<PAGE>
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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 23, 1999
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Exact Name of Registrant Commission I.R.S. Employer
as Specified in Its Charter File Number Identification No.
- --------------------------- ----------- ------------------
Hawaiian Electric Industries, Inc. 1-8503 99-0208097
Hawaiian Electric Company, Inc. 1-4955 99-0040500
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State of Hawaii
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(State or other jurisdiction of incorporation)
900 Richards Street, Honolulu, Hawaii 96813
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(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
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(Former name or former address, if changed since last report.)
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<PAGE>
Item 7. Financial Statements and Exhibits.
(c) Exhibits.
HEI Exhibit 13.1 Pages 25 to 66 of HEI's 1998 Annual Report to Stockholders
HECO Exhibit 13.2 Pages 2 to 34 and 36 of HECO's 1998 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 23, 1999 Date: February 23, 1999
1
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HEI Exhibit 13.1
----------------
<TABLE>
<CAPTION>
Selected Financial Data
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Hawaiian Electric Industries, Inc. and subsidiaries
Years ended December 31 1998 1997 1996 1995 1994
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(dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Results of operations
Revenues.......................................... $1,485,165 $1,460,427 $1,402,135 $1,291,644 $1,178,130
Net income (loss)
Continuing operations......................... $ 94,628 $ 91,843 $ 80,555 $ 80,114 $ 74,839
Discontinued operations....................... (9,817) (5,401) (1,897) (2,621) (1,809)
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$ 84,811 $ 86,442 $ 78,658 $ 77,493 $ 73,030
===================================================================================================================================
Basic earnings (loss) per common share
Continuing operations......................... $ 2.96 $ 2.93 $ 2.66 $ 2.75 $ 2.66
Discontinued operations....................... (0.31) (0.17) (0.06) (0.09) (0.06)
- -----------------------------------------------------------------------------------------------------------------------------------
$ 2.65 $ 2.76 $ 2.60 $ 2.66 $ 2.60
==================================================================================================================================
Diluted earnings per common share................. $ 2.64 $ 2.75 $ 2.59 $ 2.65 $ 2.59
==================================================================================================================================
Return on average common equity................... 10.3% 10.9% 10.5% 11.0% 11.0%
==================================================================================================================================
Return on average common equity-
continuing operations *...................... 11.5% 11.6% 10.7% 11.4% 11.3%
==================================================================================================================================
Financial position **
Total assets...................................... $8,199,260 $7,946,206 $5,925,496 $5,591,401 $5,165,872
Deposit liabilities............................... 3,865,736 3,916,600 2,150,370 2,223,755 2,129,310
Securities sold under agreements to repurchase.... 515,330 375,366 479,742 412,521 123,301
Advances from Federal Home Loan Bank.............. 805,581 736,474 684,274 501,274 616,374
Long-term debt.................................... 899,598 794,621 802,126 750,509 710,286
HEI- and HECO-obligated preferred securities of
trust subsidiaries............................. 200,000 150,000 -- -- --
Preferred stock of electric utility subsidiaries***
Subject to mandatory redemption................ 33,080 35,770 38,955 41,750 44,844
Not subject to mandatory redemption............ 48,293 48,293 48,293 48,293 48,293
Stockholders' equity............................... 826,972 814,681 772,852 729,603 682,089
Common stock
Book value per common share **..................... 25.75 25.54 25.05 24.51 23.80
Market price per common share
High........................................... 42.56 41.50 39.50 39.75 36.50
Low............................................ 36.38 32.88 33.25 32.13 29.88
December 31.................................... 40.25 40.88 36.13 38.75 32.38
Dividends per common share......................... 2.48 2.44 2.41 2.37 2.33
Dividend payout ratio.............................. 94% 88% 93% 89% 90%
Dividend payout ratio-continuing operations........ 84% 83% 91% 86% 88%
Market price to book value per common share **..... 156% 160% 144% 158% 136%
Price earnings ratio ****.......................... 13.6x 14.0x 13.6x 14.1x 12.2x
Common shares outstanding (thousands) **........... 32,116 31,895 30,853 29,773 28,655
Weighted-average............................... 32,014 31,375 30,310 29,187 28,137
Stockholders *****................................. 40,793 41,430 41,773 40,436 39,358
Employees **....................................... 3,722 3,672 3,327 3,376 3,386
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* Net income from continuing operations divided by average common equity.
** At December 31.
*** In January 1999, the electric utility subsidiaries redeemed preferred stock (including all preferred stock subject to
mandatory redemption), having a total par value of $47 million.
**** Calculated using December 31 market price per common share divided by basic earnings per common share from continuing
operations.
***** At December 31. Registered stockholders plus participants in the HEI Dividend Reinvestment and Stock Purchase Plan who are
not registered stockholders. At February 12, 1999, HEI had 41,348 stockholders.
See Note 3, "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 15, "Discontinued operations," in the "Notes to Consolidated Financial Statements" for a discussion of the Company's former
property and casualty insurance business and residential real estate development business.
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</TABLE>
25
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations
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The following discussion should be read in conjunction with HEI's 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 from continuing operations of $2.96
in 1998, 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 from continuing operations for 1998 were essentially
flat, increasing only 1% from 1997. Electric utility kilowatthour (KWH) sales
for 1998 were 1% lower than 1997 due to the slow Hawaii economy and cooler
weather, which resulted in lower air conditioning usage. In spite of the lower
sales, the electric utilities' net income increased 3% due to lower expenses, in
large part due to cost containment efforts. American Savings Bank, F.S.B. (ASB)
reported 15% higher net income for 1998 primarily due to the December 1997
acquisition of most of the Hawaii operations of Bank of America, FSB (BoA). The
"other" segment reported higher losses for 1998 primarily due to a prior year
investment gain and higher expenses of start-up operations with independent
power and integrated energy services projects in Asia and the Pacific.
The Company reported basic earnings per share of $2.65 in 1998, down 4% from
1997 and reflecting a net loss of $23.6 million from real estate operations
which HEI's Board of Directors decided in September 1998 to discontinue and a
net gain of $13.8 million from the settlement of HEI's claims against three
insurance carriers relating to the 1994 settlement of a lawsuit concerning the
Company's formerly owned property and casualty insurance subsidiary.
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 HEI Power Corp. (HEIPC) to pursue independent
power and integrated energy services projects in Asia and the Pacific through
new wholly owned subsidiaries (collectively, the HEIPC Group). The HEIPC Group
has a 20-year energy conversion agreement with the Guam Power Authority (GPA),
pursuant to which two oil-fired 25-megawatt (net) units were repaired and are
being operated and maintained, and have an effective 60% interest in a joint
venture formed to construct and operate a 206-megawatt (net) coal-fired power
plant in Inner Mongolia, People's Republic of China (PRC), over a period of
approximately 20 years.
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 a major influence on HEI's 1998 consolidated results.
Following a period of little or no growth since the recession in 1991, the
economy grew moderately in 1998 by 1.8% after inflation. Weaknesses in Asian
economies and currencies (predominantly Japan) have adversely affected two of
Hawaii's key economic drivers, tourism and capital investment. Hawaii's premier
industry, tourism, suffered its first decline after 4 straight years of
increases since 1993. A 4% increase in westbound visitors could not offset an
11% decline in eastbound visitors, resulting in an overall decline in total
visitors of almost 2% to 6.7 million. The construction industry, another key
economic sector, continued its decline in 1998, losing almost 5% of its jobs
despite a boost in capital spending by the state government. Other indicators of
a struggling economic recovery include a low 0.3% population growth rate, a 1%
decline in non-agricultural jobs, and an unemployment rate that continues to be
a full percentage point higher than the nation as a whole.
On the brighter side, Hawaii's tourism industry has been uplifted by the
strong U.S. economy, total personal income continues to grow at a moderate pace,
civilian employment has risen steadily over the last 4 quarters resulting in a
decline in the unemployment rate, inflation is at record lows boosting consumer
spending power, and low prices and interest rates have spurred home resales and
refinancings.
Hawaii's economy is expected to continue growing below 2% annually in the
short- to medium-term future based on the state government's forecast of
positive but slower U.S. economic growth and little or no growth in the Japanese
economy. Positive economic impacts are expected from continued growth in
personal income and laws passed in the last legislative session, including
personal income tax reductions and increased spending for tourism marketing.
Longer term, the state government expects the Asian tourism market to recover,
particularly as Japan's measures to strengthen its economy take root, including
public works spending, banking reforms and income tax reductions.
26
<PAGE>
Following is a general discussion of HEI's consolidated results that should be
read in conjunction with the segment discussions that follow.
Consolidated
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
% % %
1998 change 1997 change 1996 change
- --------------------------------------------------------------------------------------------------------------
(in millions, except per share amounts)
<S> <C> <C> <C> <C> <C> <C>
Revenues......................................... $1,485 2 $1,460 4 $1,402 9
Operating income................................. 225 6 213 12 190 --
Income from continuing operations................ $ 95 3 $ 92 14 $ 81 1
Loss from discontinued operations................ (10) NM (6) NM (2) NM
--------- ---------- ----------
Net income....................................... $ 85 (2) $ 86 10 $ 79 2
--------- ---------- ----------
Basic earnings (loss) per share
Continuing operations......................... $ 2.96 1 $ 2.93 10 $ 2.66 (3)
Discontinued operations....................... (0.31) NM (0.17) NM (0.06) NM
--------- --------- ----------
$ 2.65 (4) $ 2.76 6 $ 2.60 (2)
--------- ---------- ----------
As adjusted /1/
Operating income............................ $ 225 4 $ 217 6 $ 204 7
Income from continuing operations........... 95 -- 94 6 89 11
Net income.................................. 85 (5) 89 2 87 12
Basic earnings per common share -
continuing operations...................... 2.96 (2) 3.01 3 2.93 7
Basic earnings per common share............. 2.65 (6) 2.83 (1) 2.87 8
Weighted-average number of common shares
outstanding..................................... 32.0 2 31.4 4 30.3 4
Dividend payout ratio............................ 94% 88% 93%
Dividend payout ratio -
continuing operations......................... 84% 83% 91%
</TABLE>
NM Not meaningful.
/1/ In December 1997, ASB acquired most of the BoA--Hawaii operations and
incurred one-time acquisition expenses of $2.4 million after tax. In September
1996, the Deposit Insurance Funds Act of 1996 authorized a one-time deposit
insurance premium assessment by the Federal Deposit Insurance Corporation
(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 decrease in 1998 net income from 1997 was due to the loss from the
discontinued real estate operations, partly offset by the settlement received
from director and officer liability insurance carriers. The increase in 1998
income from continuing operations over 1997 was primarily due to a 15% increase
in ASB's net income and a 3% increase in the electric utilities' net income,
offset by the higher net loss from the "other" segment.
. 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 which led to
lower 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.
. Shareholder dividends are declared and paid quarterly by HEI at the
discretion of HEI's Board of Directors. Annual dividends per common share
increased in 1998 to $2.48 from $2.44 in 1997 and $2.41 in 1996.
. HEI and its predecessor company, Hawaiian Electric Company, Inc. (HECO),
have paid dividends continuously since 1901. On January 19, 1999, HEI's Board
maintained the quarterly dividend of $0.62 per common share because the Board's
objective of reducing HEI's dividend payout ratio through earnings growth had
not yet been achieved. However, HEI is beginning to see the results of two of
its growth strategies to increase shareholder value despite Hawaii's slow
economy--the acquisition of BoA's Hawaii operations and the pursuit of
independent power and integrated energy services projects in Asia and the
Pacific. When the Board considers its dividend policy in 2000, it will evaluate
the results of these strategies.
At the indicated annual dividend rate of $2.48 per share and the closing
share price on February 17, 1999 of $35.19, HEI's dividend yield was 7.0%.
27
<PAGE>
Following is a general discussion of revenues, expenses and operating income or
loss by business segment. Segment information is also shown in Note 2 in the
"Notes to Consolidated Financial Statements."
Electric utility
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
% % %
1998 change 1997 change 1996 change
- ----------------------------------------------------------------------------------------------------------
(in millions, except per barrel amounts and number of employees)
<S> <C> <C> <C> <C> <C> <C>
Revenues /1/................................... $1,016 (8) $1,108 2 $1,081 9
Expenses
Fuel oil..................................... 196 (24) 257 3 251 21
Purchased power.............................. 274 (6) 293 2 286 4
Other........................................ 369 (5) 386 4 370 7
Operating income............................... 177 3 172 (1) 174 9
Allowance for funds used
during construction.......................... 16 (6) 17 (3) 18 15
Net income..................................... 81 3 78 (4) 81 12
Return on average common equity................ 10.4% 10.3% 11.2%
Average price per barrel of fuel oil /1/....... $19.14 (24) $25.19 5 $24.08 18
Kilowatthour sales............................. 8,870 (1) 8,963 -- 8,991 2
Number of employees (at December 31)........... 2,020 (4) 2,115 (2) 2,152 (3)
</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 1998, the electric utilities' revenues decreased by 8%, or $92 million,
from 1997. Of this $92 million decrease, $82 million was due to lower fuel oil
prices and $10 million was due to a 1.0% decrease in KWH sales of electricity.
The decrease in KWH sales was partly due to Hawaii's slow economy and partly due
to cooler temperatures, which result in lower residential and commercial air
conditioning usage. The combined 14% decrease in fuel oil and purchased power
expenses is primarily due to lower fuel oil prices, fewer KWHs purchased and
better generating unit efficiency. The 5% decrease in other expenses was due to
a 6% decrease in other operation and maintenance expenses and an 8% decrease in
taxes, other than income taxes, resulting from decreased revenues. The decreases
were partly offset by a 4% increase in depreciation expense as a result of plant
additions. Other operation and maintenance expenses in 1998 decreased primarily
due to lower employee benefit costs, including lower pension costs and
negotiated bargaining unit benefit changes, less generating unit overhaul and
corrective maintenance work, and other cost containment and productivity
improvement efforts. Throughout 1998, salaries and wages were frozen. In spite
of the lower KWH sales, operating income for 1998 increased 3% compared to 1997
due to the lower expenses.
Due to Hawaii's slow economy, the electric utilities' 1999 forecast is for
lower KWH sales, which would impact operating results. Cost containment and
productivity improvement efforts will continue in 1999, but it is expected that
these efforts will not fully offset the effects of the potentially lower sales.
. 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). The increases were partly offset by a 0.3% decrease in KWH sales of
electricity, partly due to cooler weather and 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.
. 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 was 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 ex-
28
<PAGE>
penses, 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.
Competition
The electric utility industry is becoming increasingly competitive. Independent
power producers (IPPs) are well established in Hawaii and continue to actively
pursue new projects. Customer self-generation, with or without cogeneration, has
made inroads in Hawaii and is a continuing competitive factor. 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. HECO has been able to compete successfully by offering
customers economic alternatives that, among other things, employ energy
efficient electrotechnologies such as the heat pump water heater.
Legislation has been introduced in Congress that would restructure the
electric utility industry with a view toward increasing competition by, for
example, allowing customers to choose their generation supplier. Some of the
bills would exempt Alaska and Hawaii. Also, the Department of Energy's proposed
"Comprehensive Electricity Competition Act", submitted to Congress in June 1998,
includes a provision that would permit states to "opt out" of the proposed
retail competition deadline of not later than January 1, 2003.
On December 30, 1996, the PUC instituted a proceeding to identify and
examine the issues surrounding electric competition and to determine the impact
of competition on the electric utility infrastructure in Hawaii. See Note 17 in
the "Notes to Consolidated Financial Statements."
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. As of February 17,
1999, the return on average common equity (ROACE) found by the PUC to be
reasonable in the most recent final rate decision for each utility was 11.4% for
HECO (effective December 11, 1995 and based on a 1995 test year), 11.65% for
Hawaii Electric Light Company, Inc. (HELCO) (effective April 2, 1997 and based
on a 1996 test year) and 11.12% for Maui Electric Company, Limited (MECO)
(effective December 23, 1997 and based on a 1997 test year).
Hawaii Electric Light Company, Inc. In March 1998, HELCO filed a request to
- -----------------------------------
increase rates 11.5%, or $17.3 million in annual revenues, based on a 1999 test
year and a 12.5% ROACE, primarily to recover costs relating to (1) an agreement,
which is subject to PUC approval, to buy power from Encogen's planned 60megawatt
(MW) plant and (2) adding two combustion turbines (CT-4 and CT-5) at HELCO's
Keahole power plant. Depending on future developments with respect to the
Encogen power purchase agreement and with respect to obtaining the necessary
permits for CT-4 and CT-5, HELCO's test year 1999 rate increase application may
be withdrawn, in which case a new application will be filed closer to the time
when the new generation facilities are expected to be completed.
Maui Electric Company, Limited In January 1998, MECO filed a request to
- ------------------------------
increase rates by 15.3%, or $22.4 million in annual revenues, based on a 12.75%
ROACE and a 1999 test year, primarily to recover the costs related to the
addition of a new generation unit in late 1998. In December 1998, MECO received
an interim D&O, effective January 1, 1999, authorizing an 8.5%, or $11.7
million, increase in annual revenues, based on a ROACE of 11.12%, which was the
ROACE authorized in MECO's prior rate case.
29
<PAGE>
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 its
position that the energy cost adjustment clause continues to be necessary.
Commitments and contingencies
See Note 17 in the "Notes to Consolidated Financial Statements."
Savings bank
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
% % %
1998 change 1997 change 1996 change
- -------------------------------------------------------------------------------------------------------------
(in millions)
<S> <C> <C> <C> <C> <C> <C>
Revenues....................................... $ 410 39 $ 294 8 $ 271 7
Net interest income............................ 164 45 113 11 102 9
Operating income............................... 54 20 45 71 26 (35)
Net income..................................... 30 15 26 76 15 (36)
Return on average common equity................ 9.2% 11.0%/2/ 6.8%
As adjusted /1/
Operating income............................. $ 54 10 $ 49 22 $ 40 --
Net income................................... 30 5 29 23 23 --
Return on average common equity.............. 9.2% 12.1%/2/ 10.6%
Interest-earning assets
Average balance /2/.......................... $5,187 40 $ 3,708 11 $3,354 9
Weighted-average yield....................... 7.34% (2) 7.49% (2) 7.62% (1)
Interest-bearing liabilities
Average balance /2/.......................... $5,126 43 $ 3,586 11 $3,233 8
Weighted-average rate........................ 4.23% (8) 4.59% (3) 4.75% (1)
Interest rate spread........................... 3.11% 7 2.90% 1 2.87% (1)
</TABLE>
/1/ In December 1997, ASB acquired most of the BoA--Hawaii operations and
incurred one-time acquisition expenses of $2.4 million after tax. In September
1996, the Deposit Insurance Funds Act of 1996 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.
/2 /Calculated using the average month-end balances during the years.
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 has 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
30
<PAGE>
through the acquisition of loans and other assets and the assumption of $1.7
billion of deposits and other liabilities from BoA-Hawaii.
. ASB's 1998 revenues increased 39% over 1997 due to a 40% higher average
balance of interest-earning assets, reflecting the December 1997 BoA-Hawaii
acquisition and a higher demand for residential lending as the recent relatively
low interest rate environment spurred strong refinancing activity. 1998 net
interest income increased 45% over 1997 due to the higher volume of business and
a higher interest rate spread--the difference between the weighted-average yield
on interest-earning assets and the weighted-average rate on interest-bearing
liabilities. Contributing to the increase in ASB's interest rate spread was the
higher spread on the earning assets and interest-bearing liabilities acquired
from BoA and the decrease in rates paid on ASB's passbook and savings accounts
(reduced by 50 basis points) and checking accounts (reduced by 25 basis points),
effective October 1, 1998.
The significant increase in operating income reflects the full year of
earnings after the December 1997 acquisition. The higher results and 9.2% ROACE
for 1998, however, were not as high as expected, partly due to the effects of a
flat yield curve, rising delinquencies, Year 2000 remediation expenses and the
costs to integrate the BoA operations (including consulting expenditures to
consolidate and streamline operations). With the slow Hawaii economy leading to
higher delinquencies, ASB's allowance for loan losses increased by $10 million
to $40 million in 1998. ASB's ratio of net charge-offs to average loans
outstanding, however, still remained relatively low at 0.13% for 1998 compared
to an annualized 0.18% for all U.S. thrifts for the first nine months of 1998.
Despite a 20% increase in operating income, ASB and subsidiaries' 1998
income taxes were flat compared to 1997 income taxes. In March 1998, ASB formed
a wholly owned operating subsidiary, ASB Realty Corporation, which elects to be
taxed as a real estate investment trust. This reorganization has reduced ASB's
income taxes by $2.5 million for 1998. The State of Hawaii, however, has
indicated that it may challenge the tax treatment of this reorganization. ASB,
however, believes that its tax position is proper.
. 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 higher net average
balance of interest-earning assets and a slightly higher interest rate spread.
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. Taking into account the BoA acquisition, in 1997
ASB's allowance for loan losses increased by $11 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 the average for all U.S. thrifts at
0.29%.
. 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 allowance for
loan losses increased by $6 million to $19 million. ASB's ratio of net charge-
offs to average loans outstanding, however, remained relatively low at 0.07% for
1996 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.
Other
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
% % %
1998 change 1997 change 1996 change
- ------------------------------------------------------------------------------------------
(in millions)
<S> <C> <C> <C> <C> <C> <C>
Revenues.......................... $ 59 -- $ 59 18 $ 50 3
Operating loss.................... (6) (71) (4) 61 (10) (11)
</TABLE>
31
<PAGE>
The "other" business segment includes results of operations of Hawaiian Tug &
Barge Corp. (HTB) and its subsidiary, Young Brothers, Limited (YB), maritime
freight transportation companies; HEI Investment Corp. (HEIIC), a company
primarily holding investments in leveraged leases; the HEIPC Group, companies
formed to pursue independent power and integrated energy services projects in
Asia and the Pacific; Pacific Energy Conservation Services, Inc., a contract
services company primarily providing windfarm operational and maintenance
services to an affiliated electric utility; HEI District Cooling, Inc., a
company formed to develop, build, own, operate and/or maintain central chilled
water, cooling system facilities, and other energy related products and
services; ProVision Technologies, Inc., a company formed to sell, install,
operate and maintain on-site power generation equipment and auxiliary appliances
in Hawaii and the Pacific Rim; Hawaiian Electric Industries Capital Trust I, HEI
Preferred Funding, LP and Hycap Management, Inc., companies formed primarily for
the purpose of effecting the issuance in 1997 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 $5.0
million in 1998, $2.2 million in 1997 and $3.0 million in 1996. Although 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, 1998 operating
income was higher than 1997 due to higher general freight revenues, resulting
from increased rates and cargo moved, and lower operating expenses, resulting
from lower labor related expenses and a PUC approved sailing schedule
modification. 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
October 1997, YB received a final D&O authorizing a 4.7%, or $1.7 million
increase in annual revenues, based on a 14.1% ROACE.
. HEIIC recorded operating income of $0.8 million in 1998, $4.6 million in
1997 and $0.1 million in 1996. In 1997, HEIIC recognized in pretax income $3.9
million, representing its proportionate share of income from an investment in
UTECH Venture Capital Corporation, which liquidated its investment in Ciena
Corporation. No new significant 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 and integrated energy
services projects in Asia and the Pacific. HEIPC's consolidated operating loss
was $3.2 million in 1998, $2.0 million in 1997 and $2.6 million in 1996. The
increase in the 1998 operating loss was due to increased China business
development expenses, partly offset by operating income from the HEIPC Group's
first project in Guam. The decrease in operating loss for 1997 was due to
operating income from the Guam project.
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-MW (net) units 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 U.S.
Environmental Protection Agency. GPA, however, has agreed to indemnify and hold
HPG harmless from any pre-existing environmental liability.
In September 1998, HEIPC (through a wholly owned, indirect subsidiary)
acquired an effective 60% interest in a joint venture, Baotou Tianjiao Power
Co., Ltd., formed to design, construct, own, operate and manage a 206-MW (net)
coal-fired power plant to be located inside Baotou Iron & Steel (Group) Co.,
Ltd.'s (BaoSteel's) complex in Inner Mongolia, PRC. BaoSteel, a state-owned
enterprise and the fifth largest steel company in China, is a 25% partner in the
joint venture and will purchase all the electricity generated. Ownership of the
plant will be transferred, without charge, to BaoSteel in approximately 20
years. BaoSteel's current demand of 400 MWs is expected to exceed 700 MWs by the
year 2000, following the completion of a plant modernization to improve
production capability. Construction has commenced and the units are expected to
be on line by the end of 2000. The HEIPC Group has committed to invest up to
$100 million.
