SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q (Mark One) /X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended MARCH 31, 2000 or / / Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File No. 1-3548 MINNESOTA POWER, INC. A Minnesota Corporation IRS Employer Identification No. 41-0418150 30 West Superior Street Duluth, Minnesota 55802-2093 Telephone - (218) 722-2641 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Common Stock, no par value, 73,994,032 shares outstanding as of April 30, 2000
MINNESOTA POWER, INC. INDEX Page Part I. Financial Information Item 1. Financial Statements Consolidated Balance Sheet - March 31, 2000 and December 31, 1999 1 Consolidated Statement of Income - Quarter Ended March 31, 2000 and 1999 2 Consolidated Statement of Cash Flows - Quarter Ended March 31, 2000 and 1999 3 Notes to Consolidated Financial Statements 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7 Item 3. Quantitative and Qualitative Disclosures about Market Risk 11 Part II. Other Information Item 5. Other Information 11 Item 6. Exhibits and Reports on Form 8-K 13 Signatures 14 i
DEFINITIONS The following abbreviations or acronyms are used in the text. Abbreviation or Acronym Term - ----------------------- ----------------------------------------------- 1999 Form 10-K Minnesota Power's Annual Report on Form 10-K for the Year Ended December 31, 1999 ADESA ADESA Corporation AFC Automotive Finance Corporation Capital Re Capital Re Corporation Common Stock Minnesota Power, Inc. Common Stock Company Minnesota Power, Inc. and its subsidiaries DRIP Dividend Reinvestment and Stock Purchase Plan ESOP Employee Stock Ownership Plan FERC Federal Energy Regulatory Commission Heater Heater Utilities, Inc. Florida Water Florida Water Services Corporation FPSC Florida Public Service Commission MAPP Mid-Continent Area Power Pool Minnesota Power Minnesota Power, Inc. and its subsidiaries MPUC Minnesota Public Utilities Commission NCUC North Carolina Utilities Commission PCUC Palm Coast Utility Corporation PSCW Public Service Commission of Wisconsin Square Butte Square Butte Electric Cooperative ii
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 In connection with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 (Reform Act), the Company is hereby filing cautionary statements identifying important factors that could cause the Company's actual results to differ materially from those projected in forward-looking statements (as such term is defined in the Reform Act) made by or on behalf of the Company in this quarterly report on Form 10-Q, in presentations, in response to questions or otherwise. Any statements that express, or involve discussions as to expectations, beliefs, plans, objectives, assumptions or future events or performance (often, but not always, through the use of words or phrases such as "anticipates," "believes," "estimates," "expects," "intends," "plans," "predicts," "projects," "will likely result," "will continue," or similar expressions) are not statements of historical facts and may be forward-looking. Forward-looking statements involve estimates, assumptions, and uncertainties and are qualified in their entirety by reference to, and are accompanied by, the following important factors, which are difficult to predict, contain uncertainties, are beyond the control of the Company and may cause actual results to differ materially from those contained in forward-looking statements: - prevailing governmental policies and regulatory actions, including those of Congress, state legislatures, the FERC, the MPUC, the FPSC, the NCUC and the PSCW, with respect to allowed rates of return, industry and rate structure, acquisition and disposal of assets and facilities, operation and construction of plant facilities, recovery of purchased power and other capital investments, and present or prospective wholesale and retail competition (including but not limited to retail wheeling and transmission costs); - economic and geographic factors including political and economic risks; - changes in and compliance with environmental and safety laws and policies; - weather conditions; - population growth rates and demographic patterns; - competition for retail and wholesale customers; - pricing and transportation of commodities; - market demand, including structural market changes; - changes in tax rates or policies or in rates of inflation; - changes in project costs; - unanticipated changes in operating expenses and capital expenditures; - capital market conditions; - competition for new energy development opportunities; and - legal and administrative proceedings (whether civil or criminal) and settlements that influence the business and profitability of the Company. Any forward-looking statement speaks only as of the date on which such statement is made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time and it is not possible for management to predict all of such factors, nor can it assess the impact of any such factor on the business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. iii
