Edgar Filing: HAWAIIAN ELECTRIC CO INC

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


Exact Name of Registrant as Specified in Its Charter	Commission File Number	I.R.S. Employer Identification No.
HAWAIIAN ELECTRIC INDUSTRIES, INC.	1-8503	99-0208097

and Principal Subsidiary

HAWAIIAN ELECTRIC COMPANY, INC.	1-4955	99-0040500

State of Hawaii

(State or other jurisdiction of incorporation or organization)

900 Richards Street, Honolulu, Hawaii 96813

(Address of principal executive offices and zip code)

Hawaiian Electric Industries, Inc. — (808) 543-5662

Hawaiian Electric Company, Inc. — (808) 543-7771

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether Registrant Hawaiian Electric Industries, Inc. (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether Registrant Hawaiian Electric Company, Inc. (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether Registrant Hawaiian Electric Industries, Inc. is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Large accelerated filer x Accelerated filer ¨Non-accelerated filer ¨

Indicate by check mark whether Registrant Hawaiian Electric Company, Inc. is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x

Indicate by check mark whether Registrant Hawaiian Electric Industries, Inc. is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Indicate by check mark whether Registrant Hawaiian Electric Company, Inc. is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuers’ classes of common stock, as of the latest practicable date.


Class of Common Stock		Outstanding October 29, 2007
Hawaiian Electric Industries, Inc. (Without Par Value)		83,040,566 Shares
Hawaiian Electric Company, Inc. ($6²/3 Par Value)		12,805,843 Shares (not publicly traded)

Hawaiian Electric Industries, Inc. and Subsidiaries

Hawaiian Electric Company, Inc. and Subsidiaries

Form 10-Q—Quarter ended September 30, 2007

INDEX


		Page No.
Glossary of Terms		ii
Forward-Looking Statements		iv

	PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Hawaiian Electric Industries, Inc. and Subsidiaries
	Consolidated Statements of Income (unaudited) - three and nine months ended September 30, 2007 and 2006	1
	Consolidated Balance Sheets (unaudited) - September 30, 2007 and December 31, 2006	2
	Consolidated Statements of Changes in Stockholders’ Equity (unaudited) - nine months ended September 30, 2007 and 2006	3
	Consolidated Statements of Cash Flows (unaudited) - nine months ended September 30, 2007 and 2006	4
	Notes to Consolidated Financial Statements (unaudited)	5

	Hawaiian Electric Company, Inc. and Subsidiaries
	Consolidated Statements of Income (unaudited) - three and nine months ended September 30, 2007 and 2006	16
	Consolidated Balance Sheets (unaudited) - September 30, 2007 and December 31, 2006	17
	Consolidated Statements of Changes in Stockholder’s Equity (unaudited) - nine months ended September 30, 2007 and 2006	18
	Consolidated Statements of Cash Flows (unaudited) - nine months ended September 30, 2007 and 2006	19
	Notes to Consolidated Financial Statements (unaudited)	20
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	42
	HEI Consolidated	42
	Electric Utilities	49
	Bank	71
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	77
Item 4.	Controls and Procedures	78
	PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	79
Item 1A.	Risk Factors	79
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	79
Item 5.	Other Information	79
Item 6.	Exhibits	85
Signatures		86

Hawaiian Electric Industries, Inc. and Subsidiaries

Hawaiian Electric Company, Inc. and Subsidiaries

Form 10-Q—Quarter ended September 30, 2007

GLOSSARY OF TERMS


Terms		Definitions
AFUDC		Allowance for funds used during construction
AOCI		Accumulated other comprehensive income
ASB		American Savings Bank, F.S.B., a wholly-owned subsidiary of HEI Diversified, Inc. and parent company of American Savings Investment Services Corp. (and its subsidiary, Bishop Insurance Agency of Hawaii, Inc.). AdCommunications, Inc. (dissolved in May 2007) is a former subsidiary.
CHP		Combined heat and power
Company		Hawaiian Electric Industries, Inc. and its direct and indirect subsidiaries, including, without limitation, Hawaiian Electric Company, Inc., Hawaii Electric Light Company, Inc., Maui Electric Company, Limited, HECO Capital Trust III (unconsolidated subsidiary), Renewable Hawaii, Inc., Uluwehiokama Biofuels Corp., HEI Diversified, Inc., American Savings Bank, F.S.B. and its subsidiaries, Pacific Energy Conservation Services, Inc., HEI Properties, Inc., HEI Investments, Inc., Hycap Management, Inc. (in dissolution), Hawaiian Electric Industries Capital Trust II (unconsolidated subsidiary), Hawaiian Electric Industries Capital Trust III (unconsolidated subsidiary) and The Old Oahu Tug Service, Inc. Former subsidiaries include HEIPC (discontinued operations, dissolved in 2006) and its dissolved subsidiaries.
Consumer Advocate		Division of Consumer Advocacy, Department of Commerce and Consumer Affairs of the State of Hawaii
D&O		Decision and order
DG		Distributed generation
DOD		Department of Defense—federal
DOH		Department of Health of the State of Hawaii
DRIP		HEI Dividend Reinvestment and Stock Purchase Plan
DSM		Demand-side management
EPA		Environmental Protection Agency—federal
Exchange Act		Securities Exchange Act of 1934
FASB		Financial Accounting Standards Board
Federal		U.S. Government
FHLB		Federal Home Loan Bank
FIN		Financial Accounting Standards Board Interpretation No.
GAAP		U.S. generally accepted accounting principles
HECO		Hawaiian Electric Company, Inc., an electric utility subsidiary of Hawaiian Electric Industries, Inc. and parent company of Hawaii Electric Light Company, Inc., Maui Electric Company, Limited, HECO Capital Trust III (unconsolidated subsidiary), Renewable Hawaii, Inc. and Uluwehiokama Biofuels Corp.