In December 1998, HEIPC (through a wholly owned, indirect subsidiary)
invested $7.6 million to acquire convertible cumulative nonparticipating 8%
preferred shares in Cagayan Electric Power & Light Co., Inc. (CEPALCO), an
electric distribution company in the Philippines. The acquisition is a strategic
move which puts the HEIPC Group in a position to participate in the eventual
privatization of the National Power Corporation and growth in the electric
distribution business in the Philippines.
32
<PAGE>
The HEIPC Group is actively pursuing other projects in Asia and the Pacific.
The success of any project undertaken by the HEIPC Group will be dependent on
many factors, including the economic, political, monetary, technological,
regulatory and logistical circumstances surrounding each project and the
location of the project. Due to political or regulatory actions or other
circumstances, projects may be delayed or even prohibited. There is no assurance
that any project undertaken by the HEIPC Group will be successfully completed or
that the HEIPC Group's investment in any such project will not be lost, in whole
or in part.
See Note 17 in the "Notes to Consolidated Financial Statements" for a
discussion of the HEIPC Group's commitment with respect to the China project.
The HEIPC Group is pursuing additional international projects that are subject
to approval by the HEIPC and HEI Boards of Directors.
. The corporate and other subsidiaries' operating loss was $9.1 million in
1998, $8.6 million in 1997 and $10.4 million 1996.
Discontinued operations
- --------------------------------------------------------------------------------
See Note 15 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 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 4 in the "Notes to Consolidated
Financial Statements."
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.
Also, see the HEIPC Group discussion under "Other" above and Note 17 in the
"Notes to Consolidated Financial Statements."
Year 2000 issue
- --------------------------------------------------------------------------------
The following discussion includes numerous forward-looking statements. See
"Forward-Looking Information."
HEI consolidated
The Company is aware of the Year 2000 date issues associated with the practice
of encoding only the last two digits of four digit years in computer equipment,
software and devices with embedded technology. Year 2000 date issues, if not
properly addressed, may result in computer errors that could cause a disruption
of business operations. Further, the Company could be adversely impacted by Year
2000 date issues if suppliers, customers and other related businesses do not
address the issues successfully. HEI and subsidiary management have developed
Year 2000 programs and have teams in place that are actively assessing,
renovating, validating and implementing Year 2000 ready systems. All significant
computer-based systems are being included in the inventory and assessment
process. Priority is being given to systems that are considered mission or
business critical. HEI and each business unit have appointed a Year 2000 project
manager who provides periodic reporting to their respective senior management
and board of directors.
Both the electric utility and the savings bank segments are subject to
external oversight by their respective regulators. Although substantial effort
is being devoted to the Year 2000 issue, no absolute assurance can be given that
the Company will successfully avoid all problems that may arise. Further, no
absolute assurance can be given that the Year 2000 problems of other entities
will not have a material adverse impact on the Company's systems or results of
operations.
Costs. Management believes that the cost to remediate its systems to become
- ------
Year 2000 ready will not have a material adverse effect on the Company's
financial condition, results of operations or liquidity. The total cost of
initiatives undertaken primarily for Year 2000 remediation is estimated at $9
million, of which approximately $3 million has been incurred through December
31, 1998. The cost to remediate systems and the target dates provided below
represent management's best estimates at this time. These estimates are based on
information provided by various work units within the Company and
33
<PAGE>
external parties such as vendors and business partners. Numerous assumptions
have been made regarding future dates, including the continued availability of
internal and external resources, third party remediation plans and the
successful testing of mission critical systems.
Electric utility
State of readiness. HECO and its subsidiaries have identified information
- -------------------
technology (IT) and non-IT systems which will require Year 2000 remediation
work. HECO has prioritized these systems by importance, business risk and Year
2000 exposure, allocating resources accordingly. Remediation work for each of
the systems includes an assessment phase, a renovation and validation phase and
an implementation phase. Overall, the assessment phase is substantially complete
for HECO and its subsidiaries' systems and it is roughly estimated that 40% of
the renovation and validation phase has been completed as of December 31, 1998,
with lesser amounts of work completed on the implementation phase. The scheduled
completion date for each system is before the date it is expected to encounter
any Year 2000 impact (not later than September 1999).
In December 1998, HECO and its subsidiaries replaced the majority of their
business-critical applications with an integrated application suite that is
represented to be Year 2000 ready. The installation of an integrated application
suite has both simplified and lowered the cost of Year 2000 remediation efforts.
HECO and its subsidiaries have identified third parties with whom they have
significant relationships and are corresponding with these vendors and service
providers to determine their Year 2000 readiness. Significant third parties
include fuel suppliers, independent power producers, financial institutions and
large customers. Letters have been sent to 282 vendors and 83% have responded to
the inquiry. HECO has formed an Oahu Power Partners Year 2000 Group to provide a
forum to share information among HECO, independent power producers and fuel
suppliers. HECO has contracted with two of its major vendors of power plant
equipment for their services in assessing, remediating and testing their
installed control systems. HECO and these vendors have completed remediation of
seven of HECO's 16 generating units and have tested three of the seven.
Costs. HECO management believes that the cost to remediate its systems to
- ------
become Year 2000 ready will not have a material adverse effect on consolidated
HECO's financial condition, results of operations or liquidity. The total cost
of initiatives undertaken primarily for Year 2000 remediation is estimated at $2
million, of which $0.3 million has been incurred through December 31, 1998.
Risks. The Year 2000 remediation effort addresses two distinct areas of risk--
- ------
(1) electric systems, which deliver power to customers, and (2) business
systems, which handle data processing. Importantly, neither the generation nor
distribution systems are fully dependent on automated control systems. Because
HECO and its subsidiaries have the capability to manually control the generation
and dispatching of power and have some degree of diversity and redundancy in
their systems, HECO believes the most reasonably likely worst case scenario
would be brief, localized power outages and billing, collection and/or reporting
errors or delays.
Contingency plans. Contingency plans in the event of a Year 2000 problem are
- ------------------
being developed for HECO and its subsidiaries. HECO and its subsidiaries will
have personnel on standby at midnight on December 31, 1999 and on other critical
dates in 1999 and 2000, as deemed necessary. Work crews will be able to manually
operate equipment, making a prolonged power outage unlikely.
Savings Bank
State of readiness. ASB and its subsidiaries follow guidelines provided by the
- -------------------
Office of Thrift Supervision (OTS), which require ASB to first renovate its
mission critical systems. ASB, in its assessment, identified IT and non-IT
mission critical systems requiring Year 2000 remediation work. IT systems
include outsourced and in-house mainframe systems and applications, licensed
vendor applications, ATMs, desktop applications and high speed check sorting.
ASB has prioritized these systems by importance, business risk, and Year 2000
exposure, allocating resources accordingly.
The OTS guidelines use a five-phase approach to Year 2000 issues--an
awareness phase, assessment phase, renovation phase, validation phase and
implementation phase. As of December 31, 1998, the assessment and renovation of
ASB's internal mission critical systems has been completed. Validation (79%
complete) and implementation (54% complete) are the focal
34
<PAGE>
points for ASB's remaining Year 2000 effort. As of December 31, 1998, ASB had
substantially completed its internal mission critical testing. Testing with
business partners, service providers and vendors is expected to occur during the
first quarter of 1999. ASB is targeting to implement all renovated mission
critical systems by June of 1999.
ASB and its subsidiaries identified third parties with whom they have
significant relationships including software-hardware systems providers, large
customers and a service bureau. ASB has implemented a Customer Impact Program
that monitors the activities of its large business and deposit customers. ASB
monitors its service and supply vendors for Year 2000 compliance and 319 of 426
vendors have responded that they are compliant or are making efforts to be
compliant by January 1, 2000. Adequate time is being factored into the planning
to allow movement to an alternative service provider or suppliers. ASB should
reach decisions on whether to continue doing business with current suppliers and
vendors by June 30, 1999.
Costs. The total cost of initiatives undertaken by ASB primarily for Year 2000
- ------
remediation is estimated at $6 million, of which approximately $3 million has
been incurred through December 31, 1998.
Risks. The Year 2000 remediation effort addresses various areas of risk,
- ------
primarily in ASB's business systems, including in-house applications, vendor
applications, service bureau applications and electronic banking. ASB believes
that the most likely worst case scenario would be a localized disruption of
customer services. ASB believes off-line processing at any branch site is
feasible for up to five working days.
Contingency plans. ASB's overall contingency plan provides the broad steps that
- ------------------
ASB could take if entire systems or partial systems were lost. During 1998, ASB
engaged a consultant who assisted in the development of detailed contingency
plans for mission critical systems. ASB is using these contingency plans to
develop similar detailed plans for other departments. ASB's contingency plans
include implementing off-line or manual procedures, implementing stand-in
programs, activating the disaster recovery plan and relocating certain
operations to the recovery site. ASB will backup critical reports and files
prior to yearend 1999. Further, ASB and its subsidiaries will have personnel on
standby at midnight on December 31, 1999 and on other critical dates in 1999 and
2000, as deemed necessary.
Effects of inflation
- --------------------------------------------------------------------------------
U.S. inflation, as measured by the U.S. Consumer Price Index, averaged 1.6% in
1998, 2.3% in 1997 and 3.0% in 1996. Hawaii inflation, as measured by the
Honolulu Consumer Price Index, averaged an estimated (0.2)% in 1998, 0.7% in
1997 and 1.5% in 1996. 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 and obtain rate increases
to maintain adequate earnings. In the past, the PUC has generally approved rate
increases to cover the effects of inflation. In 1999, 1997 and 1996, 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 $8.2 billion and $7.9 billion at December
31, 1998 and 1997, respectively. Asset growth in 1998 primarily stemmed from the
growth in loans and cash at the savings bank and the electric utilities' capital
expenditures program. Asset growth in 1997 primarily stemmed from the
acquisition of most of BoA's Hawaii operations.
35
<PAGE>
The consolidated capital structure of HEI was as follows:
<TABLE>
<CAPTION>
December 31 1998 1997
- ------------------------------------------------------------------------------------------------------
(in millions)
<S> <C> <C> <C> <C>
Short-term borrowings.................................................. $ 223 10% $ 285 14%
Long-term debt......................................................... 900 40 794 37
HEI- and HECO-obligated preferred securities of trust subsidiaries..... 200 9 150 7
Preferred stock of electric utility subsidiaries....................... 81 4 84 4
Minority interests..................................................... 4 - -- -
Common stock equity.................................................... 827 37 815 38
- ------------------------------------------------------------------------------------------------------
$2,235 100% $2,128 100%
======================================================================================================
</TABLE>
ASB's deposit liabilities, securities sold under agreements to repurchase,
advances from the FHLB of Seattle and retail repurchase agreements are not
included in the table above.
In February 1999, the Standard & Poor's (S&P) and Moody's Investors Service's
(Moody's) ratings of HEI's and HECO's securities were as follows:
<TABLE>
<CAPTION>
S&P Moody's
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
HEI
- -----
Commercial paper..................................................................... A-2 P-2
Medium-term notes.................................................................... BBB Baa2
HEI-obligated preferred securities of trust subsidiary............................... BB+ baa3
HECO
- ------
Commercial paper..................................................................... A-2 P-2
Revenue bonds........................................................................ BBB+ Baa1
HECO-obligated preferred securities of trust subsidiaries............................ BBB- baa1
Cumulative preferred stock........................................................... BBB- baa2
</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.
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 $219 million in 1998, $180 million
in 1997 and $162 million in 1996. Investing activities used net cash of $233
million in 1998, $208 million in 1997 and $413 million in 1996. In 1998, net
cash used for investing activities consisted primarily of the origination and
purchase of loans (net of repayments) and capital expenditures, partly offset by
a decrease in mortgage-backed securities. Financing activities provided net cash
of $161 million in 1998, $191 million in 1997 and $218 million in 1996. In 1998,
cash was provided by the net increases in certain liabilities (securities sold
under agreements to repurchase, advances from the FHLB of Seattle and long-term
debt) and the proceeds from the issuances of HECO-obligated preferred securities
and common stock, partly offset by common stock dividends, preferred securities
distributions and net decreases in deposit liabilities and short-term
borrowings.
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 expected to not 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 13 in the "Notes to Consolidated
Financial Statements."
Total HEI consolidated financing requirements for 1999 through 2003, 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 preferred stock retirements, are estimated to total $1.2
billion. Of this amount, approximately $0.8 billion is for net capital
expenditures (mostly relating to the electric utilities' net capital
expenditures described below). HEI's consolidated internal sources, after the
payment of HEI dividends, are expected to provide
36
<PAGE>
approximately 55% 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 1999-2003
forecast, such as the development of additional independent power projects by
the HEIPC Group in Asia and the Pacific, or to fund changes in requirements,
such as increases in the amount of or an acceleration of capital expenditures of
the electric utilities.
In February 1997, Hawaiian Electric Industries Capital Trust I issued $100
million of its 8.36% Company-obligated preferred securities. In March 1997, HECO
Capital Trust I issued $50 million of its 8.05% HECO-obligated cumulative
quarterly income preferred securities. In December 1998, HECO Capital Trust II
issued $50 million of its 7.30% HECO-obligated cumulative quarterly income
preferred securities. See Note 7 in the "Notes to Consolidated Financial
Statements."
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 1998 1997
- ------------------------------------------------------------------------------------------------
(in millions)
<S> <C> <C> <C> <C>
Short-term borrowings from nonaffiliates and affiliate.......... $ 139 8% $ 96 6%
Long-term debt.................................................. 622 36 628 39
HECO-obligated preferred securities of trust subsidiaries....... 100 6 50 3
Preferred stock
Subject to mandatory redemption............................... 33 2 36 2
Not subject to mandatory redemption........................... 48 3 48 3
Common stock equity............................................. 787 45 769 47
- ------------------------------------------------------------------------------------------------
$1,729 100% $1,627 100%
================================================================================================
</TABLE>
In 1998, the electric utilities' investing activities used $122 million in cash,
primarily for capital expenditures. Financing activities provided net cash of
$18 million, including the proceeds from the issuance of HECO-obligated
preferred securities of $50 million and a net increase in short-term borrowings
of $44 million, offset by common and preferred stock dividends, preferred
securities distributions and a net decrease in long-term debt. Operating
activities provided $158 million toward capital expenditures and other cash
requirements.
The electric utilities' consolidated financing requirements for 1999 through
2003, including net capital expenditures, long-term debt retirements and
preferred stock retirements, are estimated to total $660 million. HECO's
consolidated internal sources, after the payment of common stock and preferred
stock dividends, are expected to provide approximately 78% of the consolidated
financing requirements, with debt and equity financing providing the remaining
requirements. As of December 31, 1998, $30 million of proceeds from previous
sales by the Department of Budget and Finance of the State of Hawaii of special
purpose revenue bonds issued for the benefit of HECO, MECO and HELCO remain
undrawn. Also as of December 31, 1998, an additional $88 million of special
purpose revenue bonds were authorized by the Hawaii Legislature for issuance for
the benefit of HECO and MECO prior to the end of 1999 and an additional $100
million of revenue bonds were authorized for issuance for the benefit of HECO
and HELCO prior to the end of 2003. HECO estimates that it will require
approximately $28 million in new common equity, in addition to retained
earnings, over the five-year period 1999 through 2003. 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 1999 through 2003
are currently estimated to total $608 million. Approximately 75% 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 25% primarily for generation projects. See Note 17 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 1999, electric utility net capital expenditures are estimated to be $142
million. Gross capital expenditures are estimated to be $157 million, comprised
of approximately $120
37
<PAGE>
million for transmission and distribution projects, approximately $12 million
for new generation projects and approximately $25 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.
Management periodically reviews capital expenditure estimates and the timing
of construction projects. These estimates may change significantly as a result
of many considerations, including changes in economic conditions, changes in
forecasts of KWH sales and peak load, the availability of purchased power, the
availability of generating sites and transmission and distribution corridors,
the ability to obtain adequate and timely rate increases, escalation in
construction costs, DSM programs and requirements of environmental and other
regulatory and permitting authorities.
<TABLE>
<CAPTION>
Savings bank
- -----------------------------------------------------------------------------------------------------
% %
December 31 1998 change 1997 change
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(in millions)
Assets.......................................................... $5,692 3 $5,548 55
Loans receivable, net........................................... 3,143 4 3,036 52
Mortgage-backed securities...................................... 1,791 (4) 1,865 39
Deposit liabilities............................................. 3,866 (1) 3,917 82
Securities sold under agreements to repurchase.................. 515 37 375 (22)
Advances from FHLB.............................................. 806 9 736 8
</TABLE>
As of December 31, 1998, ASB was the third largest financial institution in the
state based on assets of $5.7 billion and deposits of $3.9 billion. In 1997,
ASB's 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, 1998, loans which do not accrue interest totaled $85.5
million or 2.7% of net loans outstanding, compared to $71.8 million or 2.4% at
December 31, 1997. At December 31, 1998, there were 42 properties acquired in
settlement of loans valued at $5.6 million.
For 1998, investing activities used net cash of $87 million, primarily due to
the origination and purchase of loans (net of repayments) partly offset by
repayments of mortgage-backed securities (net of purchases). Net cash provided
by financing activities in 1998 was $135 million, due largely to net increases
of $139 million in securities sold under agreements to repurchase and $69
million in advances from FHLB, partly offset by a net decrease of $51 million in
deposit liabilities and by $20 million in common and preferred stock dividends.
Minimum liquidity levels are currently governed by the regulations adopted by
the OTS. ASB was in compliance with OTS liquidity requirements as of December
31, 1998.
ASB believes that a satisfactory regulatory capital position provides a basis
for public confidence, affords protection to depositors, helps to ensure
continued access to capital markets on favorable terms and provides a foundation
for growth. As of December 31, 1998, ASB was in compliance with the OTS minimum
capital requirements (ratio requirements noted in parentheses) with a tangible
capital ratio of 5.3% (1.5%), a core capital ratio of 5.3% (3.0%) and a risk-
based capital ratio of 12.7% (8.0%).
FDIC regulations restrict the ability of financial institutions that are not
"well-capitalized" to offer interest rates on deposits that are significantly
higher than the rates offered by competing institutions. As of December 31,
1998, ASB was "well-capitalized" (ratio requirements noted in parentheses) with
a leverage ratio of 5.3% (5.0%), a Tier-1 risk-based ratio of 11.7% (6.0%) and a
total risk-based ratio of 12.7% (10.0%).
Significant interstate banking legislation has been enacted at both the
federal and state levels. Under the federal Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994, a bank holding company may acquire control of
a bank in any state, subject to certain restrictions. Under state law, effective
June 1, 1997, a bank chartered under state 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 state 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 Financing Corporation
assessment rates that ASB and other thrifts have paid in relation to the rates
that most commercial banks have paid, see Note 3 in the "Notes to Consolidated
Financial
38
<PAGE>
Statements." By law, the Financing Corporation's assessment rate on deposits
insured by the Bank Insurance Fund must be one-fifth the rate on deposits
insured by the Savings Association Insurance Fund 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.
Certain legislative proposals advanced to eliminate thrift charters, if
adopted, could have a material adverse effect on the Company. For example, if
thrift charters were eliminated and ASB obtained a bank charter, HEI and its
subsidiaries might become subject to the restrictions on the permissible
activities of a bank holding company. While certain of the proposals that have
been advanced would "grandfather" the activities of existing savings and loan
holding companies such as HEI, management cannot predict whether or in what form
any of these proposals might ultimately be adopted nor the extent to which the
business of HEI or ASB might be affected.
Quantitative and Qualitative Disclosures about Market Risk
- --------------------------------------------------------------------------------
The Company manages various market risks in the ordinary course of business,
including credit risk, liquidity risk, commodity price risk and foreign currency
exchange rate risk, and believes its exposures to these risks are not material
as of December 31, 1998. 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. Interest rate
risk can be defined as the exposure of the Company's earnings to adverse
movements in interest rates. The Company's success is dependent, in part, upon
ASB's ability to manage interest rate risk. 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
interest rate risk.
ASB's Asset/Liability Management Committee (ALMCO) serves as the Senior
Investment Group charged with the responsibility of managing interest rate risk
and 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 attempted to increase the amount of variable
rate assets. This has been difficult, however, in the current low interest rate
environment.
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 purchases adjustable-rate MBS with interest rates that are
adjusted primarily based on changes in U.S. treasury indices.
ASB plans to build 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 diversifying the mix of maturities on certificates of
deposits and other interest-bearing 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 that ASB believes are a steady
funding source having less sensitivity to changes in market interest rates than
other funding sources. At December 31, 1998, core deposits comprised 55% of
ASB's deposit base, compared to the 54% at December 31, 1997.
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, 1998, and constitutes a "forward-looking
statement." The expected maturity categories take into consideration historical
prepayment rates as well as actual amortization of principal and do not take
into consideration reinvestment of cash. Various prepayment rates ranging from
13-34% 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
39
<PAGE>
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, 1998.
See Note 16 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.
<TABLE>
<CAPTION>
Savings bank
- ----------------------------------------------------------------------------------------------------------------------------------
Expected maturity/principal repayment December 31, 1998
- -----------------------------------------------------------------------------------------------------------------------------------
There- Estimated
(dollars in millions) 1999 2000 2001 2002 2003 after Total fair value
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-sensitive assets
Mortgage loans and MBS
Adjustable rate $ 654 $ 418 $ 270 $ 174 $ 112 $ 198 $1,826 $1,842
Average interest rate 7.0%
Fixed rate - one-to-four family residential $ 364 $ 315 $ 272 $ 235 $ 203 $1,152 $2,541 $2,551
Average interest rate 7.2%
Fixed rate - multi-family residential and
nonresidential $ 14 $ 15 $ 16 $ 18 $ 20 $ 85 $ 168 $ 171
Average interest rate 8.6%
Consumer loans $ 102 $ 69 $ 47 $ 31 $ 21 $ 41 $ 311 $ 321
Average interest rate 9.4%
Commercial loans $ 23 $ 20 $ 16 $ 12 $ 10 $ 7 $ 88 $ 84
Average interest rate 8.9%
Investment securities and interest-bearing
deposits $ 224 -- -- -- -- -- $ 224 $ 224
Average interest rate 4.8% 4.8%
Interest-sensitive liabilities
Passbook deposits $ 254 $ 127 $ 109 $ 94 $ 81 $ 496 $1,161 $1,161
Average interest rate 2.5% 2.5% 2.5% 2.5% 2.5% 2.5% 2.5%
NOW and other demand deposits $ 125 $ 106 $ 106 $ 62 $ 61 $ 169 $ 629 $ 629
Average interest rate 0.9% 0.9% 0.9% 0.9% 0.9% 0.9% 0.9%
Money market accounts $ 96 $ 74 $ 74 $ 27 $ 26 $ 30 $ 327 $ 327
Average interest rate 3.4% 3.4% 3.4% 3.4% 3.4% 3.4% 3.4%
Certificates of deposit $1,514 $ 118 $ 24 $ 16 $ 16 $ 61 $1,749 $1,751
Average interest rate 5.1% 5.2% 5.6% 6.2% 5.4% 5.2% 5.1%
FHLB advances $ 177 $ 108 $ 110 $ 38 $ 180 $ 193 $ 806 $ 831
Average interest rate 5.6% 5.6% 6.4% 7.0% 5.9% 7.0% 6.2%
Other borrowings $ 490 $ 33 $ 523 $ 523
Average interest rate 5.3% 5.5% 5.3%
Interest-sensitive off-balance sheet items
Loans serviced for others $ 730 $ 13
Average interest rate 7.9%
Loan commitments and loans in process $ 63 --
Average interest rate 6.6%
Unused consumer lines of credit $ 415 $ 3
Average interest rate 11.2%
</TABLE>
40
<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, 1998, and constitutes a "forward-looking
statement."