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS <TABLE> MINNESOTA POWER CONSOLIDATED BALANCE SHEET Millions <CAPTION> MARCH 31, DECEMBER 31, 2000 1999 Unaudited Audited - ----------------------------------------------------------------------------------------------------------------- <S> <C> <C> ASSETS Current Assets Cash and Cash Equivalents $ 173.7 $ 101.5 Trading Securities 181.3 179.6 Accounts Receivable (Less Allowance of $14.2 and $13.9) 269.8 176.4 Inventories 26.3 24.2 Prepayments and Other 92.7 82.8 --------- ---------- Total Current Assets 743.8 564.5 Property, Plant and Equipment 1,277.1 1,258.8 Investments 216.5 197.2 Goodwill 183.5 181.0 Other Assets 113.3 111.1 --------- ---------- TOTAL ASSETS $ 2,534.2 $ 2,312.6 - ----------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Current Liabilities Accounts Payable $ 247.1 $ 124.7 Accrued Taxes, Interest and Dividends 87.2 79.4 Notes Payable 176.0 96.5 Long-Term Debt and Preferred Stock Due Within One Year 19.3 9.1 Other 57.3 88.6 --------- ---------- Total Current Liabilities 586.9 398.3 Long-Term Debt 708.9 712.8 Accumulated Deferred Income Taxes 146.9 139.9 Other Liabilities 149.8 149.3 --------- ---------- Total Liabilities 1,592.5 1,400.3 --------- ---------- Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary MP&L Capital I Which Holds Solely Company Junior Subordinated Debentures 75.0 75.0 Redeemable Serial Preferred Stock 10.0 20.0 STOCKHOLDERS' EQUITY Cumulative Preferred Stock 11.5 11.5 Common Stock Without Par Value, 130.0 Shares Authorized 73.8 and 73.5 Shares Outstanding 560.4 552.0 Unearned ESOP Shares (58.3) (59.2) Accumulated Other Comprehensive Income 21.0 2.4 Retained Earnings 322.1 310.6 --------- ---------- Total Stockholders' Equity 856.7 817.3 --------- ---------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,534.2 $ 2,312.6 - ----------------------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of these statements. </TABLE> -1-
<TABLE> MINNESOTA POWER CONSOLIDATED STATEMENT OF INCOME Millions Except Per Share Amounts - Unaudited <CAPTION> QUARTER ENDED MARCH 31, 2000 1999 - -------------------------------------------------------------------------------------- <S> <C> <C> OPERATING REVENUE Electric Services $ 141.6 $ 132.2 Automotive Services 119.5 96.8 Water Services 28.0 24.4 Investments 33.5 4.3 ------- ------- Total Operating Revenue 322.6 257.7 ------- ------- OPERATING EXPENSES Fuel and Purchased Power 54.8 47.6 Operations 199.5 164.0 Interest Expense 16.3 14.2 ------- ------- Total Operating Expenses 270.6 225.8 ------- ------- OPERATING INCOME BEFORE CAPITAL RE 52.0 31.9 LOSS FROM INVESTMENT IN CAPITAL RE - (2.4) ------- ------- OPERATING INCOME 52.0 29.5 DISTRIBUTIONS ON REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY 1.5 1.5 INCOME TAX EXPENSE 20.1 7.1 ------- ------- NET INCOME 30.4 20.9 DIVIDENDS ON PREFERRED STOCK 0.5 0.5 ------- ------- EARNINGS AVAILABLE FOR COMMON STOCK $ 29.9 $ 20.4 ======= ======= AVERAGE SHARES OF COMMON STOCK 69.1 67.8 BASIC AND DILUTED EARNINGS PER SHARE OF COMMON STOCK $0.43 $0.30 DIVIDENDS PER SHARE OF COMMON STOCK $0.2675 $0.2675 - -------------------------------------------------------------------------------------- The accompanying notes are an integral part of this statement. </TABLE> -2-
<TABLE> MINNESOTA POWER CONSOLIDATED STATEMENT OF CASH FLOWS Millions - Unaudited <CAPTION> QUARTER ENDED MARCH 31, 2000 1999 - ------------------------------------------------------------------------------------------------------------------- <S> <C> <C> OPERATING ACTIVITIES Net Income $ 30.4 $ 20.9 Loss From Equity Investment in Capital Re - Net of Dividends Received - 2.4 Depreciation and Amortization 20.3 18.4 Deferred Income Taxes (3.3) (4.9) Changes In Operating Assets and Liabilities Trading Securities (1.7) 2.7 Accounts Receivable (93.4) (119.3) Inventories (2.1) 0.6 Accounts Payable 122.4 121.2 Other Current Assets and Liabilities (33.4) (16.5) Other - Net 6.4 3.9 ------- ------- Cash From Operating Activities 45.6 29.4 ------- ------- INVESTING ACTIVITIES Proceeds From Sale of Investments 15.0 9.9 Additions to Investments (19.8) (15.8) Additions to Property, Plant and Equipment (30.1) (15.3) Acquisitions - Net of Cash Acquired (15.7) (16.8) Other - Net 12.4 (3.6) ------- ------- Cash For Investing Activities (38.2) (41.6) ------- ------- FINANCING ACTIVITIES Issuance of Common Stock 8.2 8.7 Issuance of Long-Term Debt 35.0 3.6 Changes in Notes Payable - Net 79.5 79.4 Reductions of Long-Term Debt (38.6) (3.8) Dividends on Preferred and Common Stock (18.9) (18.0) ------- ------- Cash From Financing Activities 65.2 69.9 ------- ------- EFFECT OF EXCHANGE RATE CHANGES ON CASH (0.4) 0.8 ------- ------- CHANGE IN CASH AND CASH EQUIVALENTS 72.2 58.5 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 101.5 89.4 ------- ------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 173.7 $ 147.9 ======= ======= SUPPLEMENTAL CASH FLOW INFORMATION Cash Paid During the Period For Interest - Net of Capitalized $17.3 $17.7 Income Taxes $15.5 $3.4 - ------------------------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of this statement. </TABLE> -3-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The accompanying unaudited consolidated financial statements and notes should be read in conjunction with the Company's 1999 Form 10-K. In the opinion of the Company, all adjustments necessary for a fair statement of the results for the interim periods have been included. The results of operations for an interim period may not give a true indication of results for the year. NOTE 1. BUSINESS SEGMENTS Millions <TABLE> <CAPTION> Electric Automotive Water Corporate Consolidated Services Services Services Investments Charges - ------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> For the Quarter Ended - --------------------- March 31, 2000 - -------------- Operating Revenue $ 322.6 $ 141.6 $119.5<F1> $ 28.0 $ 33.6 $(0.1) Operation and Other Expense 234.0 107.0 90.0 17.7 15.0<F3> 4.3 Depreciation and Amortization Expense 20.3 11.5 4.8 3.8 0.1 0.1 Interest Expense 16.3 5.2 3.9 2.6 - 4.6 -------- -------- ------ ------ ------ ----- Operating Income (Loss) 52.0 17.9 20.8 3.9 18.5 (9.1) Distribution on Redeemable Preferred Securities of Subsidiary 1.5 0.4 - - - 1.1 Income Tax Expense (Benefit) 20.1 6.8 8.9 1.5 7.0 (4.1) -------- -------- ------ ------ ------ ----- Net Income (Loss) $ 30.4 $ 10.7 $ 11.9 $ 2.4 $ 11.5 $(6.1) ======== ======== ====== ====== ====== ===== Total Assets $2,534.2 $1,054.7 $848.7<F2> $318.2 $312.2 $ 0.4 Property, Plant and Equipment $1,277.1 $ 771.0 $250.9 $255.2 - - Accumulated Depreciation and Amortization $ 935.4 $ 677.0 $ 60.5 $195.9 $ 2.0 - Capital Expenditures $ 30.1 $ 9.7 $ 15.1 $ 5.3 - - - ------------------------------------------------------------------------------------------------------------------- For the Quarter Ended - --------------------- March 31, 1999 - -------------- Operating Revenue $ 257.7 $ 132.2 $ 96.8<F1> $ 24.4 $ 4.4 $(0.1) Operation and Other Expense 193.2 97.8 72.9 15.7 4.1<F3> 2.7 Depreciation and Amortization Expense 18.4 10.9 4.2 3.2 - 0.1 Interest Expense 14.2 5.3 2.4 2.4 - 4.1 -------- -------- ------ ------ ------ ----- Operating Income (Loss) Before Capital Re 31.9 18.2 17.3 3.1 0.3 (7.0) Loss from Investment in Capital Re (2.4) - - - (2.4) - -------- ------- ------ ------ ------ ----- Operating Income (Loss) 29.5 18.2 17.3 3.1 (2.1) (7.0) Distribution on Redeemable Preferred Securities of Subsidiary 1.5 0.4 - - - 1.1 Income Tax Expense (Benefit) 7.1 6.8 7.7 1.2 (5.0) (3.6) -------- -------- ------ ------ ------ ----- Net Income (Loss) $ 20.9 $ 11.0 $ 9.6 $ 1.9 $ 2.9 $(4.5) ======== ======== ====== ====== ====== ===== Total Assets $2,417.8 $1,033.1 $722.6<F2> $306.2 $355.5 $ 0.4 Property, Plant and Equipment $1,204.9 $ 764.9 $195.3 $244.7 - - Accumulated Depreciation and Amortization $ 843.1 $ 607.1 $ 44.7 $189.6 $ 1.7 - Capital Expenditures $ 15.3 $ 6.6 $ 4.5 $ 4.2 - - - ------------------------------------------------------------------------------------------------------------------- <FN> <F1> Included $17.1 million of Canadian operating revenue in 2000 ($11.4 million in 1999). <F2> Included $149.6 million of Canadian assets in 2000 ($89.1 million in 1999). <F3> Included $0.2 million of minority interest in 2000 ($0.1 million in 1999). </FN> </TABLE> -4-
NOTE 2. REGULATORY MATTERS FLORIDA WATER 1991 RATE CASE REFUNDS. In 1995 the Florida First District Court of Appeals (Court of Appeals) reversed a 1993 FPSC order establishing uniform rates for most of Florida Water's service areas. With "uniform rates" all customers in each uniform rate area pay the same rates for water and wastewater services. In response to the Court of Appeals' order, in August 1996 the FPSC ordered Florida Water to issue refunds to those customers who paid more since October 1993 under uniform rates than they would have paid under stand-alone rates. This order did not permit a balancing surcharge to customers who paid less under uniform rates. Florida Water appealed, and the Court of Appeals ruled in June 1997 that the FPSC could not order refunds without balancing surcharges. In response to the Court of Appeals' ruling, the FPSC issued an order in January 1998 that did not require refunds. Florida Water's potential refund liability at that time was about $12.5 million, which included interest, to customers who paid more under uniform rates. In the same January 1998 order, the FPSC required Florida Water to refund, with interest, $2.5 million, the amount paid by customers in the Spring Hill service area from January 1996 through June 1997 under uniform rates which exceeded the amount these customers would have paid under a modified stand-alone rate structure. No balancing surcharge was permitted. The FPSC ordered this refund because Spring Hill customers continued to pay uniform rates after other customers began paying modified stand-alone rates effective January 1996 pursuant to the FPSC's interim rate order in Florida Water's 1995 Rate Case. The FPSC did not include Spring Hill in this interim rate order because Hernando County had assumed jurisdiction over Spring Hill's rates. In June 1997 Florida Water reached an agreement with Hernando County to revert prospectively to stand-alone rates for Spring Hill customers. Customer groups which paid more under uniform rates have appealed the FPSC's January 1998 order, arguing that they are entitled to a refund because the FPSC had no authority to order uniform rates. The Company has appealed the $2.5 million refund order. Initial briefs were filed by all parties in May 1998. In June 1998 the Court of Appeals reversed its previous ruling that the FPSC was without authority to order uniform rates at which time customer groups supporting the FPSC's January 1998 order filed a motion with the Court of Appeals seeking dismissal of the appeal by customer groups seeking refunds. Customers seeking refunds filed amended briefs in September 1998. A mediation session was held in September 1999. The parties could not reach settlement of any issues. A provision for refund related to the $2.5 million refund order was recorded in 1999. The parties await the establishment of a briefing schedule. A decision is not expected before 2001. The Company is unable to predict the timing or outcome of the appeals process. NOTE 3. INCOME TAX EXPENSE <TABLE> <CAPTION> Quarter Ended March 31, 2000 1999 - -------------------------------------------------------------------------------- <S> <C> <C> Millions Current Tax Federal $ 19.6 $ 10.0 Foreign 0.5 0.4 State 3.3 1.6 ------ ------ 23.4 12.0 ------ ------ Deferred Tax Federal (2.3) (1.6) Foreign (0.1) - State (0.5) (2.9) ------ ------ (2.9) (4.5) ------ ------ Deferred Tax Credits (0.4) (0.4) ------ ------ Total Income Tax Expense $ 20.1 $ 7.1 - -------------------------------------------------------------------------------- </TABLE> -5-