GLOSSARY OF TERMS, continued


Terms		Definitions
HEI		Hawaiian Electric Industries, Inc., direct parent company of Hawaiian Electric Company, Inc., HEI Diversified, Inc., Pacific Energy Conservation Services, Inc., HEI Properties, Inc., HEI Investments, Inc., Hycap Management, Inc. (in dissolution), Hawaiian Electric Industries Capital Trust II (unconsolidated subsidiary), Hawaiian Electric Industries Capital Trust III (unconsolidated subsidiary) and The Old Oahu Tug Service, Inc. Former subsidiaries include HEI Power Corp. (discontinued operations, dissolved in 2006).
HEIDI		HEI Diversified, Inc., a wholly owned subsidiary of Hawaiian Electric Industries, Inc. and the parent company of American Savings Bank, F.S.B.
HEIII		HEI Investments, Inc. (formerly HEI Investment Corp.), a subsidiary of HEI Power Corp.
HEIPC		HEI Power Corp., a formerly wholly owned subsidiary of Hawaiian Electric Industries, Inc., and the former parent company of numerous subsidiaries, the majority of which were dissolved or otherwise wound up since 2002, pursuant to a formal plan to exit the international power business (formerly engaged in by HEIPC and its subsidiaries) adopted by the HEI Board of Directors in October 2001. HEIPC was dissolved in December 2006.
HEIRSP		Hawaiian Electric Industries Retirement Savings Plan
HELCO		Hawaii Electric Light Company, Inc., an electric utility subsidiary of Hawaiian Electric Company, Inc.
HPOWER		City and County of Honolulu with respect to a power purchase agreement for a refuse-fired plant
IPP		Independent power producer
IRP		Integrated resource plan
KWH		Kilowatthour
MECO		Maui Electric Company, Limited, an electric utility subsidiary of Hawaiian Electric Company, Inc.
MW		Megawatt/s (as applicable)
NII		Net interest income
NPV		Net portfolio value
NQSO		Nonqualified stock options
O&M		Operation and maintenance
OPEB		Postretirement benefits other than pensions
PPA		Power purchase agreement
PRPs		Potentially responsible parties
PUC		Public Utilities Commission of the State of Hawaii
RHI		Renewable Hawaii, Inc., a wholly owned subsidiary of Hawaiian Electric Company, Inc.
ROACE		Return on average common equity
ROR		Return on average rate base
SARs		Stock appreciation rights
SEC		Securities and Exchange Commission
See		Means the referenced material is incorporated by reference
SFAS		Statement of Financial Accounting Standards
SOIP		1987 Stock Option and Incentive Plan, as amended
SOX		Sarbanes-Oxley Act of 2002
SPRBs		Special Purpose Revenue Bonds
TOOTS		The Old Oahu Tug Service, a wholly owned subsidiary of Hawaiian Electric Industries, Inc.
UBC		Uluwehiokama Biofuels Corp., a newly formed, non-regulated subsidiary of Hawaiian Electric Company, Inc.
VIE		Variable interest entity

iii

FORWARD-LOOKING STATEMENTS

This report and other presentations made by Hawaiian Electric Industries, Inc. (HEI) and Hawaiian Electric Company, Inc. (HECO) and their subsidiaries contain “forward-looking statements,” which include statements that are predictive in nature, depend upon or refer to future events or conditions, and usually include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “predicts,” “estimates” or similar expressions. In addition, any statements concerning future financial performance, ongoing business strategies or prospects and possible future actions are also forward-looking statements. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties and the accuracy of assumptions concerning HEI and its subsidiaries (collectively, the Company), the performance of the industries in which they do business and economic and market factors, among other things. These forward-looking statements are not guarantees of future performance.

Risks, uncertainties and other important factors that could cause actual results to differ materially from those in forward-looking statements and from historical results include, but are not limited to, the following:

•

the effects of international, national and local economic conditions, including the state of the Hawaii tourist and construction industries, the strength or weakness of the Hawaii and continental U.S. real estate markets (including the fair value of collateral underlying loans and mortgage-related securities) and decisions concerning the extent of the presence of the federal government and military in Hawaii;

•

the effects of weather and natural disasters, such as hurricanes, earthquakes, tsunamis and the potential effects of global warming;

•

global developments, including the effects of terrorist acts, the war on terrorism, continuing U.S. presence in Iraq and Afghanistan, potential conflict or crisis with North Korea and in the Middle East, Iran’s nuclear activities and potential avian flu pandemic;

•

the timing and extent of changes in interest rates and the shape of the yield curve;

•

the risks inherent in changes in the value of and market for securities available for sale and pension and other retirement plan assets;

•

changes in assumptions used to calculate retirement benefits costs and changes in funding requirements;

•

increasing competition in the electric utility and banking industries (e.g., increased self-generation of electricity may have an adverse impact on HECO’s revenues and increased price competition for deposits, or an outflow of deposits to alternative investments, may have an adverse impact on American Savings Bank, F.S.B.’s (ASB’s) cost of funds);

•

capacity and supply constraints or difficulties, especially if generating units (utility-owned or independent power producer (IPP)-owned) fail or measures such as demand-side management (DSM), distributed generation (DG), combined heat and power (CHP) or other firm capacity supply-side resources fall short of achieving their forecasted benefits or are otherwise insufficient to reduce or meet peak demand;

•

increased risk to generation reliability as generation peak reserve margins on Oahu continue to be strained;

•

fuel oil price changes, performance by suppliers of their fuel oil delivery obligations and the continued availability to the electric utilities of their energy cost adjustment clauses (ECACs);

•

the ability of IPPs to deliver the firm capacity anticipated in their power purchase agreements (PPAs);

•

the ability of the electric utilities to negotiate, periodically, favorable fuel supply and collective bargaining agreements;

•

new technological developments that could affect the operations and prospects of HEI and its subsidiaries (including HECO and its subsidiaries and ASB and its subsidiaries) or their competitors;

•

federal, state and international governmental and regulatory actions, such as changes in laws, rules and regulations applicable to HEI, HECO, ASB and their subsidiaries (including changes in taxation, environmental laws and regulations, the potential regulation of greenhouse gas emissions and governmental fees and assessments); decisions by the Public Utilities Commission of the State of Hawaii (PUC) in rate cases (including decisions on ECACs) and other proceedings and by other agencies and courts on land use, environmental and other permitting issues (such as required corrective actions, restrictions and penalties that may arise, for example with respect to environmental conditions or renewable portfolio standards (RPS)); enforcement actions by the OTS and other governmental authorities (such as required corrective actions, restrictions and penalties that may arise, for example, with respect to compliance deficiencies under the Bank Secrecy Act or other regulatory requirements or with respect to capital adequacy);

•

increasing operation and maintenance expenses for the electric utilities, resulting in the need for more frequent rate cases, and increasing noninterest expenses at ASB;

•

the risks associated with the geographic concentration of HEI’s businesses;

•

the effects of changes in accounting principles applicable to HEI, HECO, ASB and their subsidiaries, including the adoption of new accounting principles (such as the effects of Statement of Financial Accounting Standards (SFAS) No. 158 regarding employers’ accounting for defined benefit pension and other postretirement plans), continued regulatory accounting under SFAS No. 71, “Accounting for the Effects of Certain Types of Regulation,” and the possible effects of applying Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 46R, “Consolidation of Variable Interest Entities,” and Emerging Issues Task Force Issue No. 01-8, “Determining Whether an Arrangement Contains a Lease,” to PPAs with independent power producers;

