================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1997 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Exact Name of Registrant as Commission I.R.S. Employer Specified in Its Charter File Number Identification No. - --------------------------- ----------- ------------------ HAWAIIAN ELECTRIC INDUSTRIES, INC. 1-8503 99-0208097 and Principal Subsidiary HAWAIIAN ELECTRIC COMPANY, INC. 1-4955 99-0040500 State of Hawaii - -------------------------------------------------------------------------------- (State or other jurisdiction of incorporation or organization) 900 Richards Street, Honolulu, Hawaii 96813 - -------------------------------------------------------------------------------- (Address of principal executive offices and zip code) Hawaiian Electric Industries, Inc. ----- (808) 543-5662 Hawaiian Electric Company, Inc. -------- (808) 543-7771 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) None - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) ================================================================================ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [_] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class of Common Stock Outstanding May 7, 1997 - -------------------------------------------------------------------------------- Hawaiian Electric Industries, Inc. (Without Par Value)........31,197,869 Shares Hawaiian Electric Company, Inc. ($6 2/3 Par Value)...........12,805,843 Shares (not publicly traded) ================================================================================ Hawaiian Electric Industries, Inc. and subsidiaries Hawaiian Electric Company, Inc. and subsidiaries Form 10-Q--Quarter ended March 31, 1997 INDEX Page No. Glossary of terms............................................................................ ii PART I. FINANCIAL INFORMATION Item 1. Financial statements Hawaiian Electric Industries, Inc. and subsidiaries --------------------------------------------------- Consolidated balance sheets (unaudited) - March 31, 1997 and December 31, 1996.......................................................... 1 Consolidated statements of income (unaudited) - three months ended March 31, 1997 and 1996.................................................. 2 Consolidated statements of retained earnings (unaudited) - three months ended March 31, 1997 and 1996.................................................. 2 Consolidated statements of cash flows (unaudited) - three months ended March 31, 1997 and 1996.................................................. 3 Notes to consolidated financial statements (unaudited) ........................... 4 Hawaiian Electric Company, Inc. and subsidiaries ------------------------------------------------ Consolidated balance sheets (unaudited) - March 31, 1997 and December 31, 1996.......................................................... 9 Consolidated statements of income (unaudited) - three months ended March 31, 1997 and 1996.................................................. 10 Consolidated statements of retained earnings (unaudited) - three months ended March 31, 1997 and 1996.................................................. 10 Consolidated statements of cash flows (unaudited) - three months ended March 31, 1997 and 1996.................................................. 11 Notes to consolidated financial statements (unaudited) ........................... 12 Item 2. Management's discussion and analysis of financial condition and results of operations...................................................... 17 PART II. OTHER INFORMATION Item 1. Legal proceedings................................................................. 25 Item 4. Submission of matters to a vote of security holders............................... 25 Item 5. Other information................................................................. 26 Item 6. Exhibits and reports on Form 8-K.................................................. 27 Signatures .................................................................................. 30 i Hawaiian Electric Industries, Inc. and subsidiaries Hawaiian Electric Company, Inc. and subsidiaries Form 10-Q--Quarter ended March 31, 1997 GLOSSARY OF TERMS Terms Definitions - ----- ----------- AFUDC Allowance for funds used during construction ASB American Savings Bank, F.S.B., a wholly owned subsidiary of HEI Diversified, Inc. and parent company of American Savings Investment Services Corp., ASB Service Corporation, AdCommunications, Inc. and American Savings Mortgage Co., Inc. BIF Bank Insurance Fund BLNR Board of Land and Natural Resources of the State of Hawaii CDUP Conservation District Use Permit Company Hawaiian Electric Industries, Inc. and its direct and indirect subsidiaries, including, without limitation, Hawaiian Electric Company, Inc., Maui Electric Company, Limited, Hawaii Electric Light Company, Inc., HEI Investment Corp., Malama Pacific Corp. and its subsidiaries, Hawaiian Tug & Barge Corp., Young Brothers, Limited, HEI Diversified, Inc., American Savings Bank, F.S.B. and its subsidiaries, Pacific Energy Conservation Services, Inc., HEI Power Corp. and its subsidiaries, Hycap Management, Inc., Hawaiian Electric Industries Capital Trust I, Hawaiian Electric Industries Capital Trust II and Hawaiian Electric Industries Capital Trust III Consumer Division of Consumer Advocacy, Department of Commerce and Consumer Advocate Affairs of the State of Hawaii D&O Decision and order DOH Department of Health of the State of Hawaii Enserch Enserch Development Corporation EPA Environmental Protection Agency - federal FASB Financial Accounting Standards Board FDIC Federal Deposit Insurance Corporation FHLB Federal Home Loan Bank FICO Financing Corporation Funds Act Deposit Insurance Funds Act of 1996 GAAP Generally accepted accounting principles HECO Hawaiian Electric Company, Inc., a wholly owned electric utility subsidiary of Hawaiian Electric Industries, Inc. and parent company of Maui Electric Company, Limited, Hawaii Electric Light Company, Inc. and HECO Capital Trust I HEI Hawaiian Electric Industries, Inc., parent company of Hawaiian Electric Company, Inc., HEI Investment Corp., Malama Pacific Corp., Hawaiian Tug & Barge Corp., HEI Diversified, Inc., Pacific Energy Conservation Services, Inc., HEI Power Corp., Hycap Management, Inc., Hawaiian Electric Industries Capital Trust I, Hawaiian Electric Industries Capital Trust II and Hawaiian Electric Industries Capital Trust III ii GLOSSARY OF TERMS, continued Terms Definitions - ----- ----------- HEIDI HEI Diversified, Inc., a wholly owned subsidiary of Hawaiian Electric Industries, Inc. and the parent company of American Savings Bank, F.S.B. HEIIC HEI Investment Corp., a wholly owned subsidiary of Hawaiian Electric Industries, Inc. HEIPC HEI Power Corp., a wholly owned subsidiary of Hawaiian Electric Industries, Inc., and the parent company of several subsidiaries HELCO Hawaii Electric Light Company, Inc., a wholly owned electric utility subsidiary of Hawaiian Electric Company, Inc. HIG The Hawaiian Insurance & Guaranty Company, Limited, an insurance company which was placed in state rehabilitation proceedings. HEI Diversified, Inc. was the holder of record of HIG's common stock until August 16, 1994 HTB Hawaiian Tug & Barge Corp., a wholly owned subsidiary of Hawaiian Electric Industries, Inc. and parent company of Young Brothers, Limited IPP Independent power producer IRP Integrated resource plan IRR Interest rate risk KCP Kawaihae Cogeneration Partners KWH Kilowatthour MECO Maui Electric Company, Limited, a wholly owned electric utility subsidiary of Hawaiian Electric Company, Inc. MPC Malama Pacific Corp., a wholly owned subsidiary of Hawaiian Electric Industries, Inc. and parent company of several real estate subsidiaries MW Megawatt OTS Office of Thrift Supervision, Department of Treasury PSD Prevention of Significant Deterioration/Covered Source Permit PUC Public Utilities Commission of the State of Hawaii ROACE Return on average common equity ROR Return on rate base SAIF Savings Association Insurance Fund SEC Securities and Exchange Commission SFAS Statement of Financial Accounting Standards YB Young Brothers, Limited, a wholly owned subsidiary of Hawaiian Tug & Barge Corp. iii PART I - FINANCIAL INFORMATION - -------------------------------------------------------------------------------- Item 1. Financial statements - ----------------------------- Hawaiian Electric Industries, Inc. and subsidiaries Consolidated balance sheets (unaudited) March 31, December 31, (in thousands) 1997 1996 - -------------------------------------------------------------------------------------------------------------------------- Assets - ------ Cash and equivalents............................................................... $ 98,653 $ 97,417 Accounts receivable and unbilled revenues, net..................................... 151,720 150,858 Inventories, at average cost....................................................... 47,262 48,745 Real estate developments........................................................... 31,773 33,210 Investment and mortgage-backed securities.......................................... 1,391,167 1,377,591 Other investments.................................................................. 74,071 72,609 Loans receivable, net.............................................................. 2,036,259 2,002,028 Property, plant and equipment, net of accumulated depreciation and amortization of $912,580 and $890,055.......................... 1,951,818 1,941,767 Regulatory assets.................................................................. 103,602 100,804 Other.............................................................................. 78,316 73,776 Goodwill and other intangibles..................................................... 35,984 37,035 ------------ ------------ $6,000,625 $5,935,840 ============ ============ Liabilities and stockholders' equity - ------------------------------------ Liabilities Accounts payable................................................................... $ 118,901 $ 107,896 Deposit liabilities................................................................ 2,174,429 2,150,370 Short-term borrowings.............................................................. 103,090 216,543 Securities sold under agreements to repurchase..................................... 550,276 479,742 Advances from Federal Home Loan Bank............................................... 625,274 684,274 Long-term debt..................................................................... 801,941 810,080 Deferred income taxes.............................................................. 189,190 185,609 Unamortized tax credits............................................................ 49,196 48,857 Contributions in aid of construction............................................... 197,391 197,805 Other.............................................................................. 177,427 194,564 ------------ ------------ 4,987,115 5,075,740 ------------ ------------ HEI- and HECO-obligated preferred securities of trust subsidiaries directly or indirectly holding solely subordinated debentures of HEI, HEIDI, HECO, MECO and HELCO................................. 150,000 -- Preferred stock of electric utility subsidiaries Subject to mandatory redemption................................................ 36,260 38,955 Not subject to mandatory redemption............................................ 48,293 48,293 ------------ ------------ 234,553 87,248 ------------ ------------ Stockholders' equity Preferred stock, no par value, authorized 10,000 shares; issued: none.................................................................. -- -- Common stock, no par value, authorized 100,000 shares; issued and outstanding: 31,138 shares and 30,853 shares............................... 628,260 622,945 Retained earnings.................................................................. 150,697 149,907 ------------ ------------ 778,957 772,852 ------------ ------------ $ 6,000,625 $ 5,935,840 ============ ============ See accompanying notes to consolidated financial statements. 1 Hawaiian Electric Industries, Inc. and subsidiaries Consolidated statements of income (unaudited) (in thousands, except per share amounts and Three months ended March 31, ---------------------------- ratio of earnings to fixed charges) 1997 1996 - ----------------------------------------------------------------------------------------------------------------------- Revenues Electric utility.................................................................... $273,756 $247,837 Savings bank........................................................................ 68,912 65,792 Other............................................................................... 16,525 12,540 ----------- ----------- 359,193 326,169 ----------- ----------- Expenses Electric utility.................................................................... 235,162 209,098 Savings bank........................................................................ 56,627 55,836 Other............................................................................... 18,052 14,500 ----------- ----------- 309,841 279,434 ----------- ----------- Operating income (loss) Electric utility.................................................................... 38,594 38,739 Savings bank........................................................................ 12,285 9,956 Other............................................................................... (1,527) (1,960) ----------- ----------- 49,352 46,735 ----------- ----------- Interest expense--electric utility and other........................................ (16,465) (16,159) Allowance for borrowed funds used during construction............................... 1,527 1,350 Preferred stock dividends of electric utility subsidiaries.......................... (1,571) (1,675) Preferred securities distributions of trust subsidiaries............................ (1,335) -- Allowance for equity funds used during construction................................. 2,673 2,651 ----------- ----------- Income before income taxes.......................................................... 34,181 32,902 Income taxes........................................................................ 