Securities and Exchange Commission
Washington, DC 20549
FORM 8-K
Current Report
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) - March 19, 1997
Minnesota Power & Light Company
A Minnesota Corporation
Commission File No. 1-3548
IRS Employer Identification No. 41-0418150
30 West Superior Street
Duluth, Minnesota 55802
Telephone - (218) 722-2641
Minnesota Power & Light Company
Index
Page
Item 7. Financial Statements and Exhibits
Financial Statements
Signatures 2
Management Discussion and Analysis of Financial
Condition and Results of Operations
3
Reports of Independent Accountants 13
Consolidated Balance Sheet -
December 31, 1996 and 1995 14
Consolidated Statement of Income -
For the year ended December 31, 1996, 1995 and 1994 15
Consolidated Statement of Retained Earnings -
For the year ended December 31, 1996, 1995 and 1994 15
Consolidated Statement of Cash Flows -
For the year ended December 31, 1996, 1995 and 1994 16
Notes to Consolidated Financial Statements 17
Exhibits
23 - Consent of Independent Accountants
27 - Financial Data Schedule
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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 & Light Company
--------------------------------
(Registrant)
March 19, 1997 Philip R. Halverson
--------------------------------
Philip R. Halverson
Vice President, Secretary
and General Counsel
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Management's Discussion and Analysis of Financial Condition and Results of
Operations
Minnesota Power has operations in four business segments: (1) electric
operations, which include electric and gas services, and coal mining; (2) water
services, which include water and wastewater services; (3) automotive services,
which include auctions, a finance company and an auto transport company; and (4)
investments, which include a securities portfolio, a 21% equity investment in a
financial guaranty reinsurance company and real estate operations.
Earnings Per Share. Earnings per share of common stock were $2.28 in 1996
compared to $2.16 in 1995 and $2.06 in 1994. An increase in the number of shares
of common stock outstanding in 1996 diluted 1996 earnings by 7 cents per share.
The dilution reduced electric operations earnings per share 4 cents, water
services 1 cent and investments 4 cents, and increased by 2 cents per share the
negative impact on earnings attributable to corporate charges. Return on common
equity was 11.3%, 10.7% and 10.5% for 1996, 1995 and 1994, respectively.
Earnings Per Share 1996 1995 1994
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Continuing Operations
Electric Operations $1.32 $1.36 $1.36
Water Services .18 (.04) .48
Automotive Services .13 .00 -
Investments
Portfolio and reinsurance .80 .88 .47
Real estate operations .50 .58 .36
------ ------ ------
1.30 1.46 .83
Corporate Charges and Other (.65) (.72) (.68)
------ ------ -------
Total Continuing Operations 2.28 2.06 1.99
Discontinued Operations - .10 .07
------ ------ ------
Total Earnings Per Share $2.28 $2.16 $2.06
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Average Shares of Common Stock - 000s 29,309 28,483 28,239
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Electric operations earnings per share in 1996 were down slightly due to a 3%
decrease in sales to the Company's large power customers and the dilutive effect
of the increase in common stock outstanding. The decrease was partially offset
by sales to other customers. The performance of water services in 1996 improved
over 1995 primarily as a result of rate relief and ongoing cost controls at
Florida Water. 1996 earnings from automotive services reflect twelve months of
results while only six months are included in 1995 earnings. 1996 earnings also
reflect growth in AFC's floorplan financing business and an increase in the
number of automobiles auctioned by ADESA. 1996 earnings from automotive services
were tempered in part by start-up losses at two new auction facilities. The
contribution of the Company's investments was lower in 1996 because (i) the
average securities portfolio balance was smaller in 1996 since a portion of the
portfolio was sold in 1995 to fund the purchase of ADESA and (ii) Lehigh
recognized 22 cents per share compared to 52 cents of tax benefits in 1996 and
1995, respectively. Corporate charges in 1995 included a 14 cents per share
write-off of the Company's investment in Reach All.
Electric operations contributed the same amount to earnings per share in 1995
compared to 1994. This reflected lower demand charges from large power customers
which were offset by increased sales. The performance of water services in 1995
compared to 1994 reflected lower water sales in Florida in 1995 due to high
rainfall during the year. The 1994 performance of water services was favorably
impacted by a 42 cent per share gain from the sale of certain water plant
assets. Real estate operations in 1994 reflected 13 cents per share from the
recognition of escrow funds. Portfolio and reinsurance in 1994 included a 21
cent per share write-off of a securities investment. Corporate charges in 1994
included an 11 cent per share loss from the Company's investment in Reach All.
Discontinued operations included results from the paper and pulp business
which was sold in June 1995. The increase in income from discontinued operations
reflected higher paper and pulp prices in 1995.
Consolidated Financial Review
Operating Revenue and Income. Electric operations revenue was higher in 1996
compared to 1995 due to a 14% increase in total kWh sales, setting a new sales
record for the second year in a row. The increase in sales is attributed
primarily to MPEX, the Company's new wholesale marketing division that is
selling energy, capacity and brokering services to other power suppliers.
Extreme winter weather in 1996 compared to the milder winter in 1995 increased
sales to residential and commercial customers and reduced sales to taconite
producers.
Revenue in 1995 was higher than 1994 because of increased kWh sales to
industrial customers, higher commercial and residential rates, and a 37%
increase in kWh sales for resale. One major taconite electric customer of the
Company operated all year in 1995 and only four months in 1994.
Water services revenue and income was higher in 1996 compared to 1995 due to
higher rates, a 9% increase in consumption, gains from the sale of assets, and
the inclusion of $5.3 million of revenue from ISI. Florida Water, formerly
Southern States Utilities, Inc., implemented an interim rate increase effective
Jan. 23, 1996, and final rates effective Sept. 20, 1996, in total an $11.1
million annual increase. Florida Water added 17,000 new water and wastewater
customers as a result of the December 1995 purchase of the assets of Orange
Osceola in Florida. A 2% growth in customers and normal consumption due to the
return of more typical weather in Florida both contributed to higher sales in
1996. Heater, which owns
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and operates the Company's water operations in North Carolina and South
Carolina, made a strategic decision to withdraw from South Carolina, sold the
majority of its assets in that state and recognized $1.7 million in pre-tax
gains during 1996. In April 1996 the Company purchased ISI, a company that
specializes in predictive maintenance of water supply equipment.
Operating revenue in 1995 was lower than 1994 due to 15,000 fewer customers
following the December 1994 sale of the Venice Gardens' assets in Florida. The
sale resulted in a $19.1 million gain in 1994. High rainfall in parts of Florida
and customer water conservation efforts also lowered operating revenue in 1995
and 1994.
Automotive services operating revenue and income is included as of July 1,
1995, the purchase date of ADESA. In addition to including a full year of
operations, operating revenue and income was higher in 1996 because ADESA added
eight new auction sites during the year and sold more than 600,000 cars in 1996
compared to 230,000 cars during the last six months of 1995 (470,000 cars in
total were sold by ADESA in 1995). Ancillary services, such as transportation
and reconditioning, and the expansion of AFC also contributed to revenue growth.
Investments revenue and income was higher in 1996 due to increased real
estate sales in Florida. Lehigh purchased properties at Palm Coast in Florida
and expanded its marketing program nationwide. Also included in investment
income is the contribution of the securities portfolio. Due to a smaller average
portfolio balance resulting from the sale of approximately $60 million of
securities to finance the ADESA purchase, the contribution was lower.
Investments revenue and income in 1996 reflected an after-tax return of 8.8%
compared to 9.2% in 1995 and 3.8% in 1994. The 1994 after-tax return included a
$10.1 million write-off of a securities investment. Operating revenue and income
from real estate operations was lower in 1995 compared to 1994 due to fewer
commercial land sales and Lehigh's maturing accounts receivable portfolio. In
1994 Lehigh recognized in revenue $4.5 million of escrow funds.
Operating Expenses. Fuel and purchased power expenses were higher in 1996
than 1995 because of a 14% increase in kWh sold. Sales for resale were up over
48% due to the marketing efforts initiated by MPEX in 1996. These expenses in
1995 were higher than 1994 because of a 13% increase in kWh sold.
Operations expenses were higher in 1996 reflecting $91 million for a full
year of automotive services' operations compared to $31 million for six months
in 1995. ADESA added eight auctions which contributed to the increase in
operations expense in 1996. Expenses in 1995 were higher than 1994 due to the
inclusion of automotive services, scheduled electric maintenance costs, and
increased expenses related to conservation improvement programs (CIP) and
customer services.
Administrative and general expenses were higher in 1996 reflecting $73
million for a full year of automotive services operations compared to $27
million for six months in 1995. Medical plan expenses for employees and the
amortization of an early retirement program offered to electric utility
employees in 1995 also increased expenses in 1996. Expenses in 1995 were higher
than 1994 due to the addition of automotive services' expenses totaling $27
million and salary and benefit increases company-wide. Salary and benefit
increases were tempered by lower payroll costs associated with the early
retirement program.
Interest expense was higher in 1996 due primarily to a $30 million increase
in outstanding long-term indebtedness related to the addition and expansion of
automotive services. In addition, the average short-term indebtedness balance
was higher by $60 million in 1996.
Income from equity investments of $11.8 million in 1996 was from the
Company's 21% ownership interest in Capital Re compared to $9.8 and $8.1 million
in 1995 and 1994. Income from equity investments in 1995 and 1994 also included
losses from Reach All of $6.4 and $5.2 million, respectively, a business the
Company exited in 1995.
Income tax expense in 1996 and 1995 included the recognition of $8.2 and
$18.4 million, respectively, of tax benefits associated with real estate
operations in Florida. Excluding these tax benefits, the effective tax rate in
1996 and 1995 was 31% compared to 26% in 1994.
Electric Operations
Electric operations generate, transmit, distribute, and market electricity.
Minnesota Power provides electricity to 121,000 customers in northeastern
Minnesota, while the Company's wholly owned subsidiary, Superior Water, Light
and Power Company, sells electricity to 14,000 customers and natural gas to
11,000 customers, and provides water to 10,000 customers, all in northwestern
Wisconsin. Another wholly owned subsidiary, BNI Coal, owns and operates a
lignite coal mine in North Dakota. Two electric generating cooperatives,
Minnkota Power Cooperative, Inc. and Square Butte, consume virtually all of BNI
Coal's production of lignite coal under contracts extending to 2027.
Summary of Changes in Electric Revenue 1996 1995
- --------------------------------------------------------------------------------
(Change from previous
year in millions)
Retail sales (including demand
and energy charges) $(2.7) $17.2
Sales for resale 22.4 11.0
Rate increases - 12.1
Conservation improvement programs - 3.0
Fuel clause adjustments - 2.6
Coal revenue 1.1 1.9
Other 4.9 (2.7)
----- -----
$25.7 $45.1
- --------------------------------------------------------------------------------
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Electric Sales. Kilowatthour sales in 1996 of 13.2 billion exceeded 1995's
record-setting level of 11.5 billion kWh. Minnesota Power formally established
MPEX as a new division in early 1996. MPEX is an expansion of the Company's
inter-utility marketing group which has been a buyer and seller of capacity and
energy for 25 years in the wholesale power market. The customers of MPEX are
other power suppliers in the Midwest and Canada. MPEX contracts to provide
hourly energy scheduling and power trading services. MPEX is credited with most
of the increase in kWh sales.
The two major industries in Minnesota Power's service territory are taconite
production, and paper and wood products manufacturing. Taconite mining customers
accounted for 32% of electric operating revenue in 1996, 35% in 1995 and 34% in
1994. The paper and wood products industries accounted for 11% of electric
operating revenue in 1996, 12% in 1995 and 13% in 1994. Sales for resale
accounted for 13% of electric operating revenue in 1996 compared to 9% in 1995
and 8% in 1994.
Taconite is an important raw material for the steel industry and is made from
low iron content ore mined in northern Minnesota. Taconite processing plants use
large quantities of electric power to grind the ore and concentrate the iron
particles into taconite pellets. Annual taconite production in Minnesota was 46
million tons in 1996 compared to 47 million in 1995 and 43 million tons in 1994.
Minnesota's taconite production in 1997 is expected to be approximately 47
million tons. During 1996 and early 1997 the Company successfully negotiated
extended contracts with several customers including two of the Company's largest
customers, USX and Inland Steel.
While taconite production is expected to continue at annual levels over 40
million tons, the long-term future of this cyclical industry is less certain.
Production may decline gradually some time after the year 2005.
Large Power Customer Contracts. Electric service contracts with 11 large
power industrial customers require payment of minimum monthly demand charges
that cover fixed costs associated with having capacity available to serve them,
including a return on common equity. The demand charge is paid by these
customers even if no electrical energy is taken. An energy charge is also paid
to cover the variable cost of energy actually used. A four-year cancellation
notice is required to terminate the contracts. The rates and corresponding
revenue associated with capacity and energy provided under these contracts are
subject to change through the regulatory process governing all retail electric
rates.
Summary of Minimum Revenue and Demand Under Contract as of February 1, 1997
- --------------------------------------------------------------------------------
Minimum Annual Revenue Monthly Megawatts
1997 $101.6 million 641
1998 $89.2 million 558
1999 $80.3 million 518
2000 $70.1 million 464
2001 $61.9 million 411
- --------------------------------------------------------------------------------
The Company believes revenue from large power customers will be substantially
in excess of the minimum contract amounts.
The 11 large power customers each require 10 MW or more of power and have
contract termination dates ranging from October 1999 to December 2007. Five of
these customers are taconite producers, four are paper and wood products
manufacturers and two are pipeline companies. In addition to the minimum demand
provisions, the contracts with the taconite producers and pipeline companies
require these customers to purchase their entire electric service requirements
from the Company. Six of the large power customers purchase a combined total of
200 MW of interruptible service pursuant to contract amendments incorporating an
interruptible rate schedule. Under this schedule and pursuant to these
amendments, the Company has the right to serve 100 MW of these customers' needs
through Oct. 31, 2008, and another 100 MW of these customers' needs through
April 30, 2010. The Company has the right of first refusal to serve an
additional 200 MW during these same time periods.
Fuel. The cost of coal is the Company's largest single operating expense in
generating electricity. Coal consumption at the Company's generating stations in
1996 was 4.3 million tons. Minnesota Power currently has three coal supply
agreements in place with Montana suppliers. Two terminate in December 1999 and
the other in December 2000. Under these agreements the Company has the tonnage
flexibility to procure between 55% and 100% of its total coal requirements. The
Company uses this flexibility to purchase coal under spot-market agreements when
favorable market conditions exist. The Company continues to explore future
supply options and believes that adequate supplies of low-sulfur, sub-bituminous
coal will continue to be available. The Company has contracts with Burlington
Northern Railroad to deliver coal from Montana and Wyoming to the Company's
generating facilities in Minnesota through December 2003.
Purchased Power Contract. Under an agreement extending through 2007 with
Square Butte, Minnesota Power purchases 71% (about 320 MW during the summer
months and 333 MW during the winter months) of the output of a mine-mouth
generating unit located near
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Center, North Dakota. The Square Butte unit is one of two lignite-fired units at
Minnkota Power Cooperative's Milton R. Young Generating Station.
