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 June 30, 1998
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 August 10, 1998
- --------------------------------------------------------------------------------
Hawaiian Electric Industries, Inc.
(Without Par Value).................... 32,010,493 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 June 30, 1998
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) -
June 30, 1998 and December 31, 1997......................... 1
Consolidated statements of income (unaudited) -
three and six months ended June 30, 1998 and 1997........... 2
Consolidated statements of retained earnings (unaudited) -
three and six months ended June 30, 1998 and 1997........... 2
Consolidated statements of cash flows (unaudited) -
six months ended June 30, 1998 and 1997..................... 3
Notes to consolidated financial statements (unaudited)....... 4
Hawaiian Electric Company, Inc. and subsidiaries
------------------------------------------------
Consolidated balance sheets (unaudited) -
June 30, 1998 and December 31, 1997......................... 10
Consolidated statements of income (unaudited) -
three and six months ended June 30, 1998 and 1997........... 11
Consolidated statements of retained earnings (unaudited) -
three and six months ended June 30, 1998 and 1997........... 11
Consolidated statements of cash flows (unaudited) -
six months ended June 30, 1998 and 1997..................... 12
Notes to consolidated financial statements (unaudited)....... 13
Item 2. Management's discussion and analysis of financial condition
and results of operations................................... 19
Item 3. Quantitative and qualitative disclosures about market risk... 30
PART II. OTHER INFORMATION
Item 1. Legal proceedings............................................ 30
Item 5. Other information............................................ 30
Item 6. Exhibits and reports on Form 8-K............................. 32
Signatures................................................................ 33
i
Hawaiian Electric Industries, Inc. and subsidiaries
Hawaiian Electric Company, Inc. and subsidiaries
Form 10-Q--Quarter ended June 30, 1998
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.,
American Savings Mortgage Co., Inc. and ASB Realty Corporation
(incorporated on March 27, 1998)
ASBR ASB Realty Corporation
BIF Bank Insurance Fund
BLNR Board of Land and Natural Resources of the State of Hawaii
BOA Bank of America, FSB
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., HECO Capital Trust I, 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, HEIDI Real Estate Corp.,
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
DLNR Department of Land and Natural Resources of the State of Hawaii
DOH Department of Health of the State of Hawaii
ENCOGEN Encogen Hawaii, L.P., an affiliate of Enserch Development Corporation
ENSERCH Enserch Development Corporation
EPA Environmental Protection Agency - federal
FASB Financial Accounting Standards Board
FDIC Federal Deposit Insurance Corporation
FEDERAL U.S. Government
ii
GLOSSARY OF TERMS, CONTINUED
TERMS DEFINITIONS
- ----- -----------
FHLB Federal Home Loan Bank
FICO Financing Corporation
FUNDS ACT Deposit Insurance Funds Act of 1996
GAAP Generally accepted accounting principles
GPA Guam Power Authority
HCPC Hilo Coast Power Company
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., direct 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
HEIDI HEI Diversified, Inc., a wholly owned subsidiary of Hawaiian Electric Industries,
Inc. and the parent company of American Savings Bank, F.S.B. and HEIDI Real Estate
Corp.
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 prior to August 16, 1994
HPG HEI Power Corp. Guam, a wholly owned subsidiary of HEI Power Corp.
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
KCP Kawaihae Cogeneration Partners
KWH Kilowatthour
iii
GLOSSARY OF TERMS, CONTINUED
TERMS DEFINITIONS
- ----- -----------
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
NOV Notice of Violation
OTS Office of Thrift Supervision, Department of Treasury
PSD PERMIT Prevention of Significant Deterioration/Covered Source permit
PUC Public Utilities Commission of the State of Hawaii
REIT Real estate investment trust
ROACE Return on average common equity
ROR Simple average 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.
FORWARD-LOOKING INFORMATION
This report and other presentations made by HEI and its subsidiaries contain
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934. Except for historical information contained herein, the
matters set forth 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 international, national and
local economic conditions, including the condition of the Hawaii tourist and
construction industries and the Hawaii housing market; the effects of weather
and natural disasters; product demand and market acceptance risks; increasing
competition in the electric utility industry; capacity and supply constraints or
difficulties; new technological developments; governmental and regulatory
actions, including decisions in rate cases and on permitting issues; the results
of financing efforts; the timing and extent of changes in interest rates; and
the results of integration of the acquired BoA - Hawaii operations with the
operations of ASB. Investors are also referred to other risks and uncertainties
discussed in other periodic reports filed by HEI and/or HECO in 1998 with the
Securities and Exchange Commission.
iv
PART I - FINANCIAL INFORMATION
- -----------------------------------------------------------------------------------------------------------------
Item 1. Financial statements
- -----------------------------
Hawaiian Electric Industries, Inc. and subsidiaries
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
June 30, December 31,
(in thousands) 1998 1997
- ------------------------------------------------------------------------------------------------------------------
ASSETS
- ------
Cash and equivalents............................................ $ 253,886 $ 254,356
Accounts receivable and unbilled revenues, net.................. 150,098 158,292
Inventories, at average cost.................................... 39,206 45,412
Real estate developments........................................ 30,122 30,143
Investment and mortgage-backed securities....................... 2,132,890 1,971,886
Other investments............................................... 68,643 73,769
Loans receivable, net........................................... 3,058,849 3,035,847
Property, plant and equipment, net of accumulated
depreciation and amortization of $1,022,929 and $974,759..... 2,047,739 2,019,558
Regulatory assets............................................... 110,069 104,079
Other........................................................... 152,448 138,048
Goodwill and other intangibles.................................. 119,347 122,492
---------- ----------
$8,163,297 $7,953,882
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ----------------------------------------------------------------
LIABILITIES
Accounts payable................................................ $ 106,955 $ 149,266
Deposit liabilities............................................. 3,816,787 3,916,600
Short-term borrowings........................................... 333,151 298,016
Securities sold under agreements to repurchase.................. 525,590 375,366
Advances from Federal Home Loan Bank............................ 790,581 736,474
Long-term debt.................................................. 918,861 802,575
Deferred income taxes........................................... 185,220 186,241
Unamortized tax credits......................................... 51,628 49,904
Contributions in aid of construction............................ 201,398 197,596
Other........................................................... 177,257 193,100
---------- ----------
7,107,428 6,905,138
---------- ----------
HEI- and HECO-obligated preferred securities of
trust subsidiaries directly or indirectly holding solely HEI
and HEI-guaranteed and HECO and HECO-guaranteed
subordinated debentures.................................... 150,000 150,000
Preferred stock of electric utility subsidiaries
Subject to mandatory redemption............................. 33,370 35,770
Not subject to mandatory redemption......................... 48,293 48,293
---------- ----------
231,663 234,063
---------- ----------
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: 32,009 shares and 31,895 shares............ 659,399 654,819
Retained earnings............................................... 164,807 159,862
---------- ----------
824,206 814,681
---------- ----------
$8,163,297 $7,953,882
========== ==========
See accompanying notes to consolidated financial statements.
1
Hawaiian Electric Industries, Inc. and subsidiaries
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three months ended Six months ended
June 30, June 30,
(in thousands, except per share amounts and ---------------------- --------------------------
ratio of earnings to fixed charges) 1998 1997 1998 1997
- -------------------------------------------------------------------------------------------------------------------------------
REVENUES
Electric utility...................................... $244,548 $275,324 $502,810 $549,080
Savings bank.......................................... 101,268 69,674 203,095 138,586
Other................................................. 16,656 15,255 32,188 31,780
-------- -------- -------- --------
362,472 360,253 738,093 719,446
-------- -------- -------- --------
EXPENSES
Electric utility...................................... 202,850 234,928 418,551 470,090
Savings bank.......................................... 88,638 57,438 174,414 114,065
Other................................................. 17,194 17,717 35,320 35,769
-------- -------- -------- --------
308,682 310,083 628,285 619,924
-------- -------- -------- --------
OPERATING INCOME (LOSS)
Electric utility...................................... 41,698 40,396 84,259 78,990
Savings bank.......................................... 12,630 12,236 28,681 24,521
Other................................................. (538) (2,462) (3,132) (3,989)
-------- -------- -------- --------
53,790 50,170 109,808 99,522
-------- -------- -------- --------
Interest expense--electric utility and other.......... (18,674) (15,680) (36,815) (32,145)
Allowance for borrowed funds used
during construction................................ 1,703 1,609 3,319 3,136
Preferred stock dividends of electric
utility subsidiaries............................... (1,500) (1,563) (3,008) (3,134)
Preferred securities distributions of
trust subsidiaries................................. (3,096) (3,104) (6,192) (4,439)
Allowance for equity funds used during
construction....................................... 2,866 2,752 5,642 5,425
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES............................ 35,089 34,184 72,754 68,365
Income taxes.......................................... 12,696 14,389 28,138 28,907
-------- -------- -------- --------
NET INCOME............................................ $ 22,393 $ 19,795 $ 44,616 $ 39,458
======== ======== ======== ========
Basic earnings per common share....................... $ 0.70 $ 0.63 $ 1.40 $ 1.27
======== ======== ======== ========
Diluted earnings per common share..................... $ 0.70 $ 0.63 $ 1.39 $ 1.27
======== ======== ======== ========
Dividends per common share............................ $ 0.62 $ 0.61 $ 1.24 $ 1.22
======== ======== ======== ========
Weighted average number of common
shares outstanding................................. 32,007 31,237 31,982 31,099
Effect of dilutive securities--
Stock options and dividend equivalents....... 136 82 138 85
-------- -------- -------- --------
Adjusted weighted average shares...................... 32,143 31,319 32,120 31,184
======== ======== ======== ========
Ratio of earnings to fixed charges (SEC method)
Excluding interest on ASB deposits................. 1.82 1.82
======== ========
Including interest on ASB deposits................. 1.44 1.54
======== ========
Hawaiian Electric Industries, Inc. and subsidiaries
CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (UNAUDITED)
Three months ended Six months ended
June 30, June 30,
--------------------------------- -------------------------------
(in thousands) 1998 1997 1998 1997
- ----------------------------------------------------------- ----------------------------------------------------------------------
RETAINED EARNINGS, BEGINNING OF PERIOD................ $162,259 $150,697 $159,862 $149,907
Net income............................................ 22,393 19,795 44,616 39,458
Common stock dividends................................ (19,845) (19,037) (39,671) (37,910)
-------- -------- -------- --------
RETAINED EARNINGS, END OF PERIOD...................... $164,807 $151,455 $164,807 $151,455
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
2
Hawaiian Electric Industries, Inc. and subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six months ended June 30,
------------------------------
(in thousands) 1998 1997
- ------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.................................................................... $ 44,616 $ 39,458
Adjustments to reconcile net income to net cash provided by operating
activities
Depreciation and amortization of property, plant and equipment.......... 49,543 45,592
Other amortization...................................................... 7,850 7,943
Deferred income taxes and tax credits, net.............................. 1,513 1,676
Allowance for equity funds used during construction..................... (5,642) (5,425)
Changes in assets and liabilities
Decrease in accounts receivable and unbilled revenues, net........ 8,194 2,679
Decrease in inventories........................................... 6,206 1,619
Increase in regulatory assets..................................... (3,265) (4,456)
Decrease in accounts payable...................................... (42,311) (9,606)
Changes in other assets and liabilities........................... (22,899) (18,046)
---------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES..................................... 43,805 61,434
---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Loans receivable originated and purchased..................................... (301,420) (146,280)
Principal repayments on loans receivable...................................... 238,987 73,733
Proceeds from sale of loans receivable........................................ 3,065 2,487
Held-to-maturity mortgage-backed securities purchased......................... (278,784) (94,788)
Principal repayments on held-to-maturity mortgage-backed securities........... 237,356 132,712
Held-to-maturity investment securities purchased.............................. (117,982) --
Capital expenditures.......................................................... (72,685) (66,925)
Contributions in aid of construction.......................................... 5,560 2,864
Proceeds from loans returned to Bank of America, FSB.......................... 27,514 --
Other......................................................................... 156 785
---------- ---------
NET CASH USED IN INVESTING ACTIVITIES......................................... (258,233) (95,412)
---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposit liabilities................................ (101,028) 52,317
Net increase (decrease) in short-term borrowings with
original maturities of three months or less................................ 36,174 (84,796)
Proceeds from other short-term borrowings..................................... 1,326 479
Repayment of other short-term borrowings...................................... (2,365) (1,363)
Proceeds from securities sold under agreements to repurchase.................. 412,812 494,500
Repurchase of securities sold under agreements to repurchase.................. (263,000) (453,100)
Proceeds from advances from Federal Home Loan Bank............................ 335,700 354,000
Principal payments on advances from Federal Home Loan Bank.................... (281,593) (407,500)
Proceeds from issuance of long-term debt...................................... 175,482 7,388
Repayment of long-term debt................................................... (59,400) (14,900)
Proceeds from issuance of HEI- and HECO-obligated preferred securities of
trust subsidiaries........................................................... -- 150,000
Redemption of electric utility subsidiaries' preferred stock.................. (2,400) (2,695)
Net proceeds from issuance of common stock.................................... 4,514 12,294
Common stock dividends........................................................ (39,671) (30,600)
Other......................................................................... (2,593) (10,065)
---------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES..................................... 213,958 65,959
---------- ---------
Net increase (decrease) in cash and equivalents............................... (470) 31,981
Cash and equivalents, beginning of period..................................... 254,356 97,417
---------- ---------
CASH AND EQUIVALENTS, END OF PERIOD........................................... $ 253,886 $ 129,398
========= =========
See accompanying notes to consolidated financial statements.