Other than savings bank
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Expected maturity December 31, 1998
- ------------------------------------------------------------------------------------------------------------------------------------
There- Estimated
(dollars in millions) 1999 2000 2001 2002 2003 after Total fair value
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-sensitive liabilities
Short-term borrowings $ 223 -- -- -- -- -- $223 $223
Average interest rate 5.9% -- -- -- -- -- 5.9%
Long-term debt
Fixed rate $ 7 $ 12 $ 59 $ 63 $ 39 $685 $865 $903
Average interest rate 7.5% 7.0% 7.1% 6.6% 6.8% 6.3% 6.4%
Variable rate $ 35 -- -- -- -- -- $ 35 $35
Average interest rate 5.7% -- -- -- -- -- 5.7%
HEI- and HECO-obligated preferred
securities of trust subsidiaries -- -- -- -- -- $200 $200 $202
Average distribution rate -- -- -- -- -- 8.0% 8.0%
Preferred stock of electric utility subsidiaries
subject to mandatory redemption $ 33 -- -- -- -- -- $ 33 $34
Average dividend rate 8.5% -- -- -- -- -- 8.5%
</TABLE>
Forward-Looking Information
- --------------------------------------------------------------------------------
This report and other presentations made by Hawaiian Electric Industries, Inc.
and its subsidiaries contain forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934. Except for historical
information contained herein, the matters set forth are forward-looking
statements that involve certain risks and uncertainties that could cause actual
results to differ materially from those in the forward-looking statements.
Potential risks and uncertainties include, but are not limited to, such factors
as the effect of international, national and local economic conditions,
including the condition of the Hawaii tourist and construction industries and
the Hawaii housing market; the effects of weather and natural disasters; product
demand and market acceptance risks; increasing competition in the electric
utility industry; capacity and supply constraints or difficulties; new
technological developments; governmental and regulatory actions, including
decisions in rate cases and on permitting issues; the results of financing
efforts; the timing and extent of changes in interest rates and foreign currency
exchange rates; the convertibility and availability of foreign currency;
political and business risks inherent in doing business in a developing country;
and the risks associated with the installation of new computer systems and the
avoidance of Year 2000 problems. Investors are also referred to other risks and
uncertainties discussed elsewhere in this Annual Report and in other periodic
reports previously and subsequently filed by Hawaiian Electric Industries, Inc.
and/or Hawaiian Electric Company, Inc. with the Securities and Exchange
Commission.
41
<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, 1998 and 1997, 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, 1998. 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, 1998 and 1997, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1998 in conformity with generally
accepted accounting principles.
/s/ KPMG LLP
Honolulu, Hawaii
January 18, 1999
42
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Income
- --------------------------------------------------------------------------------------------------------------------
Hawaiian Electric Industries, Inc. and subsidiaries
Years ended December 31 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(in thousands, except per share amounts)
Revenues
Electric utility........................................................... $1,016,283 $1,107,523 $1,080,868
Savings bank............................................................... 409,883 294,135 271,402
Other...................................................................... 58,999 58,769 49,865
- --------------------------------------------------------------------------------------------------------------------
1,485,165 1,460,427 1,402,135
- --------------------------------------------------------------------------------------------------------------------
Expenses
Electric utility........................................................... 838,833 935,770 907,255
Savings bank............................................................... 356,233 249,396 231,346
FDIC special assessment................................................. -- -- 13,835
Other...................................................................... 65,453 62,554 59,682
- --------------------------------------------------------------------------------------------------------------------
1,260,519 1,247,720 1,212,118
- --------------------------------------------------------------------------------------------------------------------
Operating income (loss)
Electric utility........................................................... 177,450 171,753 173,613
Savings bank............................................................... 53,650 44,739 26,221
Other...................................................................... (6,454) (3,785) (9,817)
- --------------------------------------------------------------------------------------------------------------------
224,646 212,707 190,017
- --------------------------------------------------------------------------------------------------------------------
Interest expense--electric utility and other............................... (70,524) (62,292) (64,506)
Allowance for borrowed funds used during construction...................... 5,915 6,190 5,862
Preferred stock dividends of electric utility subsidiaries................. (6,005) (6,253) (6,529)
Preferred securities distributions of trust subsidiaries................... (12,557) (10,600) --
Allowance for equity funds used during construction........................ 10,106 10,864 11,741
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations before income taxes...................... 151,581 150,616 136,585
Income taxes............................................................... 56,953 58,773 56,030
- --------------------------------------------------------------------------------------------------------------------
Income from continuing operations.......................................... 94,628 91,843 80,555
- --------------------------------------------------------------------------------------------------------------------
Discontinued operations, net of income taxes
Loss from operations.................................................... (13,598) (5,401) (1,897)
Net gain on disposals................................................... 3,781 -- --
- --------------------------------------------------------------------------------------------------------------------
Loss from discontinued operations.......................................... (9,817) (5,401) (1,897)
- --------------------------------------------------------------------------------------------------------------------
Net income................................................................. $ 84,811 $ 86,442 $ 78,658
====================================================================================================================
Basic earnings (loss) per common share
Continuing operations................................................. $ 2.96 $ 2.93 $ 2.66
Discontinued operations............................................... (0.31) (0.17) (0.06)
- --------------------------------------------------------------------------------------------------------------------
$ 2.65 $ 2.76 $ 2.60
====================================================================================================================
Diluted earnings (loss) per common share
Continuing operations................................................. $ 2.95 $ 2.92 $ 2.65
Discontinued operations............................................... (0.31) (0.17) (0.06)
- --------------------------------------------------------------------------------------------------------------------
$ 2.64 $ 2.75 $ 2.59
====================================================================================================================
Dividends per common share................................................. $ 2.48 $ 2.44 $ 2.41
====================================================================================================================
Weighted-average number of common shares outstanding....................... 32,014 31,375 30,310
Dilutive effect of stock options and dividend equivalents............ 115 95 78
- --------------------------------------------------------------------------------------------------------------------
Adjusted weighted-average shares........................................... 32,129 31,470 30,388
====================================================================================================================
Consolidated Statements of Retained Earnings
- --------------------------------------------------------------------------------------------------------------------
Hawaiian Electric Industries, Inc. and subsidiaries
Years ended December 31 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
(in thousands)
Retained earnings, beginning of year....................................... $ 159,862 $ 149,907 $ 144,216
Net income................................................................. 84,811 86,442 78,658
Common stock dividends..................................................... (79,421) (76,487) (72,967)
- --------------------------------------------------------------------------------------------------------------------
Retained earnings, end of year............................................. $ 165,252 $ 159,862 $ 149,907
====================================================================================================================
See accompanying "Notes to Consolidated Financial Statements."
</TABLE>
43
<PAGE>
<TABLE>
<CAPTION>
Consolidated Balance Sheets
- ---------------------------------------------------------------------------------------------------------------------
Hawaiian Electric Industries, Inc. and subsidiaries
December 31 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C>
ASSETS
Cash and equivalents....................................... $ 412,254 $ 253,910
Accounts receivable and unbilled revenues, net............. 156,220 158,231
Investment and mortgage-backed securities (estimated fair
value $1,917,975 and $1,982,394).......................... 1,902,927 1,970,623
Loans receivable, net...................................... 3,143,197 3,035,847
Property, plant and equipment, net
Land.................................................. $ 44,214 $ 46,124
Plant and equipment................................... 2,945,512 2,735,844
Construction in progress.............................. 166,695 212,205
------------ ----------
3,156,421 2,994,173
Less -- accumulated depreciation...................... (1,063,023) 2,093,398 (974,655) 2,019,518
----------- -------------
Regulatory assets.......................................... 110,459 104,079
Other...................................................... 265,799 281,506
Goodwill and other intangibles............................. 115,006 122,492
- ---------------------------------------------------------------------------------------------------------------------
$8,199,260 $7,946,206
=====================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Accounts payable........................................... $ 107,863 $ 148,445
Deposit liabilities........................................ 3,865,736 3,916,600
Short-term borrowings...................................... 222,847 284,663
Securities sold under agreements to repurchase............. 515,330 375,366
Advances from Federal Home Loan Bank....................... 805,581 736,474
Long-term debt............................................. 899,598 794,621
Deferred income taxes...................................... 186,138 189,955
Contributions in aid of construction....................... 198,904 197,596
Other...................................................... 285,243 253,742
- ----------------------------------------------------------------------------------------------------------------------
7,087,240 6,897,462
- ---------------------------------------------------------------------------------------------------------------------
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............. 200,000 150,000
Preferred stock of electric utility subsidiaries
Subject to mandatory redemption..................... 33,080 35,770
Not subject to mandatory redemption................. 48,293 48,293
Minority interests......................................... 3,675 --
- ---------------------------------------------------------------------------------------------------------------------
285,048 234,063
- ---------------------------------------------------------------------------------------------------------------------
Stockholders' equity
Preferred stock, no par value, authorized 10,000 shares;
issued: none............................................. -- --
Common stock, no par value, authorized 100,000 shares;
issued and outstanding: 32,116 shares and 31,895
shares.................................................... 661,720 654,819
Retained earnings.......................................... 165,252 159,862
- ---------------------------------------------------------------------------------------------------------------------
826,972 814,681
- ---------------------------------------------------------------------------------------------------------------------
$8,199,260 $7,946,206
=====================================================================================================================
See accompanying "Notes to Consolidated Financial Statements."
</TABLE>
44
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Cash Flows
- -----------------------------------------------------------------------------------------------------------------------
Hawaiian Electric Industries, Inc. and subsidiaries
Years ended December 31 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Cash flows from operating activities
Income from continuing operations.............................................. $ 94,628 $ 91,843 $ 80,555
Adjustments to reconcile income from continuing operations to net cash
provided by continuing operating activities
Depreciation and amortization of property, plant and equipment........... 96,772 91,495 82,307
Other amortization....................................................... 16,024 13,848 12,477
Provision for loan losses................................................ 13,802 6,934 7,631
Deferred income taxes.................................................... (3,788) (1,704) 2,739
Allowance for equity funds used during construction...................... (10,106) (10,864) (11,741)
Changes in assets and liabilities, net of effects from the acquisition
of Bank of America, FSB - Hawaii operations and
disposal of businesses
Decrease (increase) in accounts receivable and
unbilled revenues, net........................................... 2,011 (2,396) (8,357)
Increase (decrease) in accounts payable............................ (40,582) (13,429) 13,120
Changes in other assets and liabilities............................ 50,555 4,637 (17,016)
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided by continuing operating activities........................... 219,316 180,364 161,715
- -----------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Held-to-maturity mortgage-backed securities purchased.......................... (521,054) (799,299) (208,857)
Principal repayments on held-to-maturity mortgage-backed securities............ 592,073 272,662 309,384
Held-to-maturity investment securities purchased............................... (200,982) (64,949) --
Proceeds from maturity of investment securities................................ 199,982 -- --
Loans receivable originated and purchased...................................... (654,576) (310,903) (490,852)
Principal repayments on loans receivable....................................... 495,291 146,685 169,160
Capital expenditures........................................................... (166,738) (147,301) (205,580)
Purchase of savings bank-owned life insurance.................................. -- (35,000) (5,000)
Cash received from (paid to) Bank of America, FSB for the assumption
of deposit and other liabilities, net of purchase of loans
receivable and other assets............................................... (24,018) 714,843 --
Proceeds from loans returned to Bank of America, FSB........................... 28,763 -- --
Other.......................................................................... 18,012 15,336 18,855
- -----------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities.......................................... (233,247) (207,926) (412,890)
- -----------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Net increase (decrease) in deposit liabilities................................. (50,864) 105,982 (73,385)
Net increase (decrease) in short-term borrowings with original
maturities of three months or less....................................... (61,816) 71,143 36,374
Proceeds from securities sold under agreements to repurchase................... 531,812 1,557,000 714,100
Repurchase of securities sold under agreements to repurchase................... (392,500) (1,660,600) (646,000)
Proceeds from advances from Federal Home Loan Bank............................. 706,500 1,337,500 810,560
Principal payments on advances from Federal Home Loan Bank..................... (637,393) (1,285,300) (627,560)
Proceeds from issuance of long-term debt....................................... 194,216 74,233 124,886
Repayment of long-term debt.................................................... (89,400) (81,900) (73,400)
Proceeds from issuance of HEI- and HECO-obligated
preferred securities of trust subsidiaries............................... 50,000 150,000 --
Redemption of electric utility subsidiaries' preferred stock................... (2,690) (3,185) (2,795)
Net proceeds from issuance of common stock..................................... 8,191 22,994 19,818
Common stock dividends......................................................... (79,421) (61,799) (55,288)
Preferred securities distributions of trust subsidiaries....................... (12,557) (10,600) --
Other.......................................................................... (3,068) (24,109) (9,544)
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities...................................... 161,010 191,359 217,766
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) discontinued operations......................... 11,265 (7,000) --
- -----------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and equivalents................................ 158,344 156,797 (33,409)
Cash and equivalents, beginning of year........................................ 253,910 97,113 130,522
- -----------------------------------------------------------------------------------------------------------------------
Cash and equivalents, end of year.............................................. $ 412,254 $ 253,910 $ 97,113
=======================================================================================================================
See accompanying "Notes to Consolidated Financial Statements."
</TABLE>
45
<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 and other
businesses, primarily in the State of Hawaii, and also engaged in the
development of and investment in independent power and integrated energy service
projects in Asia and the Pacific. Effective September 14, 1998, HEI adopted a
plan to exit the residential real estate development business conducted by
Malama Pacific Corp. and its subsidiaries.
Basis of presentation. 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
include the amounts reported for regulatory assets, allowance for loan losses
and 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.
Regulation by the Public Utilities Commission of the State of Hawaii (PUC). The
electric utility subsidiaries and Young Brothers, Limited (YB) are regulated by
the 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." The actions of regulators can affect the timing of recognition
of revenues, expenses, assets and liabilities.
Investments. Debt securities that the Company intends to and has the ability to
hold to maturity are classified as held-to-maturity securities and reported at
amortized cost. Marketable equity securities 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 included in earnings. Marketable equity securities and debt
securities not classified as either held-to-maturity or trading securities are
classified as available-for-sale securities and reported at fair value, with
unrealized gains and losses excluded from earnings and reported in a separate
component of stockholders' equity.
For nontrading securities, declines in value determined to be nontemporary are
included in earnings and result in 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 reported at
cost. Self-constructed electric utility plant includes engineering, supervision,
and administrative and general costs, and an allowance for the cost of funds
used during the construction period. Upon the 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 value) are charged to accumulated
depreciation.
Postretirement benefits. Pension and other postretirement benefits 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.
46
<PAGE>
Depreciation. Depreciation is computed primarily using the straight-line method
over the estimated useful lives of the assets. Electric utility plant has useful
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 1998 and 1997 and 3.8% in 1996.
Environmental expenditures. The Company is subject to numerous federal and
state statutes and governmental regulations pertaining to the environment. In
general, environmental contamination treatment costs are charged to expense,
unless it is probable the PUC would allow such costs to be recovered in future
rates. Also, environmental costs are capitalized if: the costs extend the life,
increase the capacity, or improve the safety or efficiency of property; the
costs mitigate or prevent future environmental contamination; 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 the PUC would allow such costs to be recovered in future rates.
Income taxes. Deferred income tax assets and liabilities are established for
the temporary differences between the financial reporting bases and the tax
bases 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, 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.
Comprehensive income. In June 1997, the Financial Accounting Standards Board
(FASB) issued SFAS No. 130, "Reporting Comprehensive Income." The Company
adopted SFAS No. 130 in the first quarter of 1998, but had no material "other"
comprehensive income items for the years presented in the statements of income
or accumulated as of the balance sheet dates presented.
Segments of an enterprise and related information. In June 1997, the FASB
issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information." The Company adopted SFAS No. 131 in the first quarter of 1998. No
modification to the Company's reporting segments was required.
Costs of computer software developed or obtained for internal use and start-up
activities. In March 1998, the AICPA Accounting Standards Executive Committee
issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," which requires that certain
costs, including certain payroll and payroll-related costs, be capitalized and
amortized over the estimated useful life of the software. In April 1998, the
AICPA Accounting Standards Executive Committee issued SOP 98-5, "Reporting on
the Costs of Start-up Activities," which requires that costs of start-up
activities, including organization costs, be expensed as incurred. The
provisions of SOP 98-1 and SOP 98-5 are effective for fiscal years beginning
after December 15, 1998 and earlier application is encouraged. The Company
adopted SOP 98-1 and SOP 98-5 effective January 1, 1999. The adoption of SOP 98-
1 and SOP 98-5 did not have a material effect on the Company's financial
condition, results of operations or liquidity.
Derivative instruments and hedging activities. In June 1998, the FASB issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities,"
which establishes accounting and reporting standards for derivative instruments
and hedging activities and requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. The provisions of SFAS No. 133 are effective
for all fiscal quarters of fiscal years beginning after June 15, 1999 and
earlier application is encouraged. The Company will adopt SFAS No. 133 on
January 1, 2000 but has not yet determined the impact of adoption.
47
<PAGE>
Reclassifications. Certain reclassifications have been made to prior years'
financial statements to conform to the 1998 presentation.
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 subsidiaries amortize contributions on a straight-line basis
over 30 years as an offset against depreciation expense.
Electric utility revenues. Electric utility revenues are based on rates
authorized by the PUC and include revenues applicable to energy consumed in the
accounting period but not yet billed to the customers. Revenue amounts recorded
pursuant to a PUC interim order are subject to refund, with interest, pending a
final order.
The rate schedules of the electric utility subsidiaries include energy cost
adjustment clauses under which 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 (AFUDC). AFUDC is an accounting
practice whereby the costs of debt and equity funds used to finance plant
construction are removed from the statement of income and charged to
construction in progress on the balance sheet.
The weighted-average AFUDC rate was 8.9% in 1998, 9.0% in 1997 and 9.2% in
1996, and reflected quarterly compounding.
Savings bank
- --------------------------------------------------------------------------------
Loans receivable. American Savings Bank, F.S.B. (ASB) states loans receivable
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. Premiums are amortized and discounts are accreted over the
estimated life of the loan using the level-yield method.
Allowance for loan losses. 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 such 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 based on the fair value of
the collateral securing the loan. Impairment losses are charged to the provision
for loan losses and included in the allowance for loan losses.
For the remaining loans receivable portfolio (smaller-balance homogeneous
loans), ASB weighs several factors in determining the adequacy of the valuation
allowance for estimated losses, including management's review of the existing
risks in the loan portfolio, prevailing economic conditions and the historical
loss experience.
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. ASB records real estate acquired
in settlement of loans at the lower of cost or fair value less estimated selling
expenses.
Loan origination and commitment fees. ASB defers loan origination fees (net of
direct costs) and recognizes such fees as an adjustment of yield over the life
of the loan. ASB also defers nonrefundable commitment fees (net of direct loan
origination costs, if applicable) for commitments to originate or purchase loans
and, if the commitment is exercised, recognizes such fees as an adjustment of
yield over the life of the loan. If the commitment expires unexercised, ASB
recognizes nonrefundable commitment fees as income upon expiration.
48
<PAGE>
Amortization of goodwill and core deposit intangibles. ASB amortizes goodwill
on a straight-line basis over 25 years and core deposit intangibles 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 uses 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
- --------------------------------------------------------------------------------
The reportable segments of the Company, the electric utility and savings bank
segments, are strategic business units that offer different products and
services and operate in different regulatory environments. The accounting
policies of the segments are the same as those described in the summary of
significant accounting policies, except that income taxes for each segment is
calculated on a "stand-alone" basis. HEI evaluates segment performance based on
income from continuing operations. The Company accounts for intersegment sales
and transfers as if the sales and transfers were to third parties, that is, at
current market prices. Intersegment revenues consist primarily of interest and
preferred dividends.
Electric utility
Hawaiian Electric Company, Inc. (HECO) and its wholly owned operating
subsidiaries, Hawaii Electric Light Company, Inc. (HELCO) and Maui Electric
Company, Limited (MECO), are electric public utilities in the business of
generating, purchasing, transmitting, distributing and selling electric energy,
and are regulated by the PUC.
Savings bank
- --------------------------------------------------------------------------------
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 (FDIC), 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 (BoA). ASB's interest income, net
of interest expense, was $164 million, $113 million and $102 million in 1998,
1997 and 1996, respectively.
Other
- --------------------------------------------------------------------------------
Hawaiian Tug & Barge Corp. (HTB) provides tugboat and charter barge services in
Hawaii and the Pacific area and, together with its wholly owned subsidiary, 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.
HEI Investment Corp. holds investments primarily in leveraged leases.
HEI Power Corp. (HEIPC) and its wholly owned subsidiaries (collectively, the
HEIPC Group) were formed to pursue independent power and integrated energy
services projects in Asia and the Pacific. In 1996, an HEIPC subsidiary entered
into an energy conversion agreement for approximately 20 years with the Guam
Power Authority for the rehabilitation, operation and maintenance of two 25-
megawatt (MW) (net) generating units which began commercial operations in 1997.
In 1998, HEIPC (through a wholly owned, indirect subsidiary) acquired an
effective 60% interest in a joint venture formed to design, construct, own,
operate and manage a 206-MW (net) coal-fired power plant in China over a period
of approximately 20 years. Also in 1998, HEIPC (through a wholly owned, indirect
subsidiary) invested $7.6 million to acquire convertible cumulative
nonparticipating 8% preferred shares in Cagayan Electric Power & Light Co.,
Inc., an electric distribution company in the Philippines.
Other also includes amounts for Pacific Energy Conservation Services, Inc.,
HEI District Cooling, Inc., ProVision Technologies, Inc., Hycap Management,
Inc., Hawaiian Electric Industries Capital Trust I and HEI Preferred Funding,
LP.
49
<PAGE>
<TABLE>
<CAPTION>
Electric Savings Holding
($ in thousands) utility bank Other companies Eliminations Total
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
1998
Revenues from external customers........ 1,016,283 409,853 58,708 321 - 1,485,165
Intersegment revenues................... - 30 10,732 8,629 (19,391) -
- ---------------------------------------------------------------------------------------------------------------------
Revenues............................. 1,016,283 409,883 69,440 8,950 (19,391) 1,485,165
=====================================================================================================================
Depreciation and amortization........... 93,484 15,438 2,048 1,826 - 112,796
=====================================================================================================================
Interest expense........................ 47,921 216,994 1,829 34,471 (13,697) 287,518
=====================================================================================================================
Profit (loss)*.......................... 135,348 48,250 1,860 (33,877) - 151,581
Income taxes (benefit).................. 54,572 17,987 2,646 (18,252) - 56,953
- ---------------------------------------------------------------------------------------------------------------------
Income (loss) from
continuing operations............. 80,776 30,263 (786) (15,625) - 94,628
====================================================================================================================
Capital expenditures.................... 131,895 10,401 21,729 2,713 - 166,738
=====================================================================================================================
Assets**................................ 2,311,253 5,691,672 294,034 66,216 (163,915) 8,199,260
=====================================================================================================================
1997
Revenues from external customers........ 1,107,523 294,105 58,491 308 - 1,460,427
Intersegment revenues................... - 30 9,405 3,574 (13,009) -
- ---------------------------------------------------------------------------------------------------------------------
Revenues............................. 1,107,523 294,135 67,896 3,882 (13,009) 1,460,427
=====================================================================================================================
Depreciation and amortization........... 91,948 7,839 4,509 1,047 - 105,343
====================================================================================================================
Interest expense........................ 48,778 164,662 1,761 24,121 (12,368) 226,954
=====================================================================================================================
Profit (loss)*.......................... 130,724 44,349 4,619 (29,076) - 150,616
Income taxes (benefit).................. 52,535 18,016 1,428 (13,206) - 58,773
--------------------------------------------------------------------------------------------------------------------
Income (loss) from
continuing operations............. 78,189 26,333 3,191 (15,870) - 91,843
====================================================================================================================
Capital expenditures.................... 122,140 7,796 16,390 975 - 147,301
=====================================================================================================================
Assets**................................ 2,212,314 5,548,412 261,447 91,407 (167,374) 7,946,206
=====================================================================================================================
1996
Revenues from external customers........ 1,080,868 271,361 49,283 623 - 1,402,135
Intersegment revenues................... - 41 267 2,606 (2,914) -
- ---------------------------------------------------------------------------------------------------------------------
Revenues............................. 1,080,868 271,402 49,550 3,229 (2,914) 1,402,135
=====================================================================================================================
Depreciation and amortization........... 82,651 6,951 4,243 939 - 94,784
====================================================================================================================
Interest expense........................ 47,451 153,664 1,559 18,103 (2,607) 218,170
=====================================================================================================================
Profit (loss)*.......................... 137,236 26,221 (982) (25,890) - 136,585
Income taxes (benefit).................. 55,888 11,253 893 (12,004) - 56,030
--------------------------------------------------------------------------------------------------------------------
Income (loss) from
continuing operations............. 81,348 14,968 (1,875) (13,886) - 80,555
=====================================================================================================================
Capital expenditures.................... 188,161 3,659 12,359 1,401 - 205,580
=====================================================================================================================
Assets**................................ 2,165,546 3,590,687 119,866 95,806 (46,409) 5,925,496
=====================================================================================================================
</TABLE>
* Income before income taxes and discontinued operations.
