<PAGE>
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report: February 27, 1998
================================================================================
<TABLE>
<CAPTION>
Exact Name of Registrant Commission I.R.S. Employer
as Specified in Its Charter File Number Identification No.
- --------------------------- ----------- ------------------
<S> <C> <C>
Hawaiian Electric Industries, Inc. 1-8503 99-0208097
Hawaiian Electric Company, Inc. 1-4955 99-0040500
</TABLE>
================================================================================
State of Hawaii
----------------------------------------------
(State or other jurisdiction of incorporation)
900 Richards Street, Honolulu, Hawaii 96813
----------------------------------------------------------------
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code:
(808) 543-5662 - Hawaiian Electric Industries, Inc. (HEI)
(808) 543-7771 - Hawaiian Electric Company, Inc. (HECO)
None
--------------------------------------------------------------
(Former name or former address, if changed since last report.)
================================================================================
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
(c) Exhibits.
HEI Exhibit 13.1 Pages 25 to 66 of HEI's 1997 Annual Report to Stockholders
HECO Exhibit 13.2 Pages 2 to 34 and 36 of HECO's 1997 Annual Report to
Stockholder
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)
/s/ Robert F. Mougeot /s/ Paul Oyer
- ---------------------------------- -----------------------------------
Robert F. Mougeot Paul A. Oyer
Financial Vice President and Financial Vice President and
Chief Financial Officer of HEI Treasurer of HECO
(Principal Financial Officer of HEI) (Principal Financial Officer of HECO)
Date: February 27, 1998 Date: February 27, 1998
1
<PAGE>
HEI Exhibit 13.1
----------------
<TABLE>
<CAPTION>
SELECTED FINANCIAL DATA
- ------------------------------------------------------------------------------------------------------------------------------------
Hawaiian Electric Industries, Inc. and subsidiaries
Years ended December 31 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(dollars in thousands, except per share amounts)
RESULTS OF OPERATIONS
Revenues.................................................... $ 1,463,979 $ 1,410,572 $ 1,295,924 $ 1,188,523
Net income (loss)
Continuing operations................................... $ 86,442 $ 78,658 $ 77,493 $ 73,030
Discontinued operations................................. -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
$ 86,442 $ 78,658 $ 77,493 $ 73,030
====================================================================================================================================
Basic earnings (loss) per common share
Continuing operations................................... $ 2.76 $ 2.60 $ 2.66 $ 2.60
Discontinued operations................................. -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
$ 2.76 $ 2.60 $ 2.66 $ 2.60
====================================================================================================================================
Diluted earnings per common share........................... $ 2.75 $ 2.59 $ 2.65 $ 2.59
====================================================================================================================================
Return on average common equity............................. 10.9% 10.5% 11.0% 11.0%
====================================================================================================================================
FINANCIAL POSITION *
Total assets................................................ $ 7,953,882 $ 5,935,840 $ 5,603,745 $ 5,174,464
Deposit liabilities of the savings bank subsidiary.......... 3,916,600 2,150,370 2,223,755 2,129,310
Securities sold under agreements to repurchase
of the savings bank subsidiary........................... 375,366 479,742 412,521 123,301
Advances from Federal Home Loan Bank
to the savings bank subsidiary........................... 736,474 684,274 501,274 616,374
Long-term debt.............................................. 802,575 810,080 758,463 718,240
HEI- and HECO-obligated preferred securities of
trust subsidiaries....................................... 150,000 -- -- --
Preferred stock of electric utility subsidiaries
Subject to mandatory redemption......................... 35,770 38,955 41,750 44,844
Not subject to mandatory redemption..................... 48,293 48,293 48,293 48,293
Stockholders' equity........................................ 814,681 772,852 729,603 682,089
COMMON STOCK
Book value per common share *............................... 25.54 25.05 24.51 23.80
Market price range per common share
High.................................................... 41.50 39.50 39.75 36.50
Low..................................................... 32.88 33.25 32.13 29.88
December 31............................................. 40.88 36.13 38.75 32.38
Dividends per common share.................................. 2.44 2.41 2.37 2.33
Dividend payout ratio....................................... 88% 93% 89% 90%
Dividend payout ratio-continuing operations................. 88% 93% 89% 90%
Market price to book value per common share *............... 160% 144% 158% 136%
Price earnings ratio **..................................... 14.8x 13.9x 14.6x 12.5x
Common shares outstanding (thousands)
Weighted average........................................ 31,375 30,310 29,187 28,137
Geographic distribution of ownership *
State of Hawaii ***................................. 5,947 5,822 7,591 7,278
Other............................................... 25,948 25,031 22,182 21,377
- ------------------------------------------------------------------------------------------------------------------------------------
Total common shares outstanding................. 31,895 30,853 29,773 28,655
- ------------------------------------------------------------------------------------------------------------------------------------
Stockholders by geographic distribution *
State of Hawaii ***..................................... 26,705 22,401 22,177 21,896
Other................................................... 19,869 20,046 19,117 18,830
- ------------------------------------------------------------------------------------------------------------------------------------
Total stockholders.................................. 46,574 42,447 41,294 40,726
====================================================================================================================================
Employees................................................... 3,672 3,327 3,376 3,386
====================================================================================================================================
</TABLE>
HEI Exhibit 13.1
----------------
<TABLE>
<CAPTION>
SELECTED FINANCIAL DATA
- -----------------------------------------------------------------------------
Hawaiian Electric Industries, Inc. and subsidiaries
Years ended December 31 1993
- -----------------------------------------------------------------------------
<S> <C>
(dollars in thousands, except per share amounts)
RESULTS OF OPERATIONS
Revenues.................................................... $ 1,142,170
Net income (loss)
Continuing operations................................... $ 61,684
Discontinued operations................................. (13,025)
- -----------------------------------------------------------------------------
$ 48,659
=============================================================================
Basic earnings (loss) per common share
Continuing operations................................... $ 2.38
Discontinued operations................................. (0.50)
- -----------------------------------------------------------------------------
$ 1.88
=============================================================================
Diluted earnings per common share........................... $ 1.87
=============================================================================
Return on average common equity............................. 8.2%
=============================================================================
FINANCIAL POSITION *
Total assets................................................ $ 4,521,592
Deposit liabilities of the savings bank subsidiary.......... 2,091,583
Securities sold under agreements to repurchase
of the savings bank subsidiary........................... --
Advances from Federal Home Loan Bank
to the savings bank subsidiary........................... 289,674
Long-term debt.............................................. 697,836
HEI- and HECO-obligated preferred securities of
trust subsidiaries....................................... --
Preferred stock of electric utility subsidiaries
Subject to mandatory redemption......................... 46,730
Not subject to mandatory redemption..................... 48,293
Stockholders' equity........................................ 643,028
COMMON STOCK
Book value per common share *............................... 23.23
Market price range per common share
High.................................................... 38.88
Low..................................................... 31.00
December 31............................................. 35.88
Dividends per common share.................................. 2.29
Dividend payout ratio....................................... 121%
Dividend payout ratio-continuing operations................. 95%
Market price to book value per common share *............... 154%
Price earnings ratio **..................................... 15.1x
Common shares outstanding (thousands)
Weighted average........................................ 25,938
Geographic distribution of ownership *
State of Hawaii ***................................. 6,969
Other............................................... 20,706
- -----------------------------------------------------------------------------
Total common shares outstanding................. 27,675
- -----------------------------------------------------------------------------
Stockholders by geographic distribution *
State of Hawaii ***..................................... 22,092
Other................................................... 18,374
- -----------------------------------------------------------------------------
Total stockholders.................................. 40,466
=============================================================================
Employees................................................... 3,399
=============================================================================
</TABLE>
* At December 31.
** Calculated using December 31 market price per common share divided by
basic earnings per common share from continuing operations.
*** Does not include depository and brokerage accounts which may contain
additional shares beneficially owned by Hawaii stockholders.
See Note 4, "Savings bank subsidiary" in the "Notes to Consolidated Financial
Statements" for a discussion of American Savings Bank, F.S.B.'s acquisition of
most of the Hawaii operations of Bank of America, FSB in December 1997.
See Note 20, "Discontinued operations" in the "Notes to Consolidated Financial
Statements" for a discussion of the Company's former property and casualty
insurance business. In 1993, the Company recorded a net loss of $15.0 million
from the discontinued property and casualty insurance business. In 1992, the
Company decided to exit the nonutility wind energy business because of chronic
mechanical problems with its wind turbines and continuing operating losses. In
1993, the Company recorded a net gain of $2.0 million from the discontinued wind
energy business.
25
<PAGE>
<TABLE>
<CAPTION>
SEGMENT FINANCIAL INFORMATION
- ------------------------------------------------------------------------------------------------------------------------------------
Hawaiian Electric Industries, Inc. and subsidiaries
Years ended December 31 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
(in thousands)
REVENUES
<S> <C> <C> <C> <C>
Electric utility.......................... $1,107,523 76% $1,080,868 $ 988,722
Savings bank.............................. 294,135 20 271,402 254,616
Other..................................... 62,321 4 58,302 52,586
- ------------------------------------------------------------------------------------------------------------------------------------
$1,463,979 100% $1,410,572 $1,295,924
====================================================================================================================================
OPERATING INCOME (LOSS)
Electric utility.......................... $ 171,753 83% $ 173,613 $ 159,043
Savings bank.............................. 44,739 22 26,221 40,044
Other..................................... (10,303) (5) (11,588) (11,423)
- ------------------------------------------------------------------------------------------------------------------------------------
$ 206,189 100% $ 188,246 $ 187,664
====================================================================================================================================
DEPRECIATION AND AMORTIZATION OF
PROPERTY, PLANT AND EQUIPMENT
Electric utility.......................... $ 82,017 90% $ 73,453 $ 67,649
Savings bank.............................. 4,146 4 3,990 4,094
Other..................................... 5,342 6 4,877 4,913
- -----------------------------------------------------------------------------------------------------------------------------------
$ 91,505 100% $ 82,320 $ 76,656
===================================================================================================================================
CAPITAL EXPENDITURES
Electric utility.......................... $ 133,004 84% $ 199,902 $ 194,891
Savings bank.............................. 7,796 5 3,659 4,848
Other..................................... 17,368 11 13,763 5,086
- -----------------------------------------------------------------------------------------------------------------------------------
$ 158,168 100% $ 217,324 $ 204,825
===================================================================================================================================
IDENTIFIABLE ASSETS (AT DECEMBER 31)
Electric utility.......................... $2,212,314 28% $2,165,546 $2,016,283
Savings bank.............................. 5,548,412 70 3,590,687 3,413,426
Other..................................... 193,156 2 179,607 174,036
- -----------------------------------------------------------------------------------------------------------------------------------
$7,953,882 100% $5,935,840 $5,603,745
===================================================================================================================================
The principal segments of Hawaiian Electric Industries, Inc. (HEI) are as follows:
</TABLE>
ELECTRIC UTILITY
- --------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and its wholly owned operating subsidiaries,
Hawaii Electric Light Company, Inc. and Maui Electric Company, Limited, are
electric public utilities in the business of generating, purchasing,
transmitting, distributing and selling electric energy, and are regulated by the
Public Utilities Commission of the State of Hawaii (PUC).
SAVINGS BANK
- -------------------------------------------------------------------------------
American Savings Bank, F.S.B. (ASB) is a federally chartered savings bank
providing a full range of banking services to individual and corporate customers
through its branch system in Hawaii. ASB is subject to examination and
comprehensive regulation by the Department of Treasury, Office of Thrift
Supervision and the Federal Deposit Insurance Corporation, and is also subject
to regulations of the Board of Governors of the Federal Reserve System. In
December 1997, ASB acquired most of the Hawaii operations of Bank of America,
FSB.
OTHER
- --------------------------------------------------------------------------------
Hawaiian Tug & Barge Corp. provides tugboat and charter barge services in Hawaii
and the Pacific area and, together with its wholly owned subsidiary, Young
Brothers, Limited (YB), provides general freight and containerized cargo
transportation among the Hawaiian Islands. YB operates as an authorized common
carrier that services all major ports in Hawaii under the Hawaii Water Carrier
Act and is regulated by the PUC.
Malama Pacific Corp. and its wholly owned
subsidiaries develop and invest in real estate in Hawaii.
HEI Investment Corp. holds investments primarily in leveraged leases.
HEI Power Corp. (HEIPC) and its wholly owned subsidiaries were formed to pursue
independent power projects in Asia and the Pacific. In 1995, HEIPC did not
develop, construct, own or operate any power generation facilities. In 1996, an
HEIPC subsidiary entered into an energy conversion agreement with the Guam
Power Authority for the rehabilitation, operation and maintenance of two 25-
megawatt (net) generating units, which began commercial operations in 1997.
Other also includes amounts for HEI, HEI Diversified, Inc., Pacific Energy
Conservation Services, Inc., Hycap Management, Inc., Hawaiian Electric
Industries Capital Trust I, HEI Preferred Funding, LP and intercompany
eliminations.
26
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION,
RESULTS OF OPERATIONS AND MARKET RISK
- --------------------------------------------------------------------------------
The following discussion should be read in conjunction with the consolidated
financial statements and accompanying notes.
RESULTS OF OPERATIONS
---------------------
Hawaiian Electric Industries, Inc. (HEI) and its subsidiaries (collectively, the
Company) reported basic earnings per share of $2.76 in 1997, reflecting the
results of its major operating segments--the electric utility and the savings
bank partly offset by losses in the "other" segment. Basic earnings per share
for 1997 increased 6% from 1996. Excluding the effects the American Savings
Bank, F.S.B. (ASB) 1997 one-time expenses of $2.4 million (after taxes) related
to the acquisition of most of the Hawaii operations of Bank of America, FSB
(BoA) and ASB's 1996 Federal Deposit Insurance Corporation (FDIC) one-time
deposit-insurance premium assessment of $8.3 million (after taxes), basic
earnings per share for 1997 decreased 1% from 1996 due to lower electric utility
earnings and a greater loss from the "other" segment, partly offset by higher
ASB earnings. In 1997, the electric utilities experienced lower kilowatthour
sales due to the slow Hawaii economy and cooler weather, which resulted in lower
air conditioning usage, and increased expenses.
The Company from time to time considers various strategies designed to enhance
its competitive position and to increase its ability to anticipate and adapt to
changes in its businesses. These strategies may include the formation of new
subsidiaries or the acquisition of existing businesses. In December 1997, ASB
completed the purchase of $0.9 billion of the Hawaii-based loans and the
assumption of $1.7 billion of the Hawaii deposit liabilities of BoA. In recent
years, the Company also formed new subsidiaries to pursue independent power
projects in Asia and the Pacific. The Company may from time to time be engaged
in preliminary discussions, either internally or with third parties, regarding
potential transactions. Management cannot predict whether any of these
strategies or transactions will be successfully implemented.
Hawaii's economy was one of the key factors affecting HEI's 1997 consolidated
results. The economy again grew at a relatively slow rate of about 1% after
inflation, continuing the trend of little or no growth since the slight
recession in 1991. Tourism and investments in Hawaii, key drivers of the
economy, were affected negatively by external influences such as the weak
Japanese economy, the financial crisis in Southeast Asia and Asian currency
devaluations. After three years of healthy growth in the visitor industry, total
visitor arrivals increased only 0.7% in 1997, due largely to a decline in
eastbound visitors from Japan and Southeast Asia. Despite a large increase in
state government capital spending, another key sector, construction, declined in
1997, the fifth year of decline in the last six years. On the positive side, in
1997 the U.S. mainland economy remained healthy contributing to an increase in
westbound visitors to Hawaii, the value of private building authorizations (an
indicator of future construction activity) increased, the military sector (an
important source of outside income) remained stable, and inflation in Hawaii was
only 1%, the lowest rate since the early `60s and well below the U.S. inflation
rate.
Prospects for Hawaii's economy in the near-term future are not bright, given
the current financial problems in Southeast Asia and Japan. The State is
forecasting an annual growth rate of only 1% through the year 2000. A number of
positive factors, however, may offset the negative Asian influences, and allow
Hawaii's economy to grow in the long run. The mainland economy continues to grow
at a healthy pace, Asian countries are still expected to grow though at lower
rates of growth, inflation remains low, the Hawaii Convention Center opens in
mid-1998, exporting of niche professional services to Asia and the mainland is
increasing, local consumer confidence is improving, and Hawaii's business
climate is expected to improve as a result of the state's and the community's
stated commitment to revitalizing the economy through legislative and financial
means.
Following is a general discussion of HEI's consolidated results, which should be
read in conjunction with the segment discussions that follow.
<TABLE>
<CAPTION>
CONSOLIDATED
- --------------------------------------------------------------------------------------------------------------
% % %
1997 change 1996 change 1995 change
- ---------------------------------------------------------------------------------------------------------------
(in millions, except per share amounts)
<S> <C> <C> <C> <C> <C> <C>
Revenues......................................... $ 1,464 4 $ 1,411 9 $ 1,296 9
Operating income................................. 206 10 188 -- 188 8
Net income....................................... 86.4 10 78.7 2 77.5 6
Basic earnings per common share.................. 2.76 6 2.60 (2) 2.66 2
As adjusted /1/
Operating income............................... 210 4 202 8 188 8
Net income..................................... 88.9 2 87.0 12 77.5 6
Basic earnings per common share................ 2.83 (1) 2.87 8 2.66 2
Weighted average number of common shares
outstanding..................................... 31.4 4 30.3 4 29.2 4
Dividend payout ratio............................ 88% 93% 89%
</TABLE>
/1/ In December 1997, ASB acquired most of the BoA--Hawaii operations and
incurred one-time expenses of $2.4 million after tax. In September 1996,
President Clinton signed into law the Deposit Insurance Funds Act of 1996, which
authorized a one-time deposit-insurance premium assessment by the FDIC. ASB's
assessment was $8.3 million after tax and was accrued in 1996. The 1997 "as
adjusted" amounts exclude the one-time acquisition expenses and the 1996 "as
adjusted" amounts exclude the one-time FDIC assessment.
27
<PAGE>
. The increase in 1997 net income over 1996 was due to a 76% increase in ASB's
net income, primarily due to the one-time 1996 FDIC assessment and resulting low
FDIC insurance premiums in 1997, and a decrease in the net loss from the "other"
segment, partly offset by a 4% decrease in the net income of the electric
utility segment.
. The increase in 1996 net income over 1995 was due to a 12% increase in net
income of the electric utility segment and a decrease in the net loss from the
"other" segment, partly offset by a 36% decrease in ASB's net income due to the
one-time 1996 FDIC assessment.
. The increase in 1995 net income over 1994 was due to an increase in net income
of the electric utility segment, partly offset by lower ASB net income and an
increase in the net loss from the "other" segment.
. Shareholder dividends are declared and paid quarterly by HEI as determined by
HEI's Board of Directors. Annual dividends per common share increased in 1997 to
$2.44 from $2.41 in 1996 and $2.37 in 1995. HEI and its predecessor company,
Hawaiian Electric Company, Inc. (HECO), have paid dividends continuously since
1901. Dividends per share have been higher each year since 1964. In 1996, the
HEI Board decided to shift the dividend decision for 1997 and future years from
the fourth quarter to the first quarter of the following year, which allows the
HEI Board to consider a full year of operating results before making a dividend
decision. On January 20, 1998, the HEI Board increased the quarterly dividend
$0.01 to $0.62 per share. At the indicated annual dividend rate of $2.48 per
share and the closing share price on January 20, 1998 of $38.75, HEI's dividend
yield was 6.4%.
. In October 1997, the HEI Board adopted a stockholder rights plan. The rights
plan is designed to deter coercive or unfair takeover tactics. Under the plan,
rights were distributed as a dividend at the rate of one right for each share of
common stock of HEI held by stockholders of record at the close of business on
November 10, 1997 and rights will attach as well to shares of HEI common stock
issued thereafter. The rights generally will be exercisable only if a person or
group acquires beneficial ownership of 15% or more of HEI's common stock or
commences a tender or exchange offer upon consummation of which such person or
group would beneficially own 15% or more of HEI's common stock. The rights will
expire on November 1, 2007.
Following is a general discussion of revenues, expenses and operating income or
loss by business segment. Segment information is also shown in "Segment
Financial Information" on page 26 and in the "Notes to Consolidated Financial
Statements."
<TABLE>
<CAPTION>
ELECTRIC UTILITY
- ------------------------------------------------------------------------------------------------------------
% change % %
1997 1996 change 1995 change
- ------------------------------------------------------------------------------------------------------------
(in millions, except per barrel amounts and number of employees)
<S> <C> <C> <C> <C> <C> <C>
Revenues /1/................................... $1,108 2 $1,081 9 $ 989 8
Expenses
Fuel oil..................................... 257 3 251 21 207 11
Purchased power.............................. 293 2 286 4 276 2
Other........................................ 386 4 370 7 347 9
Operating income............................... 172 (1) 174 9 159 16
Allowance for funds used
during construction...................... 17 (3) 18 15 15 17
Net income..................................... 78 (4) 81 12 73 18
Return on average common equity................ 10.3% 11.2% 11.0%
Average price per barrel of fuel oil /1/....... $25.19 5 $24.08 18 $20.47 8
Kilowatthour sales............................. 8,963 -- 8,991 2 8,806 2
Number of employees (at December 31)........... 2,115 (2) 2,152 (3) 2,208 --
</TABLE>
/1/ The rate schedules of the electric utilities contain energy cost adjustment
clauses through which changes in fuel oil prices and certain components of
purchased energy costs are passed on to customers.
. In 1997, the electric utilities' revenues increased 2% over 1996, primarily
due to higher fuel oil prices; the recovery of integrated resource planning
related costs (including demand-side management (DSM) program costs, lost
margins and shareholder incentives related to the DSM programs) and rate
increases granted by the Public Utilities Commission of the State of Hawaii
(PUC), partly offset by a 0.3% decrease in kilowatthour (KWH) sales of
electricity. The decrease in KWH sales is partly due to cooler weather, which
results in lower residential and commercial air conditioning usage, and the
effects of Hawaii's slow economy. Fuel oil and purchased power expenses
increased 2% primarily due to higher fuel oil prices. The 4% increase in other
expenses was due to a 4% increase in other operation expenses, a 12% increase in
depreciation expense as a result of plant additions and a 3% increase in taxes,
other than income taxes, resulting from increased revenues. Other operation
expenses in 1997 increased primarily due to higher integrated resource planning
related costs (including DSM program costs). Operating income for 1997 decreased
1% compared to 1996 due to the lower KWH sales and increased expenses, partly
offset by the effects of rate increases and DSM program related shareholder
incentives.
28
<PAGE>
. 1996 revenues increased 9% compared to 1995, primarily due to higher fuel oil
prices, a 2.1% increase in KWH sales of electricity, rate increases granted by
the PUC and the recovery of integrated resource planning costs. The KWH sales
increase is partly due to the effects of the 1.4% real growth in Hawaii's
economy. Fuel oil and purchased power expenses increased because of higher fuel
oil prices and more KWHs being generated and purchased. The 7% increase in other
expenses was due to a 6% increase in other operation and maintenance expenses, a
9% increase in depreciation expense as a result of plant additions and a 9%
increase in taxes, other than income taxes, resulting from increased revenues.
Other operation expenses in 1996 increased primarily due to higher integrated
resource planning related costs. Maintenance expenses increased partly due to
more underground fault repairs and tower maintenance on Oahu and higher
production maintenance on Hawaii and Maui. Operating income for 1996 increased
9% compared to 1995 due in part to higher KWH sales, rate increases and DSM
program related shareholder incentives, partly offset by increased expenses.
. 1995 revenues increased 8% compared to 1994 primarily due to rate increases,
higher fuel oil prices and a 2.5% increase in KWH sales, which reflected the
effects of unusually warm weather and the slight growth in Hawaii's economy. The
9% increase in other expenses was due to a 10% increase in other operation and
maintenance expenses, a 6% increase in depreciation expense as a result of plant
additions and an 8% increase in taxes, other than income taxes. Other operation
and maintenance expenses in 1995 increased primarily due to higher employee
benefits expenses, which included the expense for postretirement benefits other
than pensions (PBOP) and the write-off of a regulatory asset for postretirement
executive life insurance costs. Operating income for 1995 increased 16% compared
to 1994 due in part to rate increases and higher KWH sales, partly offset by the
increased expenses.
COMPETITION
The electric utility industry is becoming increasingly competitive as a result
of various factors including product price, 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.
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
recognizes that Hawaii's stand-alone island energy systems are different from
the interconnected systems of the contiguous states, but also recognizes 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 utility industry.
There are 19 parties in the proceeding including the Consumer Advocate of the
State of Hawaii, HECO, Maui Electric Company, Limited (MECO), Hawaii Electric
Light Company, Inc. (HELCO), various IPPs, government agencies and others. The
PUC chose two facilitators for a collaborative process that was instituted by
the PUC to "compile information, create a discussion forum, and narrow the
issues on the complexities of restructuring the electric industry in response to
emerging competition." The facilitators held a number of meetings with the
parties, and discussions are on-going as to the nature and schedule for further
proceedings and discussions. Resolutions have been introduced in the Hawaii
Legislature at the request of one of the parties, the Hawaii Department of
Business, Economic Development, and Tourism, which, if adopted, would request
that the PUC provide specific recommendations to the Legislature by December 31,
1998, for "legislation to implement economical competition" in Hawaii.
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.
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.
Postretirement benefits other than pensions
- -------------------------------------------
. In November 1994, the PUC issued a D&O that authorized full recovery of PBOP
costs, determined pursuant to Statement of Financial Accounting Standards (SFAS)
No. 106, of the electric utilities and Young Brothers, Limited (YB), effective
January 1, 1995. The D&O
29
<PAGE>
also allowed the recovery, over the following 18 years, of the regulatory assets
related to PBOP costs. The costs of postretirement executive life insurance,
however, were subsequently disallowed. See Note 17 in the "Notes to Consolidated
Financial Statements."
Hawaiian Electric Company, Inc.
- -------------------------------
. In July 1993, HECO filed a request to increase rates based on a 1994 test
year. HECO requested an 8.6% increase (as revised) over rates in effect at the
time, or $53.8 million in annual revenues, based on a 12.75% return on average
common equity (ROACE).
In December 1994, HECO received a final D&O authorizing a 6.5%, or $40.5
million, increase in annual revenues, effective January 1, 1995 and based on a
12.15% ROACE. The final D&O, together with the PBOP D&O, resulted in a $50.5
million increase in annual revenues.
. In December 1993, HECO filed a request to increase rates based on a 1995 test
year. HECO requested a 4.1% increase (as revised), or $28.2 million in annual
revenues, based on a 13.25% ROACE.
In December 1995, HECO received a final D&O authorizing a 1.3%, or $9.1
million, increase in annual revenues, based on an 11.4% ROACE. The D&O required
a refund to customers because HECO had previously received four interim
increases totaling $18.9 million on an annualized basis, or $9.8 million more
than the amount that was finally approved. The reduction in rate increase
resulted primarily from the lower ROACE used by the PUC in the final D&O because
of declining interest rates subsequent to the first interim increase, which had
been effective January 1, 1995 and had been based on a 12.6% ROACE. The refund
amount of $10 million (representing amounts received under interim rates in
excess of final approved rates, with interest thereon) was accrued in December
1995 and returned to customers in the first half of 1996. The D&O also did not
provide revenue to cover costs relating to postretirement executive life
insurance. HECO and its subsidiaries wrote off a regulatory asset relating to
such costs, resulting in a 1995 after-tax charge of $1.1 million.
Hawaii Electric Light Company, Inc.
- -----------------------------------
. In November 1993, HELCO filed a request to increase rates 13.4%, or $15.8
million in annual revenues, based on a 1994 test year and a 12.4% ROACE (which
was later increased to 13.1%).
In February 1995, HELCO received a final D&O authorizing an 11.8%, or $13.7
million, increase in annual revenues, based on a 12.6% ROACE. The final D&O,
together with the PBOP D&O, resulted in a $15.5 million annual rate increase.
. In March 1995, HELCO filed a request to increase rates based on a 1996 test
year. In February 1996, HELCO revised its requested increase to 6.2%, or $8.9
million in annual revenues, based on a 12.5% ROACE.
In March 1996, HELCO received an interim D&O authorizing a 4.8%, or $6.8
million, increase in annual revenues, based on an 11.65% ROACE. In April 1997,
HELCO received a final D&O which made the interim increase final.
. HELCO plans to file a request to increase rates, based on a 1999 test year,
primarily to recover the costs related to the anticipated addition of generating
units CT-4 and CT-5 in late 1998, and the anticipated addition of generation
capacity in mid-1999 pursuant to a power purchase agreement with Encogen Hawaii,
L.P.
Maui Electric Company, Limited
- ------------------------------
. In November 1991, MECO filed a request to increase rates. In January 1993,
MECO revised its requested increase to 9.9%, or $11.4 million in annual
revenues, based on a 13.0% ROACE and a 1993 test year.
In August 1994, MECO received a final D&O authorizing a 7.0%, or $8.1 million,
increase in annual revenues, based on a 12.75% ROACE. The final D&O, together
with the PBOP D&O, resulted in a $10 million annual rate increase.
. In February 1995, MECO filed a request to increase rates based on a 1996 test
year. MECO's final requested increase was 3.8%, or $5.0 million in annual
revenues, based on an 11.5% ROACE.
In January 1996, MECO received an interim D&O authorizing an increase of 2.8%,
or $3.7 million in annual revenues, based on an 11.5% ROACE, effective February
1, 1996. In April 1997, MECO received a final D&O authorizing a 2.9%, or $3.9
million increase in annual revenues, $0.2 million more annually than the interim
increase and based on an 11.5% ROACE.
. 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/U.S. Environmental Protection Agency
(EPA). In December 1997, MECO received a final D&O authorizing no additional
increase in annual revenues, based on an 11.12% ROACE.
. In January 1998, MECO received a PSD permit for generating unit M17 and filed
a request to increase rates 15.3%, or $22.4 million in annual revenues, based on
a 12.75% ROACE and a 1999 test year, primarily to recover the costs related to
the anticipated addition of unit M17 in late 1998. The grant of the PSD permit
for this unit was appealed in February 1998.
PUC SHOW CAUSE ORDER FOR HECO
See Note 3 in the "Notes to Consolidated Financial Statements" for a discussion
of the PUC show cause order for HECO.
ENERGY COST ADJUSTMENT CLAUSES
The rate schedules of the electric utility subsidiaries include energy cost
adjustment clauses under which electric rates are adjusted for changes in the
weighted average price paid for fuel oil and certain components of purchased
power, and the relative amounts of com-
30
<PAGE>
pany-generated power and purchased power. Accordingly, changes in fuel oil
prices and certain components of purchased power costs are passed on to
customers. In the December 30, 1997 D&O's approving HECO and its subsidiaries'
fuel supply contracts, the PUC noted that, in light of the length of the fuel
supply contracts and the relative stability of fuel prices, the need for the
continued use of energy cost adjustment clauses will be the subject of
investigation in a generic docket or in a future rate case. In its rate increase
application based on a 1999 test year, MECO stated that it believes that the
energy cost adjustment clause continues to be necessary.
