Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2005, for Hawaiian Electric Industries, Inc. (HEI) and its principal subsidiary, Hawaiian Electric Company, Inc. (HECO). HEI operates as a holding company with three primary segments: Electric Utilities (HECO, MECO, HELCO), Banking (American Savings Bank, F.S.B.), and Other (investments and diversified services). The company serves the Hawaiian market, heavily influenced by local economic conditions, tourism, and federal military expenditures.
Key Financial Metrics
| Metric (Nine Months Ended Sept 30, 2005) | Value (in thousands) | Comparison (Nine Months Ended Sept 30, 2004) |
|---|---|---|
| Total Revenues | $1,590,805 | $1,405,667 (+13%) |
| Net Income | $89,165 | $84,842 (+5%) |
| Income from Continuing Operations | $89,920 | $82,929 (+8%) |
| Operating Income | $195,359 | $216,469 (-10%) |
| Basic EPS (Continuing Ops) | $1.11 | $1.05 (+6%) |
| Net Cash Provided by Operating Activities | $156,379 | $234,396 (-33%) |
| Total Assets | $9,975,518 | $9,719,257 |
| Long-term Debt, Net | $1,173,009 | $1,166,735 |
| Stockholders' Equity | $1,213,358 | $1,210,945 |
Segment Performance (Nine Months 2005)
- Electric Utility: Revenues of $1.30 billion (+15%); Net Income of $54.6 million (-20%). Revenue growth was driven by higher fuel costs passed to customers, but operating income declined due to rising O&M expenses and maintenance costs.
- Bank (ASB): Revenues of $286.6 million (+6%); Net Income of $47.2 million (+94%). The significant year-over-year increase is largely due to a $24 million tax charge in the prior year related to an adverse tax ruling on a REIT subsidiary, which was settled in late 2004.
- Other: Net loss from continuing operations of $11.9 million, compared to a $9.4 million loss in the prior year.
Material Changes vs. Prior Period
- Operating Income Decline: Consolidated operating income decreased 10% to $195.4 million. The Electric Utility segment saw a 15% drop in operating income due to higher fuel oil costs ($52.85/barrel vs. $40.38/barrel), increased maintenance expenses (18% increase), and higher retirement benefit costs.
- Net Income Increase: Despite lower operating income, consolidated net income rose 5% primarily because the prior year included a $24 million net charge for cumulative bank franchise taxes. Excluding this non-recurring item, adjusted income from continuing operations would have decreased 15%.
- Discontinued Operations: HEI Power Corp. (HEIPC) reported a loss of $0.8 million for the nine months ended Sept 30, 2005, compared to a gain of $1.9 million in 2004. The 2004 gain resulted from the transfer of a China joint venture interest.
- Cash Flow: Net cash provided by operating activities decreased significantly ($156 million vs. $234 million) due to higher tax payments in 2005 settling prior year liabilities and changes in working capital.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- Rate Relief: The Public Utilities Commission (PUC) issued an Interim Decision and Order on September 27, 2005, granting HECO a 4.36% rate increase effective September 28, 2005. This is intended to cover rising O&M costs and capital investments. A final order is pending.
- Dividends: HEI maintained its quarterly dividend at $0.31 per share. Management targets a sustainable payout ratio of 65% before considering increases.
- Capital Projects: HECO is proceeding with a new 100 MW combustion turbine project at Campbell Industrial Park (estimated cost $134 million) and the East Oahu Transmission Project. HELCO continues to resolve permitting issues for its Keahole power plant expansion (CT-4 and CT-5).
- Banking: ASB continues to focus on core lending, with loan portfolios growing due to strength in the Hawaii real estate market. Net interest income increased as yields on earning assets rose faster than the cost of liabilities.
Risks and Contingencies
- Regulatory Risk: Future earnings depend on PUC approval of rate increases. Delays or disallowance of costs (e.g., for HELCO's CT-4/CT-5 or HECO's transmission projects) could materially impact financial results.
- Pension Liability: There is a risk of a significant non-cash charge to Accumulated Other Comprehensive Income (AOCI) at year-end 2005 if the accumulated benefit obligation exceeds plan assets. This could impact financial covenants and rate base calculations.
- Interest Rate Risk: ASB faces interest rate risk; a flattening yield curve reduced the market value of mortgage-related securities, resulting in an unrealized loss of $27 million in AOCI as of September 30, 2005.
- Legal Proceedings: Pending litigation includes a Qui Tam case regarding alleged overcharges in power purchase agreements (appeal pending at Hawaii Supreme Court) and environmental remediation costs at Honolulu Harbor.
Investor Verification Checklist
- Rate Case Final Order: Verify the final PUC decision on HECO's rate increase request to confirm the recovery of O&M costs and capital investments.
- Pension Funding Status: Monitor year-end 2005 actuarial valuations to assess the potential magnitude of any minimum pension liability charge to AOCI.
- HELCO Project Costs: Confirm the status of litigation regarding HELCO's Keahole plant expansion to ensure capitalized costs ($109 million) will be recoverable in rates.
- Bank Asset Quality: Review ASB's allowance for loan losses (0.91% of average loans) and nonaccrual trends in the context of the Hawaii real estate market.
- Discontinued Operations: Track the final settlement of HEIPC's political risk insurance arbitration, which was denied in Q4 2005, to assess any remaining reserve requirements.