NOTE 4. TOTAL COMPREHENSIVE INCOME For the quarter ended March 31, 2000 total comprehensive income was $49.0 million ($21.9 million for the quarter ended March 31, 1999). Total comprehensive income includes net income, unrealized gains and losses on securities classified as available-for-sale, and foreign currency translation adjustments. NOTE 5. ACQUISITIONS ADESA AUCTION FACILITIES. On January 1, 2000 ADESA Canada Inc. acquired an additional 26 percent of Impact Auto Auctions Ltd. bringing the total ownership percentage to 73 percent. The Company anticipates acquiring the remaining 27 percent by the end of 2000. Impact Auto Auctions Ltd. is a business that auctions salvaged vehicles at several locations in Canada. On February 7, 2000 ADESA purchased the Mission City Auto Auction in San Diego, California. The transaction was accounted for using the purchase method. Financial results have been included in the Company's consolidated financial statements since the date of purchase. Pro forma financial results have not been presented due to immateriality. The Mission City auction, which has been renamed ADESA San Diego, operates six auction lanes on 30 acres with full reconditioning facilities. AFC has opened an office at ADESA San Diego. The transactions described in the two preceding paragraphs had a combined purchase price of $15.7 million. The Company funded these transactions with internally generated funds. NOTE 6. LONG-TERM DEBT On March 30, 2000 ADESA issued $35 million of 8.10% Senior Notes, Series B, due March 30, 2010. Proceeds were used to refinance short-term bank indebtedness incurred for the acquisition of vehicle auction facilities purchased in 1999 and for general corporate purposes. NOTE 7. SQUARE BUTTE PURCHASED POWER CONTRACT The Company has a power purchase agreement with Square Butte that extends through 2026 (Agreement). It provides a long-term supply of low-cost energy to customers in the Company's electric service territory and enables the Company to meet power pool reserve requirements. Square Butte, a North Dakota cooperative corporation, owns a 455-megawatt coal-fired generating unit (Unit) near Center, North Dakota. The Unit is adjacent to a generating unit owned by Minnkota Power Cooperative, Inc. (Minnkota), a North Dakota cooperative corporation whose Class A members are also members of Square Butte. Minnkota serves as the operator of the Unit and also purchases power from Square Butte. The Company is entitled to approximately 71 percent of the Unit's output under the Agreement. After 2005 and upon compliance with a two-year advance notice requirement, Minnkota has the option to reduce the Company's entitlement by 5 percent annually, to a minimum of 50 percent. The Company is obligated to pay its pro rata share of Square Butte's costs based on the Company's entitlement to Unit output. The Company's payment obligation is suspended if Square Butte fails to deliver any power, whether produced or purchased, for a period of one year. Square Butte's fixed costs consist primarily of debt service. At March 31, 2000 Square Butte had total debt outstanding of $329.6 million. Total annual debt service for Square Butte is expected to be approximately $36 million in each of the years 2000 through 2003 and $23 million in 2004. Variable operating costs include the price of coal purchased from BNI Coal, a subsidiary of Minnesota Power, under a long-term contract. The Company's payments to Square Butte are approved as purchased power expense for ratemaking purposes by both the MPUC and FERC. -6-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Minnesota Power is a multi-services company with operations in four business segments: (1) Electric Services, which include electric and gas services, coal mining and telecommunications; (2) Automotive Services, which include a network of vehicle auctions, an automobile dealer finance company, an auto transport company, a vehicle remarketing company and a company that provides field information services; (3) Water Services, which include water and wastewater services and (4) Investments, which include a securities portfolio, intermediate-term investments and real estate operations. Corporate charges represent general corporate expenses, including interest, not specifically related to any one business segment. CONSOLIDATED OVERVIEW Strong performance by each of the Company's operating segments contributed to a 45 percent increase in 2000 net income over the first three months of 1999 and a 43 percent increase in earnings per share over the first three months of 1999. <TABLE> <CAPTION> Quarter Ended March 31, 2000 1999 - --------------------------------------------------------------------------------------------------- Millions <S> <C> <C> Operating Revenue Electric Services $ 141.6 $ 132.2 Automotive Services 119.5 96.8 Water Services 28.0 24.4 Investments 33.6 4.4 Corporate Charges (0.1) (0.1) ------- -------- $ 322.6 $ 257.7 ======= ======== Operating Expenses Electric Services $ 123.7 $ 114.0 Automotive Services 98.7 79.5 Water Services 24.1 21.3 Investments 15.1 4.1 Corporate Charges 9.0 6.9 ------- -------- $ 270.6 $ 225.8 ======= ======== Net Income Electric Services $ 10.7 $ 11.0 Automotive Services 11.9 9.6 Water Services 2.4 1.9 Investments 11.5 2.9 Corporate Charges (6.1) (4.5) ------- -------- $ 30.4 $ 20.9 ======= ======== - --------------------------------------------------------------------------------------------------- Basic and Diluted Earnings Per Share of Common Stock $0.43 $0.30 Average Shares of Common Stock - Millions 69.1 67.8 - --------------------------------------------------------------------------------------------------- </TABLE> NET INCOME The following net income discussion summarizes significant events for the quarter ended March 31, 2000. Electric Services reflected stable net income in 2000 and strong megawatthour sales. An 11 percent increase in megawatthour sales was offset by lower demand revenue from large industrial customers and higher purchased power expenses. Automotive Services reported higher net income in 2000 due to a 13 percent increase in the number of vehicles sold through ADESA auction facilities and a 31 percent increase in the number of vehicles financed through AFC's loan production offices. Water Services generated higher net income in 2000. Water consumption was up 17 percent in 2000 as a result of customer growth, one additional month of PCUC operations and drier weather conditions. Investments reported higher net income in 2000 because of significant sales by the Company's real estate operations, improved returns on the Company's securities portfolio and gains on intermediate-term investments in emerging technologies relating to the electric industry. -7-