14,518 14,033 ----------- ----------- Net income.......................................................................... $ 19,663 $ 18,869 =========== =========== Earnings per common share........................................................... $0.64 $0.63 =========== =========== Dividends per common share.......................................................... $0.61 $0.60 =========== =========== Weighted average number of common shares outstanding................................ 30,960 29,884 =========== =========== Ratio of earnings to fixed charges (SEC method) Excluding interest on ASB deposits............................................. 1.83 1.91 =========== =========== Including interest on ASB deposits............................................. 1.55 1.54 =========== =========== Hawaiian Electric Industries, Inc. and subsidiaries Consolidated statements of retained earnings (unaudited) Three months ended March 31, ---------------------------- (in thousands) 1997 1996 - ----------------------------------------------------------------------------------------------------------------------- Retained earnings, beginning of period.............................................. $149,907 $144,216 Net income.......................................................................... 19,663 18,869 Common stock dividends.............................................................. (18,873) (17,913) ----------- ----------- Retained earnings, end of period.................................................... $150,697 $145,172 =========== =========== See accompanying notes to consolidated financial statements. 2 Hawaiian Electric Industries, Inc. and subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Three months ended March 31, ------------------------ (in thousands) 1997 1996 - ---------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income..................................................................................... $ 19,663 $ 18,869 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization of property, plant and equipment........................... 22,776 20,579 Other amortization....................................................................... 3,624 2,155 Deferred income taxes and tax credits, net............................................... 1,183 2,657 Allowance for equity funds used during construction...................................... (2,673) (2,651) Changes in assets and liabilities Decrease (increase) in accounts receivable and unbilled revenues, net.............. (862) 18,740 Decrease (increase) in inventories................................................. 1,483 (3,275) Increase in regulatory assets...................................................... (2,822) (858) Increase (decrease) in accounts payable............................................ 11,005 (1,809) Changes in other assets and liabilities............................................ (20,909) (18,617) --------- ---------- NET CASH PROVIDED BY OPERATING ACTIVITIES...................................................... 32,468 35,790 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Loans receivable originated and purchased...................................................... (70,812) (107,907) Principal repayments on loans receivable....................................................... 35,004 41,754 Proceeds from sale of loans receivable......................................................... 517 675 Held-to-maturity mortgage-backed securities purchased.......................................... (81,028) (65,112) Principal repayments on held-to-maturity mortgage-backed securities ........................... 68,630 87,104 Capital expenditures........................................................................... (30,287) (40,920) Contributions in aid of construction........................................................... 1,281 2,460 Other.......................................................................................... 517 21 --------- --------- NET CASH USED IN INVESTING ACTIVITIES.......................................................... (76,178) (81,925) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Net increase in deposit liabilities............................................................ 24,059 33,256 Net increase (decrease) in short-term borrowings with original maturities of three months or less................................................. (112,855) 25,063 Proceeds from other short-term borrowings...................................................... 390 76 Repayment of other short-term borrowings....................................................... (988) (391) Proceeds from securities sold under agreements to repurchase................................... 280,000 95,100 Repurchase of securities sold under agreements to repurchase................................... (209,100) (53,500) Proceeds from advances from Federal Home Loan Bank............................................. 217,000 -- Principal payments on advances from Federal Home Loan Bank..................................... (276,000) (77,000) Proceeds from issuance of long-term debt....................................................... 4,821 10,009 Repayment of long-term debt.................................................................... (13,000) (15,000) Proceeds from issuance of HEI- and HECO-obligated preferred securities of trust subsidiaries... 150,000 -- Redemption of electric utility subsidiaries' preferred stock................................... (2,695) (2,400) Net proceeds from issuance of common stock..................................................... 2,776 4,712 Common stock dividends......................................................................... (15,239) (12,380) Other.......................................................................................... (4,223) (4,184) --------- --------- NET CASH PROVIDED BY FINANCING ACTIVITIES...................................................... 44,946 3,361 --------- --------- Net increase (decrease) in cash and equivalents................................................ 1,236 (42,774) Cash and equivalents, beginning of period...................................................... 97,417 130,833 --------- --------- Cash and equivalents, end of period............................................................ $ 98,653 $ 88,059 ========= ========= See accompanying notes to consolidated financial statements. 3 Hawaiian Electric Industries, Inc. and subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1997 and 1996 (Unaudited) - -------------------------------------------------------------------------------- (1) BASIS OF PRESENTATION - ------------------------- The accompanying unaudited consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Securities and Exchange Commission (SEC) Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the balance sheet and the reported amounts of revenues and expenses for the period. Actual results could differ significantly from those estimates. The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto incorporated by reference in HEI's Annual Report on SEC Form 10-K for the year ended December 31, 1996. In the opinion of HEI's management, the accompanying unaudited consolidated financial statements contain all material adjustments required by GAAP to present fairly the Company's financial position as of March 31, 1997 and December 31, 1996, and the results of its operations and its cash flows for the three months ended March 31, 1997 and 1996. All such adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q or other referenced material. Results of operations for interim periods are not necessarily indicative of results for the full year. (2) ELECTRIC UTILITY SUBSIDIARY - -------------------------------- For Hawaiian Electric Company, Inc.'s consolidated financial information, including its commitments and contingencies, see pages 9 through 16. (3) SAVINGS BANK SUBSIDIARY - ---------------------------- SELECTED CONSOLIDATED FINANCIAL INFORMATION American Savings Bank, F.S.B. and subsidiaries Income statement data Three months ended March 31, --------------------------- (in thousands) 1997 1996 - ----------------------------------------------------------------------------------------------- Interest income..................................................... $65,200 $62,080 Interest expense.................................................... 37,820 37,538 -------- --------- NET INTEREST INCOME................................................. 27,380 24,542 Provision for loan losses........................................... (1,189) (420) Other income........................................................ 3,712 3,712 Operating, administrative and general expenses...................... (17,618) (17,878) --------- --------- OPERATING INCOME.................................................... 12,285 9,956 Income taxes........................................................ 5,186 4,166 -------- --------- NET INCOME.......................................................... $ 7,099 $ 5,790 ======== ========= 4 American Savings Bank, F.S.B. and subsidiaries Balance sheet data March 31, December 31, (in thousands) 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- Assets Cash and equivalents.............................................................. $ 90,575 $ 93,905 Held-to-maturity investment securities............................................ 38,188 37,518 Held-to-maturity mortgage-backed securities....................................... 1,351,766 1,340,073 Loans receivable, net............................................................. 2,036,259 2,002,028 Other............................................................................. 80,897 80,128 Goodwill and other intangibles.................................................... 35,984 37,035 ------------ ------------ $ 3,633,669 $ 3,590,687 ============ ============ Liabilities and equity Deposit liabilities............................................................... $ 2,174,429 $ 2,150,370 Securities sold under agreements to repurchase.................................... 550,276 479,742 Advances from Federal Home Loan Bank.............................................. 625,274 684,274 Other............................................................................. 57,474 54,251 ------------ ------------ 3,407,453 3,368,637 Common stock equity............................................................... 226,216 222,050 ------------ ------------ $ 3,633,669 $ 3,590,687 ============ ============ Deposit-insurance premiums and regulatory developments The deposit accounts of ASB and other thrifts are insured by the Savings Association Insurance Fund (SAIF). The deposit accounts of commercial banks are insured by the Bank Insurance Fund (BIF). The SAIF and BIF are administered by the Federal Deposit Insurance Corporation (FDIC). On September 30, 1996, President Clinton signed into law the Deposit Insurance Funds Act of 1996 (Funds Act), which required the FDIC to impose a one-time special assessment on SAIF members in an amount sufficient to increase the SAIF reserve ratio to 1.25% of aggregate insured deposits as of October 1, 1996. In addition, effective January 1, 1997, the Funds Act provided that the assessment base for raising funds to pay interest on obligations issued by the Financing Corporation (FICO) is to be expanded to include the deposits of banks as well as thrifts. The provisions of the Funds Act should enable SAIF institutions to achieve, over time, parity with BIF institutions in the schedules of the premiums to be paid for deposit insurance coverage and to fund FICO interest obligations. The FDIC set the one-time special assessment for SAIF deposits at 65.7 cents per $100 of deposits, to be applied against insured deposits held by SAIF institutions as of March 31, 1995. ASB's special assessment was $8.3 million after tax, and was accrued in September 1996. In December 1996, the FDIC adopted a risk-based assessment schedule for SAIF institutions, effective January 1, 1997, that was identical to the existing base rate schedule for BIF institutions: zero to 27 cents per $100 of deposits. Added to this base rate schedule through 1999 will be the assessment to fund the FICO's interest obligations of 6.5 cents per $100 of deposits for SAIF institutions and 1.3 cents per $100 of deposits for BIF institutions (subject to quarterly adjustment). By law, the FICO rate on BIF-assessable deposits must be one-fifth the rate on SAIF-assessable deposits until the insurance funds are merged or until January 1, 2000, whichever occurs first, at which time the FICO interest obligation for both banks and thrifts should thereafter be identical, at a currently estimated rate of 2.4 cents per $100 of deposits. As a "well-capitalized" thrift, ASB's base deposit-insurance premium effective January 1, 1997 is zero and its assessment for funding FICO interest payments is 6.5 cents per $100 of deposits, compared to payments that would have been calculated at 23 cents per $100 of deposits under the premium schedule in effect during the first three quarters of 1996. The Funds Act provides that the SAIF and BIF will be merged into the Deposit Insurance Fund by January 1, 1999, but only if no insured depository institution is a thrift on that date. The Funds Act leaves to subsequent legislation, however, the manner in which thrift charters might be eliminated in favor of a bank or some other form of charter. Certain of the legislative proposals advanced to address this issue, if adopted, could have a material adverse effect on the Company. For example, if thrift charters are eliminated and ASB obtains a bank charter, HEI and its subsidiaries might become subject 5 to the restrictions on the permissible activities of a bank holding company. While certain of the proposals that have been advanced would grandfather the activities of existing savings and loan holding companies such as HEI, management cannot predict whether or in what form any of these proposals might ultimately be adopted or the extent to which the business of HEI or ASB might be affected. (4) REAL ESTATE SUBSIDIARY - --------------------------- MPC and its subsidiaries' total real estate project inventory, equity investment in real estate joint ventures and loans and advances to unconsolidated joint ventures or joint venture partners amounted to $45 million and $46 million at March 31, 1997 and December 31, 1996, respectively. The amounts MPC will ultimately realize relative to these real estate investments could differ materially from the recorded