HE

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2008 for Hawaiian Electric Industries, Inc. (HEI) and its principal subsidiary, Hawaiian Electric Company, Inc. (HECO). HEI operates as a holding company with two primary segments: regulated electric utilities (HECO, HELCO, MECO) serving the Hawaiian islands, and a banking subsidiary, American Savings Bank, F.S.B. (ASB). The filing includes unaudited consolidated financial statements and management discussion.

Key Financial Metrics

Segment Performance

• Electric Utility: Revenues increased 39% to $623.9 million, driven by higher fuel costs passed to customers and interim rate relief. Operating income surged 292% to $51.0 million, significantly aided by a $12 million plant write-off in Q1 2007 that did not recur.
• Bank (ASB): Revenues were $105.8 million. Net income rose 26% to $14.6 million due to higher net interest income and lower noninterest expenses, partially offset by a $0.9 million provision for loan losses.
• Other: Reported a net loss of $5.2 million, primarily due to unrealized losses on venture capital investments.

Material Changes vs. Prior Period

• Profitability Surge: Net income increased 402% year-over-year. The primary driver was the electric utility segment, where operating income jumped from $13.0 million to $51.0 million. This was largely due to the absence of a $7 million after-tax charge recorded in Q1 2007 related to the write-off of HELCO plant costs (CT-4 and CT-5) and the implementation of interim rate increases approved by the Public Utilities Commission (PUC).
• Fuel Costs: Average fuel oil cost per barrel rose 61% to $93.89 from $58.19. While this increased utility expenses by $89.6 million, the Energy Cost Adjustment Clause (ECAC) allowed the company to pass these costs to customers, resulting in higher revenues.
• Cash Flow: Net cash provided by operating activities decreased 49% to $26.0 million. This decline was primarily due to a significant increase in taxes paid ($38 million in Q1 2008 vs. $3 million in Q1 2007) related to the timing of tax payments for prior years.
• Bank Asset Quality: Nonaccrual loans increased to $7.5 million from $4.5 million. However, the allowance for loan losses remained stable at approximately $30.6 million, and the ratio of net charge-offs to average loans decreased to 0.05%.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Rate Cases: The PUC issued a final decision on May 1, 2008, for HECO's 2005 test year rate case, authorizing a net revenue increase of $33 million. However, this decision requires HECO to refund approximately $16 million to customers (including interest) retroactive to September 2005. Interim rate increases granted in late 2007 for HECO, HELCO, and MECO are currently in effect but subject to final PUC approval.
• Capital Projects: HECO is proceeding with the construction of a new 110 MW combustion turbine at the Campbell Industrial Park, expected to be operational in mid-2009. The project is estimated to cost $164 million, with $30 million incurred as of March 31, 2008.
• Renewable Energy: The utilities are pursuing a strategy to meet Hawaii's Renewable Portfolio Standards (RPS), aiming for 20% renewable energy by 2020. HECO has committed to using 100% biofuels for its new 2009 generating unit.
• Dividends: HEI paid a quarterly dividend of $0.31 per share. Management targets a sustainable payout ratio of 65% or lower.

Risks and Contingencies

• Regulatory Risk: Future rate decisions by the PUC are uncertain. The company faces potential refunds if interim rates exceed final approved amounts. Additionally, the PUC is reviewing the design of Energy Cost Adjustment Clauses (ECACs) under Act 162 to ensure fair risk sharing.
• Environmental Compliance: The company faces potential costs related to the Regional Haze Rule, Hazardous Air Pollutant (HAP) controls, and Clean Water Act cooling water intake requirements. The outcome of the Honolulu Harbor investigation regarding petroleum contamination remains uncertain, with a remaining accrual of $2 million as of March 31, 2008.
• Banking Risks: ASB faces risks from the volatile housing market and potential impairment of mortgage-related securities. While exposure to subprime collateral is not material, a deep recession could erode the value of non-agency securities. ASB also faces a consent order from the Office of Thrift Supervision (OTS) regarding Bank Secrecy Act compliance, though no business restrictions were imposed.
• Generation Reliability: HECO faces strained generation reserve margins on Oahu, increasing the risk of outages until the new 2009 unit is installed.

Investor Verification Checklist

• Refund Liability: Verify the timing and final amount of the $16 million customer refund required by the PUC's final decision on HECO's 2005 rate case.
• Rate Case Outcomes: Monitor the final decisions for the 2007 test year rate cases for HECO, HELCO, and MECO to confirm the permanence of interim rate increases.
• Fuel Price Exposure: Assess the impact of sustained high oil prices on customer demand and the potential for PUC intervention in ECAC mechanisms.
• Bank Asset Quality: Review future quarters for changes in the allowance for loan losses and nonaccrual loan ratios given the housing market environment.
• Capital Expenditures: Track the progress and cost overruns of the Campbell Industrial Park generating unit and the East Oahu Transmission Project (EOTP).