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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 September 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
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(Registrant's telephone number, including area code)
NONE
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
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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 November 3, 1998
- ---------------------------------------------------------------------------------------------------------
Hawaiian Electric Industries, Inc. (Without Par Value).......... 32,071,530 Shares
Hawaiian Electric Company, Inc. ($6 2/3 Par Value).............. 12,805,843 Shares (not publicly traded)
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Hawaiian Electric Industries, Inc. and subsidiaries
Hawaiian Electric Company, Inc. and subsidiaries
Form 10-Q--Quarter ended September 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)-
September 30, 1998 and December 31, 1997.................... 1
Consolidated statements of income (unaudited)-
three and nine months ended September 30, 1998 and 1997..... 2
Consolidated statements of retained earnings (unaudited)-
three and nine months ended September 30, 1998 and 1997..... 3
Consolidated statements of cash flows (unaudited)-
nine months ended September 30, 1998 and 1997............... 4
Notes to consolidated financial statements (unaudited)........ 5
Hawaiian Electric Company, Inc. and subsidiaries
------------------------------------------------
Consolidated balance sheets (unaudited)-
September 30, 1998 and December 31, 1997.................... 12
Consolidated statements of income (unaudited)-
three and nine months ended September 30, 1998 and 1997..... 13
Consolidated statements of retained earnings (unaudited)-
three and nine months ended September 30, 1998 and 1997..... 13
Consolidated statements of cash flows (unaudited)-
nine months ended September 30, 1998 and 1997............... 14
Notes to consolidated financial statements (unaudited)........ 15
Item 2. Management's discussion and analysis of financial condition
and results of operations.................................... 22
Item 3. Quantitative and qualitative disclosures about market risk..... 38
PART II. OTHER INFORMATION
Item 1. Legal proceedings.............................................. 38
Item 5. Other information.............................................. 38
Item 6. Exhibits and reports on Form 8-K............................... 40
Signatures.................................................................. 41
i
Hawaiian Electric Industries, Inc. and subsidiaries
Hawaiian Electric Company, Inc. and subsidiaries
Form 10-Q--Quarter ended September 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, HECO Capital Trust II
(formed on October 15, 1998), 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, HEI District Cooling, Inc. (incorporated on August
17, 1998), ProVision Technologies, Inc. (incorporated on October
13, 1998), 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 Affairs of the
ADVOCATE 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
ii
GLOSSARY OF TERMS, CONTINUED
TERMS DEFINITIONS
- ----- -----------
FEDERAL U.S. Government
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., HECO Capital Trust I and HECO Capital Trust II
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., HEI
District Cooling, Inc., ProVision Technologies, Inc., 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
iii
GLOSSARY OF TERMS, CONTINUED
TERMS DEFINITIONS
- ----- -----------
KCP Kawaihae Cogeneration Partners
KWH Kilowatthour
MECO Maui Electric Company, Limited, a wholly owned electric utility
subsidiary of Hawaiian Electric Company, Inc.
MPC Malama Pacific Corp., a wholly owned subsidiary of Hawaiian
Electric Industries, Inc. and parent company of several real
estate subsidiaries
MW Megawatt
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
foreign currency exchange rates; the convertibility and availability of foreign
currency; political and business risks inherent in doing business in a
developing country; and the risks associated with the installation of new
computer systems and the avoidance of Year 2000 problems. 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)
September 30, December 31,
(in thousands) 1998 1997
- -----------------------------------------------------------------------------------------------------------------
ASSETS
- ------
Cash and equivalents............................................ $ 275,102 $ 253,910
Accounts receivable and unbilled revenues, net.................. 156,592 158,231
Investment and mortgage-backed securities....................... 2,014,291 1,971,886
Loans receivable, net........................................... 3,125,835 3,035,847
Property, plant and equipment, net of accumulated
depreciation and amortization of $1,048,822 and $974,759..... 2,075,760 2,019,518
Regulatory assets............................................... 110,772 104,079
Other........................................................... 241,235 258,907
Goodwill and other intangibles.................................. 117,153 122,492
---------- ----------
$8,116,740 $7,924,870
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
LIABILITIES
Accounts payable................................................ $ 113,734 $ 148,445
Deposit liabilities............................................. 3,832,053 3,916,600
Short-term borrowings........................................... 181,357 284,663
Securities sold under agreements to repurchase.................. 534,812 375,366
Advances from Federal Home Loan Bank............................ 823,081 736,474
Long-term debt.................................................. 920,737 794,621
Deferred income taxes........................................... 189,091 189,955
Contributions in aid of construction............................ 199,427 197,596
Other........................................................... 267,459 232,406
---------- ----------
7,061,751 6,876,126
---------- ----------
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............................. 33,180 35,770
Not subject to mandatory redemption......................... 48,293 48,293
---------- ----------
231,473 234,063
---------- ----------
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: 32,010 shares and 31,895 shares............ 659,470 654,819
Retained earnings............................................... 164,046 159,862
---------- ----------
823,516 814,681
---------- ----------
$8,116,740 $7,924,870
========== ==========
See accompanying notes to consolidated financial statements.
1
Hawaiian Electric Industries, Inc. and subsidiaries
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three months ended Nine months ended
September 30, September 30,
(in thousands, except per share amounts and ------------------------------ ---------------------------------
ratio of earnings to fixed charges) 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------------
REVENUES
Electric utility...................................... $259,684 $282,234 $ 762,494 $ 831,314
Savings bank.......................................... 103,229 71,625 306,324 210,211
Other................................................. 14,405 16,595 44,023 43,717
-------- -------- ---------- ----------
377,318 370,454 1,112,841 1,085,242
-------- -------- ---------- ----------
EXPENSES
Electric utility...................................... 208,418 234,089 626,969 704,179
Savings bank.......................................... 89,831 59,778 264,245 173,843
Other................................................. 16,770 15,523 48,753 46,035
-------- -------- ---------- ----------
315,019 309,390 939,967 924,057
-------- -------- ---------- ----------
OPERATING INCOME (LOSS)
Electric utility...................................... 51,266 48,145 135,525 127,135
Savings bank.......................................... 13,398 11,847 42,079 36,368
Other................................................. (2,365) 1,072 (4,730) (2,318)
-------- -------- ---------- ----------
62,299 61,064 172,874 161,185
-------- -------- ---------- ----------
Interest expense--electric utility and other.......... (17,601) (15,277) (53,345) (46,179)
Allowance for borrowed funds used
during construction................................ 1,826 1,522 5,145 4,658
Preferred stock dividends of electric
utility subsidiaries............................... (1,499) (1,563) (4,507) (4,697)
Preferred securities distributions of
trust subsidiaries................................. (3,097) (3,064) (9,289) (7,503)
Allowance for equity funds used during
construction....................................... 3,139 2,654 8,781 8,079
-------- -------- ---------- ----------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES................................ 45,067 45,336 119,659 115,543
Income taxes.......................................... 17,288 17,895 46,140 47,517
-------- -------- ---------- ----------
INCOME FROM CONTINUING OPERATIONS..................... 27,779 27,441 73,519 68,026
-------- -------- ---------- ----------
DISCONTINUED OPERATIONS, NET OF INCOME TAXES
Loss from operations............................... (12,474) (3,303) (13,598) (4,430)
Net gain on disposals.............................. 3,781 - 3,781 -
-------- -------- ---------- ----------
LOSS FROM DISCONTINUED OPERATIONS..................... (8,693) (3,303) (9,817) (4,430)
-------- -------- ---------- ----------
NET INCOME............................................ $ 19,086 $ 24,138 $ 63,702 $ 63,596
======== ======== ========== ==========
BASIC EARNINGS (LOSS) PER COMMON SHARE
Continuing operations.............................. $ 0.87 $ 0.87 $ 2.30 $ 2.18
Discontinued operations............................ (0.27) (0.10) (0.31) (0.14)
-------- -------- ---------- ----------
$ 0.60 $ 0.77 $ 1.99 $ 2.04
======== ======== ========== ==========
DILUTED EARNINGS (LOSS) PER COMMON SHARE
Continuing operations.............................. $ 0.86 $ 0.87 $ 2.29 $ 2.17
Discontinued operations............................ (0.27) (0.11) (0.31) (0.14)
-------- -------- ---------- ----------
$ 0.59 $ 0.76 $ 1.98 $ 2.03
======== ======== ========== ==========
Dividends per common share............................ $ 0.62 $ 0.61 $ 1.86 $ 1.83
======== ======== ========== ==========
Weighted average number of common
shares outstanding................................. 32,010 31,528 31,992 31,244
Dilutive effect of
stock options and dividend equivalents....... 128 99 138 85
-------- -------- ---------- ----------
Adjusted weighted average shares...................... 32,138 31,627 32,130 31,329
======== ======== ========== ==========
Ratio of earnings to fixed charges (SEC method)
Excluding interest on ASB deposits................. 1.90 1.94
========== ==========
Including interest on ASB deposits................. 1.49 1.61
========== ==========
See accompanying notes to consolidated financial statements.