3
Hawaiian Electric Industries, Inc. and subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
(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 GAAP 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, 1997 and the consolidated financial statements and the notes
thereto in HEI's Quarterly Report on SEC Form 10-Q for the quarter ended March
31, 1998.
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 June 30, 1998 and December
31, 1997, the results of its operations for the three months and six months
ended June 30, 1998 and 1997, and its cash flows for the six months ended June
30, 1998 and 1997. All such adjustments are of a normal recurring nature, unless
otherwise disclosed in this Form 10Q 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 10 through 19.
(3) SAVINGS BANK SUBSIDIARY
- ----------------------------
SELECTED CONSOLIDATED FINANCIAL INFORMATION
American Savings Bank, F.S.B. and subsidiaries
Income statement data
Three months ended Six months ended
June 30, June 30,
---------------------------------------- -------------------------
(in thousands) 1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
Interest income................................. $ 94,781 $ 65,834 $190,052 $131,034
Interest expense................................ 53,910 38,662 107,051 76,482
-------- -------- -------- --------
NET INTEREST INCOME............................. 40,871 27,172 83,001 54,552
Provision for losses............................ (3,424) (1,603) (6,348) (2,792)
Other income.................................... 6,487 3,840 13,043 7,552
Operating, administrative and general expenses.. (31,304) (17,173) (61,015) (34,791)
-------- -------- -------- --------
OPERATING INCOME................................ 12,630 12,236 28,681 24,521
Income taxes.................................... 3,928 5,064 10,269 10,250
-------- -------- -------- --------
INCOME BEFORE PREFERRED STOCK DIVIDENDS......... 8,702 7,172 18,412 14,271
Preferred stock dividends....................... 1,350 -- 2,700 --
-------- -------- -------- --------
NET INCOME...................................... $ 7,352 $ 7,172 $ 15,712 $ 14,271
======== ======== ======== ========
4
American Savings Bank, F.S.B. and subsidiaries
Balance sheet data
June 30, December 31,
(in thousands) 1998 1997
- -----------------------------------------------------------------------------------------------------------
ASSETS
Cash and equivalents................................................ $ 246,897 $ 249,607
Held-to-maturity investment securities.............................. 225,988 105,596
Held-to-maturity mortgage-backed securities......................... 1,905,702 1,865,027
Loans receivable, net............................................... 3,058,849 3,035,847
Other............................................................... 183,264 169,843
Goodwill and other intangibles...................................... 119,347 122,492
---------- ----------
$5,740,047 $5,548,412
========== ==========
LIABILITIES AND EQUITY
Deposit liabilities................................................. $3,816,787 $3,916,600
Securities sold under agreements to repurchase...................... 525,590 375,366
Advances from Federal Home Loan Bank................................ 790,581 736,474
Other............................................................... 201,747 124,185
---------- ----------
5,334,705 5,152,625
Preferred stock held by parent...................................... 75,000 75,000
Common stock equity................................................. 330,342 320,787
---------- ----------
$5,740,047 $5,548,412
========== ==========
ACQUISITION OF MOST OF THE HAWAII OPERATIONS OF BANK OF AMERICA, FSB (BOA)
Effective December 6, 1997, ASB acquired certain loans and other assets and
assumed certain deposits and other liabilities of the Hawaii operations of BoA
pursuant to a Purchase and Assumption Agreement executed by both parties on May
26, 1997, as amended. ASB used the purchase method of accounting to account for
the transaction. Accordingly, the accompanying financial statements include the
results of operations related to the assets acquired and liabilities assumed
from the acquisition date. The purchase price relative to this transaction was
$1.8 billion, comprised of $1.7 billion estimated fair value of liabilities
assumed and $0.1 billion premium paid on certain transferred deposit
liabilities. In conjunction with this acquisition, the estimated fair value of
tangible and intangible assets acquired, including cash of $0.8 billion,
amounted to $1.8 billion. ASB recorded the excess of the purchase price over the
estimated fair value of the identifiable net assets acquired of $71 million as
goodwill and is amortizing it over 25 years using the straight-line method. ASB
recorded the core deposit premium of approximately $20 million as an intangible
asset and is amortizing it annually at the greater of the actual attrition rate
of the acquired core deposits or 10% of the original premium amount.
DEPOSIT-INSURANCE PREMIUMS AND REGULATORY DEVELOPMENTS
The Savings Association Insurance Fund (SAIF) insures the deposit accounts of
ASB and other thrifts. The Bank Insurance Fund (BIF) insures the deposit
accounts of commercial banks. The Federal Deposit Insurance Corporation (FDIC)
administers the SAIF and BIF.
In September 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 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.
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
FICO's interest obligations which was initially set at 6.48 cents per $100 of
deposits for SAIF institutions and 1.3 cents per $100 of deposits for BIF
institutions (subject to quarterly adjustment). By
5
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 an estimated rate of
2.4 cents per $100 of deposits. In December 1997, ASB acquired BIF-assessable
deposits as well as SAIF-assessable deposits from BoA. As a "well-capitalized"
thrift, ASB's base deposit insurance premium effective for the June 30, 1998
quarterly payment is zero and its assessment for funding FICO interest payments
is 6.10 cents per $100 of SAIF-assessable deposits and 1.22 cents per $100 of
BIF-assessable deposits, on an annual basis, based on deposits as of March 31,
1998. ASB's assessment for funding FICO interest payments is subject to change
quarterly.
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 were eliminated and ASB obtained
a bank charter, HEI and its subsidiaries might become subject 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 $41 million and $40 million at
June 30, 1998 and December 31, 1997, respectively. The amounts MPC will
ultimately realize relative to these real estate investments could differ
materially from the recorded amounts as of June 30, 1998.
At June 30, 1998, MPC or its subsidiaries had issued (i) guarantees under which
they were jointly and severally contingently liable with their joint venture
partners for $0.1 million of outstanding loans and (ii) payment guarantees under
which MPC or its subsidiaries were severally contingently liable for $3.0
million of outstanding loans and $0.5 million of additional undrawn loan
facilities. All such loans are collateralized by real property. At June 30,
1998, HEI had agreed with the lenders of construction loans and loan facilities,
of which approximately $4.0 million was outstanding and $1.3 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 HEI AND HEI-GUARANTEED AND HECO
---------------------------------------------------------------------
AND HECO-GUARANTEED SUBORDINATED DEBENTURES
-------------------------------------------
In February 1997, Hawaiian Electric Industries Capital Trust I, a grantor trust
and wholly owned subsidiary of HEI, issued and sold, in an underwritten
registered public offering, 4 million of its HEI-obligated 8.36% preferred
securities (trust preferred securities), with an aggregate liquidation value of
$100 million. The trust preferred securities have no scheduled maturity and are
not redeemable at the option of the holders, but may be redeemed by Hawaiian
Electric Industries Capital Trust I, in whole or in part, from time to time,
after February 4, 2002.
In March 1997, HECO Capital Trust I, a grantor trust and wholly owned subsidiary
of HECO, issued and sold, in an underwritten registered public offering, 2
million of its HECO-obligated 8.05% Cumulative Quarterly Income Preferred
Securities, Series 1997, with an aggregate liquidation value of $50 million. The
HECO-obligated Cumulative Quarterly Income Preferred Securities must be redeemed
at the maturity of the underlying debt on March 27, 2027, which maturity may be
shortened to a date no earlier than March 27, 2002 or extended to a date no
later than March 27, 2046, and are not redeemable at the option of the holders,
but may be redeemed by HECO Capital Trust I, in whole or in part, from time to
time, after March 27, 2002.
6
(6) CASH FLOWS
- ----------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest (net of capitalized amounts) and income taxes was as
follows:
Six months ended
June 30,
----------------------------------
(in thousands) 1998 1997
- ---------------------------------------------------------------------------------------------------------
Interest (including interest paid by savings bank, but excluding
interest paid on nonrecourse debt on leveraged leases)................ $138,753 $106,341
======== ========
Interest on nonrecourse debt from leveraged leases..................... $ 3,136 $ 3,801
======== ========
Income taxes........................................................... $ 26,625 $ 30,846
======== ========
SUPPLEMENTAL DISCLOSURES OF NONCASH ACTIVITIES
Under the HEI Dividend Reinvestment and Stock Purchase Plan, common stock
dividends reinvested by shareholders in HEI common stock in noncash transactions
amounted to $7.3 million for the six months ended June 30, 1997. Beginning in
March 1998, HEI acquired for cash its common shares in the open market to
satisfy the requirements of the HEI Dividend Reinvestment and Stock Purchase
Plan.
The allowance for equity funds used during construction, which was capitalized
as part of the cost of electric utility plant, amounted to $5.6 million and $5.4
million for the six months ended June 30, 1998 and 1997, respectively.