** At December 31.
Revenues attributed to foreign countries and long-lived assets located in
foreign countries as of the dates and for the periods identified above were not
significant.
50
<PAGE>
3 . Savings bank subsidiary
- --------------------------------------------------------------------------------
Acquisition of most of the Hawaii operations of Bank of America, FSB. 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 on May 26, 1997, as amended. ASB
used the purchase method of accounting to account for the transaction.
Accordingly, the accompanying financial statements include the results of
operations related to the assets acquired and liabilities assumed from the
acquisition date. In this transaction, ASB assumed liabilities with an estimated
fair value of $1.7 billion and paid a $0.1 billion premium on certain
transferred deposit liabilities. The estimated fair value of tangible and
intangible assets acquired, including cash of $0.8 billion, amounted to $1.8
billion. ASB recorded the excess of the purchase price over the estimated fair
value of the identifiable net assets acquired of $72 million as goodwill and
recorded the core deposit premium of approximately $20 million as an intangible
asset.
The following unaudited pro forma financial information for consolidated HEI
assumes the BoA acquisition occurred on January 1, 1997 and 1996, respectively,
after giving effect to purchase accounting adjustments and related income tax
effects: revenues of $1.5 billion for 1997 and 1996; net income of $66.1 million
for 1997 and $60.5 million for 1996; and basic and diluted earnings per common
share of $2.11 and $2.10, respectively, for 1997 and $2.00 and $1.99,
respectively, for 1996. Management does not believe that the pro forma financial
information is indicative of HEI'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 Savings Association
Insurance Fund (SAIF) insures the deposit accounts of ASB and other thrifts.
The Bank Insurance Fund (BIF) insures the deposit accounts of commercial banks.
The FDIC administers the SAIF and BIF.
In December 1996, the FDIC adopted a risk-based assessment schedule for SAIF
institutions, effective January 1, 1997, that was identical to the existing base
rate schedule for BIF institutions: zero to 27 cents per $100 of deposits.
Added to this base rate schedule through 1999 will be the assessment to fund the
Financing Corporation's (FICO's) interest obligations, which assessment was
initially set at 6.48 cents per $100 of deposits for SAIF institutions and 1.3
cents per $100 of deposits for BIF institutions (subject to quarterly
adjustment). In December 1997, ASB acquired BIF-assessable deposits as well as
SAIF-assessable deposits from BoA. As a "well-capitalized" thrift, ASB's base
deposit insurance premium effective for the December 31, 1998 quarterly payment
is zero and its assessment for funding FICO interest payments is 6.10 cents per
$100 of SAIF-assessable deposits and 1.22 cents per $100 of BIF-assessable
deposits, on an annual basis, based on deposits as of September 30, 1998.
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 1998 1997
- --------------------------------------------------------------------------------------------------------------------------------
Gross Gross Estimated Gross Gross Estimated
Carrying unrealized unrealized fair Carrying unrealized unrealized fair
value gains losses value value gains losses value
- --------------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Investment
securities:
Stock in FHLB
of Seattle..... $ 68,553 $ - $ - $ 68,553 $ 63,528 $ - $ - $ 63,528
U.S. Treasury.. 43,021 140 - 43,161 42,068 - (9) 42,059
- --------------------------------------------------------------------------------------------------------------------------------
111,574 140 - 111,714 105,596 - (9) 105,587
- --------------------------------------------------------------------------------------------------------------------------------
Mortgage-backed
securities:
Private issue.... 522,307 1,212 (1,892) 521,627 593,433 3,966 (3,017) 594,382
FHLMC............ 164,291 2,975 (7) 167,259 222,442 2,000 (77) 224,365
GNMA............. 399,012 4,915 (485) 403,442 344,006 3,255 (503) 346,758
FNMA............. 705,743 9,923 (1,733) 713,933 705,146 9,414 (3,258) 711,302
- --------------------------------------------------------------------------------------------------------------------------------
1,791,353 19,025 (4,117) 1,806,261 1,865,027 18,635 (6,855) 1,876,807
- --------------------------------------------------------------------------------------------------------------------------------
$1,902,927 $19,165 $(4,117) $1,917,975 $1,970,623 $18,635 $(6,864) $1,982,394
================================================================================================================================
</TABLE>
51
<PAGE>
ASB owns 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). ASB classifies all such mortgage-backed securities owned as of December
31, 1998 as held-to-maturity securities.
ASB does not present contractual maturities for mortgage-backed securities
because these securities are not due at a single maturity date.
The weighted-average interest rate for mortgage-backed securities at December
31, 1998 and 1997 was 6.70% and 6.77%, respectively.
ASB pledged mortgage-backed securities with a carrying value of approximately
$1.2 billion and $1.5 billion at December 31, 1998 and 1997, respectively, 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, 1998 and 1997,
mortgage-backed securities sold under agreements to repurchase had a carrying
value of $542 million and $407 million, respectively.
ASB did not sell mortgage-backed securities or other securities held for
investment in 1998, 1997 or 1996.
Loans receivable. Loans receivable consisted of the following:
<TABLE>
<CAPTION>
December 31 1998 1997
- ------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Real estate loans
Conventional............................................................... $2,785,170 $2,631,298
Construction and development............................................... 35,274 32,569
- ------------------------------------------------------------------------------------------------------------------
2,820,444 2,663,867
Loans secured by savings deposits............................................ 16,836 17,473
Consumer loans............................................................... 304,164 342,146
Commercial loans............................................................. 94,045 88,315
- ------------------------------------------------------------------------------------------------------------------
3,235,489 3,111,801
Undisbursed portion of loans in process...................................... (31,277) (29,935)
Deferred fees and discounts, including net purchase
accounting discounts...................................................... (21,236) (16,069)
Allowance for loan losses.................................................... (39,779) (29,950)
- ------------------------------------------------------------------------------------------------------------------
$3,143,197 $3,035,847
==================================================================================================================
</TABLE>
At December 31, 1998 and 1997, the weighted-average interest rate for loans
receivable was 7.78% and 8.19%, respectively.
At December 31, 1998, ASB pledged loans with an amortized cost of
approximately $396.9 million as collateral to secure advances from the FHLB of
Seattle.
At December 31, 1998, ASB had impaired loans totaling $50 million, which
consisted of $39 million of income property loans, $9 million of residential
real estate loans for properties of one to four units and $2 million of
commercial loans. At December 31, 1997, ASB had impaired loans totaling $41
million, which consisted of $30 million of income property loans and $11 million
of residential real estate loans for properties of one to four units. The
average balances of impaired loans during 1998, 1997 and 1996 were $44 million,
$38 million and $20 million, respectively. At December 31, 1998, 1997 and 1996,
the allowance for loan losses for impaired loans was $10.7 million, $7.1 million
and $4.8 million, respectively.
At December 31, 1998 and 1997, ASB had nonaccrual and renegotiated loans of
$98 million and $74 million, respectively.
ASB services real estate loans ($730 million, $872 million and $626 million at
December 31, 1998, 1997 and 1996, respectively), which are not included in the
accompanying consolidated financial statements. ASB reports fees earned for
servicing loans as income when the related mortgage loan payments are collected
and charges loan servicing costs to expense as incurred.
Mortgage loan commitments of approximately $35.8 million are not reflected in
the consolidated balance sheet as of December 31, 1998. Of such commitments,
$3.4 million were for variable-rate mortgage loans and $32.4 million were for
fixed-rate mortgage loans.
Allowance for loan losses. For 1998, 1997 and 1996, the provision for loan
losses was $13.8 million, $6.9 million and $7.6 million, respectively; net
charge-offs amounted to $4.0 million, $2.6 million and $1.3 million,
respectively; and the ratio of net charge-offs to average loans outstanding was
0.13%, 0.12% and 0.07%, respectively.
Real estate acquired in settlement of loans. At December 31, 1998 and 1997,
ASB's real estate acquired in settlement of loans was $5.6 million and $4.0
million, respectively.
52
<PAGE>
Deposit liabilities. Deposit liabilities consisted of the following:
<TABLE>
<CAPTION>
December 31 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
Weighted- Weighted-
average average
rate Amount rate Amount
- ---------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C>
Commercial checking.............................................. -% $ 117,589 -% $ 144,425
Other checking................................................... 1.04 511,291 1.26 483,187
Passbook......................................................... 2.50 1,160,951 2.99 1,157,158
Money market..................................................... 3.37 326,685 4.38 347,692
Term certificates................................................ 5.12 1,749,220 5.45 1,784,138
- ---------------------------------------------------------------------------------------------------------------------
3.49% $3,865,736 3.91% $3,916,600
=====================================================================================================================
</TABLE>
At December 31, 1998 and 1997, deposit accounts of $100,000 or more totaled $1.1
billion.
The approximate amounts of term certificates outstanding at December 31, 1998
with scheduled maturities for 1999 through 2003 were $1.5 billion in 1999, $118
million in 2000, $24 million in 2001, $16 million in 2002 and $16 million in
2003.
Interest expense on savings deposits by type of deposit was as follows:
<TABLE>
<CAPTION>
Years ended December 31 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Interest-bearing checking............................................................ $ 5,706 $ 3,627 $ 4,337
Passbook............................................................................. 33,050 26,769 31,401
Money market......................................................................... 12,958 3,517 2,296
Term certificates.................................................................... 90,355 55,186 53,130
- --------------------------------------------------------------------------------------------------------------------
$142,069 $89,099 $91,164
====================================================================================================================
</TABLE>
Securities sold under agreements to repurchase. At December 31, 1998,
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 consolidated
balance sheet. At December 31, 1998 and 1997, ASB had agreements to repurchase
identical securities totaling $515 million and $375 million, respectively. At
December 31, 1998 and 1997, the weighted-average rate on securities sold under
agreements to repurchase was 5.36% and 5.71%, respectively, and the weighted-
average remaining days to maturity was 137 days and 115 days, respectively.
During 1998, 1997 and 1996, securities sold under agreements to repurchase
averaged $470 million, $560 million and $463 million, respectively, and the
maximum amount outstanding at any month-end was $551 million, $765 million and
$480 million, respectively.
At December 31, 1998, securities sold under agreements to repurchase were
summarized as follows:
<TABLE>
<CAPTION>
Collateralized by
mortgage-backed securities
Weighted- --------------------------
Repurchase average Carrying Market
Maturity liability rate value value
- -----------------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C>
1 to 29 days............................ $ 59,359 5.42% $ 68,495 $ 68,984
30 to 90 days........................... 306,562 5.42 312,753 314,638
Over 90 days............................ 149,409 5.23 163,308 163,590
- -----------------------------------------------------------------------------------------------
$515,330 5.36% $544,556 $547,212
===============================================================================================
</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 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
Weighted- Weighted-
average rate Amount average rate Amount
- -----------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C>
Due in
1998............................................................. -% $ - 5.68% $350,593
1999............................................................. 5.55 176,800 5.59 66,800
2000............................................................. 5.64 107,760 5.90 28,260
2001............................................................. 6.44 110,000 6.97 65,000
2002............................................................. 6.96 37,500 6.96 37,500
2003............................................................. 5.93 180,200 7.08 35,000
Thereafter....................................................... 6.97 193,321 7.31 153,321
- -----------------------------------------------------------------------------------------------------------------------
6.17% $805,581 6.26% $736,474
=======================================================================================================================
</TABLE>
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.
53
<PAGE>
Common stock equity. As of December 31, 1998, ASB was in compliance with the
minimum capital requirements under the Office of Thrift Supervision regulations.
4 . Regulatory assets
- --------------------------------------------------------------------------------
In accordance with SFAS No. 71, 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. Management believes HECO and its subsidiaries' and YB's
operations currently satisfy the 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.
Regulatory assets are expected to be fully recovered through rates over PUC
authorized periods ranging from 1 to 36 years and included the following
deferred costs at December 31, 1998 and 1997:
<TABLE>
<CAPTION>
December 31 1998 1997
- -----------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Income taxes................................................................. $ 54,506 $ 47,954
Postretirement benefits other than pensions.................................. 27,108 29,044
Other........................................................................ 28,845 27,081
- -----------------------------------------------------------------------------------------------------------------
$110,459 $104,079
=================================================================================================================
</TABLE>
5 . Short-term borrowings
- --------------------------------------------------------------------------------
Short-term borrowings consisted of commercial paper issued by HEI and HECO at
December 31, 1998 and 1997 and had a weighted-average interest rate of 5.9% and
6.1%, respectively.
At December 31, 1998 and 1997, HEI maintained bank lines of credit which
totaled $130 million and $195 million, respectively, and HECO maintained bank
lines of credit which totaled $125 million. The HEI and HECO lines of credit
support the issuance of commercial paper. There were no borrowings under any
line of credit during 1998 or 1997.
6 . Long-term debt and cumulative preferred stock
- --------------------------------------------------------------------------------
Long-term debt. Long-term debt consisted of the following:
<TABLE>
<CAPTION>
December 31 1998 1997
- ------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C>
HELCO first mortgage bonds 7.75-7.88%, due in various years through 2003.... $ 5,000 $ 5,000
- -------------------------------------------------------------------------------------------------------------------
Obligations to the State of Hawaii for the repayment of special
purpose revenue bonds issued on behalf of electric utility subsidiaries
4.95%, due 2012........................................................... 57,500 --
6.88%, refunded in 1998................................................... -- 57,500
7.20%-7.63%, due 2014-2018................................................ 61,400 61,400
5.45%-7.60%, due 2020-2023................................................ 260,000 260,000
5.65%-6.60%, due 2025-2027................................................ 272,000 272,000
- ------------------------------------------------------------------------------------------------------------------
650,900 650,900
Less funds on deposit with trustees........................................ (29,684) (53,899)
Less unamortized discount.................................................. (4,218) (4,380)
- ------------------------------------------------------------------------------------------------------------------
616,998 592,621
- ------------------------------------------------------------------------------------------------------------------
Promissory notes
5.83%, paid in 1998........................................................ -- 30,000
6.13-7.13%, due in various years through 2012.............................. 208,500 96,000
8.20-8.70%, due in various years through 2011............................... 34,100 36,000
Variable rate (5.7% at December 31, 1998), due 1999......................... 35,000 35,000
- ------------------------------------------------------------------------------------------------------------------
277,600 197,000
- ------------------------------------------------------------------------------------------------------------------
$899,598 $794,621
==================================================================================================================
</TABLE>
54
<PAGE>
The first mortgage bonds of HELCO have been secured by a mortgage which purports
to be a lien on substantially all of the real and personal property now owned or
hereafter acquired by HELCO.
At December 31, 1998, the aggregate principal payments required on long-term
debt for 1999 through 2003 are $42 million in 1999, $12 million in 2000, $59
million in 2001, $63 million in 2002 and $39 million in 2003.
Cumulative preferred stock. Certain cumulative preferred stock of HECO and its
subsidiaries is redeemable at the option of the respective company at a premium
or par. The remaining cumulative preferred stock is subject to mandatory sinking
fund provisions at par and optional redemption provisions at a premium. At
December 31, 1998 and 1997, outstanding preferred stock not subject to mandatory
redemption had dividend rates ranging from 4.25% to 8.875% and outstanding
preferred stock subject to mandatory redemption had dividend rates ranging from
7.68% to 12.75%. In January 1999, HECO and its subsidiaries redeemed several
series of preferred stock (including all preferred stock subject to mandatory
redemption), having a total par value of $47 million. The aggregate of the
redemption premiums for all series amounted to $1.5 million. The redemption
prices are being paid primarily from the proceeds of a $50 million sale of trust
preferred securities completed in December 1998.
7 . 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 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 2 million of its HECO-obligated 8.05%
Cumulative Quarterly Income Preferred Securities, Series 1997, with an aggregate
liquidation value of $50 million. The 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, on or after March 27, 2002.
In December 1998, HECO Capital Trust II, a grantor trust and wholly owned
subsidiary of HECO, issued and sold 2 million of its HECO-obligated 7.30%
Cumulative Quarterly Income Preferred Securities, Series 1998, with an aggregate
liquidation value of $50 million. The Cumulative Quarterly Income Preferred
Securities must be redeemed at the maturity of the underlying debt on December
15, 2028, which maturity may be shortened to a date no earlier than December 15,
2003 or extended to a date no later than December 15, 2047, and are not
redeemable at the option of the holders, but may be redeemed by HECO Capital
Trust II, in whole or in part, from time to time, on or after December 15, 2003.
All of the proceeds from the sale were invested by HECO Capital Trust II in the
underlying debt securities of HECO, HELCO and MECO, who are using such proceeds
primarily to effect the redemption of certain series of their preferred stock
having a total par value of $47 million.
55
<PAGE>
8 . Common stock
- --------------------------------------------------------------------------------
Changes to common stock were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------
Common Common Common
Shares stock Shares stock Shares stock
- -----------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1.................. 31,895 $654,819 30,853 $622,945 29,773 $585,387
Issuance of common stock
Dividend reinvestment and
stock purchase plan............ 30 1,174 686 24,847 822 28,718
Retirement savings and
other plans.................... 191 6,857 356 12,750 258 9,161
Expenses and other.................. -- (1,130) -- (5,723) -- (321)
- -----------------------------------------------------------------------------------------------------------------------------
Balance, December 31................ 32,116 $661,720 31,895 $654,819 30,853 $622,945
=============================================================================================================================
</TABLE>
At December 31, 1998, HEI had reserved a total of 9.5 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.
9 . Income taxes
- --------------------------------------------------------------------------------
The components of income taxes attributable to income from continuing operations
were as follows:
<TABLE>
<CAPTION>
Years ended December 31 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Federal
Current............................................................ $56,118 $52,037 $49,919
Deferred........................................................... (4,083) (2,145) 2,137
Deferred tax credits, net.......................................... (3) (1) (98)
- ----------------------------------------------------------------------------------------------------------------------
52,032 49,891 51,958
- ----------------------------------------------------------------------------------------------------------------------
State
Current............................................................ 3,497 5,773 (168)
Deferred........................................................... 295 441 602
Deferred tax credits, net.......................................... 1,129 2,668 3,638
- ----------------------------------------------------------------------------------------------------------------------
4,921 8,882 4,072
- ----------------------------------------------------------------------------------------------------------------------
$56,953 $58,773 $56,030
======================================================================================================================
</TABLE>
In March 1998, ASB formed a wholly owned operating subsidiary, ASB Realty
Corporation, which elects to be taxed as a real estate investment trust. This
reorganization has reduced ASB's income taxes by $2.5 million for 1998. The
State of Hawaii, however, has indicated that it may challenge the tax treatment
of this reorganization. ASB, however, believes that its tax position is proper.
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 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Amount at the federal statutory income tax rate..................... $53,053 $52,716 $47,805
State income taxes, net of effect on federal income taxes........... 3,199 5,773 2,646
Preferred stock dividends of electric utility subsidiaries.......... 2,102 2,189 2,285
Other, net.......................................................... (1,401) (1,905) 3,294
- ----------------------------------------------------------------------------------------------------------------------
$56,953 $58,773 $56,030
======================================================================================================================
</TABLE>
56
<PAGE>
The tax effects of temporary differences that give rise to deferred tax assets
and liabilities were as follows:
<TABLE>
<CAPTION>
December 31 1998 1997
- -------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Deferred tax assets
Property, plant and equipment............................................. $ 12,186 $ 11,776
Contributions in aid of construction and customer advances................ 55,249 54,259
Allowance for loan losses................................................. 10,984 9,468
Other..................................................................... 30,194 24,992
- -------------------------------------------------------------------------------------------------------------------
108,613 100,495
- -------------------------------------------------------------------------------------------------------------------
Deferred tax liabilities
Property, plant and equipment............................................. 185,598 182,472
Leveraged leases.......................................................... 44,151 46,322
Regulatory assets......................................................... 21,163 18,713
FHLB stock dividend....................................................... 10,231 8,233
Other..................................................................... 33,608 34,710
- -------------------------------------------------------------------------------------------------------------------
294,751 290,450
- -------------------------------------------------------------------------------------------------------------------
Net deferred income tax liability............................................ $186,138 $189,955
===================================================================================================================
</TABLE>
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. Based upon historical taxable income, projections for future
taxable income and tax planning strategies, management believes it is more
likely than not the Company will realize the benefits of the deferred tax assets
and provided no valuation allowance for deferred tax assets during 1998, 1997
and 1996.
10 . Cash flows
- --------------------------------------------------------------------------------
Supplemental disclosures of cash flow information. In 1998, 1997 and 1996, the
Company paid interest amounting to $279 million, $218 million and $213 million,
respectively.
In 1998, 1997 and 1996, the Company paid income taxes amounting to $30
million, $66 million and $44 million, respectively.
Supplemental disclosures of noncash activities. In 1997 and 1996, HEI
shareholders reinvested common stock dividends amounting to $15 million and $18
million, respectively. Beginning in March 1998, HEI acquired for cash its common
shares in the open market to satisfy the requirements of the HEI Dividend
Reinvestment and Stock Purchase Plan.
In 1998, 1997 and 1996, HECO and its subsidiaries capitalized as part of the
cost of electric utility plant an allowance for equity funds used during
construction amounting to $10 million, $11 million and $12 million,
respectively.
11 . Stock option and incentive plan
- --------------------------------------------------------------------------------
Under the 1987 Stock Option and Incentive Plan, as amended, HEI may issue an
aggregate of 2,650,000 shares of common stock to officers and key employees as
incentive stock options, nonqualified stock options, restricted stock, stock
appreciation rights, stock payments or dividend equivalents. HEI has granted
only nonqualified stock options to date. For the nonqualified stock options, the
exercise price of each option generally equals the market price of HEI'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 and has expensed $1.0 million in
1998, $0.9 million in 1997 and $0.7 million in 1996 as compensation cost for the
nonqualified stock options and dividend equivalents. 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 1998, 1997 and 1996 net income and basic and diluted
earnings per share would have been less than one cent per share for 1998, 1997
and 1996.
57
<PAGE>
Information about the HEI's stock option plan was summarized as follows:
<TABLE>
<CAPTION>
1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------------------
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........... 639,550 $35.78 610,875 $36.32 553,083 $36.30
Granted.......................... 86,000 40.99 145,000 34.61 80,000 35.83
Exercised........................ (135,425) 35.11 (84,825) 35.90 (20,208) 33.58
Forfeited or expired............. (46,750) 40.08 (31,500) 40.61 (2,000) 38.27
- -------------------------------------------------------------------------------------------------------------------------------
Outstanding, December 31......... 543,375 $36.40 639,550 $35.78 610,875 $36.32
===============================================================================================================================
Options exercisable,
December 31................... 295,875 $36.12 355,925 $36.87 377,625 $37.45
===============================================================================================================================
</TABLE>
The weighted-average fair value of each option granted during the year was
$8.42, $7.65 and $8.40 (at grant date) in 1998, 1997 and 1996, respectively. The
weighted-average assumptions used to estimate fair value include: risk-free
interest rate of 5.6%, 6.7% and 6.3%; expected volatility of 12.4%, 9.8% and
12.0%; expected dividend yield of 6.7%, 6.8% and 6.6% for 1998, 1997 and 1996,
respectively, and expected life of 4.5 years for each of the three years.
The weighted-average fair value of each option grant is estimated on the date
of grant using a Binomial Option Pricing Model for 1998 and 1997 and a Black-
Scholes Option Pricing Model for 1996. At December 31, 1998, 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.
12 . 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.
Postretirement benefits other than pensions. The Company provides various
postretirement benefits other than pensions to eligible employees upon
retirement. HEI, HECO and its subsidiaries, and YB provide eligible employees
health and life insurance benefits upon retirement. The amount of health
benefits are based on retirees' 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.
Plan amendments. In August 1998, HECO, MECO and HELCO employees represented by
the International Brotherhood of Electrical Workers, Local 1260, ratified a new
collective bargaining agreement covering a two-year period from November 1, 1998
through October 31, 2000. Under the new agreement, HECO and its subsidiaries
amended the pension and the postretirement welfare benefits plans effective
January 1, 1999.