2
Hawaiian Electric Industries, Inc. and subsidiaries
CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (UNAUDITED)
Three months ended Nine months ended
September 30, September 30,
--------------------------------- ------------------------------
(in thousands) 1998 1997 1998 1997
- ----------------------------------------------------------- --------------------------------------------------------------------
RETAINED EARNINGS, BEGINNING OF PERIOD................ $164,807 $151,455 $159,862 $149,907
Net income............................................ 19,086 24,138 63,702 63,596
Common stock dividends................................ (19,847) (19,219) (59,518) (57,129)
-------- -------- -------- --------
RETAINED EARNINGS, END OF PERIOD...................... $164,046 $156,374 $164,046 $156,374
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
3
Hawaiian Electric Industries, Inc. and subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine months ended
September 30,
------------------------------
(in thousands) 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Income from continuing operations.................................................... $ 73,519 $ 68,026
Adjustments to reconcile income from continuing operations to net cash
provided by operating activities
Depreciation and amortization of property, plant and equipment................. 74,588 68,532
Other amortization............................................................. 11,397 10,710
Deferred income taxes and tax credits, net..................................... 2,925 4,197
Allowance for equity funds used during construction............................ (8,781) (8,079)
Changes in assets and liabilities
Decrease (increase) in accounts receivable and unbilled revenues, net.... 1,639 (1,067)
Increase in regulatory assets............................................ (2,914) (5,300)
Decrease in accounts payable............................................. (34,711) (7,732)
Changes in other assets and liabilities.................................. 38,690 (21,625)
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES............................................ 156,352 107,662
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Loans receivable originated and purchased............................................ (494,683) (229,885)
Principal repayments on loans receivable............................................. 358,582 110,210
Proceeds from sale of loans receivable............................................... 4,649 2,906
Held-to-maturity mortgage-backed securities purchased................................ (401,740) (297,170)
Principal repayments on held-to-maturity mortgage-backed securities.................. 402,288 194,512
Held-to-maturity investment securities purchased..................................... (200,982) -
Principal repayments on held-to-maturity investment securities....................... 159,982 -
Capital expenditures................................................................. (124,290) (105,697)
Contributions in aid of construction................................................. 6,310 4,402
Proceeds from loans returned to Bank of America, FSB................................. 28,104 -
Other................................................................................ 5,947 2,563
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES................................................ (255,833) (318,159)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposit liabilities....................................... (85,155) 69,956
Net decrease in short-term borrowings with
original maturities of three months or less....................................... (106,278) (99,914)
Proceeds from securities sold under agreements to repurchase......................... 474,812 958,500
Repurchase of securities sold under agreements to repurchase......................... (316,000) (808,100)
Proceeds from advances from Federal Home Loan Bank................................... 661,500 578,500
Principal payments on advances from Federal Home Loan Bank........................... (574,893) (556,000)
Proceeds from issuance of long-term debt............................................. 185,394 8,371
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......................... (2,590) (2,885)
Net proceeds from issuance of common stock........................................... 4,553 18,906
Common stock dividends............................................................... (59,518) (46,132)
Preferred securities distributions of trust subsidiaries............................. (9,289) (7,503)
Other................................................................................ (3,728) (11,347)
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES............................................ 109,408 237,452
--------- ---------
NET CASH PROVIDED BY DISCONTINUED OPERATIONS......................................... 11,265 -
--------- ---------
Net increase in cash and equivalents................................................. 21,192 26,955
Cash and equivalents, beginning of period............................................ 253,910 97,113
--------- ---------
CASH AND EQUIVALENTS, END OF PERIOD.................................................. $ 275,102 $ 124,068
========= =========
See accompanying notes to consolidated financial statements.
4
Hawaiian Electric Industries, Inc. and subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 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 Reports on SEC Forms 10-Q for the quarters ended
March 31 and June 30, 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 September 30, 1998 and
December 31, 1997, the results of its operations for the three months and nine
months ended September 30, 1998 and 1997, and its cash flows for the nine months
ended September 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.
Certain reclassifications have been made to prior periods' consolidated
financial statements to conform to the 1998 presentation.
(2) ELECTRIC UTILITY SUBSIDIARY
- --------------------------------
For Hawaiian Electric Company, Inc.'s consolidated financial information,
including its commitments and contingencies, see pages 12 through 21.
(3) SAVINGS BANK SUBSIDIARY
- ----------------------------
SELECTED CONSOLIDATED FINANCIAL INFORMATION
American Savings Bank, F.S.B. and subsidiaries
Income statement data
Three months ended Nine months ended
September 30, September 30,
----------------------------------- ------------------------------
(in thousands) 1998 1997 1998 1997
- -------------------------------------------------------------------------------------------------------------------------------
Interest income..................................... $ 95,385 $ 67,425 $285,437 $198,459
Interest expense.................................... 56,214 40,240 163,265 116,722
-------- -------- -------- --------
NET INTEREST INCOME................................. 39,171 27,185 122,172 81,737
Provision for losses................................ (3,125) (2,068) (9,473) (4,860)
Other income........................................ 7,844 4,200 20,887 11,752
Operating, administrative and general expenses...... (30,492) (17,470) (91,507) (52,261)
-------- -------- -------- --------
OPERATING INCOME.................................... 13,398 11,847 42,079 36,368
Income taxes........................................ 4,144 4,807 14,413 15,057
-------- -------- -------- --------
INCOME BEFORE PREFERRED STOCK DIVIDENDS............. 9,254 7,040 27,666 21,311
Dividends on preferred stock held by parent......... 1,350 -- 4,050 --
-------- -------- -------- --------
NET INCOME.......................................... $ 7,904 $ 7,040 $ 23,616 $ 21,311
======== ======== ======== ========
5
American Savings Bank, F.S.B. and subsidiaries
Balance sheet data
September 30, December 31,
(in thousands) 1998 1997
- -------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and equivalents..................................................... $ 264,922 $ 249,607
Held-to-maturity investment securities................................... 150,010 105,596
Held-to-maturity mortgage-backed securities.............................. 1,863,081 1,865,027
Loans receivable, net.................................................... 3,125,835 3,035,847
Other.................................................................... 162,503 169,843
Goodwill and other intangibles........................................... 117,153 122,492
---------- ----------
$5,683,504 $5,548,412
========== ==========
LIABILITIES AND EQUITY
Deposit liabilities...................................................... $3,832,053 $3,916,600
Securities sold under agreements to repurchase........................... 534,812 375,366
Advances from Federal Home Loan Bank..................................... 823,081 736,474
Other.................................................................... 83,716 124,185
---------- ----------
5,273,662 5,152,625
Preferred stock held by parent........................................... 75,000 75,000
Common stock equity...................................................... 334,842 320,787
---------- ----------
$5,683,504 $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.
6
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 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 September 30, 1998 quarterly payment is zero
and its assessment for funding FICO interest payments is 5.82 cents per $100 of
SAIF-assessable deposits and 1.16 cents per $100 of BIF-assessable deposits, on
an annual basis, based on deposits as of June 30, 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) 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.
SUBSEQUENT EVENT
In October 1998, HECO, MECO, HELCO and HECO Capital Trust II filed a
registration statement on Form S-3 with the SEC related to the contemplated
public offering of 2 million of HECO-Obligated Cumulative Quarterly Income
Preferred Securities (QUIPS), Series 1998, with an aggregate liquidation
preference of $50 million. The public offering may proceed only if it is
approved by the PUC. If the proposed financing is approved by the PUC and
completed, it is currently contemplated that the proceeds of the offering will
be applied primarily to redeem HECO's Series M, Q and R cumulative preferred
stock, MECO's Series A, B, D and G cumulative preferred stock and HELCO's Series
A, D, E and F cumulative preferred stock. The new issue of $50 million of
QUIPS, coupled with the contemplated redemptions of these series of cumulative
preferred stock will bring to $100 million the aggregate liquidation preference
of QUIPS, and reduce to approximately $34 million the aggregate par value of the
remaining cumulative preferred stock, in consolidated HECO's capital structure.
This may result in a one notch downgrade of the rating by Moody's Investors
Service of the series of cumulative preferred stock that remain outstanding
after the contemplated redemptions, as has been the case with the preferred
stock of some other companies.
7
(5) CASH FLOWS
- ---------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest (net of capitalized amounts) and income taxes was as
follows:
Nine months ended
September 30,
-------------------------------
(in thousands) 1998 1997
- -----------------------------------------------------------------------------------------------------------------
Interest (including interest paid by savings bank, but excluding interest
paid on nonrecourse debt on leveraged leases)............................... $200,453 $152,631
======== ========
Income taxes................................................................. $ 27,325 $ 45,251
======== ========
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 $11.0 million for the nine months ended September 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 charged to
construction in progress as part of the cost of electric utility plant, amounted
to $8.8 million and $8.1 million for the nine months ended September 30, 1998
and 1997, respectively.
(6) 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.
8
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. In
addition, the provisions of SOP 98-5 require that the unamortized balance of
previously capitalized costs associated with start-up activities be charged to
earnings in the period of adoption. 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. Management believes, based
on the Company's current level of derivative and hedging activities, that the
adoption of SFAS No. 133 will not have a material effect on the Company's
financial condition, results of operations or liquidity.
(7) 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 Work Group to conduct independent voluntary investigations relative to
this issue. Effective January 30, 1998, the Technical Work Group 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. The Technical Work Group met in June 1998 with a consultant, Ogden
Environmental & Energy Services, to discuss 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.
9
(8) DISCONTINUED OPERATIONS
- ----------------------------
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 received $24.5 million
($13.8 million net of estimated expenses and income taxes or $0.43 in basic
earnings per share for the quarter and nine months ended September 30, 1998),
and recorded the settlement as net gain on disposal of discontinued operations
in the third quarter of 1998.
MALAMA PACIFIC CORP.
On September 14, 1998, the Board of Directors of HEI ratified management's plan
to exit the residential real estate development business (Malama Pacific Corp.
or MPC) by September 1999. Accordingly, effective September 14, 1998, management
commenced a program to actively market for sale all of MPC's real estate assets
and investments. These operations are reflected as discontinued operations for
all periods presented in the Company's consolidated statements of income. In
addition, in the third quarter of 1998, MPC recognized impairment losses
amounting to approximately $19.3 million in accordance with the provisions of
SFAS No. 121, notwithstanding management's plan to exit the residential real
estate development business. Operating activity of the residential real estate
development business for the period September 14, 1998 through September 30,
1998 was not significant.