Square Butte has the option, upon five years advance notice, to reduce the
Company's share of the unit's output to 49%. Minnesota Power has the option,
though not the obligation, to continue to purchase 49% of the output at
market-based prices after 2007 to the end of the plant's economic life.
Minnesota Power must pay any Square Butte costs and expenses that have not been
paid by Square Butte when due, regardless of whether or not the Company receives
any power from that unit.
Early Retirement Plan and Workforce Reduction. In late 1996 the Company
reduced its workforce in electric operations by 4%. In 1995 an early retirement
offer to electric utility employees resulted in a 12% reduction of the electric
operations workforce, at a cost of approximately $15 million which is being
amortized over 3 years. The workforce reductions are part of the Company's
ongoing efforts to control costs and maintain low electric rates.
Competition. The electric utility industry is changing at both the wholesale
and retail levels. The enactment of the Energy Policy Act of 1992 resulted in an
increase in the competitive forces that affect three of the four components of
the electric utility industry: generation, transmission and power marketing. The
fourth component, local distribution, is subject to state regulation. This
legislation has resulted in a more competitive market for electricity generally
and particularly in wholesale markets. Wholesale deregulation is underway, while
retail deregulation of the industry is being considered at both the Federal and
state level, and is affecting the way the Company strategically views the
future. With electric rates among the lowest in the US and with long-term
wholesale and large power retail contracts in place, Minnesota Power believes it
is well positioned to address competitive pressures.
Wholesale. During 1996 the Company completed functional unbundling of
operations under the requirements of FERC's Order No. 888 Open Access
Transmission Rules. Order No. 888 requires public utilities to take transmission
service for their own wholesale transactions under the same terms and conditions
on which transmission service is provided to third parties. The Company has
filed its open access transmission tariff with the FERC, and expects to receive
final FERC rate approval early in 1997. The Company has also filed its "Code of
Conduct" under FERC's Order No. 889 Open Access Same Time Information System and
Standards of Conduct to formalize the functional separation of generation from
transmission within the organization. As a result, the transmission component of
Minnesota Power's electric utility business is well organized for, and has begun
to operate under, these new federal regulatory requirements.
Minnesota Power's newly formed MPEX division currently conducts the power
marketing function. FERC approval of Minnesota Power's market-based rate
authority enabled MPEX to conduct a successful wholesale power and energy
marketing business in 1996. During 1996, MPEX also completed compliance filings
under FERC's Open Access Transmission Rules to separately state the transmission
component of the Company's coordination sales agreements, and is awaiting final
FERC approvals. MPEX continues to review new strategic opportunities for its
wholesale marketing operations in light of the new Open Access Transmission
Rules enacted by FERC and of the new power and energy markets within the
Mid-Continent Area Power Pool.
Retail. In 1995 the MPUC initiated an investigation into structural and
regulatory issues in the electric utility industry. To make certain that
delivery of electric service continues to be efficient following any
restructuring, the MPUC adopted 15 principles to guide a deliberate and orderly
approach to developing reasonable restructuring alternatives that ensure the
fairness of a competitive market and protect the public interest. In January
1996 the MPUC established a competition working group in which company
representatives have participated in addressing issues related to wholesale and
retail competition. Minnesota Power has implemented a key account management
process and anticipates continuing negotiations with its large industrial and
commercial customers to explore contractual options to lower energy costs. These
customers continue to aggressively seek lower energy costs and consider
alternative suppliers in anticipation of deregulated retail markets.
Legislation. In 1997 Congress and the Minnesota legislature are expected to
continue to debate proposed legislation which, if enacted, would promote
customer choice and a more competitive electric market. The Company is actively
participating in the dialogue and debate on these issues in various forums,
principally to advocate fairness and parity for all power and energy competitors
in any deregulated markets that may be created by any new legislation. The
Company cannot predict the timing or substance of any legislation which might
ultimately be enacted. However, the Company continues taking steps to maintain
its competitive position as a low-cost supplier and maintain its long-term
contracts with large industrial customers. The Company is also advocating
property tax reform before the Minnesota legislature in order to eliminate the
taxation of personal property that results in an inequitable tax burden among
current and potential competitors in local markets. Finally, SWL&P is
participating in the electric restructuring
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investigation before the PSCW, which is advising the Wisconsin legislature on
recommended restructuring in Wisconsin.
Conservation. Minnesota requires electric utilities to spend a minimum of
1.5% of annual retail electric revenue on conservation improvement programs
(CIP) each year. An annually approved billing adjustment combined with retail
base rates allow the Company to recover both costs of energy-saving programs and
"lost margins" associated with power saved as a result of such programs.
The Company's largest conservation programs are targeted at taconite and
paper customers to promote their efficient use of energy. CIP also provides
demand-side management grants on a competitive basis to commercial and small
industrial customers, low-cost financing for energy-saving investments, and
promotes energy conservation for all residential and commercial customers. SWL&P
also offers electric and gas conservation programs to qualified customers as
approved by the PSCW.
Clean Air Act. While many utilities and their customers will face high costs
to comply with clean-air legislation, the Company expects to meet future
requirements without major spending. By burning low-sulfur fuels in units
equipped with pollution control equipment, the Company's power plants already
operate at or near the sulfur dioxide emission limits set for the year 2000 by
the Federal Clean Air Act Amendment of 1990. To meet nitrogen oxide emission
limits for 2000, the Company expects to install new burner technology and other
associated equipment at a cost of $6 million.
1996 to 1995 Comparison. Operating revenue from electric operations was
higher in 1996 compared to 1995 due to a 14% increase in total kWh sales. The
increase in sales is attributed primarily to the Company's marketing of energy
to other power suppliers as well as extreme winter weather in 1996 compared to
the milder winter in 1995. Revenue from sales of electricity was up in 1996, but
provided lower margins due to the cooler summer weather in 1996 resulting in
more competitive wholesale pricing. Square Butte, one of Minnesota Power's low
priced sources of energy, produced 23% more energy in 1996, after being down for
scheduled maintenance in 1995. Costs associated with the early retirement
offering in mid-1995 are being amortized over three years. Expenses in 1996
included twelve months of amortization, while 1995 included only five months.
Employee and customer related expenses were higher in 1996. The Company measures
the profitability of its operations through careful budgeting and monitoring of
contributions by segment to corporate earnings per share. Electric operations
contributed $1.32 to earnings per share in 1996 compared to $1.36 in 1995 and
1994. The per share amount in 1996 was slightly lower due to a 3% decrease in
sales to the Company's large power customers and the 4 cent dilutive effect of
the increase in common stock outstanding. The decrease was partially offset by
sales to other customers. The contribution from electric operations is expected
to remain stable in the future as the industry continues to deregulate. Electric
operations will continue to seek additional cost saving alternatives and
efficiencies and expand unregulated services to maintain its contribution to
earnings.
1995 to 1994 Comparison. Like 1996, 1995 was an excellent year for electric
operations. The Company set records for electric sales, revenue and generation.
Operating revenue from electric operations was higher in 1995 compared to 1994,
due to a 13% increase in total kWh sales, increased retail rates and collection
of CIP expenditures. Warm summer weather and increased demand from large
industrial customers and other power suppliers significantly increased sales
over 1994.
Water Services
Water services include Florida Water, Heater and ISI, three wholly owned
subsidiaries of the Company. Florida Water provides water to 120,000 customers
and wastewater treatment services to 54,000 customers in Florida. Heater
provides water to 22,000 customers and wastewater treatment services to 1,000
customers in North Carolina and South Carolina. ISI provides predictive
maintenance services to water utility companies and other industrial operations
in North Carolina, South Carolina, Florida, Georgia, Tennessee, Virginia and
Texas. ISI was acquired in 1996.
Water and Wastewater Rates. 1995 Rate Case. Florida Water requested an $18.1
million rate increase in June 1995. On Oct. 30, 1996, the FPSC issued its final
order in the Florida Water rate case. The final order established water and
wastewater rates for all customers of Florida Water regulated by the FPSC. The
new rates, which became effective on Sept. 20, 1996, resulted in an annualized
increase in revenue of approximately $11.1 million. This increase included, and
was not in addition to, the $7.9 million increase in annualized revenue granted
as interim rates effective on Jan. 23, 1996. The FPSC approved a new rate
structure called "capband," which replaces uniform rates. The new structure
combines the concept of a "cap" on monthly bills at a certain usage level for 85
of Florida Water's facilities that are more expensive to operate, with a
"banding," or grouping, of rates paid by customers served by the 56 less
expensive facilities. On Nov. 1, 1996, Florida Water filed with the Florida
First District Court of Appeals (Court) an appeal of the FPSC's final order
seeking judicial review of issues relating to the amount of investment in
utility
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facilities recoverable in rates from current customers. Motions for
reconsideration of the FPSC's final order were subsequently filed by other
parties to the rate case. Therefore, the Court has postponed Florida Water's
appeal pending the FPSC's disposition of the reconsideration requests. The
Company is unable to predict the outcome of this matter. Florida law provides
that the new rates be implemented while the order is under appeal.
1991 Rate Case Refund Order. Responding to a Florida Supreme Court decision
addressing the issue of retroactive ratemaking with respect to another company,
in March 1996 the FPSC voted to reconsider an October 1995 order (Refund Order)
which would have required Florida Water to refund about $13 million, which
includes interest, to customers who paid more since October 1993 under uniform
rates than they would have paid under stand-alone rates. Under the Refund Order,
the collection of the $13 million from customers who paid less under uniform
rates would not be permitted. The Refund Order was in response to the Florida
First District Court of Appeals reversal in April 1995 of the 1993 FPSC order
which imposed uniform rates for most of Florida Water's service areas in
Florida. With "uniform rates," all customers in the uniform rate areas pay the
same rates for water and wastewater services. Uniform rates are an alternative
to "stand-alone" rates which are based on the cost of serving each service area.
The FPSC reconsidered the Refund Order, but upheld its decision to order refunds
in August 1996. Florida Water filed an appeal of this decision with the First
District Court of Appeals. A decision on the appeal is anticipated by early
1998. The Company continues to believe that it would be improper for the FPSC to
order a refund to one group of customers without permitting recovery of a
similar amount from the remaining customers since the First District Court of
Appeals affirmed the Company's total revenue requirement for operations in
Florida. No provision for refund has been recorded. The Company is unable to
predict the outcome of this matter.
Florida Jurisdictional Issues. In June 1995 the FPSC issued an order assuming
jurisdiction over Florida Water facilities statewide following an investigation
of all of Florida Water's facilities. Several counties in Florida appealed this
FPSC decision to the First District Court of Appeals. In December 1996 the Court
issued an opinion reversing the FPSC order. In December 1996 the FPSC filed a
motion for clarification and for rehearing with the Court. The Court denied this
motion in January 1997. The FPSC voted to require Florida Water to charge rates
to customers in Hernando County based on a modified stand-alone rate structure
in January 1997. The imposition of this rate structure would reduce Florida
Water revenue by $1.6 million on a prospective annual basis. No order has yet
been issued reflecting this vote. Florida Water is considering an appeal of such
an order. In the event county regulation of water and wastewater rates prevails,
the Company anticipates that the regulatory process will become significantly
more complex and expensive.
Competition. Water services provide water and wastewater utility services at
regulated rates within exclusive service territories granted by regulators.
1996 and 1995 Comparison. Operating revenue and income from water services
increased 29% in 1996 compared to 1995. Rate relief and a 9% increase in sales
in 1996 are primarily responsible for the increase. The addition of 17,000
customers following the December 1995 purchase of Orange Osceola offset the
15,000 customer decrease from the sale of Venice Gardens in 1994. Workforce
reductions and ongoing cost controls contributed to 1996 results. The addition
of ISI operations in 1996 increased revenue and expense about 6%. Approximately
$1.7 million in pre-tax gains were added to 1996 results due to the sale of
assets in South Carolina.
Water services contributed 18 cents per share to earnings in 1996, compared
to a 4 cent loss in 1995. The Company anticipates continued growth in earnings
from this segment as Heater aggressively pursues opportunities to expand its
business in North Carolina, additional competitive operations are added to
complement ISI and cost controls combined with efficiency gains are continued in
ongoing operations. The outcome of Florida's rate case and jurisdictional issues
have the potential for affecting the profitability of this segment.
1995 and 1994 Comparison. Operating revenue and income from water services
fell 24% in 1995 compared to 1994. The decrease is attributed to 15,000 fewer
customers following the sale of Venice Gardens' assets in December 1994 and
lower water consumption due to high rainfall in parts of Florida and customer
conservation efforts. The sale of Venice Gardens' assets contributed $19.1
million to water services' operating revenue in 1994.
Automotive Services
Automotive services include ADESA's auction facilities, AFC, which is a
finance company, and an auto transport company. ADESA is a wholly owned
subsidiary of the Company and is the third largest automobile auction business
in the US. Headquartered in Indianapolis, Indiana, ADESA owns and operates 24
automobile auctions in the US and Canada through which used cars and other
vehicles are sold to franchised automobile dealers and licensed used car
dealers. Sellers at ADESA's auctions include domestic and foreign auto
manufacturers, car dealers, fleet/lease companies, banks and finance companies.
AFC provides inventory financing for wholesale and retail automobile dealers who
purchase vehicles from independent auctions as well as auction chains.
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The Company acquired 80% of ADESA on July 1, 1995. On Jan. 31, 1996, the
Company provided additional capital in exchange for an additional 3% of ADESA.
On Aug. 21, 1996, the Company acquired the remaining 17% ownership interest of
ADESA from the ADESA management shareholders.
During 1996 ADESA opened new auto auctions in Newark, New Jersey,
Jacksonville, Florida and Moncton, New Brunswick, Canada. During 1996 in Texas,
the third largest used car market in the US, ADESA acquired auction businesses
in Houston, San Antonio and Dallas, which together with its existing Austin site
are intended to firmly establish ADESA's presence in the Texas market. During
1996 ADESA also acquired auction businesses in Portage, Wisconsin and
Pittsburgh, Pennsylvania. In February 1997 ADESA consolidated a small auction
facility in Concord, Massachusetts with its Boston facilities.
AFC's floorplan financing operations have expanded in 1996. Located at most
ADESA auction locations, AFC has opened loan production offices at seven
independently owned auto auctions. AFC expects to continue this expansion in
1997.
Competition. Within the automobile auction industry, ADESA's competition
includes independently owned auctions as well as major chains and associations
with auctions within its geographic proximity. ADESA competes with other
auctions for dealers, financial institutions, fleet and lease companies, and
other sellers to provide automobiles for auction at consignment sales and for
the supply of rental repurchase vehicles from the automobile manufacturers for
auction at factory sales. The automobile manufacturers often choose between
auctions across multi-state areas in distributing rental repurchase vehicles.
ADESA competes for sellers of automobiles by attempting to attract a large
number of dealers to purchase vehicles, which ensures competitive prices and
supports the volume of vehicles auctioned, and by providing a full range of
services including reconditioning services which prepare automobiles for
auction, transporting automobiles to auction and the prompt handling of the
paperwork necessary to complete the sales. Another factor affecting the
industry, the impact of which is yet to be determined, is the entrance of the
"superstore", large used car dealerships, that have emerged in densely populated
markets.