•

the effects of changes by securities rating agencies in their ratings of the securities of HEI and HECO and the results of financing efforts;

•

faster than expected loan prepayments that can cause an acceleration of the amortization of premiums on loans and investments and the impairment of mortgage servicing rights of ASB;

•

changes in ASB’s loan portfolio credit profile and asset quality which may increase or decrease the required level of allowance for loan losses;

•

changes in ASB’s deposit cost or mix which may have an adverse impact on ASB’s cost of funds;

•

the final outcome of tax positions taken by HEI, HECO, ASB and their subsidiaries;

•

the ability of consolidated HEI to generate capital gains and utilize capital loss carryforwards on future tax returns;

•

the risks of suffering losses and incurring liabilities that are uninsured; and

•

other risks or uncertainties described elsewhere in this report and in other periodic reports (e.g., “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K) previously and subsequently filed by HEI and/or HECO with the Securities and Exchange Commission (SEC).

Forward-looking statements speak only as of the date of the report, presentation or filing in which they are made. Except to the extent required by the federal securities laws, HEI, HECO, ASB and their subsidiaries undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Hawaiian Electric Industries, Inc. and Subsidiaries

Consolidated Statements of Income (unaudited)


(in thousands, except per share amounts and ratio of earnings to fixed charges)	Three months ended September 30						Nine months ended September 30
	2007			2006			2007			2006
Revenues
Electric utility	$	567,615		$	569,838		$	1,508,005		$	1,548,861
Bank		105,507			103,338			317,493			305,898
Other		339			718			2,749			(934	)

		673,461			673,894			1,828,247			1,853,825

Expenses
Electric utility		536,249			521,187			1,434,858			1,414,784
Bank		86,960			82,760			260,824			232,146
Other		2,235			3,591			10,698			10,659

		625,444			607,538			1,706,380			1,657,589

Operating income (loss)
Electric utility		31,366			48,651			73,147			134,077
Bank		18,547			20,578			56,669			73,752
Other		(1,896	)		(2,873	)		(7,949	)		(11,593	)

		48,017			66,356			121,867			196,236

Interest expense—other than on deposit liabilities and other bank borrowings		(19,589	)		(18,275	)		(59,382	)		(56,526	)
Allowance for borrowed funds used during construction		656			838			1,840			2,259
Preferred stock dividends of subsidiaries		(474	)		(471	)		(1,420	)		(1,417	)
Allowance for equity funds used during construction		1,336			1,838			3,770			4,974

Income from before income taxes		29,946			50,286			66,675			145,526
Income taxes		10,065			17,963			22,481			53,642

Net income	$	19,881		$	32,323		$	44,194		$	91,884

Basic earnings per common share	$	0.24		$	0.40		$	0.54		$	1.13

Diluted earnings per common share	$	0.24		$	0.40		$	0.54		$	1.13

Dividends per common share	$	0.31		$	0.31		$	0.93		$	0.93

Weighted-average number of common shares outstanding		82,481			81,213			81,949			81,099
Dilutive effect of stock options and dividend equivalents		159			343			231			284

Adjusted weighted-average shares		82,640			81,556			82,180			81,383

Ratio of earnings to fixed charges (SEC method)
Excluding interest on ASB deposits								1.53			2.23

Including interest on ASB deposits								1.35			1.85

See accompanying “Notes to Consolidated Financial Statements” for HEI.

Hawaiian Electric Industries, Inc. and Subsidiaries

Consolidated Balance Sheets (unaudited)


(dollars in thousands)	September 30, 2007			December 31, 2006
Assets
Cash and equivalents	$	167,020		$	177,630
Federal funds sold		59,009			79,671
Accounts receivable and unbilled revenues, net		276,786			248,639
Available-for-sale investment and mortgage-related securities		2,160,841			2,367,427
Investment in stock of Federal Home Loan Bank of Seattle, at cost		97,764			97,764
Loans receivable, net		4,020,112			3,780,461
Property, plant and equipment, net of accumulated depreciation of $1,735,790 and $1,651,088		2,686,584			2,647,490
Regulatory assets		142,675			112,349
Other		334,186			292,638
Goodwill and other intangibles, net		85,622			87,140

	$	10,030,599		$	9,891,209

Liabilities and stockholders’ equity
Liabilities
Accounts payable	$	219,737		$	165,505
Deposit liabilities		4,387,206			4,575,548
Short-term borrowings—other than bank		101,097			176,272
Other bank borrowings		1,731,799			1,568,585
Long-term debt, net—other than bank		1,229,949			1,133,185
Deferred income taxes		95,462			106,780
Regulatory liabilities		257,817			240,619
Contributions in aid of construction		286,403			276,728
Other		556,412			518,454

		8,865,882			8,761,676

Minority interests
Preferred stock of subsidiaries—not subject to mandatory redemption		34,293			34,293


Stockholders’ equity
Preferred stock, no par value, authorized 10,000,000 shares; issued: none		—			—
Common stock, no par value, authorized 200,000,000 shares; issued and outstanding: 82,957,753 shares and 81,461,409 shares		1,061,191			1,028,101
Retained earnings		210,344			242,667
Accumulated other comprehensive loss, net of tax benefits		(141,111	)		(175,528	)

		1,130,424			1,095,240

	$	10,030,599		$	9,891,209

See accompanying “Notes to Consolidated Financial Statements” for HEI.

