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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2003, for Hawaiian Electric Industries, Inc. (HEI) and its principal subsidiary, Hawaiian Electric Company, Inc. (HECO). HEI operates primarily through two segments: electric utilities (HECO, Maui Electric Company, and Hawaii Electric Light Company) and banking (American Savings Bank, F.S.B.). The company also holds discontinued operations related to its international power business (HEI Power Corp.).

Key Financial Metrics (Six Months Ended June 30, 2003)

Material Changes vs. Prior Period

• Revenue Growth: Consolidated revenues increased 11% to $873.4 million, driven by a 17% increase in electric utility revenues (due to higher fuel costs passed to customers and 1.8% higher KWH sales) and a 1% increase in "Other" segment revenues. This was partially offset by a 7% decline in bank revenues due to lower interest yields.
• Profit Decline: Net income decreased 21% to $46.2 million. Income from continuing operations fell 14% due to lower operating income in both utility and bank segments. Additionally, a $3.9 million loss from discontinued operations (HEI Power Corp.) reduced net income.
• Utility Segment: Operating income dropped 13% to $83.6 million. While sales volume increased, higher fuel oil costs (up 44%), purchased power costs (up 18%), and increased pension/retirement benefit expenses outweighed revenue gains.
• Bank Segment: Operating income declined 4% to $44.8 million. Net interest income decreased due to a compression in interest rate spreads (yield on assets fell faster than cost of liabilities), though this was partially offset by a lower provision for loan losses and higher gains on security sales.
• Discontinued Operations: HEI Power Corp. recorded a $5 million writedown of its investment in CEPALCO (Philippines) and a $1 million increase in reserves for future expenses, resulting in a $3.9 million after-tax loss.

Guidance, Outlook, Risks, and Contingencies

• Regulatory and Litigation Risks:
  • HELCO Keahole Project: Construction of two combustion turbines (CT-4 and CT-5) is suspended pending the outcome of a Hawaii Supreme Court appeal regarding land use permits. Approximately $83 million in costs are currently capitalized but may be written off if the project is not completed or costs are disallowed by the PUC.
  • AES Hawaii Litigation: A qui tam lawsuit alleges overcharges in the AES Hawaii power purchase agreement. The case was stayed pending a PUC proceeding; if plaintiffs initiate a PUC proceeding by August 2003, the case remains stayed.
  • ASB Realty Tax Dispute: The State of Hawaii assessed approximately $14 million in franchise taxes plus interest for 1999-2001. ASB paid $17 million (treated as a deposit) and is appealing. Potential liability for 2002-2003 is estimated at $12 million if the appeal fails.
  • PaineWebber Litigation: ASB is suing PaineWebber regarding impermissible trust certificate investments. Trial is scheduled for December 2003. ASB has agreed to indemnify HEI against losses on related income notes, payable only from litigation recoveries.
• Financial Outlook:
  • Dividends: HEI maintained a quarterly dividend of $0.62 per share. Management targets a 65% payout ratio before considering increases.
  • Pension Obligations: Due to market declines, the company may be required to record a significant non-cash charge to equity (AOCI) at year-end 2003, potentially ranging from $49 million to $100 million (net of tax), depending on discount rates and asset returns.
  • Capital Expenditures: Forecast net capital expenditures for electric utilities for 2003-2007 are estimated at $0.7 billion.
• Market Risks: The bank segment faces interest rate risk; rising rates could reduce the market value of mortgage-related securities, impacting equity through AOCI, though not net income unless impairments are deemed "other-than-temporary."

Investor Verification Checklist

• HELCO Keahole Status: Monitor the Hawaii Supreme Court ruling on the land use permit appeal, which determines the recoverability of $83 million in capitalized costs.
• Pension Liability: Verify the year-end 2003 actuarial assumptions and discount rates to assess the potential magnitude of the non-cash charge to equity.
• ASB Tax Appeal: Track the outcome of the Hawaii Tax Appeal Court case regarding the $14 million franchise tax assessment.
• Interest Rate Sensitivity: Review the bank's net interest income sensitivity to rising rates, as spreads have compressed in the current low-rate environment.
• Discontinued Operations: Confirm the final disposition value of the CEPALCO investment and the total costs associated with exiting the international power business.