AFC is well positioned as a provider of floorplan financing services to the
used vehicle industry. AFC's competition includes other specialty lenders, as
well as banks and other financial institutions. AFC competes with other
floorplan providers and strives to distinguish itself based upon ease of use,
quality of service and price. A key component of AFC's program is on-site
personnel to assist automobile dealers with their financing needs.
Auto auction sales for the industry are predicted to rise at a rate of 6% to
8% annually. With the increased popularity of leasing and the high cost of new
cars, the same cars may come to auction more than once. Automotive services
expect to participate in the industry's growth through selective acquisitions
and expanded services.
1996 and 1995 Comparison. Automotive services contributed 13 cents per share
to corporate earnings in 1996 compared to a breakeven performance in 1995.
Severe winter weather on the east coast limited auction sales in January 1996.
However, operating revenue was strong in 1996 as a result of the eight new sites
and increased ancillary services. AFC expanded its dealer financing business in
1996 increasing financing income and earnings. Start-up losses associated with
the new sites in New Jersey and Florida had a negative impact on profitability
of this segment through 1996. For the six months ended Dec. 31, 1995, operating
revenue was $61.6 million with no net income contribution. Financial results in
1995 were adversely impacted by auction cancellations due to severe weather
conditions on the east coast in December 1995, as well as start-up losses
associated with major construction projects. Growth in AFC's financing business
and growth in the number of cars being auctioned combined with improved
efficiencies and significant cost controls at existing auctions are expected to
increase the contributions to earnings in 1997. Financial results for ADESA for
periods prior to July 1, 1995, are not comparable due to several factors
including the amortization of goodwill, the severe weather in December 1995 and
January 1996, and the addition of eight auction facilities which caused ADESA to
incur additional financing expenses and significant start-up costs.
Investments
Investments include a portfolio of securities managed by Minnesota Power
which provides earnings and cash flow contributions and is available for
reinvestment in existing businesses and acquisitions. Investments also include a
21% equity investment in Capital Re, a financial guaranty reinsurance company,
and an 80% interest in Lehigh, a Florida real estate company.
Portfolio and Reinsurance. As of Dec. 31, 1996, the Company had approximately
$155 million invested in a securities portfolio. The majority of the portfolio
consists of stocks of other utility companies that have investment grade debt
securities outstanding and are considered by the Company to be conservative
investments. Additionally,
-9-
the Company sells common stock securities short and enters into short sales of
treasury futures contracts as part of an overall investment portfolio hedge
strategy. The Company plans to continue to concentrate in market neutral
strategies that are designed to provide stable and acceptable returns without
sacrificing needed liquidity. Returns will continue to be partially dependent
upon general market yields.
Capital Re is the parent company of a group of specialty reinsurance
companies. The Company's equity investment in Capital Re continues to be a major
contributor to earnings. In 1996 Capital Re contributed $7.8 million to earnings
compared to $8.2 million in 1995 and $7 million in 1994. The market value of the
Company's $102 million investment in Capital Re was $152 million at Dec. 31,
1996.
1996 and 1995 Comparison. The Company's securities portfolio performed well
in 1996. The securities portfolio and investment in Capital Re contributed 80
cents to earnings per share compared to 88 cents in 1995. Portfolio and
reinsurance earned an after-tax return of 8.8% in 1996 and 9.2% in 1995.
1995 and 1994 Comparison. In 1995 the performance of the securities portfolio
improved significantly over 1994. Earnings per share from the portfolio and
reinsurance were 88 cents per share compared to 47 cents in 1994. The write-off
of a $10.1 million securities investment lowered earnings in 1994. Portfolio and
reinsurance earned an after-tax return of 9.2% in 1995 and 3.8% in 1994.
Real Estate Operations. The Company owns 80% of Lehigh, a real estate company
which owns various real estate properties in Florida. Lehigh currently owns
4,000 acres of land and approximately 8,000 home sites near Fort Myers, Florida,
1,250 home sites in Citrus County, Florida, and 3,000 home sites and 13,000
acres of commercial land at Palm Coast, Florida. The Palm Coast properties and
$18 million receivable portfolio were purchased in April 1996. The real estate
strategy is to acquire large residential community properties at low cost, add
value, and sell them at going market prices.
Tax Benefits. The Company, through Lehigh, a 67% owned subsidiary at the
time, acquired the stock of Lehigh Corporation in a bargain purchase in 1991.
Lehigh then began execution of a business strategy pursuant to which the
majority of the acquired real estate assets would be disposed of over a five
year period. An additional interest in Lehigh was purchased in 1993 bringing the
Company's ownership interest to 80%. The structure of the transactions involved
the acquisition of stock so the tax bases of the underlying acquired assets were
carried over for income tax purposes. The carried-over tax bases exceeded the
book bases assigned in purchase accounting. The Internal Revenue Code (IRC)
limits the use of tax losses resulting from the higher tax basis over the fair
market value of the underlying assets for a period of five years. The 1993
increase in ownership by the Company to 80%, which resulted in the inclusion of
Lehigh and Lehigh Corporation in the Company's consolidated tax return, started
another five year limitation period.
SFAS 109 was adopted on a prospective basis effective Jan. 1, 1993. Upon
adoption, a valuation reserve was established for the entire amount of the tax
benefits attributable to the bases differences and alternative minimum tax
credits because, in management's judgment, realization of the tax benefits was
not "more likely than not." This judgment was based on the unlikelihood of
realizing the tax benefits due to the IRC restrictions, in light of management's
existing five year property disposal plan. This situation continued through
1994.
In 1995 Lehigh implemented a business strategy which called for Lehigh to
dispose of its remaining real estate assets with a specific view towards
maximizing realization of the tax benefits. The new strategy was adopted after
the Board of Directors of Lehigh, including the minority shareholders, were
convinced of the cash flow benefit to Lehigh of deferring the liquidation of the
remaining real estate assets. Accordingly, in 1995 the valuation reserve was
reduced by $18.4 million based on a detailed analysis of the projected future
taxable income based on the new business strategy.
In 1996 the remaining $8.2 million valuation reserve was reversed based on
the projected positive impact the acquisition of $34 million of real estate
assets at Palm Coast would have on Lehigh's taxable income. The Palm Coast
assets were not considered in the 1995 revised strategy.
1996 and 1995 Comparison. Revenue in 1996 includes increased sales from the
Palm Coast properties and $3.7 million from the sale of Lehigh's joint venture
in a resort and golf course. Lehigh also recognized $8.2 and $18.4 million of
tax benefits in 1996 and 1995, respectively. The Company's portion of the tax
benefits reflected as net income was $6.6 million in 1996 and $14.7 million in
1995. Real estate operations added 50 cents to earnings per share in 1996
compared to 58 cents in 1995, of which tax benefits were 22 cents and 52 cents
in 1996 and 1995, respectively.
1995 and 1994 Comparison. Income from real estate operations was higher in
1995 than 1994 primarily due to the recognition of $18.4 million of tax
benefits. This tax benefit was partially offset by fewer commercial land sales
and less interest income from Lehigh's maturing accounts receivable portfolio.
-10-
Liquidity and Capital Resources
As detailed in the consolidated statement of cash flows, cash flows from
operating activities were affected by a number of factors representative of
normal operations. Automotive services are included since the July 1, 1995,
acquisition of ADESA.
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 5.4 million original issue shares of common stock
are available for issuance through the DRIP. Minnesota Power's $77 million bank
lines of credit provide liquidity for the Company's commercial paper program.
The amount and timing of future sales of the Company's securities will depend
upon market conditions and the specific needs of the Company. The Company may
from time to time sell securities to meet capital requirements, to provide for
the retirement or early redemption of issues of long-term debt and/or preferred
stock, to reduce short-term debt and for other corporate purposes.
A substantial amount of ADESA's working capital is generated internally from
payments made by vehicle purchasers. However, ADESA utilizes borrowings from 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 offers short-term on-site financing for dealers to purchase
automobiles at auctions in exchange for a security interest in those
automobiles. The financing is provided through the earlier of the date the
dealer sells the automobile or a general borrowing term of 30 - 60 days. As a
result, AFC also uses borrowings from the Company to meet its operational
requirements. During 1996 AFC increased the financing program for dealers and in
December sold a $50 million participation in its finance receivables to a third
party purchaser. Under the terms of the five year agreement, the purchaser
agrees to make reinvestments up to $100 million to the extent that such
reinvestments are supported by eligible receivables. On Dec. 31, 1996, AFC
received $50 million from the sale of receivables and used the proceeds to repay
borrowings from the Company.
In January 1996 Florida Water issued $35.1 million of 6.5% Industrial
Development Refunding Revenue Bonds Series 1996 due Oct. 1, 2025. The proceeds
were used to refund existing industrial development revenue bonds totaling $33.8
million. Also in January 1996 the Company provided additional capital to ADESA
in exchange for an additional 3% of ADESA. In August 1996 the Company acquired
the remaining 17% ownership interest of ADESA from the ADESA management
shareholders. Funds from the issuance of commercial paper were used to acquire
the remaining 17% of ADESA.
MP&L Capital I (Trust) was established as a wholly owned business trust of
the Company for the purpose of issuing common and preferred securities. In March
1996 the Trust publicly issued three million 8.05% Cumulative Quarterly Income
Preferred Securities (QUIPS), representing preferred beneficial interests in the
assets held by the Trust, indirectly resulting in net proceeds to the Company of
$72.3 million. The net proceeds to the Company were used to retire approximately
$56 million of commercial paper and approximately $17 million were used to
redeem all of the outstanding shares of the Company's Serial Preferred Stock,
$7.36 Series, in May 1996.
In May 1996 ADESA issued $90 million of 7.70% Senior Notes, Series A, Due
2006 in a Rule 144A offering. Proceeds were used by ADESA to repay existing
indebtedness, including borrowings under ADESA's revolving bank credit
agreement, floating rate option notes and certain borrowings from Minnesota
Power.
In June 1996 Lehigh obtained a $20 million adjustable rate revolving line of
credit due in 2003. The proceeds were used to partially finance the acquisition
of real estate near Palm Coast, Florida. In June 1996 the Company's registration
with the Securities and Exchange Commission became effective with respect to 5
million additional shares of common stock for offer and sale pursuant to the
DRIP. Previously available to registered holders and electric utility customers,
the DRIP has been amended, effective July 2, 1996, to, among other things, allow
any interested investor to enroll in the plan with an initial investment of
$250.
In September 1996 Minnesota Power exchanged 473,006 shares of common stock
for all the outstanding shares of common stock of Alamo Auto Auction, Inc. and
Alamo Auto Auction Houston, Inc. The common stock was issued by the Company and
delivered to the sellers in a private placement transaction that has been
accounted for as a pooling of interests.
In January 1997 the Company filed a shelf registration to issue up to $80
million in principal amount of Minnesota Power First Mortgage Bonds. On Feb. 20,
1997, the Company sold $60 million of First Mortgage Bonds, 7% Series due Feb.
15, 2007, for net proceeds to the Company of $59.4 million. The net proceeds
along with internally generated funds were used for the retirement of $60
million in principal amount of the Company's First Mortgage Bonds, 7 3/8% Series
due March 1, 1997.
-11-
Minnesota Power's electric utility first mortgage bonds and secured pollution
control bonds are currently rated the following investment grades: Baa1 by
Moody's Investor Services and BBB+ by Standard and Poor's. The disclosure of
these security ratings is not a recommendation to buy, sell or hold the
Company's securities.
In 1996 the Company paid out 90% of its per-share earnings in dividends. Over
the longer term, Minnesota Power's goal is to reduce dividend payout to 75% to
80% of earnings. This is expected to be accomplished by increasing earnings
rather than reducing dividends.
Capital Requirements. Consolidated capital expenditures in 1996 totaled $101
million. These expenditures included $38 million for electric operations, $22
million for water services and $41 million for automobile auction site
relocation and development. Internally generated funds and long-term bank
financing were used to fund these capital expenditures.
Capital expenditures are expected to be $61 million in 1997 and total about
$260 million for 1998 through 2001. The 1997 amount includes $33 million for
electric system component replacement and upgrades, $21 million to meet
environmental standards, expand water and wastewater treatment facilities to
accommodate customer growth, and for water conservation initiatives, and $7
million for on-going improvements at existing automobile auction sites. The
Company expects to use internally generated funds and original issue equity
securities to fund these capital expenditures.
New Accounting Standard. In June 1996 the FASB issued SFAS 125, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," effective for fiscal years beginning after Dec. 31, 1996. SFAS 125
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities. The standards are based on
consistent application of a financial components approach that focuses on
control. The adoption of SFAS 125 is expected to be immaterial to the Company's
financial position and results of operations.
Safe Harbor Statement. 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 Annual Report, 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", "estimates", "expects", "intends", "plans", "predicts",
"projects", "will likely result", "will continue", and 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:
(i) prevailing governmental policies and regulatory actions, including those of
the FERC, the MPUC, the FPSC, the NCUC, the SCPSC 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 present or prospective wholesale and retail
competition (including but not limited to retail wheeling and transmission
costs); (ii) economic and geographic factors including political and economic
risks; (iii) changes in and compliance with environmental and safety laws and
policies; (iv) weather conditions; (v) population growth rates and demographic
patterns; (vi) competition for retail and wholesale customers; (vii) pricing and
transportation of commodities; (viii) market demand, including structural market
changes; (ix) changes in tax rates or policies or in rates of inflation; (x)
changes in project costs; (xi) unanticipated changes in operating expenses and
capital expenditures; (xii) capital market conditions; (xiii) competition for
new energy development opportunities; and (xiv) 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 each
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.
-12-
Reports
Independent Accountants [LOGO]
To the Shareholders and Board of Directors of Minnesota Power
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, of retained earnings and of cash flows
present fairly, in all material respects, the financial position of Minnesota
Power and its subsidiaries at December 31, 1996 and 1995, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
Price Waterhouse LLP
Price Waterhouse LLP
Minneapolis, Minnesota
January 27, 1997
Management
The consolidated financial statements and other financial information were
prepared by management, which is responsible for their integrity and
objectivity. The financial statements have been prepared in conformity with
generally accepted accounting principles and necessarily include some amounts
that are based on informed judgments and best estimates and assumptions of
management.
To meet its responsibilities with respect to financial information,
management maintains and enforces a system of internal accounting controls
designed to provide assurance, on a cost effective basis, that transactions are
carried out in accordance with management's authorizations and that assets are
safeguarded against loss from unauthorized use or disposition. The system
includes an organizational structure which provides an appropriate segregation
of responsibilities, careful selection and training of personnel, written
policies and procedures, and periodic reviews by the internal audit department.
In addition, the Company has a personnel policy which requires all employees to
maintain a high standard of ethical conduct. Management believes the system is
effective and provides reasonable assurance that all transactions are properly
recorded and have been executed in accordance with management's authorization.
Management modifies and improves its system of internal accounting controls in
response to changes in business conditions. The Company's internal audit staff
is charged with the responsibility for determining compliance with Company
procedures.