The changes in benefit obligations and plan assets, the funded status of the
plans and the unrecognized and recognized amounts in the balance sheet were as
follows:
58
<PAGE>
<TABLE>
<CAPTION>
Pension benefits Other benefits
---------------------------------------------------------------------------
(in thousands) 1998 1997 1998 1997
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Benefit obligation, January 1................. $583,210 $548,144 $185,134 $ 181,715
Service cost.................................. 21,629 20,040 4,831 6,379
Interest cost................................. 39,091 37,462 10,760 12,475
Amendments.................................... (11,193) 1,015 (43,212) --
Actuarial loss (gain)......................... 36,575 (1,189) (15,433) (10,905)
Benefits paid................................. (25,371) (22,262) (5,201) (4,530)
- -------------------------------------------------------------------------------------------------------------------------
Benefit obligation, December 31............... 643,941 583,210 136,879 185,134
- -------------------------------------------------------------------------------------------------------------------------
Fair value of plan assets, January 1.......... 646,968 569,935 66,030 41,295
Actual return on plan assets.................. 104,263 85,931 10,084 7,237
Employer contribution......................... 6,281 13,364 14,621 22,028
Benefits paid................................. (25,371) (22,262) (5,201) (4,530)
- -------------------------------------------------------------------------------------------------------------------------
Fair value of plan assets, December 31........ 732,141 646,968 85,534 66,030
- -------------------------------------------------------------------------------------------------------------------------
Funded status................................. 88,200 63,758 (51,345) (119,104)
Unrecognized net actuarial gain............... (95,660) (83,964) (31,334) (13,779)
Unrecognized net transition obligation........ 10,306 12,658 49,617 98,674
Unrecognized prior service cost............... (6,837) 4,812 -- --
- -------------------------------------------------------------------------------------------------------------------------
Accrued benefit cost.......................... $ (3,991) $ (2,736) $(33,062) $ (34,209)
=========================================================================================================================
Amounts recognized in the balance sheet
consist of:
Prepaid benefit cost..................... $ 3,017 $ 2,703 $ -- $ --
Accrued benefit liability................ (7,786) (6,349) (33,062) (34,209)
Intangible asset......................... 320 531 -- --
Accumulated other
comprehensive income.................. 458 379 -- --
- -------------------------------------------------------------------------------------------------------------------------
Accrued benefit cost.......................... $ (3,991) $ (2,736) $(33,062) $ (34,209)
=========================================================================================================================
</TABLE>
The following weighted-average assumptions were used in the accounting for the
plans:
<TABLE>
<CAPTION>
Pension benefits Other benefits
-----------------------------------------------
December 31 1998 1997 1996 1998 1997 1996
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Discount rate.............................. 6.5% 7.0% 7.0% 6.5% 7.0% 7.0%
Expected return on plan assets............. 10.0 10.0 9.0 10.0 10.0 9.0
Rate of compensation increase.............. 4.5 5.0 5.0 4.6 5.0 5.0
</TABLE>
At December 31, 1998, the assumed health care trend rates for 1999 and future
years were as follows: medical, 5.0%; dental, 3.5%; and vision, 3.0%.
The components of net periodic benefit cost were as follows:
<TABLE>
<CAPTION>
Pension benefits Other benefits
--------------------------------------------------------------------
(in thousands) 1998 1997 1996 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Service cost............................ $ 21,629 $ 20,040 $ 19,227 $ 4,831 $ 6,379 $ 6,139
Interest cost........................... 39,091 37,462 35,265 10,760 12,475 11,944
Expected return on plan assets.......... (55,924) (45,265) (40,566) (6,765) (4,382) (2,837)
Amortization of unrecognized transition
obligation............................. 2,352 2,352 2,368 5,846 6,585 6,585
Amortization of prior service cost...... 379 625 538 -- -- --
Recognized actuarial loss (gain)........ (68) 254 332 (1,197) -- --
- ------------------------------------------------------------------------------------------------------------
Net periodic benefit cost............... $ 7,459 $ 15,468 $ 17,164 $13,475 $21,057 $21,831
============================================================================================================
</TABLE>
59
<PAGE>
Of the net periodic pension benefit costs, the Company expensed $6 million, $12
million and $13 million in 1998, 1997 and 1996, respectively, and primarily
charged the remaining amounts to electric utility plant. Of the net periodic
other benefit costs, the Company expensed $10 million, $16 million and $16
million in 1998, 1997 and 1996, respectively, and primarily charged the
remaining amounts to electric utility plant.
At December 31, 1998 and 1997, the Company had pension plans in which the
accumulated benefit obligations exceeded plan assets at fair value, but such
plans did not have material benefit obligations.
The health care cost trend rate assumptions can have a significant effect on
the amounts reported for other benefits. At December 31, 1998, a one-percentage-
point increase in the assumed health care cost trend rates would have increased
the total service and interest cost by $1.7 million and the postretirement
benefit obligation by $7.3 million, and a one-percentage-point decrease would
have reduced the total service and interest cost by $1.4 million and the
postretirement benefit obligation by $8.1 million.
13 . Regulatory restrictions on net assets
- --------------------------------------------------------------------------------
At December 31, 1998, HEI subsidiaries could not transfer approximately $692
million of net assets to HEI in the form of dividends, loans or advances without
regulatory approval. HEI management expects that the regulatory restrictions
will not materially affect the operations of the Company nor HEI's ability to
pay common stock dividends.
14 . Significant group concentrations of credit risk
- --------------------------------------------------------------------------------
Most of the Company's business activity is with customers located in the State
of Hawaii. Most of the Company's financial instruments 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.
At December 31, 1998, 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 69% of
the portfolio was collateralized by real estate in California. As of December
31, 1998, various securities rating agencies had rated substantially all
private-issue mortgage-backed securities held by ASB as investment grade.
Major customers. HECO and its subsidiaries receive approximately 10% of their
operating revenues from the sale of electricity to various federal government
agencies, which revenues amounted to $98 million in 1998, $110 million in 1997
and $108 million in 1996.
15 . Discontinued operations
- --------------------------------------------------------------------------------
The Hawaiian Insurance & Guaranty Company, Limited (HIG). HIG and its
subsidiaries (collectively, the HIG Group) were property and casualty insurance
companies. In December 1992, due to a significant increase in the estimate of
policyholder claims from Hurricane Iniki, the HEI Board of Directors concluded
it would not contribute additional capital to HIG and the remaining investment
in the HIG Group was written off. On December 24, 1992, a formal rehabilitation
order vested full control over the HIG Group in the Insurance Commissioner of
the State of Hawaii (the Rehabilitator) and her deputies. HEI Diversified, Inc.
(HEIDI) was the holder of record of all the common stock of HIG until August 16,
1994.
In 1994, the Company settled a lawsuit stemming from this situation, with the
Company making a settlement payment of $32 million to the Rehabilitator. HEI and
HEIDI sought reimbursement for the settlement, interest and defense costs from
three director and officer liability insurance carriers. In August 1998, the
Company settled all claims with the three former insurance carriers relating to
the 1994 settlement payment. The Company received $24.5 million ($13.8 million
net of estimated expenses and income taxes, or $0.43 in basic and diluted
earnings per common share for 1998), and recorded the settlement as a net gain
on disposal of discontinued operations in the third quarter of 1998.
Malama Pacific Corp. (MPC). On September 14, 1998, the HEI Board of Directors
adopted a plan to exit the residential real estate development business (engaged
in by MPC and its subsidiaries) by September 1999. Accordingly, MPC management
commenced a program to sell all of MPC's real estate assets and investments and
HEI reported MPC as a discontinued operation in the Company's con-
60
<PAGE>
solidated statements of income in the third quarter. Due to the decline in
values of its real estate assets and investments, MPC recognized impairment
losses of $19.3 million in 1998 in accordance with the provisions of SFAS No.
121, notwithstanding the plan to exit the residential real estate development
business. MPC recognized impairment losses of $4.2 million in 1997 and nil in
1996. Operating activity of the residential real estate development business for
the period September 14, 1998 through December 31, 1998 was not significant.
Summary financial information for the discontinued operations of MPC is as
follows:
<TABLE>
<CAPTION>
Years ended December 31 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
<S> <C> <C> <C>
Operations
Revenues............................................................ $ 3,313 $ 7,702 $ 8,437
====================================================================================================================================
Operating loss (including impairment writedowns).................... $(20,648) $(6,518) $(1,771)
Interest expense.................................................... (1,609) (2,315) (1,326)
Income tax benefits................................................. 8,659 3,432 1,200
- ------------------------------------------------------------------------------------------------------------------------------------
Loss from operations................................................ (13,598) (5,401) (1,897)
- ------------------------------------------------------------------------------------------------------------------------------------
Disposal
Loss, including provision of $5,000 for loss
from operations during phase-out period......................... (16,343) -- --
Income tax benefits................................................. 6,359 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Loss on disposal.................................................... (9,984) -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Loss from discontinued operations of MPC............................ $(23,582) $(5,401) $(1,897)
====================================================================================================================================
Basic loss per common share......................................... $ (0.74) $ (0.17) $ (0.06)
====================================================================================================================================
Diluted loss per common share....................................... $ (0.73) $ (0.17) $ (0.06)
====================================================================================================================================
</TABLE>
As of December 31, 1998, the remaining net assets of the discontinued
residential real estate development operations amounted to $24 million (included
in "Other" assets) and consisted primarily of real estate assets, receivables
and deferred tax assets, reduced by loans and accounts payable. The amounts that
MPC will ultimately realize from the sale of the real estate assets could differ
materially from the recorded amounts.
Prior to September 14, 1998, interest expense (in the above table) consisted
of actual interest accrued on MPC's borrowings from banks and other third
parties, and allocated interest calculated at HEI's existing commercial paper
rates applied to intercompany borrowing amounts. Interest costs included in the
determination of the loss on disposal of MPC amounted to $2 million and
consisted of interest expected to be incurred on MPC's borrowings from banks and
other third parties and allocated interest. Allocated interest is calculated at
HEI's weighted-average cost of debt applied to 80% of MPC's expected remaining
assets, net of bank and other third party debt, over the expected disposal
period.
16 . Fair value of financial instruments
- --------------------------------------------------------------------------------
The Company used the following methods and assumptions to estimate the fair
value of each applicable class of financial instruments for which it is
practicable to estimate that value:
Cash and equivalents and short-term borrowings. The carrying amount
approximated fair value because of the short maturity of these instruments.
Investment and mortgage-backed securities. Fair value was based on quoted
market prices or dealer quotes.
Loans receivable. For certain categories of loans, such as some residential
mortgages, credit card receivables, and other consumer loans, fair value was
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 was 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 was the amount payable on demand at the reporting
date. The fair value of fixed-maturity certificates of deposit was estimated
using the rates currently offered for deposits of similar remaining maturities.
Securities sold under agreements to repurchase. Fair value was estimated using
dealer quotes for securities sold under agreements to repurchase with similar
terms and remaining maturities.
61
<PAGE>
Advances from Federal Home Loan Bank and long-term debt. Fair value was
estimated by discounting the future cash flows using the current rates available
for borrowings with similar remaining maturities.
HEI- and HECO-obligated preferred securities of trust subsidiaries. Fair value
was based on quoted market prices.
Preferred stock of electric utility subsidiaries subject to mandatory
redemption. At December 31, 1998, fair value was estimated using optional
redemption prices and par values as the preferred stock was redeemed in January
1999. At December 31, 1997, fair value was estimated using quoted market prices
for similar issues of preferred stock.
The estimated fair values of certain of the Company's financial instruments
were as follows:
<TABLE>
<CAPTION>
December 31 1998 1997
- --------------------------------------------------------------------------------------------------------------
Carrying Estimated Carrying Estimated
amount fair value amount fair value
- --------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C>
Financial assets
Cash and equivalents........................... $ 412,254 $ 412,254 $ 253,910 $ 253,910
Investment and mortgage-backed securities...... 1,902,927 1,917,975 1,970,623 1,982,394
Loans receivable, net.......................... 3,143,197 3,172,543 3,035,847 3,119,076
Financial liabilities
Deposit liabilities............................ 3,865,736 3,867,051 3,916,600 3,912,685
Short-term borrowings.......................... 222,847 222,847 284,663 284,663
Securities sold under agreements to
repurchase.................................... 515,330 514,292 375,366 373,459
Advances from Federal Home Loan Bank........... 805,581 831,277 736,474 745,034
Long-term debt................................. 899,598 938,395 794,621 829,778
HEI- and HECO-obligated preferred
securities of trust subsidiaries............. 200,000 202,453 150,000 155,000
Preferred stock of electric utility
subsidiaries subject to mandatory redemption. 33,080 34,466 35,770 37,699
Off-balance sheet
Commitments to extend credit /1/
- --------------------------------------------------------------------------------------------------------------
</TABLE>
/1/ At December 31, 1998 and 1997, neither the commitment fees received on
commitments to extend credit nor the fair value thereof were significant to
the Company's consolidated financial statements.
Limitations. The Company makes fair value estimates 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 if the Company were to sell its entire holding of a particular financial
instrument at one time. 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 could have a significant
effect on fair value estimates and have not been considered.
62
<PAGE>
17 . Commitments and contingencies
- --------------------------------------------------------------------------------
Fuel contracts and other purchase commitments. HECO and its subsidiaries have
contractual agreements to purchase minimum amounts of fuel oil and diesel fuel
through 2004 (at prices tied to the market prices of petroleum products in
Singapore and Los Angeles). Based on the average price per barrel at January 1,
1999, the estimated amount of minimum purchases under the fuel supply contracts
for 1999 is $124 million. The actual amount of purchases in 1999 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 $183 million, $248 million and $261 million of fuel under prior
contractual agreements in 1998, 1997 and 1996, respectively.
At December 31, 1998, HECO and its subsidiaries had purchase commitments,
other than fuel and power purchase contracts, amounting to approximately $64
million.
Power purchase agreements. At December 31, 1998, HECO and its subsidiaries had
power purchase agreements for 474 MW of firm capacity, representing
approximately 22% of their total generating capabilities and purchased power
firm capacities (exclusive of its power purchase agreement with Encogen for a
planned 60 MW of firm capacity, which agreement is subject to PUC approval). The
PUC allows rate recovery for energy and firm capacity payments under these
agreements. Assuming that each of the agreements (other than the Encogen
agreement) remains in place for its term 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 1999, $103 million each
in 2000 and 2001, $100 million in 2002, $103 million in 2003 and a total of $1.7
billion in 2004 through 2028.
In general, HECO and its subsidiaries base payments under the power purchase
agreements upon available capacity and energy and they are generally not
required to make payments for capacity 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. Energy
payments will vary over the terms of the agreements and HECO and its
subsidiaries 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 or its subsidiaries upon expiration of the
agreements, and the agreements do not contain bargain purchase options for the
facilities.
Interim rate increases. At December 31, 1998, HECO and its subsidiaries and YB
had recognized no revenue amounts under interim rate increases that were subject
to refund.
HELCO power situation. In 1991, HELCO identified the need, beginning in 1994,
for additional generation to provide for forecast load growth while maintaining
a satisfactory generation reserve margin, to address uncertainties about future
deliveries of power from existing firm power producers and to permit the
retirement of older generating units. Accordingly, HELCO proceeded with plans to
install at its Keahole power plant site two 20-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.
The timing of the installation of HELCO's phased combined-cycle unit at the
Keahole power plant site has been revised on several occasions due to delays in
(a) obtaining approval from the Hawaii Board of Land and Natural Resources of a
Conservation District Use Permit (CDUP) amendment and (b) obtaining from the
Department of Health of the State of Hawaii (DOH) and the U.S. Environmental
Protection Agency (EPA) a Prevention of Significant Deterioration/Covered Source
permit (PSD permit) for the Keahole power plant site. The delays are primarily
attributable to lawsuits, claims and petitions filed by independent power
producers and other parties. Subject to satisfactory resolution of the CDUP
amendment, PSD permit and other matters, HELCO's current plan continues to
contemplate that CT-4 and CT-5 will be added to its system. Current plans are
for ST-7 to be deferred to approximately 2006 or 2007.
Final judgments have been entered in several civil cases relating to HELCO's
application for a CDUP amendment. These judgments, which are currently on appeal
to the Hawaii Supreme Court, allow HELCO to use its Keahole property as
requested in its application. Motions filed both in the Third Circuit Court and
the Hawaii Supreme Court to stay these judgments pending resolution of the
appeals were denied in July and August of 1998.
There remain pending in the Third Circuit Court three declaratory judgment
actions relating to HELCO's use of the Keahole site and construction of CT-4 and
CT-5. The first of these cases, filed in February of 1997, is set for jury
trial in May 1999.
63
<PAGE>
In 1997, the EPA and the DOH issued a final PSD permit for HELCO's combined-
cycle unit at Keahole. Nine appeals of the issuance of the permit were filed
with the EPA's Environmental Appeals Board (EAB). On November 25, 1998, the EAB
issued an Order Denying Review in Part and Remanding in Part. In December 1998,
motions for reconsideration were filed with the EAB and decisions are pending.
As a result of the EAB's November 25, 1998 order, there has been a further delay
in the construction of CT-4 and CT-5. The length of the delay will depend on the
outcome of the motions for reconsideration and future developments in any remand
proceeding that may be necessary.
Although management believes it has acted prudently with respect to this
project, HELCO has decided to discontinue, for financial reporting purposes, the
accrual of AFUDC on CT-4 and CT-5 (which would have been approximately $0.4
million after tax per month) effective December 1, 1998. The length of the
delays to date and potential further delays were factors considered by
management in its decision to discontinue the accrual of AFUDC.
In 1998, HELCO determined that ST-7 would not be needed in the immediate
future and removed $0.8 million in costs accumulated against ST-7 from
construction work-in-progress, writing off $0.6 million and transferring $0.2
million to inventory.
If it becomes probable that CT-4 and/or CT-5 will not be installed, HELCO may
be required to write-off a material portion of the costs incurred in its efforts
to put these units into service. As of December 31, 1998, HELCO's costs
incurred in its efforts to put CT-4 and CT-5 into service amounted to $74.9
million, including approximately $30.1 million for equipment and material
purchases, approximately $23.3 million for planning, engineering, permitting,
site development and other costs and approximately $21.5 million as an allowance
for funds used during construction.
Competition proceeding. 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. After a collaborative process involving the 19 parties to the
proceeding, final statements of position were prepared by several of the parties
and submitted to the PUC in October 1998. HECO's position is that retail
competition is not feasible in Hawaii, but that some of the benefits of
competition can be achieved through competitive bidding for new generation,
performance-based rate-making and innovative pricing provisions. The other
parties to the proceeding advanced numerous other proposals in their statements
of position. The PUC will determine what subsequent steps will be followed in
the proceeding, but no timetable has been set for such a determination. Some of
the parties may seek state legislative action on their proposals. HECO cannot
predict what the ultimate outcome of the proceeding will be or which (if any) of
the proposals advanced in the proceeding will be implemented.
Environmental regulation. In early 1995, the DOH initially advised HECO, HTB,
YB and others that it was conducting an investigation to determine the nature
and extent of actual or potential releases of hazardous substances, oil,
pollutants or contaminants at or near Honolulu Harbor. The DOH issued letters in
December 1995, indicating that it had identified a number of parties, including
HECO, HTB and YB, who appear to be potentially responsible for the contamination
and/or to operate their facilities upon contaminated land. The DOH met with
these identified parties in January 1996 and certain of the identified parties
(including HECO, Chevron Products Company, Shell Oil Products Company, State of
Hawaii Department of Transportation Harbors Division and others, but not
including HTB and YB) formed a Technical Work Group. Effective January 30, 1998,
the Technical Work Group and the DOH entered into a voluntary agreement and
scope of work to determine the nature and extent of any contamination, the
responsible parties and appropriate remedial actions. 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.
China project. In September 1998, HEIPC (through a wholly owned, indirect
subsidiary) acquired an effective 60% interest in a joint venture, Baotou
Tianjiao Power Co., Ltd., formed to design, construct, own, operate and manage a
206-MW (net) coal-fired power plant to be located in Inner Mongolia, People's
Republic of China. Ownership of the plant will be transferred, without charge,
to the sole purchaser of the power in approximately 20 years. Construction has
commenced and the units are expected to be on line by the end of 2000. As of
December 31, 1998, the HEIPC Group had invested $16 million and is committed to
invest up to an additional $84 million toward the China project.
64
<PAGE>
18 . Quarterly information (unaudited)
- --------------------------------------------------------------------------------
Selected quarterly information was as follows:
<TABLE>
<CAPTION>
Quarters ended Year ended
- ---------------------------------------------------------------------------------------------------------------
1998 Mar. 31 Jun. 30 Sep. 30 Dec. 31 Dec. 31
- -----------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Revenues................................. $374,858 $360,665 $377,318 $372,324 $1,485,165
Operating income......................... 56,461 54,114 62,299 51,772 224,646
Net income (loss)
Continuing operations................. $ 22,819 $ 22,921 $ 27,779 $ 21,109 $ 94,628
Discontinued operations............... (596) (528) (8,693) -- (9,817)
------------------------------------------------------------------------------------
$ 22,223 $ 22,393 $ 19,086 $ 21,109 $ 84,811
------------------------------------------------------------------------------------
Basic earnings (loss) per common share /1/
Continuing operations................. $ 0.72 $ 0.72 $ 0.87 $ 0.66 $ 2.96
Discontinued operations............... (0.02) (0.02) (0.27) -- (0.31)
------------------------------------------------------------------------------------
$ 0.70 $ 0.70 $ 0.60 $ 0.66 $ 2.65
------------------------------------------------------------------------------------
Diluted earnings (loss) per common share /2/
Continuing operations................. $ 0.71 $ 0.72 $ 0.86 $ 0.66 $ 2.95
Discontinued operations............... (0.02) (0.02) (0.27) -- (0.31)
------------------------------------------------------------------------------------
$ 0.69 $ 0.70 $ 0.59 $ 0.66 $ 2.64
------------------------------------------------------------------------------------
Dividends per common share............... $ 0.62 $ 0.62 $ 0.62 $ 0.62 $ 2.48
Market price per common share /3/
High................................... 42.19 42.00 41.25 42.56 42.56
Low.................................... 38.69 37.88 36.38 38.50 36.38
</TABLE>
<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................................. $356,334 $358,454 $370,454 $375,185 $1,460,427
Operating income......................... 49,660 50,461 61,064 51,522 212,707
Net income (loss)
Continuing operations................. $ 20,232 $ 20,353 $ 27,441 $ 23,817 $ 91,843
Discontinued operations............... (569) (558) (3,303) (971) (5,401)
------------------------------------------------------------------------------------
$ 19,663 $ 19,795 $ 24,138 $ 22,846 $ 86,442
------------------------------------------------------------------------------------
Basic earnings (loss) per common share /1/
Continuing operations................. $ 0.66 $ 0.65 $ 0.87 $ 0.75 $ 2.93
Discontinued operations............... (0.02) (0.02) (0.10) (0.03) (0.17)
------------------------------------------------------------------------------------
$ 0.64 $ 0.63 $ 0.77 $ 0.72 $ 2.76
------------------------------------------------------------------------------------
Diluted earnings (loss) per common share /2/
Continuing operations................. $ 0.65 $ 0.65 $ 0.86 $ 0.75 $ 2.92
Discontinued operations............... (0.02) (0.02) (0.10) (0.03) (0.17)
-----------------------------------------------------------------------------------
$ 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 /3/
High................................... 36.38 39.13 38.63 41.50 41.50
Low.................................... 33.75 32.88 35.13 36.25 32.88
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
/1/ The quarterly basic earnings (loss) per common share are based upon the
weighted-average number of shares of common stock outstanding in each
quarter.
/2/ The quarterly diluted earnings (loss) 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.
/3/ Market prices of HEI common stock (symbol HE) shown are as reported on the
NYSE Composite Tape.