PROPERTY DAMAGE RESERVE
In March 1995, the PUC opened a generic docket to investigate whether the public
utilities in the State of Hawaii should be allowed to establish property damage
reserves to cover the cost of damage to their facilities and equipment caused by
catastrophic disasters. The electric utility subsidiaries' overhead transmission
and distribution systems are susceptible to wind and earthquake damage, and
their underground systems are susceptible to earthquake and flood damage. The
overhead and underground transmission and distribution systems (with the
exception of substation buildings and contents) have a replacement value roughly
estimated at $2 billion and are uninsured because the amount of transmission and
distribution system insurance available is limited and the premiums are
extremely high. Hearings were held in February 1997 and the electric utilities
are awaiting a PUC D&O.
COMMITMENTS AND CONTINGENCIES
See Note 3 in the "Notes to Consolidated Financial Statements" for a discussion
of the electric utilities' commitments and contingencies.
HELCO POWER SITUATION
See Note 3 in the "Notes to Consolidated Financial Statements."
SAVINGS BANK
<TABLE>
<CAPTION>
SAVINGS BANK
- ----------------------------------------------------------------------------------------------------------------
1997 % change 1996 % change 1995 % change
- ----------------------------------------------------------------------------------------------------------------
(in millions)
<S> <C> <C> <C> <C> <C> <C>
Revenues....................................... $ 294 8 $ 271 7 $ 255 18
Net interest income............................ 113 11 102 9 94 (6)
Operating income............................... 45 71 26 (35) 40 (6)
Net income..................................... 26 76 15 (36) 23 (6)
As adjusted /1/
Operating income............................. 49 22 40 -- 40 (6)
Net income................................... 29 23 23 -- 23 (6)
Interest-earning assets
Average balance.............................. $3,708 11 $3,354 9 $3,084 14
Weighted average yield....................... 7.49% (2) 7.62% (1) 7.68% 2
Interest-bearing liabilities
Average balance.............................. $3,586 11 $3,233 8 $2,985 14
Weighted average rate........................ 4.59% (3) 4.75% (1) 4.78% 20
Interest rate spread........................... 2.90% 1 2.87% (1) 2.90% (18)
</TABLE>
/1/ In December 1997, ASB acquired most of the BoA--Hawaii operations and
incurred related one-time expenses of $2.4 million after tax. In September 1996,
President Clinton signed into law the Deposit Insurance Funds Act of 1996, which
authorized a one-time deposit-insurance premium assessment by the FDIC. ASB's
assessment was $8.3 million after tax and was accrued in 1996. The 1997 "as
adjusted" amounts exclude the one-time acquisition expenses and the 1996 "as
adjusted" amounts exclude the one-time FDIC assessment. The FDIC assessment
resulted in a reduction of ASB's deposit-insurance premiums from 23 cents to
6.48 cents per $100 of deposits, effective January 1, 1997. With the reduction
in deposit-insurance premiums, ASB's annual after-tax savings was approximately
$2 million for 1997.
Earnings of ASB depend primarily on net interest income, the difference between
interest income earned on interest-earning assets (loans receivable, mortgage-
backed securities and investments) and interest expense incurred on interest-
bearing liabilities (deposit liabilities and borrowings). ASB's loan volumes and
yields are affected by market interest rates, competition, demand for real
estate financing, availability of funds and management's responses to these
factors. Other factors affecting ASB's operating results include income from
servicing loans and expenses from operations.
Deposits traditionally have been the principal source of ASB's funds for use
in lending, meeting liquidity requirements and making investments. 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
net interest income.
In December 1997, ASB was able to grow significantly through the assumption of
$1.7 billion of BoA's Hawaii deposits. In 1997, deposits increased by $1.8
billion, or 82%.
. ASB's 1997 revenues increased 8% over 1996 due to an 11% higher average
balance of interest-earning assets, partly offset by lower yields. 1997 net
interest income increased 11% over 1996 due to a slightly
31
<PAGE>
higher net average balance of interest-earning assets and a slightly higher
interest rate spread--the difference between the weighted average yield on
interest-earning assets and the weighted average rate on interest-bearing
liabilities. One of the primary factors contributing to the increase in ASB's
interest rate spread was the decrease in rates paid on ASB's deposits commencing
in November 1996. Excluding the effects of the 1997 acquisition expenses and the
one-time 1996 FDIC assessment, operating and net income were up 22% and 23%,
respectively, compared to 1996 due to higher net interest income and lower
deposit-insurance premiums, partly offset by higher employee expenses.
On the positive side, loans receivable increased a net 52% in 1997, primarily
due to the purchase of $0.9 billion of Hawaii-based BoA loans. On the negative
side, higher unemployment and other factors contributed to increased loans
receivable delinquencies. Without taking into account the BoA transaction, in
1997 ASB's nonaccrual and renegotiated loans increased by $24 million to $74
million, and the allowance for loan losses increased by $4 million to $30
million. ASB's ratio of net charge-offs to average loans outstanding, however,
remained relatively low at 0.12% for 1997 compared to an annualized 0.33% for
all U.S. thrifts for the first nine months of 1997.
. ASB's 1996 revenues increased 7% over 1995 due to a 9% higher average balance
of interest-earning assets, partly offset by lower yields on mortgage-backed
securities. 1996 net interest income increased 9% over 1995 due to a 22% higher
net average balance of interest-earning assets, partly offset by a slightly
lower interest rate spread. One of the primary factors contributing to the
decrease in ASB's interest rate spread was the flattening of the yield curve
beginning in 1995. Excluding the effects of the one-time 1996 FDIC assessment,
operating and net income were flat compared to 1995 due to higher net interest
income, offset by an increased provision for loan losses, higher compensation
and benefits expenses and higher other income in 1995, which included a $2.3
million after-tax gain on the sale of mortgage-backed securities.
Loans receivable increased a net 19% in 1996, partly due to higher
refinancings of residential mortgage loans from other financial institutions due
to the relatively low mortgage rates. However, higher unemployment and other
factors contributed to increased delinquencies. In 1996, ASB's nonaccrual and
renegotiated loans increased by $22 million to $50 million, and the allowance
for loan losses increased by $6 million to $19 million. ASB's ratio of net
charge-offs to average loans outstanding, however, still remained relatively low
at 0.07% compared to the average for all U.S. thrifts at 0.33%. In 1996,
deposits decreased 3%, partly due to competition from money market and mutual
funds.
. 1995 net interest income decreased 6% from 1994 due to an 18% decrease in
interest rate spread. Operating and net income decreased due to lower net
interest income, an increased provision for loan losses, higher compensation and
benefits expenses and higher office occupancy expenses, partly offset by higher
other income which included a $2.3 million after-tax gain on the sale of fixed
rate mortgage-backed securities under the one-time reclassification of
securities allowed by the Financial Accounting Standards Board concurrent with
the initial adoption of the implementation guidance for SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." In 1995,
loans receivable decreased 7% as the demand for mortgage loans decreased partly
due to the slow real estate market in Hawaii. Deposits increased 4% in 1995 due
primarily to interest credited.
OTHER
<TABLE>
<CAPTION>
% % %
1997 change 1996 change 1995 change
- ------------------------------------------------------------------------------------------
(in millions)
<S> <C> <C> <C> <C> <C> <C>
Revenues.......................... $ 62 7 $ 58 11 $ 53 (11)
Operating loss.................... (10) 11 (12) (1) (11) (128)
</TABLE>
The "other" business segment includes results of operations from Hawaiian Tug &
Barge Corp. (HTB) and its subsidiary, YB, maritime freight transportation
companies; Malama Pacific Corp. (MPC) and its subsidiaries, real estate
development and investment companies; HEI Investment Corp. (HEIIC), a company
primarily holding investments in leveraged leases; HEI Power Corp. (HEIPC) and
its subsidiaries, companies formed to pursue independent power projects in Asia
and the Pacific; Pacific Energy Conservation Services, Inc. (PECS), a contract
services company primarily providing limited services to an affiliate; Hawaiian
Electric Industries Capital Trust I, HEI Preferred Funding, LP and Hycap
Management, Inc., companies formed primarily for the purpose of effecting the
issuance of 8.36% Trust Originated Preferred Securities; HEI and HEI
Diversified, Inc. (HEIDI), holding companies; and eliminations of intercompany
transactions.
. The freight transportation subsidiaries recorded operating income of $2.2
million in 1997, $3.0 million in 1996 and $2.6 million in 1995. HTB and YB
continue to be negatively impacted by the slow economic activity on Oahu's
neighbor islands and the slow construction industry in Hawaii. 1997 operating
income was lower than 1996 due largely to a 19% increase in maintenance
expenses, primarily for barges and equipment. 1996 operating income was higher
than 1995 due largely to lower drydocking and overhaul expenses.
In December 1996, the PUC approved a stipulated agreement between YB and the
Consumer Advocate to increase rates by $1.4 million annually, or 3.9%. In March
1997, YB filed a request with the PUC for a general rate increase of 8.2%, which
was subsequently reduced to 5.7%. In October 1997, YB received a final decision
and order authorizing a 4.7%, or $1.7 million increase in annual revenues, based
on a ROACE of 14.1%. Also, see the discussion of postretirement benefits other
than pensions under the "Electric utility -- Recent rate requests" section.
32
<PAGE>
. MPC's consolidated operating loss was $6.5 million in 1997, $1.8 million in
1996 and $2.6 million in 1995. In 1997, a 50% owned partnership of an MPC
subsidiary recognized a noncash charge on its investment in a real estate
development project, pursuant to SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." MPC's
subsidiary's proportionate share of this noncash charge was $4.2 million. In
1996, an MPC subsidiary sold land in downtown Honolulu to a developer for a
pretax gain of $1.1 million. MPC's real estate development activities continue
to be negatively impacted by the slow real estate market in Hawaii. Adjustments
were made to reduce the carrying value of certain real estate projects in 1997,
1996 and 1995. It is expected that the Hawaii real estate market will not
rebound in the near term. MPC and its subsidiaries' present focus is to reduce
their current investment in real estate development assets and increase cash
flow by continuing the development and sales of existing projects and land.
There are currently no plans to invest in new projects. See Note 5 in the "Notes
to Consolidated Financial Statements" for a further discussion of MPC and its
subsidiaries.
. HEIIC recorded operating income of $4.6 million in 1997 and $0.1 million in
1996, compared to an operating loss of $0.8 million in 1995. In 1997, HEIIC
recognized in pretax income $3.9 million, its proportionate share of income from
an investment in UTECH Venture Capital Corporation which liquidated its
investment in Ciena Corporation. In 1995, HEIIC sold one commercial building to
a lessee pursuant to the provisions of a leveraged lease agreement and recorded
a pretax loss of $2.1 million on the sale. No new investments are currently
planned for HEIIC.
. HEIPC was formed in March 1995 and its subsidiaries have been and will be
formed from time to time to pursue independent power projects in Asia and the
Pacific. HEIPC's consolidated operating loss was $2.0 million in 1997, $2.6
million in 1996 and $1.7 million in 1995. The decrease in operating loss for
1997 was due to revenue recognized on HEIPC's first project in Guam. In
September 1996, HEI Power Corp. Guam (HPG), entered into an energy conversion
agreement for approximately 20 years with the Guam Power Authority (GPA),
pursuant to which HPG has repaired and is operating and maintaining two oil-
fired 25-megawatt (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.
. The corporate and other subsidiaries' operating loss was $8.6 million in
1997, a decrease of $1.8 million compared to 1996 partly due to lower corporate
administrative and general expenses. The corporate and other subsidiaries'
operating loss increased $1.5 million in 1996 compared to 1995, due to higher
expenses such as compensation, benefits and depreciation.
DISCONTINUED OPERATIONS
- --------------------------------------------------------------------------------
See Note 20 in the "Notes to Consolidated Financial Statements" for a discussion
of the Company's former property and casualty insurance business.
ACCOUNTING FOR THE EFFECTS OF CERTAIN TYPES OF REGULATION
- --------------------------------------------------------------------------------
In accordance with SFAS No. 71, "Accounting for the Effects of Certain Types of
Regulation," the Company's financial statements reflect assets and costs of HECO
and its subsidiaries and YB based on current cost-based rate-making regulations.
Management believes HECO and its subsidiaries' and YB's operations currently
satisfy the SFAS No. 71 criteria. However, if events or circumstances should
change so that those criteria are no longer satisfied, management believes that
a material adverse effect on the Company's results of operations, financial
position or liquidity may result. See Note 8 in the "Notes to Consolidated
Financial Statements" for further discussion.
ENVIRONMENTAL MATTERS
- --------------------------------------------------------------------------------
HEI and its subsidiaries are subject to environmental laws and regulations which
could potentially impact the Company in terms of operating existing facilities,
constructing and operating new facilities and ensuring the proper cleanup and
disposal of hazardous waste and toxic substances. Management believes that the
recovery through rates of most, if not all, of any costs incurred by HECO and
its subsidiaries and YB in complying with these environmental requirements would
be allowed by the PUC. Based on information available to the Company, management
is not aware of any contingent liabilities relating to environmental matters
that would have a material adverse effect on the Company.
On July 16, 1997, the EPA adopted national ambient air quality standards for
certain particulate matter and the ozone. The new standards will not require
local pollution controls until 2004 for the ozone and 2005 for particulate
matter, with no compliance determinations until 2007 and 2008, respectively, and
with possible extensions. The eventual impact of these new standards on the
Company is not known at this time.
Also, see HEIPC discussion under "Other" above and Note 22 in the "Notes to
Consolidated Financial Statements."
ELECTRIC AND MAGNETIC FIELDS
- --------------------------------------------------------------------------------
Research about the potential adverse health effects from exposure to electric
and magnetic fields (EMF) is ongoing. Results have conflicted, but a definite
relationship between EMF and health risks has not been demonstrated. The
National Academy of Sciences examined more than 500 studies and found that "the
current body of evidence does not show that exposure to EMFs presents a human-
health hazard." Further, an extensive study released in 1997 by the National
Cancer Institute and the Children's Cancer Group found no evidence of increased
risk for childhood leukemia from EMF. HECO and its subsidiaries continue to
participate in utility industry funded studies on EMF and, where technically
feasible and economically reasonable, reduce EMF in the design and installation
of new transmission and distribution facilities. Management cannot predict the
impact the EMF issue may have on the Company in the future.
33
<PAGE>
YEAR 2000 READINESS
- --------------------------------------------------------------------------------
HEI and its subsidiaries are aware of the Year 2000 issues associated with the
practice of encoding only the last two digits of four digit years in computer-
based systems. Year 2000 issues, if not properly addressed, could result in
disruptions of operations. Management has been actively assessing the impact of
Year 2000 issues and developing an implementation plan to resolve these issues,
which prioritizes systems (e.g., mainframe, distributed and embedded systems),
applications and equipment. Both of the major business segments, HECO and its
subsidiaries and ASB and its subsidiaries, are in the process of replacing the
majority of their business-critical applications with integrated application
suites that are represented to be Year 2000 ready. Although Year 2000 readiness
was a requirement, these application replacements were primarily driven by
business needs. Currently, management estimates that the incremental cost to
renovate other applications and test replacement applications and systems to
become Year 2000 ready will not have a material effect on the Company's
financial condition, results of operations or liquidity. No assurance can be
given that the Company will successfully avoid all problems with the Year 2000
issue.
EFFECTS OF INFLATION
- --------------------------------------------------------------------------------
U.S. inflation, as measured by the U.S. Consumer Price Index, averaged 2.3% in
1997, 3.0% in 1996 and 2.8% in 1995. Hawaii inflation, as measured by the
Honolulu Consumer Price Index, averaged an estimated 1.0% in 1997, 1.5% in 1996
and 2.2% in 1995. Although the rate of inflation over the past three years has
been relatively low compared with the late 1970's and early 1980's, inflation
continues to have an impact on HEI's operations.
Inflation increases operating costs and the replacement cost of assets.
Subsidiaries with significant physical assets, such as the electric utilities,
replace assets at much higher costs and must request rate increases to maintain
adequate earnings. In the past, the PUC has generally approved rate increases to
cover the effects of inflation. In 1997, 1996 and 1995, the electric utilities
received rate increases, in part to cover increases in construction costs and
operating expenses due to inflation.
ACCOUNTING CHANGES
- --------------------------------------------------------------------------------
See Note 1 in the "Notes to Consolidated Financial Statements."
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
CONSOLIDATED
- --------------------------------------------------------------------------------
The Company 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 its construction programs and investments and to
cover debt and other cash requirements in the foreseeable future.
The Company's total assets were $8.0 billion and $5.9 billion at December 31,
1997 and 1996, respectively. Growth in 1997 primarily stemmed from the
acquisition of most of BoA's Hawaii operations.
The consolidated capital structure of HEI was as follows:
<TABLE>
<CAPTION>
December 31 1997 1996
- ------------------------------------------------------------------------------------------------------
(in millions)
<S> <C> <C> <C> <C>
Short-term borrowings.................................................. $ 298 14% $ 217 11%
Long-term debt......................................................... 802 37 810 43
HEI- and HECO-obligated preferred securities of trust subsidiaries..... 150 7 -- --
Preferred stock of electric utility subsidiaries....................... 84 4 87 5
Common stock equity.................................................... 815 38 773 41
- ------------------------------------------------------------------------------------------------------
$2,149 100% $1,887 100%
======================================================================================================
</TABLE>
ASB's deposit liabilities, securities sold under agreements to repurchase and
advances from the FHLB of Seattle are not included in the table above.
As of February 13, 1998, the Standard & Poor's (S&P), Moody's Investors
Service (Moody's) and Duff & Phelps Credit Rating Co.'s (Duff & Phelps) ratings
of HEI's and HECO's securities were as follows:
<TABLE>
<CAPTION>
S&P Moody's Duff & Phelps
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
HEI
- ---
Medium-term notes........................................ BBB Baa2 BBB+
Commercial paper......................................... A-2 P-2 Duff 2
HEI-obligated preferred securities of trust
subsidiaries......................................... BBB- baa3 BBB
HECO
- ----
First mortgage bonds..................................... A- A3 A
Revenue bonds and medium-term notes...................... BBB+ Baa1 A-
Cumulative preferred stock............................... BBB baa1 BBB+
Commercial paper......................................... A-2 P-2 Duff 1-
HECO-obligated preferred securities of trust
subsidiary......................................... BBB baal BBB+
</TABLE>
The above ratings are not recommendations to buy, sell or hold any securities;
such ratings may be subject to revision or withdrawal at any time by the rating
agencies; and each rating should be evaluated independently of any other rating.
34
<PAGE>
Neither HEI nor HECO management can predict with certainty future rating agency
actions or their effects on the future cost of capital to HEI or HECO.
Operating activities provided net cash of $143 million in 1997, $163 million
in 1996 and $213 million in 1995. Investing activities used net cash of $210
million in 1997, $413 million in 1996 and $481 million in 1995. In 1997, net
cash used for investing activities decreased primarily due to the cash received
from the assumption of deposit and other liabilities, net of purchase of loans
receivable and other assets, from BoA. Cash was used for the origination and
purchase of loans and mortgage-backed securities (excluding those acquired from
BoA), net of repayments, and capital expenditures in 1997. Financing activities
provided net cash of $224 million in 1997, $216 million in 1996 and $312 million
in 1995. In 1997, cash was provided by the net increases in certain liabilities
(deposit liabilities, excluding those assumed from BoA, advances from the FHLB
of Seattle and short-term borrowings) and proceeds from the issuance of HEI- and
HECO-obligated preferred securities of trust subsidiaries and common stock,
partly offset by net decreases in certain liabilities (securities sold under
agreements to repurchase and long-term debt) and common stock dividends.
A portion of the net assets of HECO and ASB are not available for transfer to
HEI in the form of dividends, loans or advances without regulatory approval.
However, such restrictions are not expected to significantly affect the
operations of HEI, its ability to pay dividends on its common stock or its
ability to meet its cash obligations. See Note 18 in the "Notes to Consolidated
Financial Statements."
Total HEI consolidated financing requirements 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, are currently estimated to total $819
million. Of this amount, approximately $665 million is for net capital
expenditures (mostly relating to the electric utilities' net capital
expenditures described below). HEI's consolidated internal sources, after the
payment of HEI dividends, are expected to provide approximately 80% of the
consolidated financing requirements, with debt financing providing the remaining
requirements. Additional debt and equity financing may be required to fund
activities not included in the 1998-2002 forecast, such as the development of
additional independent power projects by HEIPC and its subsidiaries in Asia and
the Pacific, or to fund changes in requirements, such as increases in the amount
of or acceleration of capital expenditures of the electric utilities.
In February 1997, Hawaiian Electric Industries Capital Trust I, a grantor
trust, issued $100 million of its 8.36% Company-obligated preferred securities.
In March 1997, HECO Capital Trust I, a grantor trust, issued $50 million of its
8.05% cumulative quarterly income preferred securities. See Note 11 in the
"Notes to Consolidated Financial Statements" for further discussion.
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:
<TABLE>
<CAPTION>
December 31 1997 1996
- ------------------------------------------------------------------------------------------------
(in millions)
<S> <C> <C> <C> <C>
Short-term borrowings from nonaffiliates and affiliate.......... $ 96 6% $ 126 8%
Long-term debt.................................................. 628 39 602 38
HECO-obligated preferred securities of trust subsidiary......... 50 3 -- --
Preferred stock
Subject to mandatory redemption............................... 36 2 39 3
Not subject to mandatory redemption........................... 48 3 48 3
Common stock equity............................................. 769 47 751 48
- ------------------------------------------------------------------------------------------------
$1,627 100% $1,566 100%
================================================================================================
</TABLE>
In 1997, the electric utilities' investing activities used $113 million in cash,
primarily for capital expenditures. Financing activities used cash of $25
million, including cash for common and preferred stock dividends of $62 million
and a net decrease in short-term borrowings of $30 million, partly offset by a
net increase in long-term debt of $25 million and $50 million from the sale of
the HECO-obligated preferred securities of a trust subsidiary. Operating
activities provided $139 million toward the cash requirements of financing
activities and capital expenditures.
The electric utilities' consolidated financing requirements for 1998 through
2002, including net capital expenditures, long-term debt retirements and sinking
fund requirements, are estimated to total $644 million. HECO's consolidated
internal sources, after the payment of common stock and preferred stock
dividends, are expected to provide approximately 85% of the consolidated
financing requirements, with debt and equity financing providing the remaining
requirements. As of December 31, 1997, $54 million of proceeds from previous
sales by the Department of Budget and Finance of the State of Hawaii of special
purpose revenue bonds for the benefit of HECO, MECO and HELCO remain undrawn and
an additional $88 million of special purpose revenue bonds were authorized by
the Hawaii Legislature for issuance by the Department of Budget and Fi-
35
<PAGE>
nance of the State of Hawaii on behalf of HECO and MECO prior to the end of
1999. HECO estimates that it will require approximately $15 million in new
common equity, in addition to retained earnings, over the five-year period 1998
through 2002. The PUC must approve issuances of long-term securities by HECO,
HELCO and MECO.
Capital expenditures include the costs of projects which are required to meet
expected load growth, to improve reliability and to replace and upgrade existing
equipment. Net capital expenditures for the five-year period 1998 through 2002
are currently estimated to total $592 million. Approximately 72% of forecast
gross capital expenditures, which includes the allowance for funds used during
construction and capital expenditures funded by third-party cash contributions
in aid of construction, is for transmission and distribution projects, with the
remaining 28% primarily for generation projects. See Note 3 in the "Notes to
Consolidated Financial Statements" for a discussion of purchase commitments,
including commitments for fuel contracts, power purchase agreements and
construction projects.
For 1998, electric utility net capital expenditures are estimated to be $151
million. Gross capital expenditures are estimated to be $184 million, comprised
of approximately $121 million for transmission and distribution projects,
approximately $39 million for new generation projects and approximately $24
million for general plant and existing generation projects. Drawdowns of
proceeds from previous and future sales of tax-exempt special purpose revenue
bonds, sales of common stock to HEI and the generation of funds from internal
sources are expected to provide the cash needed for the net capital
expenditures.
Capital expenditure estimates and the timing of construction projects are
reviewed periodically by management and may change significantly as a result of
many considerations, including changes in economic conditions, changes in
forecasts of KWH sales and peak load, the availability of purchased power, the
availability of generating sites and transmission and distribution corridors,
the ability to obtain adequate and timely rate increases, escalation in
construction costs, DSM programs and requirements of environmental and other
regulatory and permitting authorities.
SAVINGS BANK
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31 1997 1996
- ---------------------------------------------------------------------------------------------------------
$ % change $ % change
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(in millions)
Assets.......................................................... $5,548 55 $3,591 5
Loans receivable, net........................................... 3,036 52 2,002 19
Mortgage-backed securities...................................... 1,865 39 1,340 (7)
Deposit liabilities............................................. 3,917 82 2,150 (3)
Securities sold under agreements to repurchase.................. 375 (22) 480 16
Advances from FHLB.............................................. 736 8 684 37
</TABLE>
As of December 31, 1997, ASB was the third largest financial institution in the
state based on total assets of $5.5 billion and based on deposits of $3.9
billion. In 1997, ASB's total assets increased primarily due to the acquisition
of most of BoA's Hawaii operations. The acquisition added $0.9 billion in loans
receivable and $1.7 billion in deposits. ASB also purchased $0.8 billion of
mortgage-backed securities in anticipation of and shortly after the acquisition.
At December 31, 1997, loans which do not accrue interest totaled $71.8
million or 2.4% of net loans outstanding, compared to $47 million or 2.3% at
December 31, 1996. At December 31, 1997, there were 30 properties acquired in
settlement of loans valued at $4.0 million.
For 1997, investing activities used cash of $76 million, due to the
origination and purchase of loans and mortgage-backed securities (excluding
those acquired from BoA), net of repayments, partly offset by cash received from
the assumption of deposit and other liabilities, net of purchase of loans
receivable and other assets, from BoA. Cash provided by financing activities in
1997 was $212 million, due primarily to an increase in deposit liabilities
(excluding those assumed from BoA) and issuances of common and preferred stock.
Minimum liquidity levels are currently governed by the regulations adopted by
the Office of Thrift Supervision (OTS). ASB was in compliance with OTS liquidity
requirements as of December 31, 1997.
ASB believes that a satisfactory regulatory capital position provides a basis
for public confidence, affords protection to depositors, helps to ensure
continued access to capital markets on favorable terms and provides a foundation
for growth. As of December 31, 1997, ASB was in compliance with the OTS minimum
capital requirements (noted in parentheses) with a tangible capital ratio of
5.0% (1.5%), a core capital ratio of 5.1% (3.0%) and a risk-based capital ratio
of 11.9% (8.0%).
FDIC regulations restrict the ability of financial institutions that are not
"well-capitalized" to offer interest rates on deposits that are significantly
higher than the rates offered by competing institutions. As of December 31,
1997, ASB was "well-capitalized" (ratio requirements noted in parentheses) with
a leverage ratio of 5.1% (5.0%), a Tier-1 risk-based ratio of 11.1% (6.0%) and a
total risk-based ratio of 11.9% (10.0%).
36
<PAGE>
Significant interstate banking legislation has been enacted at both the
federal and state levels. Under the federal Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994, a bank holding company may acquire control of
a bank in any state, subject to certain restrictions. Under Hawaii law,
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
apply only to banks, such legislation may nonetheless affect the competitive
balance among banks, thrifts and other financial institutions and the level of
competition among financial institutions doing business in Hawaii.
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 4 in the
"Notes to Consolidated Financial Statements."
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
The Company's success is largely dependent upon its, primarily ASB's, ability
to manage interest rate risk. Interest rate risk can be defined as the exposure
of the Company's earnings to adverse movements in interest rates. The Company
manages various market risks in the ordinary course of business, including
credit risk and liquidity risk. However, the Company considers interest rate
risk to be a very significant market risk as it could potentially have a
significant effect on the Company's financial condition and results of
operations. Because the Company does not have a portfolio of trading assets, the
Company is not exposed to market risk from trading activities. The Company does
not currently use derivatives to manage market and interest rate risk.
ASB's interest rate risk management is the responsibility of the
Asset/Liability Management Committee (ALMCO). ALMCO serves as the Senior
Investment Group charged with the responsibility of carrying out the overall
investment objectives and activities of ASB as approved by the ASB Board of
Directors. ALMCO establishes policies that monitor and coordinate ASB's sources,
uses and pricing of funds.
ASB continues to reduce the volatility of its net interest income by managing
the relationship of interest-sensitive assets to interest-sensitive liabilities.
To accomplish this, management has undertaken steps to increase the percentage
of variable rate assets, as a percentage of its total earning assets.
Residential real estate lending is and will continue to be a key component of
ASB's business. Residential lending demand in Hawaii has been primarily for
fixed rate products. Management has made significant purchases of adjustable-
rate mortgage-backed securities (MBS) to offset predominantly fixed rate loan
production. ASB's adjustable-rate MBS purchases are primarily tied to U.S.
treasury indices. The acquisition of most of BoA's Hawaii loans increased the
percentage of adjustable-rate residential loans in ASB's portfolio due to the
fact that 85% of the residential loans acquired were adjustable-rate loans.
The acquisition of most of BoA's Hawaii loans has accelerated ASB's progress
in building its portfolio of consumer and business banking loans which generally
earn higher rates of interest and have maturities shorter than residential real
estate loans. However, the origination of consumer and business banking loans
involves risks different from those associated with originating residential real
estate loans. For example, credit risk associated with consumer and business
banking loans is generally higher than for mortgage loans, the sources and level
of competition may be different and, compared to residential real estate
lending, consumer and business banking lending is a relatively new business for
ASB. These different risk factors are considered in the underwriting and pricing
standards established for consumer and business banking loans.
ASB's approach to managing interest rate risk includes the changing of
repricing terms and spreading of maturities on certificates of deposits and
other interest-costing liabilities. ASB manages the maturities of its borrowings
to balance changes in the demand for deposit maturities. ASB has emphasized the
need to attract core deposits, which ASB believes are a steady funding source
having less sensitivity to changes in market interest rates than other funding
sources. At December 31, 1997, core deposits comprised 54% of ASB's deposit
base. ASB has also taken advantage of the current "flat" yield curve to extend
the maturities of any FHLB advances made with minimal additional interest cost.
The table below provides contractual balances of ASB's on- and off-balance
sheet financial instruments in U.S. dollars at the expected maturity dates as
well as the estimated fair values of those on- and off-balance sheet financial
instruments as of December 31, 1997, and constitutes a "forward-looking
statement." The expected maturity categories take into consideration historical
prepayment speeds as well as actual amortization of principal and do not take
into consideration reinvestment of cash. Principal prepayments are the amounts
of principal reduction over and above normal amortization. Various prepayment
speeds ranging from 10-24% were used in computing the expected maturity of ASB's
interest-sensitive assets. The expected maturity categories for interest-
sensitive core deposits take into consideration historical attrition rates based
on core deposit studies. Core deposit attrition rates ranging from 14-32% were
used in expected maturity computations for core deposits. The weighted average
interest rates for the various assets and liabilities presented are as of
December 31, 1997.