Hawaiian Electric Industries, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity (unaudited)


	Common stock			Retained earnings			Accumulated other comprehensive loss			Total
(in thousands, except per share amounts)	Shares	Amount		Retained earnings			Accumulated other comprehensive loss			Total

Balance, December 31, 2006	81,461	$	1,028,101	$	242,667		$	(175,528	)	$	1,095,240
Comprehensive income:
Net income	—		—		44,194			—			44,194
Net unrealized gains on securities arising during the period, net of taxes of $6,748	—		—		—			10,219			10,219
Defined benefit retirement plans - amortization of net loss, prior service cost and transition obligation included in net periodic benefit cost, net of taxes of $3,825	—		—		—			5,993			5,993

Comprehensive income	—		—		44,194			16,212			60,406

Adjustment to initially apply a PUC interim D&O related to defined benefit retirement plans, net of taxes of $11,595	—		—		—			18,205			18,205
Adjustment to initially apply FIN 48	—		—		(228	)		—			(228	)
Issuance of common stock, net	1,497		33,090		—			—			33,090
Common stock dividends ($0.93 per share)	—		—		(76,289	)		—			(76,289	)

Balance, September 30, 2007	82,958	$	1,061,191	$	210,344		$	(141,111	)	$	1,130,424


Balance, December 31, 2005	80,983	$	1,018,966	$	235,394		$	(37,730	)	$	1,216,630
Comprehensive income:
Net income	—		—		91,884			—			91,884
Net unrealized losses on securities:
Net unrealized losses arising during the period, net of income tax benefits of $164	—		—		—			(250	)		(250	)
Less: reclassification adjustment for net realized gains included in net income, net of income taxes of $690	—		—		—			(1,045	)		(1,045	)
Minimum pension liability adjustment, net of tax benefits of $30	—		—		—			(48	)		(48	)

Comprehensive income (loss)	—		—		91,884			(1,343	)		90,541

Issuance of common stock, net	367		6,346		—			—			6,346
Common stock dividends ($0.93 per share)	—		—		(75,510	)		—			(75,510	)

Balance, September 30, 2006	81,350	$	1,025,312	$	251,768		$	(39,073	)	$	1,238,007

See accompanying “Notes to Consolidated Financial Statements” for HEI.

Hawaiian Electric Industries, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (unaudited)


Nine months ended September 30	2007			2006
(in thousands)
Cash flows from operating activities
Net income	$	44,194		$	91,884
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation of property, plant and equipment		111,007			105,862
Other amortization		9,275			7,790
Writedown of utility plant		11,701			—
Provision for loan losses		3,900			—
Deferred income taxes		(18,068	)		(8,961	)
Allowance for equity funds used during construction		(3,770	)		(4,974	)
Excess tax benefits from share-based payment arrangements		(346	)		(697	)
Loans receivable originated and purchased, held for sale		(31,699	)		(20,877	)
Proceeds from sale of loans receivable, held for sale		31,904			24,879
Changes in assets and liabilities
Increase in accounts receivable and unbilled revenues, net		(28,147	)		(21,730	)
Increase in fuel oil stock		(35,904	)		(10,520	)
Decrease in federal tax deposit		—			30,000
Increase (decrease) in accounts payable		54,232			(5,204	)
Increase in taxes accrued		18,744			11,406
Changes in other assets and liabilities		2,955			4,524

Net cash provided by operating activities		169,978			203,382

Cash flows from investing activities
Available-for-sale investment and mortgage-related securities purchased		(224,096	)		(175,000	)
Principal repayments on available-for-sale investment and mortgage-related securities		443,493			381,960
Proceeds from sale of available-for-sale mortgage-related securities		—			61,131
Net increase in loans held for investment		(240,078	)		(196,795	)
Net proceeds from sale of investments		8,879			—
Capital expenditures		(139,122	)		(146,982	)
Contributions in aid of construction		13,112			13,227
Other		5,721			2,043

Net cash used in investing activities		(132,091	)		(60,416	)

Cash flows from financing activities
Net decrease in deposit liabilities		(188,342	)		(17,295	)
Net increase (decrease) in short-term borrowings with original maturities of three months or less		(75,175	)		53,153
Proceeds from short-term borrowings with original maturities of greater than three months		—			44,890
Repayment of short-term borrowings with original maturities of greater than three months		—			(45,590	)
Net increase in retail repurchase agreements		50,814			45,577
Proceeds from other bank borrowings		904,532			1,050,907
Repayments of other bank borrowings		(791,335	)		(1,206,828	)
Proceeds from issuance of long-term debt		230,421			100,000
Repayment of long-term debt		(136,000	)		(110,000	)
Excess tax benefits from share-based payment arrangements		346			697
Net proceeds from issuance of common stock		15,449			3,392
Common stock dividends		(60,938	)		(75,469	)
Decrease in cash overdraft		(12,076	)		(4,239	)
Other		(6,855	)		(6,714	)

Net cash used in financing activities		(69,159	)		(167,519	)

Cash flows from discontinued operations-net cash provided by operating activities		—			7,190

Net decrease in cash and equivalents and federal funds sold		(31,272	)		(17,363	)
Cash and equivalents and federal funds sold, beginning of period		257,301			208,947

Cash and equivalents and federal funds sold, end of period	$	226,029		$	191,584

See accompanying “Notes to Consolidated Financial Statements” for HEI.

Hawaiian Electric Industries, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) Basis of presentation

The accompanying unaudited consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (GAAP) for interim financial information, the instructions to SEC Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the balance sheet and the reported amounts of revenues and expenses for the period. Actual results could differ significantly from those estimates. The accompanying unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in HEI’s Form 10-K for the year ended December 31, 2006 and the unaudited consolidated financial statements and the notes thereto in HEI’s Quarterly Reports on SEC Form 10-Q for the quarters ended March 31, 2007 and June 30, 2007.

In the opinion of HEI’s management, the accompanying unaudited consolidated financial statements contain all material adjustments required by GAAP to present fairly the Company’s financial position as of September 30, 2007 and December 31, 2006 and the results of its operations for the three and nine months ended September 30, 2007 and 2006 and its cash flows for the nine months ended September 30, 2007 and 2006. All such adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q or other referenced material. Results of operations for interim periods are not necessarily indicative of results for the full year. When required, certain reclassifications are made to the prior period’s consolidated financial statements to conform to the current presentation.

(2) Segment financial information


(in thousands)	Electric Utility		Bank		Other			Total
Three months ended September 30, 2007
Revenues from external customers	$	567,570	$	105,507	$	384		$	673,461
Intersegment revenues (eliminations)		45		—		(45	)		—

Revenues		567,615		105,507		339			673,461

Profit (loss)*		19,686		18,525		(8,265	)		29,946
Income taxes (benefit)		6,811		6,794		(3,540	)		10,065

Net income (loss)		12,875		11,731		(4,725	)		19,881

Nine months ended September 30, 2007
Revenues from external customers		1,507,829		317,493		2,925		$	1,828,247
Intersegment revenues (eliminations)		176		—		(176	)		—

Revenues		1,508,005		317,493		2,749			1,828,247

Profit (loss)*		36,994		56,670		(26,989	)		66,675
Income taxes (benefit)		13,016		20,761		(11,296	)		22,481