Summary financial information for the discontinued operations of MPC is as
follows:
Three months ended Nine months ended
September 30, September 30,
---------------------------------------------------------------
(in thousands) 1998 1997 1998 1997
- -------------------------------------------- ----------------------------------------------------------------
OPERATIONS
Revenues.................................... $ 743 $ 817 $ 3,313 $ 5,475
Operating loss (including writedowns)....... $(19,881) $(4,752) $(20,648) $(5,351)
Interest expense............................ (538) (652) (1,609) (1,895)
Income tax benefits......................... 7,945 2,101 8,659 2,816
-------- ------- -------- -------
LOSS FROM OPERATIONS........................ $(12,474) $(3,303) $(13,598) $(4,430)
-------- ------- -------- -------
DISPOSAL
Loss, including provision of $5,000 for
loss from operations during phase-out
period..................................... $(16,343) - $(16,343) -
Income tax benefits......................... 6,359 - 6,359 -
-------- ------- -------- -------
LOSS ON DISPOSAL............................ $ (9,984) - $ (9,984) -
-------- ------- -------- -------
LOSS FROM DISCONTINUED OPERATIONS OF MPC.... $(22,458) $(3,303) $(23,582) $(4,430)
======== ======= ======== =======
IMPACT ON BASIC EARNINGS PER SHARE.......... $(0.70) $(0.10) $(0.74) $(0.14)
======== ======= ======== =======
10
As of September 30, 1998, the remaining net assets of the discontinued
residential real estate development operations amounted to $18.9 million
(included in "Other" assets) and consisted primarily of real estate assets,
receivables and deferred tax assets, reduced by loans and accounts payable. The
amounts that MPC will ultimately realize from the sale of the real estate assets
could differ materially from the recorded amounts as of September 30, 1998.
Prior to September 14, 1998, interest expense (in the above table) consisted of
actual interest accrued on MPC's borrowings from banks and other third parties,
and allocated interest calculated at HEI's existing commercial paper rates
applied to intercompany borrowing amounts. Interest costs included in the
determination of the loss on disposal of MPC amounted to $2 million and
consisted of interest expected to be incurred on MPC's borrowings from banks and
other third parties ($1 million) and allocated interest ($1 million). Allocated
interest was calculated at HEI's weighted average cost of debt as of September
30, 1998, applied to 80% of MPC's expected remaining assets, net of bank and
other third party debt, over the expected disposal period.
11
Hawaiian Electric Company, Inc. and subsidiaries
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
September 30, December 31,
(in thousands, except par value) 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
ASSETS
Utility plant, at cost
Land.................................................................. $ 32,237 $ 32,222
Plant and equipment................................................... 2,681,983 2,559,655
Less accumulated depreciation......................................... (968,711) (904,781)
Plant acquisition adjustment, net..................................... 523 562
Construction in progress.............................................. 187,145 205,447
----------- ----------
NET UTILITY PLANT............................................... 1,933,177 1,893,105
----------- ----------
Current assets
Cash and equivalents.................................................. 5,496 1,676
Customer accounts receivable, net..................................... 67,320 69,378
Accrued unbilled revenues, net........................................ 44,789 45,980
Other accounts receivable, net........................................ 4,281 4,195
Fuel oil stock, at average cost....................................... 15,087 25,058
Materials and supplies, at average cost............................... 16,977 18,975
Prepayments and other................................................. 2,822 3,335
----------- ----------
TOTAL CURRENT ASSETS............................................ 156,772 168,597
----------- ----------
Other assets
Regulatory assets..................................................... 108,618 101,809
Other................................................................. 48,132 48,803
----------- ----------
TOTAL OTHER ASSETS.............................................. 156,750 150,612
----------- ----------
$2,246,699 $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.............................................. 296,364 296,266
Retained earnings..................................................... 406,719 387,582
----------- ----------
COMMON STOCK EQUITY............................................. 788,470 769,235
Cumulative preferred stock
Not subject to mandatory redemption................................ 48,293 48,293
Subject to mandatory redemption.................................... 31,585 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................................................... 613,137 597,621
----------- ----------
TOTAL CAPITALIZATION............................................ 1,531,485 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................................. 95,434 95,181
Short-term borrowings - affiliate..................................... - 400
Accounts payable...................................................... 38,248 49,805
Interest and preferred dividends payable.............................. 18,747 12,225
Taxes accrued......................................................... 62,686 59,952
Other................................................................. 21,023 21,633
----------- ----------
TOTAL CURRENT LIABILITIES....................................... 267,733 271,791
----------- ----------
Deferred credits and other liabilities
Deferred income taxes................................................. 127,339 125,509
Unamortized tax credits............................................... 51,290 48,675
Other................................................................. 69,425 70,419
----------- ----------
TOTAL DEFERRED CREDITS AND OTHER LIABILITIES.................... 248,054 244,603
----------- ----------
Contributions in aid of construction..................................... 199,427 197,596
----------- ----------
$ 2,246,699 $2,212,314
=========== ==========
See accompanying notes to HECO's consolidated financial statements.
12
Hawaiian Electric Company, Inc. and subsidiaries
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three months ended Nine months ended
September 30, September 30,
(in thousands, except for ratio of earnings ------------------------------- -------------------------------
to fixed charges) 1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------------
OPERATING REVENUES......................................... $257,368 $280,193 $755,615 $824,762
-------- -------- -------- --------
OPERATING EXPENSES
Fuel oil................................................... 48,554 61,733 149,734 196,065
Purchased power............................................ 69,148 75,238 204,822 218,462
Other operation............................................ 34,286 37,774 104,251 111,221
Maintenance................................................ 10,508 12,273 31,738 38,687
Depreciation and amortization.............................. 21,448 20,504 64,336 61,507
Taxes, other than income taxes............................. 24,263 26,360 71,609 77,815
Income taxes............................................... 16,693 15,071 42,253 38,848
-------- -------- -------- --------
224,900 248,953 668,743 742,605
-------- -------- -------- --------
OPERATING INCOME........................................... 32,468 31,240 86,872 82,157
-------- -------- -------- --------
OTHER INCOME
Allowance for equity funds used
during construction..................................... 3,139 2,654 8,781 8,079
Other, net................................................. 2,117 1,894 6,439 6,154
-------- -------- -------- --------
5,256 4,548 15,220 14,233
-------- -------- -------- --------
INCOME BEFORE INTEREST AND OTHER CHARGES................... 37,724 35,788 102,092 96,390
-------- -------- -------- --------
INTEREST AND OTHER CHARGES
Interest on long-term debt................................. 9,910 9,944 30,602 29,654
Amortization of net bond premium and expense............... 374 328 1,096 976
Other interest charges..................................... 1,785 2,026 5,086 5,921
Allowance for borrowed funds used
during construction..................................... (1,826) (1,522) (5,145) (4,658)
Preferred stock dividends of subsidiaries.................. 638 651 1,915 1,951
Preferred securities distributions of
trust subsidiary........................................ 1,006 974 3,019 2,046
-------- -------- -------- --------
11,887 12,401 36,573 35,890
-------- -------- -------- --------
INCOME BEFORE PREFERRED STOCK DIVIDENDS
OF HECO................................................. 25,837 23,387 65,519 60,500
Preferred stock dividends of HECO.......................... 861 912 2,592 2,746
-------- -------- -------- --------
NET INCOME FOR COMMON STOCK................................ $ 24,976 $ 22,475 $ 62,927 $ 57,754
======== ======== ======== ========
Ratio of earnings to fixed charges
(SEC method)............................................ 3.36 3.24
======== ========
Hawaiian Electric Company, Inc. and subsidiaries
CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (UNAUDITED)
Three months ended Nine months ended
September 30, September 30,
---------------------------- ------------------------------
(in thousands) 1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS, BEGINNING OF PERIOD..................... $410,207 $375,114 $387,582 $367,770
Net income for common stock................................ 24,976 22,475 62,927 57,754
Common stock dividends..................................... (28,464) (13,586) (43,790) (41,521)
-------- -------- -------- --------
RETAINED EARNINGS, END OF PERIOD........................... $406,719 $384,003 $406,719 $384,003
======== ======== ======== ========
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.
13
Hawaiian Electric Company, Inc. and subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine months ended
September 30,
------------------------------
(in thousands) 1998 1997
- --------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Income before preferred stock dividends of HECO................................... $ 65,519 $ 60,500
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.............. 64,336 61,507
Other amortization.......................................................... 5,204 8,163
Deferred income taxes....................................................... 1,830 2,599
Tax credits, net............................................................ 3,829 2,213
Allowance for equity funds used during construction......................... (8,781) (8,079)
Changes in assets and liabilities
Decrease in accounts receivable........................................ 1,972 834
Decrease in accrued unbilled revenues.................................. 1,191 1,010
Decrease in fuel oil stock............................................. 9,971 6,025
Decrease in materials and supplies..................................... 1,998 95
Increase in regulatory assets.......................................... (2,914) (5,300)
Decrease in accounts payable........................................... (11,557) (17,817)
Changes in other assets and liabilities................................ (495) (14,083)
-------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES......................................... 132,103 97,667
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures.............................................................. (98,016) (87,371)
Contributions in aid of construction.............................................. 6,310 4,402
Payments on notes receivable...................................................... 1,141 1,920
-------- --------
NET CASH USED IN INVESTING ACTIVITIES............................................. (90,565) (81,049)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Common stock dividends............................................................ (43,790) (41,521)
Preferred stock dividends......................................................... (2,592) (2,746)
Preferred securities distributions of trust subsidiary............................ (3,019) (2,046)
Proceeds from issuance of HECO-obligated mandatorily redeemable preferred
securities of trust subsidiary................................................... 50,000
Proceeds from issuance of long-term debt.......................................... 72,894 8,371
Repayment of long-term debt....................................................... (57,500) (13,000)
Redemption of preferred stock..................................................... (2,590) (2,885)
Net decrease in short-term borrowings from nonaffiliates and
affiliate with original maturities of three months or less..................... (147) (9,413)
Other............................................................................. (974) (2,273)
-------- --------
NET CASH USED IN FINANCING ACTIVITIES............................................. (37,718) (15,513)
-------- --------
Net increase in cash and equivalents.............................................. 3,820 1,105
Cash and equivalents, beginning of period......................................... 1,676 823
-------- --------
CASH AND EQUIVALENTS, END OF PERIOD............................................... $ 5,496 $ 1,928
======== ========
See accompanying notes to HECO's consolidated financial statements.