65
<PAGE>
<TABLE>
<S> <C> <C>
HEI Directors
- -------------
Robert F. Clarke, 56 (1)* Bill D. Mills, 47 (3) Oswald K. Stender, 67 (3, 4)*
Chairman, President and Chairman of the Board and Trustee
Chief Executive Officer Chief Executive Officer Kamehameha Schools/Bishop Estate
Hawaiian Electric Industries, Inc. Bill Mills Development and (charitable trust)
1989 Investment Company, Inc. 1993
(real estate development)
Don E. Carroll, 57 (3, 4) 1988 Kelvin H. Taketa, 44 (2)*
President and Chief Executive Officer President and Chief Executive Officer
Oceanic Cablevision A. Maurice Myers, 58 (3, 4) Hawaii Community Foundation
(cable television broadcasting) Chairman, President and (statewide charitable foundation)
1996 Chief Executive Officer 1993
Yellow Corporation
Richard Henderson, 70 (1, 2)* (transportation services) Jeffrey N. Watanabe, 56 (1, 4)*
President 1991 Partner
HSC, Inc. Watanabe, Ing & Kawashima
(real estate investment and development) Diane J. Plotts, 63 (1, 2, 3)* (private law firm)
1981 General Partner 1987
Mideast and China Trading Company
Victor Hao Li, S.J.D., 57 (2)* (real estate development)
Co-chairman 1987 Committees of the Board of Directors
--------------------------------------
Asia Pacific Consulting Group (1) Executive:
(international business consultant) James K. Scott, Ed.D., 47 (2)* Richard Henderson, Chairman
1988 President (2) Audit:
Punahou School Richard Henderson, Chairman
T. Michael May, 52* (private education) (3) Compensation:
President and Chief Executive Officer 1995 Diane J. Plotts, Chairman
Hawaiian Electric Company, Inc. (4) Nominating & Corporate Governance:
1995 Jeffrey N. Watanabe, Chairman
*Also member of one or more subsidiary boards
Year denotes year of election to the board of directors
Information as of February 17, 1999
HEI Officers
- ------------
Robert F. Clarke, 56 Peter C. Lewis, 64 Constance H. Lau, 46
Chairman, President and Vice President-Administration and Treasurer
Chief Executive Officer Corporate Secretary 1984
1987 1968
T. Michael May, 52 Charles F. Wall, 59 Curtis Y. Harada, 43
Senior Vice President Vice President and Controller
1992 Corporate Information Officer 1989
1990
Robert F. Mougeot, 56 Molly M. Egged, 48
Financial Vice President and Andrew I. T. Chang, 59 Assistant Secretary
Chief Financial Officer Vice President Government Relations 1980
1988 1985
Year denotes year of employment by the Company
Information as of February 17, 1999
</TABLE>
66
<PAGE>
HECO Exhibit 13.2
-----------------
Selected Financial Data
- --------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
<TABLE>
<CAPTION>
Years ended December 31 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(in thousands)
Income statement data
Operating revenues.............. $1,008,899 $1,098,755 $1,071,426 $ 981,990 $ 907,308
Operating expenses.............. 892,747 987,715 962,635 879,268 819,996
---------- ---------- ---------- ---------- ----------
Operating income................ 116,152 111,040 108,791 102,722 87,312
Other income.................... 16,832 19,042 20,675 16,325 14,793
---------- ---------- ---------- ---------- ----------
Income before interest
and other charges.............. 132,984 130,082 129,466 119,047 102,105
Interest and other
charges........................ 48,754 48,233 44,253 42,024 36,144
---------- ---------- ---------- ---------- ----------
Income before preferred
stock dividends of
HECO........................... 84,230 81,849 85,213 77,023 65,961
Preferred stock
dividends of HECO.............. 3,454 3,660 3,865 4,126 4,316
---------- ---------- ---------- ---------- ----------
Net income for common
stock.......................... $ 80,776 $ 78,189 $ 81,348 $ 72,897 $ 61,645
========== ========== ========== ========== ==========
At December 31 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Balance sheet data
Utility plant................... $2,925,344 $2,797,886 $2,674,419 $2,483,005 $2,293,521
Accumulated
depreciation................... (982,172) (904,781) (828,917) (762,770) (702,945)
---------- ---------- ---------- ---------- ----------
Net utility plant............... $1,943,172 $1,893,105 $1,845,502 $1,720,235 $1,590,576
========== ========== ========== ========== ==========
Total assets.................... $2,311,253 $2,212,314 $2,165,546 $2,016,283 $1,889,120
========== ========== ========== ========== ==========
Capitalization:1
Long-term debt.................. $ 621,998 $ 627,621 $ 602,226 $ 517,209 $ 489,586
Preferred stock
subject to mandatory
redemption..................... 33,080 35,770 38,955 41,750 44,844
Preferred stock not
subject to mandatory
redemption..................... 48,293 48,293 48,293 48,293 48,293
HECO obligated mandatorily
redeemable trust
preferred securities
of subsidiary trusts
holding solely HECO and
HECO-guaranteed
debentures..................... 100,000 50,000 -- -- --
Common stock equity............. 786,567 769,235 751,311 696,905 633,901
---------- ---------- ---------- ---------- ----------
Total capitalization............ $1,589,938 $1,530,919 $1,440,785 $1,304,157 $1,216,624
========== ========== ========== ========== ==========
Capital structure ratios (%)2
Debt............................ 44.0 44.4 46.5 45.5 45.5
Preferred stock................. 4.7 5.2 5.5 6.2 7.0
HECO obligated mandatorily
redeemable trust
preferred securities
of subsidiary trusts
holding solely HECO and
HECO-guaranteed
debentures..................... 5.8 3.1 -- -- --
Common stock equity............. 45.5 47.3 48.0 48.3 47.5
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
1 Includes amounts due within one year and sinking fund and optional redemption
payments.
2 Includes amounts due within one year, short-term borrowings from nonaffiliates
and affiliate, and sinking fund and optional redemption payments.
Note: HEI owns all of HECO's common stock. Therefore, per share data is not
meaningful.
2
<PAGE>
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 1998 was $80.8 million compared to $78.2 million
for 1997 and $81.3 million for 1996. The 1998 net income represents a 10.4%
return on the average amount of common stock equity invested in the Company,
compared to returns of 10.3% in 1997 and 11.2% in 1996.
Sales
Consolidated sales of electricity were 8,870 million kilowatthours (KWH) for
1998, 8,963 million KWH for 1997, and 8,991 million KWH for 1996. The decreases
in KWH sales in 1998 and 1997 were partly due to Hawaii's slow economy and
cooler temperatures, which resulted in lower residential and commercial air
conditioning usage. KWH sales increased in 1996 partly due to the effects of a
1.4% real growth in Hawaii's economy.
Operating revenues
Operating revenues were $1,008.9 million in 1998, compared to $1,098.8 million
in 1997 and $1,071.4 million in 1996. The 1998 decrease in operating revenues of
$89.9 million, or 8.2%, was due primarily to lower fuel oil prices which were
passed through to customers ($82.1 million), and a 1.0% decrease in KWH sales
($9.8 million). 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.
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
decrease in KWH sales.
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
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 expenses
Total operating expenses were $892.7 million in 1998 compared to $987.7 million
in 1997 and $962.6 million in 1996. The decrease in 1998 was due to decreases
in expenses for fuel oil, purchased power, other operation, maintenance, and
taxes other than income taxes.
The increase in 1997 was due to increases in expenses for fuel oil, purchased
power, other operation, depreciation and amortization, and taxes other than
income taxes. Operating expenses for 1996 increased by $83.4 million, or 9.5%,
due to increases in all categories of operating expenses.
Fuel oil expense was $195.9 million in 1998 compared to $257.0 million in 1997
and $250.5 million in 1996. The decrease in fuel oil expense in 1998 was due
primarily to lower fuel oil prices, partly offset by an increase in KWH
generated. The increase in fuel oil expense in 1997 was due primarily to higher
fuel oil prices. Fuel oil expense for 1996 increased by $43.5 million, due
primarily to higher fuel oil prices and more KWH generated. In 1998, the
Company paid an average of $19.14 per barrel for fuel oil, compared to $25.19 in
1997 and $24.08 in 1996.
3
<PAGE>
Management's Discussion and Analysis, continued
- --------------------------------------------------------------------------------
Purchased power expense was $274.5 million in 1998 compared to $292.9 million
in 1997 and $286.1 million in 1996. The decrease in purchased power expense in
1998 was due to lower fuel prices and fewer KWH purchased. Purchased power
expense increased in both 1997 and 1996, due primarily to higher fuel oil prices
and more KWH purchased. Purchased KWH provided approximately 36.6% of the total
energy net generated and purchased in 1998 compared to 38.1% in 1997 and 37.3%
in 1996.
Other operation expenses totaled $143.0 million in 1998, compared to $149.0
million in 1997 and $142.7 million in 1996. The decrease in other operation
expenses in 1998 was due primarily to lower pension costs and postretirement
benefits costs resulting from changes in actuarial assumptions and from
negotiated bargaining unit benefit changes. Other operation expenses increased
in both 1997 and 1996, due primarily to higher IRP related costs, including full
scale DSM program costs. HEI charges for general management, administrative and
support services totaled $1.9 million in 1998, $2.2 million in 1997 and $2.3
million in 1996.
Maintenance expenses in 1998 of $43.2 million decreased by $6.7 million from
1997 due primarily to less generating unit overhaul and corrective maintenance
work. 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 by $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.
Depreciation and amortization expense was up 4.4% in 1998 to $85.7 million, up
11.7% in 1997 to $82.0 million and up 8.6% in 1996 to $73.5 million. In all
years, the increases reflect depreciation on additions to plant in service in
the previous year. Major additions to plant in service included MECO's Maalaea-
Lahaina 3rd 69-kv line and generation expansion projects on Lanai and Molokai in
1996, and HECO's Waiau-Campbell Industrial Park 138-kilovolt line and MECO's
Maalaea-Naalae 69-kilovolt line in 1995.
Taxes, other than income taxes, decreased by 8.1% in 1998 to $95.8 million,
increased by 2.8% in 1997 to $104.2 million and increased by 9.1% in 1996 to
$101.4 million. These taxes consist primarily of taxes based on revenues, and
the decrease/increases in these taxes reflect the corresponding
decrease/increases in each year's operating revenues.
Operating income
Operating income for 1998 increased 4.6% compared to 1997 due to lower other
operation and maintenance expenses, partly offset by lower KWH sales and higher
depreciation and amortization expenses and income taxes. 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.
Other income
Other income for 1998 totaled $16.8 million, compared to $19.0 million for 1997
and $20.7 million for 1996. The decreases in 1998 and 1997 were 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. Other income for 1996 increased by
$4.4 million compared to 1995, due primarily to higher AFUDC-Equity and interest
income on deferred IRP costs.
Interest and other charges
Interest and other charges for 1998 totaled $48.8 million, compared to $48.2
million for 1997 and $44.3 million for 1996. Interest on long-term debt
increased by $1.0 million in 1998, $3.1 million in 1997 and $2.6 million in
1996. Interest and other charges included $4.2 million of preferred securities
distributions by
4
<PAGE>
Management's Discussion and Analysis, continued
- --------------------------------------------------------------------------------
HECO's trust subsidiaries in 1998, and $3.1 million in 1997. See Note 4 in the
"Notes to Consolidated Financial Statements" for a discussion of the preferred
securities issued by the Trusts.
The 1998 increase in interest on long-term debt was due to interest on
drawdowns of tax-exempt special purpose revenue bond proceeds during 1998, and
the full year's interest on the 1997 drawdowns of revenue bond proceeds. The
1998 increase was partially offset by lower revenue bond interest rates, and
lower medium-term note interest. In April 1998, $57.5 million of 6 7/8%
Refunding Series 1987 Special Purpose Revenue Bonds sold by the State of Hawaii
Department of Budget and Finance on behalf of HECO, MECO and HELCO, were
refinanced using the proceeds from 4.95% Refunding Series 1998A Special Purpose
Revenue Bonds, sold in March 1998. In December 1998, HECO's 5.83% medium-term
note in the principal amount of $30 million was retired.
The 1997 increase in interest on long-term debt 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 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 in the principal amount of $13 million, and the early redemptions in
November 1997 of MECO's 7.875% Series G and 7.75% Series H mortgage bonds
totaling $7 million and in December 1997 of HECO's 7 5/8% Series S mortgage
bonds in the principal amount of $10 million.
The 1996 increase in interest on long-term debt 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 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.
Other interest charges of $5.7 million for 1998 were $2.0 million lower than
for 1997 due to lower interest on short-term borrowings as a result of lower
borrowing levels during 1998. 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.
Competition
The electric utility industry is becoming increasingly competitive. Independent
power producers (IPPs) are well established in Hawaii and continue to actively
pursue new projects. Customer self-generation, with or without cogeneration,
has made inroads in Hawaii and is a continuing competitive factor. 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. HECO has been able to compete successfully by
offering customers economic alternatives that, among other things, employ energy
efficient electrotechnologies such as the heat pump water heater.
Legislation has been introduced in Congress that would restructure the
electric utility industry with a view toward increasing competition by, for
example, allowing customers to choose their generation supplier. Some of the
bills would exempt Alaska and Hawaii. Also, the Department of Energy's proposed
"Comprehensive Electricity Competition Act", submitted to Congress in June 1998,
includes a provision that would permit states to "opt out" of the proposed
retail competition deadline of not later than January 1, 2003.
On December 30, 1996, the PUC instituted a proceeding to identify and examine
the issues surrounding electric competition and to determine the impact of
competition on the electric utility infrastructure in Hawaii. See Note 12 in
the "Notes to Consolidated Financial Statements."
5
<PAGE>
Management's Discussion and Analysis, continued
- --------------------------------------------------------------------------------
Regulation of electric utility rates
The PUC has broad discretion in its regulation of the rates charged by HECO and
its 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
HECO and its 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. As of February
17, 1999, the return on average common equity (ROACE) found by the PUC to be
reasonable in the most recent final rate decision for each utility was 11.4% for
HECO (effective December 11, 1995 and based on a 1995 test year), 11.65% for
HELCO (effective April 2, 1997 and based on a 1996 test year) and 11.12% for
MECO (effective December 23, 1997 and based on a 1997 test year).
Hawaii Electric Light Company, Inc.
In March 1998, HELCO filed a request to increase rates 11.5%, or $17.3 million
in annual revenues, based on a 1999 test year and a 12.5% ROACE, primarily to
recover costs relating to (1) an agreement, which is subject to PUC approval, to
buy power from Encogen's planned 60-megawatt (MW) plant and (2) adding two
combustion turbines (CT-4 and CT-5) at HELCO's Keahole power plant. Depending
on future developments with respect to the Encogen power purchase agreement and
with respect to obtaining the necessary permits for CT-4 and CT-5, HELCO's test
year 1999 rate increase application may be withdrawn, in which case a new
application will be filed closer to the time when the new generation facilities
are expected to be completed.
Maui Electric Company, Limited
In January 1998, MECO filed a request to increase rates by 15.3%, or $22.4
million in annual revenues, based on a 12.75% ROACE and a 1999 test year,
primarily to recover the costs related to the addition of a new generation unit
in late 1998. In December 1998, MECO received an interim D&O, effective January
1, 1999, authorizing an 8.5%, or $11.7 million, increase in annual revenues,
based on a ROACE of 11.12%, which was the ROACE authorized in MECO's prior rate
case.
Energy cost adjustment clauses. The rate schedules of HECO, HELCO and MECO
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 their rate increase applications based on a 1999 test
year, HELCO and MECO stated their position 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
6
<PAGE>
Management's Discussion and Analysis, continued
- --------------------------------------------------------------------------------
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. In March 1998, the PUC determined that it would
not be in the best interests of ratepayers to allow the utilities to establish a
ratepayer funded self-insured property damage reserve. In the order, the PUC
stated that the relative responsibilities of ratepayers and shareholder's for
the cost of restoration and repair of any damage caused by uninsured
catastrophic natural disasters will be judged on the basis of the facts of each
situation.
Commitments and Contingencies
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".
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.
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 issue
The following discussion includes numerous forward-looking statements. See
- ---------------------------------------------------------------------------
"Forward-Looking Information."
- ------------------------------
State of readiness. HECO and its subsidiaries have identified information
technology (IT) and non-IT systems which will require Year 2000 remediation
work. HECO has prioritized these systems by importance, business risk and Year
2000 exposure, allocating resources accordingly. Remediation work for each of
the systems includes an assessment phase, a renovation and validation phase and
an implementation phase. Overall, the assessment phase is substantially
complete for HECO and its subsidiaries' systems and it is roughly estimated that
40% of the renovation and validation phase has been completed as of December 31,
1998, with
7
<PAGE>
Management's Discussion and Analysis, continued
- --------------------------------------------------------------------------------
lesser amounts of work completed on the implementation phase. The scheduled
completion date for each system is before the date it is expected to encounter
any Year 2000 impact (not later than September 1999).
In December 1998, HECO and its subsidiaries replaced the majority of their
business-critical applications with an integrated application suite that is
represented to be Year 2000 ready. The installation of an integrated application
suite has both simplified and lowered the cost of Year 2000 remediation efforts.
HECO and its subsidiaries have identified third parties with whom they have
significant relationships and are corresponding with these vendors and service
providers to determine their Year 2000 readiness. Significant third parties
include fuel suppliers, independent power producers, financial institutions and
large customers. Letters have been sent to 282 vendors and 83% have responded
to the inquiry. HECO has formed an Oahu Power Partners Year 2000 Group to
provide a forum to share information among HECO, independent power producers and
fuel suppliers. HECO has contracted with two of its major vendors of power
plant equipment for their services in assessing, remediating and testing their
installed control systems. HECO and these vendors have completed remediation of
seven of HECO's 16 generating units and have tested three of the seven.
Costs. HECO management believes that the cost to remediate its systems to
become Year 2000 ready will not have a material adverse effect on consolidated
HECO's financial condition, results of operations or liquidity. The total cost
of initiatives undertaken primarily for Year 2000 remediation is estimated at $2
million, of which $0.3 million has been incurred through December 31, 1998.
Risks. The Year 2000 remediation effort addresses two distinct areas of risk--
(1) electric systems, which deliver power to customers, and (2) business
systems, which handle data processing. Importantly, neither the generation nor
distribution systems are fully dependent on automated control systems. Because
HECO and its subsidiaries have the capability to manually control the generation
and dispatching of power and have some degree of diversity and redundancy in
their systems, HECO believes the most reasonably likely worst case scenario
would be brief, localized power outages and billing, collection and/or reporting
errors or delays.
Contingency plans. Contingency plans in the event of a Year 2000 problem are
being developed for HECO and its subsidiaries. HECO and its subsidiaries will
have personnel on standby at midnight on December 31, 1999 and on other critical
dates in 1999 and 2000, as deemed necessary. Work crews will be able to
manually operate equipment, making a prolonged power outage unlikely.
Effects of inflation
U.S. inflation, as measured by the U.S. Consumer Price Index, averaged 1.6% in
1998, 2.3% in 1997 and 3.0% in 1996. Hawaii inflation, as measured by the
Honolulu Consumer Price Index, averaged an estimated (0.2)% in 1998, 0.7% in
1997 and 1.5% in 1996. 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.
Inflation increases operating costs and the replacement cost of assets. With
significant physical assets, HECO and its subsidiaries replace assets at much
higher costs and must request and obtain rate increases to maintain adequate
earnings. In the past, the PUC has generally approved rate increases to cover
the effects of inflation. In 1999, 1997 and 1996, 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."
8
<PAGE>
Management's Discussion and Analysis, continued
- --------------------------------------------------------------------------------
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 $131.9 million in 1998, of
which $70.7 million was attributable to HECO, $38.3 million to HELCO and $22.9
million to MECO. Approximately 71% of the total 1998 capital expenditures was
for transmission and distribution projects, including HECO's Honolulu City Line
and Kamehameha Highway Conversion projects and, approximately 29% 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 1998 totaled $7.9 million.
In 1998, the Company's investing activities used $122.5 million in cash,
primarily for capital expenditures. Proceeds from the issuance of long-term
debt of $81.7 million were used to refund special purpose revenue bonds, to fund
capital expenditures and other cash requirements. Cash provided from financing
activities also included issuance by HECO Capital Trust II of $50.0 million of
HECO obligated mandatory redeemable preferred securities, the proceeds of which
were loaned to the utilities to finance their preferred stock redemptions in
January 1999. Financing activities used cash for common and preferred stock
dividends of $66.0 million. Short-term borrowings increased by $43.8 million.
Operating activities provided $157.7 million toward cash requirements of
financing activities and capital expenditures.
The Companies' consolidated requirements for funds in the years 1999 through
2003, including net capital expenditures, long-term debt retirements and sinking
fund requirements, are currently estimated to total $660 million. HECO's
consolidated internal sources, after payment of common stock and preferred stock
dividends, are currently expected to provide approximately 78% of the $660
million in total requirements, with debt and equity financing providing the
remaining requirements. As of December 31, 1998, $29.7 million of proceeds from
previous sales by the Department of Budget and Finance of the State of Hawaii of
special purpose revenue bonds issued for the benefit of HECO, MECO and HELCO
remained undrawn. Also as of December 31, 1998, an additional $88 million of
special purpose revenue bonds were authorized by the Hawaii Legislature for
issuance by the Department of Budget and Finance of the State of Hawaii for the
benefit of HECO and MECO prior to the end of 1999 and an additional $100 million
of revenue bonds was authorized for issuance for the benefit of HECO and HELCO
prior to the end of 2003. HECO estimates that it will require approximately $28
million in new common equity, in addition to retained earnings, over the five-
year period 1999 through 2003. 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 1999 through
2003, are currently estimated to total $608 million. Approximately 75% 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 25% primarily for
generation projects. At December 31, 1998, purchase commitments other than
those related to fuel and power purchase contracts amounted to approximately $64
million, including amounts for construction projects. See Note 12 in the "Notes
to Consolidated Financial Statements" for a discussion of purchase commitments,
including commitments for fuel contracts, power purchase agreements and
construction projects.
9
<PAGE>
Management's Discussion and Analysis, continued
- --------------------------------------------------------------------------------
For 1999, net capital expenditures are estimated to be $142 million. Gross
capital expenditures are estimated to be $157 million, comprised of
approximately $120 million for transmission and distribution projects,
approximately $12 million for new generation projects and approximately $25
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.
In February 1999, Standard & Poor's (S&P) and Moody's Investors Service's
(Moody's) ratings of HECO's outstanding securities were as follows:
<TABLE>
<CAPTION>
S&P Moody's
- -------------------------------------------------------------------------------
<S> <C> <C>
Commercial paper............................... A-2 P-2
Revenue bonds.................................. BBB+ Baa1
HECO-obligated preferred securities of trust
subsidiaries.................................. BBB- baa1
Cumulative preferred stock..................... BBB- baa2
</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.
Quantitative and Qualitative Disclosures about Market Risk
- -------------------------------------------------------------------------------
The Company manages various market risks in the ordinary course of business,
including credit risk, liquidity risk and commodity price risk, and believes its
exposures to these risks are not material as of December 31, 1998. 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. Interest rate risk can be defined as the exposure of
the Company's earnings to adverse movements in interest rates. 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 interest rate risk. The Company's general policy is to
manage 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 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, 1998, and constitutes a "forward-looking
statement."
See Note 16 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.
10
<PAGE>
Quantitative and Qualitative disclosure about Market Risk, continued
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
Expected maturity December 31, 1998
- -------------------------------------------------------------------------------------------------------
Estimated
There- fair
(dollars in millions) 1999 2000 2001 2002 2003 after Total value
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest-sensitive
liabilities
Short-term borrowings $134 -- -- -- -- -- $134 $134
Average interest
rate 6.0% -- -- -- -- -- 6.0%
Long-term debt
Fixed rate -- -- -- $2 $3 $617 $622 $655
Average interest
rate -- -- -- 7.9% 7.8% 6.2% 6.3%
HECO obligated
preferred securities
of trust subsidiaries -- -- -- -- -- $100 $100 $ 97
Average distribu-
tion rate -- -- -- -- -- 7.7% 7.7%
Cumulative preferred
stock subject to
mandatory redemption $33 -- -- -- -- -- $33 $34
Average dividend
rate 8.5% -- -- -- -- -- 8.5%
</TABLE>
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; the timing and extent of
changes in interest rates; and the risks associated with the installation of new
computer systems and the avoidance of Year 2000 problems. Investors are also
referred to other risks and uncertainties discussed elsewhere in this Annual
Report and in other periodic reports previously and subsequently filed by HECO
with the Securities and Exchange Commission.
