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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2007, 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, HELCO, MECO) and banking (American Savings Bank, F.S.B. or ASB). The company serves the Hawaiian market, heavily influenced by tourism, federal government spending, and local economic conditions.

Key Financial Metrics

Segment Performance:

• Electric Utility: Revenues of $447.7 million; Net income of $0.5 million (down from $21.0 million in Q1 2006).
• Bank (ASB): Revenues of $104.5 million; Net income of $11.6 million (down from $16.8 million in Q1 2006).
• Other: Net loss of $5.3 million, improved from a $5.5 million loss in Q1 2006 due to a gain on the sale of Hoku Scientific shares.

Material Changes vs. Prior Period

Net income decreased by 79% year-over-year, driven primarily by a 71% decline in electric utility operating income and a 32% decline in bank operating income.

• Electric Utilities: Operating income dropped significantly due to a $12 million write-off of plant-in-service costs (CT-4 and CT-5 units at HELCO) resulting from a settlement with the Consumer Advocate. Additionally, operating and maintenance expenses increased by $15 million due to higher production maintenance and employee benefit costs. Revenues declined slightly due to lower fuel oil costs passed through to customers.
• Banking: Net interest income decreased by $3.4 million due to margin compression caused by an inverted yield curve and higher funding costs. Noninterest expenses rose by $6.5 million, primarily due to increased legal and litigation expenses.
• Tax Rate: The effective tax rate decreased to 28% in Q1 2007 from 38% in Q1 2006, largely due to state tax credits and the impact of the plant write-off.

Guidance, Outlook, and Risks

Management Commentary: Management maintains the quarterly dividend at $0.31 per share, resulting in a payout ratio of 388% for the quarter due to low net income. The company aims for a sustainable payout ratio of 65% or lower. Cash flows are expected to support operations, though the electric utilities face continued pressure from rising O&M costs and strained generation reserve margins on Oahu.

Regulatory and Operational Risks:

• Rate Cases: HECO has a pending 2007 test year rate case. HELCO received an interim rate increase in April 2007, but final approval is pending. The outcome of these cases is critical for recovering costs and maintaining earnings.
• Generation Reliability: Oahu faces a reserve capacity shortfall (estimated at 70 MW for 2007-2008), increasing the risk of outages. A new 110 MW combustion turbine is planned for 2009.
• Environmental & Legal: Ongoing investigations into the Honolulu Harbor petroleum contamination and potential costs related to the Regional Haze Rule and Clean Water Act cooling water intake requirements.
• Banking Risks: Continued margin compression due to interest rate volatility and the need to manage funding costs in a competitive deposit market.

Investor Verification Checklist

• Rate Case Outcomes: Monitor the final decisions on HECO's 2005 and 2007 test year rate cases and HELCO's 2006 test year case, as interim increases are refundable if not approved in final orders.
• Plant Write-offs: Verify if additional costs related to HELCO's CT-4 and CT-5 units will be disallowed by the Public Utilities Commission (PUC), which could trigger further write-offs.
• Generation Capacity: Track the progress of the Campbell Industrial Park generating unit (targeted for 2009) and the status of the East Oahu Transmission Project to mitigate reliability risks.
• Banking Margins: Assess the impact of the inverted yield curve on ASB's net interest margin and the trajectory of legal/litigation expenses.
• Dividend Sustainability: Evaluate whether operating cash flows can support the current dividend level given the high payout ratio in Q1 2007.