(7) ACCOUNTING CHANGES
- ------------------------
EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per
Share," which requires the presentation of "basic" earnings per share, computed
by dividing net income available to common shareholders by the weighted average
number of common shares outstanding for the period, and "diluted" earnings per
share, which reflects the potential dilution that could occur if options or
other contracts to issue common stock were exercised or converted into common
stock or resulted in the issuance of common stock that then shared in the
earnings of the entity. The Company adopted SFAS No. 128 in the fourth quarter
of 1997 and has restated all prior period earnings per share data presented. The
adoption of SFAS No. 128 did not have a material effect on the Company's
previously reported earnings per share information.
COMPREHENSIVE INCOME
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which establishes standards for the reporting and display of comprehensive
income and its components in a full set of general-purpose financial statements.
The Company adopted SFAS No. 130 in the first quarter of 1998, but had no
material "other" comprehensive income items for the income statement periods
presented or accumulated as of the balance sheet dates presented.
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes standards for the way
that public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. The Company adopted SFAS No. 131 in the first quarter of 1998. No
modification to the Company's reporting segments was required.
7
COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE
In March 1998, the AICPA Accounting Standards Executive Committee issued
Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use," which requires that certain costs,
including certain payroll and payroll-related costs, be capitalized and
amortized over the estimated useful life of the software. The provisions of SOP
98-1 are effective for fiscal years beginning after December 15, 1998 and
earlier application is encouraged. The Company has not determined when it will
adopt SOP 98-1. Management currently believes that the adoption of SOP 98-1 will
not have a material effect on the Company's financial condition, results of
operations or liquidity.
COSTS OF START-UP ACTIVITIES
In April 1998, the AICPA Accounting Standards Executive Committee issued SOP 98-
5, "Reporting on the Costs of Start-up Activities," which requires that costs of
start-up activities, including organization costs, be expensed as incurred. The
provisions of SOP 98-5 are effective for fiscal years beginning after December
15, 1998 and earlier application is encouraged. The Company has not determined
when it will adopt SOP 98-5. Management currently believes that the adoption of
SOP 98-5 will not have a material effect on the Company's financial condition,
results of operations or liquidity.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments and hedging activities and requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. The
provisions of SFAS No. 133 are effective for all fiscal quarters of fiscal years
beginning after June 15, 1999 and earlier application is encouraged. The Company
has not determined when it will adopt SFAS No. 133 and has not yet determined
the impact of adoption.
(8) CONTINGENCIES
- ------------------
ENVIRONMENTAL REGULATION
In early 1995, the Department of Health of the State of Hawaii (DOH) initially
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. 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 potentially responsible
for the contamination and/or to 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. Certain parties identified in the December 1995 DOH letter
(including HECO, Chevron Products Company, Shell Oil Products Company, State of
Hawaii Department of Transportation Harbors Division and others) formed a
Technical Workgroup to conduct independent voluntary investigations relative to
this issue. Effective January 30, 1998, the Technical Workgroup and the DOH
entered into a voluntary agreement and scope of work to determine the nature and
extent of any contamination, the responsible parties and appropriate remedial
actions. On June 1, 1998, the Technical Work Group agreed in principle to sign
Ogden Environmental's consultant contract authorizing the start of Phase 1. The
Technical Work Group met in June 1998 to discuss with Ogden Environmental its
proposed work plan and schedule, and subsequently met with and informed the DOH
of the work plan. The Technical Work Group now anticipates that the Phase I
report will be completed by the end of November 1998.
Because the process for determining appropriate remedial and cleanup action, if
any, is at an early stage, management cannot predict at this time the costs of
further site analysis or future remediation and cleanup requirements, nor can it
estimate when such costs would be incurred. Certain of the costs incurred may be
claimed and covered under insurance policies, but such coverage is not
determinable at this time.
8
THE HAWAIIAN INSURANCE & GUARANTY COMPANY, LIMITED
The Hawaiian Insurance & Guaranty Company, Limited (HIG) and its subsidiaries
(collectively, the HIG Group) were property and casualty insurance companies. 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. HEI Diversified, Inc.
(HEIDI) was the holder of record of all the common stock of HIG until August 16,
1994.
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
sought reimbursement for the settlement, interest and defense costs from three
director and officer liability insurance carriers. The primary director and
officer liability insurance carrier 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. In early August
1998, the Company settled all claims with the three former insurance carriers
relating to the 1994 settlement payment. The Company will receive $24.5 million
($14 million net of estimated expenses and income taxes or approximately $0.43
per share for the third quarter of 1998), and will record the settlement as
income from discontinued operations in the third quarter of 1998. All parties
have denied, and continue to deny, liability.
9
Hawaiian Electric Company, Inc. and subsidiaries
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
June 30, December 31,
(in thousands, except par value) 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------
ASSETS
Utility plant, at cost
Land.................................................................. $ 32,238 $ 32,222
Plant and equipment................................................... 2,605,404 2,559,655
Less accumulated depreciation......................................... (946,305) (904,781)
Plant acquisition adjustment, net..................................... 536 562
Construction in progress.............................................. 224,137 205,447
---------- ----------
NET UTILITY PLANT............................................... 1,916,010 1,893,105
---------- ----------
Current assets
Cash and equivalents.................................................. 1,478 1,676
Customer accounts receivable, net..................................... 62,515 69,378
Accrued unbilled revenues, net........................................ 44,818 45,980
Other accounts receivable, net........................................ 4,806 4,195
Fuel oil stock, at average cost....................................... 19,402 25,058
Materials and supplies, at average cost............................... 18,163 18,975
Prepayments and other................................................. 3,737 3,335
---------- ----------
TOTAL CURRENT ASSETS............................................ 154,919 168,597
---------- ----------
Other assets
Regulatory assets..................................................... 107,838 101,809
Other................................................................. 51,323 48,803
---------- ----------
TOTAL OTHER ASSETS.............................................. 159,161 150,612
---------- ----------
$2,230,090 $2,212,314
========== ==========
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.............................................. 296,332 296,266
Retained earnings..................................................... 410,207 387,582
---------- ----------
COMMON STOCK EQUITY............................................. 791,926 769,235
Cumulative preferred stock
Not subject to mandatory redemption................................ 48,293 48,293
Subject to mandatory redemption.................................... 31,775 33,175
HECO-obligated mandatorily redeemable trust preferred securities
of subsidiary trust holding solely HECO and HECO-guaranteed
debentures......................................................... 50,000 50,000
Long-term debt, net................................................... 603,307 597,621
---------- ----------
TOTAL CAPITALIZATION............................................ 1,525,301 1,498,324
---------- ----------
Current liabilities
Long-term debt due within one year.................................... 30,000 30,000
Preferred stock sinking fund payments................................. 1,595 2,595
Short-term borrowings-nonaffiliates.................................. 108,945 95,181
Short-term borrowings-affiliate...................................... -- 400
Accounts payable...................................................... 40,802 49,805
Interest and preferred dividends payable.............................. 11,786 12,225
Taxes accrued......................................................... 44,184 59,952
Other................................................................. 21,627 21,633
---------- ----------
TOTAL CURRENT LIABILITIES....................................... 258,939 271,791
---------- ----------
Deferred credits and other liabilities
Deferred income taxes................................................. 126,672 125,509
Unamortized tax credits............................................... 50,418 48,675
Other................................................................. 67,362 70,419
---------- ----------
TOTAL DEFERRED CREDITS AND OTHER LIABILITIES.................... 244,452 244,603
---------- ----------
Contributions in aid of construction..................................... 201,398 197,596
---------- ----------
$2,230,090 $2,212,314
========== ==========
See accompanying notes to HECO's consolidated financial statements.
10
Hawaiian Electric Company, Inc. and subsidiaries
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three months ended Six months ended
(in thousands, except for ratio of earnings June 30, June 30,
to fixed charges) ------------------------------- -------------------------------
1998 1997 1998 1997
- -------------------------------------------------------------------------------------------------------------------------
OPERATING REVENUES................................ $242,204 $272,972 $498,247 $544,569
-------- -------- -------- --------
OPERATING EXPENSES
Fuel oil.......................................... 44,449 65,112 101,180 134,332
Purchased power................................... 69,091 72,473 135,674 143,224
Other operation................................... 33,879 36,536 69,965 73,447
Maintenance....................................... 10,866 14,351 21,230 26,414
Depreciation and amortization..................... 21,446 20,506 42,888 41,003
Taxes, other than income taxes.................... 23,054 25,818 47,346 51,455
Income taxes...................................... 12,558 12,073 25,560 23,777
-------- -------- -------- --------
215,343 246,869 443,843 493,652
-------- -------- -------- --------
OPERATING INCOME.................................. 26,861 26,103 54,404 50,917
-------- -------- -------- --------
OTHER INCOME
Allowance for equity funds used
during construction............................ 2,866 2,752 5,642 5,425
Other, net........................................ 2,320 2,189 4,322 4,260
-------- -------- -------- --------
5,186 4,941 9,964 9,685
-------- -------- -------- --------
INCOME BEFORE INTEREST AND OTHER CHARGES.......... 32,047 31,044 64,368 60,602
-------- -------- -------- --------
INTEREST AND OTHER CHARGES
Interest on long-term debt........................ 10,514 9,851 20,692 19,710
Amortization of net bond premium and expense...... 373 321 722 648
Other interest charges............................ 1,667 1,789 3,301 3,895
Allowance for borrowed funds used
during construction............................ (1,703) (1,609) (3,319) (3,136)
Preferred stock dividends of subsidiaries......... 639 650 1,277 1,300
Preferred securities distributions of
trust subsidiary............................... 1,007 1,014 2,013 1,072
-------- -------- -------- --------
12,497 12,016 24,686 23,489
-------- -------- -------- --------
INCOME BEFORE PREFERRED STOCK DIVIDENDS
OF HECO........................................ 19,550 19,028 39,682 37,113
Preferred stock dividends of HECO................. 861 913 1,731 1,834
-------- -------- -------- --------
NET INCOME FOR COMMON STOCK....................... $ 18,689 $ 18,115 $ 37,951 $ 35,279
======== ======== ======== ========
Ratio of earnings to fixed charges
(SEC method)................................... 3.13 3.08
======== ========
Hawaiian Electric Company, Inc. and subsidiaries
CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (UNAUDITED)
Three months ended Six months ended
June 30, June 30,
------------------------------ -------------------------------
(in thousands) 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS, BEGINNING OF PERIOD............ $391,518 $369,872 $387,582 $367,770
Net income for common stock....................... 18,689 18,115 37,951 35,279
Common stock dividends............................ -- (12,873) (15,326) (27,935)
-------- -------- -------- --------
RETAINED EARNINGS, END OF PERIOD.................. $410,207 $375,114 $410,207 $375,114
======== ======== ======== ========
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.