Net income (loss)		23,978		35,909		(15,693	)		44,194

Assets (at September 30, 2007)		3,224,130		6,792,413		14,056			10,030,599

Three months ended September 30, 2006
Revenues from external customers	$	569,768	$	103,338	$	788		$	673,894
Intersegment revenues (eliminations)		70		—		(70	)		—

Revenues		569,838		103,338		718			673,894

Profit (loss)*		38,202		20,578		(8,494	)		50,286
Income taxes (benefit)		14,536		7,108		(3,681	)		17,963

Net income (loss)		23,666		13,470		(4,813	)		32,323

Nine months ended September 30, 2006
Revenues from external customers		1,548,651		305,898		(724	)		1,853,825
Intersegment revenues (eliminations)		210		—		(210	)		—

Revenues		1,548,861		305,898		(934	)		1,853,825

Profit (loss)*		100,408		73,752		(28,634	)		145,526
Income taxes (benefit)		38,468		27,237		(12,063	)		53,642

Net income (loss)		61,940		46,515		(16,571	)		91,884

Assets (at September 30, 2006, including net assets of discontinued operations)		3,165,272		6,714,395		30,169			9,909,836

*	Income (loss) before income taxes.

Intercompany electric sales of consolidated HECO to the bank and “other” segments are not eliminated because those segments would need to purchase electricity from another source if it were not provided by consolidated HECO, the profit on such sales is nominal and the elimination of electric sales revenues and expenses could distort segment operating income and net income.

Bank fees that ASB charges the electric utility and “other” segments are not eliminated because those segments would pay fees to another financial institution if they were to bank with another institution, the profit on such fees is nominal and the elimination of bank fee income and expenses could distort segment operating income and net income.

(3) Electric utility subsidiary

For HECO’s consolidated financial information, including its commitments and contingencies, see pages 16 through 41.

(4) Bank subsidiary

Selected financial information

American Savings Bank, F.S.B. and Subsidiaries

Consolidated Statements of Income Data (unaudited)


	Three months ended September 30				Nine months ended September 30
(in thousands)	2007		2006		2007		2006
Interest and dividend income
Interest and fees on loans	$	61,817	$	59,417	$	182,191	$	171,893
Interest and dividends on investment and mortgage-related securities		26,497		28,368		85,090		89,315

		88,314		87,785		267,281		261,208

Interest expense
Interest on deposit liabilities		20,381		19,701		61,951		52,095
Interest on other borrowings		20,243		18,891		57,230		54,361

		40,624		38,592		119,181		106,456

Net interest income		47,690		49,193		148,100		154,752
Provision for loan losses		2,700		—		3,900		—

Net interest income after provision for loan losses		44,990		49,193		144,200		154,752

Noninterest income
Fees from other financial services		7,153		6,548		20,539		19,730
Fee income on deposit liabilities		6,583		4,653		19,095		13,218
Fee income on other financial products		1,977		1,739		5,845		6,308
Gain on sale of securities		—		1,735		—		1,735
Other income		1,480		878		4,733		3,699

		17,193		15,553		50,212		44,690

Noninterest expense
Compensation and employee benefits		16,173		17,398		52,733		52,711
Occupancy		5,418		4,942		15,707		13,895
Equipment		3,630		3,768		10,893		10,900
Services		6,385		5,600		22,638		13,441
Data processing		2,596		2,534		7,799		7,541
Other expense		9,456		9,926		27,972		27,202

		43,658		44,168		137,742		125,690

Income before income taxes		18,525		20,578		56,670		73,752
Income taxes		6,794		7,108		20,761		27,237

Net income	$	11,731	$	13,470	$	35,909	$	46,515

American Savings Bank, F.S.B. and Subsidiaries

Consolidated Balance Sheet Data (unaudited)


(in thousands)	September 30, 2007			December 31, 2006
Assets
Cash and equivalents	$	156,721		$	172,370
Federal funds sold		59,009			79,671
Available-for-sale investment and mortgage-related securities		2,160,841			2,367,427
Investment in stock of Federal Home Loan Bank of Seattle, at cost		97,764			97,764
Loans receivable, net		4,020,112			3,780,461
Other		212,344			223,666
Goodwill and other intangibles, net		85,622			87,140

	$	6,792,413		$	6,808,499

Liabilities and stockholder’s equity
Deposit liabilities–noninterest-bearing	$	657,866		$	648,915
Deposit liabilities–interest-bearing		3,729,340			3,926,633
Other borrowings		1,731,799			1,568,585
Other		98,577			104,470

		6,217,582			6,248,603

Common stock		325,330			323,154
Retained earnings		282,243			280,046
Accumulated other comprehensive loss, net of tax benefits		(32,742	)		(43,304	)

		574,831			559,896

	$	6,792,413		$	6,808,499

Other borrowings consisted of securities sold under agreements to repurchase and advances from the Federal Home Loan Bank (FHLB) of Seattle of $901 million and $831 million, respectively, as of September 30, 2007 and $730 million and $839 million, respectively, as of December 31, 2006.

As of September 30, 2007, ASB had commitments to borrowers for undisbursed loan funds, loan commitments and unused lines and letters of credit of $1.2 billion.

(5) Retirement benefits

For the first nine months of 2007, HECO contributed $8.2 million, ASB contributed $0.9 million and HEI contributed $0.1 million to their respective retirement benefit plans, compared to $7.4 million, $2.3 million and $0.1 million, respectively, in the first nine months of 2006. The Company’s current estimate of contributions to its retirement benefit plans in 2007 is $13.1 million (including $12.1 million by HECO, $0.9 million by ASB and $0.1 million by HEI), compared to contributions of $12.9 million in 2006. In addition, the Company expects to pay directly $1.7 million of benefits in 2007, compared to $1.2 million paid in 2006.