amounts as of March 31, 1997. At March 31, 1997, MPC or its subsidiaries had issued (i) guarantees under which they were jointly and severally contingently liable with their joint venture partners for $2.1 million of outstanding loans and (ii) payment guarantees under which MPC or its subsidiaries were severally contingently liable for $5.6 million of outstanding loans and $2.9 million of additional undrawn loan facilities. All such loans are collateralized by real property. At March 31, 1997, HEI had agreed with the lenders of construction loans and loan facilities, of which approximately $8.0 million was outstanding and $3.8 million was undrawn, that it will maintain ownership of l00% of the stock of MPC and that it intends, subject to good and prudent business practices, to keep MPC financially sound and responsible to meet its obligations as guarantor. (5) HEI- AND HECO-OBLIGATED PREFERRED SECURITIES OF TRUST SUBSIDIARIES - ---------------------------------------------------------------------- DIRECTLY OR INDIRECTLY HOLDING SOLELY SUBORDINATED DEBENTURES OF HEI, --------------------------------------------------------------------- HEIDI, HECO, MECO AND HELCO --------------------------- In February 1997, Hawaiian Electric Industries Capital Trust I (the Trust), a grantor trust, issued and sold, in an underwritten registered public offering, 4 million of its 8.36% Company-obligated preferred securities (trust preferred securities), representing preferred undivided beneficial ownership interests in the assets of the Trust. HEI owns 100% of the common securities of the Trust. The Trust utilized the proceeds from the issuance of the trust preferred securities ($100 million) and the trust common securities ($3.2 million) to purchase all the limited partner interests in HEI Preferred Funding, LP (the Partnership). Hycap Management, Inc. (Hycap), a wholly owned subsidiary of HEI, is the sole general partner of the Partnership. Substantially all of the proceeds from the sale of the limited partner interests and the general partner interest were used by the Partnership to purchase 8.36% junior subordinated debentures of HEI and HEIDI due in 2017 in the aggregate principal amount of $120.1 million. The limited partner interests in the Partnership is the sole asset of the Trust. HEI and HEIDI's junior subordinated debentures represent substantially all of the assets of the Partnership. In connection with these transactions, HEI issued subordinated guarantees relating to the performance of certain obligations by the Trust, the Partnership and HEIDI. HEI's obligations under the agreements related to the issuances of such securities, taken together, effectively constitute a full and unconditional guarantee on a subordinated basis by HEI of amounts due on the trust preferred securities. The debentures issued by HEI and HEIDI to the Partnership, the interests in the Partnership, HEI's investment in Hycap and the common securities of the Trust owned by HEI have been eliminated in the Company's consolidated balance sheet as of March 31, 1997. In March 1997, HECO Capital Trust I, a grantor trust, issued and sold, in an underwritten registered public offering, 2 million of its 8.05% cumulative quarterly income preferred securities with an aggregate liquidation value of $50 million. See note (2) in HECO's "Notes to consolidated financial statements" for a discussion of the HECO-obligated preferred securities of trust subsidiary holding solely subordinated debentures of HECO, MECO and HELCO. 6 (6) CASH FLOWS - --------------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid for interest (net of capitalized amounts) and income taxes was as follows: Three months ended March 31, ----------------------- (in thousands) 1997 1996 - --------------------------------------------------------------------------------------------------------- Interest (including interest paid by savings bank, but excluding interest paid on nonrecourse debt on leveraged leases)...................... $47,604 $49,203 =========== ========== Interest on nonrecourse debt from leveraged leases............................ $198 $182 =========== ========== Income taxes.................................................................. $4,822 $860 =========== ========== SUPPLEMENTAL DISCLOSURES OF NONCASH ACTIVITIES Common stock dividends reinvested by shareholders in HEI common stock in noncash transactions amounted to $3.6 million and $5.5 million for the three months ended March 31, 1997 and 1996, respectively. The allowance for equity funds used during construction, which was capitalized as part of the cost of electric utility plant, amounted to $2.7 million for each of the three months ended March 31, 1997 and 1996. (7) ACCOUNTING CHANGES - ----------------------- ENVIRONMENTAL REMEDIATION LIABILITIES In October 1996, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 96-1, "Environmental Remediation Liabilities." The provisions of the SOP are consistent with the Company's current policies and, accordingly, adoption of the SOP on January 1, 1997 did not have a material effect on the Company's financial condition, results of operations or liquidity. EARNINGS PER SHARE In February 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share". SFAS No. 128 is effective for both interim and annual periods ending after December 15, 1997. The Company will adopt SFAS No. 128 in the fourth quarter of 1997. SFAS No. 128 requires the presentation of "Basic" earnings per share, representing income available to common shareholders divided by the weighted average number of common shares outstanding for the period, and "Diluted" earnings per share, which is similar to the current presentation of fully diluted earnings per share. SFAS No. 128 requires restatement of all prior period earnings per share data presented. Management does not expect adoption of SFAS No. 128 to have a material impact on the Company's reported earnings per share, financial position, results of operations or liquidity. CAPITAL STRUCTURE In February 1997, the FASB issued SFAS No. 129, "Disclosure of Information about Capital Structure", which lists required disclosures about capital structure that had been included in a number of previously existing statements and opinions. SFAS No. 129 is effective for periods ending after December 15, 1997. The Company will adopt the provisions of SFAS No. 129 in its financial statements for 1997 and does not expect that its adoption will have a material effect on the Company's financial condition, results of operations or liquidity. 7 (8) CONTINGENCIES - ----------------- ENVIRONMENTAL REGULATION By letters in January and February 1995, the Department of Health of the State of Hawaii (DOH) advised HECO, HTB, YB and others that it was conducting an investigation to determine the nature and extent of actual or potential releases of hazardous substances, oil, pollutants or contaminants at or near Honolulu Harbor and requested information regarding past hazardous substances and oil spills that may have occurred. HECO, HTB and YB provided responses to the DOH letters. The DOH issued letters in December 1995, indicating that it had identified a number of parties, including HECO, HTB and YB, who appear to be either potentially responsible for the contamination and/or operate their facilities upon contaminated land. The DOH met with these identified parties in January 1996 to inform them of its findings and to establish the framework to determine remedial and cleanup requirements. A Technical Workgroup (comprised of certain of the parties identified in the December 1995 DOH letter, including HECO, Chevron U.S.A. Inc., Shell Oil Products Company and others) was formed to conduct independent voluntary investigations relative to this issue. Because the process for determining the nature and extent of any contamination, the responsible parties and the appropriate remedial and cleanup action, if any, is at an early stage, management cannot predict at this time the extent to which the costs of further site analysis or future remediation and cleanup requirements will be borne by HECO or YB, nor can it estimate when any such costs would be incurred. Certain of such costs if incurred by HECO or YB may be claimed and covered under insurance policies, but such coverage is not determinable at this time. THE HAWAIIAN INSURANCE & GUARANTY COMPANY, LIMITED The Hawaiian Insurance & Guaranty Company, Limited (HIG) and its subsidiaries (collectively, the HIG Group) are property and casualty insurance companies. HEIDI was the holder of record of all the common stock of HIG until August 16, 1994. In December 1992, due to a significant increase in the estimate of policyholder claims from Hurricane Iniki, the HEI Board of Directors concluded it would not contribute additional capital to HIG and the remaining investment in the HIG Group was written off. On December 24, 1992, a formal rehabilitation order vested full control over the HIG Group in the Insurance Commissioner of the State of Hawaii (the Rehabilitator) and her deputies. A lawsuit stemming from this situation was settled in 1994, with the Company making a settlement payment of $32 million to the Rehabilitator. HEI and HEIDI are seeking reimbursement for the settlement and defense costs from their insurance carriers. One of the insurance carriers filed a declaratory relief action in the U.S. District Court for Hawaii seeking resolution of insurance coverage and other policy issues, and HEI and HEIDI filed counterclaims. The U.S. District Court has acted on several motions for partial summary judgment filed by HEI, HEIDI and the insurance carrier. The remaining issues are scheduled for trial on July 28, 1997. Recoveries from HEI's insurance carriers, if any, will be recognized when realized. 8 Hawaiian Electric Company, Inc. and subsidiaries CONSOLIDATED BALANCE SHEETS (UNAUDITED) March 31, December 31, (in thousands, except par value) 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- Assets Utility plant, at cost Land.................................................................... $ 29,914 $ 29,897 Plant and equipment..................................................... 2,477,978 2,446,073 Less accumulated depreciation and amortization.......................... (849,209) (828,917) Plant acquisition adjustment, net....................................... 601 614 Construction in progress................................................ 196,463 197,835 ---------------------- ---------------------- Net utility plant................................................. 1,855,747 1,845,502 ---------------------- ---------------------- Current assets Cash and equivalents.................................................... 3,308 823 Customer accounts receivable, net ...................................... 77,560 76,578 Accrued unbilled revenues, net.......................................... 41,686 43,726 Other accounts receivable, net.......................................... 4,797 4,179 Fuel oil stock, at average cost......................................... 27,107 28,490 Materials and supplies, at average cost................................. 18,813 18,942 Prepayments and other................................................... 3,627 3,676 ---------------------- ---------------------- Total current assets.............................................. 176,898 176,414 ---------------------- ---------------------- Other assets Regulatory assets....................................................... 101,216 98,380 Other................................................................... 49,385 45,250 ---------------------- ---------------------- Total other assets................................................ 150,601 143,630 ---------------------- ---------------------- $2,183,246 $2,165,546 ====================== ====================== Capitalization and liabilities Capitalization Common stock, $6 2/3 par value, authorized 50,000 shares; outstanding 12,806 shares............................. $ 85,387 $ 85,387 Premium on capital stock................................................ 297,060 298,154 Retained earnings....................................................... 369,872 367,770 ---------------------- ---------------------- Common stock equity............................................... 752,319 751,311 Cumulative preferred stock Not subject to mandatory redemption.................................. 48,293 48,293 Subject to mandatory redemption...................................... 34,565 36,160 HECO-obligated preferred securities of trust subsidiary holding solely subordinated debentures of HECO, MECO and HELCO............... 50,000 -- Long-term debt, net..................................................... 594,087 589,226 ---------------------- ---------------------- Total capitalization.............................................. 1,479,264 1,424,990 ---------------------- ---------------------- Current liabilities Long-term debt due within one year...................................... -- 13,000 Preferred stock sinking fund payments................................... 1,695 2,795 Short-term borrowings - nonaffiliates................................... 79,165 125,920 Short-term borrowings - affiliate....................................... 28,200 -- Accounts payable........................................................ 67,389 66,062 Interest and preferred dividends payable................................ 16,311 11,034 Taxes accrued........................................................... 50,500 55,586 Other................................................................... 18,969 24,843 ---------------------- ---------------------- Total current liabilities......................................... 262,229 299,240 ---------------------- ---------------------- Deferred credits and other liabilities Deferred income taxes................................................... 119,339 119,613 Unamortized tax credits................................................. 47,964 47,634 Other................................................................... 77,059 76,264 ---------------------- ---------------------- Total deferred credits and other liabilities...................... 244,362 243,511 ---------------------- ---------------------- Contributions in aid of construction....................................... 197,391 197,805 ---------------------- ---------------------- $2,183,246 $2,165,546 ====================== ====================== See accompanying notes to HECO's consolidated financial statements. 