See Note 21 in the "Notes to Consolidated Financial Statements" for
descriptions of the methods and assumptions used to estimate fair value of each
applicable class of financial instruments.
37
<PAGE>
<TABLE>
<CAPTION>
SAVINGS BANK
Expected maturity/principal repayment December 31, 1997
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
There- Estimated
(dollars in millions) 1998 1999 2000 2001 2002 after Total fair value
- -----------------------------------------------------------------------------------------------------------------------------------
INTEREST-SENSITIVE ASSETS
Mortgage loans and MBS
Adjustable rate $ 511 $ 385 $ 289 $ 217 $ 162 $ 457 $2,021 $2,052
Average interest rate 7.5%
Fixed rate - one-to-four family $ 256 $ 230 $ 206 $ 184 $ 165 $1,197 $2,238 $2,294
Average interest rate 7.3%
Fixed rate - multi-family and non-residential $ 38 $ 33 $ 30 $ 27 $ 24 $ 48 $ 200 $ 206
Average interest rate 8.7%
Consumer loans $ 81 $ 66 $ 55 $ 45 $ 37 $ 73 $ 357 $ 363
Average interest rate 9.7%
Commercial loans $ 34 $ 30 $ 21 -- -- -- $ 85 $ 81
Average interest rate 9.2%
Investment securities and interest-bearing
deposits $ 101 -- -- -- -- -- $ 101 $ 101
Average interest rate 5.6% 5.6%
INTEREST-SENSITIVE LIABILITIES
Passbook deposits $ 242 $ 128 $ 128 $ 92 $ 92 $ 475 $1,157 $1,157
Average interest rate 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
NOW and other demand deposits $ 125 $ 106 $ 105 $ 62 $ 61 $ 169 $ 628 $ 628
Average interest rate 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0%
Money market accounts $ 103 $ 79 $ 78 $ 28 $ 28 $ 32 $ 348 $ 348
Average interest rate 4.4% 4.4% 4.4% 4.4% 4.4% 4.4% 4.4%
Certificates of deposit $1,480 $ 176 $ 32 $ 13 $ 17 $ 66 $1,784 $1,780
Average interest rate 5.4% 5.6% 5.9% 5.9% 6.2% 5.5% 5.4%
FHLB advances $ 351 $ 67 $ 28 $ 65 $ 37 $ 188 $ 736 $ 745
Average interest rate 5.7% 5.6% 5.9% 7.0% 7.0% 7.3% 6.3%
Other borrowings $ 386 $ 386 $ 385
Average interest rate 5.7% 5.7%
INTEREST-SENSITIVE OFF-BALANCE SHEET ITEMS
Loans serviced for others $ 872 $ 21
Average interest rate 7.5%
Loan commitments and loans in process $ 55 $ 1
Average interest rate 7.5%
Unused consumer lines of credit $ 247 $ (4)
Average interest rate 11.8%
</TABLE>
38
<PAGE>
The Company's general policy is to manage other than savings bank interest rate
risk through use of a combination of short- and long-term debt and preferred
securities. The table below provides information about the Company's other than
savings bank market sensitive financial instruments in U.S. dollars, including
contractual balances at the expected maturity dates as well as the estimated
fair values as of December 31, 1997, and constitutes a "forward-looking
statement."
<TABLE>
<CAPTION>
OTHER THAN SAVINGS BANK
Expected maturity/principal repayment December 31, 1997
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
There- Estimated
(dollars in millions) 1998 1999 2000 2001 2002 after Total fair value
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST-SENSITIVE LIABILITIES
Short-term borrowings $ 298 -- -- -- -- -- $298 $298
Average interest rate 6.1% -- -- -- -- -- 6.1%
Long-term debt
Fixed rate $ 32 $ 7 $ 12 $ 24 $ 8 $677 $760 $793
Average interest rate 6.0% 7.5% 7.0% 8.5% 7.6% 6.5% 6.5%
Variable rate -- $ 35 -- $ 8 -- -- $ 43 $ 46
Average interest rate -- 6.3% -- 10.0% -- -- 7.0%
HEI- AND HECO- OBLIGATED PREFERRED SECURITIES OF
TRUST SUBSIDIARIES -- -- -- -- -- $150 $150 $155
Average distribution rate -- -- -- -- -- 8.3% 8.3%
PREFERRED STOCK OF ELECTRIC UTILITY SUBSIDIARIES
SUBJECT TO MANDATORY REDEMPTION $ 3 $ 2 $ 3 $ 3 $ 3 $ 22 $ 36 $ 38
Average dividend rate 8.7% 8.7% 8.6% 8.6% 8.6% 8.5% 8.6%
</TABLE>
FORWARD-LOOKING INFORMATION
This report and other presentations made by HEI and its subsidiaries contain
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934. Except for historical information contained herein, the
matters set forth are forward-looking statements that involve certain risks and
uncertainties that could cause actual results to differ materially from those in
the forward-looking statements. Potential risks and uncertainties include, but
are not limited to, such factors as the effect of international, national and
local economic conditions, including the condition of the Hawaii tourist and
construction industries and the Hawaii housing market; the effects of weather
and natural disasters; product demand and market acceptance risks; increasing
competition in the electric utility industry; capacity and supply constraints or
difficulties; new technological developments; governmental and regulatory
actions, including decisions in rate cases and on permitting issues; the results
of financing efforts; the timing and extent of changes in interest rates; and
the results of integration of the acquired BoA - Hawaii operations with the
operations of ASB. Investors are also directed to consider other risks and
uncertainties discussed in other periodic reports previously and subsequently
filed by HEI and/or HECO with the Securities and Exchange Commission.
39
<PAGE>
INDEPENDENT AUDITORS' REPORT
- --------------------------------------------------------------------------------
The Board of Directors and Stockholders
Hawaiian Electric Industries, Inc.:
We have audited the accompanying consolidated balance sheets of Hawaiian
Electric Industries, Inc. and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of income, retained earnings and cash flows
for each of the years in the three-year period ended December 31, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Hawaiian Electric
Industries, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997 in conformity with generally accepted
accounting principles.
/s/ KPMG Peat Marwick LLP
Honolulu, Hawaii
January 19, 1998
40
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME
- --------------------------------------------------------------------------------------------------------------------
Hawaiian Electric Industries, Inc. and subsidiaries
Years ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
<S> <C> <C> <C>
REVENUES
Electric utility........................................................... $1,107,523 $1,080,868 $ 988,722
Savings bank............................................................... 294,135 271,402 254,616
Other...................................................................... 62,321 58,302 52,586
- --------------------------------------------------------------------------------------------------------------------
1,463,979 1,410,572 1,295,924
- --------------------------------------------------------------------------------------------------------------------
EXPENSES
Electric utility........................................................... 935,770 907,255 829,679
Savings bank............................................................... 249,396 231,346 214,572
FDIC special assessment................................................. -- 13,835 --
Other...................................................................... 72,624 69,890 64,009
- --------------------------------------------------------------------------------------------------------------------
1,257,790 1,222,326 1,108,260
- --------------------------------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS)
Electric utility........................................................... 171,753 173,613 159,043
Savings bank............................................................... 44,739 26,221 40,044
Other...................................................................... (10,303) (11,588) (11,423)
- --------------------------------------------------------------------------------------------------------------------
206,189 188,246 187,664
- --------------------------------------------------------------------------------------------------------------------
Interest expense--electric utility and other............................... (64,607) (65,832) (62,860)
Allowance for borrowed funds used during construction...................... 6,190 5,862 5,112
Preferred stock dividends of electric utility subsidiaries................. (6,253) (6,529) (6,885)
Preferred securities distributions of trust subsidiaries................... (10,600) -- --
Allowance for equity funds used during construction........................ 10,864 11,741 10,202
- --------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES................................................. 141,783 133,488 133,233
Income taxes............................................................... 55,341 54,830 55,740
- --------------------------------------------------------------------------------------------------------------------
NET INCOME................................................................. $ 86,442 $ 78,658 $ 77,493
====================================================================================================================
BASIC EARNINGS PER COMMON SHARE............................................ $2.76 $2.60 $2.66
====================================================================================================================
DILUTED EARNINGS PER COMMON SHARE.......................................... $2.75 $2.59 $2.65
====================================================================================================================
DIVIDENDS PER COMMON SHARE................................................. $2.44 $2.41 $2.37
====================================================================================================================
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING....................... 31,375 30,310 29,187
====================================================================================================================
ADJUSTED WEIGHTED AVERAGE SHARES........................................... 31,470 30,388 29,248
====================================================================================================================
<CAPTION>
CONSOLIDATED STATEMENTS OF RETAINED EARNINGS
- --------------------------------------------------------------------------------------------------------------------
Hawaiian Electric Industries, Inc. and subsidiaries
Years ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
RETAINED EARNINGS, BEGINNING OF YEAR....................................... $ 149,907 $ 144,216 $ 135,835
Net income................................................................. 86,442 78,658 77,493
Common stock dividends..................................................... (76,487) (72,967) (69,112)
- --------------------------------------------------------------------------------------------------------------------
RETAINED EARNINGS, END OF YEAR............................................. $ 159,862 $ 149,907 $ 144,216
====================================================================================================================
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
41
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------------------------------------------
Hawaiian Electric Industries, Inc. and subsidiaries
December 31 1997 1996
- --------------------------------------------------------------------------------------------------------------------
(in thousands)
ASSETS
<S> <C> <C> <C> <C>
Cash and equivalents....................................... $ 254,356 $ 97,417
Accounts receivable and unbilled revenues, net............. 158,292 150,858
Inventories, at average cost............................... 45,412 48,745
Real estate developments................................... 30,143 33,210
Investment and mortgage-backed securities (estimated fair
value $1,983,657 and $1,367,328).......................... 1,971,886 1,377,591
Other investments.......................................... 73,769 72,609
Loans receivable, net...................................... 3,035,847 2,002,028
Property, plant and equipment, net
Land.................................................. $ 46,124 $ 39,790
Plant and equipment................................... 2,735,988 2,587,697
Construction in progress.............................. 212,205 204,335
--------- ---------
2,994,317 2,831,822
Less -- accumulated depreciation...................... (974,759) 2,019,558 (890,055) 1,941,767
--------- ---------
Regulatory assets.......................................... 104,079 100,804
Other...................................................... 138,048 73,776
Goodwill and other intangibles............................. 122,492 37,035
- --------------------------------------------------------------------------------------------------------------------
$7,953,882 $5,935,840
====================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Accounts payable........................................... $ 149,266 $ 107,896
Deposit liabilities........................................ 3,916,600 2,150,370
Short-term borrowings...................................... 298,016 216,543
Securities sold under agreements to repurchase............. 375,366 479,742
Advances from Federal Home Loan Bank....................... 736,474 684,274
Long-term debt............................................. 802,575 810,080
Deferred income taxes...................................... 186,241 185,609
Unamortized tax credits.................................... 49,904 48,857
Contributions in aid of construction....................... 197,596 197,805
Other...................................................... 193,100 194,564
- --------------------------------------------------------------------------------------------------------------------
6,905,138 5,075,740
- --------------------------------------------------------------------------------------------------------------------
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 --
Preferred stock of electric utility subsidiaries
Subject to mandatory redemption..................... 35,770 38,955
Not subject to mandatory redemption................. 48,293 48,293
- --------------------------------------------------------------------------------------------------------------------
234,063 87,248
- --------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Preferred stock, no par value, authorized 10,000 shares;
issued: none............................................. -- --
Common stock, no par value, authorized 100,000 shares;
issued and outstanding: 31,895 shares and 30,853 shares.. 654,819 622,945
Retained earnings.......................................... 159,862 149,907
- --------------------------------------------------------------------------------------------------------------------
814,681 772,852
- --------------------------------------------------------------------------------------------------------------------
$7,953,882 $5,935,840
====================================================================================================================
See accompanying "Notes to Consolidated Financial Statements."
</TABLE>
42
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------------------------------------------------
Hawaiian Electric Industries, Inc. and subsidiaries
Years ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income..................................................................... $ 86,442 $ 78,658 $ 77,493
Adjustments to reconcile net income to net cash provided by
operating activities
Depreciation and amortization of property, plant and equipment........... 91,505 82,320 76,656
Other amortization....................................................... 13,844 12,474 8,213
Deferred income taxes and tax credits, net............................... 156 6,142 12,660
Allowance for equity funds used during construction...................... (10,864) (11,741) (10,202)
Changes in assets and liabilities, net of effects from the acquisition
of Bank of America, FSB - Hawaii operations
Increase in accounts receivable and unbilled revenues, net......... (2,365) (8,353) (11,743)
Decrease (increase) in inventories................................. 3,333 (13,487) 7,868
Decrease in other securities held for trading...................... -- -- 49,505
Increase in regulatory assets...................................... (4,910) (418) (4,247)
Increase (decrease) in accounts payable............................ (13,628) 13,090 (2,404)
Changes in other assets and liabilities............................ (20,132) 4,732 8,806
- --------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES...................................... 143,381 163,417 212,605
- --------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Held-to-maturity mortgage-backed securities purchased.......................... (799,299) (208,857) (200,943)
Principal repayments on held-to-maturity mortgage-backed securities............ 272,662 309,384 183,702
Held-to-maturity investment securities purchased............................... (64,949) -- (39,458)
Proceeds from maturity of investment securities................................ -- -- 39,600
Loans receivable originated and purchased...................................... (310,903) (490,852) (427,518)
Principal repayments on loans receivable....................................... 146,685 169,160 145,522
Proceeds from sale of loans receivable......................................... 4,371 2,414 6,769
Capital expenditures........................................................... (147,304) (205,583) (194,623)
Contributions in aid of construction........................................... 7,089 9,674 10,417
Purchase of savings bank-owned life insurance.................................. (35,000) (5,000) --
Cash received from assumption of deposit and other liabilities,
net of purchase of loans receivable and other assets, from
Bank of America, FSB...................................................... 714,843 -- --
Other.......................................................................... 1,748 6,717 (4,962)
- --------------------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES.......................................... (210,057) (412,943) (481,494)
- --------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposit liabilities................................. 105,982 (73,385) 94,445
Net increase in short-term borrowings with original maturities of
three months or less..................................................... 82,469 36,374 46,531
Proceeds from other short-term borrowings...................................... 2,817 1,466 1,098
Repayment of other short-term borrowings....................................... (3,813) (3,122) (2,559)
Proceeds from securities sold under agreements to repurchase................... 1,557,000 714,100 557,000
Repurchase of securities sold under agreements to repurchase................... (1,660,600) (646,000) (269,339)
Proceeds from advances from Federal Home Loan Bank............................. 1,337,500 810,560 585,721
Principal payments on advances from Federal Home Loan Bank..................... (1,285,300) (627,560) (700,821)
Proceeds from issuance of long-term debt....................................... 74,233 124,886 78,544
Repayment of long-term debt.................................................... (81,900) (73,400) (38,400)
Proceeds from issuance of HEI- and HECO-obligated
preferred securities of trust subsidiaries............................... 150,000 -- --
Redemption of electric utility subsidiaries' preferred stock................... (3,185) (2,795) (3,094)
Net proceeds from issuance of common stock..................................... 22,994 19,818 19,322
Common stock dividends......................................................... (61,799) (55,288) (49,415)
Other.......................................................................... (12,783) (9,544) (6,934)
- --------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES...................................... 223,615 216,110 312,099
- --------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and equivalents................................ 156,939 (33,416) 43,210
Cash and equivalents, beginning of year........................................ 97,417 130,833 87,623
- --------------------------------------------------------------------------------------------------------------------------
CASH AND EQUIVALENTS, END OF YEAR.............................................. $ 254,356 $ 97,417 $130,833
==========================================================================================================================
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
43
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 . SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
GENERAL
- --------------------------------------------------------------------------------
Hawaiian Electric Industries, Inc. (HEI) is a holding company with subsidiaries
engaged in electric utility, savings bank, freight transportation, real estate
development and other businesses, primarily in the State of Hawaii, and also
engaged in the pursuit of independent power projects in Asia and the Pacific.
BASIS OF PRESENTATION. The consolidated financial statements have been prepared
in conformity with generally accepted accounting principles (GAAP). In preparing
the consolidated financial statements, management is required to make estimates
and assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities and the reported amounts of
revenues and expenses. Actual results could differ significantly from those
estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of regulatory assets, the allowance for loan losses,
the provision for impairment losses on real estate projects and the amounts
reported for pension and other postretirement benefit obligations.
CONSOLIDATION. The consolidated financial statements include the accounts of
HEI and its subsidiaries (collectively, the Company). All significant
intercompany accounts and transactions have been eliminated in consolidation.
PUBLIC UTILITIES COMMISSION REGULATION. The electric utility subsidiaries and
Young Brothers, Limited (YB) are regulated by the Public Utilities Commission of
the State of Hawaii (PUC) and account for the effects of regulation under
Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the
Effects of Certain Types of Regulation." As a result, the actions of regulators
can affect the timing of recognition of revenues, expenses, assets and
liabilities.
INVESTMENTS.
Debt and equity securities. Debt securities that the Company has the positive
intent and ability to hold to maturity are classified as held-to-maturity
securities and reported at amortized cost. Equity securities (with readily
determinable fair values) and debt securities that are bought and held
principally for the purpose of selling them in the near term are classified as
trading securities and reported at fair value, with unrealized gains and losses,
if any, included in earnings. Equity securities (with readily determinable fair
values) and debt securities not classified as either held-to-maturity securities
or trading securities are classified as available-for-sale securities and
reported at fair value, with unrealized gains and losses, if any, excluded from
earnings and reported in a separate component of stockholders' equity.
Other Investments. Investments in joint ventures and other investments for
which the Company has the ability to exercise significant influence over the
operating and financing policies of the enterprise are accounted for under the
equity method.
For held-to-maturity investments, available-for-sale investments and other
investments described above, declines in value determined to be other than
temporary are reflected in net income and result in the establishment of a new
cost basis for the investment. The specific identification method is used in
determining realized gains and losses on the sales of securities.
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment are stated at
cost. The cost of plant constructed by the electric utility subsidiaries
includes applicable engineering, supervision, administrative and general
expenses, and an allowance for the cost of funds used during the construction
period. Upon the ordinary retirement or sale of electric utility plant, no gain
or loss is recognized. The cost of the plant retired or sold and the cost of
removal (net of salvage obtained) are charged to accumulated depreciation.
POSTRETIREMENT BENEFITS. Pension costs are charged primarily to expense and
electric utility plant. The Company's policy is to fund pension costs in amounts
consistent with the requirements of the Employee Retirement Income Security Act
of 1974. Certain health care and/or life insurance benefits are provided to
eligible retired employees and the employees' beneficiaries and covered
dependents. In 1997, 1996 and 1995, these postretirement benefits were charged
primarily to expense and electric utility plant. See Note 17.
DEPRECIATION. Depreciation of plant and equipment is computed primarily using
the straight-line method over the estimated useful lives of the assets. Electric
utility plant has service lives ranging from 20 to 45 years for production
plant, from 25 to 50 years for transmission and distribution plant and from 8 to
45 years for general plant. The electric utility subsidiaries' composite annual
depreciation rate was 3.9% in 1997 and 3.8% in 1996 and 1995.
44
<PAGE>
ENVIRONMENTAL EXPENDITURES. The Company is subject to numerous federal and state
statutes and governmental regulations pertaining to water quality, air quality
and other environmental factors. In general, environmental contamination
treatment costs are charged to expense, unless it is probable such costs will be
recovered through rates authorized by the PUC. Also, environmental costs are
capitalized if: the costs extend the life, increase the capacity, or improve the
safety or efficiency of property owned; the costs mitigate or prevent
environmental contamination that has yet to occur and that otherwise may result
from future operations; or the costs are incurred in preparing the property for
sale. Liabilities are recorded when environmental assessments and/or remedial
efforts are probable, and the cost can be reasonably estimated. Corresponding
regulatory assets are recorded when it is probable that such costs would be
allowed by the PUC as reasonable and necessary costs of service to be recovered
in future rates.
In October 1996, the American Institute of Certified Public Accountants issued
Statement of Position (SOP) 96-1, "Environmental Remediation Liabilities." The
provisions of the SOP are consistent with the Company's current policies and,
accordingly, adoption of the SOP on January 1, 1997 did not have a material
effect on the Company's financial condition, results of operations or liquidity.
INCOME TAXES. Deferred income tax assets and liabilities are established for the
temporary differences between the financial reporting basis and the tax basis of
the Company's assets and liabilities at enacted tax rates expected to be in
effect when such deferred tax assets or liabilities are realized or settled.
Generally, federal and state tax credits are deferred and amortized over the
estimated useful lives of the properties which qualified for the credits.
CASH FLOWS. The Company considers cash on hand, deposits in banks, deposits
with the Federal Home Loan Bank (FHLB) of Seattle, money market accounts,
certificates of deposit, short-term commercial paper and reverse repurchase
agreements with original maturities of three months or less to be cash and
equivalents.
ACCOUNTING CHANGES.
Transfers and servicing of financial assets and extinguishments of liabilities.
In June 1996, the Financial Accounting Standards Board (FASB) issued SFAS No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," which provides consistent standards for
distinguishing between transfers of financial assets that are sales and
transfers that are secured borrowings. The Company adopted the provisions of
SFAS No. 125 on January 1, 1997. The adoption of SFAS No. 125 did not have a
material effect on the Company's financial condition, results of operations or
liquidity.
Earnings per share. In February 1997, the FASB issued 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
securities 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. SFAS No. 130 is effective for fiscal years beginning after
December 15, 1997. The Company will adopt the provisions of SFAS No. 130 in the
first quarter of 1998. SFAS No. 130 requires reclassification of financial
statements for earlier periods provided for comparative purposes. The adoption
of SFAS No. 130 is not expected to have a material effect on the Company's
reported financial information.
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. SFAS No.
131 is effective for periods beginning after December 15, 1997. The Company will
adopt the provisions of SFAS No. 131 in the first quarter of 1998. SFAS No. 131
requires restatement of comparative information presented for earlier periods.
The adoption of SFAS No. 131 is not expected to have a material effect on the
Company's reported financial information.
ELECTRIC UTILITY
- --------------------------------------------------------------------------------
CONTRIBUTIONS IN AID OF CONSTRUCTION. The electric utility subsidiaries receive
contributions from customers for special construction requirements. As directed
by the PUC, the contributions are amortized on a straight-line basis over 30
years, which approximates the estimated useful lives of the facilities for which
the contributions were received. This amortization is an offset against
depreciation expense.
45
<PAGE>
ELECTRIC UTILITY REVENUES. Electric utility revenues are based on rates
authorized by the PUC and include revenues applicable to electric energy
consumed in the accounting period but not yet billed to the customers. Revenue
amounts recorded under PUC approved interim rate adjustments are subject to
refund, with interest, pending final authorization by the PUC.
The rate schedules of the electric utility subsidiaries include energy cost
adjustment clauses under which electric rates are adjusted for changes in the
weighted average price paid for fuel oil and certain components of purchased
power, and the relative amounts of company-generated power and purchased power.
ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION. Allowance for funds used during
construction (AFUDC) is an accounting practice whereby the costs of debt and
equity funds used to finance plant construction are transferred from the income
statement to construction in progress on the balance sheet. This procedure
removes the effect of the costs of financing construction activity from the
income statement and treats such costs in the same manner as construction labor
and material costs.
The weighted average gross-of-tax AFUDC rate was 9.0% in 1997, 9.2% in 1996
and 9.4% in 1995, and reflected quarterly compounding.
SAVINGS BANK
- --------------------------------------------------------------------------------
LOANS RECEIVABLE. Loans receivable are stated at cost less an allowance for
loan losses, loan origination and commitment fees and purchase premiums and
discounts. Interest on loans is credited to income as it is earned.
Any discount on loans is accreted or premium amortized over the estimated life
of the loan using the level-yield method.
ALLOWANCE FOR LOAN LOSSES. Considering current information and events
regarding the borrowers' ability to repay their obligations, American Savings
Bank, F.S.B. (ASB) deems a loan impaired when it is probable that ASB will be
unable to collect all amounts due according to the contractual terms of the loan
agreement. When a loan is deemed impaired, the amount of the impairment is
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate or, if the loan is considered to be
collateral dependent, based on the fair value of the collateral. Impairment
losses are included in the allowance for loan losses through a charge to the
provision for loan losses.
For the remaining loans receivable portfolio (smaller-balance homogeneous
loans), ASB provides valuation allowances for estimated losses on loans
receivable. Several factors are collectively weighed in determining the adequacy
of the valuation allowance, including management's review of the existing risks
in the loan portfolio, prevailing economic conditions and the historical loss
experience. Actual losses could differ materially from estimates as of December
31, 1997.
ASB uses either the cash or cost-recovery method to record cash receipts on
impaired loans that are not accruing interest. For smaller-balance homogeneous
loans, ASB generally ceases the accrual of interest on a loan that is more than
90 days past due or when there is reasonable doubt as to the loan's
collectibility. Subsequent recognition of interest income for such loans is
generally on the cash method.
REAL ESTATE ACQUIRED IN SETTLEMENT OF LOANS. Real estate acquired in settlement
of loans is recorded at the lower of cost or fair value less estimated selling
expenses.
LOAN ORIGINATION AND COMMITMENT FEES. Loan origination fees (net of direct loan
origination costs) are deferred and recognized as an adjustment of yield over
the life of the loan. Nonrefundable commitment fees (net of direct loan
origination costs, if applicable) for commitments to originate or purchase loans
are deferred and, if the commitment is exercised, recognized as an adjustment of
yield over the life of the loan. If the commitment expires unexercised,
nonrefundable commitment fees are recognized as income upon expiration of the
commitment.
AMORTIZATION OF GOODWILL AND CORE DEPOSIT INTANGIBLES. Goodwill is being
amortized on a straight-line basis over 25 years. Core deposit intangibles are
being amortized each year at the greater of the actual attrition rate of such
deposit base or 10% of the original value. Management evaluates whether later
events or changes in circumstances indicate the remaining estimated useful life
of an intangible asset may warrant revision or that the remaining balance of an
intangible asset may not be recoverable. When factors indicate that an
intangible asset should be evaluated for possible impairment, management will
use an estimate of undiscounted future cash flows over the remaining useful life
of the asset in measuring whether the intangible asset is recoverable.
2 . SEGMENT FINANCIAL INFORMATION
- --------------------------------------------------------------------------------
Segment financial information on page 26 is incorporated herein by reference.
46
<PAGE>
3 . ELECTRIC UTILITY SUBSIDIARY
- -------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and subsidiaries
Selected consolidated financial information
INCOME STATEMENT DATA
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
REVENUES
Operating revenues................................................. $1,098,755 $1,071,426 $981,990
Other--nonregulated................................................ 8,768 9,442 6,732
- ------------------------------------------------------------------------------------------------------------
1,107,523 1,080,868 988,722
- ------------------------------------------------------------------------------------------------------------
EXPENSES
Fuel oil........................................................... 257,002 250,544 207,001
Purchased power.................................................... 292,852 286,077 276,364
Other operation.................................................... 148,959 142,699 137,349
Maintenance........................................................ 49,858 52,305 47,225
Depreciation and amortization...................................... 82,017 73,453 67,649
Taxes, other than income taxes..................................... 104,232 101,387 92,961
Other--nonregulated................................................ 850 790 1,130
- ------------------------------------------------------------------------------------------------------------
935,770 907,255 829,679
- ------------------------------------------------------------------------------------------------------------
Operating income from regulated and nonregulated activities........ 171,753 173,613 159,043
Allowance for equity funds used during construction................ 10,864 11,741 10,202
Interest and other charges......................................... (54,423) (50,115) (47,136)
Allowance for borrowed funds used during construction.............. 6,190 5,862 5,112
- ------------------------------------------------------------------------------------------------------------
Income before income taxes and preferred stock dividends of HECO... 134,384 141,101 127,221
Income taxes....................................................... 52,535 55,888 50,198
- ------------------------------------------------------------------------------------------------------------
Income before preferred stock dividends of HECO.................... 81,849 85,213 77,023
Preferred stock dividends of HECO.................................. 3,660 3,865 4,126
- ------------------------------------------------------------------------------------------------------------
Net income for common stock........................................ $ 78,189 $ 81,348 $ 72,897
============================================================================================================
</TABLE>
47
<PAGE>
BALANCE SHEET DATA
<TABLE>
<CAPTION>
December 31 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C>
ASSETS
Utility plant, at cost
Property, plant and equipment.................................................... $2,592,439 $2,476,584
Less accumulated depreciation.................................................... (904,781) (828,917)
Construction in progress......................................................... 205,447 197,835
- -----------------------------------------------------------------------------------------------------------------------------
Net utility plant................................................................... 1,893,105 1,845,502
Accounts receivable, net............................................................ 73,573 80,757
Unbilled revenues, net.............................................................. 45,980 43,726
Regulatory assets................................................................... 101,809 98,380
Other............................................................................... 97,847 97,181
- -----------------------------------------------------------------------------------------------------------------------------
$2,212,314 $2,165,546
=============================================================================================================================
CAPITALIZATION AND LIABILITIES
Common stock equity................................................................. $ 769,235 $ 751,311
Cumulative preferred stock
Not subject to mandatory redemption, dividend rates of 4.25-8.875%................. 48,293 48,293
Subject to mandatory redemption, dividend rates of 7.68-13.75%..................... 35,770 38,955
HECO-obligated mandatorily redeemable preferred securities of
trust subsidiary holding solely HECO and HECO-guaranteed
subordinated debentures......................................................... 50,000 --
Long-term debt...................................................................... 627,621 602,226
- -----------------------------------------------------------------------------------------------------------------------------
Total capitalization................................................................ 1,530,919 1,440,785
Short-term borrowings from nonaffiliates and affiliate.............................. 95,581 125,920
Deferred income taxes............................................................... 125,509 119,613
Unamortized tax credits............................................................. 48,675 47,634
Contributions in aid of construction................................................ 197,596 197,805
Other............................................................................... 214,034 233,789
- -----------------------------------------------------------------------------------------------------------------------------
$2,212,314 $2,165,546
=============================================================================================================================
</TABLE>
CUMULATIVE PREFERRED STOCK. Certain cumulative preferred shares of Hawaiian
Electric Company, Inc. (HECO) and its subsidiaries are redeemable at the option
of the respective company at a premium or par. The remaining cumulative
preferred shares are subject to mandatory sinking fund provisions at par and
optional redemption provisions at a premium. The total sinking fund requirements
on preferred stock subject to mandatory redemption for 1998 through 2002 are $3
million in 1998, $2 million in 1999 and $3 million in each of the years 2000,
2001 and 2002.
MAJOR CUSTOMERS. The electric utility subsidiaries derive approximately 10% of
their operating revenues from the sale of electricity to various federal
government agencies. These revenues amounted to $110 million in 1997, $108
million in 1996 and $97 million in 1995.
