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Business Context and Reporting Period

Hawaiian Electric Industries, Inc. (HEI) is a holding company incorporated in Hawaii, with principal subsidiaries engaged in electric utility and banking businesses. The primary operating subsidiaries are Hawaiian Electric Company, Inc. (HECO), which provides regulated electric utility services on Oahu, Maui, Lanai, Molokai, and Hawaii, and American Savings Bank, F.S.B. (ASB), the third-largest financial institution in Hawaii. This Form 10-K covers the fiscal year ended December 31, 2005.

Key Financial Metrics

Segment Performance

• Electric Utility: Revenues increased 16% to $1.8 billion, driven primarily by higher fuel costs passed through to customers. Net income decreased 10% to $73 million due to increased operation and maintenance expenses and depreciation.
• Bank (ASB): Revenues increased 6% to $388 million. Net income increased 58% to $65 million, significantly aided by a $3.1 million reversal of the allowance for loan losses due to strong asset quality.
• Other: Recorded a net loss of $10 million, improved from a $14 million loss in 2004, largely due to a $14 million gain on the sale of an investment interest.

Material Changes vs. Prior Period

• Revenue Growth: Consolidated revenues rose 15% year-over-year, primarily due to a 33% increase in average fuel oil costs, which are passed through to customers via energy cost adjustment clauses.
• Profitability: Income from continuing operations increased 18% to $127.4 million. This growth was partially offset by lower electric utility earnings but boosted by higher investment gains in the "Other" segment and lower financing costs.
• Bank Franchise Tax Impact: The 2004 results included a $20 million after-tax charge related to a state franchise tax dispute. Excluding this non-recurring item, 2005 consolidated income would have been flat compared to 2004.
• Allowance for Loan Losses: ASB reversed its allowance for loan losses by $3.1 million in 2005 (compared to an $8.4 million reversal in 2004) due to continued strength in the Hawaii real estate market and lower delinquencies.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Dividends: HEI maintained its annual dividend at $1.24 per share. Management targets a sustainable payout ratio of 65% based on continuing operations.
• Electric Utility Capacity: HECO faces a projected reserve capacity shortfall of 170-200 MW on Oahu through 2009. A new 100 MW combustion turbine is planned for 2009, pending regulatory and environmental approvals. HECO has issued public requests for energy conservation.
• Rate Cases: HECO received interim rate relief in September 2005. HELCO plans to file a rate increase application in spring 2006 to recover costs for new generating units.
• Bank Strategy: ASB continues its transformation into a full-service community bank, diversifying its loan portfolio from residential mortgages to commercial and commercial real estate loans.

Risks and Contingencies

• Regulatory Risk: The Public Utilities Commission (PUC) has broad discretion over rates. Delays in rate approvals or disallowance of costs (e.g., for the East Oahu Transmission Project or Keahole generating units) could materially impact earnings.
• Fuel Supply and Price: Approximately 79.5% of energy is generated from oil. Disruptions in supply or significant price increases could adversely affect operations, though costs are largely passed through to customers.
• Geographic Concentration: Operations are concentrated in Hawaii, making the company vulnerable to local economic downturns, natural disasters, and lack of interconnection with mainland grids.
• Retirement Benefits: Fluctuations in interest rates and equity markets could increase pension costs or require additional minimum liability charges to accumulated other comprehensive income (AOCI).

Important Facts for Investor Verification

• Interim Rate Recovery: Verify the final outcome of HECO's rate case, as $32 million in revenues recognized in 2005 are subject to refund with interest if the final order is lower than the interim amount.
• Generation Reserve Margins: Monitor the status of HECO's Oahu reserve margins and the timeline for the new 100 MW combustion turbine, as current margins are below desirable levels.
• Bank Asset Quality: Review ASB's allowance for loan losses and nonaccrual loan ratios, which remain low (0.1% of net loans) but are sensitive to the Hawaii real estate market.
• Environmental Liabilities: Track the ongoing Honolulu Harbor environmental investigation and potential costs associated with the East Oahu Transmission Project and Keahole generating unit expansions.
• Regulatory Capital: Confirm ASB's "well-capitalized" status under OTS regulations, which is critical for maintaining its federal thrift charter and dividend-paying ability.