9 Hawaiian Electric Company, Inc. and subsidiaries CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three months ended March 31, -------------------------------------- (in thousands, except for ratio of earnings to fixed charges) 1997 1996 - ---------------------------------------------------------------------------------------------------------------------------- OPERATING REVENUES................................................................. $271,597 $245,944 -------- -------- OPERATING EXPENSES Fuel oil........................................................................... 69,220 53,622 Purchased power.................................................................... 70,751 67,807 Other operation.................................................................... 36,911 33,591 Maintenance........................................................................ 12,063 11,945 Depreciation and amortization...................................................... 20,497 18,343 Taxes, other than income taxes..................................................... 25,637 23,708 Income taxes....................................................................... 11,704 12,233 -------- -------- 246,783 221,249 -------- -------- OPERATING INCOME................................................................... 24,814 24,695 -------- -------- OTHER INCOME Allowance for equity funds used during construction................................ 2,673 2,651 Other, net......................................................................... 2,071 1,851 -------- -------- 4,744 4,502 -------- -------- INCOME BEFORE INTEREST AND OTHER CHARGES........................................... 29,558 29,197 -------- -------- INTEREST AND OTHER CHARGES Interest on long-term debt......................................................... 9,859 8,528 Amortization of net bond premium and expense....................................... 327 315 Other interest charges............................................................. 2,106 2,490 Allowance for borrowed funds used during construction.............................. (1,527) (1,350) Preferred stock dividends of subsidiaries.......................................... 650 702 Preferred securities distributions of trust subsidiary............................. 58 -- -------- -------- 11,473 10,685 -------- -------- INCOME BEFORE PREFERRED STOCK DIVIDENDS OF HECO.................................... 18,085 18,512 Preferred stock dividends of HECO.................................................. 921 973 ---------- -------- NET INCOME FOR COMMON STOCK........................................................ $ 17,164 $ 17,539 ========== ======== Ratio of earnings to fixed charges (SEC method).................................... 3.08 3.32 ========== ======== Hawaiian Electric Company, Inc. and subsidiaries CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (UNAUDITED) Three months ended March 31, ----------------------------- (in thousands) 1997 1996 - ------------------------------------------------------------------------------------------------------------------------ RETAINED EARNINGS, BEGINNING OF PERIOD............................................. $367,770 $343,425 Net income for common stock........................................................ 17,164 17,539 Common stock dividends............................................................. (15,062) (11,054) -------- -------- RETAINED EARNINGS, END OF PERIOD................................................... $369,872 $349,910 ======== ======== HEI owns all the common stock of HECO. Therefore, per share data with respect to shares of common stock of HECO are not meaningful. See accompanying notes to HECO's consolidated financial statements. 10 Hawaiian Electric Company, Inc. and subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Three months ended March 31, -------------------------------- (in thousands) 1997 1996 - ------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Income before preferred stock dividends of HECO.................................... $ 18,085 $ 18,512 Adjustments to reconcile income before preferred stock dividends of HECO to net cash provided by operating activities Depreciation and amortization of property, plant and equipment....................................................... 20,497 18,343 Other amortization........................................................... 2,502 1,219 Deferred income taxes........................................................ (274) 838 Tax credits, net............................................................. 739 920 Allowance for equity funds used during construction.......................... (2,673) (2,651) Changes in assets and liabilities Decrease (increase) in accounts receivable.............................. (1,600) 9,603 Decrease in accrued unbilled revenues................................... 2,040 9,552 Decrease (increase) in fuel oil stock................................... 1,383 (2,793) Decrease (increase) in materials and supplies........................... 129 (343) Increase in regulatory assets........................................... (2,822) (858) Increase in accounts payable............................................ 1,327 1,654 Increase in interest and preferred dividends payable.................... 5,277 1,939 Changes in other assets and liabilities................................. (17,057) (17,201) --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES.......................................... 27,553 38,734 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures............................................................... (28,144) (39,046) Contributions in aid of construction............................................... 1,281 2,460 Payments on (issuance of) notes receivable......................................... 1,191 (312) --------- --------- NET CASH USED IN INVESTING ACTIVITIES.............................................. (25,672) (36,898) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Common stock dividends............................................................. (15,062) (11,054) Preferred stock dividends.......................................................... (921) (973) Proceeds from issuance of HECO-obligated preferred securities of trust subsidiary.. 50,000 -- Proceeds from issuance of long-term debt........................................... 4,821 9 Repayment of long-term debt........................................................ (13,000) -- Redemption of preferred stock...................................................... (2,695) (2,400) Net increase (decrease) in short-term borrowings from nonaffiliates and affiliate with original maturities of three months or less.................. (18,555) 18,257 Other.............................................................................. (3,984) (4,002) --------- --------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES................................ 604 (163) --------- --------- Net increase in cash and equivalents............................................... 2,485 1,673 Cash and equivalents, beginning of period.......................................... 823 20 --------- --------- CASH AND EQUIVALENTS, END OF PERIOD................................................ $ 3,308 $ 1,693 ========= ========= See accompanying notes to HECO's consolidated financial statements. 11 Hawaiian Electric Company, Inc. and subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1997 and 1996 (Unaudited) - -------------------------------------------------------------------------------- (1) BASIS OF PRESENTATION - -------------------------- The accompanying unaudited consolidated financial statements have been prepared in conformity with GAAP for interim financial information and with the instructions to SEC Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the balance sheet and the reported amounts of revenues and expenses for the period. Actual results could differ significantly from those estimates. The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto incorporated by reference in HECO's Annual Report on SEC Form 10-K for the year ended December 31, 1996. In the opinion of HECO's management, the accompanying unaudited consolidated financial statements contain all material adjustments required by GAAP to present fairly the financial position of HECO and its subsidiaries as of March 31, 1997 and December 31, 1996, and the results of their operations and their cash flows for the three months ended March 31, 1997 and 1996. All such adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q or other referenced material. Results of operations for interim periods are not necessarily indicative of results for the full year. (2) HECO-OBLIGATED PREFERRED SECURITIES OF TRUST SUBSIDIARY HOLDING SOLELY - --------------------------------------------------------------------------- SUBORDINATED DEBENTURES OF HECO, MECO and HELCO ----------------------------------------------- In March 1997, HECO Capital Trust I, a grantor trust, issued and sold, in an underwritten registered public offering, 2 million of its 8.05% cumulative quarterly income preferred securities (trust preferred securities), Series 1997, with an aggregate liquidation value of $50 million. HECO Capital Trust I also issued shares of common securities to HECO with an aggregate liquidation value of approximately $2 million. Proceeds from the offering of the trust preferred securities and the issuance of the common securities were used by HECO Capital Trust I to purchase 8.05% junior subordinated deferrable interest debentures Series 1997 (junior deferrable debentures) issued by HECO, MECO and HELCO with a face value of approximately $52 million and a maturity date of 2027. The only assets of HECO Capital Trust I are the junior deferrable debentures. In connection with these transactions, HECO issued subordinated guarantees relating to the performance of obligations by HECO Capital Trust I, MECO and HELCO. HECO's obligations under the agreements related to the issuances of such securities, taken together, effectively constitute a full and unconditional guarantee on a subordinated basis by HECO of amounts due under the trust preferred securities. The junior deferrable debentures issued by HECO, MECO and HELCO to HECO Capital Trust I and the common securities of HECO Capital Trust I owned by HECO have been eliminated in HECO's consolidated balance sheet as of March 31, 1997. (3) CASH FLOWS - --------------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid for interest (net of capitalized amounts) and income taxes was as follows: Three months ended March 31, -------------------------- (in thousands) 1997 1996 - -------------------------------------------------------------------------------------------------------------------- Interest........................................................................... $6,244 $7,906 ======= ======= Income taxes....................................................................... $306 $711 ======= ======= 12 SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES The allowance for equity funds used during construction, which was capitalized as part of the cost of electric utility plant, amounted to $2.7 million for each of the three months ended March 31, 1997 and 1996. (4) COMMITMENTS AND CONTINGENCIES - ---------------------------------- HELCO POWER SITUATION BACKGROUND. In 1991, HELCO identified the need, beginning in 1994, for - ---------- additional generation to provide for forecast load growth while maintaining a satisfactory generation reserve margin, to address uncertainties about future deliveries of power from existing firm power producers and to permit the retirement of older generating units. Accordingly, HELCO proceeded with plans to install at its Keahole power plant site two 20-megawatt (MW) combustion turbines (CT-4 and CT-5), followed by an 18-MW heat steam recovery generator (ST-7), at which time these units would be converted to a 56-MW (net) combined-cycle unit. In January 1994, the Public Utilities Commission of the State of Hawaii (PUC) approved expenditures for CT-4, which HELCO had planned to install in late 1994. Despite HELCO's best efforts to install this additional generation, the schedule for the installation of HELCO's phased combined-cycle unit at the Keahole power plant site has been revised due to delays in (a) obtaining approval from the Hawaii Board of Land and Natural Resources (BLNR) of a Conservation District Use Permit (CDUP) amendment and (b) obtaining from the DOH and the U.S. Environmental Protection Agency (EPA) an air quality Prevention of Significant Deterioration/Covered Source (PSD) permit for the Keahole power plant site. CDUP AMENDMENT. On January 3, 1997, the Third Circuit Court of the State of - -------------- Hawaii issued a decision on HELCO's appeal of an order of the BLNR. The decision in effect allows HELCO to use its Keahole property as requested in its application for the CDUP amendment. Entry of final judgment on all unresolved issues is pending. While this decision is subject to appeal upon entry of final judgment, management believes that HELCO will ultimately prevail and the decision will be upheld. PSD PERMIT. In a November 1995 letter to the DOH, the EPA declined to sign - ---------- HELCO's PSD permit for the combined-cycle unit on the basis that a different emission control technology should be used. HELCO then proposed to reduce net nitrogen oxide emission increases resulting from the addition of the combined- cycle unit by retiring and/or reducing the use of certain existing Keahole diesel units. The EPA stated that it found the netting proposal procedurally and substantively acceptable, and that if emission increases were kept below significance levels, it would not require the use of any particular emission control technology. In December 1996, the DOH proposed a revised draft air permit which reflected HELCO's netting proposal and was acceptable to HELCO. A public hearing relating to the modifications in the revised draft permit was held on March 3, 1997. Based on the proceedings to date, management believes that HELCO will obtain the required PSD permit. DECLARATORY JUDGMENT ACTION. On February 5, 1997, the Keahole Defense Coalition - --------------------------- and three individuals filed a lawsuit in the Third Circuit Court of the State of Hawaii against HELCO, the director of the