14
Hawaiian Electric Company, Inc. and subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 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 Reports on SEC Forms 10-Q for the quarters ended
March 31 and June 30, 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
September 30, 1998 and December 31, 1997, the results of their operations for
the three months and nine months ended September 30, 1998 and 1997, and their
cash flows for the nine months ended September 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 registered 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 September
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).
SUBSEQUENT EVENT
In October 1998, HECO, MECO, HELCO and HECO Capital Trust II filed a
registration statement on Form S-3 with the SEC related to the contemplated
public offering of 2 million of HECO-Obligated Cumulative Quarterly Income
Preferred Securities (QUIPS), Series 1998, with an aggregate liquidation
preference of $50 million. The public offering may proceed only if it is
approved by the PUC. If the proposed financing is approved by the PUC and
completed, it is currently contemplated that the
15
proceeds of the offering will be applied primarily to redeem HECO's Series M, Q
and R cumulative preferred stock, MECO's Series A, B, D and G cumulative
preferred stock and HELCO's Series A, D, E and F cumulative preferred stock. The
new issue of $50 million of QUIPS, coupled with the contemplated redemptions of
these series of cumulative preferred stock, will bring to $100 million the
aggregate liquidation preference of QUIPS, and reduce to approximately $34
million the aggregate par value of the remaining cumulative preferred stock, in
consolidated HECO's capital structure. This may result in a one notch downgrade
of the rating by Moody's Investors Service of the series of cumulative preferred
stock that remain outstanding after the contemplated redemptions, as has been
the case with the preferred stock of some other companies.
(3) CASH FLOWS
- ---------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest (net of capitalized amounts) and income taxes was as
follows:
Nine months ended
September 30,
---------------------------------------------
(in thousands) 1998 1997
- -------------------------------------------------------------------------------------------------------------------------------
Interest.......................................................................... $26,249 $26,130
======= =======
Income taxes...................................................................... $22,277 $33,912
======= =======
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES
The allowance for equity funds used during construction, which was charged to
construction in progress as part of the cost of electric utility plant, amounted
to $8.8 million and $8.1 million for the nine months ended September 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 denied by the Hawaii Supreme
Court in August 1998. Management believes that HELCO will ultimately prevail on
appeal and that the final judgments of the Third Circuit Court will be upheld.
16
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 of 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 on appeal.
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 the case for trial in
1999.
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 plaintiff's constitutional
due process rights because the land use conditions (if any) which apply to
HELCO's use of the Keahole site were 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 in these 1997 and
1998 cases and, based on the status of the cases to date, 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 submitted information requests to HELCO, and HELCO
submitted responses. 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 November 20, 1998. No schedule has yet been
established for the PUC proceeding.
17
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 resumed negotiations with KCP in compliance with the Order and filed
a motion for partial reconsideration with respect to one avoided cost
issue. The PUC granted HELCO's motion and modified its order in July 1998.
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, a Declaratory Order. KCP alleged 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 requested 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. In September 1998, FERC denied KCP's petition.
BLNR PETITION. On August 5, 1998, the 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. The BLNR requested that each of the parties submit
statements of position on the issues and HELCO filed its statement in October
1998.
COMPLAINT AND MOTION FOR TEMPORARY RESTRAINING ORDER. On August 5, 1998, the
- -----------------------------------------------------
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
call
18
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. The Court issued a temporary restraining order in
September 1998. However, HELCO obtained eight new building permits and the old
permits were voided. A hearing on HELCO's motion to dismiss the case is
scheduled for November 9, 1998.
DOH NOTICE OF VIOLATION. In July 1998, the DOH issued a Notice of Violation
- -----------------------
(NOV) to HELCO for 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 required HELCO to immediately halt
construction activities on pipe rack foundations, a retaining wall and an
oil/water separator, and imposed a fine of $48,800. HELCO complied with the stop
work order on the designated items and paid the fine.
EPA NOTICE OF VIOLATION. In September 1998, the EPA issued a NOV to HELCO
- -----------------------
stating that HELCO violated the Hawaii State Implementation Plan by commencing
construction activities at the Keahole generating station without first
obtaining a final air permit. By law, 30 days after the NOV, the EPA may issue
an Order requiring compliance with applicable laws, assessing penalties and/or
commencing a civil action seeking an injunction; however, no Order has yet been
issued. HELCO has put the EPA on notice that certain construction activities not
affected by the NOV are continuing, but has halted work on other construction
activities at Keahole until otherwise instructed by the EPA or until the final
air permit is received.
COSTS INCURRED. As of September 30, 1998, HELCO's costs incurred in its efforts
- --------------
to put into service its Keahole combined-cycle unit amounted to $69.2 million,
including approximately $28.7 million for equipment and material purchases,
approximately $19.7 million for planning, engineering, permitting, site
development and other costs and approximately $20.8 million as an allowance for
funds used during construction.
CONTINGENCY PLANNING. In June 1995, HELCO filed with the PUC its generation
- --------------------
resource contingency plan detailing alternatives and mitigation measures to
address 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 the status of the implementation of the plan.
ENVIRONMENTAL REGULATION
See discussion of the DOH NOV and the EPA NOV issued to HELCO above and note
(7), "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 HECO'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.
19
(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 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. In
addition, the provisions of SOP 98-5 require that the unamortized balance of
previously capitalized costs associated with start-up activities be charged to
earnings in the period of adoption. 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.
Management believes, based on consolidated HECO's current level of derivative
and hedging activities, that the adoption of SFAS No. 133 will not have a
material effect on consolidated HECO's financial condition, results of
operations or liquidity.
(6) SUMMARIZED FINANCIAL INFORMATION
- -------------------------------------
Summarized financial information for HECO's subsidiaries, HELCO and MECO, is as
follows:
20
BALANCE SHEET DATA
HELCO MECO
------------------------------------- ----------------------------------
September 30, December 31, September 30, December 31,
(in thousands) 1998 1997 1998 1997
- --------------------------------------------------------------------------------------------------------------------------
Current assets................................. $ 26,369 $ 28,631 $ 28,063 $ 31,994
Noncurrent assets.............................. 417,764 403,981 383,459 374,766
-------- -------- -------- --------
$444,133 $432,612 $411,522 $406,760
======== ======== ======== ========
Common stock equity............................ $147,909 $144,761 $153,568 $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 5,385 5,575
Current liabilities............................ 59,810 63,500 22,916 24,454
Noncurrent liabilities......................... 219,414 207,351 221,653 218,602
-------- -------- -------- --------
$444,133 $432,612 $411,522 $406,760
======== ======== ======== ========
INCOME STATEMENT DATA
HELCO MECO
-------------------------------------------------- --------------------------------------------------
Three months Nine months Three months Nine months
ended ended ended ended
September 30, September 30, September 30, September 30,
----------------------- ------------------------ ------------------------ -----------------------
(in thousands) 1998 1997 1998 1997 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
Operating
revenues.......... $39,159 $40,674 $115,536 $120,037 $35,108 $39,133 $103,353 $115,393
Operating
income............ 5,153 5,267 14,523 13,106 5,207 5,150 14,570 13,288
Net income for
common stock...... 4,498 4,315 12,331 10,833 4,196 3,980 11,378 9,828
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, because the debentures have been fully
and unconditionally guaranteed by HECO.
(7) RECONCILIATION OF ELECTRIC UTILITY OPERATING INCOME PER HEI AND HECO
- --------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
---------------------------------
Three months ended Nine months ended
September 30, September 30,
--------------------------- ---------------------------
(in thousands) 1998 1997 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------
Operating income from regulated and nonregulated activities
before income taxes (per HEI consolidated statements of income).. $ 51,266 $ 48,145 $135,525 $127,135
Deduct:
Income taxes on regulated activities............................. (16,693) (15,071) (42,253) (38,848)
Revenues from nonregulated activities............................ (2,316) (2,041) (6,879) (6,552)
Add:
Expenses from nonregulated activities............................ 211 207 479 422
-------- -------- -------- --------
Operating income from regulated activities after income taxes
(per HECO consolidated statements of income)..................... $ 32,468 $ 31,240 $ 86,872 $ 82,157
======== ======== ======== ========
21
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
September 30,
(in thousands, except -------------------- % Primary reason(s) for
per share amounts) 1998 1997 change significant change*
- ---------------------------------------------------------------------------------------------------------------------
Revenues........................ $377,318 $370,454 2 Increase for the savings bank segment, partly
offset by decreases for the electric utility
and "other" segments
Operating income................ 62,299 61,064 2 Increases for the electric utility and savings
bank segments, partly offset by a decrease for
the "other" segment
Net income (loss)
Continuing operations........ $ 27,779 $ 27,441 1 Higher operating income and AFUDC and lower
income taxes (impact of the formation of ASB
Realty Corporation), 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
Discontinued operations...... (8,693) (3,303) NM Discontinued operations of real estate
subsidiary, partly offset by a settlement
received from director and officer liability
insurance carriers
-----------------------
$ 19,086 $ 24,138 (21)
=======================
Basic earnings (loss) per
common share
Continuing operations......... $ 0.87 $ 0.87 -- See explanation for "net income
(loss)-continuing operations," partly offset by
an increase in shares outstanding
Discontinued operations...... (0.27) (0.10) NM See explanation for "net income
(loss)-discontinued operations"
-----------------------
$ 0.60 $ 0.77 (22)
=======================
Weighted average number of
common shares outstanding......