11
<PAGE>
Consolidated Statements of Income
- -------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
<TABLE>
<CAPTION>
Years ended December 31 1998 1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(in thousands)
Operating revenues.......................... $1,008,899 $1,098,755 $1,071,426
---------- ---------- ----------
Operating expenses:
Fuel oil.................................... 195,940 257,002 250,544
Purchased power............................. 274,450 292,852 286,077
Other operation............................. 142,992 148,959 142,699
Maintenance................................. 43,183 49,858 52,305
Depreciation and amortization............... 85,655 82,017 73,453
Taxes, other than income taxes.............. 95,808 104,232 101,387
Income taxes................................ 54,719 52,795 56,170
---------- ---------- ----------
892,747 987,715 962,635
---------- ---------- ----------
Operating income............................ 116,152 111,040 108,791
---------- ---------- ----------
Other income:
Allowance for equity funds used during
construction............................... 10,106 10,864 11,741
Other, net.................................. 6,726 8,178 8,934
---------- ---------- ----------
16,832 19,042 20,675
---------- ---------- ----------
Income before interest and other charges.... 132,984 130,082 129,466
---------- ---------- ----------
Interest and other charges:
Interest on long-term debt.................. 40,749 39,783 36,645
Amortization of net bond premium and
expense.................................... 1,469 1,313 1,302
Other interest charges...................... 5,703 7,682 9,504
Allowance for borrowed funds used during
construction............................... (5,915) (6,190) (5,862)
Preferred stock dividends of subsidiaries... 2,551 2,593 2,664
Preferred securities distributions of
trust subsidiaries......................... 4,197 3,052 --
---------- ---------- ----------
48,754 48,233 44,253
---------- ---------- ----------
Income before preferred stock dividends
of HECO.................................... 84,230 81,849 85,213
Preferred stock dividends of HECO........... 3,454 3,660 3,865
---------- ---------- ----------
Net income for common stock................. $ 80,776 $ 78,189 $ 81,348
========== ========== ==========
</TABLE>
Consolidated Statements of Retained Earnings
- -------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
<TABLE>
<CAPTION>
Years ended December 31 1998 1997 1996
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(in thousands)
Retained earnings, beginning of year............... $387,582 $367,770 $343,425
Net income for common stock........................ 80,776 78,189 81,348
Common stock dividends............................. (62,522) (58,377) (57,003)
-------- -------- --------
Retained earnings, end of year..................... $405,836 $387,582 $367,770
======== ======== ========
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
12
<PAGE>
<TABLE>
<CAPTION>
Consolidated Balance Sheets
- --------------------------------------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
December 31 1998 1997
- --------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Assets
Utility plant, at cost:
Land.................................................................. $ 30,312 $ 32,222
Plant and equipment................................................... 2,750,487 2,559,655
Less accumulated depreciation......................................... (982,172) (904,781)
Plant acquisition adjustment, net..................................... 510 562
Construction in progress.............................................. 144,035 205,447
---------- ----------
Net utility plant.................................................. 1,943,172 1,893,105
---------- ----------
Current assets:
Cash and equivalents.................................................. 54,783 1,676
Customer accounts receivable, net..................................... 69,170 69,378
Accrued unbilled revenues, net........................................ 43,445 45,980
Other accounts receivable, net........................................ 4,082 4,195
Fuel oil stock, at average cost....................................... 16,778 25,058
Materials and supplies, at average cost............................... 17,266 18,975
Prepayments and other................................................. 3,858 3,335
---------- ----------
Total current assets............................................... 209,382 168,597
---------- ----------
Other assets:
Regulatory assets..................................................... 108,344 101,809
Unamortized debt expense.............................................. 12,549 13,085
Long-term receivables and other....................................... 37,806 35,718
---------- ----------
Total other assets................................................. 158,699 150,612
---------- ----------
$2,311,253 $2,212,314
========== ==========
Capitalization and liabilities
Capitalization (see Consolidated Statements of Capitalization):
Common stock equity................................................... $ 786,567 $ 769,235
Cumulative preferred stock:
Not subject to mandatory redemption.................................. 34,293 48,293
Subject to mandatory redemption...................................... -- 33,175
HECO obligated mandatorily redeemable trust preferred
securities of subsidiary trusts holding solely
HECO and HECO-guaranteed debentures.................................. 100,000 50,000
Long-term debt, net................................................... 621,998 597,621
---------- ----------
Total capitalization.............................................. 1,542,858 1,498,324
---------- ----------
Current liabilities:
Long-term debt due within one year.................................... -- 30,000
Preferred stock sinking fund and optional redemption
payments............................................................. 47,080 2,595
Short-term borrowings-nonaffiliates................................... 133,863 95,181
Short-term borrowings-affiliate....................................... 5,550 400
Accounts payable...................................................... 40,008 49,805
Interest and preferred dividends payable.............................. 11,214 12,225
Taxes accrued......................................................... 58,335 59,952
Other................................................................. 30,166 21,633
---------- ----------
Total current liabilities......................................... 326,216 271,791
---------- ----------
Deferred credits and other liabilities:
Deferred income taxes................................................. 128,327 125,509
Unamortized tax credits............................................... 48,130 48,675
Other................................................................. 66,818 70,419
---------- ----------
Total deferred credits and other liabilities...................... 243,275 244,603
---------- ----------
Contributions in aid of construction.................................. 198,904 197,596
---------- ----------
$2,311,253 $2,212,314
========== ==========
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
13
<PAGE>
Consolidated Statements of Capitalization
- --------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
<TABLE>
<CAPTION>
<S> <C> <C>
December 31 1998 1997
- ----------------------------------------------------------------------------------------------------------
(dollars in thousands, except per share amounts)
Common stock equity:
Common stock of $6 2/3 par value.
Authorized: 50,000,000 shares. Outstanding:
1998 and 1997, 12,805,843 shares........................................... $ 85,387 $ 85,387
Premium on capital stock.................................................... 295,344 296,266
Retained earnings........................................................... 405,836 387,582
-------- --------
Common stock equity..................................................... 786,567 769,235
-------- --------
</TABLE>
Cumulative preferred stock:
Authorized: 5,000,000 shares of $20 par
value and 7,000,000 shares of $100 par value.
Outstanding: 1998, 1,705,457 shares and 1997,
1,732,357 shares.
<TABLE>
<CAPTION>
Shares
outstanding
Par December 31,
Series value 1998
- ---------------------------------------------------------------
<S> <C> <C> <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
=========
Less optional redemption payments due within
one year................................................................... 14,000 --
-------- --------
34,293 48,293
-------- --------
Series subject to mandatory redemption:
Q-7.68% $100 (HECO)................... 76,000................... 7,600 8,000
R-8.75% 100 (HECO)................... 130,000................... 13,000 15,000
D-12 3/4% 100 (HELCO).................. 4,500................... 450 500
E-12.25% 100 (HELCO).................. 5,500................... 550 600
F-8.5% 100 (HELCO).................. 60,000................... 6,000 6,000
D-8 3/4% 100 (MECO)................... 4,800................... 480 670
G-8.5% 100 (MECO)................... 50,000................... 5,000 5,000
--------- -------- --------
330,800 33,080 35,770
=========
Less sinking fund and optional redemption
payments due within one year............................................... 33,080 2,595
-------- --------
-- 33,175
-------- --------
Cumulative preferred stock.............................................. $34,293 $81,468
-------- --------
See accompanying "Notes to Consolidated Financial Statements."
(Continued)
</TABLE>
14
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Capitalization, continued
- -----------------------------------------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
December 31 1998 1997
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
(in thousands)
HECO obligated mandatorily redeemable trust preferred
securities of subsidiary trusts holding solely HECO
and HECO-guaranteed debentures...................................................... $ 100,000 $ 50,000
---------- ----------
Long-term debt:
First mortgage bonds:
HELCO: 7 3/4-7 7/8%, due 2002 through 2003.......................................... 5,000 5,000
---------- ----------
Obligations to the State of Hawaii for the repayment
of Special Purpose Revenue Bonds:
HECO, 4.95%, refunding series 1998A, due 2012....................................... 42,580 --
HELCO, 4.95%, refunding series 1998A, due 2012...................................... 7,200 --
MECO, 4.95%, refunding series 1998A, due 2012....................................... 7,720 --
HECO, 5.65%, series 1997A, due 2027................................................. 50,000 50,000
HELCO, 5.65%, series 1997A, due 2027................................................ 30,000 30,000
MECO, 5.65%, series 1997A, due 2027................................................. 20,000 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, refunded in 1998............................... -- 42,580
HELCO, 6 7/8%, refunding series 1987, refunded in 1998 ............................. -- 7,200
MECO, 6 7/8%, refunding series 1987, refunded in 1998............................... -- 7,720
HELCO, 7.20%, series 1984, due 2014................................................. 11,400 11,400
---------- ----------
650,900 650,900
Less funds on deposit with trustees................................................. 29,684 53,899
---------- ----------
Total obligations to the State of Hawaii....................................... 621,216 597,001
---------- ----------
Other long-term debt - unsecured:
HECO, 5.83% note, paid in 1998...................................................... -- 30,000
---------- ----------
Total long-term debt........................................................... 626,216 632,001
Less unamortized discount............................................................ 4,218 4,380
Less amounts due within one year..................................................... -- 30,000
---------- ----------
Long-term debt, net.............................................................. 621,998 597,621
---------- ----------
Total capitalization........................................................... $1,542,858 $1,498,324
========== ==========
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
15
<PAGE>
<TABLE>
<CAPTION>
Consolidated Statements of Cash Flows
- ----------------------------------------------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
Years ended December 31 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(in thousands)
Cash flows from operating activities:
Income before preferred stock dividends of
HECO............................................................... $ 84,230 $ 81,849 $ 85,213
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............................................ 85,655 82,017 73,453
Other amortization............................................... 7,829 9,931 9,198
Deferred income taxes............................................ 2,944 5,894 2,690
Tax credits, net................................................. 1,083 2,661 3,346
Allowance for equity funds used during
construction................................................... (10,106) (10,864) (11,741)
Changes in assets and liabilities:
Decrease (increase) in accounts receivable..................... 321 7,184 (7,704)
Decrease (increase) in accrued unbilled
revenues..................................................... 2,535 (2,254) (31)
Decrease (increase) in fuel oil stock.......................... 8,280 3,432 (15,021)
Decrease (increase) in materials and
supplies..................................................... 1,709 (33) 1,596
Increase in regulatory assets.................................. (4,447) (4,910) (418)
Increase (decrease) in accounts
payable...................................................... (9,797) (16,257) 17,371
Other.......................................................... (12,495) (16,691) (15,177)
--------- --------- ---------
Net cash provided by operating activities............................ 157,741 141,959 142,775
--------- --------- ---------
Cash flows from investing activities:
Capital expenditures................................................. (131,895) (122,140) (188,161)
Contributions in aid of construction................................. 7,910 7,089 9,674
Payments on notes receivable......................................... 1,531 2,291 1,256
--------- --------- ---------
Net cash used in investing activities................................ (122,454) (112,760) (177,231)
--------- --------- ---------
Cash flows from financing activities:
Common stock dividends............................................... (62,522) (58,377) (57,003)
Preferred stock dividends............................................ (3,454) (3,660) (3,865)
Proceeds from issuance of HECO obligated
mandatorily redeemable trust preferred securities
of subsidiary trusts.............................................. 50,000 50,000 --
Preferred securities distributions of trust
subsidiaries...................................................... (4,197) (3,052) --
Proceeds from issuance of common stock............................... -- -- 30,000
Proceeds from issuance of long-term debt............................. 81,716 55,233 114,886
Repayment of long-term debt.......................................... (87,500) (30,000) (30,000)
Redemption of preferred stock........................................ (2,690) (3,185) (2,795)
Net increase (decrease) in short-term
borrowings from nonaffiliates and
affiliate with original maturities
of three months or less........................................... 43,832 (30,339) (12,833)
Other................................................................ 2,635 (4,966) (3,131)
--------- --------- ---------
Net cash provided by (used in) financing
activities........................................................ 17,820 (28,346) 35,259
--------- --------- ---------
Net increase in cash and equivalents................................. 53,107 853 803
Cash and equivalents, beginning of year.............................. 1,676 823 20
--------- --------- ---------
Cash and equivalents, end of year.................................... $ 54,783 $ 1,676 $ 823
========= ========= =========
</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 utility subsidiaries, on the islands of
Hawaii, Maui, Lanai and Molokai in the State of Hawaii.
Basis of presentation
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
include the amounts reported for regulatory assets and 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), HECO Capital Trust I and HECO Capital Trust II (Trusts).
HECO is a wholly owned subsidiary of Hawaiian Electric Industries, Inc. (HEI).
All significant intercompany accounts and transactions have been eliminated in
consolidation.
Regulation by the Public Utilities Commission of the State of Hawaii (PUC)
The Company is regulated by the 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." 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 reported at cost. Self-constructed plant
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 Company amortizes contributions on a
straight-line basis over 30 years as an offset against depreciation expense.
Revenues
Revenues are based on rates authorized by the PUC and include revenues
applicable to energy consumed in the accounting period but not yet billed to the
customers. Revenue amounts recorded pursuant to a PUC interim order are subject
to refund, with interest, pending a final order.
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.
Retirement benefits
Pension and other postretirement benefits 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
17
<PAGE>
Notes to Consolidated Financial Statements, continued
- --------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
- -------------------------------------------------------------------------------
Act of 1974. Certain health care and/or life insurance benefits are provided
to eligible retired employees and the employees' beneficiaries and covered
dependents. See Note 11.
Depreciation
Depreciation is computed primarily using the straight-line method over the
estimated useful lives of the assets. Electric utility plant has useful 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 1998 and 1997 and 3.8% in
1996.
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. Unamortized issue costs and discounts or premiums on
long-term debt retired prior to maturity are classified as regulatory assets or
liabilities and are amortized over the remaining term of the retired debt.
Allowance for funds used during construction (AFUDC)
AFUDC is an accounting practice whereby the costs of debt and equity funds used
to finance plant construction are removed from the statement of income and
charged 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 AFUDC rate was 8.9% in 1998, 9.0% in 1997 and 9.2% in
1996, and reflected quarterly compounding.
Environmental expenditures
The Company is subject to numerous federal and state statutes and governmental
regulations pertaining to the environment. In general, environmental
contamination treatment costs are charged to expense, unless it is probable that
the PUC would allow such costs to be recovered in future rates. Also,
environmental costs are capitalized if: the costs extend the life, increase the
capacity, or improve the safety or efficiency of property; the costs mitigate or
prevent future environmental contamination; 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 the
PUC would allow such costs to be recovered in future rates.
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.
18
<PAGE>
Notes to Consolidated Financial Statements, continued
- ------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
- ------------------------------------------------------------------------------
Accounting changes
Comprehensive income. In June 1997, the Financial Accounting Standards Board
(FASB) issued SFAS No. 130, "Reporting Comprehensive Income." The Company
adopted SFAS No. 130 in the first quarter of 1998, but had no material "other"
comprehensive income items for the years presented in the statements of income
or accumulated as of the balance sheet dates presented.
Segments of an enterprise and related information. In June 1997, the FASB
issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information." The Company adopted SFAS No. 131 in the first quarter of 1998.
No modification to the Company's reporting segments was required.
Costs of computer software developed or obtained for internal use and start-up
activities. In March 1998, the AICPA Accounting Standards Executive Committee
issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," which requires that certain
costs, including certain payroll and payroll-related costs, be capitalized and
amortized over the estimated useful life of the software. In April 1998, the
AICPA Accounting Standards Executive Committee issued SOP 98-5, "Reporting on
the Costs of Start-up Activities," which requires that costs of start-up
activities, including organization costs, be expensed as incurred. The
provisions of SOP 98-1 and SOP 98-5 are effective for fiscal years beginning
after December 15, 1998 and earlier application is encouraged. The Company
adopted SOP 98-1 and SOP 98-5 effective January 1, 1999. The adoption of SOP
98-1 and SOP 98-5 did not have a material effect on the Company's financial
condition, results of operations or liquidity.
Derivative instruments and hedging activities. In June 1998, the FASB issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities,"
which establishes accounting and reporting standards for derivative instruments
and hedging activities and requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. The provisions of SFAS No. 133 are effective
for all fiscal quarters of fiscal years beginning after June 15, 1999 and
earlier application is encouraged. The Company will adopt SFAS No. 133 on
January 1, 2000, but has not yet determined the impact of adoption.
Reclassifications
Certain reclassifications have been made to prior years' financial statements to
conform to the 1998 presentation.
19
<PAGE>
Notes to Consolidated Financial Statements, continued
- --------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
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 1998 1998
- ------------------------------------------------------------------------------------------------------------------
<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>
On December 15, 1998, the Company announced that it would redeem all
outstanding shares of four series of the above cumulative preferred stock.
In January 1999, HECO redeemed all 80,000 shares of its Series M preferred
stock, HELCO redeemed all 30,000 shares of its Series A preferred stock and MECO
redeemed all 20,000 and 10,000 shares of its Series A and Series B preferred
stock, respectively.
HELCO's series G and MECO's series H preferred stock may not be redeemed by
the respective subsidiary prior to December 2003.
The following series of cumulative preferred stock are subject to mandatory
sinking fund, voluntary liquidation and optional redemption provisions as
indicated below:
<TABLE>
<CAPTION>
Annual sinking fund provision Voluntary Optional
------------------------------- liquidation redemption
Number of shares price price
---------------- Commencement December 31, December 31,
Series Minimum Maximum date 1998 1998
- ------------------------------------------------------------------------------------------------------------------
<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 1/15/95 100.00 103.50
D (HELCO)................................ 500 500 10/15/88 104.78 104.25
E (HELCO)................................ 500 500 10/15/90 105.33 104.79
F (HELCO)................................ 10,000 20,000 1/15/00 100.00 103.04
D (MECO)................................. 950 1,900 7/15/89 101.00 101.00
G (MECO)................................. 8,333 16,667 1/15/00 100.00 103.04
- ------------------------------------------------------------------------------------------------------------------
</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.
20
<PAGE>
Notes to Consolidated Financial Statements, continued
- -------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
- -------------------------------------------------------------------------------
On December 15, 1998, the Company announced that it would redeem all
outstanding shares of seven series of cumulative preferred stock, subject to
mandatory sinking fund provisions.
In January 1999, HECO redeemed all 76,000 and 130,000 shares of its Series Q
and R preferred stock, respectively. Of the outstanding Series Q preferred
stock, 4,000 shares were redeemed under applicable sinking fund provisions and
the remaining 72,000 shares were redeemed at the December 31, 1998 optional
redemption price. Of the outstanding Series R preferred stock, 20,000 shares
were redeemed under applicable sinking fund provisions and the remaining 110,000
shares were redeemed at the December 31, 1998 optional redemption price. HELCO
redeemed all 4,500, 5,500 and 60,000 shares of its Series D, E and F preferred
stock, respectively, at the December 31, 1998 optional redemption price. MECO
redeemed all 4,800 and 50,000 shares of its Series D and G preferred stock,
respectively, at the December 31, 1998 optional redemption price.
The total sinking fund and optional redemption payments in January 1999
amounted to $48,606,000, including redemption premiums in the aggregate amount
of approximately $1,526,000. The December 31, 1998, aggregate carrying amount
of the redeemed shares ($47,080,000) is reflected as a current liability in the
accompanying consolidated balance sheets. The aggregate redemption amount in
excess of the aggregate carrying amount of the redeemed shares ($1,526,000) is
recorded as a regulatory asset upon redemption.
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 HECO issued 503,186 shares of common stock to its parent, HEI, for $30
million (nil in 1998 and 1997).
4. HECO obligated mandatorily redeemable trust preferred securities of
subsidiary trusts holding solely HECO and HECO-guaranteed debentures
- -------------------------------------------------------------------------------
In March 1997, HECO Capital Trust I (Trust I), 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
(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 1997 trust preferred
securities and the common securities were used by Trust I to purchase 8.05%
Junior Subordinated Deferrable Interest Debentures, Series 1997 (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 1997 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 Trust I.
The 1997 trust 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
Trust I, in whole or in part, from time to time, on or after March 27, 2002 or
upon the occurrence of certain events.
In December 1998, HECO Capital Trust II (Trust II), a grantor trust and a
wholly owned subsidiary of HECO, sold (i) in a public offering, 2 million of its
HECO-Obligated 7.30% Cumulative Quarterly Income Preferred Securities, Series
1998 (1998 trust preferred securities) with an aggregate liquidation preference
of $50 million and (ii) to HECO, common securities with a liquidation preference
of approximately
21
<PAGE>
Notes to Consolidated Financial Statements, continued
- ------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
- ------------------------------------------------------------------------------
$1.55 million. Proceeds from the sale of the 1998 trust preferred securities
and the common securities were used by Trust II to purchase 7.30% Junior
Subordinated Deferrable Interest Debentures, Series 1998 (1998 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 1998 junior deferrable debentures, which bear interest at 7.30% and mature
on December 15, 2028, 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 Trust II. The
1998 trust preferred securities must be redeemed at the maturity of the
underlying debt on December 15, 2028, which maturity may be shortened to a date
no earlier than December 15, 2003 or extended to a date no later than December
15, 2047, and are not redeemable at the option of the holders, but may be
redeemed by Trust II, in whole or in part, from time to time, on or after
December 15, 2003 or upon the occurrence of certain events. All of the proceeds
from the sale were invested by HECO Capital Trust II in the underlying debt
securities of HECO, HELCO and MECO, who are using such proceeds from the sale of
the 1998 junior deferrable debentures primarily to effect the redemption of
certain series of their preferred stock having a total par value of $47 million
(see Note 2).
Contractural arrangements (the "Back-up Undertakings") entered into by HECO in
connection with the issuance of the 1997 and 1998 trust preferred securities,
considered together, constitute a full and unconditional guarantee by HECO, on a
subordinated basis, of the periodic distributions due on the 1997 and 1998 trust
preferred securities and of amounts due upon the redemption thereof or upon
liquidation of the Trusts. The Back-up Undertakings include HECO's (i)
guarantee that the Trusts will make their respective periodic distributions and
redemption and liquidation payments to the extent the Trusts have funds
available therefor, (ii) the subsidiary guarantees, (iii) obligations under an
agreement to pay all expenses and liabilities of the Trusts (other than the
obligation of the Trusts to pay amounts due to the holders of the 1997 and 1998
trust preferred securities) and (iv) obligations under the trust agreements,
HECO's 1997 and 1998 junior subordinated debentures and the respective
indentures pursuant to which the 1997 and 1998 junior subordinated debentures
were issued. The 1997 and 1998 junior deferrable debentures and the common
securities of the Trusts have been eliminated in HECO's consolidated balance
sheets as of December 31, 1998 and 1997. The 1997 and 1998 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 (1997 junior
deferrable debentures) and December 15, 2003 (1998 junior deferrable debentures)
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
- -------------------------------------------------------------------------------
The first mortgage bonds of HELCO are secured by a mortgage 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, 1998, the aggregate payments of principal required on long-
term debt during the next five years are nil in 1999, 2000 and 2001, $2,000,000
in 2002 and $3,000,000 in 2003.
In March 1998, the Refunding Series 1987, 6 7/8% Special Purpose Revenue Bonds
were refunded with the proceeds from the Refunding Series 1998A, 4.95% Special
Purpose Revenue Bonds. The premium paid on refunding these bonds is recorded as
a regulatory asset and amortized against income over the remaining term of the
refunded bonds.
22
<PAGE>
Notes to Consolidated Financial Statements, continued
- ------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
- -------------------------------------------------------------------------------
6. Short-term borrowings
- -------------------------------------------------------------------------------
Short-term borrowings from nonaffiliates at December 31, 1998 and 1997 had a
weighted average interest rate of 6.0% and 6.2%, respectively, and consisted
entirely of commercial paper.
The Company maintained bank lines of credit which totaled approximately
$125 million at December 31, 1998 and 1997. The lines of credit support the
issuance of commercial paper. There were no borrowings against any line of
credit during 1998 or 1997.
7. Regulatory assets
- -------------------------------------------------------------------------------
In accordance with SFAS No. 71, 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. Management
believes the Company's operations currently satisfy the 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.