DOH, and the BLNR, seeking declaratory rulings that, with regard to the Keahole project, one or more of the defendants had violated, or could not allow the plant to operate without violating, the State Clean Air Act, the State Noise Pollution Act, conditions of HELCO's conditional use permit, covenants of HELCO's land patent and Hawaii administrative rules regarding standard conditions applicable to land permits. While management believes the allegations are without merit, it is too early to predict the outcome of this lawsuit. HELCO has filed its answer, and intends to vigorously defend against the claims raised. IPP COMPLAINTS. Two independent power producers (IPPs), Kawaihae Cogeneration - -------------- Partners (KCP) and Enserch Development Corporation (Enserch), filed separate complaints against HELCO with the PUC in 1993 and 1994, respectively, alleging that they are entitled to power purchase contracts to provide HELCO with additional capacity which they claim would be a substitute for HELCO's planned 56-MW combined-cycle unit at Keahole. Under HELCO's current estimate of generating capacity requirements, there is a near term need for capacity in addition to the capacity which might be provided by either of the proposed IPP units. In September 1995, the PUC allowed HELCO to continue to pursue construction of and commit expenditures for the second combustion turbine (CT-5) and the steam recovery generator (ST-7) for its planned combined-cycle unit, stating in its order that "no part of the project may be included in 13 HELCO's rate base unless and until the project is in fact installed, and is used and useful for utility purposes." In view of permitting delays and the need for power, the PUC also ordered HELCO to continue negotiating with the IPPs and directed that the facility to be built (i.e., either HELCO's or one of the IPPs') should be the one that can be most expeditiously put into service at "allowable cost." On January 26, 1996, the PUC ordered HELCO to continue in good faith to negotiate a power purchase agreement with KCP. Status reports were filed with the PUC in March 1996. On December 12, 1996, KCP filed directly with the PUC a new proposal pursuant to which it would construct a facility and have HELCO operate and manage the facility. Although the new proposal had not been submitted to or negotiated with HELCO, KCP asked the PUC to compel HELCO to enter into the agreement. On December 19, 1996, HELCO filed a Motion to Dismiss or to extend the time for responding. On March 10, 1997, the PUC denied KCP's motion to compel HELCO to enter into KCP's proposed agreement, noting that KCP's proposal was in the nature of a lease of a generating facility, rather than a power purchase agreement within the purview of the Public Utility Regulatory Policies Act of 1978. The PUC Order also confirmed the importance of placing the next generating unit on line as quickly as possible to meet the recognized generation shortfall on the island of Hawaii, and directed KCP and HELCO to resume negotiations aimed at finalizing a power purchase agreement. The Order directed HELCO and KCP to submit to the PUC, within 45 days of the Order, either a finalized power purchase agreement or a written report on the matters preventing an agreement, including specific positions on each disputed issue, as to which the parties may request a hearing or submit to the PUC for resolution. KCP and HELCO filed their written reports on April 24 and 25, 1997, respectively. KCP has requested a hearing to resolve the remaining issues. On October 4, 1996, the PUC issued its D&O that, among other things, required HELCO and Enserch to continue to negotiate on an expeditious basis and, within 75 days, to submit to the PUC either a finalized power purchase agreement or reports on matters that are preventing the finalization of an agreement. The parties were not able to finalize a power purchase agreement within the 75 days and, accordingly, filed status reports with the PUC on December 24, 1996. Negotiations are ongoing, and the parties have continued to update the PUC on the status of the negotiations. On April 1, 1997, Hilo Coast Processing Company (HCPC) filed a complaint against HELCO with the PUC, requesting an immediate hearing on HCPC's offer for a new 20-year power purchase contract for its existing facility, which is proposed to be expanded from 22 MW to 32 MW. HCPC's existing power purchase agreement is scheduled to terminate at the end of 1999. HELCO's answer to the complaint is due at the end of May 1997. Management cannot determine at this time whether the negotiations with the IPPs and related PUC proceedings will result in a power purchase agreement. COSTS INCURRED. As of March 31, 1997, HELCO's costs incurred in its efforts to - -------------- put into service its combined-cycle unit amounted to $50.6 million, including approximately $26.8 million for equipment and material purchases, approximately $10.5 million for planning, engineering, permitting, site development and other costs and approximately $13.3 million as an allowance for funds used during construction. CONTINGENCY PLANNING. In June 1995, HELCO filed with the PUC its generation - -------------------- resource contingency plan detailing alternatives and mitigation measures to address possible further delays in obtaining the permits necessary to construct its combined-cycle unit. HELCO arranged for additional firm capacity to be provided by its existing firm power producers, obtained contracts shifting loads to off-peak hours, deferred generation unit retirements and, in January 1996, began the implementation of its energy-efficiency demand-side management programs. These measures have helped HELCO maintain its reserve margin and reduce the risk of capacity shortages. In January 1996, the PUC opened a proceeding to evaluate HELCO's contingency resource plan and HELCO's efforts to insure system reliability. HELCO filed reports in March and October 1996 and April 1997 to update the PUC on its contingency plan and its implementation. ENVIRONMENTAL REGULATION See note (8), "Contingencies," in HEI's "Notes to consolidated financial statements." 14 PUC SHOW CAUSE ORDER FOR HECO On March 10, 1997, the PUC issued a show cause order to HECO requesting information to assist the PUC in determining if it should reduce HECO's rates and require HECO to refund any excess earnings to its ratepayers. In the order, the PUC cites that for 1996 HECO recorded a return on average common equity (ROACE) of 11.93% and a simple average rate of return on rate base (ROR) of 9.70% which exceeded the 11.40% ROACE and the 9.16% ROR determined to be reasonable by the PUC in the utility's last rate case. The PUC also compared HECO's 1994, 1995 and 1996 actual results of operations (for ratemaking purposes) with the projected results of operations that the PUC used in approving electric rates in HECO's last two rate cases. The PUC stated that those results appeared to indicate that it is unlikely that the ROR experienced by HECO in 1996 will decrease significantly in the future and that it is therefore appropriate to examine HECO's rate of return. The revenues recorded by HECO during 1996 were based on rates approved in a final PUC D&O in HECO's 1995 test year rate case. The amount of 1996 net income represented by the difference between the actual ROR of 9.70% and the 9.16% determined reasonable in December 1995 by the PUC was less than $4.5 million. It would be highly unusual if this show cause order were to result in a refund to customers based on a retroactive calculation. By contrast, the refund of $10 million of revenues, which was ordered by the PUC in December of 1995 and refunded in the first half of 1996, related to revenues that had been collected under interim rate orders in which the PUC clearly stated that revenues collected under the interim orders were subject to refund. On April 7, 1997, HECO filed its response to the PUC's order. HECO indicated the reported RORs for 1995 and 1996 were higher than the return used to determine the 1995 test year revenue requirements primarily due to the impact in 1995 of higher kilowatthour sales because of warmer than normal weather, and the impact in 1996 of higher kilowatthour sales because of normal expected sales growth, increased military sales and warmer than normal weather. HECO also reported that its pro forma results for 1997 projects a ROR (for ratemaking purposes) of 9.39%. HECO indicated that the return it expects to earn in 1997 is within the "zone of reasonableness" and should not be deemed excessive. Among other things, HECO explained that the weighted average cost of capital in 1997 should be higher than the 9.16% found to be reasonable in HECO's 1995 test year rate case, because a higher ROACE is appropriate under 1997 market conditions. HECO also pointed out that it is not compensated in those years when its actual results fall below returns that were found to be reasonable in the most recent rate case. Management cannot predict the PUC's assessment of HECO's response or what future PUC action may be taken in this proceeding. (5) ACCOUNTING CHANGES - ----------------------- ENVIRONMENTAL REMEDIATION LIABILITIES In October 1996, the American Institute of Certified Public Accountants issued SOP 96-1, "Environmental Remediation Liabilities." The provisions of the SOP are consistent with HECO and its subsidiaries' current policies and, accordingly, adoption of the SOP on January 1, 1997 did not have a material effect on HECO's consolidated financial condition, results of operations or liquidity. CAPITAL STRUCTURE In February 1997, the FASB issued SFAS No. 129, "Disclosure of Information about Capital Structure", which lists required disclosures about capital structure that had been included in a number of previously existing statements and opinions. SFAS No. 129 is effective for periods ending after December 15, 1997. HECO and its subsidiaries' will adopt the provisions of SFAS No. 129 in its financial statements for 1997 and does not expect the adoption will have a material effect on HECO's consolidated financial condition, results of operations or liquidity. 15 (6) SUMMARIZED FINANCIAL INFORMATION - ------------------------------------- Summarized financial information for HECO's subsidiaries, HELCO and MECO, is as follows: BALANCE SHEET DATA HELCO MECO --------------------------------- ---------------------------------- March 31, December 31, March 31, December 31, (in thousands) 1997 1996 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- Current assets...................................... $ 27,921 $ 26,345 $ 29,864 $ 30,701 Noncurrent assets................................... 394,006 390,464 372,519 366,489 --------- ---------- --------- --------- $421,927 $416,809 $402,383 $397,190 ========= ========== ========= ========= Common stock equity................................. $140,718 $143,212 $147,892 $147,573 Cumulative preferred stock Not subject to mandatory redemption............. 10,000 10,000 8,000 8,000 Subject to mandatory redemption................. 7,200 7,200 5,765 5,960 Current liabilities................................. 71,411 73,650 36,324 41,700 Noncurrent liabilities.............................. 192,598 182,747 204,402 193,957 --------- --------- --------- --------- $421,927 $416,809 $402,383 $397,190 ========= ========= ========= ========= INCOME STATEMENT DATA HELCO MECO ---------------------------------- ---------------------------------- Three months ended Three months ended March 31, March 31, ---------------------------------- ---------------------------------- (in thousands) 1997 1996 1997 1996 - --------------------------------------------------------------------------------------------------------------------------- Operating revenues................................. $40,338 $35,189 $37,979 $32,795 Operating income................................... 3,343 2,689 4,429 3,930 Net income for common stock........................ 2,736 2,139 3,295 3,167 (7) RECONCILIATION OF ELECTRIC UTILITY OPERATING INCOME PER HEI AND HECO -------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF INCOME --------------------------------- Three months ended March 31, ------------------------------- (in thousands) 1997 1996 - ----------------------------------------------------------------------------------------------------------------------- Operating income from regulated and nonregulated activities before income taxes (per HEI consolidated statements of income)............................................. $38,594 $38,739 Deduct: Income taxes on regulated activities............................................... (11,704) (12,233) Revenues from nonregulated activities.............................................. (2,159) (1,893) Add: Expenses from nonregulated activities.............................................. 83 82 ------- ------- Operating income from regulated activities after income taxes (per HECO consolidated statements of income).............................................................. $24,814 $24,695 ======= ======= 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - -------------------------------------------------------------------------------- OF OPERATIONS - ------------- The following discussion should be read in conjunction with the consolidated financial statements and accompanying notes. Except for historical information contained herein, the matters set forth in management's discussion and analysis of financial condition and results of operations are forward-looking statements that involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Potential risks and uncertainties include, but are not limited to, such factors as the effect of economic conditions, product demand and market acceptance risks, the impact of competitive products and pricing, capacity and supply constraints or difficulties, new technological developments, governmental and regulatory actions, actual purchases under agreements, the results of financing efforts and the timing and extent of changes in interest rates. Investors are also directed to consider other risks and uncertainties discussed in other periodic reports filed by HEI and/or HECO with the SEC. RESULTS OF OPERATIONS HEI CONSOLIDATED - ---------------- Three months ended March 31, (in thousands, except per ----------------- % Primary reason(s) for significant share amounts) 1997 1996 change change* - ---------------------------------------------------------------------------------------------------------------- Revenues............................. $359,193 $326,169 10 Increases for all segments Operating income .................... 