COMPARISON OF THE QUARTERS ENDED MARCH 31, 2000 AND 1999 OPERATING REVENUE Electric Services operating revenue was $9.4 million higher in 2000. Megawatthour sales were up 11 percent from 1999 while the average price of power sold was 4 percent lower in 2000. More sales from wholesale power marketing activities and higher requirements by large industrial retail customers led to the increase in megawatthour sales. Megawatthour sales from wholesale power marketing activities increased 63 percent in 2000 and contributed $4.4 million more to revenue. Megawatthour sales to industrial customers increased 5 percent in 2000 and contributed $1.4 million more to revenue. The average price of power sold was lower in 2000 primarily because of lower wholesale prices and $0.8 million less demand revenue from large industrial customers. Revenue from electric sales to taconite customers accounted for 13 percent of consolidated operating revenue in 2000 (16 percent in 1999). Electric sales to paper and pulp mills accounted for 4 percent of consolidated operating revenue in 2000 (6 percent in 1999). Sales to other power suppliers accounted for 6 percent of consolidated operating revenue in both 2000 and 1999. Automotive Services operating revenue was $22.7 million higher in 2000 primarily due to increased sales at ADESA auction facilities and financing at AFC loan production offices. At ADESA auction facilities 295,000 vehicles were sold in 2000 (260,000 in 1999). Financial results for 2000 included three months of operations for two auction facilities acquired in April and July of 1999 and two months of operations for one auction facility acquired in February 2000. AFC financed approximately 195,000 vehicles in 2000 (149,000 in 1999) through its 84 loan production offices. Water Services operating revenue was $3.6 million higher in 2000 because of a 17 percent increase in water consumption. Customer growth, the inclusion of water systems acquired during 1999 and drier weather conditions led to the increase in water consumption. Investments operating revenue was $29.2 million higher in 2000. Significant sales by the Company's real estate operations were the primary reason for the increase. In 2000 two large sales contributed $17.2 million to revenue. One of these sales was real estate operations' largest single transaction to date. Improved returns from the securities portfolio and $3.6 million of gains on intermediate-term investments in emerging technologies relating to the electric industry also contributed to higher operating revenue from Investments in 2000. The Company's securities portfolio reported an after-tax return of 3.96 percent in 2000 (0.06 percent in 1999). OPERATING EXPENSES Electric Services operating expenses were $9.7 million higher in 2000 primarily due to increased purchased power expense. Purchased power expense was higher because of increased prices in the wholesale market and more megawatthours bought to support additional wholesale power marketing activities and the higher requirements of industrial customers. Automotive Services operating expenses were $19.2 million higher in 2000 primarily because of increased sales activity at the auction facilities and financing activity at the automobile dealer floorplan financing business. The inclusion of three additional vehicle auctions also increased operating expenses at the auction facilities in 2000. Water Services operating expenses were $2.8 million higher in 2000 due to the inclusion of water systems acquired in 1999. Investments operating expenses were $11.0 million higher in 2000 due to the cost of property sold by the Company's real estate operations. INCOME TAX EXPENSE Income tax expense was $13 million higher in 2000 primarily the result of an increase in operating income. -8-
OUTLOOK ELECTRIC SERVICES. As the electric industry continues to restructure, the contribution from Electric Services is expected to remain stable with a solid customer base. Approximately half of the electricity the Company sells is to large industrial customers, primarily taconite producers, which have long-term all-requirements contracts. Approximately 80 percent of the ore consumed by integrated steel facilities in the Great Lakes region originates from five taconite customers of Minnesota Power. The domestic steel industry continues to face high levels of imported products. In 1999 the United States imported 35,657,000 net tons of steel, higher than any year except 1998. That level is also 14.4 percent higher than in 1997, the last record year prior to the unprecedented import surge in 1998. Overall steel prices remain somewhat depressed. Despite the high level of imports, the strong U.S. economy is helping fuel demand for steel produced domestically. Through March 2000, production of U.S. steel mills was up approximately 20 percent over the same time period in 1999. AUTOMOTIVE SERVICES. ADESA is the second largest and the fastest growing vehicle auction business in North America. ADESA