11
Hawaiian Electric Company, Inc. and subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six months ended
June 30,
----------------------------------------
(in thousands) 1998 1997
- -------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Income before preferred stock dividends of HECO...................... $ 39,682 $ 37,113
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......................................... 42,888 41,003
Other amortization............................................. 3,625 5,924
Deferred income taxes.......................................... 1,163 (162)
Tax credits, net............................................... 2,553 1,474
Allowance for equity funds used during construction............ (5,642) (5,425)
Changes in assets and liabilities
Decrease in accounts receivable........................... 6,252 4,505
Decrease in accrued unbilled revenues..................... 1,162 145
Decrease in fuel oil stock................................ 5,656 2,533
Decrease (increase) in materials and supplies............. 812 (719)
Increase in regulatory assets............................. (3,265) (4,456)
Decrease in accounts payable.............................. (9,003) (12,834)
Decrease in interest and preferred dividends payable...... (439) (550)
Changes in other assets and liabilities................... (30,343) (23,507)
-------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES............................ 55,101 45,044
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures................................................. (60,542) (56,377)
Contributions in aid of construction................................. 5,560 2,864
Payments on notes receivable......................................... 756 1,553
-------- --------
NET CASH USED IN INVESTING ACTIVITIES................................ (54,226) (51,960)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Common stock dividends............................................... (15,326) (27,935)
Preferred stock dividends............................................ (1,731) (1,834)
Proceeds from issuance of HECO-obligated mandatorily redeemable
preferred securities of trust subsidiary............................ -- 50,000
Proceeds from issuance of long-term debt............................. 62,982 7,388
Repayment of long-term debt.......................................... (57,500) (13,000)
Redemption of preferred stock........................................ (2,400) (2,695)
Net increase in short-term borrowings from nonaffiliates
and affiliate with original maturities of three months or less.... 13,364 4
Other................................................................ (462) (4,355)
-------- --------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES.................. (1,073) 7,573
-------- --------
Net increase (decrease) in cash and equivalents...................... (198) 657
Cash and equivalents, beginning of period............................ 1,676 823
-------- --------
CASH AND EQUIVALENTS, END OF PERIOD.................................. $ 1,478 $ 1,480
======== ========
See accompanying notes to HECO's consolidated financial statements.
12
Hawaiian Electric Company, Inc. and subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998 and 1997
(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 GAAP 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, 1997 and the consolidated financial statements and the notes
thereto in HECO's Quarterly Report on SEC Form 10-Q for the quarter ended March
31, 1998.
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 June
30, 1998 and December 31, 1997, the results of their operations for the three
months and six months ended June 30, 1998 and 1997, and their cash flows for the
six months ended June 30, 1998 and 1997. 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 MANDATORILY REDEEMABLE PREFERRED SECURITIES OF TRUST
- ------------------------------------------------------------------------
SUBSIDIARY HOLDING SOLELY HECO AND HECO-GUARANTEED SUBORDINATED DEBENTURES
--------------------------------------------------------------------------
In March 1997, HECO Capital Trust I (Trust), a grantor trust and a wholly owned
subsidiary of HECO, sold (i) in a public offering, 2 million of its HECO-
Obligated 8.05% Cumulative Quarterly Income Preferred Securities, Series 1997
(trust preferred securities) with an aggregate liquidation preference of $50
million and (ii) to HECO, common securities with a liquidation preference of
approximately $1.55 million. Proceeds from the sale of the trust preferred
securities and the common securities were used by the Trust to purchase 8.05%
Junior Subordinated Deferrable Interest Debentures, Series 1997 (junior
deferrable debentures) issued by HECO in the principal amount of $31.55 million
and issued by each of MECO and HELCO in the principal amounts of $10 million.
The junior deferrable debentures, which mature on March 27, 2027, together with
the subsidiary guarantees (pursuant to which the obligations of MECO and HELCO
under their respective debentures are fully and unconditionally guaranteed by
HECO), are the sole assets of the Trust. Contractual arrangements entered into
by HECO in connection with the issuance of the trust preferred securities,
considered together, constitute a full and unconditional guarantee by HECO, on a
subordinated basis, of the periodic distributions due on the trust preferred
securities and of amounts due upon the redemption thereof or upon liquidation of
the Trust. The junior deferrable debentures and the common securities of the
Trust have been eliminated in HECO's consolidated balance sheets as of June 30,
1998 and December 31, 1997. The trust preferred securities are subject to
mandatory redemption upon redemption of the junior deferrable debentures. The
junior deferrable debentures are redeemable only (i) at the option of HECO, MECO
and HELCO, respectively, in whole or in part, on or after March 27, 2002 or (ii)
at the option of HECO, in whole, upon the occurrence of a "Special Event"
(relating to certain changes in laws or regulations).
13
(3) CASH FLOWS
- ---------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest (net of capitalized amounts) and income taxes was as
follows:
Six months ended
June 30,
---------------------------------------
(in thousands) 1998 1997
- ------------------------------------------------------------------------------------------------------------
Interest............................................................. $22,641 $21,703
======= =======
Income taxes......................................................... $22,277 $22,245
======= =======
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 $5.6 million and $5.4
million for the six months ended June 30, 1998 and 1997, respectively.
(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.
The timing of 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
Department of Health of the State of Hawaii (DOH) and the U.S. Environmental
Protection Agency (EPA) a Prevention of Significant Deterioration/Covered Source
permit (PSD permit) for the Keahole power plant site. Subject to satisfactory
resolution of the CDUP amendment and PSD permit matters, HELCO's current plan
contemplates that CT-4 and CT-5 will be the next generating units added to its
system. Current plans are for ST-7 to be deferred to approximately 2006 unless
the Encogen Hawaii, L.P. facility (described below) is not placed in service as
planned.
CDUP AMENDMENT. On July 10, 1997, the Third Circuit Court of the State of Hawaii
- ---------------
issued its Amended Findings of Fact, Conclusions of Law, Decision and Order on
HELCO's appeal of an order of the BLNR, along with other civil cases relating to
HELCO's application for a CDUP amendment. This decision allows HELCO to use its
Keahole property as requested in its application. An amended order to the same
effect was issued on August 18, 1997. Final judgments have been entered as to
all of the consolidated cases. Appeals with respect to the final judgments for
certain of the cases have been filed with the Hawaii Supreme Court. Motions
filed with the Third Circuit Court to stay the effectiveness of the judgments
pending resolution of the appeals were denied in April and July 1998 (in
response to a motion for reconsideration). Nonhearing motions for stay of final
judgment pending resolution of the appeals were filed with the Hawaii Supreme
Court, which has not yet ruled on the motions. Management believes that HELCO
will ultimately prevail with regard to any appeals and that the final judgments
of the Third Circuit Court will be upheld.
PSD PERMIT. In November 1995, the EPA declined to sign HELCO's PSD permit for
- ----------
the combined-cycle unit. In October 1997, the EPA approved a revised draft
permit and the DOH issued a final PSD permit. Nine appeals from the issuance of
the permit have been filed with the Environmental Appeals Board of the EPA. All
briefing in the case has been completed. Based on the proceedings to date,
management believes that HELCO will ultimately prevail in the appeals.
14
DECLARATORY JUDGMENT ACTIONS. In February 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.
Discovery is ongoing and the parties are seeking to set a trial date.
In March 1998, an individual filed a complaint for declaratory judgment against
HELCO, the BLNR and the Department of Land and Natural Resources of the State of
Hawaii (DLNR). The complaint alleges a violation of her constitutional due
process rights because the land use conditions (if any) which apply to HELCO's
use of the Keahole site was determined administratively by the DLNR (through a
letter issued to HELCO in January 1998) rather than being decided by the BLNR in
a contested case. Also filed with the complaint was a motion to stay enforcement
of the DLNR letter, which motion was denied in April 1998.
In May 1998, Waimana Enterprises, whose subsidiary is a partner in Kawaihae
Cogeneration Partners (KCP), filed a lawsuit in the Third Circuit Court of the
State of Hawaii, asking for a declaration that the January 1998 DLNR letter is
void and seeking an injunction to prevent HELCO from further construction until
the Court or the BLNR, at a public hearing, determines what conditions and
limitations apply and whether HELCO is in compliance with them.
The two 1998 cases have been consolidated before the Third Circuit Court of the
State of Hawaii. HELCO intends to vigorously defend against the claims raised
and management believes the allegations are without merit.
IPP complaints. Two independent power producers (IPPs), 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 claimed
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 HELCO's rate base unless
and until the project is in fact installed, and is used and useful for utility
purposes." 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
IPP's) should be the one that can be most expeditiously put into service at
"allowable cost."
The status of the IPPs PUC complaints, and of a complaint filed by Hilo Coast
Power Company (HCPC) in April 1997, is as follows:
Enserch complaint. In January 1998, HELCO filed with the PUC an application
-----------------
for approval of a power purchase agreement for a 60-MW facility and an
interconnection agreement with Encogen, an Enserch affiliate, dated
October 22, 1997. The agreements were entered into following a settlement
agreement between Enserch and HELCO and are subject to PUC approval. The
parties to the proceeding include HELCO, Encogen and the Consumer Advocate.
The Consumer Advocate has submitted information requests to HELCO. Motions
to intervene filed by KCP, HCPC and one other IPP were denied by the PUC.
KCP filed an appeal with the First Circuit Court, challenging the denial of
its intervention. KCP's appeal is scheduled for oral argument on September
25, 1998. No schedule has yet been established for the PUC proceeding.
KCP complaint. In January 1996, the PUC ordered HELCO to continue in good
-------------
faith to negotiate a power purchase agreement with KCP. In May 1997, KCP
filed a motion for unspecified "sanctions" against HELCO for allegedly
failing to negotiate in good faith. In June 1997, KCP filed a motion asking
the PUC to designate KCP's facility as the next generating unit on the
HELCO system and to determine the "allowable cost" which would be payable
by HELCO to KCP. HELCO filed memoranda in opposition to KCP's motions. An
evidentiary hearing was held in August 1997. KCP filed two motions, which
HELCO also opposed, to supplement the record. The PUC issued an Order in
June 1998 which denied all of KCP's pending motions; provided rulings
and/or guidance on certain avoided cost and contract issues; directed HELCO
to prepare an updated avoided cost calculation, which includes the Encogen
agreement; and directed HELCO and KCP to resume contract negotiations.
HELCO has commenced activity to comply with the Order. HELCO filed a motion
for partial reconsideration with respect to one avoided cost issue. The PUC
granted the motion and modified its order in July 1998.
15
HCPC complaint. In April 1997, 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. The PUC converted the HCPC
complaint into a purchased power contract negotiation proceeding. HCPC
submitted a new proposal in the proceeding in February 1998. An evidentiary
hearing limited to certain avoided cost issues was held in April 1998 and
post-hearing briefs on these issues have been submitted. Action by the PUC
is pending.
Management cannot determine at this time whether the PUC will approve the
Encogen power purchase agreement or whether the negotiations with KCP and HCPC
and related PUC proceedings will result in the execution and/or PUC approval of
a power purchase agreement or impact management's plans with regard to
installation of HELCO's combined-cycle unit at the Keahole power plant site.
KCP'S FERC PETITION. On July 29, 1998, KCP tendered for filing with the Federal
- --------------------
Energy Regulatory Commission (FERC) a Petition for Enforcement under section
210(h) of PURPA, or in the alternative, for Declaratory Order.