49,352 46,735 6 Increase for the savings bank segment and "other" segment Net income........................... 19,663 18,869 4 Higher operating income, partly offset by higher preferred securities distributions due to the issuance of HEI-obligated preferred securities of trust subsidiary and higher interest expense due to higher average borrowings and higher cost of borrowings Earnings per common share............ $0.64 $0.63 2 See explanation for "net income," partly offset by an increase in shares outstanding Weighted average number of common shares outstanding.................. 30,960 29,884 4 Issuances under the Dividend Reinvestment and Stock Purchase Plan and other plans * Also see segment discussions which follow. 17 Following is a general discussion of the results of operations by business segment. ELECTRIC UTILITY - ---------------- Three months ended March 31, (in thousands,except per ------------------------------ % Primary reason(s) for significant barrel amounts) 1997 1996 change change - ----------------------------------------------------------------------------------------------------------------------------- Revenues...................... $273,756 $247,837 10 Recovery through rates of higher fuel prices ($19 million) and integrated resource planning costs ($3 million, including demand-side management program costs and lost margins), higher rates ($2 million) and a 0.7% increase in KWH sales ($2 million) Expenses Fuel oil................... 69,220 53,622 29 Higher fuel oil prices and more KWHs generated Purchased power............ 70,751 67,807 4 Higher fuel prices, partly offset by less KWHs purchased Other...................... 95,191 87,669 9 Higher other operation expense (partly due to higher integrated resource plan related costs), depreciation expense and taxes, other than income taxes Operating income.............. 38,594 38,739 -- Higher revenues offset by higher expenses Net income................... 17,164 17,539 (2) Lower operating income and higher interest expense Fuel oil price per barrel..... 28.12 22.50 25 Kilowatthour (KWH) sales in the first quarter of 1997 increased 0.7% from the same quarter in 1996, partly due to an increase in the number of customers. However, electric utility operating income was essentially flat due to higher expenses, such as higher other operation expenses due to higher production expenses and higher depreciation expense due to additions to plant in 1996. Interest expense increased primarily due to additional revenue bond drawdowns. REGULATION OF ELECTRIC UTILITY RATES The PUC has broad discretion in its regulation of the rates charged by HEI's electric utility subsidiaries and in other matters. Any adverse decision and order (D&O) by the PUC concerning the level or method of determining electric utility rates, the authorized returns on equity or other matters, or any prolonged delay in rendering a D&O in a rate or other proceeding, could have a material adverse effect on the Company's financial condition and results of operations. Upon a showing of probable entitlement, the PUC is required to issue an interim D&O in a rate case within 10 months from the date of filing a completed application if the evidentiary hearing is completed (subject to extension for 30 days if the evidentiary hearing is not completed). There is no time limit for rendering a final D&O. Interim rate increases are subject to refund with interest, pending the final outcome of the case. Management cannot predict with certainty when D&Os in pending or future rate cases will be rendered or the amount of any interim or final rate increase that will be granted. 18 RECENT RATE REQUESTS - -------------------- HEI's electric utility subsidiaries have requested electric rate increases to cover rising operating costs, the cost of purchased power and the cost of plant and equipment, including the cost of new capital projects to maintain and improve service reliability. HAWAII ELECTRIC LIGHT COMPANY, INC. - ----------------------------------- . In March 1995, HELCO filed a request to increase rates based on a 1996 test year. In February 1996, HELCO revised its requested increase to 6.2%, or $8.9 million in annual revenues, based on a 12.5% ROACE. In March 1996, HELCO received an interim D&O authorizing a 4.8%, or $6.8 million, increase in annual revenues, based on an 11.65% ROACE, effective March 4, 1996. In April 1997, HELCO received a final D&O which made permanent the $6.8 million interim increase. MAUI ELECTRIC COMPANY, LIMITED - ------------------------------ . In February 1995, MECO filed a request to increase rates based on a 1996 test year. MECO's final requested increase was 3.8%, or $5.0 million in annual revenues, based on an 11.5% ROACE. The Consumer Advocate stipulated to the proposed ROACE. In January 1996, MECO received an interim D&O authorizing an increase of 2.8%, or $3.7 million in annual revenues, based on an 11.5% ROACE, effective February 1, 1996. In April 1997, MECO received a final D&O authorizing a 2.9%, or $3.9 million increase in annual revenues, based on a ROACE of 11.5%, or a $0.2 million increase in annual revenues over the $3.7 million increase allowed in the interim order. . In May 1996, MECO filed a request to increase rates based on a 1997 test year, primarily to recover the costs related to the anticipated 1997 addition of new generating unit M17. MECO requested an increase of 13%, or $18.9 million in annual revenues over rates in effect at the time of filing, based on a 12.9% ROACE. On November 7, 1996, MECO filed a motion with the PUC to approve a stipulation between MECO and the Consumer Advocate which would close the MECO 1997 rate case and would provide MECO with an increase in annual revenues of $1.5 million over revenues at currently effective rates, based on an 11.65% ROACE. The stipuluation stated that the increase would be effective January 1, 1997, but it has not and will not become effective unless and until the PUC approves the stipulation. The primary reason for the stipulation was a delay in the expected in-service date for MECO's generating unit M17, from the second half of 1997 to the first half of 1998, which resulted from delays in obtaining the necessary PSD permit from the DOH/EPA. MECO anticipates that it will obtain the PSD permit necessary to place M17 in service in 1998, in which event it is likely that MECO will file a request to increase rates based on a 1998 test year. CONTINGENCIES See note (4) in HECO's "Notes to consolidated financial statements" for a discussion of contigencies, including the HELCO power situation, environmental regulation and the PUC show cause order for HECO. 19 SAVINGS BANK - ------------ Three months ended March 31, ----------------------------- % (in thousands) 1997 1996 change Primary reason(s) for significant change - ------------------------------------------------------------------------------------------------------------------------------ Revenues....................... $68,912 $65,792 5 Higher interest income as a result of the higher average loans receivable balance, partly offset by the lower average mortgage-backed securities balance and lower weighted average yields on these assets Operating income*.............. 12,285 9,956 23 Higher net interest income and a reduction in deposit-insurance premiums, partly offset by an increase in the provision for loan losses and higher compensation and employee benefit expenses Net income*.................... 7,099 5,790 23 Higher operating income Interest rate spread........... 2.97% 2.85% 9 basis points decrease in the weighted average yield on interest-earning assets offset by a 21 basis points decrease in the weighted average rate on interest-bearing liabilities * On September 30, 1996, President Clinton signed into law the Deposit Insurance Funds Act of 1996, which authorized a one-time deposit-insurance premium assessment by the FDIC. ASB's assessment was $8.3 million after-tax and was accrued in September 1996. After the one-time assessment, ASB's deposit-insurance premiums (including assessments to pay interest on the FICO bond) were reduced from 23 cents to 6.5 cents per $100 of deposits, effective January 1, 1997. As a result of the reduction in deposit-insurance premiums, ASB's pretax and after-tax savings were approximately $0.9 million and $0.5 million, respectively, for the first quarter of 1997. See note (3) in HEI's "Notes to consolidated financial statements" for additional information. Several factors contributed to the increase in ASB's interest rate spread--the difference between the weighted average yield on interest-earning assets and the weighted average rate on interest-bearing liabilities. One of the primary factors was the decrease in ASB's deposit rates since September 1996. Comparing first quarter 1997 to the same period in 1996, the weighted average rate on interest-bearing liabilities decreased more than the weighted average yield on interest-earning assets decreased. Deposits traditionally have been the principal source of ASB's funds for use in lending, meeting liquidity requirements and making investments. Deposits increased by $24 million in the first quarter of 1997, including $17 million of interest credited to accounts. ASB also derives funds from receipt of interest and principal on outstanding loans receivable and mortgage-backed securities, borrowings from the Federal Home Loan Bank (FHLB) of Seattle, securities sold under agreements to repurchase and other sources. In recent years, securities sold under agreements to repurchase and advances from the FHLB of Seattle have become more significant sources of funds as the demand for deposits decreased. Using sources of funds with a higher cost than deposits, such as securities sold under agreements to repurchase, puts downward pressure on ASB's net interest income. In 1996, the federal funds rate, which is the rate charged by banks for overnight loans to each other and which has a significant influence on deposit and loans receivable rates, decreased from 5.5% to 5.25%. In the first quarter of 1997, the federal funds rate increased 25 basis points to 5.5%. 20 OTHER - ----- Three months ended March 31, -------------------------- % (in thousands) 1997 1996 change Primary reason(s) for significant change - ------------------------------------------------------------------------------------------------------------------------------ Revenues....................... $16,525 $12,540 32 MPC's higher unit sales, freight transportation subsidiaries' higher interstate revenue and HEIIC's investment income Operating loss................. (1,527) (1,960) 22 HEIIC's investment income The "Other" business segment includes results of operations from HTB and its subsidiary, YB, which are maritime freight transportation companies; HEIIC, which is a company primarily holding investments in leveraged leases; MPC and its subsidiaries, which are real estate development and investment companies; HEIPC and its subsidiaries, which are companies formed to pursue independent power projects in Asia and the Pacific; Pacific Energy Conservation Services, Inc., a contract services company providing limited services to an affiliate; HEI and HEIDI, which are holding companies; and eliminations of intercompany transactions. FREIGHT TRANSPORTATION The freight transportation subsidiaries recorded operating income of $0.4 million in each of the first quarters of 1997 and 1996. The flat operating income for the quarter is due to higher interstate revenue offset by higher operation and maintenance expenses. The freight transportation subsidiaries continue to be negatively impacted by the slow economic activity on the neighbor islands and the slow construction industry in Hawaii. In December 1996, the PUC approved a stipulated agreement between YB and the Consumer Advocate to increase rates by $1.4 million annually, or 3.9%, effective in that month. In March 1997, YB filed a request with the PUC for a general rate increase based on a 1997 test year. YB requested an increase of 8.2%, or $2.9 million in annual revenues, based on a 14.99% ROACE. On April 11, 1997, the PUC suspended the request until October 10, 1997. REAL ESTATE MPC's real estate development activities have been negatively impacted by the slow real estate market in Hawaii. It is expected that Hawaii's real estate market will not rebound in the near term. MPC's present focus is to reduce its current investment in real estate development assets and increase cash flow by continuing the development and sales of its existing projects. There are currently no plans to invest in new projects. For further information on MPC, see note (4) in HEI's "Notes to consolidated financial statements." OTHER HEIPC was formed in March 1995 and its subsidiaries have been and will be formed from time to time to pursue independent power projects in Asia and the Pacific. HEIPC's consolidated operating loss in the first quarter of 1997 was $0.3 million, compared with $0.4 million for the same period in 1996. In September 1996, HEI Power Corp. Guam (HPG), entered into an energy conversion agreement with the Guam Power Authority, pursuant to which HPG will rehabilitate, operate and maintain for approximately 20 years two oil-fired 25- MW (net) units at Tanguisson, Guam. On October 30, 1996, HEI filed with the SEC a "Notification of Foreign Utility Company Status" on Form U-57. On November 11, 1996, HPG assumed operational control of the Tanguisson facility. HPG's total cost to rehabilitate the two units is expected to be approximately $14 million, approximately 80% of which HPG is seeking to fund through nonrecourse financing. Repair of the facility is expected to be complete by the end of July 1997, but payments by the Guam Power Authority under the agreement commenced in January 1997. 