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Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 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, HELCO, MECO) serving the Hawaiian Islands and a banking subsidiary, American Savings Bank, F.S.B. (ASB). The company also reports results for "Other" operations and discontinued international power operations (HEI Power Corp.).

Key Financial Metrics (Nine Months Ended Sept 30, 2003)

Segment Performance

• Electric Utility: Revenues increased 13% to $1,042.7 million due to higher fuel costs passed to customers and a 2.1% increase in kilowatthour sales. However, operating income decreased 13% to $130.2 million due to higher operating expenses, depreciation, and a $1.6 million accrual for a potential environmental penalty.
• Bank (ASB): Revenues decreased 6% to $281.6 million. Net interest income declined due to lower yields on loans and mortgage securities, though this was partially offset by lower interest expense and higher fee income. Operating income decreased slightly to $69.9 million.
• Discontinued Operations: Reported a loss of $3.9 million, primarily driven by a $5 million writedown of the investment in CEPALCO (Philippines) and increased reserves for disposal costs.

Material Changes vs. Prior Period

• Net Income Decline: Consolidated net income fell 16% year-over-year. The decline was driven by lower operating income in the utility and bank segments and losses from discontinued operations.
• Utility Expenses: Fuel oil costs rose 34% and purchased power costs rose 13% due to higher market prices and increased generation. Other operating expenses increased 11%, largely due to higher pension costs and the environmental accrual.
• Bank Spreads: The bank's interest rate spread narrowed to 3.06% from 3.28% in the prior year due to the low interest rate environment and high prepayment rates on mortgage securities.
• Discontinued Operations: The HEI Power Corp. segment recorded significant writedowns related to its international assets, which did not occur in the same period of 2002.

Guidance, Outlook, and Risks

• Dividends: HEI maintained its quarterly dividend at $0.62 per share. Management targets a 65% payout ratio before considering increases.
• Capital Expenditures: Forecast net capital expenditures for the electric utilities for 2003-2007 are estimated at $0.7 billion. Funding is expected to come from operating cash flows and existing debt facilities.
• Regulatory & Legal Risks:
  • HELCO Keahole Project: A settlement agreement was reached to potentially restart construction of CT-4 and CT-5, subject to court approval and permit conditions. If approved, HELCO expects to incur $3.1 million in legal costs and $25 million in capital expenditures for noise mitigation and emissions control.
  • Environmental: MECO accrued $1.6 million for a potential penalty regarding opacity violations at the Maalaea Power Plant. Honolulu Harbor remediation costs are estimated at $1.1 million total, with $0.25 million incurred to date.
  • Tax Dispute: ASB is appealing a $14 million tax assessment (plus interest) regarding a dividends-received deduction. The company has paid the amount as a deposit pending the appeal outcome.
  • Interest Rate Risk: ASB is "liability sensitive," meaning rising interest rates could compress net interest margins. Management is managing this via deposit growth and liability restructuring.

Investor Verification Checklist

• HELCO Keahole Status: Verify the final court ruling on the motion to vacate the November 2002 judgment and the subsequent ability to resume construction.
• Environmental Accruals: Monitor the outcome of the MECO opacity violation hearing and the final cost allocation for the Honolulu Harbor remediation.
• Bank Tax Appeal: Track the Hawaii Tax Appeal Court proceedings regarding the $14 million franchise tax assessment against ASB.
• Pension Liability: Review year-end 2003 actuarial assumptions, as a minimum pension liability charge to equity (AOCI) may be required, potentially impacting financial ratios.
• Discontinued Operations: Confirm the final sale price and terms for the HEI Power Corp. (CEPALCO) investment to assess if further writedowns are necessary.