KCP alleges that the PUC and HECO have taken actions that violate PURPA thereby
allowing HELCO to begin construction of its own facility and preventing KCP from
building its qualifying facility. KCP requests that FERC initiate enforcement
proceedings or, in the alternative, issue an order declaring that the PUC's
actions violate FERC's rules under PURPA and are therefore preempted under the
Federal Power Act.
FERC's notice of filing provides for the filing of motions to intervene or
protest by August 31, 1998. In requesting denial of the petition, HECO
currently intends to assert that the petition requests relief beyond FERC's
jurisdiction and is without merit, and that the initiation of an enforcement
action would not be consistent with FERC's enforcement policy.
BLNR PETITION. On August 5, 1998, Keahole Defense Coalition filed with the BLNR
- --------------
a Petition for Declaratory Ruling under Section 91-8, Hawaii Revised Statutes.
The petition alleges that all conditions in Hawaii Administrative Rules 13-2-21
apply to HELCO's default entitlement to use its Keahole site, that the letter
issued to HELCO by the DLNR in January 1998 was erroneous because it failed to
incorporate all conditions applicable to the existing permits, and that the DOH
issued three separate Notices of Violation (NOVs) to HELCO in 1992 and 1998 for
violation of clean air rules, which NOVs constitute violations under the
existing permits and render such permits null and void. The petition requests
that the BLNR commence a contested case on the petition; that the BLNR determine
that HELCO has violated the terms of its existing conditional use permits,
causing such permits to be null and void; and that the BLNR determine that
HELCO has violated the conditions applicable to its default entitlement, such
that HELCO should be enjoined from using the Keahole property under such default
entitlement.
COMPLAINT AND MOTION FOR TEMPORARY RESTRAINING ORDER. On August 5, 1998, Keahole
- -----------------------------------------------------
Defense Coalition filed in the Third Circuit Court of the State of Hawaii a
Complaint and Motion for Temporary Restraining Order and Preliminary Mandatory
Injunction against HELCO and the Chief Engineer, Department of Public Works,
County of Hawaii, and on August 6, 1998, filed an amended complaint. The
complaint and amended complaint do not identify a cause of action, but allege
that the City Engineer issued eight building permits to HELCO for the expansion
of the Keahole Generating Station without requiring HELCO to obtain a final
Covered Source Permit as a precondition to construction on the belief that the
DOH and the EPA had authorized certain construction activities. The complaints
further allege that the existing units at Keahole are not being improved or
upgraded, and that the DOH has issued a NOV for construction of pipe rack
foundations, a retaining wall and an oil/water separator. The complaints call
for the suspension and revocation of the eight building permits and an
injunction to prevent further construction by HELCO. The motion calls for the
Court to mandate that the Chief Engineer suspend or revoke certain building
permits for structures, improvements and facilities which are directly or solely
associated with or which are of a permanent nature aimed at completing CT-4, CT-
5 and ST-7 and enjoin HELCO from construction at Keahole while the permits are
suspended or revoked.
Notice of Violation. In July 1998, the DOH issued a Notice of Violation (NOV) to
- --------------------
HELCO for three items allegedly constituting unauthorized construction activity
at the Keahole Generating Station prior to receipt of an effective PSD air
permit for CT-4 and CT-5. The NOV requires HELCO to immediately halt
construction activities on pipe rack foundations, a retaining wall and an
oil/water separator, and imposes a fine of $48,800. HELCO has complied with the
stop work order on the three items and is currently considering its response to
the NOV. HELCO has until mid-August 1998 to either request a hearing or pay the
fine.
COSTS INCURRED. As of June 30, 1998, HELCO's costs incurred in its efforts to
- --------------
put into service its Keahole combined-cycle unit amounted to $61.1 million,
including approximately $27.0 million for equipment and material purchases,
approximately $14.8 million for planning, engineering, permitting, site
development and other costs and approximately $19.3 million as an allowance for
funds used during construction. Of the total costs incurred, approximately $0.8
million is for ST-7.
16
CONTINGENCY PLANNING. In June 1995, HELCO filed with the PUC its generation
- --------------------
resource contingency plan detailing alternatives and mitigation measures to
address the further delays that subsequently occurred in obtaining the permits
necessary to construct its combined-cycle unit. Actions under the plan have
helped HELCO maintain its reserve margin and reduce the risk of near-term
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 has filed reports with the PUC from time to time updating
the contingency plan and its implementation.
ENVIRONMENTAL REGULATION
See discussion of the DOH NOV issued to HELCO above and note (8),
"Contingencies," in HEI's "Notes to consolidated financial statements."
PUC SHOW CAUSE ORDER FOR HECO
In March 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. The PUC noted 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 9.16% ROR determined to be reasonable by the PUC in the
utility's last rate case. HECO filed a motion to close the proceeding in March
1998, based on the fact that the actual returns for 1997--a 10.26% ROACE and a
8.75% ROR--were below the returns the PUC found to be fair and reasonable in the
last rate proceeding. The Consumer Advocate has filed with the PUC a statement
that it does not oppose HECO's request to close the proceedings. Management
cannot predict what future PUC action may be taken in this proceeding.
HECO POWER OUTAGE
On April 9, 1991, HECO experienced a power outage that affected all customers on
the island of Oahu. The PUC initiated an investigation of the April 9, 1991
outage and consolidated it with a pending investigation of an outage that
occurred in 1988. Power Technologies, Inc., an independent consultant hired by
HECO with the approval of the PUC, investigated the 1991 outage. HECO is
implementing certain of Power Technologies, Inc.'s recommendations and provides
the PUC with summaries of its progress on those recommendations. Management
cannot predict the timing and outcome of a PUC decision and order (D&O) that may
be issued, if any, with respect to the outages.
(5) ACCOUNTING CHANGES
- -----------------------
COMPREHENSIVE INCOME
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which establishes standards for the reporting and display of comprehensive
income and its components in a full set of general-purpose financial statements.
Consolidated HECO adopted SFAS No. 130 in the first quarter of 1998, but had no
material "other" comprehensive income items for the income statement periods
presented or accumulated as of the balance sheet dates presented.
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes standards for the way
that public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. Consolidated HECO adopted SFAS No. 131 in the first quarter of
1998. No modification to consolidated HECO's reporting segment was required.
COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE
In March 1998, the AICPA Accounting Standards Executive Committee issued SOP 98-
1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," which requires that certain costs, including certain payroll and
payroll-related costs, be capitalized and amortized over the estimated useful
life of the software. The provisions of SOP 98-1 are effective for fiscal years
beginning after December 15, 1998 and earlier application is encouraged. HECO
and its subsidiaries have not determined when they will adopt SOP 98-1.
Management currently believes that the adoption of SOP
17
98-1 will not have a material effect on consolidated HECO's financial condition,
results of operations or liquidity.
COSTS OF START-UP ACTIVITIES
In April 1998, the AICPA Accounting Standards Executive Committee issued SOP 98-
5, "Reporting on the Costs of Start-up Activities," which requires that costs of
start-up activities, including organization costs, be expensed as incurred. The
provisions of SOP 98-5 are effective for fiscal years beginning after December
15, 1998 and earlier application is encouraged. HECO and its subsidiaries have
not determined when they will adopt SOP 98-5. Management currently believes that
the adoption of SOP 98-5 will not have a material effect on consolidated HECO's
financial condition, results of operations or liquidity.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments and hedging activities and requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. The
provisions of SFAS No. 133 are effective for all fiscal quarters of fiscal years
beginning after June 15, 1999 and earlier application is encouraged. HECO and
its subsidiaries have not determined when they will adopt SFAS No. 133 and have
not yet determined the impact of adoption.
(6) SUMMARIZED FINANCIAL INFORMATION
- -------------------------------------
Summarized financial information for HECO's subsidiaries, HELCO and MECO, is as
follows:
BALANCE SHEET DATA
HELCO MECO
--------------------------------------- ------------------------------
June 30, December 31, June 30, December 31,
(in thousands) 1998 1997 1998 1997
- --------------------------------------------------------------------------------------------------------------------
Current assets............................ $ 25,331 $ 28,631 $ 26,180 $ 31,994
Noncurrent assets......................... 409,886 403,981 378,782 374,766
----------- ----------- ----------- -----------
$435,217 $432,612 $404,962 $406,760
=========== =========== =========== ===========
Common stock equity....................... $149,283 $144,761 $152,063 $150,129
Cumulative preferred stock
Not subject to mandatory redemption... 10,000 10,000 8,000 8,000
Subject to mandatory redemption....... 7,000 7,000 5,575 5,575
Current liabilities....................... 57,973 63,500 18,938 24,454
Noncurrent liabilities.................... 210,961 207,351 220,386 218,602
----------- ----------- ----------- -----------
$435,217 $432,612 $404,962 $406,760
=========== =========== =========== ===========
INCOME STATEMENT DATA
HELCO MECO
------------------------------------------------------------ ---------------------------------------------------
Three months Six months Three months Six months
ended June 30, ended June 30, ended June 30, ended June 30,
-------------------------- --------------------------- ----------------------- ------------------------
(in thousands) 1998 1997 1998 1997 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
Operating
revenues....... $37,602 $39,025 $76,377 $79,363 $32,515 $38,281 $68,245 $76,260
Operating
income......... 4,804 4,496 9,370 7,839 4,662 3,709 9,363 8,138
Net income for
common stock... 4,082 3,782 7,833 6,518 3,598 2,553 7,182 5,848
HECO has not presented separate financial statements and other disclosures
concerning MECO and HELCO because management has determined that such
information is not material to holders of the junior deferrable debentures
issued by MECO and HELCO, respectively, which have been fully and
unconditionally guaranteed by HECO.
18
(7) RECONCILIATION OF ELECTRIC UTILITY OPERATING INCOME PER HEI AND HECO
- --------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
---------------------------------
Three months ended Six months ended
June 30, June 30,
-------------------------- -------------------------
(in thousands) 1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------
Operating income from regulated and nonregulated
activities before income taxes (per HEI consolidated
statements of income)................................. $ 41,698 $ 40,396 $ 84,259 $ 78,990
Deduct:
Income taxes on regulated activities.................. (12,558) (12,073) (25,560) (23,777)
Revenues from nonregulated activities................. (2,344) (2,352) (4,563) (4,511)
Add:
Expenses from nonregulated activities................. 65 132 268 215
----------- ----------- ----------- -----------
Operating income from regulated activities after
income taxes (per HECO consolidated statements of
income)............................................... $ 26,861 $ 26,103 $ 54,404 $ 50,917
=========== =========== =========== ===========
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 of HEI and HECO and accompanying notes.