21 CONTINGENCIES - ------------- See note (8) in HEI's "Notes to consolidated financial statements" for a discussion of contingencies, including environmental regulation and The Hawaiian Insurance & Guaranty Company, Limited. ACCOUNTING CHANGES - ------------------ For a discussion of SOP 96-1, "Environmental Remediation Liabilities", SFAS No. 128, "Earnings Per Share" and SFAS No. 129, "Disclosure of Information about Capital Structure", see note (7) in HEI's "Notes to consolidated financial statements." FINANCIAL CONDITION LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- The Company and HECO and its subsidiaries believe that their ability to generate cash, both internally from operations and externally from debt and equity issues, is adequate to maintain sufficient liquidity to fund their construction programs and to cover debt retirements and other cash requirements in the foreseeable future. The consolidated capital structure of HEI was as follows: (in millions) March 31, 1997 December 31, 1996 - ------------------------------------------------------------------------------------------------------------------------ Short-term borrowings.................................. $ 103 5% $ 217 11% Long-term debt......................................... 802 42 810 43 HEI- and HECO-obligated preferred securities of trust subsidiaries ......... 150 8 -- -- Preferred stock of electric utility subsidiaries....... 85 4 87 5 Common stock equity.................................... 779 41 773 41 -------- -------- -------- -------- $1,919 100% $1,887 100% ======== ======== ======== ======== ASB's deposit liabilities, securities sold under agreements to repurchase and advances from FHLB are not included in the table above. For the first three months of 1997, net cash provided by operating activities was $32 million. Net cash used in investing activities was $76 million, largely due to ASB's loan originations and mortgage-backed securities purchased, net of repayments, and consolidated HECO's capital expenditures. Net cash provided by financing activities was $45 million as a result of several factors, including net increases in securities sold under agreements to repurchase and deposit liabilities, and the issuance of HEI- and HECO-obligated preferred securities of trust subsidiaries, partly offset by decreases in short-term borrowings and advances from FHLB, and by common stock dividends. See note (5) in HEI's "Notes to consolidated financial statements" and note (2) in HECO's "Notes to consolidated financial statements" for a discussion of HEI- and HECO-obligated preferred securities of trust subsidiaries. Proceeds related to the issuance of these securities were used by HEI and HEIDI primarily to repay short-term borrowings and to make loans to affiliates, and proceeds to HECO, MECO and HELCO were used primarily to repay short-term borrowings incurred to finance capital expenditures. Total HEI consolidated financing requirements for 1997 through 2001, including net capital expenditures (which exclude the allowance for funds used during construction and capital expenditures funded by third-party cash contributions in aid of construction), long-term debt retirements (excluding repayments of advances from the FHLB of Seattle and securities sold under agreements to repurchase) and sinking fund requirements, are currently estimated to total $1.0 billion. Of this amount, approximately $0.8 billion is for net capital expenditures (mostly relating to the electric utilities' net capital expenditures described below). HEI's consolidated internal sources, after the payment of HEI dividends, are expected to provide approximately 67% of the consolidated financing requirements, with debt and equity financing providing the remaining requirements. Over the five-year period 1997 through 2001, HEI currently estimates that, in addition to retained earnings and the proceeds from the sale of the HEI- and HECO-obligated preferred securities of trust subsidiaries, it will require not more than $158 million in additional equity, which is expected to be provided principally by the HEI Dividend Reinvestment and Stock Purchase Plan and the Hawaiian Electric Industries Retirement Savings Plan. The additional 22 equity will be used primarily to reduce HEI's overall borrowing level and to fund the common equity requirements of its subsidiaries. Additional equity in excess of the $158 million described above, and additional debt financing, may be required to fund activities not included in the 1997-2001 forecast, such as the development of additional independent power projects by HEIPC and its subsidiaries in Asia and the Pacific. Following is a discussion of the liquidity and capital resources of HEI's largest segments. ELECTRIC UTILITY HECO's consolidated capital structure was as follows: (in millions) March 31, 1997 December 31, 1996 - ----------------------------------------------------------------------------------------------------------------------------- Short-term borrowings from nonaffiliates and affiliate....................................... $ 107 7% $ 126 8% Long-term debt..................................... 594 38 602 38 HECO-obligated preferred securities of trust subsidiary...................................... 50 3 -- -- Preferred stock.................................... 85 5 87 6 Common stock equity................................ 752 47 751 48 ------ ----- ------ ----- $1,588 100% $1,566 100% ====== ===== ====== ===== Operating activities provided $28 million in net cash during the first three months of 1997. Investing activities used net cash of $26 million primarily for capital expenditures. Financing activities provided net cash of $1 million, including $50 million of proceeds from the sale of the HECO-obligated preferred securities of trust subsidiary, mostly offset by net decreases in short-term borrowings, long-term debt and preferred stock, and the payment of common and preferred dividends. The electric utilities' consolidated financing requirements for 1997 through 2001, including net capital expenditures, long-term debt retirements and sinking fund requirements, are estimated to total $768 million. HECO's consolidated internal sources, after the payment of common and preferred stock dividends, are currently expected to provide approximately 75% of the consolidated financing requirements, with debt and equity financing providing the remaining requirements. As of March 31, 1997, an additional $45 million of revenue bonds was authorized by the Hawaii Legislature for issuance by the Department of Budget and Finance of the State of Hawaii on behalf of HECO and HELCO prior to the end of 1997, and an additional $150 million was authorized for issuance on behalf of HECO and MECO prior to the end of 1999. Taking into account the HECO-obligated preferred securities of trust subsidiary, HECO currently estimates that it will require approximately $23 million in new common equity, in addition to retained earnings, over the five-year period 1997 through 2001. The PUC must approve issuances of long-term securities by HECO, HELCO and MECO. Capital expenditures include the costs of projects which are required to meet expected load growth, to improve reliability and to replace and upgrade existing equipment. Net capital expenditures for the five-year period 1997 through 2001 are currently estimated to total $711 million. Approximately 65% of gross capital expenditures, including the allowance for funds used during construction and capital expenditures funded by third-party cash contributions in aid of construction, is for transmission and distribution projects, with the remaining 35% primarily for generation projects. For 1997, electric utility net capital expenditures are estimated to be $118 million and gross capital expenditures are estimated to be $153 million. Approximately 63% of forecast gross capital expenditures is for transmission and distribution projects. An estimated $36 million is planned for new generation projects. In addition to the proceeds from the issuance of the HECO-obligated preferred securities of trust subsidiary received in March 1997, drawdowns of proceeds from the sales of tax-exempt special purpose revenue bonds and the generation of funds from internal sources are expected to provide the cash needed for the net capital expenditures. Capital expenditure estimates and the timing of construction projects are reviewed periodically by management and may change significantly as a result of many considerations, including changes in economic conditions, changes in forecasts of KWH sales and peak load, the availability of purchased power, the availability of generating sites and transmission and distribution corridors, the ability to obtain adequate and timely rate increases, escalation in construction costs, demand-side management programs and requirements of environmental and other regulatory and permitting authorities. 23 SAVINGS BANK March 31, December 31, % (in millions) 1997 1996 change - ------------------------------------------------------------------------------------------------------------------------ Assets...................................................... $3,634 $3,591 1% Mortgage-backed securities.................................. 1,352 1,340 1 Loans receivable, net....................................... 2,036 2,002 2 Deposit liabilities......................................... 2,174 2,150 1 Securities sold under agreements to repurchase.............. 550 480 15 Advances from Federal Home Loan Bank........................ 625 684 (9) As of December 31, 1996, ASB was the fourth largest financial institution in the state based on total assets of $3.6 billion and the third largest financial institution based on deposits of $2.2 billion. For the first three months of 1997, net cash provided by ASB's operating activities was $11.1 million. Net cash used in ASB's investing activities was $47 million, due largely to the origination of loans receivable and mortgage-backed securities purchased, partly offset by principal repayments. Net cash provided by financing activities was $33 million as a result of net increases of $71 million in securities sold under agreements to repurchase and $24 million in deposit liabilities, partly offset by a net decrease of $59 million in advances from the FHLB of Seattle and common stock dividends of $3 million. Minimum liquidity levels are currently governed by the regulations adopted by the Office of Thrift Supervision (OTS). ASB was in compliance with OTS liquidity requirements as of March 31, 1997. ASB believes that a satisfactory regulatory capital position provides a basis for public confidence, affords protection to depositors, helps to ensure continued access to capital markets on favorable terms and provides a foundation for growth. As of March 31, 1997, ASB was in compliance with the OTS minimum capital requirements (noted in parenthesis) with a tangible capital ratio of 5.3% (1.5%), a core capital ratio of 5.4% (3.0%) and a risk-based capital ratio of 12.4% (8.0%). The OTS has adopted a rule adding an interest rate risk (IRR) component to the existing risk-based capital requirement. Institutions with an "above normal" level of IRR exposure will be required to deduct an amount from total capital and may be required to hold additional capital. Although the rule became effective January 1, 1994, the OTS has provided a waiver of the IRR capital deduction until it can finalize an appeals process for institutions subject to such deductions. As of March 31, 1997, ASB would not have been required to hold additional capital if the rule adding the IRR component had been implemented. FDIC regulations restrict the ability of financial institutions that are not well-capitalized to offer interest rates on deposits that are significantly higher than the rates offered by competing institutions. As of March 31, 1997, ASB was well-capitalized (ratio requirements noted in parenthesis) with a leverage ratio of 5.4% (5.0%), a Tier-1 risk-based ratio of 11.5% (6.0%) and a total risk-based ratio of 12.4% (10.0%). Significant interstate banking legislation has been enacted at both the federal and state levels. Under the federal Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, a bank holding company may acquire control of a bank in any state, subject to certain restrictions. Under Hawaii law which takes effect on June 1, 1997, a bank chartered under Hawaii law may merge with an out-of-state bank and convert all branches of both banks into branches of a single bank, subject to certain restrictions. Although the federal and Hawaii laws apply only to banks, such legislation may nonetheless affect the competitive balance among banks, thrifts and other financial institutions and the level of competition among financial institutions doing business in Hawaii. With the enactment of federal legislation in 1996 to recapitalize the SAIF and to reallocate the repayment burden on bonds issued to recapitalize the SAIF's predecessor, it appears that legislation addressing the merger of the BIF and the SAIF, thrift rechartering and financial modernization will remain a priority for the U.S. Congress. Bills are now pending, or expected to be introduced in Congress, that will contain proposals for altering the structure, regulation and competitive relationships of the nation's financial institutions. Some of these bills would abolish the thrift charter, requiring savings associations to convert to banks, subject to certain grandfathering and transition provisions. For a discussion of the unfavorable disparity in the deposit insurance assessment rates and FICO assessment 24 rates that ASB and other thrifts have paid in relation to the rates that most commercial banks have paid, and certain legislation affecting financial institutions, see note (3) in HEI's "Notes to consolidated financial statements." PART II - OTHER INFORMATION - -------------------------------------------------------------------------------- Item 1. LEGAL PROCEEDINGS - -------------------------- There are no significant developments except as set forth in HEI's and HECO's "Notes to consolidated financial statements," management's discussion and analysis of financial condition and results of operations and Item 5, "Other information." Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------ HEI The Annual Meeting of Stockholders of HEI was held on April 22, 1997. Proxies for the meeting were solicited pursuant to Regulation 14A under the Securities Exchange Act of 1934. As of February 12, 1997, the record date for the Annual Meeting, there were 30,940,397 shares of common stock issued and outstanding and entitled to vote. There was no solicitation in opposition to the management nominees to the Board of Directors as listed in the proxy statement for the meeting and such nominees were elected to the Board of Directors. The results of the voting for the single Class I director-nominees and the independent auditor are as follows: Shares of Common stock ------------------------------------------------------------------------------------- Broker For Withheld Against Abstain nonvotes ------------------ --------------- -------------- -------------- --------------- Election of Class I Directors Robert F. Clarke 27,646,220 427,571 -- A. Maurice Myers 27,638,246 435,545 -- James K. Scott 27,608,247 465,544 -- Election of KPMG Peat Marwick LLP as independent auditor 27,597,694 179,532 296,565 -- Class II Directors--Victor Hao Li, T. Michael May, Diane J. Plotts, Kelvin H. Taketa and Jeffrey N. Watanabe --continue in office with terms ending at the 1998 Annual Meeting. Class III Directors--Don E. Carroll, Edwin L. Carter, Richard Henderson, Bill D. Mills and Oswald K. Stender--continue in office with terms ending at the 1999 Annual Meeting. The number of Class I directors was reduced to three as a result of the retirement of John D. Field on December 31, 1996 and the retirement of Ruth M. Ono, who did not stand for reelection at the Annual Meeting. The HEI Board of Directors consists of 13 persons. HECO The Annual Meeting of the Sole Stockholder of HECO was conducted by written consent effective April 22, 1997. Anne M. Takabuki was elected a director of HECO at that time. The incumbent members of the Board of Directors of HECO were re-elected. The incumbent members continuing in office are Edwin L. Carter, Robert F. Clarke, Richard Henderson, T. Michael May, Paul A. Oyer, Diane J. Plotts and Paul C. Yuen. In addition, KPMG Peat Marwick LLP was elected independent auditor of HECO for the fiscal year 1997. 25 Item 5. OTHER INFORMATION - -------------------------- A. Environmental matters WATER QUALITY CONTROL - --------------------- Due to a leak in the fuel transfer system, approximately 100 gallons of bunker fuel oil were released to a HELCO Shipman facility drainage well system in November 1996. The release was reported to state and county agencies in December 1996. Although the fuel oil was removed from the well system and the well system was steam cleaned, oil continues to seep back into the well system from behind the retaining walls. Removal of this residual oil continues and HELCO has filed a status report with the DOH. In March 1997, HELCO received a letter from the DOH concurring with the ongoing cleanup approach. The DOH stated that more aggressive cleanup measures should be considered if oil seepage into the drainage wells worsens. HELCO's cleanup and visual monitoring efforts continue. In April 1997, HECO notified the DOH that it became aware that HELCO was discharging industrial oily wastewater into its Waimea facility's dry well system in noncompliance with the facility's Underground Injection Control (UIC) permit. A written incident report was submitted to the DOH in May 1997. HELCO is currently developing alternative collection, treatment and disposal options for the wastewater. Management anticipates that the DOH will issue a notice of violation. It is unknown what further actions may be taken, if any. AIR QUALITY CONTROL - ------------------- In April 1997, the DOH met with MECO representatives to review all outstanding air regulatory compliance issues which occurred at MECO during 1988 through 1996. The affected MECO facilities include Maalaea, Palaau, Lanai City and Miki Basin generation sites. MECO is continuing discussions with the DOH to finalize settlement of the outstanding issues. B. Ratio of earnings to fixed charges The following tables set forth the ratio of earnings to fixed charges for HEI and its subsidiaries for the periods indicated: RATIO OF EARNINGS TO FIXED CHARGES EXCLUDING INTEREST ON ASB DEPOSITS Three months Years Ended December 31, ended ----------------------------------------------------------------------------- March 31, 1997 1996 1995 1994 1993 1992 -------------- ------------- --------------- ------------- -------------- --------- 1.83 1.87 1.94 2.22 2.25 2.08 ============== ============= =============== ============= ============== ========= RATIO OF EARNINGS TO FIXED CHARGES INCLUDING INTEREST ON ASB DEPOSITS Three months Years Ended December 31, ended ------------------------------------------------------------------------------- March 31, 1997 1996 1995 1994 1993 1992 --------------- ------------ ------------- ------------- -------------- --------- 1.55 1.53 1.57 1.69 1.65 1.50 ================ ============= ============= ============= ============== ========= For purposes of calculating the ratio of earnings to fixed charges, "earnings" represent the sum of (i) pretax income from continuing operations (excluding undistributed net income or net loss from less than fifty-percent-owned persons) and (ii) fixed charges (as hereinafter defined, but excluding capitalized interest). "Fixed charges" are calculated both excluding and including interest on ASB's deposits during the applicable periods and represent the sum of (i) interest, whether capitalized or expensed, incurred by HEI and its subsidiaries plus their proportionate share of interest on debt to outsiders incurred by fifty-percent-owned persons, but excluding interest on nonrecourse debt from leveraged leases which is not included in interest expense in HEI's consolidated statements of income, (ii) amortization of debt expense and discount or premium related to any indebtedness, whether capitalized or expensed, (iii) the interest factor in rental expense, (iv) the preferred stock dividend 26 requirements of HEI's subsidiaries, increased to an amount representing the pretax earnings required to cover such dividend requirements and (v) the preferred securities distribution requirements of trust subsidiaries. The following table sets forth the ratio of earnings to fixed charges for HECO and its subsidiaries for the periods indicated: RATIO OF EARNINGS TO FIXED CHARGES Three months Years Ended December 31, ended ------------------------------------------------------------------------------------- March 31, 1997 1996 1995 1994 1993 1992 ---------------------- --------------- --------------- ------------- -------------- --------------- 3.08 3.58 3.46 3.47 3.25 3.03 ====================== =============== =============== ============= ============== =============== For purposes of calculating the ratio of earnings to fixed charges, "earnings" represent the sum of (i) pretax income before preferred stock dividends of HECO and (ii) fixed charges (as hereinafter defined, but excluding the allowance for borrowed funds used during construction). "Fixed charges" represent the sum of (i) interest, whether capitalized or expensed, incurred by HECO and its subsidiaries, (ii) amortization of debt expense and discount or premium related to any indebtedness, whether capitalized or expensed, (iii) the interest factor in rental expense, (iv) the preferred stock dividend requirements of HELCO and MECO, increased to an amount representing the pretax earnings required to cover such dividend requirements and (v) the preferred securities distribution requirements of trust subsidiary. Item 6. EXHIBITS AND REPORTS ON FORM 8-K - ----------------------------------------- (a) EXHIBITS HEI Amended and Restated Agreement of Limited Exhibit 4.1 Partnership of HEI Preferred Funding, LP (the Partnership) dated as of February 1, 1997 (Exhibit 4(e) to HEI's Current Report on Form 8-K dated February 4, 1997, File No. 1-8503). HEI Amended and Restated Trust Agreement of Exhibit 4.2 Hawaiian Electric Industries Capital Trust I (HEI Trust I) dated as of February 1, 1997 (Exhibit 4(f) to HEI's Current Report on Form 8-K dated February 4, 1997, File No. 1-8503). HEI Junior Indenture between HEI and The Bank of Exhibit 4.3 New York, as Trustee, dated as of February 1, 1997 (Exhibit 4(i) to HEI's Current Report on Form 8-K dated February 4, 1997, File No. 1-8503). HEI Officers' Certificate in connection with Exhibit 4.4 issuance of 8.36% Junior Subordinated Debenture, Series A, Due 2017 under Junior Indenture of HEI (Exhibit 4(l) to HEI's Current Report on Form 8-K dated February 4, 1997, File No. 1-8503). HEI 8.36% Trust Originated Preferred Security Exhibit 4.5 (Liquidation Amount $25 Per Trust Preferred Security) of HEI Trust I (Exhibit 4(m) to HEI's Current Report on Form 8-K dated February 4, 1997, File No. 1-8503). HEI 8.36% Junior Subordinated Debenture Series A, Exhibit 4.6 Due 2017, of HEI (Exhibit 4(n) to HEI's Current Report on Form 8-K dated February 4, 1997, File No. 1-8503). HEI Trust Preferred Securities Guarantee Agreement Exhibit 4.7 with respect to HEI Trust I dated as of February 1, 1997 (Exhibit 4(o) to HEI's Current Report on Form 8-K dated February 4, 1997, File No. 1-8503). 27 (a) EXHIBITS (CONTINUED) HEI Partnership Guarantee Agreement with respect Exhibit 4.8 to the Partnership dated as of February 1, 1997 (Exhibit 4(p) to HEI's Current Report on Form 8-K dated February 4, 1997, File No. 1-8503). HEI Affiliate Investment Instruments Guarantee Exhibit 4.9 Agreement with respect to 8.36% Junior Subordinated Debenture of HEIDI dated as of February 1, 1997 (Exhibit 4(q) to HEI's Current Report on Form 8-K dated February 4, 1997, File No. 1-8503). HECO Amended and Restated Trust Agreement of HECO Exhibit 4.1 Capital Trust I (HECO Trust I) dated as of March 1, 1997 (Exhibit 4(c) to HECO's Current Report on Form 8-K dated March 27, 1997, File No. 1-4955). HECO HECO Junior Indenture with The Bank of New Exhibit 4.2 York, as Trustee, dated as of March 1, 1997 (Exhibit 4(d) to HECO's Current Report on Form 8-K dated March 27, 1997, File No. 1-4955). HECO 8.05% Cumulative Quarterly Income Preferred Exhibit 4.3 Security (liquidation preference $25 per preferred security) of HECO Trust I (Exhibit 4(e) to HECO's Current Report on Form 8-K dated March 27, 1997, File No. 1-4955). HECO 8.05% Junior Subordinated Deferrable Interest Exhibit 4.4 Debenture, Series 1997 of HECO (Exhibit 4(f) to HECO's Current Report on Form 8-K dated March 27, 1997, File No. 1-4955). HECO Trust Guarantee Agreement with respect to HECO Exhibit 4.5 Trust I dated as of March 1, 1997 (Exhibit 4(g) to HECO's Current Report on Form 8-K dated March 27, 1997, File No. 1-4955). HECO MECO Junior Indenture with The Bank of New Exhibit 4.6 York, as Trustee, including HECO Subsidiary Guarantee, dated as of March 1, 1997 (with the form of MECO's 8.05% Junior Subordinated Deferrable Interest Debenture, Series 1997 included as Exhibit A) (Exhibit 4(h)-1 to HECO's Current Report on Form 8-K dated March 27, 1997, File No. 1-4955). HECO HELCO Junior Indenture with The Bank of New Exhibit 4.7 York, as Trustee, including HECO Subsidiary Guarantee, dated as of March 1, 1997 (with the form of HELCO's 8.05% Junior Subordinated Deferrable Interest Debenture, Series 1997 included as Exhibit A) (Exhibit 4(h)-2 to HECO's Current Report on Form 8-K dated March 27, 1997, File No. 1-4955). HECO Agreement as to Expenses and Liabilities among Exhibit 4.8 HECO Trust I, HECO, MECO and HELCO (Exhibit 4(i) to HECO's Current Report on Form 8-K dated March 27, 1997, File No. 1-4955). 28 (a) EXHIBITS (CONTINUED) HEI Hawaiian Electric Industries, Inc. and subsidiaries Exhibit 12.1 Computation of ratio of earnings to fixed charges, three months ended March 31, 1997 and 1996 HECO Hawaiian Electric Company, Inc. and subsidiaries Exhibit 12.2 Computation of ratio of earnings to fixed charges, three months ended March 31, 1997 and 1996 HEI Hawaiian Electric Industries, Inc. and subsidiaries Exhibit 27.1 Financial Data Schedule March 31, 1997 and three months ended March 31, 1997 HECO Hawaiian Electric Company, Inc. and subsidiaries Exhibit 27.2 Financial Data Schedule March 31, 1997 and three months ended March 31, 1997 HEI Sixth Amendment to Trust Agreement, made and entered into on April 1, 1997, Between Fidelity Exhibit 99.1 Management Trust Company and HEI for the Hawaiian Electric Industries Retirement Savings Plan for incorporation by reference in Registration Statement on Form S-8 (Regis. No. 333-02103) HEI Amendment 1997-1 to the Hawaiian Electric Industries Retirement Savings Plan for Exhibit 99.2 incorporation by reference in Registration Statement on Form S-8 (Regis. No. 333-02103) HEI Amendment 1996-1 to the Hawaiian Electric Industries Retirement Savings Plan for Exhibit 99.3 incorporation by reference in Registration Statement on Form S-8 (Regis. No. 333-02103) 29 (b) REPORTS ON FORM 8-K During the quarter, HEI and/or HECO filed Current Reports, Forms 8-K, with the SEC as follows: Dated Registrant/s Items reported - ---------------------------------------------------------------------------------------------------------------------- April 30, 1996 HECO Item 5, certain information contained in the preliminary official statement prepared in connection with a proposed offering of Special Purpose Revenue Bonds for the benefit of HECO, MECO and HELCO January 3, 1997 HEI, HECO Item 5, HELCO power situation and docket on electric competition January 27, 1997 HEI, HECO Item 5, News release: HEI reports 1996 earnings February 4, 1997 HEI Item 5, Hawaiian Electric Industries Capital Trust I issued and sold 4,000,000 of its 8.36% Trust Obligated Preferred Securities; Item 7, final form of documents delivered in connection with the offer and sale of the securities February 26, 1997 HEI Item 7, HEI Exhibit 13, pages 25 to 62 of HEI's 1996 Annual Report to Stockholders February 26, 1997 HECO Item 7, HEI Exhibit 13, pages 25 to 62 of HEI's 1996 Annual Report to Stockholders March 10, 1997 HEI, HECO Item 5, portions of HECO's Annual Report to Stockholder filed as an exhibit, HELCO power situation and PUC show cause order; Item 7, HECO Exhibit 13, pages 2 to 34 and 36 of HECO's 1996 Annual Report to Stockholder March 27, 1997 HEI, HECO Item 5, HECO Capital Trust I issued and sold 2,000,000 of its 8.05% Cumulative Quarterly Income Preferred Securities; Item 7, final form of documents delivered in connection with the offer and sale of the securities SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrants have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized. The signature of the undersigned companies shall be deemed to relate only to matters having reference to such companies and any subsidiaries thereof. HAWAIIAN ELECTRIC INDUSTRIES, INC. HAWAIIAN ELECTRIC COMPANY, INC. (Registrant) (Registrant) By /s/ Robert F. Mougeot By /s/ Paul Oyer ----------------------------- ----------------------------- Robert F. Mougeot Paul A. Oyer Financial Vice President and Financial Vice President and Chief Financial Officer Treasurer (Principal Financial Officer of HEI) (Principal Financial Officer of HECO) Date: May 12, 1997 Date: May 12, 1997 30