COMMITMENTS AND CONTINGENCIES.
Fuel contracts and other purchase commitments. HECO and its subsidiaries have
contractual agreements to purchase minimum amounts of 0.5% sulfur residual fuel
oil (at prices tied to the market prices of petroleum products in Singapore) and
2.0% sulfur residual fuel oil and 0.4% sulfur diesel fuel (at prices tied to the
market prices of petroleum products in Los Angeles) through 2004. Based on the
average price per barrel prevailing as of January 1, 1998, the estimated amount
of minimum purchases under the fuel supply contracts for 1998 is $201 million.
The actual amount of purchases in 1998 could vary substantially from this
estimate as a result of changes in market prices, quantities actually purchased
and other factors. HECO and its subsidiaries purchased $248 million, $261
million and $194 million of fuel under prior contractual agreements in 1997,
1996 and 1995, respectively.
At December 31, 1997, HECO and its subsidiaries had purchase commitments,
other than fuel and power purchase contracts, amounting to approximately $45
million.
48
<PAGE>
Power purchase agreements. At December 31, 1997, HECO and its subsidiaries had
power purchase agreements for 474 megawatts (MW) of firm capacity, representing
approximately 22% of the total of their generating capabilities and purchased
power firm capacities. Rate recovery is allowed for energy and firm capacity
payments under these agreements. Assuming that each of the agreements remains in
place and the minimum availability criteria in the power purchase agreements are
met, aggregate minimum fixed capacity charges are expected to be approximately
$110 million in 1998 and 1999, $103 million each in 2000 and 2001, $100 million
in 2002 and a total of $1.8 billion in 2003 through 2028.
In general, payments under the power purchase agreements for 474 MW of firm
capacity are based upon available capacity and energy. Payments for capacity
generally are not required if the contracted capacity is not available, and
payments are reduced, under certain conditions, if available capacity drops
below contracted levels. In general, the payment rates for capacity have been
predetermined for the terms of the agreements. The energy payment will vary over
the terms of the agreements and HECO and its subsidiaries may pass on changes in
the fuel component of the energy charges to customers through the energy cost
adjustment clause in their rate schedules. HECO and its subsidiaries do not
operate nor participate in the operation of any of the facilities that provide
power under the agreements. Title to the facilities does not pass to HECO nor
its subsidiaries upon expiration of the agreements, and the agreements do not
contain bargain purchase options with respect to the facilities.
Interim rate increases. At December 31, 1997, there were no revenue amounts
recognized under interim rate increases and subject to refund.
PUC SHOW CAUSE ORDER FOR HECO. In March 1997, the PUC issued a show cause order
to HECO requesting information to assist the PUC in determining if it should
reduce HECO's rates and require HECO to refund any excess earnings to its
ratepayers. The PUC noted that for 1996 HECO recorded a return on average common
equity (ROACE) of 11.93% and a simple average rate of return on rate base (ROR)
of 9.70%, which exceeded the 11.40% ROACE and 9.16% ROR determined to be
reasonable by the PUC in the utility's last rate case. The amount of 1996 net
income represented by the difference between the two RORs of 9.70% and 9.16% was
less than $4.5 million.
In April 1997, HECO filed its response to the PUC's order. HECO indicated the
reported ROR for 1996 was higher than the return used to determine the 1995 test
year revenue requirements primarily due to the impact in 1996 of higher
kilowatthour sales because of normal expected sales growth, increased military
sales and warmer than normal weather. Among other things, HECO explained that
the weighted average cost of capital in 1997 should be higher than the 9.16%
found to be reasonable in HECO's 1995 test year rate case, because a higher
ROACE is appropriate under 1997 market conditions. HECO also pointed out that it
is not compensated in those years when its actual results fall below returns
that were found to be reasonable in the most recent rate case. This point was
subsequently demonstrated when, for 1997, HECO reported a ROACE of 10.26% and a
ROR of 8.75%, both below the returns found to be reasonable in HECO's last rate
case. Management cannot predict what future PUC action may be taken in this
proceeding.
HECO power outage. On April 9, 1991, HECO experienced a power outage that
affected all customers on the island of Oahu. The PUC initiated an
investigation of the April 9, 1991 outage, which was consolidated with a pending
investigation of an outage that occurred in 1988. Power Technologies, Inc., an
independent consultant hired by HECO with the approval of the PUC, investigated
the 1991 outage. HECO is implementing certain of Power Technologies, Inc.'s
recommendations and provides the PUC with summaries of its progress on those
recommendations. Management cannot predict the timing and outcome of any PUC D&O
that may be issued, if any, with respect to the outages.
HELCO power situation.
Background. In 1991, Hawaii Electric Light Company, Inc. (HELCO) proceeded with
- ----------
plans to install at its Keahole power plant site two 20-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 PUC approved expenditures for CT-4, which HELCO had planned
to install in late 1994.
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) an air quality
Prevention of Significant Deterioration/Covered Source permit (PSD permit) for
the Keahole power plant site.
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. Opposing parties filed a Notice
of Appeal of the final judgment in one set of the civil cases and have filed a
motion to stay the project pending resolution of the appeal. Upon entry of the
final judgments in other civil cases, it is anticipated that further appeals
will be filed. Management believes that HELCO will ultimately prevail with
regard to any appeals which may be taken and that the amended decision of the
Third Circuit Court will be upheld.
49
<PAGE>
PSD permit. In November 1995, the EPA declined to sign HELCO's PSD permit for
- ----------
the combined-cycle unit. In October 1997, the EPA approved a revised draft
permit and the DOH issued a final PSD permit. Nine appeals from the issuance of
the permit have been filed with the Environmental Appeals Board of the EPA.
Based on the proceedings to date, management believes that HELCO will ultimately
prevail in the appeals.
Declaratory judgment action. 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.
HELCO intends to vigorously defend against the claims raised and management
believes the allegations are without merit.
IPP complaints. Two independent power producers (IPPs), Kawaihae Cogeneration
- --------------
Partners (KCP) and Enserch Development Corporation (Enserch), filed separate
complaints against HELCO with the PUC in 1993 and 1994, respectively, alleging
that they are entitled to power purchase contracts to provide HELCO with
additional capacity which they claim would be a substitute for HELCO's planned
56-MW combined-cycle unit at Keahole. Under HELCO's current estimate of
generating capacity requirements, there is a near term need for capacity in
addition to the capacity which might be provided by either of the proposed IPP
units.
In September 1995, the PUC allowed HELCO to continue to pursue construction of
and commit expenditures for the second combustion turbine (CT-5) and the steam
recovery generator (ST-7) for its planned combined-cycle unit, stating in its
order that "no part of the project may be included in 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
IPPs') should be the one that can be most expeditiously put into service at
"allowable cost."
In April 1997, Hilo Coast Processing Company (HCPC) filed a complaint against
HELCO with the PUC, requesting an immediate hearing on HCPC's offer for a new
20-year power purchase contract for its existing facility, which is proposed to
be expanded from 22 MW to 32 MW. HCPC's existing power purchase agreement is
scheduled to terminate at the end of 1999.
Enserch complaint. In January 1998, HELCO filed with the PUC an application
-----------------
for approval of a power purchase agreement and an interconnection agreement
with Encogen, Hawaii, L. P. (an Enserch affiliate) dated October 22, 1997.
The agreements are subject to final, nonappealable approval by the PUC.
Enserch, KCP, HCPC and one other IPP have filed motions to intervene in
that docket.
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, and 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 and briefs were filed by both
parties. Action by the PUC is pending.
HCPC complaint. The PUC converted the HCPC complaint to a purchased power
--------------
contract negotiation proceeding. An evidentiary hearing is scheduled for
April 1998.
Management cannot determine at this time 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.
Costs incurred. As of December 31, 1997, HELCO's costs incurred in its efforts
- --------------
to put into service its Keahole combined-cycle unit amounted to $55.1 million,
including approximately $26.8 million for equipment and material purchases,
approximately $11.6 million for planning, engineering, permitting, site
development and other costs and approximately $16.7 million as an allowance for
funds used during construction.
Contingency planning. In June 1995, HELCO filed with the PUC its generation
- --------------------
resource contingency plan detailing alternatives and mitigation measures to
address possible further delays in obtaining the permits necessary to construct
its combined-cycle unit. 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 update
reports with the PUC on the contingency plan and its implementation.
ENVIRONMENTAL REGULATION. See Note 22, "Contingencies."
MANAGEMENT SERVICES AND OTHER FEES. HEI's charges to HECO and its subsidiaries
for general management and administrative services totaled $2.2 million, $2.3
million and $2.5 million in 1997, 1996 and 1995, respectively. HEI's charges to
HECO for data processing services totaled $1.9 million, $3.1 million and $3.5
million in 1997, 1996 and 1995, respectively.
50
<PAGE>
4 . SAVINGS BANK SUBSIDIARY
- --------------------------------------------------------------------------------
American Savings Bank, F.S.B. and subsidiaries
Selected consolidated financial information
INCOME STATEMENT DATA
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Interest income............................................................ $277,618 $255,714 $236,694
Interest expense........................................................... 164,662 153,664 142,705
- --------------------------------------------------------------------------------------------------------------
Net interest income........................................................ 112,956 102,050 93,989
Provision for loan losses.................................................. (6,934) (7,631) (4,887)
Other income............................................................... 16,517 15,688 17,922
Operating, administrative and general expenses............................. (77,800) (83,886) (66,980)
- --------------------------------------------------------------------------------------------------------------
Operating income........................................................... 44,739 26,221 40,044
Income taxes............................................................... 18,016 11,253 16,765
- --------------------------------------------------------------------------------------------------------------
Income before preferred stock dividends.................................... 26,723 14,968 23,279
Preferred stock dividends.................................................. (390) -- --
- --------------------------------------------------------------------------------------------------------------
Net income................................................................. $ 26,333 $ 14,968 $ 23,279
==============================================================================================================
</TABLE>
BALANCE SHEET DATA
<TABLE>
<CAPTION>
December 31 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------
(in thousands)
ASSETS
<S> <C> <C>
Cash and equivalents................................................................ $ 249,607 $ 93,905
Held-to-maturity investment securities.............................................. 105,596 37,518
Held-to-maturity mortgage-backed securities......................................... 1,865,027 1,340,073
Loans receivable, net............................................................... 3,035,847 2,002,028
Other............................................................................... 169,843 80,128
Goodwill and other intangibles...................................................... 122,492 37,035
- ----------------------------------------------------------------------------------------------------------------------------
$5,548,412 $3,590,687
============================================================================================================================
LIABILITIES AND EQUITY
Deposit liabilities................................................................. $3,916,600 $2,150,370
Securities sold under agreements to repurchase...................................... 375,366 479,742
Advances from Federal Home Loan Bank................................................ 736,474 684,274
Other............................................................................... 124,185 54,251
- ----------------------------------------------------------------------------------------------------------------------------
5,152,625 3,368,637
Preferred stock held by parent...................................................... 75,000 --
Common stock equity................................................................. 320,787 222,050
- ----------------------------------------------------------------------------------------------------------------------------
$5,548,412 $3,590,687
============================================================================================================================
</TABLE>
51
<PAGE>
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. The transaction was accounted for using the purchase
method of accounting. 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, subject to post-closing adjustments, comprised of $1.7 billion
estimated fair value of liabilities assumed and $0.1 billion premium paid on
certain transferred deposit liabilities (at 7%). 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. The
estimated fair value of deposit and other liabilities assumed amounted to $1.7
billion. The excess of the purchase price over the estimated fair value of the
identifiable net assets acquired of $69 million was recorded as goodwill and is
being amortized over 25 years using the straight-line method of amortization.
The core deposit premium arising from this transaction amounted to approximately
$20 million, was recorded as an other intangible, and is being amortized
annually at the greater of the actual attrition rate of the acquired core
deposits or 10% of the original premium amount.
The following unaudited pro forma financial information for the years ended
December 31, 1997 and 1996 assumes the transaction occurred on January 1, 1997
and 1996, respectively, after giving effect to purchase accounting adjustments
and related income tax effects:
<TABLE>
<CAPTION>
Years ended December 31 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
HEI Consolidated ASB Consolidated HEI Consolidated ASB Consolidated
(unaudited)
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(in thousands,
except per share amounts)
Revenues........................... $1,547,081 $377,237 $1,500,114 $360,944
Net income (loss).................. 66,088 6,135 60,540 (2,914)
Earnings per common share:
Basic............................. 2.11 na 2.00 na
Diluted........................... 2.10 na 1.99 na
na Not applicable.
</TABLE>
Management does not believe that the pro forma financial information is
indicative of HEI's or ASB's future results of operations or the results of
operations which would have been obtained had the acquisition been consummated
on January 1, 1997 or 1996. Among other things, the pro forma financial
information does not include estimated earnings on the $0.7 billion of net cash
received from BoA, most of which was invested in interest-bearing assets, nor
the reduction which management expects to achieve in the BoA expenses of its
former operations.
DEPOSIT-INSURANCE PREMIUMS AND REGULATORY DEVELOPMENTS. The deposit accounts of
ASB and other thrifts are insured by the Savings Association Insurance Fund
(SAIF). The deposit accounts of commercial banks are insured by the Bank
Insurance Fund (BIF). The SAIF and BIF are administered by the Federal Deposit
Insurance Corporation (FDIC).
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 an amount sufficient to increase the SAIF
reserve ratio to 1.25% of aggregate insured deposits as of October 1, 1996. In
addition, effective January 1, 1997, the Funds Act provided that the assessment
base for raising funds to pay interest on obligations issued by the Financing
Corporation (FICO) is to be expanded to include the deposits of banks as well as
thrifts. The provisions of the Funds Act should enable SAIF institutions to
achieve, over time, parity with BIF institutions in the schedules of the
premiums to be paid for deposit insurance coverage and to fund FICO interest
obligations.
In October 1996, the FDIC set the one-time special assessment for SAIF
deposits at 65.7 cents per $100 of deposits, to be applied against insured
deposits held by SAIF institutions as of March 31, 1995. ASB's special
assessment was $8.3 million after tax, and was accrued in September 1996. In
December 1996, the FDIC adopted a risk-based assessment schedule for SAIF
institutions, effective January 1, 1997, that was identical to the existing base
rate schedule for BIF institutions: zero to 27 cents per $100 of deposits.
Added to this base rate schedule through 1999 will be the assessment to fund
FICO's interest obligations of 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 a currently estimated rate of 2.4 cents per $100 of deposits.
52
<PAGE>
As a "well-capitalized" thrift, ASB's base deposit insurance premium effective
January 1, 1997 is zero and its assessment for funding FICO interest payments is
6.48 cents per $100 of deposits, compared to its payments through the third
quarter of 1996 calculated at 23 cents per $100 of deposits.
The Funds Act provides that the SAIF and BIF will be merged into the Deposit
Insurance Fund by January 1, 1999, but only if no insured depository institution
is a thrift on that date. The Funds Act leaves to subsequent legislation,
however, the manner in which thrift charters might be eliminated in favor of a
bank or some other form of charter. Certain of the legislative proposals
advanced to address this issue, if adopted, could have a material adverse effect
on the Company. For example, if thrift charters are eliminated and ASB obtains a
bank charter, HEI and its subsidiaries might become subject 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.
INVESTMENT AND MORTGAGE-BACKED SECURITIES. The carrying value and estimated
fair value of investment and mortgage-backed securities were summarized as
follows:
<TABLE>
<CAPTION>
December 31 1997 1996
- --------------------------------------------------------------------------------------------------------------------------------
Gross Gross Estimated Gross Gross Estimated
Carrying unrealized unrealized fair Carrying unrealized unrealized fair
value gains losses value value gains losses value
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(in thousands)
Investment
securities:
Stock in FHLB
of Seattle..... $ 63,528 $ -- $ -- $ 63,528 $ 37,518 $ -- $ -- $ 37,518
U.S. Treasury.. 42,068 -- (9) 42,059 -- -- -- --
- --------------------------------------------------------------------------------------------------------------------------------
105,596 -- (9) 105,587 37,518 -- -- 37,518
- --------------------------------------------------------------------------------------------------------------------------------
Mortgage-backed
securities:
Private issue.. 593,433 3,966 (3,017) 594,382 605,477 4,004 (5,320) 604,161
FHLMC.......... 222,442 2,000 (77) 224,365 134,720 920 (476) 135,164
GNMA........... 344,006 3,255 (503) 346,758 64,732 990 (1,201) 64,521
FNMA........... 705,146 9,414 (3,258) 711,302 535,144 3,028 (12,208) 525,964
- --------------------------------------------------------------------------------------------------------------------------------
1,865,027 18,635 (6,855) 1,876,807 1,340,073 8,942 (19,205) 1,329,810
- --------------------------------------------------------------------------------------------------------------------------------
$1,970,623 $18,635 $(6,864) $1,982,394 $1,377,591 $8,942 $(19,205) $1,367,328
================================================================================================================================
</TABLE>
ASB has private-issue mortgage-backed securities and mortgage-backed securities
purchased from the Federal Home Loan Mortgage Corporation (FHLMC), Government
National Mortgage Association (GNMA) and Federal National Mortgage Association
(FNMA). All such mortgage-backed securities as of December 31, 1997 are
classified as held-to-maturity securities.
Contractual maturities are not presented for ASB's mortgage-backed
securities held for investment because these securities are not due at a single
maturity date.
The weighted average interest rate for mortgage-backed securities at December
31, 1997 and 1996 was 6.77% and 6.98%, respectively.
Mortgage-backed securities with a carrying value of approximately $1.5 billion
and $0.8 billion at December 31, 1997 and 1996, respectively, were pledged as
collateral to secure public funds, deposits with the Federal Reserve Bank of San
Francisco and advances from the FHLB of Seattle. At December 31, 1997 and 1996,
mortgage-backed securities sold under agreements to repurchase had a carrying
value of $407 million and $523 million, respectively.
ASB did not sell mortgage-backed securities or other securities held for
investment in 1997, 1996 or 1995.
In November 1995, the FASB issued a special report, "A Guide to Implementation
of Statement 115 on Accounting for Certain Investments in Debt and Equity
Securities." In connection with the guidance provided in the special report, the
FASB indicated that an enterprise may reassess the appropriateness of the
classifications of all securities held at that time and account for any
resulting reclassifications at fair value in accordance with the requirements of
SFAS No. 115. Such reclassifications were required to occur no later than
December 31, 1995. The guidance indicated that reclassifications from the held-
to-maturity category that resulted from this one-time reassessment would not
call into question the intent of an enterprise to hold other debt securities to
maturity in the future. In accordance with the implementation guidance provided
in the special report, ASB transferred approximately $50 million of mortgage-
backed securities previously classified as held-to-maturity securities to
trading account securities on November 28, 1995.
In 1997 and 1996, there were no proceeds from the sale of trading account
securities. In 1995, proceeds from the sale of trading account securities
(transferred from mortgage-backed securities classified as held-to-maturity)
were approximately $53 million, resulting in a net gain of $3.9 million.
53
<PAGE>
LOANS RECEIVABLE. Loans receivable consisted of the following:
<TABLE>
<CAPTION>
December 31 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Real estate loans
Conventional....................................................................... $2,631,298 $1,800,365
Construction and development....................................................... 32,569 29,964
- -----------------------------------------------------------------------------------------------------------------------------
2,663,867 1,830,329
Loans secured by savings deposits................................................... 17,473 15,441
Consumer loans...................................................................... 342,146 192,315
Commercial loans.................................................................... 88,315 18,548
- -----------------------------------------------------------------------------------------------------------------------------
3,111,801 2,056,633
Undisbursed portion of loans in process............................................. (29,935) (17,618)
Deferred fees and discounts, including net purchase accounting discounts............ (16,069) (17,782)
Allowance for loan losses........................................................... (29,950) (19,205)
- -----------------------------------------------------------------------------------------------------------------------------
$3,035,847 $2,002,028
=============================================================================================================================
</TABLE>
At December 31, 1997 and 1996, the weighted average interest rate for loans
receivable was 8.19% and 8.10%, respectively.
At December 31, 1997, loans with an amortized cost of approximately $122
million were pledged as collateral to secure advances from the FHLB of Seattle.
At December 31, 1997, impaired loans were $41 million and consisted of $30
million of income property loans and $11 million of residential real estate
loans for properties of one to four units. At December 31, 1996, impaired loans
were $33 million and consisted of $20 million of income property loans and $13
million of residential real estate loans for properties of one to four units.
The average balances of impaired loans during 1997 and 1996 were $38 million and
$20 million, respectively. At December 31, 1997 and 1996, the allowance for loan
losses for impaired loans was $7.1 million and $4.8 million, respectively.
At December 31, 1997 and 1996, nonaccrual and renegotiated loans were $74
million and $50 million, respectively.
ASB services real estate loans ($872 million, $626 million and $697 million at
December 31, 1997, 1996 and 1995, respectively) which are not included in the
accompanying consolidated financial statements. Fees earned for servicing loans
are reported as income when the related mortgage loan payments are collected.
Loan servicing costs are charged to expense as incurred.
Mortgage loan commitments of approximately $22 million are not reflected in
the consolidated balance sheet as of December 31, 1997. Of such commitments, $4
million were for variable-rate mortgage loans and $18 million were for fixed-
rate mortgage loans.
ALLOWANCE FOR LOAN LOSSES. For 1997, 1996 and 1995, net charge-offs amounted to
$2.6 million, $1.3 million and $0.8 million, respectively. For 1997, 1996 and
1995, the ratio of net charge-offs to average loans outstanding was 0.12%, 0.07%
and 0.04%, respectively.
REAL ESTATE ACQUIRED IN SETTLEMENT OF LOANS. At December 31, 1997 and 1996,
ASB's real estate acquired in settlement of loans was $4.0 million and $2.6
million, respectively.
DEPOSIT LIABILITIES. Deposit liabilities consisted of the following:
<TABLE>
<CAPTION>
December 31 1997 1996
- -----------------------------------------------------------------------------------------------------------
Weighted Weighted
average average
rate Amount rate Amount
- -----------------------------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C>
Commercial checking...................................... -- % $ 144,425 -- % $ 25,436
Other checking........................................... 1.26 483,187 1.39 253,263
Passbook................................................. 2.99 1,157,158 2.98 913,616
Money market............................................. 4.38 347,692 3.67 65,026
Term certificates........................................ 5.45 1,784,138 5.42 893,029
- -----------------------------------------------------------------------------------------------------------
3.91% $3,916,600 3.79% $2,150,370
===========================================================================================================
</TABLE>
At December 31, 1997 and 1996, deposit accounts of $100,000 or more totaled $1.1
billion and $468 million, respectively.
The approximate amounts of term certificates outstanding at December 31, 1997
with scheduled maturities for 1998 through 2002 were $1.5 billion in 1998, $176
million in 1999, $32 million in 2000, $13 million in 2001 and $17 million in
2002.
Interest expense on savings deposits by type of deposit was as follows:
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Interest-bearing checking.................................................. $ 3,627 $ 4,337 $ 5,535
Passbook................................................................... 26,769 31,401 34,039
Money market............................................................... 3,517 2,296 2,287
Term certificates.......................................................... 55,186 53,130 47,435
- ------------------------------------------------------------------------------------------------------------------------------
$89,099 $91,164 $89,296
==============================================================================================================================
</TABLE>
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE. At December 31, 1997,
securities sold under agreements to repurchase consisted of mortgage-backed
securities sold under fixed-coupon agreements. The FHLMC, GNMA and FNMA
mortgage-backed securities are book-entry securities and were delivered by
appropriate entry into the counterparties' accounts at the Federal Reserve
System. The remaining securities underlying the agreements were delivered to the
brokers/dealers who arranged the transactions. The carrying value of securities
underlying the agreements remained in ASB's asset accounts and the obligation to
repurchase securities sold is reflected as a liability in the consoli-
54
<PAGE>
dated balance sheet. At December 31, 1997 and 1996, approximately $375 million
and $480 million, respectively, of agreements to repurchase identical securities
were outstanding. At December 31, 1997 and 1996, the weighted average rate on
securities sold under agreements to repurchase was 5.71% and 5.50%,
respectively, and the weighted average remaining days to maturity was 115 days
and 92 days, respectively. During 1997, 1996 and 1995, securities sold under
agreements to repurchase averaged $560 million, $463 million and $277 million,
respectively, and the maximum amount outstanding at any month-end was $765
million, $480 million and $413 million, respectively.
At December 31, 1997, securities sold under agreements to repurchase were
summarized as follows:
<TABLE>
<CAPTION> Collateralized by
Weighted mortgage-backed securities
Repurchase average -------------------------------------------
Maturity liability rate Carrying value Market value
- --------------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C>
1 to 29 days $ 40,128 5.70% $ 45,431 $ 45,347
30 to 90 days 195,385 5.67 204,928 205,611
Over 90 days 139,853 5.76 158,829 156,858
- --------------------------------------------------------------------------------------------------------------------------------
$375,366 5.71% $409,188 $407,816
================================================================================================================================
</TABLE>
ADVANCES FROM FEDERAL HOME LOAN BANK. Advances from the FHLB of Seattle,
secured by mortgage-backed securities and stock in the FHLB of Seattle, were
summarized as follows:
<TABLE>
<CAPTION>
December 31 1997 1996
- ---------------------------------------------------------------------------------------------------------------
Weighted Weighted
average rate Amount average rate Amount
- ---------------------------------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C>
Due in
1997..................................................... na na 5.98% $227,300
1998..................................................... 5.68% $350,593 5.69 105,093
1999..................................................... 5.59 66,800 5.54 32,800
2000..................................................... 5.90 28,260 5.90 28,260
2001..................................................... 6.97 65,000 6.97 65,000
2002..................................................... 6.96 37,500 6.96 37,500
Thereafter............................................... 7.27 188,321 7.27 188,321
- ---------------------------------------------------------------------------------------------------------------
6.26% $736,474 6.42% $684,274
===============================================================================================================
</TABLE>
na Not applicable.
As a member of the FHLB system, ASB is required to own a specific number of
shares of capital stock of the FHLB of Seattle and is required to maintain cash
and investments in U.S. Government and other qualifying securities in an amount
equal to 4% of the amount of its savings accounts and other obligations due
within one year.
COMMON STOCK EQUITY. As of December 31, 1997, ASB was in compliance with the
minimum capital requirements under the Office of Thrift Supervision regulations.
MANAGEMENT SERVICES AND OTHER FEES. HEI's charges to ASB for general
management, administrative and other services totaled $2.7 million, $3.3 million
and $3.0 million in 1997, 1996 and 1995, respectively.
5 . REAL ESTATE SUBSIDIARY
- ------------------------------------------------------------------------------
Malama Pacific Corp. (MPC) engages in real estate development activities, both
directly and through joint ventures. MPC's real estate development investments
in residential projects are targeted for Hawaii's owner-occupant market. MPC's
subsidiaries are currently involved in the active development of four
residential projects on the islands of Oahu, Maui and Hawaii.
Residential development generally requires a long lead time to obtain
necessary zoning changes, building permits and other required approvals. MPC's
projects are subject to the usual risks of real estate development, including
fluctuations in interest rates, the receipt of timely and appropriate state and
local zoning and other necessary approvals, possible cost overruns and
construction delays, adverse changes in general commerce and local market
conditions, compliance with applicable environmental and other regulations, and
potential competition from other new projects and resales of existing
residences.
MPC and its subsidiaries' total real estate project inventory, equity
investment in real estate joint ventures and loans and advances to
unconsolidated joint ventures or joint venture partners totaled $40 million and
$46 million at December 31, 1997 and 1996, respectively. The amounts MPC will
ultimately realize relative to these real estate investments could differ
materially from the recorded amounts as of December 31, 1997. In 1997, a 50%
owned partnership of an MPC subsidiary recognized a noncash charge on its
investment in a real estate development project, pursuant to SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." MPC's subsidiary's proportionate share of this noncash charge
was $4.2 million.
RELATED PARTY TRANSACTIONS. Two joint ventures involve partnerships in which a
director of HEI has significant interests. Another joint venture involves a
corporate partner in which the family of an HEI officer has a significant
interest. Investments in joint ventures with related parties totaled $9 million
and $12 million, respectively, at December 31, 1997 and 1996.
55
<PAGE>
COMMITMENTS AND CONTINGENCIES. At December 31, 1997, MPC or its subsidiaries
had issued (i) guarantees under which they were jointly and severally
contingently liable with their joint venture partners for $1.4 million of
outstanding loans and (ii) payment guarantees under which MPC or its
subsidiaries were severally contingently liable for $3.8 million of outstanding
loans and $1.5 million of additional undrawn loan facilities. All such loans are
collateralized by real property. At December 31, 1997, HEI had agreed with the
lenders of construction loans and loan facilities, of which approximately $5.8
million was outstanding and $2.4 million was undrawn, that it will maintain
ownership of 100% of the stock of MPC and that it intends, subject to good and
prudent business practices, to keep MPC financially sound and responsible to
meet its obligations as guarantor.
6 . OTHER INVESTMENTS
- --------------------------------------------------------------------------------
Other investments, which have no ready market, consisted of the following:
<TABLE>
<CAPTION>
December 31 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Leveraged leases (see Note 7)....................................................... $54,993 $54,869
Real estate joint venture interests................................................. 9,113 12,032
Other............................................................................... 9,663 5,708
- ----------------------------------------------------------------------------------------------------------------------------
$73,769 $72,609
============================================================================================================================
</TABLE>
Realized gains and losses from the sale and/or writedown of other investments
were not material in 1997, 1996 or 1995.
7 . INVESTMENT IN LEVERAGED LEASES
- --------------------------------------------------------------------------------
HEI Investment Corp. (HEIIC) owns commercial buildings which are subject to
several leveraged lease agreements entered into in 1987. The initial lease terms
expire in 2009 and 2010, after which the lessees have options to renew the
leases at fixed rentals for additional periods of up to 28 years. The buildings
revert back to HEIIC at the end of the last renewal term if not purchased by the
lessees.
HEIIC also has a 15% ownership interest in an 818-MW coal-fired generating
unit, which is subject to a leveraged lease agreement entered into in 1985 and
expiring in 2013. The lessee has options to renew the lease at fixed rentals for
at least 8.5 additional years, and thereafter at fair market rentals.
HEIIC's net investment in leveraged leases was as follows:
<TABLE>
<CAPTION>
December 31 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Rentals receivable, net of principal and interest on nonrecourse debt............... $ 53,194 $ 54,763
Estimated residual value of leased assets........................................... 33,060 33,062
Less unearned income................................................................ (31,261) (32,956)
- -----------------------------------------------------------------------------------------------------------------------------
Investment in leveraged leases...................................................... 54,993 54,869
Less deferred income taxes arising from leveraged leases............................ (46,322) (45,592)
- -----------------------------------------------------------------------------------------------------------------------------
$ 8,671 $ 9,277
=============================================================================================================================
</TABLE>
8 . REGULATORY ASSETS
- --------------------------------------------------------------------------------
In accordance with SFAS No. 71, "Accounting for the Effects of Certain Types of
Regulation," the Company's financial statements reflect assets and costs of HECO
and its subsidiaries and YB based on current cost-based rate-making regulations.
