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 JUNE 30, 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, 74,259,810 shares outstanding as of July 31, 2000 MINNESOTA POWER, INC. INDEX Page Part I. Financial Information Item 1. Financial Statements Consolidated Balance Sheet - June 30, 2000 and December 31, 1999 1 Consolidated Statement of Income - Quarter and Six Months Ended June 30, 2000 and 1999 2 Consolidated Statement of Cash Flows - Six Months Ended June 30, 2000 and 1999 3 Notes to Consolidated Financial Statements 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9 Item 3. Quantitative and Qualitative Disclosures about Market Risk 16 Part II. Other Information Item 4. Submission of Matters to a Vote of Security Holders 16 Item 5. Other Information 17 Item 6. Exhibits and Reports on Form 8-K 18 Signatures 19 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 ACE ACE Limited ADESA ADESA Corporation ADESA Canada ADESA Canada Inc. ADT ADT Automotive Holdings, Inc. AFC Automotive Finance Corporation AFG Auction Finance Group, Inc. CAG Canadian Auction Group 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. Impact Auto Impact Auto Auctions Ltd. and Suburban Auto Parts Inc., collectively Florida Water Florida Water Services Corporation FPSC Florida Public Service Commission FTC Federal Trade Commission LTV LTV Steel Company, Inc. Manheim Manheim Auctions, Inc. MAPP Mid-Continent Area Power Pool Mid South Mid South Water Systems, Inc. Minnesota Power Minnesota Power, Inc. and its subsidiaries MPUC Minnesota Public Utilities Commission NCUC North Carolina Utilities Commission Note ____ Note ____ to the consolidated financial statements included in this Quarterly Report on Form 10-Q PCUC Palm Coast Utility Corporation PSCW Public Service Commission of Wisconsin SEC United States Securities and Exchange Commission Spruce Creek Spruce Creek South Utilities Inc. 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 that 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 these factors, nor can it assess the impact of each of these factors 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 MINNESOTA POWER CONSOLIDATED BALANCE SHEET Millions JUNE 30, DECEMBER 31, 2000 1999 Unaudited Audited - ------------------------------------------------------------------------------------------------------------------- ASSETS Current Assets Cash and Cash Equivalents $ 193.7 $ 101.5 Trading Securities 98.1 179.6 Accounts Receivable (Less Allowance of $15.4 and $13.9) 283.3 176.4 Inventories 26.5 24.2 Prepayments and Other 106.3 82.8 --------- --------- Total Current Assets 707.9 564.5 Property, Plant and Equipment 1,311.5 1,258.8 Investments 109.0 197.2 Goodwill 322.2 181.0 Other Assets 109.6 111.1 --------- --------- TOTAL ASSETS $ 2,560.2 $ 2,312.6 - ------------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES Current Liabilities Accounts Payable $ 292.1 $ 124.7 Accrued Taxes, Interest and Dividends 86.9 79.4 Notes Payable 126.7 96.5 Long-Term Debt and Preferred Stock Due Within One Year 19.2 9.1 Other 75.7 88.6 --------- --------- Total Current Liabilities 600.6 398.3 Long-Term Debt 720.1 712.8 Accumulated Deferred Income Taxes 125.8 139.9 Other Liabilities 152.0 149.3 --------- --------- Total Liabilities 1,598.5 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 - 20.0 STOCKHOLDERS' EQUITY Cumulative Preferred Stock 11.5 11.5 Common Stock Without Par Value, 130.0 Shares Authorized 74.2 and 73.5 Shares Outstanding 565.7 552.0 Unearned ESOP Shares (57.5) (59.2) Accumulated Other Comprehensive Income (Loss) (0.5) 2.4 Retained Earnings 367.5 310.6 --------- --------- Total Stockholders' Equity 886.7 817.3 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,560.2 $ 2,312.6 - ------------------------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of these statements. -1- MINNESOTA POWER CONSOLIDATED STATEMENT OF INCOME Millions Except Per Share Amounts - Unaudited QUARTER ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2000 1999 2000 1999 - ------------------------------------------------------------------------------------------------------------------- OPERATING REVENUE Electric Services $ 138.9 $ 135.3 $ 280.5 $ 267.5 Automotive Services 129.7 104.0 249.2 200.8 Water Services 31.7 29.9 59.7 54.3 Investments 26.7 10.0 60.2 14.3 ------- -------- -------- ------- Total Operating Revenue 327.0 279.2 649.6 536.9 ------- -------- -------- ------- OPERATING EXPENSES Fuel and Purchased Power 55.1 52.3 109.9 99.9 Operations 199.6 170.9 399.1 334.9 Interest Expense 15.2 14.4 31.5 28.6 ------- -------- -------- ------- Total Operating Expenses 269.9 237.6 540.5 463.4 ------- -------- -------- ------- OPERATING INCOME BEFORE CAPITAL RE AND ACE 57.1 41.6 109.1 73.5 INCOME (LOSS) FROM INVESTMENT IN CAPITAL RE AND RELATED DISPOSITION OF ACE 48.0 (13.4) 48.0 (15.8) ------- -------- -------- ------- OPERATING INCOME 105.1 28.2 157.1 57.7 DISTRIBUTIONS ON REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY 1.5 1.5 3.0 3.0 INCOME TAX EXPENSE 39.4 24.8 59.5 31.9 ------- -------- -------- ------- NET INCOME 64.2 1.9 94.6 22.8 DIVIDENDS ON PREFERRED STOCK 0.3 0.5 0.8 1.0 ------- -------- -------- ------- EARNINGS AVAILABLE FOR COMMON STOCK $ 63.9 $ 1.4 $ 93.8 $ 21.8 ======= ======== ======== ======= AVERAGE SHARES OF COMMON STOCK 69.6 68.2 69.4 68.0 BASIC AND DILUTED EARNINGS PER SHARE OF COMMON STOCK $0.92 $0.02 $1.35 $0.32 DIVIDENDS PER SHARE OF COMMON STOCK $0.2675 $0.2675 $0.535 $0.535 - ------------------------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of this statement. -2- MINNESOTA POWER CONSOLIDATED STATEMENT OF CASH FLOWS Millions - Unaudited SIX MONTHS ENDED JUNE 30, 2000 1999 - ------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net Income $ 94.6 $ 22.8 (Gain) Loss