RESULTS OF OPERATIONS
HEI CONSOLIDATED
- ----------------
Three months ended
June 30,
(in thousands, except ---------------------- % Primary reason(s) for
per share amounts) 1998 1997 change significant change*
- --------------------------------------------------------------------------------------------------------------
Revenues.................. $362,472 $360,253 1 Increases for the savings bank and
"other" segments, partly offset by a
decrease for the electric utility
segment
Operating income.......... 53,790 50,170 7 Improvement for all segments
Net income................ 22,393 19,795 13 Higher operating income and lower
income taxes**, partly offset by higher
interest expense primarily due to
higher average borrowings partly used
to finance the infusion of capital into
the savings bank for the acquisition of
most of BoA's Hawaii operations
Basic and diluted
earnings per
common share........... $ 0.70 $ 0.63 11 See explanation for "net income,"
partly offset by an increase in shares
outstanding
Weighted average number
of common shares
outstanding.............. 32,007 31,237 2 Issuances under the Stock Option and
Incentive Plan and Nonemployee Director
Stock Plan
19
Six months ended
June 30,
(in thousands, except -------------------- % Primary reason(s) for
per share amounts) 1998 1997 change significant change*
- ------------------------------------------------------------------------------------------------------------
Revenues.................. $738,093 $719,446 3 Increases for the savings bank and
"other" segments, partly offset by a
decrease for the electric utility
segment
Operating income.......... 109,808 99,522 10 Improvement for all segments
Net income................ 44,616 39,458 13 Higher operating income and lower
income taxes**, partly offset by
higher preferred securities
distributions (due to the issuance of
HEI- and HECO-obligated preferred
securities of trust subsidiaries in
February and March 1997) and higher
interest expense primarily due to
higher average borrowings partly used
to finance the infusion of capital
into the savings bank for the
acquisition of most of BoA's Hawaii
operations
Basic earnings per common
share.................... $ 1.40 $ 1.27 10 See explanation for "net income,"
Diluted earnings per partly offset by an increase in
common share............. $ 1.39 $ 1.27 9 shares outstanding
Weighted average number
of common shares
outstanding.............. 31,982 31,099 3 Issuances under the Dividend
Reinvestment and Stock Purchase Plan
and other plans***
* Also see segment discussions which follow.
** Income taxes decreased primarily due to the favorable resolution of HEI's
prior years' tax audit issues (with respect to which HEI had established a
reserve) and the impact of the formation of ASB Realty Corporation (see
savings bank segment discussion which follows).
*** Beginning in March 1998, HEI purchased its common shares in the open
market to satisfy the requirements of the HEI Dividend Reinvestment and
Stock Purchase Plan and the Hawaiian Electric Industries Retirement
Savings Plan.
20
Following is a general discussion of the results of operations by business
segment.
ELECTRIC UTILITY
- ----------------
Three months ended
June 30,
(in thousands, except per ------------------------ % Primary reason(s) for
barrel amounts) 1998 1997 change significant change
- -------------------------------------------------------------------------------------------------------------
Revenues.................. $244,548 $275,324 (11) Lower fuel prices, the effects of
which are passed on to ratepayers
($24 million), and a 3% decrease in
KWH sales ($7 million)
Expenses
Fuel oil................. 44,449 65,112 (32) Lower fuel oil prices, fewer KWHs
generated and better generating unit
efficiency
Purchased power.......... 69,091 72,473 (5) Lower fuel oil prices and fewer KWHs
purchased
Other.................... 89,310 97,343 (8) Lower other operation and maintenance
expenses and lower revenue taxes
Operating income.......... 41,698 40,396 3 Lower revenues more than offset by
lower expenses
Net income................ 18,689 18,115 3 Higher operating income, partly
offset by higher interest expense
Kilowatthour sales
(millions).............. 2,152 2,209 (3)
Fuel oil price per barrel. $18.59 $25.86 (28)
Six months ended
June 30,
(in thousands, except per --------------------- % Primary reason(s) for
barrel amounts) 1998 1997 change significant change
- -------------------------------------------------------------------------------------------------------------
Revenues.................. $502,810 $549,080 (8) Lower fuel prices, the effects of
which are passed on to ratepayers
($41 million), and a 1% decrease in
KWH sales ($6 million)
Expenses
Fuel oil................. 101,180 134,332 (25) Lower fuel oil prices, fewer KWHs
generated and better generating unit
efficiency
Purchased power.......... 135,674 143,224 (5) Lower fuel oil prices and fewer KWHs
purchased
Other.................... 181,697 192,534 (6) Lower other operation and maintenance
expenses and lower revenue taxes
Operating income.......... 84,259 78,990 7 Lower revenues more than offset by
lower expenses
21
(continued)
Six months ended
June 30,
(in thousands, except per --------------------- % Primary reason(s) for
barrel amounts) 1998 1997 change significant change
- --------------------------------------------------------------------------------------------------------------
Net income................ 37,951 35,279 8 Higher operating income, partly
offset by higher interest expense and
preferred securities distributions
Kilowatthour sales
(millions).............. 4,279 4,333 (1)
Fuel oil price per barrel. $ 20.87 $ 26.98 (23)
Kilowatthour (KWH) sales in the second quarter and first six months of 1998
decreased 3% and 1%, respectively, from the same periods in 1997, partly due to
the slow Hawaii economy and cooler weather. Despite the lower KWH sales,
electric utility operating income increased 3% and 7% during the second quarter
and first six months of 1998, respectively, compared to the same periods in 1997
as a result of lower expenses, partly resulting from cost containment efforts.
Lower other operation and maintenance expenses (reflecting fewer unit overhauls
and lower labor related expenses) contributed to the increases in operating
income. Electric utility net income increased 3% and 8% during the second
quarter and first six months of 1998, respectively, compared to the same periods
in 1997 as a result of the higher operating income, partly offset by higher
interest expense due to higher average borrowings and higher preferred
securities distributions due to the issuance of the HECO-obligated preferred
securities of HECO Capital Trust I in March 1997.
PUC 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 may be
granted.
In June 1998, PUC Chairman Yukio Naito resigned effective July 31, 1998 after
serving on the PUC since 1988. On July 29, 1998, Governor Benjamin Cayetano
named Gregory Pai as Mr. Naito's replacement on the PUC effective August 1, 1998
and named Dennis Yamada as Chairman. Mr. Yamada has been serving on the PUC
since July 1994 and had recently been confirmed for a new-six year term ending
June 30, 2004. Mr. Pai's nomination is subject to Senate approval.
RECENT RATE REQUESTS
HEI's electric utility subsidiaries initiate PUC proceedings from time to time
to request 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 1998, HELCO filed a request to increase rates 11.5%, or $17.3 million
in annual revenues, based on a 1999 test year and a 12.5% return on average
common equity (ROACE), primarily to recover costs relating to two power
generation projects--an agreement to buy power from Encogen's 60megawatt (MW)
plant in Hamakua and the cost of adding generating units at HELCO's Keahole
power plant. The Encogen agreement has been submitted to the PUC for approval.
Under HELCO's
22
request, the portion of the rate increase related to Encogen's generators would
not go into effect until the facilities are completed and providing electric
service to customers.
Maui Electric Company, Limited
- ------------------------------
In May 1996, MECO filed a request to increase rates 13%, or $18.9 million in
annual revenues, based on a 1997 test year and a 12.9% ROACE, primarily to
recover the costs related to the anticipated 1997 addition of new generating
unit M17. In November 1996, MECO filed a motion with the PUC to approve a
stipulation between MECO and the Consumer Advocate which would provide MECO with
an increase in annual revenues of $1.5 million, based on an 11.65% ROACE. In May
1997, the stipulated increase was revised to $1.3 million after considering the
final decision in the 1996 test year case. The primary reason for the
stipulation was a delay in the expected in-service date for MECO's generating
unit M17 until late 1998 because of delays in obtaining the necessary Prevention
of Significant Deterioration/Covered Source (PSD) permit from the Department of
Health of the State of Hawaii (DOH)/U.S. Environmental Protection Agency (EPA).
In December 1997, MECO received a final D&O authorizing no additional increase
in annual revenues, based on an 11.12% ROACE.
In January 1998, MECO received a PSD permit for generating unit M17 and filed a
request to increase rates 15.3%, or $22.4 million in annual revenues, based on a
12.75% ROACE and a 1999 test year, primarily to recover the costs related to the
anticipated addition of unit M17 in late 1998. In February 1998, KCP filed a
petition with the EPA's Environmental Appeals Board (EAB) to review the air
permit issued to MECO for units M17 and M19, staying construction. In April
1998, the DOH submitted its brief to the EAB responding to issues raised in
KCP's petition and requesting that the petition be denied. On May 1, 1998, EPA
Region IX filed its response to the KCP petition, indicating their continued
concurrence with the permit issued to MECO and requesting that the KCP petition
be denied. An EAB ruling is pending.
CONTINGENCIES
See note (4) in HECO's "Notes to consolidated financial statements."
SAVINGS BANK
- ------------
Three months ended
June 30,
----------------------- % Primary reason(s) for
(in thousands) 1998 1997 change significant change
- ----------------------------------------------------------------------------------------------------------------
Revenues.................. $101,268 $69,674 45 Higher interest income as a result of
the higher average interest-earning
assets balance due to the acquisition
of most of the Hawaii operations of
BoA, partly offset by the lower
weighted average yields on these assets
Operating income.......... 12,630 12,236 3 Higher net interest income and other
income due to the acquisition, partly
offset by an increase in operating
expenses as a result of the acquisition
and a higher provision for loan losses
Net income................ 7,352 7,172 3 Higher operating income and lower
income taxes, partly offset by
preferred stock dividends
Interest rate spread...... 3.12% 2.96% 5 36 basis points decrease in the
weighted average rate on
interest-bearing liabilities, partly
offset by 20 basis points decrease in
the weighted average yield on
interest-earning assets
23
Six months ended
June 30,
------------------------ % Primary reason(s) for
(in thousands) 1998 1997 change significant change
- --------------------------------------------------------------------------------------------------------------
Revenues.................. $203,095 $138,586 47 See explanation above
Operating income.......... 28,681 24,521 17 See explanation above
Net income................ 15,712 14,271 10 Higher operating income, partly
offset by preferred stock dividends
Interest rate spread...... 3.18% 2.97% 7 33 basis points decrease in the
weighted average rate on
interest-bearing liabilities, partly
offset by a 12 basis points decrease
in the weighted average yield on
interest-earning assets
ASB's revenues, operating income and net income for the second quarter and first
six months of 1998 reflect the results of the acquired BoA Hawaii operations.
Partly offsetting the higher results compared to the first six months of 1997
were increased consulting expenditures to consolidate and streamline operations
and an after-tax increase of $2 million in ASB's loan loss provision (see
discussion below).
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--increased 5% and 7% for the second quarter and first six months of
1998 compared to same periods in 1997. Comparing the first half of 1998 to the
same period in 1997, 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. In December
1997, ASB was able to grow significantly through the assumption of $1.7 billion
of BoA's Hawaii deposits. There was an outflow of deposits of $156 million in
the first six months of 1998, partly offset by $55 million of interest credited
to accounts. ASB also derives funds from borrowings, payments of interest and
principal on outstanding loans receivable and mortgage-backed securities, and
other sources. In recent years, advances from the Federal Home Loan Bank (FHLB)
of Seattle and securities sold under agreements to repurchase have become more
significant sources of funds as the demand for deposits decreased due in part to
increased competition from money market and mutual funds. Using sources of funds
with a higher cost than deposits, such as advances from the FHLB, puts downward
pressure on ASB's interest rate spread and net interest income.