projects a 10 percent estimated annual growth in vehicles sold through sales at existing and new auction facilities. AFC, the largest independent automobile dealer floorplan financing business in North America, estimates a 15 to 20 percent annual growth in receivables at existing locations. AFC also plans to grow through the introduction of new products and services. The Company is unable to predict the impact of the recently announced merger between Manheim Auctions, Inc. and ADT Automotive Holdings, Inc. on AFC's offices located at ADT auctions. WATER SERVICES includes the largest investor owned water utilities in both Florida and North Carolina. The Company continues to position itself by selectively acquiring targeted water systems and developing a non-regulated presence in the contract maintenance business. Both Florida Water and Heater operate in states that are currently experiencing rapid population growth which should contribute to annual customer growth of 3 to 5 percent over the next two years. INVESTMENTS. Over the last 5 years, sales by real estate operations have been 3 to 4 times the acquisition cost of property sold, creating strong cash generation and profitability. The real estate strategy is to acquire large portfolios of property, add value and resell them at going market prices. LIQUIDITY AND FINANCIAL POSITION CASH FLOW ACTIVITIES. Cash flow from operations during the first quarter of 2000 reflected improved operating results and continued focus on working capital management. Cash from operating activities was also affected by a number of factors representative of normal operations. Working capital, if and when needed, generally is provided by the sale of commercial paper. In addition, securities investments can be liquidated to provide funds for reinvestment in existing businesses or acquisition of new businesses, and approximately 7 million original issue shares of Common Stock are available for issuance through the DRIP. A substantial amount of ADESA's working capital is generated internally from payments made by vehicle purchasers. However, ADESA has arrangements to use the proceeds from the sale of commercial paper issued by the Company to meet short-term working capital requirements arising from the timing of payment obligations to vehicle sellers and the availability of funds from vehicle purchasers. During the sales process, ADESA does not typically take title to vehicles. AFC also has arrangements to use proceeds from the sale of commercial paper issued by the Company to meet its operational requirements. AFC offers short-term on-site financing for dealers to purchase vehicles at auctions in exchange for a security interest in those vehicles. The financing is provided through the earlier of the date the dealer sells the vehicle or a general borrowing term of 30 to 45 days. AFC sells certain finance receivables on a revolving basis to a wholly owned, unconsolidated, qualified special purpose subsidiary. This subsidiary in turn sells, on a revolving basis, an undivided interest in eligible finance receivables, up to a maximum at any one time outstanding of $300 million, to third party purchasers under an agreement which expires at the end of 2002. At March 31, 2000 AFC had sold $347.3 million of finance receivables to the special purpose subsidiary ($296.8 million at December 31, 1999). Third party purchasers had purchased an undivided interest in finance receivables of $247 million -9-
from this subsidiary at March 31, 2000 ($225 million at December 31, 1999). Unsold finance receivables held by the special purpose subsidiary are recorded by AFC as residual interest at fair value. Fair value is based upon estimates of future cash flows, using assumptions that market participants would use to value such instruments, including estimates of anticipated credit losses over the life of the receivables sold; a discount rate was not used due to the short-term nature of the receivables sold. The fair value of AFC's residual interest was $67.0 million at March 31, 2000 ($57.6 million at December 31, 1999). Proceeds from the sale of the receivables were used to repay borrowings from the Company and fund vehicle inventory purchases for AFC's customers. Significant changes in accounts receivable and accounts payable balances at March 31, 2000 compared to December 31, 1999 were due to increased sales and financing activity at Automotive Services. Typically auction volumes are down during the winter months and in December because of the holidays. As a result, both ADESA and AFC had lower receivables and fewer payables at year end. In January 2000 ADESA Canada Inc. acquired an additional 26 percent of Impact Auto Auctions Ltd. bringing the total ownership percentage to 73 percent. The Company anticipates acquiring the remaining 27 percent by the end of 2000. Impact Auto Auctions Ltd. is a business that auctions salvaged vehicles at several locations in Canada. In February 2000 ADESA purchased the Mission City Auto Auction in San Diego, California. The Mission City auction, which has been renamed ADESA San Diego, operates six auction lanes on 30 acres with full reconditioning facilities. AFC has opened an office at ADESA San Diego. The transactions described in the two preceding paragraphs had a combined purchase price of $15.7 million. The Company funded these transactions with internally generated funds. In March 2000 ADESA issued $35 million of 8.10% Senior Notes, Series B, due March 30, 2010. Proceeds were used to refinance short-term bank indebtedness incurred for the acquisition of vehicle auction facilities purchased in 1999 and for general corporate purposes. In April 2000 the Company redeemed $10 million, or 100,000 shares, of Redeemable Serial Preferred