Three directors of the Company, not members of management, serve as the Audit
Committee. The Board of Directors, through its Audit Committee, oversees
management's responsibilities for financial reporting. The Audit Committee meets
regularly with management, the internal auditors and the independent accountants
to discuss auditing and financial matters and to assure that each is carrying
out its responsibilities. The internal auditors and the independent accountants
have full and free access to the Audit Committee without management present.
Price Waterhouse LLP, independent accountants, are engaged to express an
opinion on the financial statements. Their audit is conducted in accordance with
generally accepted auditing standards and includes a review of internal controls
and tests transactions to the extent necessary to allow them to report on the
fairness of the operating results and financial condition of the Company.
Edwin L. Russell
Edwin L. Russell
Chairman, President and Chief Executive Officer
David G. Gartzke
David G. Gartzke
Chief Financial Officer
-13-
Consolidated Financial Statements
Minnesota Power Consolidated Balance Sheet
December 31 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
In thousands
Plant and Other Assets
Electric operations $ 796,055 $ 800,477
Water services 323,869 323,182
Automotive services 167,274 123,632
Investments 236,509 201,360
---------- ----------
Total plant and other assets 1,523,707 1,448,651
---------- ----------
Current Assets
Cash and cash equivalents 40,095 31,577
Trading securities 86,819 40,007
Trade accounts receivable (less reserve of $6,568 and $3,325) 144,060 128,072
Notes and other accounts receivable 20,719 12,220
Fuel, material and supplies 23,221 26,383
Prepayments and other 17,195 13,706
---------- ----------
Total current assets 332,109 251,965
---------- ----------
Deferred Charges
Regulatory 83,496 88,631
Other 27,086 25,037
---------- ----------
Total deferred charges 110,582 113,668
---------- ----------
Intangible Assets
Goodwill 166,986 120,245
Other 12,665 13,096
---------- ----------
Total intangible assets 179,651 133,341
---------- ----------
Total Assets $2,146,049 $1,947,625
- ---------------------------------------------------------------------------------------------------------------------------
Capitalization and Liabilities
Capitalization
Common stock, without par value, 65,000,000 shares authorized;
32,758,310 and 31,467,650 shares outstanding $ 394,187 $ 377,684
Unearned ESOP shares (69,124) (72,882)
Net unrealized gain on securities investments 2,752 3,206
Cumulative translation adjustment 73 (177)
Retained earnings 282,960 276,241
---------- ----------
Total common stock equity 610,848 584,072
Cumulative preferred stock 11,492 28,547
Redeemable serial preferred stock 20,000 20,000
Company obligated mandatorily redeemable preferred securities
of subsidiary MP&L Capital I which holds solely Company
Junior Subordinated Debentures 75,000 -
Long-term debt 694,423 639,548
---------- ----------
Total capitalization 1,411,763 1,272,167
---------- ----------
Current Liabilities
Accounts payable 72,787 68,083
Accrued taxes 48,813 40,999
Accrued interest and dividends 14,851 14,471
Notes payable 155,726 96,218
Long-term debt due within one year 7,208 9,743
Other 37,598 27,292
---------- ----------
Total current liabilities 336,983 256,806
---------- ----------
Deferred Credits
Accumulated deferred income taxes 148,931 164,737
Contributions in aid of construction 98,378 98,167
Regulatory 64,394 57,950
Other 85,600 97,798
---------- ----------
Total deferred credits 397,303 418,652
---------- ----------
Commitments and Contingencies
---------- ----------
Total Capitalization and Liabilities $2,146,049 $1,947,625
- ---------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
-14-
Minnesota Power Consolidated Statement of Income
For the Year Ended December 31 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
In thousands except per share amounts
Operating Revenue and Income
Electric operations $529,190 $503,457 $458,356
Water services 85,230 66,154 87,465
Automotive services 183,941 61,560 -
Investments 48,567 41,746 36,348
-------- -------- --------
Total operating revenue and income 846,928 672,917 582,169
-------- -------- --------
Operating Expenses
Fuel and purchased power 190,928 176,960 157,687
Operations 354,210 286,204 232,280
Administrative and general 157,896 102,896 68,302
Interest expense 62,115 48,041 46,750
-------- -------- --------
Total operating expenses 765,149 614,101 505,019
-------- -------- --------
Income from Equity Investments 11,810 4,196 2,972
-------- -------- --------
Operating Income from Continuing Operations 93,589 63,012 80,122
Distributions on Redeemable
Preferred Securities of Subsidiary 4,729 - -
Income Tax Expense 19,639 1,155 20,657
-------- -------- --------
Income from Continuing Operations 69,221 61,857 59,465
Income from Discontinued Operations - 2,848 1,868
-------- -------- --------
Net Income 69,221 64,705 61,333
Dividends on Preferred Stock 2,408 3,200 3,200
-------- -------- --------
Earnings Available for Common Stock $ 66,813 $ 61,505 $ 58,133
-------- -------- --------
Average Shares of Common Stock 29,309 28,483 28,239
Earnings Per Share of Common Stock
Continuing operations $2.28 $2.06 $1.99
Discontinued operations - .10 .07
-------- -------- --------
Total $2.28 $2.16 $2.06
-------- -------- --------
Dividends Per Share of Common Stock $2.04 $2.04 $2.02
- ---------------------------------------------------------------------------------------------------------------------------
Consolidated Statement of Retained Earnings
For the Year Ended December 31 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
In thousands
Balance at Beginning of Year $276,241 $272,646 $271,177
Net income 69,221 64,705 61,333
Redemption of preferred stock (513) - -
-------- -------- --------
Total 344,949 337,351 332,510
-------- -------- --------
Dividends Declared
Preferred stock 2,408 3,200 3,200
Common stock 59,581 57,910 56,664
-------- -------- --------
Total 61,989 61,110 59,864
-------- -------- --------
Balance at End of Year $282,960 $276,241 $272,646
- ---------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
-15-
Minnesota Power Consolidated Statement of Cash Flows
For the Year Ended December 31 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
In thousands
Operating Activities
Net income $ 69,221 $ 64,705 $ 61,333
Income from equity investments --
net of dividends received (10,993) (10,751) (4,201)
Depreciation and amortization 65,092 59,554 50,236
Deferred income taxes (9,770) (26,082) 6,201
Deferred investment tax credits (1,986) (865) (2,478)
Pre-tax (gain) loss on sale of plant (1,632) 1,786 (19,147)
Changes in operating assets and liabilities
net of the effects of discontinued operations
and subsidiary acquisitions
Trading securities (46,812) 34,039 24,198
Notes and accounts receivable (17,502) (12,989) (14,061)
Fuel, material and supplies 3,221 (3,164) (5,641)
Accounts payable (2,854) (9,794) 1,112
Other current assets and liabilities 14,871 15,890 4,935
Other -- net 16,170 874 9,777
-------- -------- --------
Cash from operating activities 77,026 113,203 112,264
-------- -------- --------
Investing Activities
Proceeds from sale of investments in securities 43,129 103,189 59,339
Proceeds from sale of discontinued operations --
net of cash sold - 107,606 -
Proceeds from sale of plant 8,837 - 37,361
Additions to investments (76,680) (50,343) (90,073)
Additions to plant (94,147) (117,749) (80,161)
Acquisition of subsidiaries -- net of cash acquired (66,902) (129,531) -
Changes to other assets -- net (971) (1,019) (14,045)
-------- -------- --------
Cash for investing activities (186,734) (87,847) (87,579)
-------- -------- --------
Financing Activities
Issuance of long-term debt 205,537 28,070 21,982
Issuance of Company obligated mandatorily redeemable
preferred securities of subsidiary MP&L Capital I -- net 72,270 - -
Issuance of common stock 18,973 6,438 1,033
Changes in notes payable -- net 56,281 16,726 33,623
Reductions of long-term debt (155,278) (10,904) (26,132)
Redemption of preferred stock (17,568) - -
Dividends on preferred and common stock (61,989) (61,110) (59,864)
-------- -------- --------
Cash from (for) financing activities 118,226 (20,780) (29,358)
-------- -------- --------
Change in Cash and Cash Equivalents 8,518 4,576 (4,673)
Cash and Cash Equivalents at Beginning of Period 31,577 27,001 31,674
-------- -------- --------
Cash and Cash Equivalents at End of Period $ 40,095 $ 31,577 $ 27,001
-------- -------- --------
Supplemental Cash Flow Information
Cash paid during the period for
Interest (net of capitalized) $ 54,434 $ 48,913 $ 48,385
Income taxes $ 25,531 $ 25,018 $ 20,584
- ---------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these statements.
-16-
Notes to Consolidated Financial Statements
1 Business Segments
Thousands
Investments
----------------------- Corporate
Electric Water Automotive Portfolio & Real Charges
For the Year Ended December 31 Consolidated Operations Services Services Reinsurance Estate & Other
- --------------------------------------------------------------------------------------------------------------------------------
1996
Operating revenue and income $ 846,928 $529,190 $ 85,230 $183,941 $ 20,674 $29,166 $ (1,273)
Operation and other expense 637,942 400,868 53,571 152,840 2,738 17,056 10,869
Depreciation and amortization
expense 65,092 42,184 10,979 11,753 - 176 -
Interest expense 62,115 22,501 12,534 11,667 2 1,180 14,231
Income from equity investments 11,810 - - - 11,810 - -
---------- -------- -------- -------- -------- ------- ---------
Operating income (loss) 93,589 63,637 8,146 7,681 29,744 10,754 (26,373)
Distributions on redeemable
preferred securities
of subsidiary 4,729 1,332 - - - - 3,397
Income tax expense (benefit) 19,639 22,888 2,761 4,029 6,426 (4,038) (12,427)
---------- -------- -------- -------- -------- ------- ---------
Net income $ 69,221 $ 39,417 $ 5,385 $ 3,652 $ 23,318 $14,792 $ (17,343)
---------- -------- -------- -------- -------- ------- ---------
Total assets $2,146,049 $995,801 $346,989 $456,862 $256,356 $88,261 $ 1,780
Accumulated depreciation $ 653,816 $533,554 $113,786 $ 6,476 - - -
Accumulated amortization $ 8,551 - - $ 7,536 - $ 1,015 -
Construction work in progress $ 22,652 $ 3,959 $ 7,114 $ 11,579 - - -
- -------------------------------------------------------------------------------------------------------------------------------
1995
Operating revenue and income $ 672,917 $503,457 $ 66,154 $ 61,560 $ 24,198 19,558 $ (2,010)
Operation and other expense 508,753 373,647 46,021 55,314 3,217 20,242 10,312
Depreciation and amortization
expense 57,307 40,294 12,369 4,367 - 277 -
Interest expense 48,041 22,397 10,110 675 9 26 14,824
Income (loss) from equity
investments 4,196 - - - 9,811 - (5,615)
---------- -------- -------- -------- -------- ------- ---------
Operating income (loss) from
continuing operations 63,012 67,119 (2,346) 1,204 30,783 (987) (32,761)
Income tax expense (benefit) 1,155 26,135 (1,278) 1,242 5,810 (17,435) (13,319)
---------- -------- -------- -------- -------- ------- ---------
Income (loss) from continuing
operations 61,857 $ 40,984 $ (1,068) $ (38) $ 24,973 $16,448 $ (19,442)
-------- -------- -------- -------- ------- ---------
Income from discontinued
operations 2,848
----------
Net income $ 64,705
----------
Total assets $1,947,625 $992,635 $337,693 $355,843 $209,556 $51,416 $ 482
Accumulated depreciation $ 619,343 $508,566 $108,787 $ 1,990 - - -
Accumulated amortization $ 3,036 - - $ 2,311 - $ 725 -
Construction work in progress $ 56,019 $ 5,676 $ 12,024 $ 38,319 - - -
- -------------------------------------------------------------------------------------------------------------------------------
1994
Operating revenue and income $ 582,169 $458,356 $ 87,465 - $ 6,537 $31,653 $ (1,842)
Operation and other expense 412,493 335,196 45,435 - 3,516 20,510 7,836
Depreciation and amortization
expense 45,776 36,963 8,534 - - 276 3
Interest expense 46,750 20,741 11,423 - 5 12 14,569
Income (loss) from equity
investments 2,972 - - - 8,138 - (5,166)
---------- -------- -------- -------- -------- ------- -------
Operating income (loss) from
continuing operations 80,122 65,456 22,073 - 11,154 10,855 (29,416)
Income tax expense (benefit) 20,657 24,839 8,386 - (2,054) 691 (11,205)
---------- -------- -------- -------- -------- ------- ---------
Income (loss) from continuing
operations $ 59,465 $ 40,617 $ 13,687 - $ 13,208 $10,164 $ (18,211)
-------- -------- -------- -------- ------- ---------
Income from discontinued
operations 1,868
----------
Net income $ 61,333
----------
Total assets $1,807,798 $990,040 $313,709 - $289,025 $36,434 $ 3,457
Accumulated depreciation $ 582,075 $492,674 $ 84,715 - $ 5 - -
Accumulated amortization $ 435 - - - - $ 435 -
Construction work in progress $ 27,619 $ 21,865 $ 5,754 - - - -
- -------------------------------------------------------------------------------------------------------------------------------
Purchased July 1, 1995.
Includes $3.7 million of minority interest.
Includes $8.2 million of tax benefits. (See Note 14.)
Includes $4.1 million of minority interest.
Includes a $6.4 million pre-tax provision from exiting the equipment
manufacturing business.
Includes $18.4 million of tax benefits. (See Note 14.)
Includes a $19.1 million pre-tax gain from the sale of
certain water plant assets.
Includes a $10.1 million pre-tax loss from the write-off
of an investment.
Includes $3.6 million of income related to escrow funds.
Includes $2.5 million of minority interest.
Includes $175.1 million related to operations discontinued
in 1995.
Includes $4.7 million related to operations discontinued
in 1995.
-17-
2 Operations and Significant Accounting Policies
Financial Statement Preparation. Minnesota Power prepares its financial
statements in conformity with generally accepted accounting principles. These
principles require management to make informed judgments and best estimates and
assumptions that (1) affect the reported amounts of assets and liabilities, (2)
disclose contingent assets and liabilities at the date of the financial
statements, and (3) report amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
Principles of Consolidation. The consolidated financial statements include
the accounts of the Company and all of its majority owned subsidiary companies.
All material intercompany balances and transactions have been eliminated in
consolidation. Information for prior periods has been reclassified to present
comparable information for all periods.
Nature of Operations and Revenue Recognition. Minnesota Power is a
diversified utility that has operations in four principal business segments.
Electric Operations. Electric service is provided to 135,000 customers in
northern Minnesota and northwestern Wisconsin. Large power customers, which
include Minnesota's taconite producers, paper and wood products manufacturers
and two pipeline companies, purchase under contracts, which extend from October
1999 through December 2007, about half of the electricity the Company sells. BNI
Coal, a wholly owned subsidiary, mines and sells lignite coal to two North
Dakota mine-mouth generating units, one of which is Square Butte. Square Butte
supplies Minnesota Power with 71% of its output under a long-term contract. (See
Note 17.)