From Investment in Capital Re and Related Disposition of ACE (48.0) 15.8 Depreciation and Amortization 41.4 37.8 Deferred Income Taxes (12.8) 7.6 Changes In Operating Assets and Liabilities Trading Securities 81.5 1.1 Accounts Receivable (89.5) (128.2) Inventories (2.3) (0.4) Accounts Payable 153.6 125.1 Other Current Assets and Liabilities (28.3) (29.9) Other - Net 14.0 10.9 ------- ------- Cash From Operating Activities 204.2 62.6 ------- ------- INVESTING ACTIVITIES Proceeds From Sale of Investments 144.6 36.1 Additions to Investments (27.6) (20.1) Additions to Property, Plant and Equipment (56.5) (42.7) Acquisitions - Net of Cash Acquired (181.0) (64.6) Other - Net 9.0 (1.3) ------- ------- Cash For Investing Activities (111.5) (92.6) ------- ------- FINANCING ACTIVITIES Issuance of Common Stock 13.1 14.9 Issuance of Long-Term Debt 48.8 25.6 Changes in Notes Payable - Net 30.2 83.3 Reductions of Long-Term Debt (41.4) (7.7) Redemption of Preferred Stock (10.0) - Dividends on Preferred and Common Stock (37.7) (36.5) ------- ------- Cash From Financing Activities 3.0 79.6 ------- ------- EFFECT OF EXCHANGE RATE CHANGES ON CASH (3.5) 2.1 ------- ------- CHANGE IN CASH AND CASH EQUIVALENTS 92.2 51.7 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 101.5 89.4 ------- ------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 193.7 $ 141.1 ======= ======= SUPPLEMENTAL CASH FLOW INFORMATION Cash Paid During the Period For Interest - Net of Capitalized $24.0 $30.8 Income Taxes $54.6 $27.2 - ------------------------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of this statement. -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 Electric Automotive Water Corporate Consolidated Services Services Services Investments Charges - ------------------------------------------------------------------------------------------------------------------- For the Quarter Ended - --------------------- June 30, 2000 - ------------- Operating Revenue $327.0 $138.9 $129.7<F1> $31.7 $ 26.8 $(0.1) Operation and Other Expense 233.6 106.2 95.2 18.8 10.2<F2> 3.2 Depreciation and Amortization Expense 21.1 11.6 5.7 3.7 - 0.1 Interest Expense 15.2 5.3 3.8 2.5 - 3.6 ------ ------ ------ ----- ------ ----- Operating Income (Loss) Before ACE 57.1 15.8 25.0 6.7 16.6 (7.0) Income from Disposition of ACE 48.0 - - - 48.0 - ------ ------ ------ ----- ------ ----- Operating Income (Loss) 105.1 15.8 25.0 6.7 64.6 (7.0) Distribution on Redeemable Preferred Securities of Subsidiary 1.5 0.5 - - - 1.0 Income Tax Expense (Benefit) 39.4 6.0 10.3 2.6 24.0 (3.5) ------ ------ ------ ----- ------ ----- Net Income (Loss) $ 64.2 $ 9.3 $ 14.7 $ 4.1 $ 40.6 $(4.5) ====== ====== ====== ===== ====== ===== - ------------------------------------------------------------------------------------------------------------------- For the Quarter Ended - --------------------- June 30, 1999 - ------------- Operating Revenue $279.2 $135.3 $104.0<F1> $29.9 $ 10.0 $ - Operation and Other Expense 203.8 104.1 75.9 17.8 3.5<F2> 2.5 Depreciation and Amortization Expense 19.4 11.4 4.4 3.4 0.1 0.1 Interest Expense 14.4 5.3 2.5 2.5 - 4.1 ------ ------ ------ ----- ------ ----- Operating Income (Loss) Before Capital Re 41.6 14.5 21.2 6.2 6.4 (6.7) Loss from Investment in Capital Re (13.4) - - - (13.4) - ------ ------ ------ ----- ------ ----- Operating Income (Loss) 28.2 14.5 21.2 6.2 (7.0) (6.7) Distribution on Redeemable Preferred Securities of Subsidiary 1.5 0.5 - - - 1.0 Income Tax Expense (Benefit) 24.8 5.4 9.2 2.4 10.7 (2.9) ------ ------ ------ ----- ------ ----- Net Income (Loss) $ 1.9 $ 8.6 $ 12.0 $ 3.8 $(17.7) $(4.8) ====== ====== ====== ===== ====== ===== - ------------------------------------------------------------------------------------------------------------------- <FN> <F1> Included $26.2 million of Canadian operating revenue in 2000 ($13.4 million in 1999). <F2> Included $0.2 million of minority interest in 2000 ($0.1 million in 1999). </FN> -4- NOTE 1. BUSINESS SEGMENTS Millions Electric Automotive Water Corporate Consolidated Services Services Services Investments Charges - ------------------------------------------------------------------------------------------------------------------- For the Six Months Ended - ------------------------ June 30, 2000 - ------------- Operating Revenue $ 649.6 $ 280.5 $ 249.2<F1> $ 59.7 $ 60.4 $ (0.2) Operation and Other Expense 467.6 213.2 185.2 36.5 25.2<F3> 7.5 Depreciation and Amortization Expense 41.4 23.1 10.5 7.5 0.1 0.2 Interest Expense 31.5 10.5 7.7 5.1 - 8.2 -------- -------- -------- ------ ------ ------ Operating Income (Loss) Before ACE 109.1 33.7 45.8 10.6 35.1 (16.1) Income from Disposition of ACE 48.0 - - - 48.0 - -------- -------- -------- ------ ------ ------ Operating Income (Loss) 157.1 33.7 45.8 10.6 83.1 (16.1) Distribution on Redeemable Preferred Securities of Subsidiary 3.0 0.9 - - - 2.1 Income Tax Expense (Benefit) 59.5 12.8 19.2 4.1 31.0 (7.6) -------- -------- -------- ------ ------ ------ Net Income (Loss) $ 94.6 $ 20.0 $ 26.6 $ 6.5 $ 52.1 $(10.6) ======== ======== ======== ====== ====== ====== Total Assets $2,560.2 $ 889.4 $1,073.8<F2> $324.4 $272.1 $ 0.5 Property, Plant and Equipment $1,311.5 $ 769.4 $ 279.5 $262.6 - - Accumulated Depreciation and Amortization $1,018.0 $ 650.7 $ 162.5 $202.8 $ 2.0 - Capital Expenditures $ 56.5 $ 20.4 $ 24.5 $ 11.6 - - - ------------------------------------------------------------------------------------------------------------------- For the Six Months Ended - ------------------------ June 30, 1999 - ------------- Operating Revenue $ 536.9 $ 267.5 $ 200.8<F1> $ 54.3 $ 14.4 $ (0.1) Operation and Other Expense 397.0 201.9 148.8 33.5 7.6<F3> 5.2 Depreciation and Amortization Expense 37.8 22.3 8.6 6.6 0.1 0.2 Interest Expense 28.6 10.6 4.9 4.9 - 8.2 -------- -------- -------- ------ ------ ------ Operating Income (Loss) Before Capital Re 73.5 32.7 38.5 9.3 6.7 (13.7) Loss from Investment in Capital Re (15.8) - - - (15.8) - -------- -------- -------- ------ ------ ------ Operating Income (Loss) 57.7 32.7 38.5 9.3 (9.1) (13.7) Distribution on Redeemable Preferred Securities of Subsidiary 3.0 0.9 - - - 2.1 Income Tax Expense (Benefit) 31.9 12.2 16.9 3.6 5.7 (6.5) -------- -------- -------- ------ ------ ------ Net Income (Loss) $ 22.8 $ 19.6 $ 21.6 $ 5.7 $(14.8) $ (9.3) ======== ======== ======== ====== ====== ====== Total Assets $2,438.3 $1,018.7 $ 733.0<F2> $322.3 $363.9 $ 0.4 Property, Plant and Equipment $1,220.4 $ 766.7 $ 199.5 $254.2 - - Accumulated Depreciation and Amortization $ 865.7 $ 617.7 $ 49.2 $197.0 $ 1.8 - Capital Expenditures $ 42.7 $ 20.9 $ 12.5 $ 9.3 - - - ------------------------------------------------------------------------------------------------------------------- <FN> <F1> Included $44.3 million of Canadian operating revenue in 2000 ($24.8 million in 1999). <F2> Included $227.9 million of Canadian assets in 2000 ($100.7 million in 1999). <F3> Included $0.4 million of minority interest in 2000 ($0.2 million in 1999). </FN> -5- 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 provision for refund related to the $2.5 million refund order was recorded in the third quarter of 1999. 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 Quarter Ended Six Months Ended June 30, June 30, 2000 1999 2000 1999 - ------------------------------------------------------------------------------------------------------------------- Millions Current Tax Federal $ 43.1 $ 12.5 $ 62.7 $ 22.5 Foreign 0.6 0.5 1.1 0.9 State 5.2 (0.7) 8.5 0.9 ------ ------ ------ ------ 48.9 12.3 72.3 24.3 ------ ------ ------ ------ Deferred Tax Federal (8.3) 13.3 (10.6) 11.7 Foreign (0.2) - (0.3) - State (0.8) (0.5) (1.3) (3.4) ------ ------ ------ ------ (9.3) 12.8 (12.2) 8.3 ------ ------ ------ ------ Deferred Tax Credits (0.2) (0.3) (0.6) (0.7) ------ ------ ------ ------ Total Income Tax Expense $ 39.4 $ 24.8 $ 59.5 $ 31.9 - ------------------------------------------------------------------------------------------------------------------- -6- NOTE 4. TOTAL COMPREHENSIVE INCOME For the quarter ended June 30, 2000 total comprehensive income was $42.7 million ($1.5 million loss for the quarter ended June 30, 1999). For the six months ended June 30, 2000 total comprehensive income was $91.7 million ($20.4 million for the six months ended June 30, 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 June 20, 2000 ADESA acquired all of the outstanding common shares of Auction Finance Group, Inc. (AFG). AFG, which is headquartered in Miami, Florida, owns CAAG Auto Auction Holdings Ltd., a wholesale automotive remarketing company with locations throughout Canada, doing business as Canadian Auction Group. The transaction was accounted for using the purchase method which included an estimated allocation of the purchase price. Final purchase accounting adjustments are not expected to be material. 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. This acquisition added 13 vehicle auction facilities and associated dealer financing business to ADESA's existing locations and established ADESA as the premier automotive services company in Canada. On May 31, 2000 ADESA Canada purchased the remaining 27 percent of Impact Auto. ADESA Canada acquired 20 percent of Impact Auto on October 1, 1995, 27 percent in March 1999 and another 26 percent in January 2000. 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 each purchase. Pro forma financial results have not been presented due to immateriality. Impact Auto is Canada's largest national salvage auction chain with 11 sites in six provinces. Impact Auto provides remarketing services to insurance companies for their "total loss" vehicles. 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. The transactions described in the three preceding paragraphs had a combined purchase price of approximately $175.5 million and resulted in goodwill of $145.9 million, which the Company expects to amortize over a 40-year useful life. The Company funded these transactions with proceeds from the sale of ACE shares and proceeds from the sale of a portion of the Company's securities portfolio. SPRUCE CREEK SOUTH UTILITIES INC. On June 29, 2000 Florida Water purchased the assets of Spruce Creek for $5.5 million, plus a commitment to pay a fee for water connections through June 2005. 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. Spruce Creek serves 3,100 water and 2,500 wastewater customers in three communities in Marion County, Florida. The systems acquired are designed to accommodate 10,000 customers. The Company funded this transaction with internally generated funds. -7- NOTE 6. INVESTMENTS IN CAPITAL RE AND ACE In May 2000 Minnesota Power recorded a $30.4 million, or $0.44 per share, after-tax gain on the sale of the 4.7 million shares of ACE that Minnesota Power received in December 1999 when Capital Re merged with ACE. As a result of the merger, in 1999 Minnesota Power recorded a $36.2 million, or $0.52 per share, after-tax non-cash charge as follows: a $24.1 million, or $0.35 per share, charge in the second quarter following the merger agreement and discontinuance of Minnesota Power's equity accounting for Capital Re and a $12.1 million, or $0.17 per share, charge in the fourth quarter upon completion of the merger. NOTE 7. 