Continued accounting under SFAS No. 71 requires that certain criteria be met. An
enterprise's operations or a portion of its operations can cease to meet the
criteria for various reasons, including a change in the method of regulation or
a change in the competitive environment for regulated services. When an
enterprise's operations or a portion of its operations cease to meet the
criteria, it should discontinue application of SFAS No. 71 and write off any
regulatory assets and liabilities for those operations that no longer meet the
requirements of SFAS No. 71. Management believes HECO and its subsidiaries' and
YB's operations currently satisfy the SFAS No. 71 criteria. However, if events
or circumstances should change so that the criteria are no longer satisfied,
management believes that a material adverse effect on the Company's results of
operations, financial position or liquidity may result.
56
<PAGE>
Regulatory assets at December 31, 1997 and 1996 included the following
deferred costs:
<TABLE>
<CAPTION>
December 31 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
(in thousands)
Income taxes........................................................................ $ 47,954 $ 41,023
Postretirement benefits other than pensions......................................... 29,044 30,981
Integrated resource planning costs.................................................. 6,951 7,354
Vacation earned, but not yet taken.................................................. 6,645 6,392
Unamortized debt expense on retired issuances....................................... 5,773 6,207
Preliminary plant costs on suspended project........................................ 5,759 5,759
Other............................................................................... 1,953 3,088
- ----------------------------------------------------------------------------------------------------------------------------
$104,079 $100,804
============================================================================================================================
</TABLE>
In 1995, HECO applied to the PUC for recovery of the preliminary plant costs on
a suspended project.
9 . SHORT-TERM BORROWINGS
- --------------------------------------------------------------------------------
Short-term borrowings at December 31, 1997 and 1996 had a weighted average
interest rate of 6.1% and 5.9%, respectively, and consisted of commercial paper
and bank loans.
At December 31, 1997 and 1996, HEI maintained bank lines of credit which
totaled $195 million and $90 million, respectively, and HECO maintained bank
lines of credit which totaled $125 million and $170 million, respectively. The
HEI and HECO lines of credit support the issuance of commercial paper. There
were no borrowings under any line of credit during 1997 or 1996.
10 . LONG-TERM DEBT
- --------------------------------------------------------------------------------
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
December 31 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
First mortgage bonds
<S> <C> <C>
5.75%, paid in 1997................................................................ $ -- $ 13,000
7.63-7.88%, due in various years through 2003...................................... 5,000 22,000
- ----------------------------------------------------------------------------------------------------------------------------
5,000 35,000
- -----------------------------------------------------------------------------------------------------------------------------
Obligations to the State of Hawaii for the repayment of special purpose revenue
bonds issued on behalf of electric utility subsidiaries
6.88% refunding series 1987, due 2012.............................................. 57,500 57,500
7.20% series 1984, due 2014........................................................ 11,400 11,400
7.63% series 1988, due 2018........................................................ 50,000 50,000
7.35-7.60% series 1990, due 2020................................................... 100,000 100,000
6.55% series 1992, due 2022........................................................ 60,000 60,000
5.45% series 1993, due 2023........................................................ 100,000 100,000
6.60% series 1995A, due 2025....................................................... 47,000 47,000
5.88-6.20% series 1996, due 2026................................................... 125,000 125,000
5.65% series 1997A, due 2027....................................................... 100,000 --
- -----------------------------------------------------------------------------------------------------------------------------
650,900 550,900
Less funds on deposit with trustees................................................. (53,899) (9,132)
Less unamortized discount........................................................... (4,380) (4,542)
- -----------------------------------------------------------------------------------------------------------------------------
592,621 537,226
- -----------------------------------------------------------------------------------------------------------------------------
Promissory notes
5.83%, due in 1998................................................................. 30,000 30,000
6.26-7.13%, due in various years through 2012...................................... 96,000 127,000
8.20-8.70%, due in various years through 2011...................................... 36,000 37,900
Variable rate (6.33% at December 31, 1997), due 1999............................... 35,000 35,000
Variable rate (10% at December 31, 1997), due 2001................................. 7,954 7,954
- -----------------------------------------------------------------------------------------------------------------------------
204,954 237,854
- -----------------------------------------------------------------------------------------------------------------------------
$802,575 $810,080
=============================================================================================================================
</TABLE>
57
<PAGE>
The first mortgage bonds have been secured by separate indentures which purport
to be liens on substantially all of the real and personal property now owned or
hereafter acquired by the respective electric utility subsidiaries. All of the
remaining first mortgage bonds of HECO and Maui Electric Company, Limited (a
HECO subsidiary) were redeemed in 1997.
At December 31, 1997, the aggregate principal payments required on long-term
debt for 1998 through 2002 are $32 million in 1998, $42 million in 1999, $12
million in 2000, $32 million in 2001 and $8 million in 2002.
11 . 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.
12 . COMMON STOCK
- --------------------------------------------------------------------------------
Changes to common stock were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
- -----------------------------------------------------------------------------------------------------
Common Common Common
Shares stock Shares stock Shares stock
- -----------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1..................... 30,853 $622,945 29,773 $585,387 28,655 $546,254
Issuance of common stock
Dividend reinvestment and
stock purchase plan............... 686 24,847 822 28,718 786 27,892
Retirement savings and
other plans....................... 356 12,750 258 9,161 332 11,324
Expenses and other..................... -- (5,723) -- (321) -- (83)
- -----------------------------------------------------------------------------------------------------
Balance, December 31................... 31,895 $654,819 30,853 $622,945 29,773 $585,387
=====================================================================================================
</TABLE>
At December 31, 1997, the Company had reserved a total of 7.7 million shares of
common stock for future issuance under the HEI Dividend Reinvestment and Stock
Purchase Plan, the Hawaiian Electric Industries Retirement Savings Plan, the
1987 Stock Option and Incentive Plan and other plans.
A reconciliation of the denominators of the basic and diluted earnings per
share computations was as follows:
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- -----------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Weighted average number of common shares outstanding................ 31,375 30,310 29,187
Effect of dilutive securities --
Stock options and dividend equivalents........................... 95 78 61
- -----------------------------------------------------------------------------------------------
Adjusted weighted average shares.................................... 31,470 30,388 29,248
===============================================================================================
</TABLE>
58
<PAGE>
<TABLE>
<S> <C>
13 . Interest expense
- ------------------------------------------------------------------------------
Interest expense by segment (including amounts capitalized as allowance for
borrowed funds used during construction and excluding interest on nonrecourse
debt on leveraged leases) was as follows:
</TABLE>
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Electric utility........................................................... $ 48,778 $ 47,451 $ 44,377
Other...................................................................... 15,829 18,381 18,483
- ------------------------------------------------------------------------------------------------------------------------------
64,607 65,832 62,860
Savings bank............................................................... 164,662 153,664 142,705
- ------------------------------------------------------------------------------------------------------------------------------
$229,269 $219,496 $205,565
==============================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
14 . INCOME TAXES
- ------------------------------------------------------------------------------------------------------------------------------
The components of income taxes were as follows:
Years ended December 31 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Federal
Current................................................................... $49,817 $49,022 $39,187
Deferred.................................................................. (2,827) 2,020 8,352
Deferred tax credits, net................................................. (1) (98) (34)
- -----------------------------------------------------------------------------------------------------------
46,989 50,944 47,505
- -----------------------------------------------------------------------------------------------------------
State
Current................................................................... 5,368 (334) 3,893
Deferred.................................................................. 316 582 1,596
Deferred tax credits, net................................................. 2,668 3,638 2,746
- -----------------------------------------------------------------------------------------------------------
8,352 3,886 8,235
- -----------------------------------------------------------------------------------------------------------
$55,341 $54,830 $55,740
===========================================================================================================
</TABLE>
A reconciliation of the amount of income taxes computed at the federal statutory
rate of 35% to the amount provided in the Company's consolidated statements of
income was as follows:
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Amount at the federal statutory income tax rate............................ $49,624 $46,721 $46,632
State income taxes, net of effect on federal income taxes.................. 5,428 2,525 5,353
Preferred stock dividends of electric utility subsidiaries................. 2,189 2,285 2,410
Other, net................................................................. (1,900) 3,299 1,345
- -------------------------------------------------------------------------------------------------------------------------------
$55,341 $54,830 $55,740
===============================================================================================================================
</TABLE>
The tax effects of temporary differences which give rise to deferred tax assets
and liabilities were as follows:
<TABLE>
<CAPTION>
December 31 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Deferred tax assets
Property, plant and equipment.................................................... $ 11,799 $ 10,283
Contributions in aid of construction and customer advances....................... 54,259 55,305
Other............................................................................ 39,085 31,239
- ------------------------------------------------------------------------------------------------------------------------------
105,143 96,827
- ------------------------------------------------------------------------------------------------------------------------------
Deferred tax liabilities
Property, plant and equipment.................................................... 182,472 175,823
Leveraged leases................................................................. 46,322 45,592
Regulatory assets................................................................ 18,713 15,984
Other............................................................................ 43,877 45,037
- ------------------------------------------------------------------------------------------------------------------------------
291,384 282,436
- ------------------------------------------------------------------------------------------------------------------------------
Net deferred income tax liability................................................... $186,241 $185,609
==============================================================================================================================
</TABLE>
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income
and tax planning strategies in making this assessment.
Based upon the level of historical taxable income and projections for future
taxable income over the periods which the deferred tax assets are deductible,
management believes it is more likely than not the Company will realize the
benefits of these deductible differences. There was no valuation allowance
provided for deferred tax assets at December 31, 1997 or 1996.
59
<PAGE>
15 . CASH FLOWS
- --------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION. In 1997, 1996 and 1995, cash
paid for interest (including interest paid by the savings bank, but excluding
interest paid on nonrecourse debt on leveraged leases), net of capitalized
amounts which were not material, amounted to $218 million, $214 million and $196
million, respectively. In 1997, 1996 and 1995, cash paid for interest on
nonrecourse debt on leveraged leases amounted to $7 million, $8 million and $9
million, respectively.
In 1997, 1996 and 1995, cash paid for income taxes amounted to $59 million,
$40 million and $44 million, respectively.
SUPPLEMENTAL DISCLOSURES OF NONCASH ACTIVITIES. In 1995, ASB received $409
million in mortgage-backed securities in exchange for loans and ASB transferred
$50 million of mortgage-backed securities from held-to-maturity securities to
trading account securities.
Common stock dividends reinvested by shareholders in HEI common stock in
noncash transactions amounted to $15 million, $18 million and $20 million in
1997, 1996 and 1995, respectively.
The estimated fair value of noncash contributions in aid of construction
received by the electric utility subsidiaries in 1997, 1996 and 1995 amounted to
$2 million, $5 million and $11 million, respectively.
The allowance for equity funds used during construction, which was capitalized
as part of the cost of electric utility plant, amounted to $11 million, $12
million and $10 million in 1997, 1996 and 1995, respectively.
16 . STOCK OPTION AND INCENTIVE PLAN
- --------------------------------------------------------------------------------
Under the 1987 Stock Option and Incentive Plan, as amended, an aggregate of
2,650,000 shares of common stock may be issued to officers and key employees as
incentive stock options, nonqualified stock options, restricted stock, stock
appreciation rights, stock payments or dividend equivalents. Only nonqualified
stock options have been granted to date. For the nonqualified stock options, the
exercise price of each option generally equals the market price of the Company's
stock on or near the date of grant. Options generally become exercisable in
installments of 25% each year for four years, and expire, if not exercised ten
years from the date of the grant. Certain options include dividend equivalents
over the four-year vesting period.
The Company applies the provisions of Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees," and related interpretations, in
accounting for stock-based compensation awards. The compensation cost that has
been charged against income for the nonqualified stock options and dividend
equivalents amounted to $0.9 million in 1997 and $0.7 million in 1996 and 1995.
As of January 1, 1996, the Company adopted the disclosure-only option under SFAS
No. 123, "Accounting for Stock-Based Compensation." If the accounting provisions
of SFAS No. 123 had been adopted, the effect on 1997, 1996 and 1995 net income
and basic and diluted earnings per share would have been immaterial (i.e., less
than one cent per share for 1997, 1996 and 1995).
Information about the Company's stock option plan was summarized as follows:
<TABLE>
<CAPTION>
1997 1996 1995
- ----------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Shares price Shares price Shares price
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, January 1 610,875 $36.32 553,083 $36.30 568,333 $36.46
Granted 145,000 34.61 80,000 35.83 141,000 32.83
Exercised (84,825) 35.90 (20,208) 33.58 (150,250) 33.72
Forfeited or expired (31,500) 40.61 (2,000) 38.27 (6,000) 34.64
- ----------------------------------------------------------------------------------------------------------
Outstanding, December 31 639,550 $35.78 610,875 $36.32 553,083 $36.30
==========================================================================================================
Options exercisable, December 31 355,925 $36.87 377,625 $37.45 303,458 $38.02
==========================================================================================================
</TABLE>
60
<PAGE>
The weighted average fair value of options granted during the year was $7.65,
$8.40 and $6.03 (at grant date) in 1997, 1996 and 1995, respectively. The
weighted average assumptions used to estimate fair value include: risk-free
interest rate of 6.7%, 6.3% and 6.7%; expected volatility of 9.8%, 12.0% and
13.7%; expected dividend yield of 6.8%, 6.6% and 6.4% for 1997, 1996 and 1995,
respectively, and expected life of 4.5 years for each of the three years.
The 1997 weighted average fair value of each option grant is estimated on the
date of grant using a Binomial Option Pricing Model. The 1996 and 1995 weighted
average fair value of each option grant is estimated on the date of grant using
a Black-Scholes Option Pricing Model. At December 31, 1997, unexercised stock
options have exercise prices ranging from $32.72 to $41.00 per common share, and
a weighted average remaining contractual life of 6.8 years.
17 . RETIREMENT BENEFITS
- --------------------------------------------------------------------------------
PENSIONS. The Company has several defined benefit pension plans which cover
substantially all employees. In general, benefits are based on the employees'
years of service and base compensation.
The funded status of the pension plans and the amounts recognized in the
consolidated financial statements were as follows:
<TABLE>
<CAPTION>
December 31 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Accumulated benefit obligation
Vested............................................................................. $ 432,459 $ 398,167
Nonvested.......................................................................... 41,010 43,397
- -----------------------------------------------------------------------------------------------------------------------------
$ 473,469 $ 441,564
=============================================================================================================================
Projected benefit obligation........................................................ $ 583,210 $ 548,144
Plan assets at fair value, primarily equity securities and fixed income
investments........................................................................ 646,968 569,935
- -----------------------------------------------------------------------------------------------------------------------------
Projected benefit obligation less than plan assets.................................. (63,758) (21,791)
Unrecognized prior service cost..................................................... (4,812) (4,422)
Unrecognized net gain............................................................... 83,964 41,645
Unrecognized net transition obligation.............................................. (12,658) (15,009)
Adjustment required to recognize minimum liability.................................. 910 1,029
- -----------------------------------------------------------------------------------------------------------------------------
Accrued pension liability........................................................... $ 3,646 $ 1,452
=============================================================================================================================
</TABLE>
Plans with an accumulated benefit obligation exceeding plan assets at fair value
were not material. For all pension plans at December 31, 1997 and 1996, the
assumed discount rate used to measure the projected benefit obligation was 7%.
Net periodic pension cost included the following components:
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Service cost--benefits earned during the period............................ $ 20,040 $ 19,227 $ 14,805
Interest cost on projected benefit obligation.............................. 37,462 35,265 32,929
Actual return on plan assets............................................... (85,931) (69,640) (105,674)
Amortization and deferral, net............................................. 43,897 32,312 70,692
- ---------------------------------------------------------------------------------------------------------------
$ 15,468 $ 17,164 $ 12,752
===============================================================================================================
</TABLE>
Of these net periodic pension costs, $12 million, $13 million and $9 million
were expensed in 1997, 1996 and 1995, respectively, and the remaining amounts
were charged primarily to electric utility plant.
The expected long-term rate of return on assets was 9% for 1997, 1996 and
1995. The assumed rate of increase in future compensation levels was 5% for
1997, 1996 and 1995.
For most of the plans, the transition obligation (the projected benefit
obligation in excess of plan assets at January 1, 1987) is being amortized
ratably over 16 years beginning in 1987.
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS. The Company provides various
postretirement benefits other than pensions to eligible employees upon
retirement. Health and life insurance benefits are provided to eligible
employees of HEI, HECO and its subsidiaries, and YB upon their retirement.
Health benefits are provided with contributions by retirees toward costs based
on their years of service and retirement date. Generally, employees are eligible
for these benefits if, upon retirement, they participate in one of the Company's
defined benefit pension plans. The Company began funding some of these benefits
in December 1994.
In February 1992, the PUC opened a generic docket to determine whether SFAS
No. 106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions," should be adopted for rate-making purposes. Effective January 1,
1993, the Company adopted the provisions of SFAS No. 106. In November 1994, the
PUC issued a decision and order authorizing recovery of the full cost of
postretirement benefits other than pensions effective January 1, 1995. The
electric utility subsidiaries and YB were required
61
<PAGE>
to fund the recovered SFAS No. 106 costs. The regulatory asset established from
January 1, 1993 through December 31, 1994 for postretirement benefits other than
pensions is being amortized ratably over 18 years beginning in 1995 for rate-
making and financial reporting purposes. In December 1995, however, the PUC
issued a decision and order which did not provide revenue to cover HECO's costs
relating to postretirement executive life insurance and HECO and its
subsidiaries wrote off the regulatory asset relating to such costs, resulting in
a 1995 after-tax charge of $1.1 million.
The funded status of the postretirement benefit plans and the amounts
recognized in the consolidated financial statements were as follows:
<TABLE>
<CAPTION>
December 31 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Accumulated postretirement benefit obligation
Retirees........................................................................... $ 61,099 $ 66,249
Fully eligible active plan participants............................................ 55,678 50,757
Other active plan participants..................................................... 68,357 64,709
- -----------------------------------------------------------------------------------------------------------------------------
185,134 181,715
Plan assets at fair value, primarily equity securities and fixed income
investments........................................................................ 66,030 41,295
- -----------------------------------------------------------------------------------------------------------------------------
Accumulated postretirement benefit obligation in excess of plan assets.............. 119,104 140,420
Unrecognized net gain............................................................... 13,779 19
Unrecognized net transition obligation.............................................. (98,674) (105,259)
- -----------------------------------------------------------------------------------------------------------------------------
Accrued postretirement benefit liability............................................ $ 34,209 $ 35,180
==============================================================================================================================
</TABLE>
At December 31, 1997 and 1996, the assumed discount rate used to measure the
accumulated postretirement benefit obligation was 7%.
Net periodic postretirement benefit cost included the following components:
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Service cost............................................................... $ 6,379 $ 6,139 $ 5,283
Interest cost.............................................................. 12,475 11,944 11,539
Actual return on plan assets............................................... (7,237) (3,271) (997)
Amortization and deferral, net............................................. 9,440 7,019 6,959
- -----------------------------------------------------------------------------------------------------------
$21,057 $21,831 $22,784
===========================================================================================================
</TABLE>
Of these net periodic postretirement benefit costs, $16 million, $16 million and
$17 million were expensed in 1997, 1996 and 1995, respectively, and the
remaining amounts were charged primarily to electric utility plant.
For 1997, 1996 and 1995, the expected long-term rate of return on assets for
trusts whose income was not subject to income taxes was 9%. At December 31, 1997
and 1996, trusts holding plan assets with a fair value of $1.7 million and $2.7
million, respectively, had income that was subject to income taxes at a rate of
45%. The after-tax expected long-term rate of return on these plan assets was 6%
for 1997, 1996 and 1995. For 1997, 1996 and 1995, the assumed rate of increase
in future compensation levels was 5%.
At December 31, 1997, the assumed health care trend rates for 1998 and future
years were as follows: medical, 6.5%; dental, 5.0%; and vision, 4.0%. The health
care cost trend rate assumption can have a significant effect on the amounts
reported. For example, a 1% increase in the trend rate for health care costs
would have increased the accumulated postretirement benefit obligation at
December 31, 1997 by approximately $25 million and the service and interest
costs for 1997 by approximately $2 million.
The transition obligation (the accumulated postretirement benefit obligation
at January 1, 1993) is being amortized ratably over 20 years beginning in 1993.
18 . REGULATORY RESTRICTIONS ON NET ASSETS
- --------------------------------------------------------------------------------
At December 31, 1997, net assets of approximately $682 million were not
available for transfer to HEI from its subsidiaries in the form of dividends,
loans or advances without regulatory approval. However, HEI expects that the
regulatory restrictions will not materially affect the operations of the Company
nor its ability to pay dividends on its common stock.
19 . SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
- --------------------------------------------------------------------------------
Substantially all of the Company's business activity is with customers located
in the State of Hawaii. Most of the financial instruments reflected on the
consolidated balance sheets are based in the State of Hawaii, except for the
mortgage-backed securities. Substantially all real estate loans receivable are
secured by real estate in Hawaii. ASB's policy is to require mortgage insurance
on all real estate loans with a loan to appraisal ratio in excess of 80% at
origination.
62
<PAGE>
At December 31, 1997, ASB's private-issue mortgage-backed securities
represented whole or participating interests in pools of first mortgage loans
collateralized by real estate in the continental U.S., and approximately 68% of
the portfolio was collateralized by real estate in California. At December 31,
1997, substantially all private-issue mortgage-backed securities were rated
investment grade by various securities rating agencies.
20 . DISCONTINUED OPERATIONS
- -------------------------------------------------------------------------------
The Hawaiian Insurance & Guaranty Company, Limited (HIG) and its subsidiaries
(collectively, the HIG Group) were property and casualty insurance companies.
HEI Diversified, Inc. (HEIDI) was the holder of record of all the common stock
of HIG until August 16, 1994. In December 1992, due to a significant increase in
the estimate of policyholder claims from Hurricane Iniki, the HEI Board of
Directors concluded it would not contribute additional capital to HIG and the
remaining investment in the HIG Group was written off. On December 24, 1992, a
formal rehabilitation order vested full control over the HIG Group in the
Insurance Commissioner of the State of Hawaii (the Rehabilitator) and her
deputies. A lawsuit stemming from this situation was settled in 1994, with the
Company making a settlement payment of $32 million to the Rehabilitator. HEI and
HEIDI are seeking reimbursement for the settlement and defense costs from their
insurance carriers. One of the insurance carriers filed a declaratory relief
action in the U.S. District Court for Hawaii seeking resolution of insurance
coverage and other policy issues, and HEI and HEIDI filed counterclaims. Trial
is scheduled to begin on July 28, 1998. Recoveries from HEI's insurance
carriers, if any, will be recognized when realized.
21 . FAIR VALUE OF FINANCIAL INSTRUMENTS
- -------------------------------------------------------------------------------
The following methods and assumptions were used to estimate the fair value of
each applicable class of financial instruments for which it is practicable to
estimate that value:
CASH AND EQUIVALENTS. The carrying amount approximates fair value because of
the short maturity of these instruments.
INVESTMENT AND MORTGAGE-BACKED SECURITIES. Fair value is based on quoted market
prices or dealer quotes.
LOANS RECEIVABLE. For certain homogeneous categories of loans, such as some
residential mortgages, credit card receivables, and other consumer loans, fair
value is estimated using the quoted market prices for securities backed by
similar loans, adjusted for differences in loan characteristics. The fair value
of other types of loans is estimated by discounting the future cash flows using
the current rates at which similar loans would be made to borrowers with similar
credit ratings and for similar remaining maturities.
DEPOSIT LIABILITIES. Under SFAS No. 107, "Disclosures about Fair Value of
Financial Instruments," the fair value of demand deposits, savings accounts, and
certain money market deposits is the amount payable on demand at the reporting
date. The fair value of fixed-maturity certificates of deposit is estimated
using the rates currently offered for deposits of similar remaining maturities.
SHORT-TERM BORROWINGS. The carrying amount approximates fair value because of
the short maturity of these instruments.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE. Current dealer quotes for
securities sold under agreements to repurchase with similar terms and remaining
maturities are used to estimate fair value.
ADVANCES FROM FEDERAL HOME LOAN BANK AND LONG-TERM DEBT. Fair value is
estimated based on quoted market prices for the same or similar issues or on the
current rates offered for debt of the same or similar remaining maturities.
HEI- AND HECO-OBLIGATED PREFERRED SECURITIES OF TRUST SUBSIDIARIES. Fair value
is based on quoted market prices.
PREFERRED STOCK OF ELECTRIC UTILITY SUBSIDIARIES SUBJECT TO MANDATORY
REDEMPTION. There are no quoted market prices for the electric utility
subsidiaries' preferred stocks. Fair value is estimated based on quoted market
prices for similar issues of preferred stock.
63
<PAGE>
The estimated fair values of certain of the Company's financial instruments
were as follows:
<TABLE>
<CAPTION>
December 31 1997 1996
- -------------------------------------------------------------------------------------------------------------
Carrying Estimated Carrying Estimated
amount fair value amount fair value
- -------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C>
FINANCIAL ASSETS
Cash and equivalents.................................... $ 254,356 $ 254,356 $ 97,417 $ 97,417
Investment and mortgage-backed securities............... 1,971,886 1,983,657 1,377,591 1,367,328
Other investments for which it is not
practicable to estimate fair value /1/............... 9,663 na 5,708 na
Loans receivable, net................................... 3,035,847 3,119,076 2,002,028 2,054,036
FINANCIAL LIABILITIES
Deposit liabilities..................................... 3,916,600 3,912,685 2,150,370 2,148,561
Short-term borrowings................................... 298,016 298,016 216,543 216,543
Securities sold under agreements to repurchase.......... 375,366 373,459 479,742 476,338
Advances from Federal Home Loan Bank.................... 736,474 745,034 684,274 688,597
Long-term debt.......................................... 802,575 839,003 810,080 819,935
HEI- AND HECO-OBLIGATED PREFERRED SECURITIES
OF TRUST SUBSIDIARIES................................ 150,000 155,000 -- --
PREFERRED STOCK OF ELECTRIC UTILITY SUBSIDIARIES SUBJECT
TO MANDATORY REDEMPTION................................. 35,770 37,699 38,955 41,086
OFF-BALANCE SHEET
Commitments to extend credit /2/
Financial guarantees written /3/
- -------------------------------------------------------------------------------------------------------------
</TABLE>
/1/ At December 31, 1997 and 1996, the other investments for which it is not
practicable to estimate fair value consists primarily of an investment
representing approximately 10% of the issued common stock of an untraded
company; that investment had a carrying value of $8.2 million and $4.9
million at December 31, 1997 and 1996, respectively. At December 31, 1996,
the total assets reported by this company were $56 million and the common
stockholders' equity was $50 million. For 1996, revenues were $1.2 million,
net realized and unrealized gain on investments was $9.4 million and net
income was $4.9 million.
/2/ At December 31, 1997 and 1996, neither the commitment fees received on
commitments to extend credit nor the fair value thereof were significant to
the consolidated financial statements of the Company.
/3/ At December 31, 1997 and 1996, MPC or its subsidiaries had issued
guarantees of loans with outstanding balances of $5.2 million and $7.9
million, respectively. All such loans are collateralized by real property.
These guarantees relate to borrowings from third parties which bear
interest at rates ranging from prime plus 1.0% to prime plus 2.0%. It is
not practicable to estimate the fair value of these guarantees.
na Not available.
LIMITATIONS. Fair value estimates are made at a specific point in time, based
on relevant market information and information about the financial instrument.
These estimates do not reflect any premium or discount that could result from
offering for sale at one time the Company's entire holdings of a particular
financial instrument. Because no market exists for a significant portion of the
Company's financial instruments, fair value estimates cannot be determined with
precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are provided for certain existing on- and off-balance
sheet financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities that are not
considered financial instruments. In addition, the tax ramifications related to
the realization of the unrealized gains and losses can have a significant effect
on fair value estimates and have not been considered.
22 . CONTINGENCIES
- --------------------------------------------------------------------------------
ENVIRONMENTAL REGULATION. In early 1995, the DOH initially advised HECO,
Hawaiian Tug & Barge Corp. (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. A Technical Workgroup (comprised of certain
of the parties identified in the December 1995 DOH letter, including HECO,
64
<PAGE>
Chevron U.S.A. Inc., Shell Oil Products Company, State of Hawaii Department of
Transportation Harbors Division and others) was formed to conduct independent
voluntary investigations relative to this issue. Effective January 30, 1998, the
Technical Workgroup and the DOH entered into a voluntary agreement and scope of
work to determine the nature and extent of any contamination, the responsible
parties and appropriate remedial actions.
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.
23 . QUARTERLY INFORMATION (UNAUDITED)
- --------------------------------------------------------------------------------
Selected quarterly information was as follows:
<TABLE>
<CAPTION>
Quarters ended
- ----------------------------------------------------------------------------------------------------------------- Year Ended
1997 Mar. 31 Jun. 30 Sep. 30 Dec. 31 Dec. 31
- -----------------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Revenues..................................... $359,193 $360,253 $367,121 $377,412 $1,463,979
Operating income............................. 49,352 50,170 56,312 50,355 206,189
Net income................................... 19,663 19,795 24,138 22,846 86,442
Basic earnings per common share /2/.......... 0.64 0.63 0.77 0.72 2.76
Diluted earnings per common share /3/........ 0.63 0.63 0.76 0.72 2.75
Dividends per common share................... 0.61 0.61 0.61 0.61 2.44
Market price per common share /4/
High........................................ 36.38 39.13 38.63 41.50 41.50
Low......................................... 33.75 32.88 35.13 36.25 32.88
</TABLE>
<TABLE>
<CAPTION>
Quarters ended
- ------------------------------------------------------------------------------------------------------------------ Year Ended
1996 Mar. 31 Jun. 30 Sep. 30 Dec. 31 Dec. 31
- ----------------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Revenues..................................... $326,169 $347,243 $ 368,158 $369,002 $ 1,410,572
Operating income............................. 46,735 51,412 44,743/1/ 45,356 188,246/1/
Net income................................... 18,869 21,363 17,372/1/ 21,054 78,658/1/
Basic earnings per common share /2/.......... 0.63 0.71 0.57/1/ 0.69 2.60/1/
Diluted earnings per common share /3/........ 0.63 0.71 0.57/1/ 0.68 2.59/1/
Dividends per common share................... 0.60 0.60 0.60 0.61 2.41
Market price per common share /4/
High........................................ 39.50 35.50 36.00 37.50 39.50
Low......................................... 34.63 33.25 34.00 33.88 33.25
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
/1/ Amounts reported for the quarter ended September 30, 1996 and the year
ended December 31, 1996 include the effect of the FDIC special assessment
of $13.8 million pretax and $8.3 million after tax.
/2/ The quarterly basic earnings per common share are based upon the weighted
average number of shares of common stock outstanding in each quarter.