32,010 31,528 2 Issuances under the Dividend Reinvestment and
Stock Purchase Plan and other plans***
22
Nine months ended
September 30,
(in thousands, except -------------------- % Primary reason(s) for
per share amounts) 1998 1997 change significant change*
- -------------------------------------------------------------------------------------------------------------------------
Revenues........................ $1,112,841 $1,085,242 3 Increase for the savings bank segment, partly
offset by a decrease for the electric utility
segment
Operating income................ 172,874 161,185 7 Increases for the electric utility and savings
bank segments, partly offset by a decrease for
the "other" segment
Net income (loss)
Continuing operations........ $ 73,519 $ 68,026 8 Higher operating income and AFUDC 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
Discontinued operations...... (9,817) (4,430) NM Discontinued operations of real estate
subsidiary, partly offset by a settlement
received from director and officer liability
insurance carriers
---------------------------
$ 63,702 $ 63,596 --
===========================
Basic earnings (loss) per
common share
Continuing operations......... $ 2.30 $ 2.18 6 See explanation for "net income
(loss)-continuing operations," partly offset by
an increase in shares outstanding
Discontinued operations...... (0.31) (0.14) NM See explanation for "net income
(loss)-discontinued operations"
---------------------------
$ 1.99 $ 2.04 (2)
===========================
Weighted average number of
common shares outstanding......
31,992 31,244 2 Issuances under the Dividend Reinvestment and
Stock Purchase Plan and other plans***
NM Not meaningful.
* 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).
*** In March 1998, HEI began purchasing its common shares in the open market,
rather than issuing additional shares, to satisfy the requirements of the
HEI Dividend Reinvestment and Stock Purchase Plan and the Hawaiian Electric
Industries Retirement Savings Plan.
23
Following is a general discussion of the results of operations by business
segment.
ELECTRIC UTILITY
- ----------------
Three months ended
September 30,
(in thousands, except per -------------------- % Primary reason(s) for
barrel amounts) 1998 1997 change significant change
- -------------------------------------------------------------------------------------------------------------
Revenues.................. $259,684 $282,234 (8) Lower fuel prices, the effects of
which are passed on to ratepayers
($19 million), and a 2.1% decrease in
KWH sales ($3 million)
Expenses
Fuel oil................. 48,554 61,733 (21) Lower fuel oil prices and better
generating unit efficiency, partly
offset by higher KWHs generated
Purchased power.......... 69,148 75,238 (8) Lower fuel prices and fewer KWHs
purchased
Other.................... 90,716 97,118 (7) Lower other operation and maintenance
expenses and lower revenue taxes
Operating income.......... 51,266 48,145 6 Lower revenues more than offset by
lower expenses
Net income................ 24,976 22,475 11 Higher operating income and higher
allowance for funds used during
construction
Kilowatthour sales
(millions).............. 2,323 2,371 (2)
Fuel oil price per barrel. $17.79 $22.88 (22)
24
Nine months ended
September 30,
(in thousands, except per ----------------------- % Primary reason(s) for
barrel amounts) 1998 1997 change significant change
- -------------------------------------------------------------------------------------------------------------
Revenues.................. $762,494 $831,314 (8) Lower fuel prices, the effects of
which are passed on to ratepayers
($60 million), and a 1.5% decrease in
KWH sales ($11 million)
Expenses
Fuel oil................. 149,734 196,065 (24) Lower fuel oil prices, better
generating unit efficiency and fewer
KWHs generated
Purchased power.......... 204,822 218,462 (6) Lower fuel prices and fewer KWHs
purchased
Other.................... 272,413 289,652 (6) Lower other operation and maintenance
expenses and lower revenue taxes
Operating income.......... 135,525 127,135 7 Lower revenues more than offset by
lower expenses
Net income................ 62,927 57,754 9 Higher operating income and higher
allowance for funds used during
construction, partly offset by higher
preferred securities distributions
Kilowatthour sales
(millions).............. 6,601 6,704 (2)
Fuel oil price per barrel. $19.77 $25.54 (23)
Despite lower kilowatthour (KWH) sales, electric utility operating income
increased 6% and 7% during the third quarter and first nine 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 11% and 9% during the third quarter and first nine
months of 1998, respectively, compared to the same periods in 1997 as a result
of the higher operating income and higher allowance for funds used during
construction. The increase in electric utility net income for the nine months
ended September 30, 1998 was partly offset by higher preferred securities
distributions due to the issuance of the HECO-obligated preferred securities of
HECO Capital Trust I in March 1997.
KWH sales for the third quarter and nine months of 1998 were down 2.1% and 1.5%,
respectively, from the same periods of 1997 primarily due to the slow Hawaii
economy and cooler weather. For the first eight months of 1998, visitor
arrivals in Hawaii were 1% lower than for the same period in 1997. In addition,
cooler temperatures on Oahu resulted in lower residential and commercial air
conditioning usage. In light of current economic conditions, the electric
utilities have revised their five-year (1998-2002) sales forecast downward. The
forecasted five-year average annual compounded growth rate has been lowered to
0.3% from 1.0%. HECO and its subsidiaries expect KWH sales to decline by 1.4%
in 1998 and 0.7% in 1999, and to pick up thereafter, assuming Hawaii's economy
improves.
25
COMPETITION
The electric utility industry is becoming increasingly competitive as a result
of various factors including pricing, service reliability, new technologies and
government actions. Competition in the generation sector in Hawaii is moderated,
however, by the scarcity of generation sites, various permitting processes and
lack of interconnections to other electric utilities.
Independent power producers (IPPs) are well established in Hawaii and continue
to actively pursue new projects. Customer self-generation, with or without co-
generation, has made inroads in Hawaii and is a continuing competitive factor.
HECO has been able to compete successfully in this environment by offering
customers economic alternatives that, among other things, employ energy
efficient electrotechnologies such as the heat pump water heater.
Legislation has been introduced in Congress that would restructure the electric
utility industry with a view toward increasing competition by, for example,
requiring retail wheeling and allowing customers to choose their generation
supplier. Some of the bills would exempt Alaska and Hawaii, which have no
interstate electric transmission lines. Also, the Department of Energy's
proposed "Comprehensive Electricity Competition Act", submitted to Congress in
June 1998, includes a provision that would permit states to "opt out" of the
proposed retail competition deadline of not later than January 1, 2003.
On December 30, 1996, the PUC instituted a proceeding to identify and examine
the issues surrounding electric competition and to determine the impact of
competition on the electric utility infrastructure in Hawaii. Similar
proceedings have occurred in other jurisdictions. In its order, the PUC
recognized that Hawaii's stand-alone island energy systems are different from
the interconnected systems of the contiguous states, but also recognized the
need to determine how to respond in Hawaii to changes occurring in the industry.
The PUC set forth a preliminary enumeration of the issues, including feasible
forms of competition, the regulatory compact, public interest benefits, long-
term integrated resource planning, appropriate treatment of potential stranded
costs, and the identification of the objectives and the establishment of a time
frame for the introduction of competition in the electric industry. There are
19 parties in the proceeding including the Consumer Advocate of the State of
Hawaii, HECO, HELCO and MECO (which presented a joint position), Citizens
Utilities (which serves the island of Kauai), the Department of Business,
Economic Development, and Tourism of the State of Hawaii (DBEDT), the Counties
of Maui, Hawaii and Kauai, the Department of Defense (the DOD, HECO's largest
customer), various IPPs and others. The PUC initiated a collaborative process to
"compile information, create a discussion forum, and narrow the issues on the
complexities of restructuring the electric industry in response to emerging
competition." Following a number of meetings, and the submission and
presentation to the collaborative group of preliminary statements of positions,
the parties individually submitted final statements of positions (SOPs), which
were compiled and sent to the PUC in October 1998.
HECO's position is that retail competition is not feasible in Hawaii. The
conditions making electric industry restructuring feasible in a number of states
generally are not present in Hawaii. None of the island electric systems are
interconnected and one electric utility physically can supply electricity to a
particular island. In addition, (1) the island electricity markets are
relatively small, and economies of scale and scope would be lost if the existing
utilities were required to divest their generating or customer services
functions, (2) there are barriers to entry by new generation suppliers,
including the difficulty and time required to acquire and permit power plant
sites in Hawaii, and the lack of access to low cost natural gas in Hawaii, and
(3) transaction volume would not be sufficiently large to support the additional
costs incurred to implement a competitive framework (such as the cost of an
independent system operator) and the recovery of any stranded costs incurred by
the utilities.
If each individual generating station and purchased power contracts were
"divested" to separate entities, HECO's market concentration analysis indicates
that the electricity market would still be too concentrated to permit workable
retail competition with respect to the generation of electricity. Market
concentration analyses done for the CA and the DOD support HECO's position.
However, based on its consultant's preliminary assessment of the extent to which
market power would influence deregulated market prices in the Oahu market (with
each existing generating plant and IPP facility assumed to compete as an
individual supplier, and without regard to potential market constraints), DBEDT
concluded that "competition appears feasible for Oahu's generation market."
