Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 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: electric utilities (HECO and subsidiaries HELCO and MECO) and banking (American Savings Bank, F.S.B. or ASB). The reporting period was significantly impacted by the global financial crisis, volatile capital markets, and the signing of the Hawaii Clean Energy Initiative (HCEI) Energy Agreement on October 20, 2008.
Key Financial Metrics
| Metric (Nine Months Ended Sept 30, 2008) | Value (in thousands) | Comparison (Nine Months Ended Sept 30, 2007) |
|---|---|---|
| Total Revenues | $2,419,103 | $1,828,247 (+32%) |
| Operating Income | $166,477 | $121,867 (+37%) |
| Net Income | $76,384 | $44,194 (+73%) |
| Diluted EPS | $0.91 | $0.54 (+69%) |
| Cash Flow from Operations | $74,119 | $169,978 (-56%) |
| Total Assets | $9,240,927 | $10,293,916 (-10%) |
| Long-term Debt (Excl. Bank) | $1,210,901 | $1,242,099 (-3%) |
| Stockholders' Equity | $1,320,600 | $1,275,427 (+4%) |
Segment Performance (Nine Months 2008)
- Electric Utility: Revenues of $2.14 billion; Net Income of $77.9 million. Driven by higher fuel costs passed to customers and interim rate relief.
- Bank (ASB): Revenues of $279.5 million; Net Income of $11.9 million. Results were significantly impacted by a balance sheet restructuring in Q2 2008, which included a $36 million charge for early debt extinguishment and security sales losses.
- Other: Net loss of $13.5 million, primarily due to unrealized losses on venture capital investments.
Material Changes vs. Prior Period
- Revenue Growth: Consolidated revenues increased 32% year-over-year, primarily due to a 42% increase in electric utility revenues driven by higher fuel oil costs (average $111.37/barrel vs. $65.52 in 2007) and interim rate increases approved by the Public Utilities Commission (PUC).
- Profitability Surge: Net income rose 73% to $76.4 million. This was fueled by higher operating income in the utility segment and lower interest expenses, partially offset by higher income taxes.
- Bank Restructuring Impact: ASB's operating income decreased 70% year-over-year due to a one-time $40 million loss on the early extinguishment of debt and $17.4 million in losses on the sale of securities as part of a balance sheet restructuring to improve capital ratios.
- Asset Reduction: Total assets declined by approximately $1.05 billion, largely due to ASB's sale of $1.3 billion in mortgage-related securities and agency notes to reduce leverage.
- Utility Sales Decline: Despite revenue growth, kilowatthour (KWH) sales decreased 1.2% due to customer conservation, demand-side management programs, and a slowing Hawaii economy.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- Economic Conditions: Management anticipates continued declines in KWH sales in 2008 and 2009 due to the recessionary environment and customer conservation. Tourism and construction sectors in Hawaii are weakening.
- HCEI Energy Agreement: On October 20, 2008, HEI signed an agreement with the State of Hawaii to pursue a 70% clean energy goal by 2030. This involves significant investments in renewable infrastructure, potential revenue decoupling from sales, and new regulatory models.
- Capital Markets: While HEI and HECO currently have access to commercial paper markets, rising rates and market volatility have increased borrowing costs. HEI drew on its line of credit in late September 2008 to manage liquidity.
- Pension Funding: Due to a significant decline in pension plan asset values (down 18.6% in the first nine months), the company expects minimum required contributions for 2009 to be approximately $21 million, compared to no contribution anticipated at the start of the year.
Risks and Contingencies
- Regulatory Risk: Future rate cases and the implementation of the HCEI agreement are subject to PUC approval. Delays or unfavorable decisions could impact revenue recovery.
- Interest Rate Risk: ASB faces significant interest rate risk. While the balance sheet restructuring improved the Net Portfolio Value (NPV) ratio, rising rates could negatively impact net interest income.
- Environmental and Legal: Ongoing investigations into historical petroleum contamination at Honolulu Harbor and potential costs related to new environmental regulations (e.g., Regional Haze Rule, Clean Water Act) present financial uncertainties.
- Generation Reliability: HECO faces strained generation reserve margins on Oahu until a new 110 MW biofuel unit is installed in 2009, increasing the risk of outages.
Investor Verification Checklist
- Verify Fuel Cost Pass-Through: Confirm the extent to which rising fuel costs are being recovered through Energy Cost Adjustment Clauses (ECACs) and interim rate orders.
- Assess Pension Liability: Review the projected 2009 pension funding requirements ($21 million) and the impact of continued market volatility on plan assets.
- Monitor HCEI Implementation: Track the PUC's approval process for the new regulatory model (revenue decoupling) and the Clean Energy Infrastructure Surcharge (CEIS).
- Review ASB Asset Quality: Examine the composition of ASB's remaining investment portfolio and the impact of downgraded bond insurers on its revenue bonds.
- Check Capital Expenditure Forecasts: Validate the $205 million gross capital expenditure forecast for 2009, particularly regarding the Campbell Industrial Park generating unit and renewable energy projects.