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. On June 22, 2000 Minnesota Power refinanced $4.6 million of 6.875% Pollution Control Revenue Refunding Bonds, Series 1991-A with $4.6 million of Adjustable Rate Pollution Control Revenue Refunding Bonds Series 2000 due December 1, 2015. The new bonds had an initial rate of 4.75%. On June 29, 2000 Heater issued an $8 million, 8.24%, note to COBANK, ACB, due June 20, 2025. Proceeds were used to refinance short-term indebtedness incurred for the 1999 acquisition of Mid South and capital improvements in 1999 and 2000. NOTE 8. PREFERRED STOCK In April 2000 the Company redeemed all 100,000 shares of Redeemable Serial Preferred Stock A, $7.125 Series for an aggregate of $10 million. Proceeds from the Company's securities portfolio were used to fund this redemption. NOTE 9. 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 June 30, 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. -8- 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, a 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 For the quarter and six months ended June 30, 2000 the Company reported continued strong performance across all business segments. Significant acquisitions and growth in Automotive Services and the performance of Investments contributed to higher operating results in 2000. Excluding the Capital Re and ACE transactions (see net income discussion for Investments below), net income for the second quarter of 2000 increased 30 percent over the second quarter of 1999 and net income for the six months ended June 30, 2000 increased 37 percent over the same period in 1999. Excluding the Capital Re and ACE transactions, earnings per share were $0.48 for the second quarter of 2000, an increase of 30 percent over the second quarter of 1999 and earnings per share were $0.91 per share for the six months ended June 30, 2000, a 36 percent increase over the same period in 1999. Quarter Ended Year to Date June 30, June 30, 2000 1999 2000 1999 - -------------------------------------------------------------------------------------------------------------------- Millions Operating Revenue Electric Services $138.9 $135.3 $280.5 $267.5 Automotive Services 129.7 104.0 249.2 200.8 Water Services 31.7 29.9 59.7 54.3 Investments 26.8 10.0 60.4 14.4 Corporate Charges (0.1) - (0.2) (0.1) ------ ------ ------ ------ $327.0 $279.2 $649.6 $536.9 Operating Expenses Electric Services $123.1 $120.8 $246.8 $234.8 Automotive Services 104.7 82.8 203.4 162.3 Water Services 25.0 23.7 49.1 45.0 Investments 10.2 3.6 25.3 7.7 Corporate Charges 6.9 6.7 15.9 13.6 ------ ------ ------ ------ $269.9 $237.6 $540.5 $463.4 Net Income Electric Services $ 9.3 $ 8.6 $ 20.0 $ 19.6 Automotive Services 14.7 12.0 26.6 21.6 Water Services 4.1 3.8 6.5 5.7 Investments 10.2<F1> 6.4<F2> 21.7<F1> 9.3<F2> Corporate Charges (4.5) (4.8) (10.6) (9.3) ------ ------ ------ ------ 33.8 26.0 64.2 46.9 Capital Re and ACE Transactions 30.4 (24.1) 30.4 (24.1) ------ ------ ------ ------ $ 64.2 $ 1.9 $ 94.6 $ 22.8 - -------------------------------------------------------------------------------------------------------------------- Basic and Diluted Earnings Per Share of Common Stock Before Capital Re and ACE Transactions $ 0.48 $ 0.37 $ 0.91 $ 0.67 Capital Re and ACE Transactions 0.44 (0.35) 0.44 (0.35) ------ ------ ------ ------ $ 0.92 $ 0.02 $ 1.35 $ 0.32 Average Shares of Common Stock - Millions 69.6 68.2 69.4 68.0 - -------------------------------------------------------------------------------------------------------------------- <FN> <F1> Including the $30.4 million gain associated with the ACE transaction, net income from Investments was $40.6 million for the quarter ended June 30, 2000 and $52.1 million for the six months ended June 30, 2000. (See Note 6.) <F2> Including the $24.1 million non-cash charge associated with the Capital Re transaction, net income from Investments was a $17.7 million loss for the quarter ended June 30, 1999 and a $14.8 million loss for the six months ended June 30, 1999. (See Note 6.) </FN> -9- NET INCOME The following net income discussion summarizes significant events for the six months ended June 30, 2000. ELECTRIC SERVICES reflected stable net income in 2000 with growth in megawatthour sales offset by associated expenses. AUTOMOTIVE SERVICES reported higher net income in 2000 due to increased sales activity at ADESA auctions facilities and increased financing activity at AFC's loan production offices. During 2000 ADESA acquired or opened 16 new vehicle auction facilities, completed the acquisition of 11 salvage auction facilities and announced plans to purchase 9 additional vehicle auction facilities in the third quarter of 2000. WATER SERVICES generated higher net income in 2000 due to increased water consumption as a result of drier weather conditions and customer growth. Net income in 2000 also reflected higher rates approved by the FPSC in 1999. 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. In May 2000 Minnesota Power recorded a $30.4 million, or $0.44 per share, after-tax gain on the sale of the 4.7 million shares of ACE that Minnesota Power received in December 1999 when Capital Re merged with ACE. As a result of the merger, in 1999 Minnesota Power recorded a $36.2 million, or $0.52 per share, after-tax non-cash charge as follows: a $24.1 million, or $0.35 per share, charge in the second quarter following the merger agreement and discontinuance of Minnesota Power's equity accounting for Capital Re and a $12.1 million, or $0.17 per share, charge in the fourth quarter upon completion of the merger. COMPARISON OF THE QUARTERS ENDED JUNE 30, 2000 AND 1999 OPERATING REVENUE ELECTRIC SERVICES operating revenue was up $3.6 million in 2000, even though total megawatthour sales were about the same as in 1999. Megawatthour sales from retail customers were 5 percent higher in 2000 and contributed $3.8 million more to revenue. The increase was primarily due to higher requirements from large industrial customers. Megawatthour sales from wholesale power marketing activities decreased 28 percent in 2000 and