26
In lieu of restructuring Hawaii's electric utility industry to permit retail
generation and/or customer services competition, HECO proposes to achieve some
of the benefits of competition through proposals for (1) competitive bidding for
new generation, (2) performance based ratemaking (which would include an index-
based price cap, an earnings sharing mechanism, and a benchmark incentive plan)
and (3) innovative pricing provisions (including rate restructuring, expanded
time-of-use rates, customer migration rates such as standby charges, flexible
pricing to encourage economic development and to compete with customer
generation options, new service options and two-part rates incorporating real-
time pricing). HECO suggests in its statement of position that these proposals
be implemented through applications for PUC approval in a series of separate
proceedings to be initiated by HECO in 1999 and 2000.
While the other parties' SOPs generally support competitive bidding for new
generation, there is no consensus as to whether or as to the extent Hawaii's
electricity markets should be restructured to introduce further competition. For
example, the Consumer Advocate agrees that full scale retail generation
competition is not now feasible in Hawaii, but proposes immediate rate
unbundling and customer education, followed by rulemaking proceedings (1) to
open transmission and distribution access on a limited basis (such as when new
generation is needed) and determine the degree of any stranded cost recovery
through nonbypassable access charges, (2) to permit conservation and energy
management services to be provided to retail customers on a competitive basis,
and (3) to implement competition for other customer services (metering and
billing), as determined to be appropriate. The DOD also recognizes that retail
generation competition is not now feasible, and proposes rate unbundling, the
establishment of cost-based rates, the offering of additional rate options,
performance based ratemaking, and investigation of the unbundling and separate
pricing of customer services. DBEDT proposes (1) rate unbundling, (2)
competition for customer services and energy efficiency services, and (3) if
additional analysis by the PUC confirms the feasibility of retail generation
competition on Oahu, open T&D access for generators, divestiture of generation
and customer service functions by utilities, and formation of independent system
operators (all targeted to 2002).
The PUC will determine what procedural steps, if any, will follow the submittal
of the parties' SOPs. No timetable has been set for such a determination. It is
also possible that parties may seek legislative action on their proposals.
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 Dr. Gregory Pai as Mr. Naito's replacement on the PUC effective August 1,
1998 and named Mr. Dennis Yamada as Chairman. Mr. Yamada has served on the PUC
since July 1994 and has recently been confirmed for a six year term ending June
30, 2004. Dr. Pai's nomination is subject to Senate approval. The third
commissioner, Ms. Rae Loui, has served on the PUC since January 1998.
27
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 request, the portion of the rate increase related to Encogen's
generators would not go into effect until the facilities are completed and
providing electricity to HELCO.
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) and the 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 by 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. To expedite the rate case
proceedings, in October 1998, MECO and the Consumer Advocate negotiated a
compromise agreement which, if accepted by the PUC, will resolve most of the
issues raised by the Consumer Advocate. The agreement provides for a $3.4
million reduction in the costs accumulated as of September 30, 1998 for the
construction of M17. The $3.4 million reduction in M17 costs will result in a
charge to expenses which will reduce MECO's net income by $3.0 million in the
fourth quarter of 1998 (regardless of whether the PUC accepts the compromise
agreement). Total estimated costs for the construction of M17 expected to be
included in MECO's rate base amount to $56.4 million. The M17 construction
project will be segregated into sub-projects, thereby allowing for more frequent
additions to plant in service and a reduced level of allowance for funds used
during construction.
MECO's final position in the case (which incorporates the compromise agreement
between MECO and the Consumer Advocate) is a requested increase of $16.4 million
in annual revenues, or 11.9%, based on a 12.75% ROACE. The remaining
significant issue to be resolved relates to the ROACE to be used in determining
MECO's cost of capital. The midpoint of the ROACE range recommended by the
Consumer Advocate was 10.5%. Evidentiary hearings on MECO's rate increase
request, which were limited to the issue of the appropriate ROACE, were held on
October 27, 1998.
CONTINGENCIES
See note (4) in HECO's "Notes to consolidated financial statements."
28
SAVINGS BANK
- ------------
Three months ended
September 30,
----------------------- % Primary reason(s) for
(dollars in thousands) 1998 1997 change significant change
- ------------------------------------------------------------------------------------------------------------------
Revenues....................... $103,229 $71,625 44 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............... 13,398 11,847 13 Higher net interest income and other income due
to the BoA acquisition, partly offset by an
increase in operating expenses as a result of
the BoA acquisition and a higher provision for
loan losses
Net income..................... 7,904 7,040 12 Higher operating income and lower income taxes,
partly offset by preferred stock dividends
Interest rate spread........... 2.99% 2.90% 3 36 basis points decrease in the weighted
average rate on interest-bearing liabilities,
partly offset by 27 basis points decrease in
the weighted average yield on interest-earning
assets
Nine months ended
September 30,
------------------------ % Primary reason(s) for
(dollars in thousands) 1998 1997 change significant change
- --------------------------------------------------------------------------------------------------------------
Revenues.................. $306,324 $210,211 46 See explanation above
Operating income.......... 42,079 36,368 16 See explanation above
Net income................ 23,616 21,311 11 See explanation above
Interest rate spread...... 3.10% 2.96% 5 33 basis points decrease in the
weighted average rate on
interest-bearing liabilities, partly
offset by a 19 basis points decrease
in the weighted average yield on
interest-earning assets
ASB's revenues, operating income and net income for the third quarter and first
nine months of 1998 reflect the results of the acquired BoA Hawaii operations.
Partly offsetting the higher results compared to the first nine months of 1997
were increased consulting expenditures to consolidate and streamline operations
and an increase in ASB's loan loss provision. Hawaii's weak economy, including
the effects of increased delinquencies, and the relatively flat yield curve has
reduced some of the earnings increase expected from the acquired BoA Hawaii
operations.
29
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 3% and 5% for the third quarter and first nine months of
1998 compared to same periods in 1997. Comparing the first nine months of 1998
to the same period in 1997, the decrease in the weighted average rate on
interest-bearing liabilities was greater than the decrease in the weighted
average yield on interest-earning assets. In October 1998, ASB lowered the rates
paid on passbook and savings accounts by 50 basis points and on checking
accounts by 25 basis points.
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. ASB experienced an outflow of deposits of $180 million
in the first nine months of 1998, partly offset by $95 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 experienced an increase in nonaccrual loans
and loan loss reserves. During the first nine months of 1998, ASB added $9.5
million to its allowance for loan losses--95% more than the additions made in
the same period last year. As of September 30, 1998, ASB's allowance for loan
losses was 1.18% of average loans outstanding. The following table presents the
changes in the allowance for loan losses for the periods indicated.
Nine months ended
September 30,
-----------------------------
(in thousands) 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
Allowance for loan losses, beginning of period...................................... $29,950 $19,205
Additions to provisions for losses.................................................. 9,473 4,860
Allowance for losses on loans returned to BoA....................................... (107) -
Net charge-offs..................................................................... (2,719) (1,432)
------- -------
Allowance for loan losses, end of period............................................ $36,597 $22,633
======= =======
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 third quarter of 1998, in spite of a 13% increase in operating
income, ASB and subsidiaries' income taxes were $0.7 million lower than the same
period in 1997.
30
OTHER
- -----
Three months ended
September 30,
-------------------------- % Primary reason(s) for
(in thousands) 1998 1997 change significant change
- ----------------------------------------------------------------------------------------------------------------
Revenues.................. $14,405 $16,595 (13) HEIIC's higher investment gains in
prior year, partly offset by HEIPC's
higher Guam revenues and freight
transportation subsidiaries' higher
general freight revenues in 1998
Operating loss............ (2,365) 1,072 NM HEIIC's higher investment gains in
prior year and, in 1998, HEIPC's higher
business development expenses, partly
offset by higher freight transportation
operating income (see below)
Nine months ended
September 30,
----------------------------- % Primary reason(s) for
(in thousands) 1998 1997 change significant change
- ----------------------------------------------------------------------------------------------------------------
Revenues.................. $44,023 $43,717 1 HEIPC's higher Guam revenues and
freight transportation subsidiaries'
higher general freight revenues, partly
offset by HEIIC's higher investment
gains in prior year
Operating loss............ (4,730) (2,318) NM HEIIC's higher investment gains in
prior year and, in 1998, HEIPC's higher
business development expenses, partly
offset by higher freight transportation
operating income (see below)
NM Not meaningful.
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; 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 windfarm
operational and maintenance services to an affiliate; HEI District Cooling,
Inc., a company formed to develop, build, own, operate and/or maintain, either
directly or indirectly, central chilled water, cooling system facilities, and
other energy related products and services for commercial and residential
buildings; 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. Subsequent to September 30, 1998, ProVision
Technologies, Inc. was formed to sell, install, operate and maintain on-site
power generation equipment and auxiliary appliances in Hawaii and the Pacific
Rim.
FREIGHT TRANSPORTATION
The freight transportation subsidiaries recorded operating income of $1.0
million and $3.2 million in the third quarter and first nine months of 1998,
respectively, compared with $0.6 million and $1.4 million in the same periods of
1997. The higher operating incomes for 1998 are due to higher general freight
revenues and lower operating expenses, resulting from lower labor related
expenses and a PUC approved sailing schedule modification. 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.
31
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 for a modification in 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.
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 $2.6 million in the third quarter and first nine months of 1998,
respectively, compared with $0.5 million and $1.6 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.
In September 1998, HEIPC (through a wholly owned subsidiary's 80% ownership of a
Mauritius Company) acquired an effective 60% interest in a joint venture,
Baotou Tianjiao Power Co., Ltd., formed to design, construct, own, operate and
manage a 206-megawatt (net) coal-fired power plant to be located inside Baotou
Iron & Steel Company's (BaoSteel's) complex in Inner Mongolia, People's Republic
of China (PRC). BaoSteel, a state-owned enterprise and the fifth largest steel
company in China, is a 25% partner in the joint venture and will purchase all
the electricity generated. Ownership of the plant will be transferred, without
charge, to BaoSteel in approximately 20 years. BaoSteel's current demand of 400
MWs is expected to exceed 700 MWs by the year 2000, following a major plant
expansion. Construction has commenced and the units are expected to be online by
the end of 2000. The total project cost is estimated at $115 million. HEIPC has
committed to invest up to $100 million; however, contractor financing through
the construction period and limited recourse project financing may be available,
which would reduce the amount of equity to be invested.
