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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 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, HELCO, MECO) serving the Hawaiian Islands, and a banking subsidiary, American Savings Bank, F.S.B. (ASB). The company also holds discontinued operations related to its former international power business (HEI Power Corp.).

Key Financial Metrics

Segment Performance:

• Electric Utility: Revenues increased 18% to $328.9 million, driven by higher fuel costs passed to customers and a 2.5% increase in kilowatthour sales. Operating income decreased 10% to $41.0 million due to higher operating expenses and depreciation.
• Bank (ASB): Revenues decreased 4% to $95.1 million due to lower interest yields. Net income increased 1% to $13.5 million, aided by a lower provision for loan losses.

Material Changes vs. Prior Period

• Revenue Growth: Consolidated revenues rose 13% year-over-year, primarily due to the electric utility segment's 18% increase, which offset a slight decline in the bank segment.
• Profit Decline: Net income fell 9% to $24.3 million. The electric utility segment saw a 13% drop in net income due to increased pension costs, higher property insurance premiums, and environmental expenses.
• Fuel Costs: Fuel oil costs for the utility segment surged 53% to $90.8 million as the cost per barrel rose 47% to $35.91.
• Bank Spreads: ASB's interest rate spread narrowed to 3.14% from 3.27% as yields on earning assets declined faster than the cost of liabilities.

Outlook, Risks, and Contingencies

Guidance and Outlook: Management forecasts modest economic growth in Hawaii for 2003, though tourism remains vulnerable to the war in Iraq and SARS. Electric utility KWH sales growth is forecast at 1.8% for 2003. The company expects to meet financing requirements through internal cash flows and existing credit facilities.

Key Risks and Contingencies:

• HELCO Keahole Project: Construction of two combustion turbines (CT-4 and CT-5) is suspended following a Circuit Court ruling that reversed a land use permit extension. Approximately $83 million in costs are at risk if the project cannot be completed or costs are disallowed by the Public Utilities Commission (PUC). HELCO is appealing the ruling.
• Transmission Line: The Kamoku to Pukele transmission line project faces regulatory hurdles; the Board of Land and Natural Resources denied the required permit. $18 million in costs are recorded in construction in progress.
• Litigation:
  • AES Hawaii: A qui tam lawsuit alleges overcharges in a power purchase agreement. The case was stayed pending a PUC proceeding.
  • PaineWebber: ASB is litigating against PaineWebber regarding impermissible trust certificate investments. Trial is scheduled for July 2003.
  • Tax Dispute: The State of Hawaii has assessed approximately $14 million in franchise taxes against ASB for 1999-2001, plus interest. ASB has appealed.
• Pension Obligations: Declines in equity markets have reduced pension plan assets. Management projects a potential additional reduction in common equity of approximately $78 million by year-end 2003 if market conditions do not improve.

Investor Verification Checklist

• Keahole Project Status: Monitor the appeal of the Circuit Court ruling regarding the land use permit extension and the potential write-off of $83 million in capitalized costs.
• Fuel Cost Pass-Through: Verify the effectiveness of energy cost adjustment clauses in passing rising fuel costs to ratepayers.
• Bank Liquidity: Review ASB's interest rate spread management strategies and the impact of the low-interest-rate environment on net interest income.
• Legal Resolutions: Track the outcomes of the AES Hawaii qui tam suit, the PaineWebber litigation, and the state tax assessment appeal.
• Pension Funding: Assess the impact of potential additional minimum pension liabilities on the balance sheet and cash flow requirements.