Electric rates are under the jurisdiction of various state and federal
regulatory authorities. Billings are rendered on a cycle basis. Revenue is
accrued for service provided but not yet billed. Electric rates include
adjustment clauses which bill or credit customers for fuel and purchased energy
costs above or below the base levels in rate schedules and bill retail customers
for the recovery of CIP expenditures not collected in base rates.
During 1996, 1995 and 1994, revenue derived from one major customer was
$57.1, $60.4 and $60.2 million, respectively. Revenue derived from another major
customer was $41.2, $44.9 and $45.3 million, respectively.
Water Services. Florida Water, formerly Southern States Utilities, Inc., a
wholly owned subsidiary, is the largest investor owned supplier of water and
wastewater utility services in Florida. Heater, another wholly owned subsidiary,
provides water and wastewater services in North Carolina and South Carolina.
ISI, a wholly owned subsidiary, provides predictive maintenance services to
water utility companies and other industrial operations in North Carolina, South
Carolina, Florida, Georgia, Tennessee, Virginia and Texas. In total, 142,000
water and 56,000 wastewater treatment customers are served. Water and wastewater
rates are under the jurisdiction of various state and county regulatory
authorities. Billings are rendered on a cycle basis. Revenue is accrued for
water sold but not billed.
Automotive Services. ADESA, a wholly owned subsidiary, owns and operates 24
automobile auctions in the US and Canada. ADESA acts as an agent in the sales
process, receiving fees from both buyers and sellers of automobiles. During the
sales process, ADESA does not generally take title to vehicles. ADESA also
provides a wide range of related services such as auto reconditioning, title
processing and vehicle transport. Floorplan financing is provided by AFC.
Revenue is recognized when services are performed.
Investments. The Company's securities portfolio provides funds for
reinvestment and business acquisitions. The Company has a 21% ownership in
Capital Re, a financial guaranty reinsurance company, accounted for using the
equity method, and an 80% ownership in Lehigh, a Florida real estate business.
Real estate revenue is recognized on the accrual basis.
Income Taxes. The Company accounts for income taxes under SFAS 109,
"Accounting for Income Taxes." SFAS 109 is an asset and liability approach that
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of temporary differences between the carrying amounts
and the tax bases of other assets and liabilities.
Plant Depreciation. Plant is recorded at original cost. The cost of additions
to plant and replacement of retirement units of property are capitalized.
Maintenance costs and replacements of minor items of property are charged to
expense as incurred. Costs of depreciable units of plant retired are eliminated
from the plant accounts. Such costs plus removal expenses less salvage are
charged to accumulated depreciation for utility plant. Plant stated on the
balance sheet includes construction work in progress and is net of accumulated
depreciation. Various pollution abatement facilities are leased from
municipalities which have issued pollution control revenue bonds to finance the
cost of the facilities. The cost of the facilities and the related debt
obligation, which is guaranteed by the Company, has been recorded as electric
plant and long-term debt, respectively.
Depreciation of utility plant is computed using rates based on estimated
useful lives of the various classes of property. Provisions for depreciation of
the average original cost of depreciable property approximated 3.2% in 1996,
3.3% in 1995 and 3% in 1994. Contributions in aid of construction (CIAC) relate
to water and wastewater plant contributed to the Company by developers and cash
from customers. CIAC is amortized on a straight-line basis over the estimated
life of the asset to which it relates when placed in service. Amortization of
CIAC reduces depreciation expense.
Fuel, Material and Supplies. Fuel, material and supplies are stated at the
lower of cost or market. Cost is determined by the average cost method.
Goodwill. Goodwill represents the excess of cost over net assets of
businesses acquired and is amortized on a straight-line basis over forty years.
The Company continually evaluates whether events or circumstances have occurred
indicating that the remaining estimated useful life of goodwill may not be
appropriate. When factors indicate that goodwill should be evaluated for
possible impairment, the Company uses an estimate of the acquired business'
undiscounted future cash flows compared to the carrying value of goodwill to
determine if a write-off is necessary.
-18-
Deferred Regulatory Charges and Credits. The Company's utility operations are
subject to the provisions of SFAS 71, "Accounting for the Effects of Certain
Types of Regulation." The Company capitalizes as deferred regulatory charges
incurred costs which are probable of recovery in future utility rates. Deferred
regulatory credits represent amounts expected to be credited to customers in
rates. (See Note 4.)
Unamortized Expense, Discount and Premium on Debt. Expense, discount and
premium on debt are deferred and amortized over the lives of the related issues.
Cash and Cash Equivalents. The Company considers all investments purchased
with maturities of three months or less to be cash equivalents.
Foreign Currency Translation. Results of operations for ADESA's foreign
subsidiaries are translated into US dollars using the average exchange rates
during the period. Assets and liabilities are translated into US dollars using
the exchange rate at the balance sheet date, except for intangibles and fixed
assets, which are translated at historical rates. Resulting translation
adjustments are recorded as cumulative translation adjustment under the heading
Capitalization on the Company's consolidated balance sheet.
3 Acquisitions and Divestitures
Acquisition of Palm Coast. In April 1996 Palm Coast Holdings, Inc., a wholly
owned subsidiary of Lehigh Acquisition Corporation, acquired real estate assets
(Palm Coast) from ITT Community Development Corp. and other affiliates of ITT
Industries, Inc. (ITT) for $34 million. These assets include developed
residential lots, a real estate contract receivables portfolio and approximately
13,000 acres of commercial and other land. Palm Coast is a planned community
located between St. Augustine and Daytona Beach, Florida.
ITT's wholly owned subsidiary, Palm Coast Utility Corporation (PCUC), has
granted an option to the Company to acquire PCUC's water and wastewater utility
assets in Palm Coast. PCUC provides services to approximately 12,000 customers
in Flagler County, Florida. If the option is exercised, closing of the
transaction will be subject to various regulatory approvals.
Acquisition of ISI. In April 1996 MP Water Resources acquired all the
outstanding common stock of Instrumentation Services, Inc., a predictive
maintenance service business, in exchange for 96,526 shares of Minnesota Power
common stock. The acquisition was accounted for as a pooling of interest. Prior
period financial results for 1996 have not been restated due to immateriality.
Acquisition of Orange Osceola. In December 1995 Florida Water acquired the
operating assets of Orange Osceola Utilities for approximately $13 million. The
acquisition added over 17,000 water customers.
Sale of Water Plant Assets. In March 1996 Heater of Seabrook, Inc., a wholly
owned subsidiary of Heater, sold all of its water and wastewater utility assets
to the Town of Seabrook Island, South Carolina for $5.9 million. This sale was
negotiated in anticipation of an eminent domain action by the Town of Seabrook
Island, South Carolina. In December 1996 Heater sold its Columbia, South
Carolina area water systems to South Carolina Water and Sewer, L.L.C. Water
services on the Company's consolidated statement of income includes pre-tax
gains of $1.7 million from these sales.
In December 1994 Florida Water sold all of the assets of its Venice Gardens
water and wastewater utilities to Sarasota County in Florida (the County) for
$37.6 million. The sale increased 1994 net income by $11.8 million and
contributed 42 cents to 1994 earnings per share. Water services on the Company's
consolidated statement of income includes a pre-tax gain of $19.1 million from
the sale. This sale was negotiated in anticipation of an eminent domain action
by the County.
Acquisition of ADESA. The Company acquired 80% of ADESA on July 1, 1995, for
$167 million in cash. The Company accounted for the acquisition as a purchase.
Acquired goodwill and other intangible assets associated with this acquisition
are being amortized on a straight line basis over periods not exceeding 40
years. In January 1996 the Company provided an additional $15 million of capital
in exchange for 1,982,346 original issue common stock shares of ADESA. This
capital contribution increased the Company's ownership interest in ADESA to 83%.
In August 1996 the Company acquired the remaining 17% ownership interest of
ADESA from the ADESA management shareholders. Financial results for ADESA have
been included in the Company's consolidated financial statements as of July 1,
1995.
The following summary presents unaudited pro forma consolidated results as if
the Company acquired a 100% ownership interest in ADESA on Jan. 1, 1995. The pro
forma results are not necessarily indicative of what actually would have
occurred if the acquisition had been completed as of the beginning of 1995, nor
are they necessarily indicative of future consolidated results. The pro forma
results should be read in conjunction with the historical consolidated financial
statements and related notes of Minnesota Power.
Summary Pro Forma Financial Information -- Unaudited
Year Ended December 31 1996 1995
- ----------------------------------------------------------------------
In thousands
Operating revenue and income $846,928 $729,674
Income from continuing operations $68,720 $59,800
Net income $68,720 $62,648
Earnings per share of common stock
from continuing operations $2.26 $1.99
Total earnings per share
of common stock $2.26 $2.09
- ----------------------------------------------------------------------
In September 1996 Minnesota Power exchanged 473,006 shares of its common
stock for all the outstanding common stock of Alamo Auto Auction, Inc. and Alamo
Auto Auction Houston, Inc. These acquisitions were accounted for as pooling of
interests. Prior period financial results for 1996 have not been restated due to
immateriality. Three other auction facilities were also acquired in 1996 and
were accounted for using the purchase method. Pro forma consolidated results
reflecting these purchases have not been presented due to immateriality.
-19-
Discontinued Operations. On June 30, 1995, Minnesota Power sold its interest
in the paper and pulp business to Consolidated Papers, Inc. (CPI) for $118
million in cash, plus CPI's assumption of certain debt and lease obligations.
The Company is still committed to a maximum guaranty of $95 million to ensure a
portion of a $33.4 million annual lease obligation for paper mill equipment
under an operating lease extending to 2012. CPI has agreed to indemnify the
Company for any payments the Company may make as a result of the Company's
obligation relating to this operating lease. The financial results of the paper
and pulp business, including the loss on disposition, have been accounted for as
discontinued operations.
Summary of Discontinued Operations
Year Ended December 31 1995 1994
- -----------------------------------------------------------------------
In thousands
Operating revenue and income $44,324 $55,615
Income from equity investments $7,496 $2,327
Income from operations $7,476 $2,677
Income tax expense 3,117 809
------ ------
4,359 1,868
------ ------
Loss on disposal (1,786) -
Income tax benefit 275 -
------
(1,511) -
------ ------
Income from discontinued operations $2,848 $1,868
- -----------------------------------------------------------------------
Exit from Equipment Manufacturing Business. In June 1995 Reach All ceased
operations and sold its operating assets. Pre-tax losses from Reach All were
$6.4 million in 1995 and $5.2 million in 1994.
4 Regulatory Matters
The Company files for periodic rate revisions with the Minnesota Public
Utilities Commission (MPUC), the Federal Energy Regulatory Commission (FERC),
the Florida Public Service Commission (FPSC) and other state and county
regulatory authorities. The MPUC had regulatory authority over approximately 69%
in 1996, 73% in 1995 and 75% in 1994 of the Company's total electric operating
revenue. Interim rates in Minnesota and Florida are placed into effect, subject
to refund with interest, pending a final decision by the appropriate commission.
Electric Rate Proceedings. The Company's most recent Minnesota retail case
was filed Jan. 3, 1994. Interim rates were in effect from March 1, 1994, until
final rates became effective on June 1, 1995. The MPUC approved an 11.6% return
on common equity and an overall increase in annual revenue of $19 million. The
MPUC also approved revenue neutral rate adjustments which increased residential
rates 3.5% on Jan. 1, 1996 and 3.5% on Jan. 1, 1997. The residential increases
were offset by lower large power demand charge rates.
The MPUC also allows the Company to collect the cost of fuel burned (over
what is already included in the base rate) and the expenditures and lost margins
related to conservation improvement programs (CIP). These expenses are being
collected through an adjustment on the customers' bills known as the "resource
adjustment."
Water and Wastewater Rates. 1995 Rate Case. Florida Water requested an $18.1
million rate increase in June 1995. On Oct. 30, 1996, the FPSC issued its final
order in the Florida Water rate case. The final order established water and
wastewater rates for all customers of Florida Water regulated by the FPSC. The
new rates, which became effective on Sept. 20, 1996, resulted in an annualized
increase in revenue of approximately $11.1 million. This increase included, and
was not in addition to, the $7.9 million increase in annualized revenue granted
as interim rates effective on Jan. 23, 1996. The FPSC approved a new rate
structure called "capband," which replaces uniform rates. The new structure
combines the concept of a "cap" on monthly bills at a certain usage level for 85
of Florida Water's facilities that are more expensive to operate, with a
"banding," or grouping, of rates paid by customers served by the 56 less
expensive facilities. On Nov. 1, 1996, Florida Water filed with the Florida
First District Court of Appeals (Court) an appeal of the FPSC's final order
seeking judicial review of issues relating to the amount of investment in
utility facilities recoverable in rates from current customers. Motions for
reconsideration of the FPSC's final order were subsequently filed by other
parties to the rate case. Therefore, the Court has postponed Florida Water's
appeal pending the FPSC's disposition of the reconsideration requests. The
Company is unable to predict the outcome of this matter. Florida law provides
that the new rates be implemented while the order is under appeal.
1991 Rate Case Refund Order. Responding to a Florida Supreme Court decision
addressing the issue of retroactive ratemaking with respect to another company,
in March 1996 the FPSC voted to reconsider an October 1995 order (Refund Order)
which would have required Florida Water to refund about $13 million, which
includes interest, to customers who paid more since October 1993 under uniform
rates than they would have paid under stand-alone rates. Under the Refund Order,
the collection of the $13 million from customers who paid less under uniform
rates would not be permitted. The Refund Order was in response to the Florida
First District Court of Appeals reversal in April 1995 of the 1993 FPSC order
which imposed uniform rates for most of Florida Water's service areas in
Florida. With "uniform rates," all customers in the uniform rate areas pay the
same rates for water and wastewater services. Uniform rates are an alternative
to "stand-alone" rates which are based on the cost of serving each service area.
The FPSC reconsidered the Refund Order, but upheld its decision to order refunds
in August 1996. Florida Water filed an appeal of this decision with the First
District Court of Appeals. A decision on the appeal is anticipated by early
1998. The Company continues to believe that it would be improper for the FPSC to
order a refund to one group of customers without permitting recovery of a
similar amount from the remaining customers since the First District Court of
Appeals affirmed the Company's total revenue requirement for operations in
Florida.
-20-
No provision for refund has been recorded. The Company is unable to
predict the outcome of this matter.
Florida Jurisdictional Issues. In June 1995 the FPSC issued an order assuming
jurisdiction over Florida Water facilities statewide following an investigation
of all of Florida Water's facilities. Several counties in Florida appealed this
FPSC decision to the First District Court of Appeals. In December 1996 the Court
issued an opinion reversing the FPSC order. In December 1996, the FPSC filed a
motion for clarification and for rehearing with the Court. The Court denied this
motion in January 1997. The FPSC voted in January 1997 to require Florida Water
to charge rates to customers in Hernando County based on a modified stand-alone
rate structure. The imposition of this rate structure would reduce Florida Water
revenue by $1.6 million on a prospective annual basis. No order has yet been
issued reflecting this vote. Florida Water is considering an appeal of such an
order. In the event county regulation of water and wastewater rates prevails,
the Company anticipates that the regulatory process will become significantly
more complex and expensive.