Regulatory assets are expected to be fully recovered through rates over PUC
authorized periods ranging from 1 to 36 years, and included the following
deferred costs at December 31, 1998 and 1997:
<TABLE>
<CAPTION>
December 31 1998 1997
- --------------------------------------------------------------------------------------
<S> <C> <C>
(in thousands)
Income taxes................................................. $ 54,442 $ 47,882
Postretirement benefits other than pensions.................. 25,057 26,846
Integrated resource planning costs........................... 8,335 6,951
Unamortized debt expense and premiums on retired issuances... 6,921 5,773
Vacation earned, but not yet taken........................... 6,620 6,645
Other........................................................ 6,969 7,712
-------- --------
$108,344 $101,809
======== ========
</TABLE>
8. Income taxes
- -------------------------------------------------------------------------------
The components of income taxes charged to operating expenses were as follows:
<TABLE>
<CAPTION>
Years ended December 31 1998 1997 1996
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(in thousands)
Federal:
Current......................................................... $44,934 $40,728 $46,491
Deferred........................................................ 3,985 6,498 3,625
Deferred tax credits, net ...................................... (1,634) (1,620) (1,796)
------- ------- -------
47,285 45,606 48,320
------- ------- -------
State:
Current......................................................... 5,801 3,496 3,688
Deferred........................................................ 547 1,032 741
Deferred tax credits, net....................................... 1,086 2,661 3,421
------- ------- -------
7,434 7,189 7,850
------- ------- -------
Total............................................................ $54,719 $52,795 $56,170
======= ======= =======
</TABLE>
Income tax benefits related to nonoperating activities, included in "Other,
net" on the consolidated statements of income, amounted to $147,000, $260,000
and $282,000 for 1998, 1997 and 1996, respectively.
23
<PAGE>
Notes to Consolidated Financial Statements, continued
- -------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
- -------------------------------------------------------------------------------
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 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(in thousands)
Amount at the federal statutory income tax rate..................................................... $49,525 $ 48,033 $ 50,416
State income taxes on operating income, net of
effect on federal income taxes..................................................................... 4,832 4,673 5,102
Other............................................................................................... 362 89 652
------- -------- --------
Income taxes charged to operating expenses.......................................................... $54,719 $ 52,795 $ 56,170
======= ======== ========
</TABLE>
The tax effects of temporary differences which give rise to deferred tax
assets and liabilities were as follows:
<TABLE>
<CAPTION>
December 31 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Deferred tax assets:
Property, plant and equipment................................................................................ $ 10,530 $ 10,148
Contributions in aid of construction and customer
advances................................................................................................... 55,248 54,259
Other........................................................................................................ 15,031 12,033
-------- --------
80,809 76,440
-------- --------
Deferred tax liabilities:
Property, plant and equipment................................................................................ 171,557 169,220
Regulatory assets............................................................................................ 21,163 18,605
Other........................................................................................................ 16,416 14,124
-------- --------
209,136 201,949
-------- --------
Net deferred income tax liability............................................................................. $128,327 $125,509
======== ========
</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, 1998, 1997 and 1996.
9. Cash flows
- -------------------------------------------------------------------------------
Supplemental disclosures of cash flow information
Cash paid during 1998, 1997 and 1996 for interest (net of AFUDC-Debt) and income
taxes was as follows:
<TABLE>
<CAPTION>
Years ended December 31 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(in thousands)
Interest..................................................................... $45,286 $41,685 $40,235
======= ======= =======
Income taxes................................................................. $44,302 $44,027 $44,296
======= ======= =======
</TABLE>
Supplemental disclosures of noncash activities
The allowance for equity funds used during construction, which was charged
primarily to construction in progress, amounted to $10,106,000, $10,864,000 and
$11,741,000 in 1998, 1997 and 1996, respectively.
24
<PAGE>
Notes to Consolidated Financial Statements, continued
- -------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
- -------------------------------------------------------------------------------
The estimated fair value of noncash contributions in aid of construction
amounted to $2,446,000, $1,931,000 and $4,680,000 in 1998, 1997 and 1996,
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 1998,
1997 and 1996. These revenues amounted to $98,183,000 in 1998, $110,410,000 in
1997 and $107,606,000 in 1996.
11. 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.
Postretirement benefits other than pensions
The Company provides various postretirement benefits other than pensions to
eligible employees upon retirement. HECO and its subsidiaries provide eligible
employees health and life insurance benefits upon retirement. The amount of
health benefits are based on retirees' 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.
Plan amendments
In August 1998, HECO, MECO and HELCO employees represented by the International
Brotherhood of Electrical Workers, Local 1260, ratified a new collective
bargaining agreement covering a two-year period from November 1, 1998 through
October 31, 2000. Under the new agreement, HECO and its subsidiaries amended
the pension and the postretirement welfare benefits plans effective January 1,
1999.
25
<PAGE>
Notes to Consolidated Financial Statements, continued
- -------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
- -------------------------------------------------------------------------------
The changes in benefit obligations and plan assets, the funded status of the
plans and the unrecognized and recognized amounts in the balance sheet were as
follows:
<TABLE>
<CAPTION>
Pension benefits Other benefits
----------------------------------------------------------
(in thousands) 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Benefit obligation, January 1.......................... $ 529,361 $ 500,519 $ 173,759 $ 170,581
Service cost........................................... 18,192 17,012 4,462 5,927
Interest cost.......................................... 35,534 34,118 10,117 11,730
Amendments............................................. (11,083) -- (42,515) --
Actuarial loss (gain).................................. 34,051 (1,375) (13,595) (10,183)
Benefits paid.......................................... (23,542) (20,913) (4,935) (4,296)
- -------------------------------------------------------------------------------------------------------------------------------
Benefit obligation, December 31........................ $ 582,513 $ 529,361 $ 127,293 $ 173,759
- -------------------------------------------------------------------------------------------------------------------------------
Fair value of plan assets, January 1 . $ 597,725 $ 528,932 $ 61,895 $ 38,595
Actual return on plan assets........................... 96,397 79,732 9,429 6,849
Employer contribution.................................. 4,054 9,973 13,852 20,747
Benefits paid.......................................... (23,542) (20,913) (4,935) (4,296)
- -------------------------------------------------------------------------------------------------------------------------------
Fair value of plan assets, December 31 $ 674,634 $ 597,724 $ 80,241 $ 61,895
- -------------------------------------------------------------------------------------------------------------------------------
Funded status.......................................... $ 92,121 $ 68,363 $ (47,052) $(111,864)
Unrecognized net actuarial gain........................ (93,927) (83,081) (28,562) (12,923)
Unrecognized net transition obligation 10,041 12,314 45,699 93,737
Unrecognized prior service cost........................ (10,718) 171 -- --
- -------------------------------------------------------------------------------------------------------------------------------
Accrued benefit cost................................... $ (2,483) $ (2,233) (29,915) $ (31,050)
===============================================================================================================================
Amounts recognized in the balance
sheet consist of:
Prepaid benefit cost............................... $ 744 $ -- $ -- $ --
Accrued benefit liability.......................... (3,392) (2,421) (29,915) (31,050)
Intangible asset................................... 109 134 -- --
Other.............................................. 56 54 -- --
- -------------------------------------------------------------------------------------------------------------------------------
Accrued benefit cost................................... $ (2,483) $ (2,233) $ (29,915) $ (31,050)
===============================================================================================================================
</TABLE>
The following weighted-average assumptions were used in the accounting for
the plans:
<TABLE>
<CAPTION>
Pension benefits Other benefits
--------------------------------------------------------------
December 31 1998 1997 1996 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Discount rate.................................... 6.5% 7.0% 7.0% 6.5% 7.0% 7.0%
Expected return on plan assets................... 10.0 10.0 9.0 10.0 10.0 9.0
Rate of compensation increase.................... 4.7 5.0 5.0 4.7 5.0 5.0
</TABLE>
At December 31, 1998, the assumed health care trend rates for 1999 and future
years were as follows: medical, 5.0%; dental, 3.5%; and vision, 3.0%.
26
<PAGE>
Notes to Consolidated Financial Statements, continued
- --------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
- --------------------------------------------------------------------------------
The components of the net periodic benefit cost were as follows:
<TABLE>
<CAPTION>
Pension benefits Other benefits
----------------------------------------------------------------------
(in thousands) 1998 1997 1996 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Service cost........................ $ 18,192 $ 17,012 $ 16,386 $ 4,462 $ 5,926 $ 5,677
Interest cost....................... 35,533 34,119 32,274 10,118 11,730 11,228
Expected return on plan
assets............................ (51,493) (41,826) (37,730) (6,371) (4,123) (2,667)
Amortization of unrecog-
nized transition
obligation........................ 2,273 2,273 2,275 5,523 6,249 6,249
Amortization of prior
service cost...................... (194) 80 63 -- -- --
Recognized actuarial
loss (gain)....................... (7) 99 52 (1,015) -- --
- ----------------------------------------------------------------------------------------------------------
Net periodic benefit
cost.............................. $ 4,304 $ 11,757 $ 13,320 $12,717 $19,782 $20,487
==========================================================================================================
</TABLE>
Of the net periodic pension benefit costs, the Company expensed $2.9 million,
$7.9 million and $8.9 million in 1998, 1997 and 1996, respectively, and
primarily charged the remaining amounts to electric utility plant. Of the net
periodic other benefit costs, the Company expensed $9.4 million, $14.2 million
and $14.6 million in 1998, 1997 and 1996, respectively, and primarily charged
the remaining amounts to electric utility plant.
At December 31, 1998 and 1997, the Company had pension plans in which the
accumulated benefit obligations exceeded plan assets at fair value, but such
plans did not have material benefit obligations.
The health care cost trend rate assumptions can have a significant effect on
the amounts reported for other benefits. At December 31, 1998, a one-
percentage-point increase in the assumed health care cost trend rates would have
increased the total service and interest cost by $1.7 million and the
postretirement benefit obligation by $7.2 million, and a one-percentage-point
decrease would have reduced the total service and interest cost by $1.4 million
and the postretirement benefit obligation by $8.0 million.
12. Commitments and contingencies
- -------------------------------------------------------------------------------
Fuel contracts and other purchase commitments
The Company has contractual agreements to purchase minimum amounts of fuel oil
and diesel fuel through 2004 (at prices tied to the market prices of petroleum
products in Singapore and Los Angeles). Based on the average price per barrel
at January 1, 1999, the estimated amount of minimum purchases under the fuel
supply contracts for 1999 is $124 million. The actual amount of purchases in
1999 could vary substantially from this estimate as a result of changes in
market prices, quantities actually purchased and other factors. The Company
purchased $183 million, $248 million and $261 million of fuel under prior
agreements in 1998, 1997 and 1996, respectively.
At December 31, 1998, the Company had purchase commitments, other than fuel
and power purchase contracts, amounting to approximately $64 million.
27
<PAGE>
Notes to Consolidated Financial Statements, continued
- -------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
Power purchase agreements
At December 31, 1998, the Company had power purchase agreements for 474 MW of
firm capacity, representing approximately 22% of its total generating
capabilities and purchased power firm capacities (exclusive of its power
purchase agreement with Encogen for a planned 60 MW of firm capacity, which
agreement is subject to PUC approval). The PUC allows rate recovery for energy
and firm capacity payments under these agreements. Assuming that each of the
agreements (other than the Encogen agreement) remains in place for its current
term and the minimum availability criteria in the power purchase agreements are
met, aggregate minimum fixed capacity charges under such agreements are expected
to be approximately $110 million in 1999, $103 million each in 2000 and 2001,
$100 million in 2002, $103 million in 2003 and a total of $1.7 billion in 2004
through 2028.
In general, Company payments under the power purchase agreements are based
upon available capacity and energy; payments for capacity are generally 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. Energy payments will vary over the terms of the agreements
and the Company passes on changes in the fuel component of the energy charges to
customers through the energy cost adjustment clause in their 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.
Interim rate increases
At December 31, 1998, HECO and its subsidiaries had recognized no revenue
amounts under interim rate increases that were subject to refund.
HELCO power situation
In 1991, HELCO identified the need, beginning in 1994, for additional generation
to provide for forecast load growth while maintaining a satisfactory generation
reserve margin, to address uncertainties about future deliveries of power from
existing firm power producers and to permit the retirement of older generating
units. Accordingly, HELCO proceeded with plans to install at its Keahole power
plant site two 20-megawatt (MW) combustion turbines (CT-4 and CT-5), followed by
an 18-MW heat steam recovery generator (ST-7), at which time these units would
be converted to a 56-MW (net) combined-cycle unit.
The timing of the installation of HELCO's phased combined-cycle unit at the
Keahole power plant site has been revised on several occasions due to delays in
(a) obtaining approval from the Hawaii Board of Land and Natural Resources of a
Conservation District Use Permit (CDUP) amendment and (b) obtaining from the
Department of Health of the State of Hawaii (DOH) and the U.S. Environmental
Protection Agency (EPA) a Prevention of Significant Deterioration/Covered Source
permit (PSD permit) for the Keahole power plant site. The delays are partly
attributable to lawsuits, claims and petitions filed by independent power
producers and other parties. Subject to satisfactory resolution of the CDUP
amendment, PSD permit and other matters, HELCO's current plan continues to
contemplate that CT-4 and CT-5 will be added to its system. Current plans are
for ST-7 to be deferred to approximately 2006 or 2007.
Final judgments have been entered in several civil cases relating to HELCO's
application for a CDUP amendment. These judgments, which are currently on
appeal to the Hawaii Supreme Court, allow HELCO to use its Keahole property as
requested in its application. Motions filed both in the Third Circuit Court and
the Hawaii Supreme Court to stay these judgments pending resolution of the
appeals were denied in July and August of 1998.
There remain pending in the Third Circuit Court three declaratory judgment
actions relating to HELCO's use of the Keahole site and construction of CT-4 and
CT-5. The first of these cases, filed in February of 1997, is set for jury
trial in May 1999.
28
<PAGE>
Notes to Consolidated Financial Statements, continued
- -------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
- -------------------------------------------------------------------------------
In 1997, the EPA and the DOH issued a final PSD permit for HELCO's combined-
cycle unit at Keahole. Nine appeals of the issuance of the permit were filed
with the EPA's Environmental Appeals Board (EAB). On November 25, 1998, the EAB
issued an Order Denying Review in Part and Remanding in Part. In December 1998,
motions for reconsideration were filed with the EAB and decisions are pending.
As a result of the EAB's November 25, 1998 order, there has been a further delay
in the construction of CT-4 and CT-5. The length of the delay will depend on
the outcome of the motions for reconsideration and future developments in any
remand proceeding that may be necessary.
Although management believes it has acted prudently with respect to this
project, HELCO has decided to discontinue, for financial reporting purposes, the
accrual of AFUDC on CT-4 and CT-5 (which would have been approximately $0.4
million after tax per month) effective December 1, 1998. The length of the
delays to date and potential further delays were factors considered by
management in its decision to discontinue the accrual of AFUDC.
In 1998, HELCO determined that ST-7 would not be needed in the immediate
future and removed $0.8 million in costs accumulated against ST-7 from
construction work-in-progress, writing off $0.6 million and transferring $0.2
million to inventory.
If it becomes probable that CT-4 and/or CT-5 will not be installed, HELCO may
be required to write-off a material portion of the costs incurred in its efforts
to put these units into service. As of December 31, 1998, HELCO's costs
incurred in its efforts to put CT-4 and CT-5 into service amounted to $74.9
million, including approximately $30.1 million for equipment and material
purchases, approximately $23.3 million for planning, engineering, permitting,
site development and other costs and approximately $21.5 million as an allowance
for funds used during construction.
Competition proceeding
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. After a
collaborative process involving the 19 parties to the proceeding, final
statements of position were prepared by several of the parties and submitted to
the PUC in October 1998. HECO's position is that retail competition is not
feasible in Hawaii, but that some of the benefits of competition can be achieved
through competitive bidding for new generation, performance-based ratemaking and
innovative pricing provisions. The other parties to the proceeding advanced
numerous other proposals in their statements of position. The PUC will
determine what subsequent steps will be followed in the proceeding, but no
timetable has been set for such a determination.Some of the parties may seek
state legislative action on their proposals. HECO cannot predict what the
ultimate outcome of the proceeding will be or which (if any) of the proposals
advanced in the proceeding will be implemented.
Environmental regulation
In early 1995, the Department of Health of the State of Hawaii (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 and certain of the identified parties
(including HECO, Chevron Products Company, Shell Oil Products Company, State of
Hawaii Department of Transportation Harbors Division and others) formed a
Technical Work Group. Effective January 30, 1998, the Technical Work Group and
the DOH entered into a voluntary agreement and scope of work to determine the
nature and extent of any contamination, the responsible parties and appropriate
remedial actions. 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
29
<PAGE>
Notes to Consolidated Financial Statements, continued
- -------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
- -------------------------------------------------------------------------------
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.
13. Regulatory restrictions on distributions to parent
- -------------------------------------------------------------------------------
At December 31, 1998, net assets (assets less liabilities and preferred stock)
of approximately $433 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 $1,852,000, $2,230,000 and $2,254,000 for
general management and administrative services in 1998, 1997 and 1996,
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 $2,236,000, $1,871,000 and $3,094,000 for data
processing services in 1998, 1997 and 1996, respectively.
HECO's borrowings from HEI fluctuate during the year, and totaled
$5,550,000 and $400,000 at December 31, 1998 and 1997, 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
$67,000, $433,000 and $289,000 in 1998, 1997 and 1996, 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 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 Company used the following methods and assumptions 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 approximated fair value because of the short maturity of
these instruments.
Notes receivable
Fair value was 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 approximated fair value because of the short maturity of
these instruments.
Long-term debt
Fair value was estimated based on quoted market prices for the same or similar
issues of debt.
30
<PAGE>
Notes to Consolidated Financial Statements, continued
- -------------------------------------------------------------------------------
Hawaiian Electric Company, Inc. and Subsidiaries
- -------------------------------------------------------------------------------
Cumulative preferred stock subject to mandatory redemption
At December 31, 1998, fair value was estimated using optional redemption prices
and par values, as the preferred stock was redeemed in January 1999. At
December 31, 1997, fair value was estimated using quoted market prices for
similar issues of preferred stock.
HECO obligated mandatorily redeemable trust preferred securities
of subsidiary trusts holding solely HECO and HECO-guaranteed debentures
Fair value was based on quoted market prices.
The estimated fair values of the Company's financial instruments were as
follows:
<TABLE>
<CAPTION>
December 31 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
Estimated Estimated
Carrying fair Carrying fair
amount value amount value
- ------------------------------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C> <C>
Financial assets:
Cash and equivalents................................. $ 54,783 $ 54,783 $ 1,676 $ 1,676
Notes receivable..................................... 1,747 1,737 3,278 3,244
Financial liabilities:
Short-term borrowings from
nonaffiliates and affiliate......................... 139,413 139,413 95,581 95,581
Long-term debt, net, including
amounts due within one year......................... 621,998 655,397 627,621 658,393
Cumulative preferred stock subject
to mandatory redemption, including
sinking fund requirements............................ 33,080 34,466 35,770 37,699
HECO obligated mandatorily redeemable
trust preferred securities of
subsidiary trusts holding solely
HECO and HECO-guaranteed
debentures........................................... 100,000 96,952 50,000 51,000
</TABLE>
Limitations
The Company makes fair value estimates 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 if the
Company were to sell its entire holding of a particular financial instrument at
one time. 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 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 could 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 1998 1997
- -----------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Balance sheet data
Current assets............................................ $ 35,473 $ 28,631
Noncurrent assets......................................... 424,278 403,981
-------- --------
$459,751 $432,612
======== ========
Common stock equity....................................... $157,269 $144,761
Cumulative preferred stock:
Not subject to mandatory redemption.................... 7,000 10,000
Subject to mandatory redemption, net of sinking fund
payments due within one year......................... -- 7,000
Current liabilities....................................... 62,313 63,500
Noncurrent liabilities.................................... 233,169 207,351
-------- --------
$459,751 $432,612
======== ========
Years ended December 31 1998 1997 1996
- -----------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Income statement data
Operating revenues........................................ $154,135 $161,120 $153,202
Operating income.......................................... 19,360 18,467 15,984
Net income for common stock............................... 16,074 15,263 14,673
</TABLE>
Maui Electric Company, Limited
<TABLE>
<CAPTION>
December 31 1998 1997
- -----------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C>
Balance sheet data
Current assets........................................... $ 41,103 $ 31,994
Noncurrent assets........................................ 382,517 374,766
-------- --------
$423,620 $406,760
======== ========
Common stock equity...................................... $157,402 $150,129
Cumulative preferred stock:
Not subject to mandatory redemption.................... 5,000 8,000
Subject to mandatory redemption, net of sinking fund
payments due within one year........................ -- 5,575
Current liabilities...................................... 32,052 24,454
Noncurrent liabilities................................... 229,166 218,602
-------- --------
$423,620 $406,760
======== ========
Years ended December 31 1998 1997 1996
- ----------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Income statement data
Operating revenues....................................... $137,923 $152,947 $145,776
Operating income......................................... 19,741 17,882 17,124
Net income for common stock.............................. 12,369 13,260 14,744
- ----------------------------------------------------------------------------------------------
</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 1998 and 1997 follows:
<TABLE>
<CAPTION>
Quarters ended Year ended
- -------------------------------------------------------------------------------------------------------------
1998 March 31 June 30 Sept. 30 Dec. 31 Dec. 31
(in thousands)
<S> <C> <C> <C> <C> <C>
Operating revenues.................. $256,043 $242,204 $257,368 $253,284 $1,008,899
Operating income.................... 27,543 26,861 32,468 29,280 116,152
Net income for common
stock............................. 19,262 18,689 24,976 17,849/1/ 80,776/1/
- -------------------------------------------------------------------------------------------------------------
1997
- -------------------------------------------------------------------------------------------------------------
(in thousands)
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>
/1/ Includes the effect of MECO's reduction in costs of generating unit M17
of $3.4 million pretax and $3.0 million after tax.
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, 1998 and 1997, 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, 1998. 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, 1998 and 1997, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1998 in conformity with generally
accepted accounting principles.
/s/ KPMG LLP
Honolulu, Hawaii
January 18, 1999
34
<PAGE>
Directors and Officers
- -------------------------------------------------------------------------------
HAWAIIAN ELECTRIC COMPANY, INC.
<TABLE>
<S> <C>
DIRECTORS
Robert F. Clarke, 56, 1990 Diane J. Plotts, 63, 1991 [1]
Richard Henderson, 70, 1970 James K. Scott, 47, 1999
T. Michael May, 52, 1995 Anne M. Takabuki, 42, 1997 [1]
Paul A. Oyer, 58, 1985 Jeffrey N. Watanabe, 56, 1999
Paul C. Yuen, 70, 1993 [1]
</TABLE>
[1] Audit committee member.
Note: Year indicates first year elected or appointed. All directors serve one
year terms.
<TABLE>
<S> <C>
OFFICERS
Robert F. Clarke Paul A. Oyer
Chairman of the Board Financial Vice President and Treasurer
T. Michael May Patricia U. Wong
President and Chief Executive Officer Vice President-Corporate Excellence
Jackie Mahi Erickson Ernest T. Shiraki
Vice President-Customer Operations and General Counsel Controller
Charles M. Freedman Molly M. Egged
Vice President-Corporate Relations Secretary
Edward Y. Hirata Lorie Ann K. Nagata
Vice President-Regulatory Affairs and Assistant Treasurer
Government Relations
Thomas J. Jezierny
Vice President-Energy Delivery
Thomas L. Joaquin
Vice President-Power Supply
</TABLE>
HAWAII ELECTRIC LIGHT COMPANY, INC.
<TABLE>
<CAPTION>
<S> <C>
DIRECTORS
T. Michael May Barry K. Taniguchi
Richard Henderson Donald K. Yamada
Warren H. W. Lee
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 Lorie Ann K. Nagata
Financial Vice President and Treasurer Assistant Treasurer
Edward Y. Hirata Deorna L. Ikeda
Vice President Assistant Secretary
Molly M. Egged
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 Duane T. Hayashi
Chairman of the Board Assistant Treasurer
William A. Bonnet Michael E. Kam
President Assistant Treasurer
Paul A. Oyer Stanley T. Nakamoto
Financial Vice President and Treasurer Assistant Treasurer
Edward Y. Hirata Lorie Ann K. Nagata
Vice President Assistant Treasurer
Molly M. Egged Eileen S. Wachi
Secretary Assistant Secretary
</TABLE>
Information provided as of February 17, 1999
36