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.
HEIPC has committed to invest up to $115 million in connection with existing
projects. HEIPC is pursuing additional international projects, which are subject
to approval of the HEIPC and HEI Boards of Directors.
CONTINGENCIES
- -------------
See note (7) in HEI's "Notes to consolidated financial statements" for a
discussion of environmental regulation.
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.
32
YEAR 2000 ISSUE
- ---------------
HEI consolidated
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 equipment, software and devices with imbedded technology. Year 2000
date issues, if not properly addressed, may result in computer errors that could
cause a disruption of business operations. Further, the Company could be
adversely impacted by Year 2000 date issues if suppliers, customers and other
related businesses do not address the issues successfully. HEI and subsidiary
management have developed Year 2000 programs and have teams in place that are
actively assessing, renovating, validating and implementing Year 2000 ready
systems. All significant computer-based systems are being included in the
inventory and assessment process. Priority is being given to systems that are
considered mission or business critical. The Company's mainframe computer and
operating systems software, which serves HEI's operating subsidiaries, have been
upgraded to Year 2000 ready versions, subject to testing targeted to be
completed by June 1999. HEI and each business unit have appointed a Year 2000
project manager who provides periodic reporting to their respective senior
management and board of directors. An oversight and reporting role has been
established at the HEI corporate level.
Both the electric utility and the savings bank segments are subject to external
oversight by their respective regulators. Although substantial effort is being
devoted to the Year 2000 issue, no absolute assurance can be given that HEI and
its subsidiaries will successfully avoid all problems that may arise. Further,
no absolute assurance can be given that the Year 2000 problems of other entities
will not have a material adverse impact on HEI and its subsidiaries' systems or
results of operations.
Costs. Management believes that the cost to remediate its systems to become
- ------
Year 2000 ready will not have a material adverse effect on the Company's
financial condition, results of operations or liquidity. The total cost of
initiatives undertaken primarily for Year 2000 remediation is estimated at $9
million, of which an immaterial amount has been incurred through September 30,
1998. The cost to remediate systems and the target dates provided represent
management's best estimates at this time. These estimates are based on
information provided by various work units within the Company and external
parties such as vendors and business partners. Numerous assumptions have been
made regarding future dates, including the continued availability of internal
and external resources, third party remediation plans and the successful testing
of mission critical systems.
ELECTRIC UTILITY
State of readiness. HECO and its subsidiaries have identified information
- -------------------
technology (IT) and non-IT systems which will require Year 2000 remediation
work. HECO has prioritized these systems by importance, business risk and Year
2000 exposure, allocating resources accordingly. Remediation work for each of
the systems includes an assessment phase, a renovation and validation phase and
an implementation phase. Overall, it is roughly estimated that 95% of the
assessment phase for HECO and its subsidiaries' systems and 15% of the
renovation and validation phase have been completed as of September 30, 1998,
with lesser amounts of work completed on the implementation phase. The scheduled
completion date for each system is before the date it is expected to encounter
any Year 2000 impact. In December 1998, HECO and its subsidiaries will be
replacing the majority of their business-critical applications with an
integrated application suite that is represented to be Year 2000 ready. The
installation of integrated application suites has both simplified and lowered
the cost of Year 2000 remediation efforts. HECO and its subsidiaries have
identified third parties with whom they have significant relationships and are
corresponding with these vendors and service providers to determine their
readiness. Letters have been sent to 272 vendors and 72% have responded to the
inquiry. HECO and its subsidiaries continue to work with these third parties to
ensure they understand their responsibilities to HECO and its subsidiaries and
other business partners in the Year 2000 remediation process. Significant third
parties include fuel suppliers, independent power producers, financial
institutions and large customers. HECO has formed an Oahu Power Partners Year
2000 Group to provide a forum to share information among HECO, independent power
producers and fuel suppliers. HECO is contracting with two of its major vendors
of power plant equipment for their services in assessing, remediating and
testing their installed control systems.
Costs. HECO management believes that the cost to remediate its systems to become
- ------
Year 2000 ready will not have a material adverse effect on consolidated HECO's
financial condition, results of operations or liquidity. The total cost of
initiatives undertaken primarily for Year 2000 remediation is estimated at
$2 million, of which an immaterial amount has been incurred through September
30, 1998.
Risks. The Year 2000 remediation effort addresses two distinct areas of
- ------
risk--(1) electric systems, which deliver power to customers, and (2) business
systems, which handle data processing, including the exchange of data with
suppliers, vendors and customers. The worst case consequences if HECO is not
Year 2000 ready could include temporary disruptions of the electric supply and
critical business processes. Importantly, neither the generation
33
nor distribution systems are fully dependent on automated control systems.
Because HECO and its subsidiaries have the capability to manually control the
generation and dispatching of power and have some degree of diversity and
redundancy in their systems, HECO believes the most reasonably likely worst case
scenario would be brief, localized power outages and billing, collection and/or
reporting errors or delays. HECO and its subsidiaries continue to identify and
address the numerous scenarios which may result from not becoming Year 2000
ready. However, no absolute assurance can be given that HECO and its
subsidiaries will successfully identify and avoid all problems that may arise
from the Year 2000 issue.
Contingency plans. Contingency plans in the event of a Year 2000 problem are
- ------------------
being developed for HECO and its subsidiaries. HECO and its subsidiaries are
accustomed to being self-sufficient because they have no interconnected power
grids. HECO and its subsidiaries will have personnel on standby at midnight on
December 31, 1999 and on other critical dates in 1999 and 2000, as deemed
necessary. Work crews would be able to manually operate equipment, making a
prolonged power outage or rolling blackouts unlikely.
SAVINGS BANK
State of readiness. ASB and its subsidiaries follow guidelines provided by the
- ------------------
Office of Thrift Supervision (OTS). All savings banks use these same guidelines.
The guideline requires ASB to first renovate its mission critical systems. ASB,
in its assessment, identified IT and non-IT mission critical systems which will
require Year 2000 remediation work. IT systems include outsourced and in-house
main frame systems and applications, licensed vendor applications, ATMs, desktop
applications and high speed check sorting. ASB has prioritized these systems by
importance, business risk, and Year 2000 exposure, allocating resources
accordingly.
The OTS guideline uses a five-phase approach to Year 2000 remediation.
Remediation work for each of the systems includes an awareness phase, assessment
phase, renovation phase, validation phase and an implementation phase. As of
September 30, 1998, the assessment of ASB's in-house mission critical systems
has been completed. The renovation phase is approximately 84% complete.
Validation (14% complete) and implementation (5% complete) are the focal points
for ASB's remaining Year 2000 effort. ASB expects to substantially complete its
internal mission critical testing by yearend 1998. Testing with business
partners, service providers and vendors is expected to occur during the first
quarter of 1999. ASB is targeting to implement all renovated mission critical
systems by June of 1999.
ASB and its subsidiaries also identified third parties with whom they have
material relationships and continue to work with these third parties to ensure
they understand their responsibilities to ASB, its subsidiaries and other
business partners in the Year 2000 remediation process. Significant third
parties include software-hardware systems providers, large customers and a
service bureau. ASB has implemented a Customer Impact Program that monitors the
activities of its large business and deposit customers. ASB monitors its service
and supply vendors for Year 2000 compliance and 134 of 315 vendors have
responded that they are compliant or are making efforts to be compliant by
January 1, 2000. Year 2000 project coordinators are aware that adequate time
must be factored into the planning to allow movement to an alternative service
provider or suppliers. Project coordinators have been advised that a decision to
continue doing business with current suppliers and vendors should be reached by
June 30, 1999.
Costs. The total cost of initiatives undertaken primarily for Year 2000
- -----
remediation is estimated at $6 million, of which an immaterial amount has been
incurred through September 30, 1998. It is expected that approximately
$3 million of the remediation costs will be incurred and expensed in the fourth
quarter of 1998.
Risks. The Year 2000 remediation effort addresses various areas of risk,
- -----
primarily in ASB's business systems, including in-house applications, vendor
applications, service bureau applications and electronic banking. ASB believes
that the most likely worst case scenario would be a localized disruption of
customer services. ASB believes off-line processing at any branch site is
feasible for up to five working days. ASB and its subsidiaries continue to
identify and address the numerous scenarios, which may result from not becoming
Year 2000 ready. However, no absolute assurance can be given that ASB and its
subsidiaries will successfully identify and avoid all problems that may arise
from the Year 2000 issue.
Contingency plans. ASB's contingency plans provide a global view of the steps
- -----------------
that ASB could take if entire systems or partial systems were lost due to Year
2000 events. ASB has engaged a consultant to assist in developing detailed
contingency plans for mission critical systems by yearend 1998. ASB will use
these contingency plans to develop similar detailed plans for other ASB
departments. ASB's contingency plans include implementing off-line or manual
procedures, implementing stand-in programs and activating the disaster recovery
plan and relocating certain operations to the recovery site. ASB will backup
critical reports and files prior to yearend 1999. Further, ASB and its
subsidiaries will have personnel on standby at midnight on December 31, 1999 and
on other critical dates in 1999 and 2000, as deemed necessary.
34
ACCOUNTING CHANGES
- ------------------
See note (6) 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) September 30, 1998 December 31, 1997
- --------------------------------------------------------------------------------------------------------------
Short-term borrowings.................................. $ 181 8% $ 285 14%
Long-term debt......................................... 921 43 795 37
HEI- and HECO-obligated preferred
securities of trust subsidiaries.................... 150 7 150 7
Preferred stock of electric utility subsidiaries....... 81 4 84 4
Common stock equity.................................... 823 38 815 38
------ --- ------ ---
$2,156 100% $2,129 100%
====== === ====== ===
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.
