significance of the 80% nomination in September and the step up to 90% in October through December? Is that --? It's too early to sense a trend there, but it's headed in the right direction, right?

I would take the trend and the direction as a very positive thing of returning to service, confirmation, affirmation of temporary versus more long lasting. Obviously they have got to ramp these facilities back up again. As I suggested to you and others, it is not as simple as a light switch in a bedroom, so you have to take time to ramp them all back. But I take the trend as a very positive thing for the industry.

Okay. And if we wanted to tax affect the development fee on the MDU project, what tax rate should we use on the $20 million to $25 million?

Those earnings will be taxed closer to the statutory rate, which is in the 40% range.

Okay, great. And then what is your year-end 2015 projected shares outstanding?

We have not disclosed that, but I will say you can look at our shares outstanding at the end of the second quarter and we currently have no plans to issue any additional significant equity other than through modest amounts through our employee and dividend reinvestment plans.

Okay, great. Then lastly, if we were to back out the MDU gain and transaction fees from your updated guidance of $3.20 to $3.40, where would you be? Just trying to get a sense of what you are estimating the impact for the demand nominations is on 2015 guidance?

Well, if you run through the math, the MDU fee is currently estimated at between $20 million and $25 million pretax. You run it through the math it's probably approximately $0.25 to $0.30 a share. So you can take that away from our $3.20 to $3.40 and our guidance does reflect, though -- in addition to that $20 million to $25 million, it reflects the recent taconite nominations.

It reflects the ceasing of operations at Mesabi Nugget earlier this year. It reflects the impact of the FERC ROE complaints, both at ATC and MISO, some of which the charges we have taken are related to prior years. And it also includes some storm damage costs for a severe weather event we had in July near Brainerd, Minnesota.

We are still assessing those costs. They will be several million dollars. We are assessing what will be capitalized and what will be charged to operating and maintenance expense, but all those events and items are reflected in our updated guidance.

Okay. So if you adjust out the MDU, it's kind of like to $2.95 to $3.10 versus your previous read at $3.20?

That would be the math and it's the result of the items that I listed.

Okay, great. Thank you very much.

Chris Ellinghaus, Williams Capital.

A little bit more on the nominations. Is Cliffs the predominant element of the 10% shortfall of full nominations?

Yes, that's correct. Cliff's United Taconite temporary idling is really the major impact resulting in the 90%.

Okay. Can you give us a little more flavor for what they have said? I know you talked about the switching of technologies, so that will take some time. But have they given you some indications of how they see the phase back in to full production?

No, other than what they have signaled. They are looking to see a reduction in steel dumping and an increase in ore pricing, like everybody else, macro. On a micro level, of course they are working with their customers and other off-takers who would be interested in their pellets, both existing and the new type of quality pellets that they are producing.

Their mines are all in pretty good shape. As Lourenco Goncalves has suggested many, many times, their focus is Minnesota, all of their operations in Minnesota, and focusing on the iron ore business. So some of the distractions that have sort of impacted Cliffs over the last several years have also been alleviated a bit. Lourenco's focus is on Minnesota or operations.

I think that is well -- bodes well for Northeastern Minnesota. And the fact that they are interested in these technology leaps, if you will, or taking their pellets to a new level of quality I think bodes well for application in a variety of settings, both blast furnace and also with the sort of DRI-type electric arc style furnaces.

So I am actually feeling pretty good about Cliffs in the longer term, Chris. Obviously all of them are working through these sorts of fuel dumping and low ore pricing challenges that they are facing at the moment.

Okay. Can you just go over the [prior-year] portions of the transmission reserves again?

I will, sure. So with respect to ATC and their FERC ROE complaints, approximately $1.1 million pretax or $700,000 after-tax year-to-date -- that is a year-to-date number -- is related to prior years. And that was mainly reflected in the first quarter.

With respect to the additional MISO charges Minnesota Power will incur, approximately $1.5 million, or $900,000 after tax, is related to the prior year and that was reflected in the second quarter.

Okay, great. And can you give us a little flavor on your thinking on the next Minnesota Power case?

Sure. Our strategy for a Minnesota Power rate case remains unchanged. As we've stated, our strategy is to improve Minnesota Power's return on equity over time through cost containment and load growth; remain committed to that plan. Temporary deviations in industrial sales don't impact that. We, as we have talked, have no indication other than to believe those are temporary and it seems like some current events are demonstrating that.