The components of net periodic benefit cost were as follows:


	Three months ended September 30												Nine months ended September 30
	Pension benefits						Other benefits						Pension benefits						Other benefits
(in thousands)	2007			2006			2007			2006			2007			2006			2007			2006
Service cost	$	7,746		$	8,200		$	1,166		$	1,277		$	23,250		$	24,454		$	3,606		$	3,822
Interest cost		14,494			13,603			2,598			2,616			43,358			40,639			8,232			8,003
Expected return on plan assets		(17,091	)		(18,005	)		(2,619	)		(2,486	)		(51,291	)		(53,679	)		(7,321	)		(7,432	)
Amortization of unrecognized transition obligation		—			1			785			785			2			4			2,354			2,353
Amortization of prior service cost (gain)		(50	)		(29	)		3			3			(148	)		(256	)		10			10
Recognized actuarial loss		2,796			2,965			—			43			8,486			9,090			—			369

Net periodic benefit cost	$	7,895		$	6,735		$	1,933		$	2,238		$	23,657		$	20,252		$	6,881		$	7,125

The Company recorded retirement benefits expense of $25 million and $21 million in the first nine months of 2007 and 2006, respectively. The electric utilities charged a portion of the net periodic benefit costs to plant. Also, in

an interim order issued in April 2007, the amount of HELCO’s net periodic benefit costs to be recovered in rates was established. Thus, any costs determined under SFAS No. 87, as amended, that are over/under this amount subsequent to the interim order are charged/credited to a regulatory asset/liability. Further, under the interim order, a regulatory asset (representing HELCO’s $12.8 million prepaid pension asset as of December 31, 2006 prior to the adoption of SFAS No. 158) was allowed to be recovered (and is being amortized) over a period of five years. Retirement benefits expense for HELCO for the first nine months of 2007 was $3.5 million, but would have been $2.5 million if the pension and postretirement benefits other than pensions (OPEB) tracking mechanisms had not been adopted in the April 2007 interim order issued in HELCO’s 2006 test year rate case.

Also, see Note 4, “Retirement benefits,” and Note 5, “Commitments and contingencies—Interim increases,” of HECO’s “Notes to Consolidated Financial Statements” for a discussion of the PUC’s treatment of HECO’s prepaid pension asset and retirement benefits expenses in an interim D&O rendered in HECO’s 2007 test year rate case and in an amended proposed final D&O in HECO’s 2005 test year rate case, both rendered in October 2007.

ASB retirement benefit plan changes (subject to approval)

In October 2007, ASB informed its employees of its intent, subject to the approval of the HEI Board of Directors (Board), to adopt changes to its defined benefit pension plan effective December 31, 2007 and provide employer contributions to its retirement savings plan beginning January 1, 2008.

The changes to the plans would affect most employees and senior management and include:

Ending the accrual of benefits in ASB’s defined benefit pension plan for participants effective December 31, 2007. There would be no new participants to ASB’s defined benefit pension plan after that date.

Providing for a matching employer contribution under ASB’s retirement savings plan of 100% on the first 4% of eligible pay contributed by participants.

Providing for a discretionary employer contribution up to 6% of eligible pay to ASB’s retirement savings plan that would not be contingent on contributions by participants. The discretionary contribution would be based on the participant’s number of years of vested service.

The changes would not affect the vested pension benefits of former participants, including ASB retirees, as of December 31, 2007. All active participants who are employed on December 31, 2007 will become fully vested in their accrued pension benefit as of December 31, 2007.

Upon Board approval, both plan assets and obligations will be remeasured, and any curtailment gain or loss will be recognized. ASB anticipates a curtailment gain will be recorded, but no assurance can be given that the Board will approve the changes or that, if approved, the facts and actuarial assumptions at the time of approval will result in a gain.

(6) Share-based compensation

Under the 1987 Stock Option and Incentive Plan, as amended (SOIP), HEI may issue an aggregate of 9.3 million shares of common stock (4,799,822 shares available for issuance under outstanding and future grants and awards as of September 30, 2007) to officers and key employees as incentive stock options, nonqualified stock options (NQSOs), restricted stock, stock appreciation rights (SARs), stock payments or dividend equivalents. HEI has issued new shares for NQSOs, restricted stock (nonvested stock), SARs and dividend equivalents under the SOIP. All information presented has been adjusted for the 2-for-1 stock split in June 2004.

For the NQSOs and SARs, the exercise price of each NQSO or SAR generally equaled the fair market value of HEI’s stock on or near the date of grant. NQSOs, SARs and related dividend equivalents issued in the form of stock awarded prior to and through 2004 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. The 2005 SARs awards, which have a ten year exercise life, generally become exercisable at the end of four years (i.e., cliff vesting) with the related dividend equivalents issued in the form of stock on an annual basis. Accelerated vesting is provided in the event of a change-in-control or upon retirement. NQSOs and SARs compensation expense has been recognized in accordance with the fair value-based measurement method of accounting. The estimated fair value of each NQSO and SAR grant was calculated on the date of grant using a Binomial Option Pricing Model.

Restricted stock grants generally become unrestricted three to five years after the date of grant and restricted stock compensation expense has been recognized in accordance with the fair value-based measurement method of accounting. Dividends on restricted stock are paid quarterly in cash.

The Company’s share-based compensation expense and related income tax benefit (including a valuation allowance due to limits on the deductibility of executive compensation) are as follows:


($ in millions)	Three months ended September 30		Nine months ended September 30
($ in millions)	2007	2006	2007	2006
Share-based compensation expense ¹	0.4	0.4	1.1	1.3
Income tax benefit	0.1	0.1	0.3	0.6

¹	The Company has not capitalized any share-based compensation cost. The estimated forfeiture rate for SARs was 4.6% and the estimated forfeiture rate for restricted stock was 6.3%.

Nonqualified stock options

Information about HEI’s NQSOs is summarized as follows:


September 30, 2007			Outstanding & Exercisable
Year of grant	Range of exercise prices		Number of options	Weighted- average remaining contractual life	Weighted- average exercise price
1998	$	20.50	6,000	0.5	$	20.50
1999		17.61 –17.63	48,300	1.8		17.62
2000		14.74	52,000	2.6		14.74
2001		17.96	83,000	3.6		17.96
2002		21.68	134,000	4.4		21.68
2003		20.49	280,500	5.5		20.49

	$	14.74 –21.68	603,800	4.4	$	19.68

As of December 31, 2006, NQSOs outstanding totaled 660,000, with a weighted-average exercise price of $19.68. As of September 30, 2007, all NQSOs outstanding were exercisable and had an aggregate intrinsic value (including dividend equivalents) of $3.3 million.

NQSO activity and statistics are summarized as follows:


($ in thousands, except prices)	Three months ended September 30			Nine months ended September 30
($ in thousands, except prices)	2007	2006		2007		2006
Shares granted	—		—		—		—
Shares forfeited	—		—		—		—
Shares expired	—		—		—		—
Shares vested	—		1,000		79,000		198,500
Aggregate fair value of vested shares	—	$	4	$	350	$	916
Shares exercised	—		50,500		56,200		167,000
Weighted-average exercise price	—	$	18.04	$	19.70	$	20.32
Cash received from exercise	—	$	911	$	1,107	$	3,393
Intrinsic value of shares exercised ¹	—	$	758	$	575	$	1,931
Tax benefit realized for the deduction of exercises	—	$	295	$	224	$	751
Dividend equivalent shares distributed under Section 409A	—		52		21,892		43,265
Weighted-average Section 409A distribution price	—	$	27.72	$	26.15	$	26.27
Intrinsic value of shares distributed under Section 409A	—	$	1	$	572	$	1,137
Tax benefit realized for Section 409A distributions	—	$	1	$	223	$	442

¹	Intrinsic value is the amount by which the fair market value of the underlying stock and the related dividend equivalents exceeds the exercise price of the option.