contributed $2.3 million less to revenue due to cooler weather in 2000. Non-regulated subsidiaries within Electric Services contributed $1.1 million more to revenue in 2000. Revenue from electric sales to taconite customers accounted for 13 percent of consolidated operating revenue in 2000 (14 percent in 1999). Electric sales to paper and pulp mills accounted for 5 percent of consolidated operating revenue in both 2000 and 1999. Sales to other power suppliers accounted for 6 percent of consolidated operating revenue in 2000 (8 percent in 1999). AUTOMOTIVE SERVICES operating revenue was up $25.7 million in 2000 primarily due to a 14 percent increase in vehicles sold through ADESA auction facilities and a 16 percent increase in the number of vehicles financed at AFC loan production offices. At ADESA auction facilities 307,000 vehicles were sold in 2000 (270,000 in 1999). The increase in vehicles sold was primarily attributable to new auctions acquired or opened in 1999 and 2000. Financial results for 2000 included three months of operations for one auction facility acquired in July of 1999, one auction facility acquired in February 2000 and two auction facilities opened in April 2000. Financial results for 2000 also reflected one month of operations for 11 salvage auctions acquired in May 2000 and a partial month of operations for 13 auction facilities acquired in June 2000. AFC financed approximately 202,000 vehicles in 2000 (175,000 in 1999). AFC had 86 loan production offices at June 30, 2000 (84 at June 30, 1999). WATER SERVICES operating revenue was up $1.8 million in 2000 because of a 10 percent increase in water consumption. Drier weather conditions, customer growth and the inclusion of water systems acquired during 1999 and early 2000 led to the increase in water consumption. In addition, revenue in 2000 was $0.3 million higher due to higher rates approved by the FPSC in 1999. -10- INVESTMENTS operating revenue was up $16.8 million in 2000. Significant sales by the Company's real estate operations were the primary reason for the increase. In 2000 revenue from real estate operations was $15.1 million higher. The increase was primarily attributed to four large sales that contributed $13.1 million to revenue. Revenue from Investments was also higher due to $2.7 million of gains on intermediate-term investments in emerging technologies relating to the electric industry. OPERATING EXPENSES ELECTRIC SERVICES operating expenses were up $2.3 million in 2000 primarily due to increased fuel expense. Fuel expense was $5.8 million higher in 2000 because the Company paid higher prices for coal and generated 422,000, or 36 percent, more megawatthours. Purchased power expense was $3.0 million lower in 2000 because the Company purchased 411,000, or 37 percent, fewer megawatthours. During 1999 one of the Company's generating plants was down for scheduled maintenance which forced the Company to incur higher purchased power expense in 1999 to meet requirements. AUTOMOTIVE SERVICES operating expenses were up $21.9 million in 2000 primarily due to the inclusion of new vehicles auctions facilities acquired or opened in late 1999 and 2000. Increased sales activity at existing auction facilities and financing activity at the automobile dealer floorplan financing business also increased operating expenses in 2000. WATER SERVICES operating expenses were up $1.3 million in 2000 due to the inclusion of water systems acquired in the second quarter of 1999 and early 2000. INVESTMENTS operating expenses were up $6.6 million in 2000 due to the cost of property sold by the Company's real estate operations. INCOME (LOSS) FROM INVESTMENT IN CAPITAL RE AND RELATED DISPOSITION OF ACE Income (loss) from investment in Capital Re and related disposition of ACE reflected a $48 million gain on the disposition of ACE shares in 2000 and a $16.1 million non-cash charge associated with the loss on the Capital Re share exchange at June 30, 1999. INCOME TAX EXPENSE Income tax expense was up $14.6 million in 2000 primarily due to the gain on the disposition of ACE shares and increased operating income. In 1999 income tax expense included the recognition of $15.0 million of deferred taxes related to the Company's investment in Capital Re. COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999 OPERATING REVENUE ELECTRIC SERVICES operating revenue was up $13.0 million in 2000 primarily due to a 5 percent increase in megawatthour sales. More sales from wholesale power marketing activities and higher requirements by large industrial customers led to the increase in megawatthour sales. Megawatthour sales from wholesale power marketing activities increased 6 percent in 2000 and contributed $2.1 million more to revenue, while megawatthour sales to industrial customers increased 5 percent in 2000 and contributed $4.4 million more to revenue. Residential and commercial megawatthour sales were up 2 percent in 2000 and contributed $1.8 million more to revenue. In addition, non-regulated subsidiaries within Electric Services contributed $1.9 million more to revenue in 2000. Revenue from electric sales to taconite customers accounted for 13 percent of consolidated operating revenue in 2000 (15 percent in 1999). Electric sales to paper and pulp mills accounted for 5 percent of consolidated operating revenue in both 2000 and 1999. Sales to other power suppliers accounted for 6 percent of consolidated operating revenue in 2000 (7 percent in 1999). -11- AUTOMOTIVE SERVICES operating revenue was up $48.4 million in 2000 primarily due to a 14 percent increase in vehicles sold through ADESA auction facilities and a 23 percent increase in the number of vehicles financed at AFC loan production offices. At ADESA auction facilities 602,000 vehicles were sold in 2000 (530,000 