Stock A, $7.125 Series. Proceeds from the Company's securities portfolio were used to fund this redemption. In April 2000 leases for three ADESA auction facilities (Boston, Charlotte and Knoxville) were refinanced in a $28.4 million leveraged lease transaction. The new lease expires on April 1, 2010, but may be terminated after 2005 under certain conditions. Minnesota Power has guaranteed ADESA's obligations under the lease. CAPITAL REQUIREMENTS. Consolidated capital expenditures for the three months ended March 31, 2000 totaled $30.1 million ($15.3 million in 1999). Expenditures for 2000 included $9.7 million for Electric Services, $15.1 million for Automotive Services and $5.3 million for Water Services. Internally generated funds and the issuance of long-term debt were the primary sources of funding for these expenditures. NEW ACCOUNTING STANDARDS. In June 1998 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. (SFAS) 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS 137, effective for fiscal years beginning after June 15, 2000. SFAS 133 establishes accounting and reporting standards requiring that every derivative instrument be recorded on the balance sheet as either an asset or liability measured at fair value. SFAS 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset the related results on the hedged item. The Company currently believes it has only a limited amount of derivative activity and adoption of SFAS 133 is not expected to have a material impact on the Company's financial position and results of operations. -------------------- Readers are cautioned that forward-looking statements including those contained above, should be read in conjunction with the Company's disclosures under the heading: "SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995" located in the preface of this Form 10-Q. -10-
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's securities portfolio has exposure to both price and interest rate risk. Investments held principally for near-term sale are classified as trading securities and recorded at fair value. Trading securities consist primarily of the common stock of publicly traded companies. In strategies designed to hedge overall market risks, the Company also sells common stock short. Investments held for an indeterminate period of time are classified as available-for-sale securities and also recorded at fair value. Available-for-sale securities consisted of 4.7 million shares of ACE Limited and securities in a grantor trust established to fund certain employee benefits. March 31, 2000 Fair Value ---------------------------------------------------------------------- Millions Trading Securities Portfolio $181.3 Available-For-Sale Securities Portfolio $124.2 ---------------------------------------------------------------------- PART II. OTHER INFORMATION ITEM 5. OTHER INFORMATION Reference is made to the Company's 1999 Form 10-K for background information on the following updates. Unless otherwise indicated, cited references are to the Company's 1999 Form 10-K. Ref. Page 4. - First and Second Paragraphs The domestic steel industry continues to face high levels of imported products. In 1999 the United States imported 35,657,000 net tons of steel, higher than any year except 1998. That level is also 14.4 percent higher than in 1997, the last record year prior to the unprecedented import surge in 1998. Overall steel prices remain somewhat depressed. Despite the high level of imports, the strong U.S. economy is helping fuel demand for steel produced domestically. Through March 2000, production of U.S. steel mills is up approximately 20 percent over the same time period in 1999. Ref. Page 7. - Eighth Paragraph On April 12, 2000 MAPP, of which Minnesota Power is a member, approved the execution of a Memorandum of Understanding (MOU) with the Mid-American Interconnected Network (MAIN) to merge the reliability functions of the two organizations into a Regional Reliability Organization (RRO). MAIN approved the MOU on April 7, 2000. The new RRO will be designed and structured to comply with statutory requirements applicable to regional reliability organizations. Definitive agreements are expected to be completed by July 2000. The goal is to have the new RRO operational by November 2000. Both organizations provide for the reliable transmission of electric power in the central United States. Ref. Page 8. - First Paragraph The Minnesota Department of Commerce (DOC) approved the petitions of several of the Company's largest customers to opt-out of the CIP minimum spending requirements. As a result, the Company has indicated to the DOC that its 2000 and 2001 minimum spending level of $5.6 million has been reduced to $2.7 million annually. On February 18, 2000 the MPUC issued its order regarding the denial of Minnesota Power's 1998 lost margin recovery. Minnesota Power timely filed a Notice of Appeal of the MPUC's decision with the Minnesota Court of Appeals (Court of Appeals). Northern States Power Company (NSP) also filed a -11-