As of September 30, 2007, all NQSOs were vested.

Stock appreciation rights

Information about HEI’s SARs is summarized as follows:


September 30, 2007			Outstanding				Exercisable
Year of grant	Range of exercise prices		Number of shares underlying SARs	Weighted- average remaining contractual life	Weighted- average exercise price		Number of shares underlying SARs	Weighted- average remaining contractual life	Weighted- average exercise price
2004	$	26.02	325,000	4.4	$	26.02	280,000	4.1	$	26.02
2005		26.18	532,000	5.7		26.18	166,000	1.7		26.18

	$	26.02 – 26.18	857,000	5.2	$	26.12	446,000	3.2	$	26.08

As of December 31, 2006, the shares underlying SARs outstanding totaled 879,000, with a weighted-average exercise price of $26.12. As of September 30, 2007, the SARs outstanding and the SARs exercisable (including dividend equivalents) had no intrinsic value.

SARs activity and statistics are summarized as follows:


	Three months ended September 30			Nine months ended September 30
($ in thousands, except prices)	2007	2006		2007		2006
Shares granted	—		—		—		—
Shares forfeited	18,000		—		18,000		—
Shares expired	—		—		—		—
Shares vested	—		4,000		51,000		317,750
Aggregate fair value of vested shares	—	$	24	$	269	$	1,773
Shares exercised	—		—		4,000		—
Weighted-average exercise price	—		—	$	26.18		—
Cash received from exercise	—		—		—		—
Intrinsic value of shares exercised¹	—		—	$	3		—
Tax benefit realized for the deduction of exercises	—		—	$	1		—
Dividend equivalent shares distributed under Section 409A	—		94		23,760		28,600
Weighted-average Section 409A distribution price	—	$	27.72	$	26.15	$	26.37
Intrinsic value of shares distributed under Section 409A	—	$	3	$	621	$	754
Tax benefit realized for Section 409A distributions	—	$	1	$	242	$	293

¹	Intrinsic value is the amount by which the fair market value of the underlying stock and the related dividend equivalents exceeds the exercise price of the right.

As of September 30, 2007, there was $0.7 million of total unrecognized compensation cost related to SARs and that cost is expected to be recognized over a weighted average period of 1.5 years.

Section 409A modification

As a result of the changes enacted in Section 409A of the Internal Revenue Code of 1986, as amended (Section 409A), for the nine months ended September 30, 2007 and 2006, a total of 45,652 and 71,865 dividend equivalent shares for NQSO and SAR grants were distributed to SOIP participants, respectively. Section 409A, which amended the rules on deferred compensation, required the Company to change the way certain affected dividend equivalents are paid in order to avoid significant adverse tax consequences to the SOIP participants. Generally, dividend equivalents subject to Section 409A will be paid within 2¹/2 months after the end of the calendar year. Upon retirement, an SOIP participant may elect to take distributions of dividend equivalents subject to Section 409A at the time of retirement or at the end of the calendar year.

Restricted stock

As of December 31, 2006, restricted stock shares outstanding totaled 91,800, with a weighted-average grant date fair value of $25.68. As of September 30, 2007, restricted stock shares outstanding totaled 150,500, with a weighted-average grant date fair value of $25.82. The grant date fair value of a grant of a restricted stock share is the closing price of HEI common stock on the date of grant.

During the first nine months of 2007, 16,000 restricted stock shares vested, 1,000 restricted stock shares were forfeited, and 75,700 shares of restricted stock with a grant date fair value of $1.9 million were granted. During the third quarter of 2007, no restricted stock shares vested, 1,000 restricted stock shares were forfeited and 9,300 shares of restricted stock with a grant date fair value of $0.2 million were granted. During the first nine months of 2006, 60,800 shares of restricted stock with a grant date fair value of $1.6 million were granted, 10,000 shares of restricted stock with a grant date fair value of $0.2 million vested and no restricted stock shares were forfeited. During the third quarter of 2006, no restricted stock shares were granted or forfeited and 10,000 shares of restricted stock with a grant date fair value of $0.2 million vested (with a realized tax benefit for tax deductions of $0.1 million). The tax benefit realized for the tax deductions from restricted stock was $0.2 million for the first nine months of 2007 and not significant for the first nine months of 2006.

As of September 30, 2007, there was $2.7 million of total unrecognized compensation cost related to nonvested restricted stock. The cost is expected to be recognized over a weighted-average period of 3.3 years.

(7) Commitments and contingencies

See Note 4, “Bank subsidiary,” above and Note 5, “Commitments and contingencies,” of HECO’s “Notes to Consolidated Financial Statements.”

(8) Cash flows

Supplemental disclosures of cash flow information

For the nine months ended September 30, 2007 and 2006, the Company paid interest (net of amounts capitalized and including bank interest) to non-affiliates amounting to $167 million and $144 million, respectively.

For the nine months ended September 30, 2007 and 2006, the Company paid income taxes amounting to $5 million and $30 million, respectively.

Supplemental disclosures of noncash activities

Noncash increases in common stock for director and officer compensatory plans of the Company were $2.0 million and $2.3 million for the nine months ended September 30, 2007 and 2006, respectively.

Under the HEI Dividend Reinvestment and Stock Purchase Plan (DRIP), common stock dividends reinvested by shareholders in HEI common stock in noncash transactions amounted to $15 million and nil for the nine months ended September 30, 2007 and 2006, respectively. From March 23, 2004 to March 5, 2007, HEI satisfied the requirements of the HEI DRIP and the Hawaiian Electric Industries Retirement Savings Plan (HEIRSP) by acquiring for cash its common shares through open market purchases rather than the issuance of additional shares. On March 6, 2007, it began satisfying those requirements by the issuance of additional shares.