In the slow Hawaii economy, ASB has seen a rise in nonaccrual loans and loan
loss reserves. During the first six months of 1998, ASB added $6.3 million to
its allowance for loan losses -- 127% more than the additions made in the same
period last year. As of June 30, 1998, ASB's allowance for loan losses was
1.15% of average loans outstanding. Charge-offs, however, remain low compared to
mainland thrifts. Annualized charge-offs based on the six month period ended
June 30, 1998 were 12 basis points of average loans outstanding, compared to 39
basis points for all U.S. thrifts for the year ended December 31, 1997. The
following table presents the changes in the allowance for loan losses for the
periods indicated.
24
Six months ended
June 30,
-----------------------------
(in thousands) 1998 1997
- ---------------------------------------------------------------------------------------------------------
Allowance for loan losses, beginning of period......................... $29,950 $19,205
Additions to provisions for losses..................................... 6,348 2,792
Allowance for losses on loans returned to BoA.......................... (107) --
Net charge-offs........................................................ (1,427) (956)
---------- ----------
Allowance for loan losses, end of period............................... $34,764 $21,041
========== ==========
On March 27, 1998, ASB formed a wholly owned operating subsidiary, ASB Realty
Corporation (ASBR). ASBR elects to be taxed as a real estate investment trust
(REIT). ASBR's objective is to acquire, hold, finance and manage qualifying REIT
assets. For the second quarter of 1998, in spite of a 3% increase in operating
income, ASB and subsidiaries' income taxes were $1.1 million lower than the same
period in 1997.
OTHER
- -----
Three months ended
June 30,
------------------------ % Primary reason(s) for
(in thousands) 1998 1997 change significant change
- ----------------------------------------------------------------------------------------------------------------
Revenues.................. $16,656 $15,255 9 Freight transportation subsidiaries'
higher general freight revenues and
HEIPC's higher Guam revenues
Operating loss............ (538) (2,462) 78 Higher freight transportation operating
income (see below) and lower holding
company administrative and general
expenses
Six months ended
June 30,
------------------------ % Primary reason(s) for
(in thousands) 1998 1997 change significant change
- ----------------------------------------------------------------------------------------------------------------
Revenues.................. $32,188 $31,780 1 Freight transportation subsidiaries'
higher general freight revenues and
HEIPC's higher Guam revenues, partly
offset by MPC's lower unit sales
Operating loss............ (3,132) (3,989) 21 Higher freight transportation operating
income (see below)
The "other" business segment includes results of operations from Hawaiian Tug &
Barge Corp. (HTB) and its subsidiary, Young Brothers, Limited (YB), maritime
freight transportation companies; Malama Pacific Corp. (MPC) and its
subsidiaries, real estate development and investment companies; HEI Investment
Corp. (HEIIC), a company primarily holding investments in leveraged leases; HEI
Power Corp. (HEIPC) and its subsidiaries, companies formed to pursue independent
power and integrated energy services projects in Asia and the Pacific; Pacific
Energy Conservation Services, Inc., a contract services company primarily
providing limited services to an affiliate; Hawaiian Electric Industries Capital
Trust I, HEI Preferred Funding, LP and Hycap Management, Inc., companies formed
primarily for the purpose of effecting the issuance of 8.36% Trust Originated
Preferred Securities; HEI and HEI Diversified, Inc. (HEIDI), holding companies;
and eliminations of intercompany transactions.
25
FREIGHT TRANSPORTATION
The freight transportation subsidiaries recorded operating income of $1.5
million and $2.1 million in the second quarter and first half of 1998,
respectively, compared with $0.4 million and $0.8 million in the same periods of
1997. The higher operating incomes for 1998 are due to higher general freight
revenues, lower maintenance and drydocking expenses and lower operating expenses
resulting from a PUC approved sailing schedule change. The freight
transportation subsidiaries, however, continue to be negatively impacted by the
slow economic activity on Oahu's neighbor islands and the slow construction
industry in Hawaii.
In March 1997, YB filed a request with the PUC for a general rate increase of
8.2%. In September 1997, the PUC approved YB's request to change its sailing
schedule that resulted in a reduction in YB's requested rate increase from 8.2%
to 5.7%. In October 1997, YB received a final D&O authorizing a 4.7%, or $1.7
million increase in annual revenues, based on a 14.1% ROACE.
REAL ESTATE
MPC recorded operating losses of $0.3 million and $0.8 million in the second
quarter and first half of 1998, respectively, compared with $0.3 million and
$0.6 million in the same periods of 1997. The slow real estate market in Hawaii
has negatively impacted MPC's real estate development activities. 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 1995 and its subsidiaries have been and will be formed from
time to time to pursue independent power and integrated energy services projects
in Asia and the Pacific. HEIPC's consolidated operating losses were $1.0 million
and $1.6 million in the second quarter and first half of 1998, respectively,
compared with $0.8 million and $1.1 million in the same periods of 1997. The
increases in 1998 operating losses were due to increased business development
expenses, partly offset by operating income from the energy conversion agreement
described below.
In September 1996, an HEIPC subsidiary, HEI Power Corp. Guam (HPG), entered into
a 20-year energy conversion agreement with the Guam Power Authority (GPA),
pursuant to which HPG has repaired and is operating and maintaining two oil-
fired 25-MW (net) units on GPA property at Tanguisson, Guam. In November 1996,
HPG assumed operational control of the Tanguisson facility. HPG's total cost to
repair the two units was $15 million. The GPA project site is contaminated with
oil from spills occurring prior to HPG's assuming operational control. HPG has
agreed to manage the operation and maintenance of GPA's waste oil recovery
system at the project site consistent with GPA's oil recovery plan as approved
by the EPA. GPA, however, has agreed to indemnify and hold HPG harmless from any
pre-existing environmental liability.
HEIPC is actively pursuing other projects in Asia and the Pacific. The success
of any project undertaken by HEIPC will be dependent on many factors, including
the economic, political, monetary, technological, regulatory and logistical
circumstances surrounding each project and the location of the project. Due to
political or regulatory actions or other circumstances, projects may be delayed
or even prohibited. There is no assurance that any project undertaken by HEIPC
will be successfully completed or acquired or that HEIPC's investment in any
such project will not be lost, in whole or in part.
Management's initial plans were to invest approximately $25 million to $30
million in HEIPC. HEIPC is pursuing projects which, if successful, could result
in an aggregate investment of approximately $150 million over the next 3 to 4
years. Each project, however, would be subject to approval from the HEI Board of
Directors. Further, the amount of equity invested may be reduced if debt
financing is obtained.
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.
26
FUTURE ENVIRONMENTAL REGULATION
On July 16, 1997, the EPA adopted national ambient air quality standards for
certain particulate matter and ozone. The new standards will not require local
pollution controls until 2004 for the ozone standards and 2005 for the
particulate matter standards, with no compliance determinations until 2007 and
2008, respectively, and with possible extensions. The eventual impact of these
new standards on the Company and consolidated HECO is not known at this time.
YEAR 2000 COMPLIANCE
HEI and its subsidiaries are aware of the Year 2000 date issues associated with
the practice of encoding only the last two digits of four digit years in
computer-based systems. Year 2000 date issues, if not properly addressed, could
result in computer errors that might result in a disruption of business
operations. Further, the Company could be adversely impacted by Year 2000 date
issues if suppliers, customers and other businesses do not address the issues
successfully. HEI and subsidiary management have developed Year 2000 programs
and projects and have teams in place that are actively assessing, renovating,
validating and implementing Year 2000 ready systems. Both of HEI's major
business segments, HECO and its subsidiaries and ASB and its subsidiaries, are
in the process of replacing the majority of their business-critical applications
with integrated application suites that are warranted to be Year 2000 ready.
Although Year 2000 readiness is a requirement, these application replacements
are primarily driven by business needs. Management estimates that the
incremental cost to renovate other applications and test replacement
applications and systems to become Year 2000 ready will not have a material
adverse effect on the Company's financial condition, results of operations or
liquidity. No assurance can be given that the Company will successfully avoid
all problems that arise out of the Year 2000 issue.
ACCOUNTING CHANGES
- ------------------
See note (7) and note (5) in HEI's and HECO's "Notes to consolidated financial
statements," respectively.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The Company and consolidated HECO each believes that its ability to generate
cash, both internally from operations and externally from debt and equity
issues, is adequate to maintain sufficient liquidity to fund their respective
construction programs and investments and to satisfy debt and other cash
requirements in the foreseeable future.
The consolidated capital structure of HEI was as follows:
(in millions) June 30, 1998 December 31, 1997
- ------------------------------------------------------------------------------------------------------------------------
Short-term borrowings......................... $ 333 14% $ 298 14%
Long-term debt................................ 919 40 802 37
HEI- and HECO-obligated preferred
securities of trust subsidiaries........... 150 6 150 7
Preferred stock of electric utility
subsidiaries................................. 82 4 84 4
Common stock equity........................... 824 36 815 38
--------- --------- ---------- ---------
$2,308 100% $2,149 100%
========= ========= ========== =========
ASB's deposit liabilities, securities sold under agreements to repurchase and
advances from FHLB are not included in the table above.
In February and June 1998, HEI issued $53 million and $60 million in medium-term
notes bearing weighted average interest rates of 6.2% and 6.5%, respectively,
and primarily used the proceeds to pay down short-term borrowings. This decrease
in short-term borrowings at HEI was more than offset by an increase at ASB of
$118 million in State of Hawaii retail repurchase agreements (classified as
short-term borrowings), which matured on July 1, 1998.
27
On May 29, 1998, Standard & Poor's changed its outlook for HEI, HECO, HELCO and
MECO securities from positive to stable citing continuing weakness in Hawaii's
economy as the reason for this change.
For the first six months of 1998, net cash provided by operating activities was
$44 million. Net cash used in investing activities was $258 million, largely due
to ASB's origination of loans and purchase of mortgage-backed and investment
securities, net of repayments, and consolidated HECO's capital expenditures,
partly offset by cash received from BoA for loans returned after the acquisition
(in accordance with the provisions of the Purchase and Assumption Agreement).
Net cash provided by financing activities was $214 million as a result of
several factors, including net increases in securities sold under agreements to
repurchase, long-term debt, advances from FHLB and short-term borrowings, partly
offset by net decreases in deposit liabilities and the payment of common stock
dividends.
HEI estimates its consolidated requirements for funds for 1998 through 2002,
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, to total $819 million.
Of this amount, approximately $665 million is for net capital expenditures
(mostly relating to the electric utilities' net capital expenditures described
below). HEI estimates that its consolidated internal sources, after the payment
of HEI dividends, will provide approximately 80% of the consolidated
requirements, with debt financing providing the remaining requirements.
Additional debt and equity financing may be required to fund activities not
included in the 1998-2002 forecast, such as the development of additional power
projects in the Asia Pacific region, or to fund changes in requirements, such as
increases in the amount of or acceleration of capital expenditures of the
electric utilities.