So we are actively managing our costs and we will have more to report on that as we move through the next 12 to 18 months. Certainly we look forward to load growth both at Essar and PolyMet.

Okay, great. Thanks for the color.

Jay Dobson, Wunderlich.

Good morning. Al and Steve, I guess on UTAC and the taconite nominations, walk us through just what it would look like I guess from a revenue perspective, but as well from an earnings perspective if UTAC elected in the fourth quarter to start producing again.

And I'm not asking you to predict whether they will or they won't, but if you look at how long Minntac and Keetac were out, UTAC could come back just about October/November before the cooling ponds froze and be able to operate through the winter, still having reduced inventory. What would be the impact of them since they probably nominated at a very minimal level?

Well, it would not be material for that short period of time, and I'm going to use our rule of thumb that we provide, about $0.03 per million tons. UTAC produces just under 5 million tons, so you could take $0.03 times 5 million tons would roughly give you the zone of $0.15 for the year. And then pro-rata that, divide that by two months or whatever, you can kind of get the -- it gets to be pretty small.

Got you. Perfect. And then back to the tax element associated with MDU, just making sure I understand that. So it's almost sort of a -- I'm sure it's GAAP and the accountants are way smarter than I am, but it seems as if it's almost a lack of matching that you are increasing the tax rate actually before you receive any proceeds.

So, Steve, I think you were indicating by year-end sort of it all washes out in the annualized numbers; you've booked what is then the gain and the effective tax rate is appropriate. But it does have a depressing impact on second quarter and really first quarter I guess, given the amount you've booked there, even though I appreciate it's not a nonrecurring item.

That is true, Jay, and it is complicated and somewhat difficult to explain. It's not new. This has been -- accounting has been this way for quite some time. What is different here in this quarter is the size of it, and that's why we felt the need to really provide some color and to talk about it.

And the reason it's bigger -- and it is timing, as you indicated, and it is a result of what you indicated -- but the reason it's bigger this quarter is that we have more earnings that are taxed at a higher rate. And earlier we talked about the MDU transaction tax closer to the statutory rate; that is the reason. And the overwhelming majority of those earnings are in the second half of the year, which creates this somewhat of a timing difference as we record to our effective rate estimated for the full year.

So it is a little bit of an anomaly in the second quarter here, primarily just the result of timing because some of our -- most of our higher tax earnings are back-end weighted. I hope that helped.

Very helpful. And then lastly, on costs. I guess sort of a two-part question. First, how you see costs trending for the balance of the year. And I'm thinking of the controllable costs in reaction to a little bit of the nominations, although still pretty close to full power.

And then, Al, maybe talk about some of those longer-term cost studies you are working on and how -- I appreciate that is a long-term effort, but sort of how the longer term on costs is looking as you stare down some of the preliminary results of those studies.

Thank you for that question. First of all, if you looked at our regulated and operating and maintenance expense for the first six months of the year, it has decreased approximately $8 million, despite a $2 million required increase attributable to a maintenance service agreement with our Bison 4 wind facility that went into service at the end of last year.

Now about half of that, or $4 million, was a charge we took last year for the non-recurring EPA settlement liability, but the rest we are beginning to see some of the work we have done. It's lower salaries and wages, some lower maintenance, and other miscellaneous expenses. So while not tremendously large at this point, we are beginning to see the trend downward already, so we're happy with the progress we are making.

It will take time for some of these cost containment efforts we're doing. And I mentioned a minute ago over the next 12 to 18 months and that's what we can expect. It will come across a broad spectrum of expense items here at Minnesota Power, but I wanted to point out that you are beginning to see, albeit somewhat small, but it's trending down in the right way.

That's great. Thanks very much for the time.

Andy Levi, Avon Capital.

Just unrelated to steel, believe it or not. Just on the water side I just want to see just longer term what the strategy is there. Should we expect more acquisitions for you guys to make? Was this a one-off? Are there opportunities to make more acquisitions further out?

Thanks for that question and good morning. This is Steve. First of all, we are very excited about U.S. Water, and Al had mentioned how much we just really believe in the nexus between energy and water.

I will say this: we expect organic revenue growth there of between 10% and 15%. As well it is a somewhat fragment of market, so it has the opportunity to do some bolt-on acquisitions to fill a strategic need. That could be geographic. It could be product line. It could be things like that. So we're excited about it and I think you will see growth on both fronts.