/3/ The quarterly diluted earnings per common share are based upon the weighted
average number of shares of common stock outstanding in each quarter plus
the dilutive incremental shares at quarter end.
/4/ Market prices shown are as reported on the NYSE Composite Tape. The common
stock of HEI is traded on the New York Stock Exchange under the symbol HE.
65
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
HEI Directors
- -------------
Robert F. Clarke, 55 (1)* T. Michael May, 51* Oswald K. Stender, 66 (3, 4)*
President and Chief Executive Officer President and Chief Executive Officer Trustee
Hawaiian Electric Industries, Inc. Hawaiian Electric Company, Inc. Kamehameha Schools/Bishop Estate
1989 1995 (charitable trust)
1993
Don E. Carroll, 56 (3, 4) Bill D. Mills, 46 (3)
President and Chief Executive Officer Chairman of the Board and Kelvin H. Taketa, 43 (2)*
Oceanic Cablevision Chief Executive Officer Vice President and Director-
(cable television broadcasting) Bill Mills Development and Asia Pacific Region
1996 Investment Company, Inc. The Nature Conservancy
(real estate development) (nonprofit international conservation
1988 agency)
Edwin L. Carter, 72 (1, 3)* 1993
Retired President and
Chief Executive Officer A. Maurice Myers, 57 (3, 4) Jeffrey N. Watanabe, 55 (1, 4)*
Bishop Trust Company, Ltd. President and Chief Executive Officer Partner
(financial services) Yellow Corporation Watanabe, Ing & Kawashima
1985 (transportation services) (private law firm)
1991 1987
Richard Henderson, 69 (1, 2)*
President Diane J. Plotts, 62 (1, 2, 3)* COMMITTEES OF THE BOARD OF DIRECTORS
HSC, Inc. General Partner ------------------------------------
(real estate investment and development) Mideast and China Trading Company (1) EXECUTIVE:
1981 (real estate development) Richard Henderson, Chairman
1987 (2) AUDIT:
Victor Hao Li, S.J.D., 56 (2)* Diane J. Plotts, Chairman
Co-chairman James K. Scott, Ed.D., 46 (2) (3) COMPENSATION:
Asia Pacific Consulting Group President Edwin L. Carter, Chairman
(international business consultant) Punahou School (4) NOMINATING:
1988 (private education) Jeffrey N. Watanabe, Chairman
1995
*Also member of one or more subsidiary
Year denotes year of election to the board of directors boards
Information as of February 13, 1998
HEI Officers
- ------------
Robert F. Clarke, 55 Charles F. Wall, 58 Curtis Y. Harada, 42
President and Chief Executive Officer Vice President and Controller
1987 Corporate Information Officer 1989
1990
T. Michael May, 51
Senior Vice President Andrew I. T. Chang, 58 Betty Ann M. Splinter, 52
1992 Vice President - Government Relations Secretary
1985 1974
Robert F. Mougeot, 55
Financial Vice President and Constance H. Lau, 45 Molly M. Egged, 47
Chief Financial Officer Treasurer Assistant Secretary
1988 1984 1980
Peter C. Lewis, 63
Vice President - Administration
1968
Year denotes year of employment by the company
Information as of February 13, 1998
</TABLE>
66
<PAGE>
HECO EXHIBIT 13.2
SELECTED FINANCIAL DATA
- --------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA
Operating revenues................ $1,098,755 $1,071,426 $ 981,990 $ 907,308 $ 874,010
Operating expenses................ 987,715 962,635 879,268 819,996 795,925
---------- ---------- ---------- ---------- ----------
Operating income.................. 111,040 108,791 102,722 87,312 78,085
Other income...................... 19,042 20,675 16,325 14,793 11,556
---------- ---------- ---------- ---------- ----------
Income before interest
and other charges................ 130,082 129,466 119,047 102,105 89,641
Interest and other.
charges.......................... 48,233 44,253 42,024 36,144 33,515
---------- ---------- ---------- ---------- ----------
Income before preferred
stock dividends of HECO ......... 81,849 85,213 77,023 65,961 56,126
Preferred stock
dividends of HECO................ 3,660 3,865 4,126 4,316 4,421
---------- ---------- ---------- ---------- ----------
Net income for common
stock............................ $ 78,189 $ 81,348 $ 72,897 $ 61,645 $ 51,705
========== ========== ========== ========== ==========
<CAPTION>
At December 31 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Utility plant..................... $2,797,886 $2,674,419 $2,483,005 $2,293,521 $2,102,534
Accumulated
depreciation..................... (904,781) (828,917) (762,770) (702,945) (641,230)
---------- ---------- ---------- ---------- ----------
Net utility plant................. $1,893,105 $1,845,502 $1,720,235 $1,590,576 $1,461,304
========== ========== ========== ========== ==========
Total assets...................... $2,212,314 $2,165,546 $2,016,283 $1,889,120 $1,703,276
========== ========== ========== ========== ==========
Capitalization:/1/
Long-term debt.................... $ 627,621 $ 602,226 $ 517,209 $ 489,586 $ 484,736
Preferred stock
subject to mandatory
redemption....................... 35,770 38,955 41,750 44,844 46,730
Preferred stock not
subject to mandatory
redemption....................... 48,293 48,293 48,293 48,293 48,293
HECO-obligated
mandatorily redeemable
preferred securities
of trust subsidiary
holding solely HECO and
HECO-guaranteed subor-
dinated debentures............... 50,000 -- -- -- --
Common stock equity............... 769,235 751,311 696,905 633,901 570,663
---------- ---------- ---------- ---------- ----------
Total capitalization.............. $1,530,919 $1,440,785 $1,304,157 $1,216,624 $1,150,422
========== ========== ========== ========== ==========
CAPITAL STRUCTURE RATIOS (%)/2/
Debt.............................. 44.4 46.5 45.5 45.5 44.1
Preferred stock................... 5.2 5.5 6.2 7.0 8.0
HECO-obligated
mandatorily redeemable
preferred securities
of trust subsidiary
holding solely HECO and
HECO-guaranteed subor-
dinated debentures............... 3.1 -- -- -- --
Common stock equity............... 47.3 48.0 48.3 47.5 47.9
</TABLE>
- -------------------------------------------------------------------------------
/1/ Includes amounts due within one year and sinking fund requirements.
/2/ Includes amounts due within one year, short-term borrowings from
nonaffiliates and affiliate, and sinking fund requirements.
NOTE: HEI owns all of HECO's common stock. Therefore, per share data is not
meaningful.
2
<PAGE>
FORWARD-LOOKING INFORMATION
- --------------------------------------------------------------------------------
This report and other presentations made by HECO and its subsidiaries
(collectively, "the Company") 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; product demand and market acceptance risks; the effects of weather
and natural disasters; 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 and the timing and extent of
changes in interest rates. Investors are also directed to consider other risks
and uncertainties discussed in other periodic reports previously and
subsequently filed by HECO with the Securities and Exchange Commission.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
The following discussion should be read in conjunction with the consolidated
financial statements and accompanying notes.
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
EARNINGS
Net income for common stock for 1997 was $78.2 million compared to $81.3 million
for 1996 and $72.9 million for 1995. The 1997 net income represents a 10.3%
return on the average amount of common stock equity invested in the Company,
compared to returns of 11.2% in 1996 and 11.0% in 1995.
SALES
Consolidated sales of electricity were 8,963 million kilowatthours (KWH) for
1997, 8,991 million KWH for 1996, and 8,806 million KWH for 1995. The decrease
in KWH sales in 1997 is partly due to cooler weather, which results in lower
residential and commercial air conditioning usage, and the effect of Hawaii's
slow economy. The KWH sales increase in 1996 is partly due to the effects of
the 1.4% real growth in Hawaii's economy. The increase in KWH sales in 1995
reflects the effects of the slight growth in Hawaii's economy and warmer
weather.
OPERATING REVENUES
Operating revenues were $1,098.8 million in 1997, compared to $1,071.4 million
in 1996 and $982.0 million in 1995. The 1997 increase in operating revenues of
$27.4 million, or 2.6%, was due primarily to higher fuel oil prices which were
passed through to customers, and recovery through rates of Integrated Resource
Planning (IRP) related costs, including Demand Side Management (DSM) program
costs, lost margins and shareholder incentives related to the DSM programs,
partly offset by the aforementioned decrease in KWH sales. The rate schedules
of the Company include energy cost adjustment clauses under which electric rates
are adjusted for changes in the weighted average price paid for fuel oil and
certain components of purchased power costs, and the relative amounts of
company-generated power and purchased power.
Operating revenues for 1996 increased by $89.4 million, or 9.1%, over 1995
revenues due primarily to higher fuel oil prices which were passed through to
3
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS, continued
- --------------------------------------------------------------------------------
customers, higher KWH sales, rate relief granted by the PUC, and recovery
through rates of IRP related costs, including DSM program costs, lost margins
and shareholder incentives.
Operating revenues for 1995 increased by $74.7 million, or 8.2%, over 1994
revenues due primarily to interim rate increases granted by the PUC, higher KWH
sales and higher fuel oil prices, which were passed through to customers.
OPERATING EXPENSES
Total operating expenses were $987.7 million in 1997 compared to $962.6 million
in 1996 and $879.3 million in 1995. The increase in 1997 was due to increases
in fuel oil, purchased power, other operation and depreciation and amortization
expenses, and taxes other than income taxes. The increase in 1996 was due to
increases in all categories of operating expenses. The increase in 1995 was due
to increases in fuel oil, purchased power, other operation and depreciation and
amortization expenses, taxes, other than income taxes, and income taxes.
Fuel oil expense was $257.0 million in 1997 compared to $250.5 million in 1996
and $207.0 million in 1995. The increase in fuel oil expense in 1997 was due
primarily to higher fuel oil prices. The increase in fuel oil expense in both
1996 and 1995 was due primarily to higher fuel oil prices and higher KWH
generated. In 1997, the Company paid an average of $25.19 per barrel for fuel
oil, compared to $24.08 in 1996 and $20.47 in 1995.
Purchased power expense was $292.9 million in 1997 compared to $286.1 million
in 1996 and $276.4 million in 1995. The increases in purchased power expense in
both 1997 and 1996 were due primarily to higher fuel prices and higher KWH
purchased. The increase in purchased power expense in 1995 was due primarily to
an increase in capacity and nonfuel purchased power costs paid to independent
power producers (IPPs), and an increase in the number of KWH purchased, mostly
by HECO. Purchased KWH provided approximately 38.1% of the total energy net
generated and purchased in 1997 compared to 37.3% in 1996 and 37.5% in 1995.
Other operation expenses totaled $149.0 million in 1997, compared to $142.7
million in 1996 and $137.3 million in 1995. The increase in other operation
expenses in both 1997 and 1996 was due primarily to higher IRP related costs,
including full scale DSM program costs. The increase in other operation
expenses in 1995 was due primarily to higher employee benefit costs, which
included the recognition of postretirement benefits other than pension (PBOP)
costs as required under Statement of Financial Accounting Standards (SFAS) No.
106, and the write off of a regulatory asset (i.e. deferred cost) for the 1994
and 1993 costs of postretirement executive life insurance. HEI charges for
general management, administrative and support services totaled $2.2 million in
1997, $2.3 million in 1996 and $2.5 million in 1995.
Maintenance expenses in 1997 of $49.9 million decreased by $2.4 million from
1996 due primarily to lower maintenance on the transmission and distribution
systems on Oahu and lower production maintenance expenses for HELCO and MECO.
Maintenance expenses in 1996 of $52.3 million increased $5.1 million from 1995
due primarily to more underground fault repairs on the transmission and
distribution systems on Oahu and higher production maintenance expenses for
HELCO and MECO. In 1995, maintenance expenses totaled $47.2 million, a slight
increase from 1994 primarily due to higher production maintenance expenses,
partially offset by lower weather related maintenance on the transmission and
distribution systems.
Depreciation and amortization expense was up 11.7% in 1997 to $82.0 million,
up 8.6% in 1996 to $73.5 million and up 6.1% in 1995 to $67.6 million. In all
years, the increases reflect depreciation on additions to plant in service in
the previous year. Major additions to plant in service in 1996 included MECO's
Maalaea-Lahaina 3rd 69-kv line, and generation expansion projects on Lanai and
Molokai. Major additions to plant in service in 1995 included HECO's Waiau-
Campbell Industrial Park 138-kilovolt line and MECO's Maalaea-Naalae 69-kilovolt
line. Additions to plant in service in 1994 consisted primarily of transmission
and distribution projects.
4
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS, continued
- --------------------------------------------------------------------------------
Taxes, other than income taxes, increased by 2.8% in 1997 to $104.2 million,
by 9.1% in 1996 to $101.4 million and by 8.2% in 1995 to $93.0 million. These
taxes consist primarily of taxes based on revenues, and the increases in these
taxes reflect the corresponding increases in each year's operating revenues.
OPERATING INCOME
Operating income for 1997 increased 2.1% compared to 1996 due in part to higher
DSM program related shareholder incentives, partially offset by increased
expenses. Operating income for 1996 increased 5.9% compared to 1995 due in part
to higher KWH sales, rate increases and DSM program related shareholder
incentives, partly offset by increased expenses. Operating income for 1995
increased 17.6% compared to the prior year due in part to rate increases and
higher KWH sales, partly offset by increased expenses.
OTHER INCOME
Other income for 1997 totaled $19.0 million, compared to $20.7 million for 1996
and $16.3 million for 1995. The decrease in 1997 was due primarily to lower
Allowance for Equity Funds Used During Construction (AFUDC-Equity), reflecting
lower average levels of construction in progress during the year, and less
interest income on deferred IRP costs. The increase in 1996 was due primarily
to higher AFUDC-Equity and interest income on deferred IRP costs. The increase
in 1995 was due primarily to higher AFUDC-Equity.
INTEREST AND OTHER CHARGES
Interest and other charges for 1997 totaled $48.2 million, compared to $44.3
million for 1996 and $42.0 million for 1995. Interest on long-term debt
increased by $3.1 million in 1997, by $2.6 million in 1996 and by $2.7 million
in 1995. The increase in 1997 was due to interest on drawdowns of tax-exempt
special purpose revenue bond proceeds during 1997, and the full year's interest
on the 1996 drawdowns of revenue bond proceeds. The 1997 increase in interest
on long-term debt was partially offset by lower interest on first mortgage bonds
resulting from the retirement in March 1997 of HECO's 5.75% Series O mortgage
bonds of $13 million, and the early redemptions in November 1997 of MECO's
7.875% Series G and 7.75% Series H mortgage bonds of $7 million and in December
1997 of HECO's 7 5/8% Series S mortgage bonds of $10 million. Interest and
other charges in 1997 also included $3.1 million of preferred securities
distributions of HECO'S trust subsidiary. See Note 4 in the "Notes to
Consolidated Financial Statements" for a discussion of the preferred securities
issued by HECO Capital Trust I.
The increase in 1996 was due to interest on drawdowns of tax-exempt special
purpose revenue bond proceeds during 1996, and the full year's interest on the
drawdowns of revenue bond proceeds in 1995. The 1996 increase in interest on
long-term debt was partially offset by lower medium-term note interest resulting
from the retirement of HECO's 5.15% medium-term note of $20 million and MECO's
5.15% medium-term note of $10 million in December 1996.
The increase in interest on long-term debt in 1995 was due to interest on
drawdowns of tax-exempt special purpose revenue bond proceeds during 1995 and
the full year's interest on the drawdowns of revenue bond proceeds in 1994. The
1995 increase in interest on long-term debt was partially offset by lower
interest on first mortgage bonds resulting from the early redemptions in
February 1995 of HECO's 4.55% Series N mortgage bonds of $11 million, and lower
medium-term note interest resulting from the retirement in December 1995 of
HELCO's 4.85% medium-term note of $10 million.
Other interest charges of $7.7 million for 1997 were $1.8 million lower than
for 1996 due to lower interest on short-term borrowings as a result of lower
borrowing levels during 1997, partially offset by higher interest rates. Other
interest charges of $9.5 million for 1996 were $.5 million higher than for 1995
due to higher interest on short-term borrowings as a result of higher borrowing
levels during the year, partially offset by lower interest rates. Other
interest charges of $9.0 million for 1995 were $4.3 million higher than for 1994
due to higher interest on short-term borrowings as a result of higher borrowing
levels during the year and higher interest rates.
5
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS, continued
- --------------------------------------------------------------------------------
COMPETITION
The electric utility industry is becoming increasingly competitive as a result
of various factors including product price, 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.
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.
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
recognizes that Hawaii's stand-alone island energy systems are different from
the interconnected systems of the contiguous states, but also recognizes 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 utility industry.
There are 19 parties in the proceeding including the Consumer Advocate of the
State of Hawaii, HECO, HELCO, MECO, various IPPs, government agencies and
others. The PUC chose two facilitators for a collaborative process that was
instituted by the PUC to "compile information, create a discussion forum, and
narrow the issues on the complexities of restructuring the electric industry in
response to emerging competition." The facilitators held a number of meetings
with the parties, and discussions are ongoing as to the nature and schedule for
further proceedings and discussions. Resolutions have been introduced in the
Hawaii Legislature at the request of one of the parties, the Hawaii Department
of Business, Economic Development, and Tourism, which, if adopted, would request
that the PUC provide specific recommendations to the Legislature by December 31,
1998, for "legislation to implement economical competition" in Hawaii.
REGULATION OF ELECTRIC UTILITY RATES
The PUC has broad discretion in its regulation of the rates charged by the
Company 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.
RECENT RATE REQUESTS
HECO and its 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.
6
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS, continued
- --------------------------------------------------------------------------------
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS. In November 1994, the PUC issued a
D&O that authorized full recovery of PBOP costs, determined pursuant to SFAS
No. 106, of the Company, effective January 1, 1995. The D&O also allowed the
recovery, over the following 18 years, of the regulatory assets related to PBOP
costs. The costs of postretirement executive life insurance, however, were
subsequently disallowed. See Note 11 in the "Notes to Consolidated Financial
Statements."
HAWAIIAN ELECTRIC COMPANY, INC. In July 1993, HECO filed a request to increase
rates based on a 1994 test year. HECO requested an 8.6% increase (as revised)
over rates in effect at the time, or $53.8 million in annual revenues, based on
a 12.75% return on average common equity (ROACE). In December 1994, HECO
received a final D&O authorizing a 6.5%, or $40.5 million, increase in annual
revenues, effective January 1, 1995 and based on a 12.15% ROACE. The final D&O,
together with the PBOP D&O, resulted in a $50.5 million increase in annual
revenues.
In December 1993, HECO filed a request to increase rates based on a 1995 test
year. HECO requested a 4.1% increase (as revised), or $28.2 million in annual
revenues, based on a 13.25% ROACE. In December 1995, HECO received a final D&O
authorizing a 1.3%, or $9.1 million, increase in annual revenues, based on an
11.4% ROACE. The D&O required a refund to customers because HECO had previously
received four interim increases totaling $18.9 million on an annualized basis,
or $9.8 million more than the amount that was finally approved. The reduction
in rate increase resulted primarily from the lower ROACE used by the PUC in the
final D&O because of declining interest rates subsequent to the first interim
increase, which had been effective January 1, 1995 and had been based on a 12.6%
ROACE. The refund amount of $10 million (representing amounts received under
interim rates in excess of final approved rates, with interest thereon) was
accrued in December 1995 and returned to customers in the first half of 1996.
The D&O also did not provide revenue to cover costs relating to postretirement
executive life insurance. HECO and its subsidiaries wrote off a regulatory
asset relating to such costs, resulting in a 1995 after-tax charge of $1.1
million.
HAWAII ELECTRIC LIGHT COMPANY, INC. In November 1993, HELCO filed a request to
increase rates 13.4%, or $15.8 million in annual revenues, based on a 1994 test
year and a 12.4% ROACE (which was later increased to 13.1%). In February
1995, HELCO received a final D&O authorizing an 11.8%, or $13.7 million,
increase in annual revenues, based on a 12.6% ROACE. The final D&O, together
with the PBOP D&O, resulted in a $15.5 million increase in annual revenues.
In March 1995, HELCO filed a request to increase rates based on a 1996 test
year. In February 1996, HELCO revised its requested increase to 6.2%, or
$8.9 million in annual revenues, based on a 12.5% ROACE. In March 1996, HELCO
received an interim D&O authorizing a 4.8%, or $6.8 million, increase in annual
revenues, based on an 11.65% ROACE. In April 1997, HELCO received a final D&O
which made the interim increase final.
HELCO plans to file a request to increase rates, based on a 1999 test year,
primarily to recover the costs related to the anticipated addition of generating
units CT-4 and CT-5 in late 1998, and the anticipated addition of generation
capacity in mid-1999 pursuant to a power purchase agreement with Encogen Hawaii,
L.P.
MAUI ELECTRIC COMPANY, LIMITED. In November 1991, MECO filed a request to
increase rates. In January 1993, MECO revised its requested increase to 9.9%,
or $11.4 million in annual revenues, based on a 13.0% ROACE and a 1993 test
year. In August 1994, MECO received a final D&O authorizing a 7.0%, or $8.1
million, increase in annual revenues, based on a 12.75% ROACE. The final D&O,
together with the PBOP D&O, resulted in a $9.9 million increase in annual
revenues.
In February 1995, MECO filed a request to increase rates based on a 1996 test
year. MECO's final requested increase was 3.8%, or $5.0 million in annual
revenues, based on an 11.5% ROACE. In January 1996, MECO received an interim
D&O authorizing an increase of 2.8%, or $3.7 million in annual revenues, based
on an 11.5% ROACE, effective February 1, 1996. In April 1997, MECO received a
final D&O
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS, continued
- --------------------------------------------------------------------------------
authorizing a 2.9%, or $3.9 million increase in annual revenues, $0.2
million more annually than the interim increase and based on an 11.5% ROACE.
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/U.S. Environmental Protection Agency
(EPA). In December 1997, MECO received a final D&O authorizing no additional
increase in annual revenues, based on an 11.12% ROACE.
In January 1998, MECO received a PSD permit for generating unit M17 and filed
a request to increase rates 15.3%, or $22.4 million in annual revenues, based on
a 12.75% ROACE and a 1999 test year, primarily to recover the costs related to
the anticipated addition of unit M17 in late 1998. The grant of the PSD permit
for this unit was appealed in February 1998.
PUC SHOW CAUSE ORDER FOR HECO. See Note 12 in the "Notes to Consolidated
Financial Statements" for a discussion of the PUC show cause order for HECO.
ENERGY COST ADJUSTMENT CLAUSES. The rate schedules of the electric utility
subsidiaries include energy cost adjustment clauses under which electric rates
are adjusted for changes in the weighted average price paid for fuel oil and
certain components of purchased power, and the relative amounts of company-
generated power and purchased power. Accordingly, changes in fuel oil prices
and certain components of purchased power costs are passed on to customers. In
the December 30, 1997 D&O's approving HECO and its subsidiaries' fuel supply
contracts, the PUC noted that, in light of the length of the fuel supply
contracts and the relative stability of fuel prices, the need for the continued
use of energy cost adjustment clauses will be the subject of investigation in a
generic docket or in a future rate case. In its rate increase application based
on a 1999 test year, MECO stated that it believes that the energy cost
adjustment clause continues to be necessary.
PROPERTY DAMAGE RESERVE. In March 1995, the PUC opened a generic docket to
investigate whether the public utilities in the State of Hawaii should be
allowed to establish property damage reserves to cover the cost of damage to
their facilities and equipment caused by catastrophic disasters. The Company's
overhead transmission and distribution systems are susceptible to wind and
earthquake damage, and its underground systems are susceptible to earthquake and
flood damage. The overhead and underground transmission and distribution systems
(with the exception of substation buildings and contents) have a replacement
value roughly estimated at $2 billion and are uninsured because the amount of
transmission and distribution system insurance available is limited and the
premiums are extremely high. Hearings were held in February 1997 and the
Company is awaiting a PUC D&O.
HELCO POWER SITUATION
See Note 12 in the "Notes to Consolidated Financial Statements."
ACCOUNTING FOR THE EFFECTS OF CERTAIN TYPES OF REGULATION
In accordance with SFAS No. 71, "Accounting for the Effects of Certain Types of
Regulation," the Company's financial statements reflect assets and costs based
on current cost-based rate-making regulations. Management believes HECO and its
subsidiaries' operations currently satisfy the SFAS No. 71 criteria. However,
if events or circumstances should change so that those criteria are no longer
satisfied, management believes that a material adverse effect on the Company's
results of operations, financial position, and/or liquidity would result. See
Note 7 in the "Notes to Consolidated Financial Statements" for further
discussion.
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS, continued
- --------------------------------------------------------------------------------
ENVIRONMENTAL MATTERS
HECO and its subsidiaries are subject to environmental laws and regulations
which could potentially impact the Company in terms of operating existing
facilities, constructing and operating new facilities and ensuring the proper
cleanup and disposal of hazardous waste and toxic substances. Management
believes that the recovery through rates of most, if not all, of any costs
incurred by HECO and its subsidiaries in complying with these environmental
requirements would be allowed by the PUC. Based on information available to the
Company, management is not aware of any contingent liabilities relating to
environmental matters that would have a material adverse effect on the Company.
On July 16, 1997, the EPA adopted national ambient air quality standards for
certain particulate matter and the ozone. The new standards will not require
local pollution controls until 2004 for the ozone and 2005 for particulate
matter, with no compliance determinations until 2007 and 2008, respectively, and
with possible extensions. The eventual impact of these new standards on the
Company is not known at this time.
For a discussion of an ongoing environmental investigation related to Honolulu
Harbor, see Note 12 in the "Notes to Consolidated Financial Statements."
ELECTRIC AND MAGNETIC FIELDS
Research about the potential adverse health effects from exposure to electric
and magnetic fields (EMF) is ongoing. Results have conflicted, but a definite
relationship between EMF and health risks has not been demonstrated. The
National Academy of Sciences examined more than 500 studies and found that "the
current body of evidence does not show that exposure to EMFs presents a human-
health hazard." Further, an extensive study released in 1997 by the National
Cancer Institute and the Children's Cancer Group found no evidence of increased
risk for childhood leukemia from EMF. HECO and its subsidiaries continue to
participate in utility industry funded studies on EMF and, where technically
feasible and economically reasonable, reduce EMF in the design and installation
of new transmission and distribution facilities. Management cannot predict the
impact the EMF issue may have on the Company in the future.
YEAR 2000 READINESS
HECO and its subsidiaries are aware of the Year 2000 issues associated with the
practice of encoding only the last two digits of four digit years in computer-
based systems. Year 2000 issues, if not properly addressed, could result in
disruptions of operations. Management has been actively assessing the impact of
Year 2000 issues and developing an implementation plan to resolve these issues,
which prioritizes systems (e.g. mainframe, distributed and embedded systems),
applications and equipment. HECO and its subsidiaries are in the process of
replacing the majority of its business-critical applications with integrated
application suites that are represented to be Year 2000 ready. Although Year
2000 readiness was a requirement, these application replacements were primarily
driven by business needs. Currently, management estimates that the incremental
cost to renovate other applications and test replacement applications and
systems to become Year 2000 ready will not have a material effect on the
Company's financial condition, results of operations or liquidity. No assurance
can be given that the Company will successfully avoid all problems with the Year
2000 issue.
ACCOUNTING CHANGES
See Note 1 in the "Notes to Consolidated Financial Statements."
EFFECTS OF INFLATION
U.S. inflation, as measured by the U.S. Consumer Price Index, averaged 2.3% in
1997, 3.0% in 1996, and 2.8% in 1995. Hawaii inflation, as measured by the
Honolulu Consumer Price Index, averaged an estimated 1.0% in 1997, 1.5% in 1996
and 2.2% in 1995. Although the rate of inflation over the past three years has
been relatively low compared with the late 1970's and early 1980's, inflation
continues to have an impact on the Company's operations.
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS, continued
- --------------------------------------------------------------------------------
Inflation increases operating costs and the replacement cost of assets. The
Company has significant physical assets and replaces assets at much higher costs
and must request rate increases to maintain adequate earnings. In the past, the
PUC has generally approved rate increases to cover the effects of inflation. In
1997, 1996 and 1995, HECO and/or its subsidiaries received rate increases, in
part to cover increases in construction costs and operating expenses due to
inflation.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------------------------------------------------------
The Company 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 its construction programs and to cover debt and
other cash requirements in the foreseeable future.
Capital expenditures requiring the use of cash, as shown on the "Consolidated
Statements of Cash Flows," totaled approximately $122.1 million in 1997, of
which $75.6 million was attributable to HECO, $28.5 million to HELCO and $18.0
million to MECO. Approximately 76% of the total 1997 capital expenditures was
for transmission and distribution projects, including HECO's Honolulu City line
and, approximately 24% was for generation and general plant projects, including
MECO's Maalaea and HELCO's Keahole combustion turbines. Cash contributions in
aid of construction received in 1997 totaled $7.1 million.
In 1997, the Company's investing activities used $112.8 million in cash,
primarily for capital expenditures. Proceeds from the issuance of long-term
debt of $55.2 million contributed toward funding capital expenditures and other
uses of cash. Cash provided from financing activities also included issuance by
a trust subsidiary of HECO-obligated mandatorily redeemable preferred securities
of $50.0 million. Financing activities used cash for common and preferred
dividends of $62.0 million and for a reduction in short-term borrowings of $30.3
million. Operating activities provided $138.9 million toward cash requirements
of financing activities and capital expenditures.
The Companies' consolidated requirements for funds in the years 1998 through
2002, including net capital expenditures, long-term debt retirements and sinking
fund requirements, are currently estimated to total $644 million. HECO's
consolidated internal sources, after payment of common stock and preferred stock
dividends, are currently expected to provide approximately 85% of the $644
million in total requirements, with debt and equity financing providing the
remaining requirements. As of December 31, 1997, $53.9 million of proceeds from
previous sales by the Department of Budget and Finance of the State of Hawaii of
special purpose revenue bonds for the benefit of HECO, MECO and HELCO remained
undrawn and an additional $88 million of special purpose revenue bonds was
authorized by the Hawaii Legislature for issuance by the Department of Budget
and Finance of the State of Hawaii on behalf of HECO and MECO prior to the end
of 1999. HECO estimates that it will require approximately $15 million in new
common equity, in addition to retained earnings, over the five-year period 1998
through 2002. The PUC must approve issuances of long-term securities for HECO,
HELCO and MECO.
Capital expenditures include the costs of projects which are required to meet
expected load growth, to improve reliability and to replace and upgrade existing
equipment. Net capital expenditures, for the five-year period 1998 through
2002, are currently estimated to total $592 million. Approximately 72% of
forecast gross capital expenditures, including AFUDC and capital expenditures
funded by third-party cash contributions in aid of construction, is for
transmission and distribution projects, with the remaining 28% primarily for
generation projects. At December 31, 1997, purchase commitments other than
those related to fuel and power purchase contracts amounted to approximately $45
million, including amounts for construction projects. See Note 12 in the "Notes
to Consolidated Financial Statements" for a discussion of fuel and power
purchase commitments.