in 1999). The increase in vehicles sold was primarily attributable to new auctions acquired or opened in 1999 and 2000. Financial results for 2000 included six months of operations for two auction facilities acquired in 1999, five months of operations for one auction facility acquired in February 2000 and three months of operations for two auction facilities opened in April 2000. Financial results for 2000 also reflected one month of operations for 11 salvage auctions acquired in May 2000 and a partial month of operations for 13 auction facilities acquired in June 2000. AFC financed approximately 397,000 vehicles in 2000 (323,000 in 1999). AFC had 86 loan production offices at June 30, 2000 (84 at June 30, 1999). WATER SERVICES operating revenue was up $5.4 million in 2000 because of a 13 percent increase in water consumption. Drier weather conditions, customer growth and the inclusion of water systems acquired during 1999 and early 2000 led to the increase in water consumption. In addition, revenue in 2000 was $0.5 million higher due to higher rates approved by the FPSC in 1999. INVESTMENTS operating revenue was up $46.0 million in 2000. Significant sales by the Company's real estate operations were the primary reason for the increase. In 2000 seven large sales contributed $31.9 million to revenue. Improved returns from the securities portfolio and the $6.3 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 recorded an after-tax return of 6.02 percent in 2000 (3.32 percent in 1999). OPERATING EXPENSES ELECTRIC SERVICES operating expenses were up $12.0 million in 2000 primarily due to increased fuel and purchased power expenses. Fuel expense was $5.8 million higher in 2000 because the Company paid higher prices for coal and generated 418,000, or 15 percent, more megawatthours to support the higher requirements of industrial retail customers. Purchased power expense was $4.2 million higher in 2000 because of increased prices in the wholesale market and more megawatthours bought to meet MPEX's marketing activities in the first quarter of 2000. MPEX is the Company's wholesale power marketing division. AUTOMOTIVE SERVICES operating expenses were up $41.1 million in 2000 primarily due to the inclusion of new vehicles auctions facilities acquired or opened in 1999 and 2000. Increased sales activity at the auction facilities and financing activity at the automobile dealer floorplan financing business also increased operating expenses in 2000. WATER SERVICES operating expenses were up $4.1 million in 2000 due to the inclusion of water systems acquired in the second quarter of 1999 and early 2000. INVESTMENTS operating expenses were up $17.6 million in 2000 due to the cost of property sold by the Company's real estate operations. INCOME (LOSS) FROM INVESTMENT IN CAPITAL RE AND RELATED DISPOSITION OF ACE Income (loss) from investment in Capital Re and related disposition of ACE reflected a $48 million gain on the disposition of ACE shares in 2000 and a $16.1 million non-cash charge associated with the loss on the Capital Re share exchange at June 30, 1999. INCOME TAX EXPENSE Income tax expense was up $27.6 million in 2000 primarily due to the gain on the disposition of the ACE shares and increased operating income. In 1999 income tax expense included the recognition of $15.0 million of deferred taxes related to the Company's investment in Capital Re. -12- 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 Power 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. On May 24, 2000 LTV announced its intention to close permanently its taconite pellet operation in Hoyt Lakes, Minnesota because it is no longer able to provide taconite pellets of competitive quality or cost. The financial impact of the LTV closure on Minnesota Power is minimal because LTV is not a Large Power Customer. LTV plans to close in the summer of 2001. The domestic steel industry continues to face high levels of imported products. Through May 2000, finished steel imports, at 12,599,000 net tons, were 17 percent higher than in the same period in 1999 and remain on pace to exceed 30 million tons this year. In 1999 the United States imported 35,657,000 tons of steel, higher than any year except 1998. Overall steel prices remain somewhat depressed. On a national level, despite the high level of imports, the strong U.S. economy continues to help fuel demand for domestically produced steel. AUTOMOTIVE SERVICES. ADESA is the second largest and the fastest growing vehicle auction business in North America. In May 2000 ADESA purchased the remaining 27 percent ownership in Impact Auto, which added 11 salvage auctions to the Automotive Services segment. The June 2000 acquisition of AFG added 13 Canadian vehicle auction facilities and associated dealer financing business to ADESA and established ADESA as the premier automotive services company in Canada. The ADESA/Manheim transaction, which is scheduled to close in the third quarter of 2000, will add nine vehicle auction facilities to ADESA. These acquisitions are expected to increase the number of vehicles sold by 60 percent in the near term with additional growth potential in the future. ADESA currently owns (or leases) and operates 45 vehicle auction facilities throughout the United States and Canada. Once the Manheim transaction closes and operations begin at the Calgary auction, which is under construction, ADESA will have 55 vehicle auction facilities. By the end of 2000 AFC will exit 17 of the 21 ADT auctions where it now has loan production offices. AFC plans to continue to serve these areas from newly established loan production offices or from other existing offices. AFC does not anticipate that the relocations will have a material financial impact. LIQUIDITY AND CAPITAL RESOURCES CASH FLOW ACTIVITIES. Cash flow from operations during the six months ended June 30, 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. Additional 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 6 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 for services provided. 