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 nine months of 1998, net cash provided by operating activities was
$156 million. Net cash used in investing activities was $256 million, largely
due to ASB's origination of loans and purchase of 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 $109 million as a result of several factors, including
net increases in securities sold under agreements to repurchase, long-term debt
and advances from FHLB, partly offset by net decreases in short-term borrowings
and deposit liabilities, and the payment of common stock dividends and preferred
securities distributions.
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 $1.1 billion.
Of this amount, approximately $0.8 billion is for net capital expenditures
(mostly relating to the electric utilities' net capital expenditures described
below). HEI estimates that its consolidated internal sources, after the payment
of HEI dividends, will provide approximately 53% of the consolidated
requirements, with debt financing providing the remaining requirements. The
increase in consolidated requirements and the decrease in the percentage of
internally generated funds are due in part to the investment in the Baotou
Tianjiao Power Co., Ltd. joint venture and higher capital expenditures of the
electric utilities. 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.
35
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) September 30, 1998 December 31, 1997
- ------------------------------------------------------------------------------------------
Short-term borrowings from
nonaffiliates and affiliate......... $ 96 6% $ 96 6%
Long-term debt....................... 643 39 628 39
HECO-obligated preferred securities 3
of trust subsidiary................. 50 50 3
Preferred stock...................... 81 5 84 5
Common stock equity.................. 789 47 769 47
------ --- ------ ---
$1,659 100% $1,627 100%
====== === ====== ===
Operating activities provided $132 million in net cash during the first nine
months of 1998. Investing activities used net cash of $91 million, primarily for
capital expenditures. Financing activities used net cash of $38 million,
including $49 million for the payment of common and preferred dividends and
preferred securities distributions and $3 million for preferred stock
redemptions, partially offset by the $15 million net increase in 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, will total $706 million. HECO
estimates that its consolidated internal sources, after the payment of common
stock and preferred stock dividends, will provide approximately 70% of the
consolidated requirements, with debt and equity financing providing the
remaining requirements. As of September 30, 1998, approximately $39 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. Also as of September 30, 1998, 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 and an additional $100 million
of revenue bonds were authorized for issuance on behalf of HECO and HELCO prior
to the end of 2003. The PUC must approve issuances of long-term securities by
HECO, MECO and HELCO.
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 $624 million. Approximately 64% 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 36% primarily for generation projects.
For 1998, electric utility net capital expenditures are estimated to be $141
million. Gross capital expenditures are estimated to be $173 million, comprised
of approximately $120 million for transmission and distribution projects,
approximately $30 million for new generation projects and approximately $23
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.
36
SAVINGS BANK
September 30, December 31, %
(in millions) 1998 1997 change
- --------------------------------------------------------------------------------------------------------------------------------
Total assets............................................... $5,684 $5,548 2%
Mortgage-backed securities................................. 1,863 1,865 -
Loans receivable, net...................................... 3,126 3,036 3
Deposit liabilities........................................ 3,832 3,917 (2)
Securities sold under agreements to repurchase............. 535 375 43
Advances from Federal Home Loan Bank....................... 823 736 12
As of September 30, 1998, ASB was the third largest financial institution in the
state based on total assets of $5.7 billion and deposits of $3.8 billion.
For the first nine months of 1998, net cash provided by ASB's operating
activities was $22 million. Net cash used in ASB's investing activities was $150
million, due largely to the origination of loans and the purchase of 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 $143 million largely due to a net increase of $159 million in
securities sold under agreements to repurchase and of $87 million in advances
from FHLB, partly offset by a net decrease of $85 million in deposit liabilities
and by $14 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 September 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 September 30, 1998, ASB was in compliance with the OTS minimum
capital requirements (noted in parentheses) with a tangible capital ratio of
5.2% (1.5%), a core capital ratio of 5.3% (3.0%) and a risk-based capital ratio
of 12.7% (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
September 30, 1998, ASB was "well-capitalized" (ratio requirements noted in
parentheses) with a leverage ratio of 5.3% (5.0%), a Tier-1 risk-based ratio of
11.6% (6.0%) and a total risk-based ratio of 12.7% (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 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."
37
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 September 30, 1998 and December 31, 1997 were as
follows:
(%) September 30, 1998 December 31, 1997
--- ------------------ -----------------
3 month 4.35 5.34
1 year 4.39 5.48
3 year 4.38 5.66
5 year 4.22 5.71
7 year 4.37 5.76
10 year 4.41 5.74
20 year 5.16 6.01
30 year 4.97 5.92
As interest rates (as measured by U.S. Treasury yields) have declined between 85
and 149 basis points from December 31, 1997 to September 30, 1998, management
believes there has been a favorable change with respect to the Company's
quantitative disclosures of its interest-sensitive assets, liabilities and off-
balance sheet items because a larger amount of liabilities than assets are
repricing in the short-term.
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 collective bargaining agreement
In August 1998, HECO, MECO and HELCO employees represented by the International
Brotherhood of Electrical Workers (IBEW), AFL-CIO, Local 1260, ratified new
agreement provisions covering approximately 67% of the employees of HECO, HELCO
and MECO. The new agreements cover a two-year period from November 1, 1998
through October 31, 2000. The main provisions of the agreements include
noncompounded wage increases of 1.5% effective May 1, 1999 and 2.0% effective
January 1, 2000, and lump sum payments of $350 or $500 per employee following
ratification. Benefit provisions include increased employee contributions for
medical coverage, limits on employer contributions for postretirement health
benefits applicable to current and future employees, and a drug plan in lieu of
the dental and vision plans for future retirees when they become eligible for
Medicare coverage. Revisions to the pension plan include a new pre-retirement
survivor benefit for single employees and a partial lump sum pension benefit
option. Both parties also signed an agreement committing the parties to work
towards resolving issues in order to succeed in a competitive environment,
seeking improvements in efficiency and service, while lowering costs, which will
include changes in work practices and rules.
B. 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.
38
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 and the DOH executed a final consent order, disposing of the
NOV, dated August 10, 1998. In accordance with the order, MECO will pay $100,000
over two years to the Hawaii Nature Center for funding environmental education
projects.
C. 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
Nine months Years ended December 31,
ended --------------------------------------------
September 30, 1998 1997 1996 1995 1994 1993
------------------ ---- ---- ---- ---- ----
1.90 1.89 1.93 2.02 2.31 2.34
================== ==== ==== ==== ==== ====
RATIO OF EARNINGS TO FIXED CHARGES INCLUDING INTEREST ON ASB DEPOSITS
Nine months Years ended December 31,
ended --------------------------------------------
September 30, 1998 1997 1996 1995 1994 1993
------------------ ---- ---- ---- ---- ----
1.49 1.58 1.56 1.60 1.73 1.69
================== ==== ==== ==== ==== ====
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.
39
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
Nine months Years ended December 31,
ended --------------------------------------------
September 30, 1998 1997 1996 1995 1994 1993
------------------ ---- ---- ---- ---- ----
3.36 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, nine
months ended September 30, 1998 and 1997
HECO Hawaiian Electric Company, Inc. and subsidiaries
Exhibit 12.2 Computation of ratio of earnings to fixed charges, nine
months ended September 30, 1998 and 1997
HEI Hawaiian Electric Industries, Inc. and subsidiaries
Exhibit 27.1 Financial Data Schedule
September 30, 1998 and nine months ended September 30,
1998
HEI Hawaiian Electric Industries, Inc. and subsidiaries
Exhibit 27.1(a) Financial Data Schedule
September 30, 1997 and nine months ended September 30,
1997
HECO Hawaiian Electric Company, Inc. and subsidiaries
Exhibit 27.2 Financial Data Schedule
September 30, 1998 and nine months ended September 30,
1998
HECO Hawaiian Electric Company, Inc. and subsidiaries
Exhibit 27.2(a) Financial Data Schedule
September 30, 1997 and nine months ended September 30,
1997
HEI Tenth Amendment to Trust Agreement, made and entered into
Exhibit 99.1 on August 1, 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)
40
(B) REPORTS ON FORM 8-K
Since June 30, 1998, HEI and/or HECO filed Current Reports, Forms 8-K, with the
SEC as follows:
Dated Registrant/s Items reported
- ---------------------------------------------------------------------------------------------------------
August 3, 1998 HEI Item 5, HEI's settlement with insurance
carriers
September 3, 1998 HEI Item 5, News release: Hawaiian Electric
Industries, Inc. subsidiary acquires 60%
interest in power plant in China
September 16, 1998 HEI Item 5, News release: Hawaiian Electric
Industries, Inc. announces plan to exit
residential real estate business
October 19, 1998 HEI/HECO Item 5, News release: Hawaiian Electric
Industries, Inc. reports third quarter
earnings. Excerpts from Form S-3
registration statement to be filed by HECO
related to the issuance of trust preferred
securities
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrants have duly caused this report to be signed on their behalf by the
undersigned, thereunto duly authorized. The signature of the undersigned
companies shall be deemed to relate only to matters having reference to such
companies and any subsidiaries thereof.
HAWAIIAN ELECTRIC INDUSTRIES, INC. HAWAIIAN ELECTRIC COMPANY, INC.
(Registrant) (Registrant)
By /s/ Robert F. Mougeot By /s/ Paul Oyer
---------------------------- ----------------------------
Robert F. Mougeot Paul A. Oyer
Financial Vice President and Financial Vice President and
Chief Financial Officer Treasurer
(Principal Financial Officer (Principal Financial Officer
of HEI) of HECO)
Date: November 5, 1998 Date: November 5, 1998
41