Business Context and Reporting Period
Company: Hawaiian Electric Industries, Inc. (HEI) and principal subsidiary Hawaiian Electric Company, Inc. (HECO).
Reporting Period: Quarterly report (Form 10-Q) for the period ended June 30, 2005.
Business Overview: HEI operates through three primary segments: Electric Utilities (HECO, HELCO, MECO), Bank (American Savings Bank, F.S.B. or ASB), and Other (investments and holding companies). The company serves the Hawaiian market, heavily influenced by local tourism, construction, and federal military spending.
Key Financial Metrics (Six Months Ended June 30, 2005)
| Metric | 2005 (in thousands) | 2004 (in thousands) |
|---|---|---|
| Total Revenues | $994,890 | $898,908 |
| Operating Income | $118,120 | $134,783 |
| Net Income | $51,675 | $42,170 |
| Basic EPS (Continuing Ops) | $0.65 | $0.54 |
| Cash from Operating Activities | $70,167 | $175,721 |
| Total Assets | $9,807,071 | $9,719,257 |
| Long-term Debt (Net) | $1,168,079 | $1,166,735 |
| Stockholders' Equity | $1,216,086 | $1,210,945 |
Material Changes vs. Prior Period
- Revenue Growth: Consolidated revenues increased 11% year-over-year, driven by higher kilowatthour (KWH) sales and increased fuel costs passed through to customers in the utility segment, alongside growth in the bank segment.
- Profitability: Net income increased 23% to $51.7 million. This increase is largely attributable to the absence of a $24 million net charge recorded in the second quarter of 2004 related to an adverse bank franchise tax ruling. On an adjusted basis excluding the 2004 tax charge, income from continuing operations would have decreased approximately 20%.
- Operating Income Decline: Operating income decreased 12% to $118.1 million. The Electric Utility segment saw a significant 18% drop in operating income due to rising fuel oil costs (up 25% per barrel), higher purchased power costs, and increased operation and maintenance expenses (including pension costs and equipment overhauls).
- Bank Segment Performance: ASB reported a 249% increase in net income to $31.3 million, primarily due to lower income taxes (excluding the 2004 tax charge) and higher operating income. Net interest income increased 7% due to higher loan volumes and yields.
- Cash Flow: Net cash provided by operating activities decreased significantly to $70.2 million from $175.7 million in the prior year, largely due to a $30 million tax deposit made in 2005 to stop interest accrual on disputed tax issues and changes in working capital.
Guidance, Outlook, Risks, and Unusual Items
- Rate Case Proceedings: HECO filed a request for a base rate increase in November 2004. The requested increase was revised downward to $63 million (5.2%) in August 2005 after bifurcating energy efficiency programs. An interim decision is expected in the fourth quarter of 2005. HELCO and MECO also face rate-making challenges regarding recovery of new generation costs.
- Regulatory Risks:
- HELCO Power Situation: Ongoing litigation regarding the Keahole power plant expansion (CT-4 and CT-5) remains pending before the Hawaii Supreme Court. Full operation is contingent on resolving appeals and meeting settlement conditions.
- Competition: The Public Utilities Commission (PUC) is conducting proceedings on competitive bidding and distributed generation (DG), which could impact future utility infrastructure and market structure.
- Discontinued Operations: HEI Power Corp. (HEIPC) continues to wind down international operations. A $1 million reserve was added for arbitration costs related to a China joint venture. Remaining net assets are approximately $11 million.
- Tax Contingencies: ASB settled a long-standing dispute with the State of Hawaii regarding bank franchise taxes in December 2004. In 2005, ASB made a $30 million deposit to halt interest accrual on a separate disputed timing of dividend income recognition. Management believes provisions are adequate but notes potential for additional charges if adverse developments occur.
- Interest Rate Risk: ASB's net interest income is sensitive to interest rate changes. The yield curve flattened in 2005, reducing the market value of mortgage-related securities (recorded in AOCI, not net income). The Federal Home Loan Bank of Seattle has suspended dividends, impacting ASB's investment income.
- Dividends: HEI maintained the quarterly dividend at $0.31 per share. The payout ratio for the first half of 2005 was 97% of net income.
Investor Verification Checklist
- Rate Case Outcome: Monitor the PUC's interim decision on HECO's rate increase request (expected Q4 2005) to assess revenue recovery for rising O&M and fuel costs.
- HELCO Litigation: Track the status of Hawaii Supreme Court appeals regarding the Keahole plant expansion, as a negative ruling could require write-offs of capitalized costs (~$108 million).
- Bank Tax Resolution: Verify the final resolution of the disputed dividend income timing issue with federal and state tax authorities to confirm the adequacy of the $3 million accrual and $30 million deposit.
- Fuel Cost Pass-Through: Confirm the continued effectiveness of energy cost adjustment clauses in passing volatile fuel oil prices to customers.
- Capital Expenditures: Review the funding status for the proposed 100 MW combustion turbine at Campbell Industrial Park ($134 million estimated cost) and the East Oahu Transmission Project.