For 1998, net capital expenditures are estimated to be $151 million. Gross
capital expenditures are estimated to be $184 million, comprised of
approximately $121 million for transmission and distribution projects,
approximately $39 million
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS, continued
- --------------------------------------------------------------------------------
for new generation projects and approximately $24 million for general plant and
existing generation projects. Drawdowns of proceeds from previous and future
sales of tax-exempt special purpose revenue bonds, the sale of common stock to
HEI, and funds from internal sources are expected to provide the cash needed for
the net capital expenditures.
Capital expenditure estimates and the timing of construction projects are
reviewed periodically by management and may change significantly as a result of
many considerations, including changes in economic conditions, changes in
forecasts of KWH sales and peak load, the availability of purchased power, the
availability of generating sites and transmission and distribution corridors,
the ability to obtain adequate and timely rate relief, escalation in
construction costs, DSM programs and requirements of environmental and other
regulatory and permitting authorities.
As of February 13, 1998, Standard & Poor's (S&P), Moody's Investors Service
(Moody's) and Duff & Phelps Credit Rating Co.'s (Duff & Phelps) ratings of
HECO's securities were as follows:
<TABLE>
<CAPTION>
S&P Moody's Duff & Phelps
- --------------------------------------------------------------------------
<S> <C> <C> <C>
First mortgage bonds..................... A- A3 A
Revenue bonds and medium term notes...... BBB+ Baa1 A-
Cumulative preferred stock............... BBB baa1 BBB+
Commercial paper......................... A-2 P-2 Duff 1-
HECO-obligated preferred securities of
trust subsidiary........................ BBB baa1 BBB+
- --------------------------------------------------------------------------
</TABLE>
The above ratings are not recommendations to buy, sell or hold any securities;
such ratings may be subject to revision or withdrawal at any time by the rating
agencies; and each rating should be evaluated independently of any other rating.
The Company's management cannot predict with certainty future rating agency
actions or their effects on the future cost of capital to the Company.
11
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
- --------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- ------------------------------------------------------------------------------------
<S> <C> <C> <C>
(in thousands)
OPERATING REVENUES.......................... $1,098,755 $1,071,426 $981,990
---------- ---------- --------
OPERATING EXPENSES:
Fuel oil.................................... 257,002 250,544 207,001
Purchased power............................. 292,852 286,077 276,364
Other operation............................. 148,959 142,699 137,349
Maintenance................................. 49,858 52,305 47,225
Depreciation and amortization............... 82,017 73,453 67,649
Taxes, other than income taxes.............. 104,232 101,387 92,961
Income taxes................................ 52,795 56,170 50,719
---------- ---------- --------
987,715 962,635 879,268
---------- ---------- --------
OPERATING INCOME............................ 111,040 108,791 102,722
---------- ---------- --------
OTHER INCOME:
Allowance for equity funds used during
construction............................... 10,864 11,741 10,202
Other, net.................................. 8,178 8,934 6,123
---------- ---------- --------
19,042 20,675 16,325
---------- ---------- --------
INCOME BEFORE INTEREST AND OTHER CHARGES.... 130,082 129,466 119,047
---------- ---------- --------
INTEREST AND OTHER CHARGES:
Interest on long-term debt.................. 39,783 36,645 34,088
Amortization of net bond premium and
expense.................................... 1,313 1,302 1,273
Other interest charges...................... 7,682 9,504 9,016
Allowance for borrowed funds used during
construction............................... (6,190) (5,862) (5,112)
Preferred stock dividends of subsidiaries... 2,593 2,664 2,759
Preferred securities distributions of
trust subsidiary........................... 3,052 -- --
---------- ---------- --------
48,233 44,253 42,024
---------- ---------- --------
INCOME BEFORE PREFERRED STOCK DIVIDENDS
OF HECO.................................... 81,849 85,213 77,023
Preferred stock dividends of HECO........... 3,660 3,865 4,126
---------- ---------- --------
NET INCOME FOR COMMON STOCK................. $ 78,189 $ 81,348 $ 72,897
========== ========== ========
</TABLE>
CONSOLIDATED STATEMENTS OF RETAINED EARNINGS
- --------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
(in thousands)
RETAINED EARNINGS, BEGINNING OF YEAR... $367,770 $343,425 $308,535
Net income for common stock............ 78,189 81,348 72,897
Common stock dividends................. (58,377) (57,003) (38,007)
-------- -------- --------
RETAINED EARNINGS, END OF YEAR......... $387,582 $367,770 $343,425
======== ======== ========
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
12
<PAGE>
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
<TABLE>
<CAPTION>
December 31 1997 1996
- --------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
ASSETS
UTILITY PLANT, AT COST:
Land................................................................................... $ 32,222 $ 29,897
Plant and equipment.................................................................... 2,559,655 2,446,073
Less accumulated depreciation.......................................................... (904,781) (828,917)
Plant acquisition adjustment, net...................................................... 562 614
Construction in progress............................................................... 205,447 197,835
---------- ----------
NET UTILITY PLANT.................................................................. 1,893,105 1,845,502
---------- ----------
CURRENT ASSETS:
Cash and equivalents................................................................... 1,676 823
Customer accounts receivable, net...................................................... 69,378 76,578
Accrued unbilled revenues, net......................................................... 45,980 43,726
Other accounts receivable, net......................................................... 4,195 4,179
Fuel oil stock, at average cost........................................................ 25,058 28,490
Materials and supplies, at average cost................................................ 18,975 18,942
Prepayments and other.................................................................. 3,335 3,676
---------- ----------
TOTAL CURRENT ASSETS............................................................... 168,597 176,414
---------- ----------
OTHER ASSETS:
Regulatory assets...................................................................... 101,809 98,380
Unamortized debt expense............................................................... 13,085 12,466
Long-term receivable and other......................................................... 35,718 32,784
---------- ----------
TOTAL OTHER ASSETS................................................................. 150,612 143,630
---------- ----------
$2,212,314 $2,165,546
========== ==========
CAPITALIZATION AND LIABILITIES
CAPITALIZATION (see Consolidated Statements of Capitalization):
Common stock equity.................................................................... $ 769,235 $ 751,311
Cumulative preferred stock:
Not subject to mandatory redemption................................................... 48,293 48,293
Subject to mandatory redemption....................................................... 33,175 36,160
HECO-obligated mandatorily redeemable preferred
securities of trust subsidiary holding solely
HECO and HECO-guaranteed subordinated debentures...................................... 50,000 --
Long-term debt, net.................................................................... 597,621 589,226
---------- ----------
TOTAL CAPITALIZATION............................................................... 1,498,324 1,424,990
---------- ----------
CURRENT LIABILITIES:
Long-term debt due within one year..................................................... 30,000 13,000
Preferred stock sinking fund payments.................................................. 2,595 2,795
Short-term borrowings-nonaffiliates.................................................... 95,181 125,920
Short-term borrowings-affiliate........................................................ 400 --
Accounts payable....................................................................... 49,805 66,062
Interest and preferred dividends payable............................................... 12,225 11,034
Taxes accrued.......................................................................... 59,952 55,586
Other.................................................................................. 21,633 24,843
---------- ----------
TOTAL CURRENT LIABILITIES.......................................................... 271,791 299,240
---------- ----------
DEFERRED CREDITS AND OTHER LIABILITIES:
Deferred income taxes.................................................................. 125,509 119,613
Unamortized tax credits................................................................ 48,675 47,634
Other.................................................................................. 70,419 76,264
---------- ----------
TOTAL DEFERRED CREDITS AND OTHER LIABILITIES....................................... 244,603 243,511
---------- ----------
CONTRIBUTIONS IN AID OF CONSTRUCTION................................................... 197,596 197,805
---------- ----------
$2,212,314 $2,165,546
========== ==========
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
13
<PAGE>
CONSOLIDATED STATEMENTS OF CAPITALIZATION
- --------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
<TABLE>
<CAPTION>
December 31 1997 1996
- ------------------------------------------------------------------------------------------
(dollars in thousands, except per share amounts)
<S> <C> <C>
COMMON STOCK EQUITY:
Common stock of $6 2/3 par value.
Authorized: 50,000,000 shares. Outstanding:
1997 and 1996, 12,805,843 shares..................... $ 85,387 $ 85,387
Premium on capital stock.............................. 296,266 298,154
Retained earnings..................................... 387,582 367,770
-------- --------
COMMON STOCK EQUITY............................... 769,235 751,311
-------- --------
CUMULATIVE PREFERRED STOCK:
Authorized: 5,000,000 shares of $20 par value and
7,000,000 shares of $100 par value. Outstanding:
1997, 1,732,357 shares and 1996, 1,764,207 shares.
<CAPTION>
SHARES
OUTSTANDING
PAR DECEMBER 31,
SERIES VALUE 1997
- -------------------------------------------------------
<S> <C> <C>
SERIES NOT SUBJECT TO MANDATORY REDEMPTION:
C-4 1/4% $ 20 (HECO)............ 150,000........... 3,000 3,000
D-5% 20 (HECO)............ 50,000........... 1,000 1,000
E-5% 20 (HECO)............ 150,000........... 3,000 3,000
H-5 1/4% 20 (HECO)............ 250,000........... 5,000 5,000
I-5% 20 (HECO)............ 89,657........... 1,793 1,793
J-4 3/4% 20 (HECO)............ 250,000........... 5,000 5,000
K-4.65% 20 (HECO)............ 175,000........... 3,500 3,500
M-8.05% 100 (HECO)............ 80,000........... 8,000 8,000
A-8 7/8% 100 (HELCO)........... 30,000........... 3,000 3,000
G-7 5/8% 100 (HELCO)........... 70,000........... 7,000 7,000
A-8% 100 (MECO)............ 20,000........... 2,000 2,000
B-8 7/8% 100 (MECO)............ 10,000........... 1,000 1,000
H-7 5/8% 100 (MECO)............ 50,000........... 5,000 5,000
--------- --------- --------
1,374,657........... 48,293 48,293
--------- --------- --------
SERIES SUBJECT TO MANDATORY REDEMPTION:
Q-7.68% $100 (HECO)........... 80,000............ 8,000 8,400
R-8.75% 100 (HECO)........... 150,000............ 15,000 17,000
C-9 1/4% 100 (HELCO).......... --............ -- 200
D-12 3/4% 100 (HELCO).......... 5,000............ 500 550
E-12.25% 100 (HELCO).......... 6,000............ 600 650
F-8.5% 100 (HELCO).......... 60,000............ 6,000 6,000
D-8 3/4% 100 (MECO)........... 6,700............ 670 955
F-13 3/4% 100 (MECO)........... --............ -- 200
G-8.5% 100 (MECO)........... 50,000............ 5,000 5,000
--------- --------- --------
357,700............ 35,770 38,955
--------- --------- --------
Less sinking fund payments due within one year............... 2,595 2,795
--------- --------
33,175 36,160
--------- --------
CUMULATIVE PREFERRED STOCK............................... $ 81,468 $ 84,453
--------- --------
(continued)
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
14
<PAGE>
CONSOLIDATED STATEMENTS OF CAPITALIZATION, continued
- --------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
<TABLE>
<CAPTION>
December 31 1997 1996
- -----------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
HEC0-OBLIGATED MANDATORILY REDEEMABLE PREFERRED
SECURITIES OF TRUST SUBSIDIARY HOLDING SOLELY HECO
AND HECO-GUARANTEED SUBORDINATED DEBENTURES........... $ 50,000 $ --
---------- ----------
LONG-TERM DEBT:
First mortgage bonds:
HECO: 5.75%, paid in 1997............................ -- 13,000
7 5/8%, paid in 1997........................... -- 10,000
HELCO: 7 3/4-7 7/8%, due 2002 through 2003............ 5,000 5,000
MECO: 7 3/4-7 7/8%, paid in 1997..................... -- 7,000
---------- ----------
Total first mortgage bonds....................... 5,000 35,000
---------- ----------
Obligations to the State of Hawaii for the repayment
of Special Purpose Revenue Bonds:
HECO, 5.65%, series 1997A, due 2027................... 50,000 --
HELCO, 5.65%, series 1997A, due 2027.................. 30,000 --
MECO, 5.65%, series 1997A, due 2027................... 20,000 --
HECO, 5 7/8%, series 1996B, due 2026.................. 14,000 14,000
HELCO, 5 7/8%, series 1996B, due 2026................. 1,000 1,000
MECO, 5 7/8%, series 1996B, due 2026.................. 35,000 35,000
HECO, 6.20%, series 1996A, due 2026................... 48,000 48,000
HELCO, 6.20%, series 1996A, due 2026.................. 7,000 7,000
MECO, 6.20%, series 1996A, due 2026................... 20,000 20,000
HECO, 6.60%, series 1995A, due 2025................... 40,000 40,000
HELCO, 6.60%, series 1995A, due 2025.................. 5,000 5,000
MECO, 6.60%, series 1995A, due 2025................... 2,000 2,000
HECO, 5.45%, series 1993, due 2023.................... 50,000 50,000
HELCO, 5.45%, series 1993, due 2023................... 20,000 20,000
MECO, 5.45%, series 1993, due 2023.................... 30,000 30,000
HECO, 6.55%, series 1992, due 2022.................... 40,000 40,000
HELCO, 6.55%, series 1992, due 2022................... 12,000 12,000
MECO, 6.55%, series 1992, due 2022.................... 8,000 8,000
HECO, 7 3/8%, series 1990C, due 2020.................. 25,000 25,000
HELCO, 7 3/8%, series 1990C, due 2020................. 10,000 10,000
MECO, 7 3/8%, series 1990C, due 2020.................. 20,000 20,000
HECO, 7.60%, series 1990B, due 2020................... 21,000 21,000
HELCO, 7.60%, series 1990B, due 2020.................. 4,000 4,000
HECO, 7.35%, series 1990A, due 2020................... 16,000 16,000
HELCO, 7.35%, series 1990A, due 2020.................. 3,000 3,000
MECO, 7.35%, series 1990A, due 2020................... 1,000 1,000
HECO, 7 5/8%, series 1988, due 2018................... 30,000 30,000
HELCO, 7 5/8%, series 1988, due 2018.................. 11,000 11,000
MECO, 7 5/8%, series 1988, due 2018.................. 9,000 9,000
HECO, 6 7/8%, refunding series 1987, due 2012......... 42,580 42,580
HELCO, 6 7/8%, refunding series 1987, due 2012........ 7,200 7,200
MECO, 6 7/8%, refunding series 1987, due 2012......... 7,720 7,720
HELCO, 7.20%, series 1984, due 2014................... 11,400 11,400
---------- ----------
650,900 550,900
Less funds on deposit with trustees................... 53,899 9,132
---------- ----------
Total obligations to the State of Hawaii......... 597,001 541,768
---------- ----------
Other long-term debt - unsecured:
HECO, 5.83% note, due in 1998......................... 30,000 30,000
---------- ----------
Total other long-term debt - unsecured........... 30,000 30,000
---------- ----------
Total long-term debt............................. 632,001 606,768
Less unamortized discount.............................. 4,380 4,542
Less amounts due within one year....................... 30,000 13,000
---------- ----------
LONG-TERM DEBT, NET................................. 597,621 589,226
---------- ----------
TOTAL CAPITALIZATION............................. $1,498,324 $1,424,990
========== ==========
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
15
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- ---------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Income before preferred stock dividends of
HECO............................................. $ 81,849 $ 85,213 $ 77,023
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............................ 82,017 73,453 67,649
Other amortization............................... 9,931 9,198 9,389
Deferred income taxes............................ 5,894 2,690 9,767
Tax credits, net................................. 2,661 3,346 2,698
Allowance for equity funds used during
construction................................... (10,864) (11,741) (10,202)
Changes in assets and liabilities:
Decrease (increase) in accounts receivable..... 7,184 (7,704) (2,345)
Increase in accrued unbilled revenues.......... (2,254) (31) (5,260)
Decrease (increase) in fuel oil stock.......... 3,432 (15,021) 8,497
Decrease (increase) in materials and
supplies..................................... (33) 1,596 (430)
Increase in regulatory assets.................. (4,910) (418) (4,247)
Increase (decrease) in accounts
payable...................................... (16,257) 17,371 (5,971)
Increase in interest and preferred
dividends payable............................ 1,191 1,080 1,379
Other.......................................... (20,934) (16,257) (9,711)
--------- --------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES......... 138,907 142,775 138,236
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.............................. (122,140) (188,161) (184,689)
Contributions in aid of construction.............. 7,089 9,674 10,417
Payments on (issuance of) notes receivable........ 2,291 1,256 (6,825)
--------- --------- ---------
NET CASH USED IN INVESTING ACTIVITIES............. (112,760) (177,231) (181,097)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in short-term
borrowings from nonaffiliates and
affiliate with original maturities
of three months or less.......................... (30,339) (12,833) 20,887
Proceeds from issuance of HECO-obligated
mandatorily redeemable preferred securities
of trust subsidiary.............................. 50,000 -- --
Proceeds from issuance of long-term debt.......... 55,233 114,886 48,544
Repayment of long-term debt....................... (30,000) (30,000) (21,000)
Redemption of preferred stock..................... (3,185) (2,795) (3,094)
Preferred stock dividends......................... (3,660) (3,865) (4,126)
Proceeds from issuance of common stock............ -- 30,000 28,000
Common stock dividends............................ (58,377) (57,003) (38,007)
Other............................................. (4,966) (3,131) 983
--------- --------- ---------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES....................................... (25,294) 35,259 32,187
--------- --------- ---------
Net increase (decrease) in cash and equivalents... 853 803 (10,674)
CASH AND EQUIVALENTS, BEGINNING OF YEAR........... 823 20 10,694
--------- --------- ---------
CASH AND EQUIVALENTS, END OF YEAR................. $ 1,676 $ 823 $ 20
========= ========= =========
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ----------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- ----------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ----------------------------------------------------------------------------
GENERAL
Hawaiian Electric Company, Inc. is engaged in the business of generating,
purchasing, transmitting, distributing and selling electric energy on the island
of Oahu and, through its two electric subsidiaries, on the islands of Hawaii,
Maui, Lanai and Molokai in the State of Hawaii.
BASIS OF PRESENTATION
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles (GAAP). In preparing the consolidated
financial statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities and the reported amounts of revenues and
expenses. Actual results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of regulatory assets and the amounts reported for
pension and other postretirement benefit obligations.
CONSOLIDATION
The consolidated financial statements include the accounts of Hawaiian Electric
Company, Inc. (HECO) and its wholly owned subsidiaries (collectively, the
"Company"), Maui Electric Company, Limited (MECO), Hawaii Electric Light
Company, Inc. (HELCO) and HECO Capital Trust I (Trust). HECO is a wholly owned
subsidiary of Hawaiian Electric Industries, Inc. (HEI).
All significant intercompany accounts and transactions have been eliminated in
consolidation.
PUBLIC UTILITIES COMMISSION REGULATION
The Company is regulated by the Public Utilities Commission of the State of
Hawaii (PUC) and accounts for the effects of regulation under Statement of
Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of
Certain Types of Regulation." As a result, the actions of regulators can affect
the timing of recognition of revenues, expenses, assets and liabilities.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost. The cost of plant constructed
by the Company includes applicable engineering, supervision, administrative and
general expenses, and an allowance for the cost of funds used during the
construction period. Upon the ordinary retirement or sale of electric utility
plant, no gain or loss is recognized. The cost of the plant retired or sold and
the cost of removal (net of salvage obtained) are charged to accumulated
depreciation.
CONTRIBUTIONS IN AID OF CONSTRUCTION
The Company receives contributions from customers for special construction
requirements. As directed by the PUC, the contributions are amortized on a
straight-line basis over 30 years, which approximates the estimated useful lives
of the facilities for which the contributions were received. This amortization
is an offset against depreciation expense.
REVENUES
Revenues are based on rates authorized by the PUC and include revenues appli-
cable to electric energy consumed in the accounting period but not yet billed to
the customers. Revenue amounts recorded under PUC approved interim rate adjust-
ments are subject to refund, with interest, pending final authorization by the
PUC.
The rate schedules of the Company include energy cost adjustment clauses under
which electric rates are adjusted for changes in the weighted average price paid
for fuel oil and certain components of purchased power, and the relative amounts
of company-generated power and purchased power.
17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
POSTRETIREMENT BENEFITS
Pension costs are charged primarily to expense and electric utility plant. The
Company's policy is to fund pension costs in amounts consistent with the
requirements of the Employee Retirement Income Security Act of 1974. Certain
health care and/or life insurance benefits are provided to eligible retired
employees and the employees' beneficiaries and covered dependents. In 1997,
1996 and 1995, these postretirement benefits were charged primarily to expense
and plant. See Note 11.
DEPRECIATION
Depreciation of plant and equipment is computed primarily using the straight-
line method over the estimated useful lives of the assets. Electric utility
plant has average service lives ranging from 20 to 45 years for production
plant, from 25 to 50 years for transmission and distribution plant and from 8 to
45 years for general plant. The composite annual depreciation rate was 3.9% in
1997 and 3.8% in 1996 and 1995.
PREMIUM, DISCOUNT AND EXPENSE
The expenses of issuing long-term debt securities and the premiums or discounts
at which they were sold are amortized against income over the terms of the
respective securities.
ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION
Allowance for funds used during construction (AFUDC) is an accounting practice
whereby the costs of debt and equity funds used to finance plant construction
are transferred from the income statement to construction in progress on the
balance sheet. This procedure removes the effect of the costs of financing
construction activity from the income statement and treats such costs in the
same manner as construction labor and material costs.
The weighted average gross-of-tax AFUDC rate was 9.0% in 1997, 9.2% in 1996
and 9.4% in 1995, and reflected quarterly compounding.
INCOME TAXES
HECO and its subsidiaries are included in the consolidated income tax returns of
HECO's parent, HEI. Income tax expense has been computed for financial
statement purposes as if HECO and its subsidiaries filed separate consolidated
HECO income tax returns.
Deferred income tax assets and liabilities are established for the temporary
differences between the financial reporting basis and the tax basis of the
Company's assets and liabilities at enacted tax rates expected to be in effect
when such deferred tax assets or liabilities are realized or settled.
Federal and state tax credits are deferred and amortized over the estimated
useful lives of the properties which qualified for the credits.
CASH FLOWS
The Company considers cash on hand, deposits in banks, money market accounts,
certificates of deposit, short-term commercial paper and reverse repurchase
agreements with original maturities of three months or less to be cash and
equivalents.
ENVIRONMENTAL EXPENDITURES
The Company is subject to numerous federal and state statutes and governmental
regulations pertaining to water quality, air quality and other environmental
factors. In general, environmental contamination treatment costs are charged to
expense, unless it is probable such costs will be recovered through rates
authorized by the PUC. Also, environmental costs are capitalized if: the costs
extend the life, increase the capacity, or improve the safety or efficiency of
property owned; the costs mitigate or prevent environmental contamination that
has yet to occur and that otherwise may result from future operations; or the
costs are
18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
incurred in preparing property for sale. Liabilities are recorded
when environmental assessments and/or remedial efforts are probable, and the
cost can be reasonably estimated. Corresponding regulatory assets are recorded
when it is probable that such costs would be allowed by the PUC as reasonable
and necessary costs of service to be recovered in future rates.
In October 1996, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 96-1, "Environmental Remediation
Liabilities." The provisions of the SOP are consistent with the Company's
current policies and, accordingly, adoption of the SOP on January 1, 1997 did
not have a material effect on the Company's financial condition, results of
operations or liquidity.
ACCOUNTING CHANGES
COMPREHENSIVE INCOME. In June 1997, the Financial Accounting Standards Board
(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. SFAS No. 130
is effective for fiscal years beginning after December 15, 1997. The Company
will adopt the provisions of SFAS No. 130 in the first quarter of 1998. SFAS
No. 130 requires reclassification of financial statements for earlier periods
provided for comparative purposes. The adoption of SFAS No. 130 is not expected
to have a material effect on the Company's reported financial information.
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. SFAS
No. 131 is effective for periods beginning after December 15, 1997. The Company
will adopt the provisions of SFAS No. 131 in the first quarter of 1998. SFAS
No. 131 requires restatement of comparative information presented for earlier
periods. The adoption of SFAS No. 131 is not expected to have a material effect
on the Company's reported financial information.
2. CUMULATIVE PREFERRED STOCK
- --------------------------------------------------------------------------------
The following series of cumulative preferred stock are redeemable only at the
option of the respective company and are subject to voluntary liquidation
provisions as follows:
<TABLE>
<CAPTION>
Voluntary
liquidation Redemption
price price
December 31, December 31,
Series 1997 1997
- -----------------------------------------------------------
<S> <C> <C>
C, D, E, H, J and K (HECO)... $ 20.00 $ 21.00
I (HECO)..................... 20.00 20.00
M (HECO)..................... 100.00 101.00
A (HELCO).................... 101.00 101.00
G (HELCO).................... 100.00 --
A and B (MECO)............... 101.00 101.00
H (MECO)..................... 100.00 --
- -----------------------------------------------------------
</TABLE>
HELCO's series G and MECO's series H preferred stock may not be redeemed by
the respective subsidiary prior to December 2003.
19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
The following series of cumulative preferred stock are subject to mandatory
sinking fund, voluntary liquidation and optional redemption provisions as
indicated below:
<TABLE>
<CAPTION>
Voluntary Optional
liquidation redemption
Annual sinking fund provision price price
--------------------------------
Number of shares Commencement December 31, December 31,
-----------------
Series Minimum Maximum date 1997 1997
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Q (HECO).... 4,000 4,000 1/15/93 $100.00 $108.56
R (HECO).... 10,000 20,000 1/15/95 100.00 104.67
D (HELCO)... 500 500 10/15/88 104.78 104.78
E (HELCO)... 500 500 10/15/90 105.33 105.33
F (HELCO)... 10,000 20,000 1/15/00 100.00 104.25
D (MECO).... 950 1,900 7/15/89 101.00 101.00
G (MECO).... 8,333 16,667 1/15/00 100.00 104.25
- -------------------------------------------------------------------------------
</TABLE>
Shares redeemed under the annual sinking fund provisions are redeemable at par
value of $100.
Under optional redemption provisions, shares are redeemable at the option of
the respective company at redemption prices shown above. In the event of
voluntary liquidation, preferred shareholders would be entitled, insofar as the
assets of the Company would permit, to the liquidation prices shown above.
The total sinking fund payments on preferred stock subject to mandatory
redemption are expected to amount to $2,595,000 in 1998, $1,595,000 in 1999,
$3,428,000 in 2000, 2001 and 2002 and a total of $21,296,000 thereafter.
HECO is obligated to make dividend, redemption and liquidation payments on the
preferred stock of either of its subsidiaries if the respective subsidiary is
unable to make such payments, provided that such obligation is subordinated to
any obligation to make payments on HECO's own preferred stock.
3. COMMON STOCK
- -------------------------------------------------------------------------------
In 1996 and 1995 HECO issued 503,186 and 489,510 shares of common stock to its
parent, HEI, for $30 million and $28 million, respectively (nil in 1997).
4. HECO-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF TRUST
SUBSIDIARY HOLDING SOLELY HECO AND HECO-GUARANTEED SUBORDINATED DEBENTURES
- -------------------------------------------------------------------------------
In March 1997, HECO Capital Trust I (Trust), a grantor trust and a wholly owned
subsidiary of HECO, sold (i) in a public offering, 2 million of its HECO-
Obligated 8.05% Cumulative Quarterly Income Preferred Securities, Series 1997
(trust preferred securities) with an aggregate liquidation preference of $50
million and (ii) to HECO, common securities with a liquidation preference of
approximately $1.55 million. Proceeds from the sale of the trust preferred
securities and the common securities were used by the Trust to purchase 8.05%
Junior Subordinated Deferrable Interest Debentures, Series 1997 (junior
deferrable debentures) issued by HECO in the principal amount of $31.55 million
and issued by each of MECO and HELCO in the respective principal amounts of $10
million. The junior deferrable debentures, which bear interest at 8.05% and
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 (the "Back-up Undertakings") entered into by HECO in
connection with the issuance of the trust preferred securities, considered
together, constitute a full and unconditional
20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
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 Back-up Undertakings include HECO's (i)
guarantee that the Trust will make periodic distributions and redemption and
liquidation payments to the extent the Trust has funds available therefor, (ii)
the subsidiary guarantees, (iii) obligations under an agreement to pay all
expenses and liabilities of the Trust (other than the obligation of the Trust to
pay amounts due to the holders of the trust preferred securities) and (iv)
obligations under the trust agreement, HECO's junior subordinated debentures and
the respective indentures pursuant to which the junior subordinated debentures
were issued. The junior deferrable debentures and the common securities of the
Trust have been eliminated in HECO's consolidated balance sheet as of 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).
5. LONG-TERM DEBT
- --------------------------------------------------------------------------------
All of the remaining first mortgage bonds of HECO and MECO were redeemed (or
retired) in 1997. The first mortgage bonds of HELCO are secured by an indenture
which purports to be a lien on substantially all of the real and personal
property now owned or hereafter acquired by HELCO.
The funds on deposit with trustees represent the undrawn proceeds from the
issuance of the special purpose revenue bonds and earn interest at market rates.
These funds are available only to pay (or reimburse payment of) expenditures in
connection with certain authorized construction projects and certain expenses
related to the bonds.
At December 31, 1997, the aggregate payments of principal required on long-
term debt during the next five years are $30,000,000 in 1998, nil in 1999, 2000
and 2001 and $2,000,000 in 2002.
In October 1997, the Department of Budget and Finance of the State of Hawaii
issued tax-exempt special purpose revenue bonds in the principal amount of $100
million with a maturity of 30 years and a fixed coupon interest rate of 5.65%,
and loaned the proceeds from the sale to HECO, HELCO and MECO. As of December
31, 1997, proceeds from this and previous sales of special purpose revenue bonds
in the aggregate amount of $53.9 million had not been drawn. Long-term debt
will increase as these proceeds are drawn down in future periods.
6. SHORT-TERM BORROWINGS
- --------------------------------------------------------------------------------
Short-term borrowings from nonaffiliates at December 31, 1997 and 1996 had a
weighted average interest rate of 6.2% and 5.7%, respectively, and consisted
entirely of commercial paper.
The Company maintained bank lines of credit which totaled approximately
$125 million and $170 million at December 31, 1997 and 1996, respectively. The
lines of credit support the issuance of commercial paper. There were no
borrowings against any line of credit during 1997 or 1996.
7. REGULATORY ASSETS
- --------------------------------------------------------------------------------
In accordance with SFAS No. 71, "Accounting for the Effects of Certain Types of
Regulation," the Company's financial statements reflect assets and costs based
on current cost-based rate-making regulations. Continued accounting under SFAS
No. 71 requires that certain criteria be met. A utility's operations or a
portion of its operations can cease to meet the criteria for various reasons,
including a change in the method of regulation or a change in the competitive
environment for regulated services. A utility whose operations or portion of
operations cease to
21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
meet these criteria should discontinue application of SFAS No. 71 and write off
any regulatory assets and liabilities for those operations that no longer meet
the requirements of SFAS No. 71. Management believes the Company's operations
currently satisfy the SFAS No. 71 criteria. However, if events or circumstances
should change so that the criteria are no longer satisfied, management believes
that a material adverse effect on the Company's results of operations, financial
condition and/or liquidity would result.