Andy, this is Al. I would like (technical difficulty) an additional comment. In the last 24 hours of course the clean power plant has gotten the most airplay -- greenhouse gas, carbon, and climate change.

But certainly, just from a regulatory stringency perspective -- drought, water reuse, and conservation, sort of all of that -- when I think of the EPA and the U.S. Water's Active America, when I think of state regulations in California and Colorado with respect to water consumption or reduction in water consumption, it just implies to me and speaks to me about, first of all, the nexus of energy and water. Secondly, that the water, and use of water, reuse of water, and wastewater are going to become enormous issues in the next few years.

So I guess the answer is yes?

We certainly are going to look at both the organic side and also looking at rollup acquisitions in the industry, you bet.

Okay. Then is there -- just on the rollup side, obviously the organic growth is self explanatory. You are in various different states in the acquisition that you made, but is there a particular area of the country, or region of the country is probably a better way to phrase it, that you may focus on just based on the opportunities?

And I assume these are like -- these would be more mom-and-pops or these would be sizable acquisitions like you've made this year?

As you know, or may not know, our U.S. Water Services has a national presence predominantly, but there are a few geographic areas that we would like to have a more significant presence in. I can't name those today, but we are certainly looking at those.

And, yes, the acquisitions would be much smaller than the initial acquisition of U.S. Water. They are more on the smaller regional and local size entities.

Okay, great. I appreciate it.

Paul Ridzon, KeyBanc.

Thank you, my question was answered.

Brian Russo, Ladenburg Thalmann.

Thanks for the follow-up. Just curious on any upcoming ACE opportunities or what does the pipeline look like? And then what is the long-term strategy for that business or are you trying to achieve some sort of critical mass?

Well, we feel very good about what ACE has accomplished so far, Brian, as expressed. I think the [build-to-own] transfer competency that has been added to ACE with the MDU project; we don't view that as one-off at all, kind of a one-off deal. We think that's a great competency and a great add to their playbook.

Certainly if you look at the Clean Power Plan as delivered yesterday by the Obama administration, certainly biased towards enhanced renewable production across the country, all forms; biased even further in that way than natural gas even, if you look at the rule as it sits in the last 24 hours. So we see many more opportunities that way for ALLETE Clean Energy to be involved in both acquisition of projects, in building of projects, and growing in the renewable space. So we think it is well-positioned at this point in time.

As far as size and mass, no way to predict that just yet as well, but we see it as very much complementary to what we are doing. It is going to be heavily involved in what I would call reoccurring revenues and power purchase agreements. It makes sense for the long term, so nothing emergent; we haven't changed our views in that regard either and we see lots of opportunities ahead for ACE across the country.

Again, ACE, like U.S. Water, is also spread across the country. We will be careful and selective and disciplined, as we have been right along, with our acquisitions, but we see the United States as being fertile ground. Renewables as being fertile ground; EPA or CPP as being the enabler to help ALLETE Clean Energy grow further.

All right, great. Thank you.

Andy Levi, Avon Capital.

I apologize; I did have a follow-up question. And I apologize if someone asked it before or you talked about it, because I hopped on a little late. But just on the segment reporting on the water side from the acquisition, when could we possibly start to see that?

We expect to report segment information for ALLETE Clean Energy and U.S. Water Services later this year. Whether that will be Q3 or Q4, work in progress still.

Okay. And is that just more like an accounting thing and trying to get all the numbers together or is there another reason?

It will be when it trips; the required rules around segment reporting will be the driver.

Okay. And just if you could just let us know what the required rules are just so we understand them?

Simply stated, and generally, if it is more than 10% of certain metrics, which you are going to have to give me a little leeway here, I believe they are assets, revenues, and net income are the three. I may not have that exactly right.

Yes, I don't remember there being a CPA next to your name. Okay.

Well, there is.

Oh, there is? I apologize. I didn't mean to insult you. Okay, well, thank you very much.

Thank you. At this time I would like to turn the call back to Mr. Hodnik for any closing remarks.

Well, thanks again for joining us, everyone. We are very excited about ALLETE's progress broadly and we will look forward to catching up with you and meeting with you along the way here as the year courses towards the end of the year. Thank you very much.

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