Deferred Regulatory Charges and Credits. Based on current rate treatment, the
Company believes all deferred regulatory charges are probable of recovery.
Summary of Deferred Regulatory
Charges and Credits
December 31 1996 1995
- --------------------------------------------------------------------
In thousands
Deferred Charges
Income taxes $22,080 $22,726
Conservation improvement programs 21,301 15,793
Early retirement plan 8,188 14,290
Postretirement benefits 8,123 10,801
Premium on reacquired debt 7,466 8,293
Other 16,338 16,728
------- -------
83,496 88,631
Deferred Credits
Income taxes 64,394 57,950
------- -------
Net deferred regulatory charges
and credits $19,102 $30,681
- --------------------------------------------------------------------
5 Financial Instruments
Securities Investments. The majority of the Company's securities investments
are primarily stocks of other utility companies with investment grade debt
securities outstanding and are considered by the Company to be conservative
investments. The Company also has investments in four limited partnerships that
invest in equity and debt securities.
Investments in equity and debt securities are classified in two categories on
the balance sheet: Trading securities are those bought and held principally for
near-term sale. They are recorded at fair value as part of current assets, with
changes in fair value during the period included in earnings. Available-for-sale
securities, which are held for an indefinite period of time, are recorded at
fair value in investments. Changes in fair value during the period are recorded
net of tax as a separate component of common stock equity. If the fair value of
any available-for-sale securities declines below cost and the decline is
considered other than temporary, the securities are written down to fair value
and the losses charged to earnings. Realized gains and losses are computed on
each specific investment sold.
Summary of Securities
- --------------------------------------------------------------------------------
Gross Unrealized Fair
----------------
Cost Gain (Loss) Value
- --------------------------------------------------------------------------------
In thousands
December 31, 1996
Trading $86,819
--------
Available-for-sale
Common stock $ 2,599 $ - $ (551) $ 2,048
Preferred stock 65,363 1,962 (1,557) 65,768
------- ------ -------- -------
$67,962 $1,962 $(2,108) $67,816
- --------------------------------------------------------------------------------
December 31, 1995
Trading $40,007
-------
Available-for-sale
Common stock $ 2,599 $ - $ (451) $ 2,148
Preferred stock 64,506 1,969 (3,090) 63,385
------- ------ -------- -------
$67,105 $1,969 $(3,541) $65,533
- --------------------------------------------------------------------------------
The net unrealized gain on securities investments on the balance sheet at
Dec. 31, 1996 and 1995, also included $2.8 and $4.1 million from the Company's
share of Capital Re's unrealized holding gains and losses.
Year Ended December 31 1996 1995 1994
- ---------------------------------------------------------------
In thousands
Trading securities
Change in net unrealized
holding gains included
in earnings $943 $1,518 $253
Available-for-sale securities
Proceeds from sales $43,129 $97,139 $53,559
Gross realized gains $910 $2,974 $1,194
Gross realized (losses) $(1,362) $(3,313) $(2,902)
- ----------------------------------------------------------------
Off-Balance-Sheet Risks. In portfolio strategies designed to reduce market
risks, the Company sells common stock securities short and enters into short
sales of treasury futures contracts.
Selling common stock securities short is intended to reduce market price
risks associated with holding common stock securities in the Company's trading
securities portfolio. Realized and unrealized gains and losses from short sales
of common stock securities are included in investment income.
Treasury futures are used as a cross hedge to reduce interest rate risks
associated with holding fixed dividend preferred stocks included in the
Company's available-for-sale portfolio. Changes in market values of treasury
futures are recognized as an adjustment to the carrying amount of the underlying
hedged item. Gains and losses on treasury futures are deferred and recognized in
investment income concurrently with gains and losses arising from the underlying
hedged item. Generally, treasury futures contracts entered into have a maturity
date of 90 days.
As a consequence of refunding industrial revenue bonds, in July 1996 Florida
Water entered into a five-year interest rate
-21-
swap agreement to exchange fixed for floating interest rates, which are reset
quarterly, over the life of the swap agreement without the exchange of the
underlying notional amounts totaling $30 million. The interest rate swap is
subject to market risk due to fluctuation of interest rates.
Under the swap agreement, Florida Water is required to make quarterly
interest payments to the counterparty at a variable rate based upon a
weighted average of the PSA Municipal Swap Index (4.11% at Dec. 31, 1996),
while the counterpart is required to make quarterly interest payments to
Florida Water at an annual fixed rate (4.79% at Dec. 31, 1996).
The notional amounts summarized below do not represent amounts exchanged and
are not a measure of the Company's financial exposure. The amounts exchanged
are calculated on the basis of these notional amounts and other terms which
relate to the change in interest rates and securities prices. The Company
continually evaluates the credit standing of counterparties and market
conditions with respect to its off-balance-sheet financial instruments. The
Company does not expect any counterparties to fail to meet their obligations or
any material adverse impact to its financial position from these financial
instruments.
Summary of Off-Balance-Sheet
Financial Instrument
December 31 1996 1995
- --------------------------------------------------------------------------------
In thousands
Short stock sales outstanding $31,662 $16,714
Treasury futures $20,800 $12,700
Interest rate swap $30,000 -
- --------------------------------------------------------------------------------
Fair Value of Financial Instruments. The carrying amount of cash and cash
equivalents, trading securities, notes and other accounts receivable, and notes
payable approximates fair value because of the short maturity of those
instruments. The Company records its trading and available-for-sale securities
at fair value based on quoted market prices. The fair values for all other
financial instruments were based on quoted market prices for the same or similar
issues.
Summary of Fair Values
December 31 1996
- --------------------------------------------------------------------------------
In thousands
Carrying Fair
Amount Value
--------- ---------
Long-term debt $(694,423) $(690,709)
Redeemable serial preferred stock $(20,000) $(21,200)
Quarterly income preferred securities $(75,000) $(73,890)
Short stock sales outstanding (trading) - $31,644
Treasury futures - $23,426
Interest rate swap - $150
Summary of Fair Values
December 31 1995
- --------------------------------------------------------------------------------
In thousands
Carrying Fair
Amount Value
--------- ---------
Long-term debt $(639,548) $(660,277)
Redeemable serial preferred stock $(20,000) $(21,050)
Short stock sales outstanding (trading) - $17,840
Treasury futures - $15,427
- --------------------------------------------------------------------------------
Concentration of Credit Risk. Financial instruments that subject the Company
to concentrations of credit risk consist primarily of trade and other
receivables. The Company sells electricity to about 14 customers in northern
Minnesota's taconite, and paper and wood products industries. At Dec. 31, 1996
and 1995, receivables from these customers totaled $6.9 and $7.6 million. The
Company does not obtain collateral to support utility receivables, but monitors
the credit standing of major customers. The Company has not incurred and does
not expect to incur significant credit losses. At Dec. 31, 1996 and 1995
approximately $23 and $29 million of trade accounts receivable at AFC were due
from automobile dealers. AFC has possession of car titles collateralizing these
amounts.
Sale of Finance Receivables. Effective Dec. 31, 1996, AFC sold a $50 million
participation in its finance receivables to a third party purchaser. Under the
terms of the purchase agreement, the purchaser agrees to make reinvestments of
up to $100 million to the extent that such reinvestments are supported by
eligible receivables. The purchase agreement terminates Dec. 31, 2001.
6 Investment in Capital Re
The Company has an equity investment in Capital Re, a company engaged in
financial guaranty reinsurance. The Company uses the equity method to account
for this investment.
Summary of Capital Re
Financial Information
Year Ended December 31 1996 1995 1994
- --------------------------------------------------------------------------------
In thousands
Investment portfolio $901,102 $771,767 $638,751
Other assets $255,299 $210,118 $171,289
Liabilities $254,951 $180,491 $134,610
Deferred revenue $337,104 $314,451 $274,916
Net revenue $144,945 $107,032 $101,462
Net income $56,524 $45,527 $39,806
- --------------------------------------------------------------------------------
Summary of Minnesota Power's
Ownership in Capital Re
Year Ended December 31 1996 1995 1994
- --------------------------------------------------------------------------------
In thousands
Equity in earnings $11,810 $9,811 $8,138
Accumulated equity in
undistributed earnings $53,685 $42,755 $33,683
Equity investment $102,290 $92,851 $72,054
Fair value of equity
investment $152,265 $100,422 $86,662
Equity ownership 21% 22% 21%
- --------------------------------------------------------------------------------
-22-
7 Common Stock and Retained Earnings
The Articles of Incorporation, mortgage, and preferred stock purchase
agreements contain provisions that, under certain circumstances, would restrict
the payment of common stock dividends. As of Dec. 31, 1996, no retained earnings
were restricted as a result of these provisions.
Summary of Common Stock Shares Equity
- -------------------------------------------------------------------
In thousands
Balance Dec. 31, 1993 31,207 $370,681
1994 ESPP 40 1,033
Other - (536)
------ -------
Balance Dec. 31, 1994 31,247 371,178
1995 ESPP 32 786
DRIP 189 5,653
Other - 67
------ -------
Balance Dec. 31, 1995 31,468 377,684
1996 ESPP 27 718
DRIP 669 18,541
Other 594 (2,756)
------ --------
Balance Dec. 31, 1996 32,758 $394,187
- -------------------------------------------------------------------
Shareholder Rights Plan. On July 24, 1996, the Board of Directors of the
Company adopted a rights plan (Rights Plan) pursuant to which it declared a
dividend distribution of one preferred share purchase right (Right) for each
outstanding share of common stock to shareholders of record at the close of
business on July 24, 1996, (the Record Date) and authorized the issuance of one
Right with respect to each share of common stock that becomes outstanding
between the Record Date and July 23, 2006, or such earlier time as the Rights
are redeemed.
Each Right will be exercisable to purchase one one-hundredth of a share of
Junior Serial Preferred Stock A, without par value, at an exercise price of $90,
subject to adjustment, following a distribution date which shall be the earlier
to occur of (i) 10 days following a public announcement that a person or group
(Acquiring Person) has acquired, or obtained the right to acquire, beneficial
ownership of 15% or more of the outstanding shares of common stock (Stock
Acquisition Date) or (ii) 15 business days (or such later date as may be
determined by the Board of Directors prior to the time that any person becomes
an Acquiring Person) following the commencement of, or a public announcement of
an intention to make, a tender or exchange offer if, upon consummation thereof,
such person would meet the 15% threshold.
Subject to certain exempt transactions, in the event that the 15% threshold
is met, each holder of a Right (other than the Acquiring Person) will thereafter
have the right to receive, upon exercise at the then current exercise price of
the Right, common stock (or, in certain circumstances, cash, property or other
securities of the Company) having a value equal to two times the exercise price
of the Right. If, at any time following the Stock Acquisition Date, the Company
is acquired in a merger or other business combination transaction or 50% or more
of the Company's assets or earning power are sold, each Right will entitle the
holder (other than the Acquiring Person) to receive, upon exercise at the then
current exercise price of the Right, common stock of the acquiring or surviving
company having a value equal to two times the exercise price of the Right.
Certain stock acquisitions will also trigger a provision permitting the Board of
Directors to exchange each Right for one share of common stock.
The Rights are nonvoting and expire on July 23, 2006, unless redeemed by the
Company at a price of $.01 per Right at any time prior to the time a person
becomes an Acquiring Person. The Board of Directors has authorized the
reservation of one million shares of Junior Serial Preferred Stock A for
issuance under the Rights Plan in the event of exercise of the Rights.
8 Preferred Stock
Summary of Cumulative Preferred Stock
December 31 1996 1995
- --------------------------------------------------------------------
In thousands
Preferred stock, $100 par value,
116,000 shares authorized;
5% Series - 113,358 shares
outstanding, callable at
$102.50 per share $11,492 $11,492
Serial preferred stock,
$7.36 Series - 170,000 shares
outstanding - 17,055
------- -------
Total cumulative preferred stock $11,492 $28,547
- ---------------------------------------------------------------------
In May 1996 Minnesota Power redeemed all of the 170,000 outstanding shares of
its Serial Preferred Stock, $7.36 Series. The redemption price was $103.34 per
share plus accrued and unpaid dividends in the amount of $.86 per share.
Summary of Redeemable
Serial Preferred Stock
December 31 1996 1995
- ----------------------------------------------------------------------
In thousands
Serial preferred stock A, without
par value, 2,500,000 shares
authorized;
$6.70 Series - 100,000 shares
outstanding, noncallable,
redeemable in 2000 at
$100 per share $10,000 $10,000
$7.125 Series - 100,000 shares
outstanding, noncallable,
redeemable in 2000 at
$100 per share 10,000 10,000
------- -------
Total redeemable serial preferred stock $20,000 $20,000
- -----------------------------------------------------------------------
-23-
9 Long-Term Debt
Schedule of Long-Term Debt
December 31 1996 1995
- --------------------------------------------------------------------------------
In thousands
Minnesota Power
First mortgage bonds
7 3/8% Series due 1997 $ 60,000 $ 60,000
6 1/2% Series due 1998 18,000 18,000
6 1/4% Series due 2003 25,000 25,000
7 1/2% Series due 2007 35,000 35,000
7 3/4% Series due 2007 55,000 55,000
7% Series due 2008 50,000 50,000
6% Pollution control Series E due 2022 111,000 111,000
Pollution control revenue bonds,
5-6 7/8%, due 1997-2010 33,880 34,655
Leveraged ESOP loan,
9.125%, due 1997-2004 12,175 13,039
Other long-term debt, variable,
due 2001-2013 17,330 17,194
Subsidiary companies
First mortgage bonds,
8.75%, due 2013 45,000 45,000
Senior Notes, Series A,
7.70%, due 2006 90,000 -
Industrial development
revenue bonds, 6.50%, due 2025 33,599 -
Note payable, 10.44%, due 1999 30,000 30,000
Notes payable, variable - 57,926
Other long-term debt,
6.1-8 7/8%, due 1997-2026 85,647 97,477
Less due within one year (7,208) (9,743)
-------- --------
Total long-term debt $694,423 $639,548
- --------------------------------------------------------------------------------
Aggregate amounts of long-term debt maturing during each of the next five
years are $7.2, $24.2, $66.8, $10.7 and $11.8 million in 1997, 1998, 1999,
2000 and 2001. Substantially all Company electric and water plant is subject
to the lien of the mortgages securing various first mortgage bonds.
In January 1996 Florida Water issued $35.1 million of 6.5% Industrial
Development Refunding Revenue Bonds Series 1996 due Oct. 1, 2025. Proceeds were
used to refund four industrial development bond issues totaling $33.8 million
that Florida Water had outstanding at Dec. 31, 1995.
In May 1996 ADESA issued $90 million of 7.70% Senior Notes, Series A, Due
2006 in a Rule 144A offering. Proceeds were used by ADESA to repay $76 million
of existing indebtedness, including borrowings under ADESA's revolving bank
credit agreement, floating rate option notes and certain borrowings from
Minnesota Power.
In June 1996 Lehigh obtained a $20 million adjustable rate revolving line of
credit due in 2003. The proceeds were used to partially finance the acquisition
of real estate near Palm Coast, Florida.