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) June 30, 1998 December 31, 1997
- -------------------------------------------------------------------------------------------------------
Short-term borrowings from
nonaffiliates and affiliate... $ 109 7% $ 96 6%
Long-term debt................. 633 38 628 39
HECO-obligated preferred
securities of trust subsidiary 50 3 50 3
Preferred stock................ 82 5 84 5
Common stock equity............ 792 47 769 47
-------- -------- -------- --------
$1,666 100% $1,627 100%
======== ======== ======== ========
Operating activities provided $55 million in net cash during the first six
months of 1998. Investing activities used net cash of $54 million, primarily for
capital expenditures. Financing activities used net cash of $1 million,
including $17 million for the payment of common and preferred dividends and $2
million for preferred stock redemptions, almost entirely offset by the net
increases in short-term borrowings and long-term debt.
The electric utilities estimate their consolidated requirements for funds for
1998 through 2002, including net capital expenditures, long-term debt
retirements and sinking fund requirements, total $644 million. HECO estimates
that its consolidated internal sources, after the payment of common stock and
preferred stock dividends, will provide approximately 87% of the consolidated
requirements, with debt and equity financing providing the remaining
requirements. As of June 30, 1998, $48 million of proceeds from previous sales
by the Department of Budget and Finance of the State of Hawaii of special
purpose revenue bonds on behalf of HECO, MECO and HELCO remain undrawn and an
additional $88 million of special purpose revenue bonds were authorized by the
Hawaii Legislature for issuance by the Department of Budget and Finance of the
State of Hawaii on behalf of HECO and MECO prior to the end of 1999. In July
1998, an additional $100 million of revenue bonds were authorized by the Hawaii
legislature for issuance prior to the end of 2003. The PUC must approve
issuances of long-term securities by HECO, MECO and HELCO.
28
Capital expenditures include the costs of projects that are required to meet
expected load growth, to improve reliability and to replace and upgrade existing
equipment. The electric utilities estimate that net capital expenditures for the
five-year period 1998 through 2002 will total $592 million. Approximately 72% of
forecast gross capital expenditures, which include 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 28% primarily for generation projects.
For 1998, electric utility net capital expenditures are estimated to be $151
million. Gross capital expenditures are estimated to be $184 million, comprised
of approximately $121 million for transmission and distribution projects,
approximately $39 million for new generation projects and approximately $24
million for general plant and existing generation projects. Drawdowns of
proceeds from 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.
Management periodically reviews capital expenditure estimates and the timing of
construction projects. These estimates 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.
SAVINGS BANK
June 30, December 31, %
(in millions) 1998 1997 change
- --------------------------------------------------------------------------------------------------------------
Total assets..................................... $5,740 $5,548 3
Mortgage-backed securities....................... 1,906 1,865 2
Loans receivable, net............................ 3,059 3,036 1
Deposit liabilities.............................. 3,817 3,917 (3)
Securities sold under agreements to repurchase... 526 375 40
Advances from Federal Home Loan Bank............. 791 736 7
As of June 30, 1998, ASB was the third largest financial institution in the
state based on total assets of $5.7 billion and based on deposits of $3.8
billion.
For the first six months of 1998, net cash used in ASB's operating activities
was $14 million. Net cash used in ASB's investing activities was $197 million,
due largely to the origination of loans and the purchase of mortgage-backed and
investment securities, partly offset by principal repayments and the cash
received from BoA for loans returned to BoA after the acquisition. Net cash
provided by financing activities was $209 million largely due to a net increase
of $150 million in securities sold under agreements to repurchase, $115 million
in short-term borrowings and $54 million in advances from FHLB, partly offset by
a net decrease of $101 million in deposit liabilities and $9 million in common
and preferred stock dividends.
Minimum liquidity levels are currently governed by the regulations adopted by
the Office of Thrift Supervision, Department of Treasury (OTS). ASB was in
compliance with OTS liquidity requirements as of June 30, 1998.
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 June 30, 1998, ASB was in compliance with the OTS minimum
capital requirements (noted in parentheses) with a tangible capital ratio of
5.1% (1.5%), a core capital ratio of 5.1% (3.0%) and a risk-based capital ratio
of 12.4% (8.0%).
FDIC regulations restrict the ability of financial institutions that are not
"well-capitalized" to compete on the same terms as "well-capitalized"
institutions, such as by offering interest rates on deposits that are
significantly higher than the rates offered by competing institutions. As of
June 30, 1998, ASB was "well-capitalized" (ratio requirements noted in
parentheses) with a leverage ratio of 5.1% (5.0%), a Tier-1 risk-based ratio of
11.4% (6.0%) and a total risk-based ratio of 12.4% (10.0%).
The federal and state governments have enacted significant interstate banking
legislation. Under the federal Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994, a bank holding company
29
may acquire control of a bank in any state, subject to certain restrictions.
Under Hawaii law, effective 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 do not apply to thrifts, 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.
For a discussion of the unfavorable disparity in the deposit insurance
assessment rates and Financing Corporation assessment 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."
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------------------------------------------------------------------
The Company's results are impacted by ASB's ability to manage interest rate
risk. For quantitative and qualitative information about the Company's market
risks, see pages 37 to 39 of HEI's 1997 Annual Report to Stockholders.
U.S. Treasury yields at June 30, 1998 and December 31, 1997 were as follows:
(%) June 30, 1998 December 31, 1997
--- ------------- -----------------
3 month 5.07 5.34
3 year 5.49 5.66
5 year 5.46 5.71
7 year 5.51 5.76
10 year 5.44 5.74
20 year 5.72 6.01
30 year 5.63 5.92
As interest rates (as measured by U.S. Treasury yields) have declined between
3.0% and 5.2% from December 31, 1997 to June 30, 1998, management does not
believe there has been a material change in the Company's quantitative
disclosures of its interest-sensitive assets, liabilities and off-balance sheet
items.
PART II - OTHER INFORMATION
- --------------------------------------------------------------------------------
ITEM 1. LEGAL PROCEEDINGS
- --------------------------
There are no significant developments in pending legal proceedings except as set
forth in HEI's and HECO's "Notes to consolidated financial statements," and
management's discussion and analysis of financial condition and results of
operations.
ITEM 5. OTHER INFORMATION
- --------------------------
A. HECO, MECO and HELCO labor negotiations
The current collective bargaining agreement between HECO, MECO and HELCO and the
International Brotherhood of Electrical Workers (IBEW), Local 1260, covering
approximately 63% of the total employees of these companies, was extended in
November 1995 for a two-year period from November 1, 1996 through October 31,
1998. The current benefits agreement was also extended for a two-year period.
HECO, MECO and HELCO and the IBEW are currently in negotiations.
30
B. HTB and YB labor negotiations
HTB and YB had a collective bargaining agreement with the Inlandboatmen's Union
of the Pacific (IBU) effective from July 26, 1995 through July 25, 1998. This
agreement was extended during negotiations. On August 1, 1998, a new agreement
was ratified. The new agreement is effective from July 26, 1998 to July 30, 2001
and provides for a 1.9% wage increase for the first year, a 1.8% wage increase
for the second year and a 2.4% wage increase for the third year. The agreement
covers all unionized employees of HTB and YB employed on ocean, interisland,
harbor tug operations and dispatchers. It excludes journeyman craftsmen (covered
in YB's contract with the International Longshoremen's and Warehousemen's
Union), office clerical employees, professional and management employees, guards
and watchmen.
C. MECO air quality compliance
On November 1, 1989, the Department of Health of the State of Hawaii (DOH)
issued a Notice of Violation (NOV) indicating that Maalaea units X-1 and X-2 had
exceeded operating limitations of 12 hours per day at various times in 1988.
These incidents resulted from unscheduled unit outages and resulted in no net
increase in emissions by MECO. Subsequently, MECO took steps to preclude future
violations. An application for a permit modification was submitted to the EPA
and approval was received from the EPA in July 1992. Units X-1 and X-2 continue
to operate in compliance with the revised permit.
Following a unit overhaul, emission compliance tests conducted for MECO's
Maalaea Unit 14 in late 1995 indicated that particulate emissions were in excess
of PSD permit limits. Corrective actions were taken and a retest in February
1996 confirmed that the unit returned to compliance with PSD limits. All test
reports were submitted to the DOH. By letter dated July 15, 1996, the DOH
indicated that a NOV would be issued for the past violations.
By letter dated January 31, 1997, the DOH invited MECO to meet to discuss
settlement of open matters. An agreement was reached with the DOH to resolve the
NOV issued for X-1 and X-2 operating hours during 1988 and any other air permit
violations which may have occurred from November 1, 1989 until November 1, 1996
(including past violations of Maalaea Unit 14 discussed in the previous
paragraph). MECO signed the final consent order on July 24, 1998. In accordance
with the agreement, MECO will contribute $100,000 over the next two years to a
public education program on air quality after an executed copy of the consent
order is received from the DOH.
D. 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
Six months Years Ended December 31,
ended -------------------------------------------------------------------------------------------
June 30, 1998 1997 1996 1995 1994 1993
- ------------------- --------------- -------------- ------------- -------------- ---------------
1.82 1.82 1.87 1.94 2.22 2.25
=================== =============== ============== ============= ============== ===============
RATIO OF EARNINGS TO FIXED CHARGES INCLUDING INTEREST ON ASB DEPOSITS
Six months Years Ended December 31,
ended -------------------------------------------------------------------------------------------
June 30, 1998 1997 1996 1995 1994 1993
- ------------------- --------------- -------------- ------------- -------------- ---------------
1.44 1.53 1.53 1.57 1.69 1.65
=================== =============== ============== ============= ============== ===============
31
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 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
Six months Years Ended December 31,
ended -------------------------------------------------------------------------------------------
June 30, 1998 1997 1996 1995 1994 1993
- ------------------- --------------- -------------- ------------- -------------- ---------------
3.13 3.26 3.58 3.46 3.47 3.25
=================== =============== ============== ============= ============== ===============
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 the trust subsidiary.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
(a) EXHIBITS
HEI Hawaiian Electric Industries, Inc. and subsidiaries
Exhibit 12.1 Computation of ratio of earnings to fixed charges, six months
ended June 30, 1998 and 1997
HECO Hawaiian Electric Company, Inc. and subsidiaries
Exhibit 12.2 Computation of ratio of earnings to fixed charges, six months
ended June 30, 1998 and 1997
HEI Hawaiian Electric Industries, Inc. and subsidiaries
Exhibit 27.1 Financial Data Schedule
June 30, 1998 and six months ended June 30, 1998
HEI Hawaiian Electric Industries, Inc. and subsidiaries
Exhibit 27.1(a) Financial Data Schedule
June 30, 1997 and six months ended June 30, 1997
HECO Hawaiian Electric Company, Inc. and subsidiaries
Exhibit 27.2 Financial Data Schedule
June 30, 1998 and six months ended June 30, 1998
32
HEI Ninth Amendment to Trust Agreement, made and entered into on
Exhibit 99.1 May 4, 1998, Between Fidelity Management Trust Company and HEI
for the Hawaiian Electric Industries Retirement Savings Plan
for incorporation by reference in the Registration Statement on Form S-8
(Regis. No. 333-02103)
(b) REPORTS ON FORM 8-K
During the second quarter of 1998, HEI and HECO did not file a Current Report,
Form 8-K, with the SEC.
On August 4, 1998, HEI filed a Current Report on Form 8-K dated August 3, 1998,
reporting HEI's settlement with insurance carriers under "Item 5 Other Events."
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: August 10, 1998 Date: August 10, 1998
33