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 -13- purchasers under an agreement which expires at the end of 2002. At June 30, 2000 AFC had sold $333.1 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 $237 million from this subsidiary at June 30, 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 $79.5 million at June 30, 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 June 30, 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. SALE OF INVESTMENTS. In May 2000 Minnesota Power sold its 4.7 million shares of ACE. Minnesota Power received the ACE shares and $25 million in cash in December 1999 when Capital Re merged with ACE. Prior to the merger, Minnesota Power owned 7.3 million shares, or 20 percent, of Capital Re. The $127 million in proceeds from the sale of ACE shares and proceeds from the sale of a portion of the Company's securities portfolio were used to fund the acquisitions of AFG and Impact Auto. ACQUISITIONS. 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. In May 2000 ADESA Canada purchased the remaining 27 percent of Impact Auto. ADESA Canada acquired 20 percent of Impact Auto on October 1, 1995, 27 percent in March 1999 and another 26 percent in January 2000. Impact is Canada's largest national salvage auction chain with 11 sites in six provinces. Impact Auto provides remarketing services to insurance companies for their "total loss" vehicles. In June 2000 ADESA acquired all of the outstanding common shares of AFG. AFG, which is headquartered in Miami, Florida, owns CAAG Auto Auction Holdings Ltd., a wholesale automotive remarketing company with locations throughout Canada, doing business as Canadian Auction Group. The acquisition of AFG added 13 vehicle auction facilities and associated dealer financing business to ADESA's existing locations and established ADESA as the premier automotive services company in Canada. The transactions described in the three preceding paragraphs had a combined purchase price of approximately $175.5 million. The Company funded these transactions with proceeds from the sale of ACE shares and proceeds from the sale of a portion of the Company's securities portfolio. In July 2000 ADESA signed a definitive agreement with Manheim to buy eight ADT auctions and one Manheim auction for $251 million. In January 2000 Manheim agreed to purchase 28 ADT auctions. Following FTC review of the Manheim/ADT transaction, Manheim agreed to sell the nine auctions ADESA intends to purchase. The ADESA/Manheim transaction is subject to approval by the FTC and satisfaction of various other customary conditions. Closing is anticipated in the third quarter of 2000. The Company expects to finance the transaction through the issuance of long-term debt. As a result of these transactions, by the end of 2000 AFC will exit 17 of the 21 ADT auctions where it now has loan production offices. AFC plans to continue to serve these areas from newly established loan production offices or from other existing offices. AFC does not anticipate that the relocations will have a material financial impact. In June 2000 Florida Water purchased the assets of Spruce Creek for $5.5 million, plus a commitment to pay fees for water connections through June 2005. Spruce Creek serves 3,100 water and 2,500 wastewater customers in three communities in Marion County, Florida. The systems acquired are designed to accommodate 10,000 customers. The Company funded this transaction with internally generated funds. -14- LONG-TERM DEBT. 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 June 2000 Minnesota Power refinanced $4.6 million of 6.875% Pollution Control Revenue Refunding Bonds, Series 1991-A with $4.6 million of Adjustable Rate Pollution Control Revenue Refunding Bonds Series 2000 due December 1, 2015. The new bonds had an initial rate of 4.75%. In June 2000 Heater issued an $8 million, 8.24%, note to COBANK, ACB, due June 20, 2025. Proceeds were used to refinance short-term indebtedness incurred for the 1999 acquisition of Mid South and capital improvements in 1999 and 2000. On July 21, 2000 the Company filed a registration statement with the SEC pursuant to Rule 415 under the Securities Act of 1933 for an aggregate of $400 million of first mortgage bonds and debt securities. The registration statement has not yet been declared effective by the SEC. Any offer and sale of the first mortgage bonds and debt securities will be made only by means of a prospectus. PREFERRED STOCK. In April 2000 the Company redeemed all 100,000 shares of Redeemable Serial Preferred Stock A, $7.125 Series for an aggregate of $10 million. In July 2000 the Company redeemed all 100,000 shares of Redeemable Serial Preferred Stock A, $6.70 Series for an aggregate of $10 million. Proceeds from the sale of a portion of the Company's securities portfolio were used to fund these redemptions. In July 2000 the Company called all 113,358 outstanding shares of 5% Preferred Stock at $102.50 per share plus accrued and unpaid dividends of $0.75 per share. The redemption date is August 24, 2000. Internally generated funds will be used to fund this redemption. LEASES. 