At Dec. 31, 1996 and 1995, subsidiaries of the Company had long-term bank
lines of credit, aggregating $50 and $18 million, respectively. One line of
credit requires a commitment fee of 1/20 of 1%. Drawn portions on these lines of
credit aggregate $20 and $18 million at Dec. 31, 1996 and 1995, and are included
in subsidiary companies other long-term debt.
On Feb. 20, 1997, the Company sold $60 million of First Mortgage Bonds, 7%
Series due Feb. 15, 2007. The proceeds from the issuance were used for the
retirement of $60 million in principal amount of the Company's First Mortgage
Bonds, 7 3/8% Series due March 1, 1997.
10 Short-Term Borrowings and Compensating Balances
The Company had bank lines of credit, which make short-term financing
available through short-term bank loans and provide support for commercial
paper. At Dec. 31, 1996 and 1995 the Company had bank lines of credit
aggregating $84 and $118 million, respectively, of which $84 million was
available for use at the end of each year. At Dec. 31, 1996 and 1995, the
Company had issued commercial paper with face values of $155 and $63 million,
respectively, with liquidity provided by bank lines of credit and the Company's
securities portfolio.
Certain lines of credit require a commitment fee of 1/10 of 1% and/or a 5%
compensating balance. Interest rates on commercial paper and borrowings under
the lines of credit range from 6.0% to 8.0% at Dec. 31, 1996, and 6.0% to 9.5%
at Dec. 31, 1995. The weighted average interest rate on short-term borrowings at
Dec. 31, 1996 and 1995, was 5.7% and 6.1%. The total amount of compensating
balances at Dec. 31, 1996 and 1995, was immaterial.
11 Jointly Owned Electric Facility
The Company owns 80% of Boswell Unit 4. While the Company operates the plant,
certain decisions with respect to the operations of Boswell Unit 4 are subject
to the oversight of a committee on which the Company and Wisconsin Public Power,
Inc. SYSTEM (WPPI), the owner of the other 20% of Boswell Unit 4, have equal
representation and voting rights. Each owner must provide its own financing and
is obligated to pay its ownership share of operating costs. The Company's share
of direct operating expenses of Boswell Unit 4 is included in operating expense
on the consolidated statement of income. The Company's 80% share of the original
cost included in electric plant at Dec. 31, 1996 and 1995, was $304 and $303
million. The corresponding provisions for accumulated depreciation were $129 and
$123 million.
-24-
12 Leasing Agreements
ADESA leases auction facilities located in North Carolina, Massachusetts and
Tennessee from an unrelated third party. The term of these leases is for five
years ending 2001 with no renewal options. However, at the beginning of the
fourth year of the lease term, ADESA has the option to purchase the leased
facilities at an aggregate price of $26.5 million. In the event ADESA does not
exercise its option to purchase, ADESA is required to guarantee any deficiency
in sales proceeds the lessor realizes in disposing of the leased properties
should the selling price fall below $25.7 million. ADESA is entitled to any
excess sales proceeds over the option price. ADESA has guaranteed the payment of
principal and interest on the lessor's indebtedness which consists of $25.7
million of mortgage notes, due Aug. 1, 2000. Interest on the notes accrues at
9.82% per annum and is payable monthly.
The Company leases other properties and equipment in addition to those listed
above pursuant to operating and capital lease agreements with terms expiring
through 2008. Aggregate amounts of future minimum lease payments for capital and
operating leases during each of the next five years are $10.7, $7.5, $10.0, $3.8
and $2.9 million in 1997, 1998, 1999, 2000 and 2001. Total rent expense was
$7.4, $1.6 and $2.0 million in 1996, 1995 and 1994, respectively.
13 Mandatorily Redeemable Preferred Securities of MP&L Capital I
MP&L Capital I (Trust) was established as a wholly owned business trust of
the Company for the purpose of issuing common and preferred securities (Trust
Securities). On March 20, 1996, the Trust publicly issued three million 8.05%
Cumulative Quarterly Income Preferred Securities (QUIPS), representing preferred
beneficial interests in the assets held by the Trust. The proceeds of the sale
of the QUIPS, and of common securities of the Trust to the Company, were used by
the Trust to purchase from the Company $77.5 million of 8.05% Junior
Subordinated Debentures, Series A, Due 2015 (Subordinated Debentures), resulting
in net proceeds to the Company of $72.3 million. Holders of the QUIPS are
entitled to receive quarterly distributions at an annual rate of 8.05% of the
liquidation preference value of $25 per security. The Company has the right to
defer interest payments on the Subordinated Debentures which would result in the
similar deferral of distributions on the QUIPS during extension periods of up to
20 consecutive quarters, provided that no single distribution payment period, as
extended, may exceed 20 consecutive quarterly interest payment periods or extend
beyond the maturity of the Junior Subordinated Debentures. The Company is the
owner of all the common trust securities, which constitute approximately 3% of
the aggregate liquidation amount of all the Trust Securities. The sole asset of
the Trust is the Subordinated Debentures, interest on which is deductible by the
Company for income tax purposes. The Trust will use interest payments received
on the Subordinated Debentures it holds to make the quarterly cash distributions
on the QUIPS.
The QUIPS are subject to mandatory redemption upon repayment of the
Subordinated Debentures at maturity or upon redemption. The Company has the
option at any time on or after March 20, 2001, to redeem the Subordinated
Debentures, in whole or in part. The Company also has the option, upon the
occurrence of certain events, (i) to redeem at any time the Subordinated
Debentures, in whole but not in part, which would result in the redemption of
all the Trust Securities, or (ii) to terminate the Trust and cause the pro rata
distribution of the Subordinated Debentures to the holders of the Trust
Securities.
In addition to the Company's obligations under the Subordinated Debentures,
the Company has guaranteed, on a subordinated basis, payment of distributions on
the Trust Securities, to the extent the Trust has funds available to pay such
distributions, and has agreed to pay all of the expenses of the Trust (such
additional obligations collectively, the Back-up Undertakings). Considered
together, the Back-up Undertakings constitute a full and unconditional guarantee
by the Company of the Trust's obligations under the QUIPS.
14 Income Tax Expense
Schedule of Income Tax Expense 1996 1995 1994
- --------------------------------------------------------------------------------
In thousands
Continuing operations
Current tax expense
Federal $23,625 $ 8,559 $19,308
Foreign 1,701 573 -
State 6,069 4,224 4,808
------- ------- -------
31,395 13,356 24,116
------- ------- -------
Deferred tax expense
Federal 330 6,820 (511)
State (1,900) 244 (470)
------- ------- -------
(1,570) 7,064 (981)
------- ------- -------
Change in valuation
allowance (8,200) (18,400) -
------- ------- -------
Deferred tax credits (1,986) (865) (2,478)
------- ------- -------
Income tax --
continuing operations 19,639 1,155 20,657
------- ------- -------
Discontinued operations
Current tax expense
Federal - 13,396 (4,302)
State - 4,192 (2,071)
------- ------- -------
- 17,588 (6,373)
------- ------- -------
Deferred tax expense
Federal - (11,851) 5,677
State - (2,895) 1,505
------- ------- -------
- (14,746) 7,182
------- ------- -------
Income tax --
discontinued operations - 2,842 809
------- ------- -------
Total income tax expense $19,639 $ 3,997 $21,466
- --------------------------------------------------------------------------------
-25-
The Company's overall effective tax rates were 22.1%, 5.8% and 25.9% in 1996,
1995 and 1994 compared to the federal statutory rate of 35%.
Reconciliation of
Federal Statutory Rate
to Effective Tax Rate 1996 1995 1994
- --------------------------------------------------------------------------------
In thousands
Tax computed at federal
statutory rate $31,101 $24,046 $28,979
Increase in tax from
state income taxes,
net of federal income
tax benefit 2,890 3,504 2,608
Basis difference in land 293 (72) (2,433)
Change in valuation allowance (8,200) (18,400) -
Income from escrow funds - - (1,550)
Dividend received deduction (1,882) (2,284) (2,867)
Tax credits (1,908) (1,916) (2,478)
Other (2,655) (881) (793)
------- ------- -------
Total income tax expense $19,639 $ 3,997 $21,466
- --------------------------------------------------------------------------------
Schedule of Deferred Tax
Assets and Liabilities
December 31 1996 1995
- ---------------------------------------------------------------------
In thousands
Deferred tax assets
Contributions in aid of construction $ 18,775 $ 17,528
Lehigh basis difference 23,565 25,071
Deferred compensation plans 12,085 9,346
Depreciation 15,029 11,950
Investment tax credits 22,813 23,904
Other 35,143 32,056
-------- --------
Gross deferred tax assets 127,410 119,855
Deferred tax asset valuation allowance (743) (8,943)
-------- --------
Total deferred tax assets 126,667 110,912
-------- --------
Deferred tax liabilities
Depreciation 188,818 188,804
AFDC 18,688 19,399
Investment tax credits 32,590 34,369
Other 35,502 33,077
-------- --------
Total deferred tax liabilities 275,598 275,649
-------- --------
Accumulated deferred income taxes $148,931 $164,737
- ---------------------------------------------------------------------
Tax Benefits. The Company, through Lehigh, a 67% owned subsidiary at the
time, acquired the stock of Lehigh Corporation in a bargain purchase in 1991.
Lehigh then began execution of a business strategy pursuant to which the
majority of the acquired real estate assets would be disposed of over a five
year period. An additional interest in Lehigh was purchased in 1993 bringing the
Company's ownership interest to 80%. The structure of the transactions involved
the acquisition of stock so the tax bases of the underlying acquired assets were
carried over for income tax purposes. The carried-over tax bases exceeded the
book bases assigned in purchase accounting. The Internal Revenue Code (IRC)
limits the use of tax losses resulting from the higher tax basis over the fair
market value of the underlying assets for a period of five years. The 1993
increase in ownership by the Company to 80%, which resulted in the inclusion of
Lehigh and Lehigh Corporation in the Company's consolidated tax return, started
another five year limitation period.
SFAS 109 was adopted on a prospective basis effective Jan. 1, 1993. Upon
adoption, a valuation reserve was established for the entire amount of the tax
benefits attributable to the bases differences and alternative minimum tax
credits because, in management's judgment, realization of the tax benefits was
not "more likely than not." This judgment was based on the unlikelihood of
realizing the tax benefits due to the IRC restrictions, in light of management's
existing five year property disposal plan. This situation continued through
1994.
In 1995 Lehigh implemented a business strategy which called for Lehigh to
dispose of its remaining real estate assets with a specific view towards
maximizing realization of the tax benefits. The new strategy was adopted after
the Board of Directors of Lehigh, including the minority shareholders, were
convinced of the cash flow benefit to Lehigh of deferring the liquidation of the
remaining real estate assets. Accordingly, in 1995 the valuation reserve was
reduced by $18.4 million based on a detailed analysis of the projected future
taxable income based on the new business strategy.
In 1996 the remaining $8.2 million valuation reserve was reversed based on
the projected positive impact the acquisition of $34 million of real estate
assets at Palm Coast would have on Lehigh's taxable income. The Palm Coast
assets were not considered in the 1995 revised strategy.
No provision has been made for taxes on $19.1 million of pre-1993
undistributed earnings of Capital Re, an investment accounted for under the
equity method. Those earnings have been and are expected to continue to be
reinvested. The Company estimates that $7.9 million of tax would be payable on
the pre-1993 undistributed earnings of Capital Re if the Company should sell its
investment. The Company has recognized the income tax impact on undistributed
earnings of Capital Re earned since Jan. 1, 1993.
-26-
15 Pension Plans and Benefits
The Company's Minnesota and Wisconsin utility operations have noncontributory
defined benefit pension plans covering eligible employees. Pension benefits for
employees in Minnesota and Wisconsin are fully vested after five years and are
based on years of service and the highest average monthly compensation earned
during four consecutive years within the last 15 years of employment. Company
policy is to fund accrued pension costs, including amortization of past service
costs, over 5 to 30 years. Part of the pension cost is capitalized as a cost of
plant construction. Benefits under the Company's noncontributory defined benefit
pension plan for Florida utility operations were frozen as of Dec. 31, 1996.
Schedule of Pension Costs 1996 1995 1994
- --------------------------------------------------------------------------------
In thousands
Service cost $ 3,663 $ 4,290 $ 4,130
Interest cost 15,091 13,025 11,753
Actual return on assets (21,153) (34,515) (15,103)
Net amortization 3,284 17,823 454
Amortization of early
retirement cost 4,748 1,978 -
------- ------- -------
Net cost $ 5,633 $ 2,601 $ 1,234
- --------------------------------------------------------------------------------
At Dec. 31, 1996, approximately 54% of pension plan assets were invested in
equity securities, 27% in fixed income securities, 12% in other investments and
7% in Company common stock.
Pension Plans Funded Status
October 1 1996 1995
- --------------------------------------------------------------------------------
In thousands
Actuarial present value of
benefit obligations
Vested benefit obligation $(173,204) $(167,590)
Nonvested benefit obligation (9,635) (7,326)
--------- ---------
Accumulated benefit obligation (182,839) (174,916)
Excess of projected benefit
obligation over accumulated
benefit obligation (22,684) (25,991)
--------- ---------
Projected benefit obligation (205,523) (200,907)
Plan assets at fair value 233,033 222,755
--------- ---------
Plan assets in excess of
projected benefit obligation 27,510 21,848
Unrecognized net gain (40,886) (35,474)
Prior service cost not yet recognized
in net periodic pension cost 5,684 6,166
Unrecognized net obligation at
Oct. 1, 1985, being recognized
over 20 years 1,634 1,898
Unrecognized early
retirement expense 7,517 12,265
--------- ---------
Prepaid (accrued) pension cost
recognized on the consolidated
balance sheet $ 1,459 $ 6,703
- --------------------------------------------------------------------------------
The weighted average discount rate for 1996 and 1995 was 8% and 7.75%.
Projected pension obligations assume pay increases averaging 6% in 1996 and
1995. The assumed long-term rate of return on assets was 9% in 1996 and 8.75%
for 1995.
BNI Coal, ADESA and Heater have defined contribution pension plans covering
eligible employees. The aggregate annual pension cost for these plans was about
$900,000 in 1996 and 1995, and $600,000 in 1994.
Postretirement Benefits. The Company provides certain health care and life
insurance benefits for retired employees. The regulatory asset for deferred
postretirement benefits is being amortized in electric rates over a five year
period which began in 1995.
Schedule of Postretirement Benefit Costs 1996 1995
- --------------------------------------------------------------------------------
In thousands
Service cost $ 2,687 $2,544
Interest cost 4,228 3,624
Actual return on plan assets (883) (103)
Amortization of transition obligation 2,416 1,213
------- ------
Net periodic cost 8,448 7,278
Net amortization (deferral) 2,630 2,015
------- ------
Net cost $11,078 $9,293
- --------------------------------------------------------------------------------
Company policy is to fund the net periodic postretirement costs and the
amortization of the costs deferred as the amounts are collected in rates. The
Company is funding these benefits using Voluntary Employee Benefit Association
(VEBA) trusts and an irrevocable grantor trust. The maximum tax deductible
contributions are made to the VEBAs. The remainder of the funds are placed in
the irrevocable grantor trust until the funds can be used to make tax deductible
contributions to the VEBAs. The funds in the irrevocable grantor trust do not
qualify as plan assets for purposes of SFAS 106 "Employers' Accounting for
Postretirement Benefits Other Than Pensions."