Notice of Appeal regarding its similar denial of lost margin recovery. On March 23, 2000 the Court of Appeals issued an order consolidating the Minnesota Power and NSP appeals because they raise almost identical legal issues. Initial briefs will be filed by mid June 2000. The Company cannot predict the timeframe or the outcome of the Court of Appeals decision in this matter. Ref. Page 9. - Fourth Full Paragraph On April 14, 2000 Minnesota Power and Great River Energy signed an agreement to form Split Rock Energy LLC (Split Rock). Split Rock was formed as a result of the alliance between Minnesota Power and Great River Energy. The alliance between the two companies combines power supply capabilities and customer loads for power pool operations. Ownership of existing generation assets and current customer supply arrangements will not change for either company. Split Rock will contract for exclusive services from MPEX, the Company's power marketing division. Pending regulatory approval, Split Rock is expected to begin operations during the second quarter of 2000. Split Rock has submitted filings with the FERC for approval to use market-based rates and applied for membership in the MAPP as a transmission-using member. This membership application was approved by MAPP. Split Rock is currently resolving certain issues raised by several MAPP operating committees to allow Split Rock to combine the load and capability of both Minnesota Power and Great River Energy for joint operating and reporting purposes. Minnesota Power has also filed for MPUC approval of all transactional agreements entered into with Split Rock. Great River Energy is in the process of receiving approval from the Rural Utilities Service to assign its native load and power and marketing obligations to Split Rock. Ref. Page 12. - Third Full Paragraph On January 1, 2000 ADESA Canada Inc. acquired an additional 26 percent of Impact Auto Auctions Ltd. bringing the total ownership percentage to 73 percent. The Company anticipates acquiring the remaining 27 percent by the end of 2000. Impact Auto Auctions Ltd. is a business that auctions salvaged vehicles at several locations in Canada. On February 7, 2000 ADESA purchased the Mission City Auto Auction in San Diego, California. The Mission City auction, which has been renamed ADESA San Diego, operates six auction lanes on 30 acres with full reconditioning facilities. With the San Diego auction facility, ADESA has three auction facilities in California. ADESA Sacramento was acquired in 1997 and ADESA Los Angeles opened in April 2000. AFC has opened an office at ADESA San Diego. California is one of America's largest car markets. In April 2000 operations also began at ADESA Concord, located in Concord, Massachusetts. ADESA now owns and operates 32 vehicle auction facilities. Ref. Page 12. - Footnotes to Table In April 2000 leases for three ADESA auction facilities (Boston, Charlotte and Knoxville) were refinanced in a $28.4 million leveraged lease transaction. The new lease is treated as an operating lease for financial reporting purposes and expires on April 1, 2010. The lease may be terminated after 2005 under certain conditions. Minnesota Power has guaranteed ADESA's obligations under the lease. -12-
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. 4 (a) Guarantee of Minnesota Power, dated as of March 30, 2000, relating to ADESA Corporation's 8.10% Senior Notes, Series B, Due 2010. 4 (b) ADESA Corporation Officer's Certificate 2-D-2, dated as of March 30, 2000, relating to ADESA Corporation's 8.10% Senior Notes, Series B, Due 2010. 10 (a) Participation Agreement, dated as of March 31, 2000, among Asset Holdings III, L.P., as Lessor, ADESA Corporation, as Lessee, SunTrust Bank, as Credit Bank, and Cornerstone Funding Corporation I, as Issuer. 10 (b) Lease Agreement, dated as of March 31, 2000, between Asset Holdings III, L.P., as Lessor and ADESA Corporation, as Lessee. 10 (c) Reimbursement Agreement, dated as of March 31, 2000, between SunTrust Bank, as Credit Bank, and Asset Holdings III, L.P., as Lessor. 10 (d) Appendix I to Participation Agreement, Lease Agreement and Reimbursement Agreement, all which are dated as of March 31, 2000, relating to the Lease Financing for ADESA Corporation Auto Auction Facilities. 10 (e) Assignment of Lease and Rents (without Exhibit A) entered into as of March 31, 2000, by and between Asset Holdings III, L.P., as Lessor and SunTrust Bank, as Credit Bank. 10 (f) Limited Guaranty of Minnesota Power, dated as of March 31, 2000, relating to the Lease Financing for ADESA Corporation Auto Auction Facilities. 27 Financial Data Schedule for the Three Months Ended March 31, 2000. (b) Reports on Form 8-K. None. -13-
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Minnesota Power, Inc. ------------------------------- (Registrant) May 9, 2000 D. G. Gartzke ------------------------------- D. G. Gartzke Senior Vice President - Finance and Chief Financial Officer May 9, 2000 Mark A. Schober ------------------------------- Mark A. Schober Controller -14-
INDEX TO EXHIBITS Exhibit Number 4 (a) Guarantee of Minnesota Power, dated as of March 30, 2000, relating to ADESA Corporation's 8.10% Senior Notes, Series B, Due 2010. 4 (b) ADESA Corporation Officer's Certificate 2-D-2, dated as of March 30, 2000, relating to ADESA Corporation's 8.10% Senior Notes, Series B, Due 2010. 10 (a) Participation Agreement, dated as of March 31, 2000, among Asset Holdings III, L.P., as Lessor, ADESA Corporation, as Lessee, SunTrust Bank, as Credit Bank, and Cornerstone Funding Corporation I, as Issuer. 10 (b) Lease Agreement, dated as of March 31, 2000, between Asset Holdings III, L.P., as Lessor and ADESA Corporation, as Lessee. 10 (c) Reimbursement Agreement, dated as of March 31, 2000, between SunTrust Bank, as Credit Bank, and Asset Holdings III, L.P., as Lessor. 10 (d) Appendix I to Participation Agreement, Lease Agreement and Reimbursement Agreement, all which are dated as of March 31, 2000, relating to the Lease Financing for ADESA Corporation Auto Auction Facilities. 10 (e) Assignment of Lease and Rents (without Exhibit A) entered into as of March 31, 2000, by and between Asset Holdings III, L.P., as Lessor and SunTrust Bank, as Credit Bank. 10 (f) Limited Guaranty of Minnesota Power, dated as of March 31, 2000, relating to the Lease Financing for ADESA Corporation Auto Auction Facilities. 27 Financial Data Schedule for the Three Months Ended March 31, 2000.