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 six months ended June 30, 2000 totaled $56.5 million ($42.7 million in 1999). Expenditures for 2000 included $20.4 million for Electric Services, $24.5 million for Automotive Services and $11.6 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. -15- 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 securities in a grantor trust established to fund certain employee benefits. In May 2000 Minnesota Power sold its entire investment in ACE. (See Note 6.) June 30, 2000 Fair Value ------------------------------------------------------------------- Millions Trading Securities Portfolio $98.1 Available-For-Sale Securities Portfolio $15.6 ------------------------------------------------------------------- PART II. OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) The Company held its Annual Meeting of Shareholders on May 12, 2000. (b) Not applicable. (c) The election of directors and the appointment of independent accountants were voted on at the Annual Meeting of Shareholders. The results were as follows: Votes Withheld or Broker Directors Votes For Against Abstentions Nonvotes --------- --------- ------- ----------- -------- Kathleen A. Brekken 60,712,617 969,462 - - Merrill K. Cragun 60,781,641 900,438 - - Dennis E. Evans 60,668,305 1,013,774 - - Glenda E. Hood 60,689,798 992,281 - - Peter J. Johnson 60,816,228 865,851 - - George L. Mayer 60,827,600 854,479 - - Jack I. Rajala 60,774,686 907,393 - - Edwin L. Russell 55,351,436 6,330,643 - - Arend J. Sandbulte 58,430,776 3,251,303 - - Nick Smith 60,741,616 940,463 - - Bruce W. Stender 60,832,047 850,032 - - Donald C. Wegmiller 58,440,100 3,241,979 - - Independent Accountants ----------------------- PricewaterhouseCoopers LLP 60,675,157 474,377 532,545 - (d) Not applicable. -16- 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 Ref. 10-Q for the quarter ended March 31, 2000, Page 11. - Third and Fourth Paragraphs The domestic steel industry continues to face high levels of imported products. Through May 2000, finished steel imports, at 12,599,000 net tons, were 17 percent higher than in the same period in 1999 and remain on pace to exceed 30 million tons this year. In 1999 the United States imported 35,657,000 tons of steel, higher than any year except 1998. Overall steel prices remain somewhat depressed. On a national level, despite the high level of imports, the strong U.S. economy continues to help fuel demand for domestically produced steel. Ref. Page 5. - Second Paragraph On May 24, 2000 LTV announced its intention to close permanently its taconite pellet operation in Hoyt Lakes, Minnesota because it is no longer able to provide taconite pellets of competitive quality or cost. The financial impact of the LTV closure on Minnesota Power is minimal because LTV is not a full-requirements customer. LTV plans to close in the summer of 2001. Ref. Page 9. - Fourth Full Paragraph Ref. 10-Q for the quarter ended March 31, 2000, Page 12. - Second Full Paragraph During the second quarter of 2000 Split Rock Energy LLC received the necessary regulatory approvals and began operations in June 2000. Ref. Page 12. - Third Full Paragraph Ref. 10-Q for the quarter ended March 31, 2000, Page 9. - Third Paragraph Ref. 8-K filed June 28, 2000 On July 28, 2000 ADESA signed a definitive agreement with Manheim to buy eight ADT auctions and one Manheim auction for $251 million. In January 2000 Manheim agreed to purchase 28 ADT auctions. Following FTC review of the Manheim/ADT transaction, Manheim agreed to sell the nine auctions ADESA intends to purchase. The ADESA/Manheim transaction is subject to approval by the FTC and satisfaction of various other customary conditions. Closing is anticipated in the third quarter of 2000. The Company expects to finance the transaction through the issuance of long-term debt. As a result of these transactions, by the end of 2000 AFC will exit 17 of the 21 ADT auctions where it now has loan production offices. AFC plans to continue to serve these areas from newly established loan production offices or from other existing offices. AFC does not anticipate that the relocations will have a material financial impact. Ref. Page 14. - Fourth Full Paragraph In June 2000 Florida Water purchased the assets of Spruce Creek for $5.5 million, plus a commitment to pay fees for water connections through June 2005. Spruce Creek serves 3,100 water and 2,500 wastewater customers in three communities in Marion County, Florida. The systems acquired are designed to accommodate 10,000 customers. The Company funded this transaction with internally generated funds. -17- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. 10 (a) Wholesale Power Coordination and Dispatch Operating Agreement, dated April 14, 2000, between Minnesota Power, Inc. and Split Rock Energy LLC. 10 (b) Letter addressed to the Federal Regulatory Commission, dated April 21, 2000, amending the Wholesale Power Coordination and Dispatch Operating Agreement, dated April 14, 2000, between Minnesota Power, Inc. and Split Rock Energy LLC. 27 Financial Data Schedule for the Six Months Ended June 30, 2000. (b) Reports on Form 8-K. Report on Form 8-K filed June 20, 2000 with respect to Item 5. Other Events. Report on Form 8-K filed June 28, 2000 with respect to Item 5. Other Events. Report on Form 8-K filed July 19, 2000 with respect to Item 7. Financial Statements and Exhibits. -18- 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) August 3, 2000 D. G. Gartzke ------------------------------- D. G. Gartzke Senior Vice President - Finance and Chief Financial Officer August 3, 2000 Mark A. Schober ------------------------------- Mark A. Schober Controller -19- EXHIBIT INDEX Exhibit Number 10(a) Wholesale Power Coordination and Dispatch Operating Agreement, dated April 14, 2000, between Minnesota Power, Inc. and Split Rock Energy LLC. 10(b) Letter addressed to the Federal Regulatory Commission, dated April 21, 2000, amending the Wholesale Power Coordination and Dispatch Operating Agreement, dated April 14, 2000, between Minnesota Power, Inc. and Split Rock Energy LLC. 27 Financial Data Schedule for the Six Months Ended June 30, 2000.