Postretirement Benefit Plan
Funded Status - December 31 1996 1995
- --------------------------------------------------------------------------------
In thousands
Accumulated postretirement
benefit obligation
Retirees $(29,675) $(35,056)
Fully eligible participants (10,541) (9,414)
Other active participants (12,952) (15,090)
-------- --------
(53,168) (59,560)
Plan assets 10,872 5,702
-------- --------
Accumulated postretirement
benefit in excess of plan assets (42,296) (53,858)
Unrecognized transition obligation 23,112 39,397
-------- --------
Accrued postretirement
benefit obligation $(19,184) $(14,461)
- --------------------------------------------------------------------------------
For measurement purposes, it was assumed per capita health care benefit costs
would increase 10.25% in 1996 and that cost increases would thereafter decrease
1% each year until stabilizing at 5.25% in 2002. Accelerating the rate of
assumed health care cost increases by 1% each year would raise the 1996
transition obligation by $3.2 million and service and interest costs by a total
of $1.1 million. The weighted average discount rate used in estimating
accumulated postretirement benefit obligations was 7.75% in 1996 and 1995. The
expected long-term rate of return on plan assets was 9% in 1996 and 8.75% for
1995.
-27-
16 Employee Stock and Incentive Plans
Employee Stock Ownership Plan. The Company has sponsored an ESOP since 1975,
amending it in 1989 and 1990 to establish two leveraged accounts. The Company
accounts for the ESOP in accordance with the American Institute of Certified
Public Accountants' (AICPA) Statement of Position 93-6 (SOP 93-6).
The 1989 leveraged ESOP account covers all nonunion Minnesota and Wisconsin
employees who work more than 1,000 hours per year and have one year of service.
The ESOP used the proceeds from a $16.5 million 15-year loan at 9.125%,
guaranteed by the Company, to purchase 633,489 shares of Minnesota Power common
stock on the open market in early 1990. These shares fund employee benefits
totaling not less than 2% of the participants' salaries.
The 1990 leveraged ESOP account covers Minnesota and Wisconsin employees who
participated in the non-leveraged ESOP plan prior to Aug. 4, 1989. The ESOP
issued a $75 million promissory note at 10.25% with a term not to exceed 25
years to the Company (Employer Loan) as consideration for 2.8 million shares of
newly issued Minnesota Power common stock in November 1990. These shares are
used to fund a benefit at least equal to the value of the following: (a)
dividends on shares held in participants' 1990 leveraged ESOP accounts which are
used to make loan payments, and (b) the tax savings generated from deducting all
dividends paid on shares currently in the ESOP which were held by the plan on
Aug. 4, 1989.
The loans will be repaid with dividends received by the ESOP and with
employer contributions. ESOP shares acquired with the loans were initially
pledged as collateral for the loans. The ESOP shares are released from
collateral and allocated to participants based on the portion of total debt
service paid in the year.
Schedule of ESOP Compensation
and Interest Expense
Year Ended December 31 1996 1995 1994
- --------------------------------------------------------------------------------
In thousands
Interest expense $1,190 $1,258 $1,328
Compensation expense 1,812 1,823 2,037
------ ------ ------
Total $3,002 $3,081 $3,365
- --------------------------------------------------------------------------------
Schedule of ESOP Shares
December 31 1996 1995
- --------------------------------------------------------------------------------
In thousands
Allocated shares 1,783 1,820
Shares released for allocation 38 41
Unreleased shares 2,615 2,757
----- -----
Total ESOP shares 4,436 4,618
- --------------------------------------------------------------------------------
Fair value of unreleased shares $71,907 $78,241
- --------------------------------------------------------------------------------
Employee Stock Purchase Plan. The Company has an Employee Stock Purchase Plan
(ESPP). At Dec. 31, 1996, 195,097 shares of common stock were held in reserve
for future issuance under the ESPP. The ESPP permits eligible employees to buy
up to $23,750 per year in Company common stock. Purchases are at 95% of the
stock's closing market price on the first day of each month. At Dec. 31, 1996,
449,195 shares had been issued under the ESPP.
Stock Option and Award Plans. In May 1996 Company shareholders approved an
Executive Long-Term Incentive Compensation Plan (the Executive Plan) and a
Director Long-Term Stock Incentive Plan (the Director Plan), both effective as
of Jan. 1, 1996.
The Executive Plan allows for the grant of up to an aggregate of 2.1 million
shares of common stock to key employees of the Company. Such grants may be in
the form of stock options and other awards, including stock appreciation rights,
restricted stock, performance units and performance shares. In January 1996 the
Company granted non-qualified stock options to purchase 118,708 shares of common
stock and granted 80,788 performance shares. Additionally, 24,000 restricted
shares of common stock were granted, with the restriction expiring over a
four-year period. The Director Plan provides for the grant of up to 150,000
shares of common stock to nonemployee directors of the Company. Pursuant to the
Director Plan each nonemployee director receives an annual grant of 725 stock
options and a biennial grant of performance shares equal to $10,000 in value of
common stock on the date of grant.
The exercise price for stock options is equal to the market value of the
common stock on the date of a grant. Stock options may be exercised 50% on the
first anniversary date of the grant and the remaining 50% on the second
anniversary, and expire on the tenth anniversary. Grants of performance shares
are earned over multi-year time periods upon the achievement of performance
objectives.
The Company has elected to recognize compensation cost for its stock-based
compensation plans in accordance with Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees." Generally, no compensation
expense is recognized for stock options with exercise prices equal to the market
value of the underlying shares of stock at the date of the grant. Compensation
cost is recognized over the vesting periods for performance and restricted share
awards based on the market value of the underlying shares of stock.
Pro forma amounts of net income and earnings per share reflecting
compensation cost determined based on the fair value at the grant dates for
awards under these plans consistent with the method of SFAS 123, "Accounting for
Stock-Based Compensation," have not been presented because the amounts are not
material. The initial effects of applying SFAS 123 may not be representative of
the pro forma effects on reported net income and earnings per share for future
years if additional awards are granted.
-28-
17 Square Butte Purchased Power Contract
Under the terms of a 30-year contract with Square Butte that extends through
2007, the Company is purchasing 71% of the output from a mine-mouth,
lignite-fired generating plant capable of generating up to 470 MW. This
generating unit (Project) is located near Center, N.D. Reductions to about 49%
of the output are provided for in the contract and, at the option of Square
Butte, could begin after a five-year advance notice to the Company and continue
for the remaining economic life of the Project. The Company has the option but
not the obligation to continue to purchase 49% of the output after 2007.
The Project is leased to Square Butte through Dec. 31, 2007, by certain banks
and their affiliates which have beneficial ownership in the Project. Square
Butte has options to renew the lease after 2007 for essentially the entire
remaining economic life of the Project.
The Company is obligated to pay Square Butte all Square Butte's leasing,
operating and debt service costs (less any amounts collected from the sale of
power or energy to others) that shall not have been paid by Square Butte when
due. These costs include the price of lignite coal purchased by Square Butte
under a cost-plus contract with BNI Coal. The Company's cost of power and energy
purchased from Square Butte during 1996, 1995 and 1994 was $58.2, $57.6 and
$55.4 million, respectively. The leasing costs of Square Butte included in the
cost of power delivered to the Company totaled $19.1 million in 1996, and $19.3
million in 1995 and in 1994, which included approximately $10.2, $11 and $12
million, respectively, of interest expense. The annual fixed lease obligations
of the Company for Square Butte are $20.1 million from 1997 through 2001. At
Dec. 31, 1996, Square Butte had total debt outstanding of $207 million. The
Company's obligation is absolute and unconditional whether or not any power is
actually delivered to the Company.
The Company's payments to Square Butte for power and energy are approved as
purchased power expense for ratemaking purposes by both the MPUC and FERC.
One principal reason the Company entered into the agreement with Square Butte
was to obtain a power supply for large industrial customers. Present electric
service contracts with these customers require payment of minimum monthly demand
charges that cover a portion of the fixed costs associated with having capacity
available to serve them. These contracts minimize the negative impact on
earnings that could result from significant reductions in kilowatthour sales to
industrial customers. The initial minimum contract term for the large power
customers is 10 years, with a four-year cancellation notice required for
termination of the contract at or beyond the end of the tenth year. Under the
terms of existing contracts as of Feb. 1, 1997, the Company would collect
approximately $101.6, $89.2, $80.3, $70.1 and $61.9 million under current rate
levels for firm power during the years 1997, 1998, 1999, 2000 and 2001,
respectively, even if no power or energy were supplied to these customers after
Dec. 31, 1996. The minimum contract provisions are expressed in megawatts of
demand, and if rates change, the amounts the Company would collect under the
contracts will change in proportion to the change in the demand rate.
18 Quarterly Financial Data (Unaudited)
Information for any one quarterly period is not necessarily indicative of the
results which may be expected for the year. Previously reported quarterly
information has been revised to reflect reclassifications to conform with the
1996 method of presentation. These reclassifications had no effect on previously
reported consolidated net income.
Quarter Ended March 31 June 30 Sept. 30 Dec. 31
- --------------------------------------------------------------------------------
In thousands except earnings per share
1996
Operating revenue
and income $202,676 $208,503 $215,150 $220,599
Operating income $28,828 $21,094 $21,724 $21,943
Net income $18,303 $14,832 $17,514 $18,572
Earnings available
for common stock $17,503 $14,198 $17,027 $18,085
Earnings per share
of common stock $0.61 $0.49 $0.58 $0.60
- --------------------------------------------------------------------------------
1995
Operating revenue
and income $146,686 $147,336 $186,121 $192,774
Operating income from
continuing operations $8,404 $16,431 $23,663 $14,514
Income
Continuing operations $23,805 $10,923 $15,685 $11,444
Discontinued operations 1,652 1,190 33 (27)
------- ------- ------- -------
Net income $25,457 $12,113 $15,718 $11,417
Earnings available
for common stock $24,657 $11,313 $14,918 $10,617
Earnings per share
of common stock
Continuing operations $0.81 $0.36 $0.52 $0.37
Discontinued operations 0.06 0.04 - -
----- ----- ----- -----
$0.87 $0.40 $0.52 $0.37
- --------------------------------------------------------------------------------
-29-
Definitions
These abbreviations or acronyms are used throughout this document.
Abbreviations or Acronyms Term
- ------------------------- -------------------------------------------------
ADESA ADESA Corporation
AFC Automotive Finance Corporation
APB Accounting Principles Board
BNI Coal BNI Coal, Ltd.
Boswell Boswell Energy Center Units No. 1, 2, 3 and 4
Capital Re Capital Re Corporation
CIP Conservation Improvement Programs
Company Minnesota Power & Light Company and its
Subsidiaries
DRIP Dividend Reinvestment and Stock Purchase Plan
ESOP Employee Stock Ownership Plan
ESPP Employee Stock Purchase Plan
FASB Financial Accounting Standards Board
FERC Federal Energy Regulatory Commission
Florida Water Florida Water Services Corporation
FPSC Florida Public Service Commission
Heater Heater Utilities, Inc.
Hibbard M.L. Hibbard Station
ISI Instrumentation Services, Inc.
kWh Kilowatthour(s)
Lehigh Lehigh Acquisition Corporation
Minnesota Power Minnesota Power & Light Company and its
Subsidiaries
MPUC Minnesota Public Utilities Commission
MP Water Resources MP Water Resources Group, Inc.
MW Megawatt(s)
NCUC North Carolina Utilities Commission
Note ___ Note ___ to the consolidated financial statements
in the Minnesota Power 1996 Annual Report
Orange Osceola Orange Osceola Utilities
PSCW Public Service Commission of Wisconsin
QUIPS Quarterly Income Preferred Securities
Reach All Reach All Partnership
SCPSC South Carolina Public Service Commission
SFAS Statement of Financial Accounting Standards No.
Square Butte Square Butte Electric Cooperative
SWL&P Superior Water, Light and Power Company
USX Minntac (USX)
Price Ranges and Dividends
New York Stock Exchange American Stock Exchange
------------------------------ -------------------------------
Common 5% Preferred
------------------------------ -------------------------------
Dividends Dividends
Quarter High Low Paid High Low Paid
------------------------------ --------------------------------
1996 - First $29 3/4 $26 1/8 $0.51 $73 $67 $1.25
Second 29 26 0.51 70 62 1/2 1.25
Third 28 3/4 26 0.51 65 1/8 62 1/2 1.25
Fourth 28 7/8 26 3/8 0.51 68 1/4 62 1.25
----- -----
Annual $2.04 $5.00
----- -----
1995 - First $26 3/8 $24 1/4 $0.51 $62 $54 3/4 $1.25
Second 28 25 1/4 0.51 65 1/4 59 1/2 1.25
Third 28 1/8 26 3/8 0.51 75 62 3/4 1.25
Fourth 29 1/4 27 1/2 0.51 69 64 1/2 1.25
----- -----
Annual $2.04 $5.00
----- -----
The Company has paid dividends without interruption on its common stock since
1948, the date of initial distribution of the Company's common stock by American
Power & Light Company, the former holder of all such stock. Listed above are
dividends paid and the high and low prices for the Company's common stock and 5%
preferred stock as reported by The Wall Street Journal, Midwest Edition. On Dec.
31, 1996, there were approximately 24,300 common stock shareholders. On Jan. 28,
1997, the Board of Directors declared a quarterly dividend of 51 cents, payable
March 1, 1997, to common stock shareholders of record on Feb. 14, 1997.
-30-
Exhibit 23
Consent of Independent Accountants
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (Nos. 33-51989, 33-32033, 333-16463, 333-16445) of
Minnesota Power & Light Company of our report dated January 27, 1997 appearing
on page 13 of Minnesota Power & Light Company's Current Report on Form 8-K,
dated March 19, 1997.
We also consent to the incorporation by reference in the Prospectus constituting
part of the Registration Statement on Form S-3 (Nos. 33-51941, 33-50143,
333-07963, 333-13445, 333-02109, 333-20745, 33-45551) of Minnesota Power & Light
Company of our report dated January 27, 1997 appearing on page 13 of Minnesota
Power & Light Company's Current Report on Form 8-K, dated March 19, 1997.
PRICE WATERHOUSE LLP
Minneapolis, Minnesota
March 19, 1997
UT
1,000
YEAR
DEC-31-1996
JAN-01-1996
DEC-31-1996
PER-BOOK
1,119,924
403,783
332,109
110,582
179,651
2,146,049
394,187
0
282,960
610,848
75,000
31,492
694,423
155,726
0
0
7,208
0
0
0
505,053
2,146,049
846,928
19,639
703,034
765,149
93,589
7,081
131,336
62,115
69,221
2,408
66,813
59,581
50,930
77,026
2.28
2.28
Includes $11,810,000 of Income from Equity Investments and $4,729,000 for
Distributions on Redeemable Preferred Securities of Subsidiary.