Regulatory assets are amortized over various periods ranging from 1 to 36
years and include the following deferred costs at December 31, 1997 and 1996:
<TABLE>
<CAPTION>
December 31 1997 1996
- ---------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Income taxes.................................... $ 47,882 $40,944
Postretirement benefits other than pensions..... 26,846 28,636
Integrated resource planning costs.............. 6,951 7,354
Vacation earned, but not yet taken.............. 6,645 6,392
Unamortized debt expense on retired issuances... 5,773 6,207
Preliminary plant costs on suspended project.... 5,759 5,759
Computer system development costs............... 1,022 1,665
Other........................................... 931 1,423
-------- -------
$101,809 $98,380
======== =======
</TABLE>
In 1995, the Company applied to the PUC for recovery of the preliminary plant
costs on suspended project.
8. INCOME TAXES
- --------------------------------------------------------------------------------
The components of income taxes charged to operating expenses were as follows:
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- -------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Federal:
Current..................... $40,728 $46,491 $35,553
Deferred.................... 6,498 3,625 9,761
Deferred tax credits, net... (1,620) (1,796) (1,702)
------- ------- -------
45,606 48,320 43,612
------- ------- -------
State:
Current..................... 3,496 3,688 2,751
Deferred.................... 1,032 741 1,658
Deferred tax credits, net... 2,661 3,421 2,698
------- ------- -------
7,189 7,850 7,107
------- ------- -------
Total........................ $52,795 $56,170 $50,719
======= ======= =======
</TABLE>
Income tax benefits related to nonoperating activities, included in "Other,
net" on the consolidated statements of income, amounted to $260,000, $282,000
and $521,000 for 1997, 1996 and 1995, respectively.
A reconciliation between income taxes charged to operating expenses and the
amount of income taxes computed at the federal statutory rate of 35% on income
before income taxes and preferred stock dividends follows:
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Amount at the federal statutory income tax rate...................................................... $48,033 $ 50,416 $ 45,675
State income taxes on operating income, net of
effect on federal income taxes...................................................................... 4,673 5,102 4,620
Other................................................................................................ 89 652 424
------- -------- --------
Income taxes charged to operating expenses........................................................... $52,795 $ 56,170 $ 50,719
======= ======== ========
</TABLE>
22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
The tax effects of temporary differences which give rise to deferred tax
assets and liabilities were as follows:
<TABLE>
<CAPTION>
December 31 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Deferred tax assets:
Property, plant and equipment....................................................................... $ 10,148 $ 9,217
Contributions in aid of construction and customer
advances.......................................................................................... 54,259 55,305
Other............................................................................................... 12,033 12,357
-------- --------
76,440 76,879
-------- --------
Deferred tax liabilities:
Property, plant and equipment....................................................................... 169,220 163,458
Regulatory assets................................................................................... 18,605 15,878
Other............................................................................................... 14,124 17,156
-------- --------
201,949 196,492
-------- --------
Net deferred income tax liability.................................................................... $125,509 $119,613
======== ========
</TABLE>
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income,
and tax planning strategies in making this assessment.
Based upon the level of historical taxable income and projections for future
taxable income over the periods which the deferred tax assets are deductible,
management believes it is more likely than not the Company will realize the
benefits of these deductible differences. There was no valuation allowance
provided for deferred tax assets as of December 31, 1997, 1996 and 1995.
9. CASH FLOWS
- --------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during 1997, 1996 and 1995 for interest (net of AFUDC-Debt) and income
taxes was as follows:
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- --------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Interest.................. $41,685 $40,235 $36,161
======= ======= =======
Income taxes.............. $44,027 $44,296 $43,148
======= ======= =======
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NONCASH ACTIVITIES
The allowance for equity funds used during construction, which was charged
primarily to construction in progress, amounted to $10,864,000, $11,741,000 and
$10,202,000 in 1997, 1996 and 1995, respectively.
The estimated fair value of noncash contributions in aid of construction
amounted to $1,931,000, $4,680,000 and $10,552,000 in 1997, 1996 and 1995,
respectively.
10. MAJOR CUSTOMERS
- --------------------------------------------------------------------------------
HECO and its subsidiaries derived approximately 10% of their operating revenues
from the sale of electricity to various federal government agencies in 1997,
1996 and 1995. These revenues amounted to $110,410,000 in 1997, $107,606,000 in
1996 and $97,175,000 in 1995.
23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
11. POSTRETIREMENT BENEFITS
- -------------------------------------------------------------------------------
PENSIONS
HECO and its subsidiaries participate in several of HEI's defined benefit
pension plans which cover substantially all employees of HECO and its
subsidiaries. Benefits are based on the employees' years of service and base
compensation.
The funded status of HECO and its subsidiaries' portion of the HEI pension
plans and the amounts recognized in the consolidated financial statements were
as follows:
<TABLE>
<CAPTION>
December 31 1997 1996
- --------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Accumulated benefit obligation:
Vested.................................................. $393,716 $364,663
Nonvested............................................... 37,223 39,533
-------- --------
$430,939 $404,196
======== ========
Projected benefit obligation............................. $529,361 $500,519
Plan assets at fair value, primarily equity securities
and fixed income investments............................ 597,725 528,932
-------- --------
Projected benefit obligation less than plan assets....... (68,364) (28,413)
Unrecognized prior service cost.......................... (171) (252)
Unrecognized net gain.................................... 83,081 43,748
Unrecognized net transition obligation................... (12,314) (14,586)
Adjustment required to recognize minimum liability....... 189 276
-------- --------
Accrued pension liability................................ $ 2,421 $ 773
======== ========
</TABLE>
Plans with an accumulated benefit obligation exceeding plan assets at fair
value were not material. For all pension plans, at December 31, 1997 and 1996,
the assumed discount rate used to measure the projected benefit obligation was
7%.
Net periodic pension cost included the following components:
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- ----------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Service cost-benefits earned during the period... $ 17,012 $ 16,386 $ 12,701
Interest cost on projected benefit obligation.... 34,119 32,274 30,369
Actual return on plan assets..................... (79,733) (65,002) (99,313)
Amortization and deferral, net................... 40,359 29,662 66,253
-------- -------- --------
Net periodic pension cost........................ $ 11,757 $ 13,320 $ 10,010
======== ======== ========
</TABLE>
Of these net periodic pension costs, $7,956,000, $8,968,000 and $6,686,000
were expensed in 1997, 1996 and 1995, respectively, and the remaining amounts
were charged primarily to electric utility plant.
The expected long-term rate of return on assets was 9% for 1997, 1996 and
1995. The assumed rate of increase in future compensation levels was 5% for
1997, 1996 and 1995.
The transition obligation (the projected benefit obligation in excess of plan
assets at January 1, 1987) is being amortized ratably over 16 years beginning in
1987.
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company provides various postretirement benefits other than pensions to
eligible employees upon retirement. Health and life insurance benefits are
provided to eligible employees upon their retirement. Health benefits are
provided with contributions by retirees toward costs based on their years of
service and retirement date. Employees are eligible for these benefits if, upon
retirement,
24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
they participate in one of the Company's defined benefit pension
plans. The Company began funding some of these benefits in December 1994.
In February 1992, the PUC opened a generic docket to determine whether SFAS
No. 106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions," should be adopted for rate-making purposes. Effective January 1,
1993, the Company adopted the provisions of SFAS No. 106. In November 1994, the
PUC issued a decision and order (D&O) authorizing recovery of the full cost of
postretirement benefits other than pensions effective January 1, 1995. The
companies were required to fund the recovered SFAS No. 106 costs. The
regulatory asset established from January 1, 1993 through December 31, 1994 for
postretirement benefits other than pensions is being amortized ratably over 18
years beginning in 1995 for rate-making and financial reporting purposes. In
December 1995, however, the PUC issued a D&O in a rate case proceeding which did
not provide revenue to cover the Company's costs relating to postretirement
executive life insurance and the Company wrote off the regulatory asset relating
to such costs, resulting in a 1995 after-tax charge of $1.l million.
The funded status of the postretirement benefit plans and the amounts
recognized in the consolidated financial statements were as follows:
<TABLE>
<CAPTION>
December 31 1997 1996
- ------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees................................................ $ 57,508 $ 62,559
Fully eligible active plan participants................. 52,910 48,436
Other active plan participants.......................... 63,341 59,586
-------- --------
173,759 170,581
Plan assets at fair value, primarily equity securities
and fixed income investments............................ 61,895 38,595
-------- --------
Accumulated postretirement benefit obligation in
excess of plan assets................................... 111,864 131,986
Unrecognized net gain.................................... 12,923 14
Unrecognized net transition obligation................... (93,737) (99,986)
-------- --------
Accrued postretirement benefits liability................ $ 31,050 $ 32,014
======== ========
</TABLE>
At December 31, 1997 and 1996, the assumed discount rate used to measure the
accumulated postretirement benefit obligation was 7%.
Net periodic postretirement benefit cost included the following components:
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- ---------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Service cost............................... $ 5,926 $ 5,677 $ 4,878
Interest cost.............................. 11,730 11,228 10,836
Actual return on plan assets............... (6,849) (3,078) (937)
Amortization and deferral, net............. 8,975 6,660 6,605
------- ------- -------
Net periodic postretirement benefit cost... $19,782 $20,487 $21,382
======= ======= =======
</TABLE>
In 1997, 1996 and 1995, $14,275,000, $14,664,000 and $15,351,000 of the net
periodic postretirement benefit costs were expensed, respectively, and the
remaining amounts were charged primarily to electric utility plant.
For 1997, 1996 and 1995, the expected long-term rate of return on assets for
trusts whose income was not subject to income taxes was 9%. At December 31,
1997 and 1996, trusts holding plan assets with a fair value of $1.2 million and
$2.3 million, respectively, had income that was subject to income taxes at a
rate of 45%. The after-tax expected long-term rate of return on these plan
assets was 6% for 1997, 1996 and 1995. For 1997, 1996 and 1995, the assumed
rate of increase in future compensation levels was 5%.
25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
At December 31, 1997, the assumed health care trend rates for 1998 and future
years were as follows: medical, 6.5%; dental, 5.0% and vision, 4.0%. The health
care cost trend rate assumption can have a significant effect on the amounts
reported. For example, a 1% increase in the trend rate for health care costs
would have increased the accumulated postretirement benefit obligation at
December 31, 1997 by approximately $23.7 million and the service and interest
costs for 1997 by approximately $2.1 million.
The transition obligation (the accumulated postretirement benefit obligation
at January 1, 1993) is being amortized ratably over 20 years beginning in 1993.
12. COMMITMENTS AND CONTINGENCIES
- --------------------------------------------------------------------------------
INTERIM RATE INCREASES
At December 31, 1997, there were no revenue amounts recognized under interim
rate increases and subject to refund.
FUEL CONTRACTS AND OTHER PURCHASE COMMITMENTS
HECO and its subsidiaries have contractual agreements to purchase minimum
amounts of 0.5% sulfur residual fuel oil (at prices tied to the market prices of
petroleum products in Singapore) and 2.0% sulfur residual fuel oil and 0.4%
sulfur diesel fuel (at prices tied to the market prices of petroleum products in
Los Angeles) through 2004. Based on the average price per barrel prevailing as
of January 1, 1998, the estimated amount of minimum purchases under the fuel
supply contracts for 1998 is $201 million. The actual amount of purchases in
1998 could vary substantially from this estimate as a result of changes in
market prices, quantities actually purchased and other factors. HECO and its
subsidiaries purchased $248 million, $261 million and $194 million of fuel under
prior contractual agreements in 1997, 1996 and 1995, respectively.
At December 31, 1997, the Company had purchase commitments, other than fuel
and power purchase contracts, amounting to approximately $45 million.
POWER PURCHASE AGREEMENTS
At December 31, 1997, the Company had power purchase agreements for 474
megawatts (MW) of firm capacity, representing approximately 22% of the total of
its generating capabilities and purchased power firm capacities. Rate recovery
is allowed for energy and firm capacity payments under these agreements.
Assuming that each of the agreements remains in place and the minimum
availability criteria in the power purchase agreements are met, aggregate
minimum fixed capacity charges are expected to be approximately $110 million in
1998 and 1999, $103 million each in 2000 and 2001, $100 million in 2002 and a
total of $1.8 billion in 2003 through 2028.
In general, payments under the power purchase agreements for 474 MW of firm
capacity are based upon available capacity and energy. Payments for capacity
generally are not required if the contracted capacity is not available, and
payments are reduced, under certain conditions, if available capacity drops
below contracted levels. In general, the payment rates for capacity have been
pre-determined for the terms of the agreements. The energy payment will vary
over the terms of the agreements and the Company may pass on changes in the fuel
component of the energy charges to customers through the energy cost adjustment
clause in its rate schedules. The Company does not operate nor participate in
the operation of any of the facilities that provide power under the agreements.
Title to the facilities does not pass to the Company upon expiration of the
agreements, and the agreements do not contain bargain purchase options with
respect to the facilities.
HECO POWER OUTAGE
On April 9, 1991, HECO experienced a power outage that affected all customers on
the island of Oahu. The PUC initiated an investigation of the April 9, 1991
outage, which was consolidated with a pending investigation of an outage that
occurred in 1988. Power Technologies, Inc. (PTI), an independent consultant
hired
26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
by HECO with the approval of the PUC, investigated the 1991 outage. HECO
is implementing certain of PTI's recommendations and provides the PUC with
summaries of its progress on those recommendations. Management cannot predict
the timing and outcome of any PUC D&O that may be issued, if any, with respect
to the outages.
HELCO POWER SITUATION
BACKGROUND. In 1991, HELCO proceeded with plans to install at its Keahole power
plant site two 20-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 PUC
approved expenditures for CT-4, which HELCO had planned to install in late 1994.
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) an air quality
Prevention of Significant Deterioration/Covered Source permit (PSD permit) for
the Keahole power plant site.
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. Opposing parties filed
a Notice of Appeal of the final judgment in one set of the civil cases and have
filed a motion to stay the project pending resolution of the appeal. Upon entry
of the final judgments in the other civil cases, it is anticipated that further
appeals will be filed. Management believes that HELCO will ultimately prevail
with regard to any appeals which may be taken and that the amended decision of
the Third Circuit Court will be upheld.
PSD PERMIT. In November 1995, the EPA declined to sign HELCO's PSD permit for
the combined-cycle unit. In October 1997, the EPA approved a revised draft
permit and the DOH issued a final PSD permit. Nine appeals from the issuance of
the permit have been filed with the Environmental Appeals Board of the EPA.
Based on the proceedings to date, management believes that HELCO will ultimately
prevail in the appeals.
DECLARATORY JUDGMENT ACTION. 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.
HELCO intends to vigorously defend against the claims raised and management
believes the allegations are without merit.
IPP COMPLAINTS. Two independent power producers (IPPs), Kawaihae Cogeneration
Partners (KCP) and Enserch Development Corporation (Enserch), filed separate
complaints against HELCO with the PUC in 1993 and 1994, respectively, alleging
that they are entitled to power purchase contracts to provide HELCO with
additional capacity which they claim would be a substitute for HELCO's planned
56-MW combined-cycle unit at Keahole. Under HELCO's current estimate of
generating capacity requirements, there is a near term need for capacity in
addition to the capacity which might be provided by either of the proposed IPP
units.
In September 1995, the PUC allowed HELCO to continue to pursue construction
of, and commit expenditures for the second combustion turbine (CT-5) and the
steam recovery generator (ST-7)for its planned combined-cycle unit, stating in
its order that "no part of the project may be included in HELCO's rate base
unless and until
27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
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 IPPs') should be the one that can be most expeditiously put into service at
"allowable cost."
In April 1997, Hilo Coast Processing Company (HCPC) filed a complaint against
HELCO with the PUC, requesting an immediate hearing on HCPC's offer for a new
20-year power purchase contract for its existing facility, which is proposed to
be expanded from 22 MW to 32 MW. HCPC's existing power purchase agreement is
scheduled to terminate at the end of 1999.
ENSERCH COMPLAINT. In January 1998, HELCO filed with the PUC an application
for approval of a power purchase agreement and an interconnection agreement with
Encogen Hawaii, L.P. (an Enserch affiliate) dated October 22, 1997. The
agreements are subject to final nonappealable approval by the PUC. Enserch,
KCP, HCPC and one other IPP have filed motions to intervene in that docket.
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, and 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 a memoranda in opposition to KCP's motions. An evidentiary hearing was
held and briefs were filed by both parties. Action by the PUC is pending.
HCPC COMPLAINT. The PUC converted the HCPC complaint to a purchased power
contract negotiation proceeding. An evidentiary hearing is scheduled for April
1998.
Management cannot determine at this time 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.
COSTS INCURRED. As of December 31, 1997, HELCO's costs incurred in its efforts
to put into service its Keahole combined-cycle unit amounted to $55.1 million,
including approximately $26.8 million for equipment and material purchases,
approximately $11.6 million for planning, engineering, permitting, site
development and other costs and approximately $16.7 million as an allowance for
funds used during construction.
CONTINGENCY PLANNING. In June 1995, HELCO filed with the PUC its generation
resource contingency plan detailing alternatives and mitigation measures to
address possible further delays in obtaining the permits necessary to construct
its combined-cycle unit. 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
update reports with the PUC on the contingency plan and its implementation.
ENVIRONMENTAL REGULATION
In early 1995, the DOH initially advised HECO 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, 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. A Technical Workgroup (comprised of certain of the
parties identified in the December 1995 DOH letter, including HECO, Chevron
U.S.A. Inc., Shell Oil Products Company, State of Hawaii Department of
Transportation Harbors Division and others) was formed to conduct independent
voluntary investigations relative to this issue.
28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
Effective January 30, 1998, the Technical Workgroup and the DOH entered into a
voluntary agreement and scope of work to determine the nature and extent of any
contamination, the responsible parties, and appropriate remedial actions.
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.
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 the 9.16% ROR determined to be reasonable by the PUC in the
utility's last rate case. The amount of 1996 net income represented by the
difference between the two RORs of 9.70% and 9.16% was less than $4.5 million.
In April 1997, HECO filed its response to the PUC's order. HECO indicated the
reported ROR for 1996 was higher than the return used to determine the 1995 test
year revenue requirements primarily due to the impact in 1996 of higher
kilowatthour sales because of normal expected sales growth, increased military
sales and warmer than normal weather. Among other things, HECO explained that
the weighted average cost of capital in 1997 should be higher than the 9.16%
found to be reasonable in HECO's 1995 test year rate case, because a higher
ROACE is appropriate under 1997 market conditions. HECO also pointed out that
it is not compensated in those years when its actual results fall below returns
that were found to be reasonable in the most recent rate case. This point was
subsequently demonstrated when, for 1997, HECO reported a ROACE of 10.26% and a
ROR of 8.75%, both below the returns found to be reasonable in HECO's last rate
case. Management cannot predict what future PUC action may be taken in this
proceeding.
13. REGULATORY RESTRICTIONS ON DISTRIBUTIONS TO PARENT
- --------------------------------------------------------------------------------
At December 31, 1997, net assets (assets less liabilities and preferred stock)
of approximately $410 million were not available for transfer to HEI in the form
of dividends, loans or advances without regulatory approval.
14. RELATED-PARTY TRANSACTIONS
- -------------------------------------------------------------------------------
HEI charged HECO and its subsidiaries for general management and administrative
services totaling $2,230,000, $2,254,000 and $2,469,000 in 1997, 1996 and 1995,
respectively. The amounts charged by HEI to its subsidiaries are allocated
primarily on the basis of actual labor hours expended in providing such
services.
HEI also charged HECO for data processing services totaling $1,871,000,
$3,094,000 and $3,461,000 in 1997, 1996 and 1995, respectively.
HECO's borrowings from HEI fluctuate during the year, and totaled $400,000 and
nil at December 31, 1997 and 1996, respectively. The interest charged on short-
term borrowings from HEI is computed based on HECO's short-term borrowing
interest rate. Interest charged by HEI to HECO totaled $433,000, $289,000 and
$621,000 in 1997, 1996 and 1995, respectively.
15. SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
- -------------------------------------------------------------------------------
HECO and its utility subsidiaries are regulated operating electric public
utilities engaged in the generation, purchase, transmission, distribution and
sale of electricity on the islands of Oahu, Hawaii, Maui, Lanai and Molokai in
the State of
29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
Hawaii. HECO and its subsidiaries provide the only electric public
utility service on the islands they serve. HECO and its subsidiaries grant
credit to customers, all of whom reside or conduct business in the State of
Hawaii.
16. FAIR VALUE OF FINANCIAL INSTRUMENTS
- -------------------------------------------------------------------------------
The following methods and assumptions were used to estimate the fair value of
each applicable class of financial instruments for which it is practicable to
estimate that value:
CASH AND EQUIVALENTS
The carrying amount approximates fair value because of the short maturity of
these instruments.
NOTES RECEIVABLE
Fair value is estimated by discounting future cash flows using rates offered by
local lending institutions for loans of similar terms to companies with
comparable credit risk.
SHORT-TERM BORROWINGS
The carrying amount approximates fair value because of the short maturity of
these instruments.
LONG-TERM DEBT
Fair value is estimated based on quoted market prices for the same or similar
issues of debt.
CUMULATIVE PREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION
There are no quoted market prices for the Company's preferred stocks. Fair
value is estimated based on quoted market prices for similar issues of preferred
stock.
HECO-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF TRUST SUBSIDIARY
HOLDING SOLELY HECO AND HECO-OBLIGATED SUBORDINATED DEBENTURES
Fair value is estimated based on quoted market prices.
The estimated fair values of the Company's financial instruments were as
follows:
<TABLE>
<CAPTION>
December 31 1997 1996
- ------------------------------------------------------------------------------------------
Estimated Estimated
Carrying fair Carrying fair
amount value amount value
- -----------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C>
FINANCIAL ASSETS:
Cash and equivalents....................... $ 1,676 $ 1,676 $ 823 $ 823
Notes receivable........................... 3,278 3,244 5,569 5,500
FINANCIAL LIABILITIES:
Short-term borrowings from
nonaffiliates and affiliate.............. 95,581 95,581 125,920 125,920
Long-term debt, net, including
amounts due within one year.............. 627,621 658,393 602,226 612,192
CUMULATIVE PREFERRED STOCK SUBJECT
TO MANDATORY REDEMPTION, INCLUDING
SINKING FUND REQUIREMENTS.................. 35,770 37,699 38,955 41,086
HECO-OBLIGATED MANDATORILY REDEEMABLE
PREFERRED SECURITIES OF TRUST
SUBSIDIARY HOLDING SOLELY HECO AND
HECO-OBLIGATED SUBORDINATED DEBENTURES..... 50,000 51,000 -- --
- ------------------------------------------------------------------------------------------
</TABLE>
30
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
LIMITATIONS
Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These
estimates do not reflect any premium or discount that could result from offering
for sale at one time the Company's entire holdings of a particular financial
instrument. Because no market exists for a significant portion of the Company's
financial instruments, fair value estimates cannot be determined with precision.
Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing financial instruments without
attempting to estimate the value of anticipated future business and the value of
assets and liabilities that are not considered financial instruments. In
addition, the tax ramifications related to the realization of the unrealized
gains and losses can have a significant effect on fair value estimates and have
not been considered.
31
<PAGE>
NOTES To CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. AND SUBSIDIARIES
- -------------------------------------------------------------------------------
17. SUMMARIZED FINANCIAL INFORMATION
- -------------------------------------------------------------------------------
Summarized financial information for HECO's consolidated electric utility
subsidi-aries, HELCO and MECO, follows:
HAWAII ELECTRIC LIGHT COMPANY, INC.
<TABLE>
<CAPTION>
December 31 1997 1996
- -----------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
BALANCE SHEET DATA
Current assets........................................... $ 28,631 $ 26,345
Noncurrent assets........................................ 403,981 390,464
-------- --------
$432,612 $416,809
======== ========
Common stock equity...................................... $144,761 $143,212
Cumulative preferred stock:
Not subject to mandatory redemption.................... 10,000 10,000
Subject to mandatory redemption, net of sinking fund
payments due within one year......................... 7,000 7,200
Current liabilities...................................... 63,500 73,650
Noncurrent liabilities................................... 207,351 182,747
-------- --------
$432,612 $416,809
======== ========
</TABLE>
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- ------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
INCOME STATEMENT DATA
Operating revenues....................................... $161,120 $153,202 $135,730
Operating income......................................... 18,467 15,984 15,959
Net income for common stock.............................. 15,263 14,673 13,109
- ------------------------------------------------------------------------------------------
</TABLE>
MAUI ELECTRIC COMPANY, LIMITED
<TABLE>
<CAPTION>
December 31 1997 1996
- ------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
BALANCE SHEET DATA
Current assets........................................... $ 31,994 $ 30,701
Noncurrent assets........................................ 374,766 366,489
-------- --------
$406,760 $397,190
======== ========
Common stock equity...................................... $150,129 $147,573
Cumulative preferred stock:
Not subject to mandatory redemption.................... 8,000 8,000
Subject to mandatory redemption, net of sinking fund
payments due within one year......................... 5,575 5,960
Current liabilities...................................... 24,454 41,700
Noncurrent liabilities................................... 218,602 193,957
-------- --------
$406,760 $397,190
======== ========
</TABLE>
<TABLE>
<CAPTION>
Years ended December 31 1997 1996 1995
- ------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
INCOME STATEMENT DATA
Operating revenues....................................... $152,947 $145,776 $128,707
Operating income......................................... 17,882 17,124 16,575
Net income for common stock.............................. 13,260 14,744 11,798
- ------------------------------------------------------------------------------------------
</TABLE>
HECO has not provided separate financial statements and other disclosures
concern-ing MECO and HELCO because management has concluded that such financial
statements and other information are not material to holders of securities
issued by MECO or HELCO which have been fully and unconditionally guaranteed by
HECO.
32
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC. and Subsidiaries
- -------------------------------------------------------------------------------
18. CONSOLIDATED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
- -------------------------------------------------------------------------------
Selected quarterly consolidated financial information for 1997 and 1996 follows:
<TABLE>
<CAPTION>
Quarter ended
------------------------------------------- Year ended
1997 March 31 June 30 Sept. 30 Dec. 31 Dec. 31
- ----------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C> <C>
Operating revenues....... $271,597 $272,972 $280,193 $273,993 $1,098,755
Operating income......... 24,814 26,103 31,240 28,883 111,040
Net income for common
stock.................. 17,164 18,115 22,475 20,435 78,189
---------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
1996
- ----------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C> <C>
Operating revenues....... $245,944 $262,807 $282,395 $280,280 $1,071,426
Operating income......... 24,695 27,608 31,802 24,686 108,791
Net income for common
stock.................. 17,539 19,888 23,839 20,082 81,348
- ----------------------------------------------------------------------------------
</TABLE>
Note: HEI owns all of HECO's common stock, therefore, per share data
is not meaningful.
33
<PAGE>
INDEPENDENT AUDITORS' REPORT
- -------------------------------------------------------------------------------
To the Board of Directors and Stockholder
Hawaiian Electric Company, Inc.:
We have audited the accompanying consolidated balance sheets and consolidated
statements of capitalization of Hawaiian Electric Company, Inc. (a wholly owned
subsidiary of Hawaiian Electric Industries, Inc.) and subsidiaries as
of December 31, 1997 and 1996, and the related consolidated statements of
income, retained earnings and cash flows for each of the years in the three-year
period ended December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Hawaiian
Electric Company, Inc. and subsidiaries as of December 31, 1997 and 1996, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1997 in conformity with generally
accepted accounting principles.
/s/ KPMG Peat Marwick LLP
Honolulu, Hawaii
January 19, 1998
34
<PAGE>
DIRECTORS AND OFFICERS
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC.
DIRECTORS
ROBERT F. CLARKE, 55, 1990 DIANE J. PLOTTS, 62, 1991 (1)
RICHARD HENDERSON, 69, 1970 T. MICHAEL MAY, 51, 1995
EDWIN L. CARTER, 72, 1996 (1) ANNE M. TAKABUKI, 41, 1997
PAUL A. OYER, 57, 1985 PAUL C. YUEN, 69, 1993 (1)
(1) Audit committee member.
Note: Year indicates first elected or appointed. All directors serve one year
terms.
OFFICERS
ROBERT F. CLARKE THOMAS L. JOAQUIN
Chairman of the Board Vice President-Power Supply
T. MICHAEL MAY RICHARD L. O'CONNELL
President and Chief Executive Officer Vice President-Customer Operations
JACKIE MAHI ERICKSON PAUL A. OYER
Vice President-General Counsel and Financial Vice President and
Government Relations Treasurer
CHARLES M. FREEDMAN ERNEST T. SHIRAKI
Vice President-Corporate Excellence Controller
EDWARD Y. HIRATA MOLLY M. EGGED
Vice President-Regulatory Affairs Secretary
THOMAS J. JEZIERNY MARVIN A. HAWTHORNE
Vice President-Energy Delivery Assistant Treasurer
LORIE ANN K. NAGATA
Assistant Treasurer
HAWAII ELECTRIC LIGHT COMPANY, INC.
DIRECTORS
T. MICHAEL MAY DENZIL W. ROSE
RICHARD HENDERSON BARRY K. TANIGUCHI
WARREN H. W. LEE DONALD K. YAMADA
OFFICERS
T. MICHAEL MAY MICHAEL F. H. CHANG
Chairman of the Board Assistant Treasurer
WARREN H. W. LEE PAUL N. FUJIOKA
President Assistant Treasurer
PAUL A. OYER MARVIN A. HAWTHORNE
Financial Vice President and Treasurer Assistant Treasurer
EDWARD Y. HIRATA LORIE ANN K. NAGATA
Vice President Assistant Treasurer
MOLLY M. EGGED DEORNA L. IKEDA
Secretary Assistant Secretary
MAUI ELECTRIC COMPANY, LIMITED
DIRECTORS
T. MICHAEL MAY SANFORD J. LANGA
GLADYS C. BAISA B. MARTIN LUNA
WILLIAM A. BONNET ANNE M. TAKABUKI
OFFICERS
T. MICHAEL MAY MARVIN A. HAWTHORNE
Chairman of the Board Assistant Treasurer
WILLIAM A. BONNET DUANE T. HAYASHI
President Assistant Treasurer
PAUL A. OYER MICHAEL E. KAM
Financial Vice President and Treasurer Assistant Treasurer
EDWARD Y. HIRATA STANLEY T. NAKAMOTO
Vice President Assistant Treasurer
MOLLY M. EGGED LORIE ANN K. NAGATA
Secretary Assistant Treasurer
EILEEN S. WACHI
Assistant Secretary
36