(9) Recent accounting pronouncements and interpretations

Fair value measurements

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value under GAAP and expands disclosures about fair value measurements. SFAS No. 157 applies to fair value measurements that are already required or permitted under existing accounting pronouncements with some exceptions. SFAS No. 157 retains the exchange price notion in defining fair value and clarifies that the exchange price is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability. It emphasizes that fair value is a market-based, not an entity-specific, measurement based upon the assumptions that market participants would use in pricing an asset or liability. As a basis for considering assumptions in fair value measurements, SFAS No. 157 establishes a hierarchy that gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). SFAS No. 157 expands disclosures about the use of fair value, including disclosure of the level within the hierarchy in which the fair value measurements fall and the effect of the measurements on earnings (or changes in net assets) for the period. SFAS No. 157 must be adopted by the first quarter of the fiscal year beginning after November 15, 2007. The Company plans to adopt SFAS No. 157 on January 1, 2008. Management has not yet determined what impact, if any, the adoption of SFAS No. 157 will have on the Company’s financial statements.

The fair value option for financial assets and financial liabilities

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value, which should improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 must be adopted by January 1, 2008. The Company plans to adopt SFAS No. 159 on January 1, 2008. Management has not yet determined what impact, if any, the adoption of SFAS No. 159 will have on the Company’s financial statements.

Income tax benefits of dividends on share-based payment awards

In June 2007, the FASB ratified the EITF consensus reached on EITF Issue No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.” The consensus applies to share-based payment arrangements in which the employee receives dividends on the award during the vesting period, the dividend payment results in a tax deduction, and the employer thereby realizes a tax benefit during the vesting period (e.g., restricted stock awards issued by the Company). Under SFAS No. 123R, dividends paid during the vesting period on share-based payments that are expected to vest are charged to retained earnings because the compensation cost already reflects the expected value of those dividends, which are included in the grant date fair value of the award, but dividends on awards that do not vest are recognized as additional compensation cost. The consensus requires the tax benefit received on dividends associated with share-based awards that are charged to retained earnings to be recorded in additional paid-in capital and included in the pool of excess tax benefits available to absorb potential future tax deficiencies on share-based payment awards. A tax benefit recognized from a dividend on an award that is subsequently forfeited or is no longer expected to vest (and that is therefore reclassified as additional compensation expense) would be reclassified to the income statement if sufficient excess tax benefits are available in the pool of excess tax benefits in additional paid-in capital on the date of the reclassification. The consensus is effective for the tax benefits of dividends declared in fiscal years beginning after December 15, 2007. The Company will adopt this consensus on January 1, 2008 and the adoption is not expected to have an impact on the Company’s financial statements.

(10) Income taxes

In June 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109,” which prescribes a “more-likely-than-not” recognition threshold and measurement attribute (the largest amount of benefit that is greater than 50% likely of being realized upon ultimate resolution with tax authorities) for the financial statement recognition and measurement of an income tax position taken or expected to be taken in a tax return. The Company adopted FIN 48 in the first quarter of 2007. The impact to the Company was a reclassification of certain deferred tax liabilities to a liability for tax uncertainties and a charge of $0.2 million to retained earnings as of January 1, 2007 for the cumulative effect of adoption of FIN 48.

In general, prior to January 1, 2007, the Company (except for ASB) recorded known interest on income taxes in “Interest expense – other than bank” (in “Interest and other charges” in HECO’s consolidated statements of income) and ASB recorded known interest on income taxes in “Expenses - Bank” (in “Other expense” in ASB’s consolidated statements of income). Since the adoption of FIN 48, the electric utilities and ASB record all (potential and known) interest on income taxes in “Interest and other charges” and “Other expense,” respectively, but the Company records such amounts in “Interest expense – other than on deposit liabilities and other bank borrowings.” For the first nine months of 2006, interest accrued on income taxes was insignificant. For the first nine months of 2007, $0.9 million of interest on income taxes was reflected in “Interest expense – other than on deposit liabilities and bank borrowings.” The Company will record penalties, if any, in the respective segment’s expenses.

As of January 1, 2007, the total amount of accrued interest related to uncertain tax positions and recognized on the balance sheet was $2.0 million.

As of January 1, 2007, the total amount of unrecognized tax benefits was $11 million, and of this amount, $0.6 million, if recognized, would affect the Company’s effective tax rate. Management concluded that it is reasonably possible that the unrecognized tax benefits will significantly decrease within the next 12 months due to the resolution of issues under examination by the Internal Revenue Service. Management cannot estimate the range of the reasonably possible change.

Tax years 2003 to 2006 currently remain subject to examination by the Internal Revenue Service and Department of Taxation of the State of Hawaii. HEIII, which owns leveraged lease investments in other states, is also subject to examination by those state tax authorities for tax years 2003 to 2006.

The Company’s effective tax rate for the first nine months of 2007 was 34%, compared to an effective tax rate for the first nine months of 2006 of 37%. The lower effective tax rate was primarily due to domestic production activities deductions related to the generation of electricity and the impact of state tax credits (including the acceleration of the

state tax credits associated with the write-off of a portion of CT-4 and CT-5 costs) recognized against a smaller income tax expense base.

(11) Sale of shares in Hoku Scientific, Inc.

HEI Properties, Inc. (HEIPI) held shares of Hoku Scientific, Inc. (Hoku), a materials science company focused on clean energy technologies. Shares of Hoku began trading on the Nasdaq Stock Market on August 5, 2005 and since then HEIPI had classified its Hoku shares as trading securities, carried at fair value with changes in fair value recorded in earnings. HEIPI began selling Hoku stock in February 2006 when HEIPI’s lock-up agreement expired. In the first nine months of 2006, HEIPI recognized a $1.3 million loss (unrealized and realized, net of taxes) on its Hoku shares. As of December 31, 2006, HEIPI had carried its remaining investment in Hoku shares at $1.2 million. In January 2007, HEIPI sold its remaining Hoku shares for a net after-tax gain of $0.9 million.

(12) Credit agreement

Effective April 3, 2006, HEI entered into a revolving unsecured credit agreement establishing a line of credit facility of $100 million, with a letter of credit sub-facility, expiring on March 31, 2011, with a syndicate of eight financial institutions. Any draws on the facility bear interest, at the option of HEI, at either the “Adjusted LIBO Rate” plus 50 basis points or the greater of (a) the “Prime Rate” and (b) the sum of the “Federal Funds Rate” plus 50 basis points, as defined in the agreement. The annual fee is 10 basis points on the undrawn commitment amount. The agreement contains provisions for revised pricing in the event of a ratings change. For example, a ratings downgrade of HEI’s Senior Debt Rating (e.g., from BBB/Baa2 to BBB-/Baa3 by S&P and Moody’s, respectively) would result in a commitment fee increase of 2.5 basis points and an interest rate increase of 10 basis points on any drawn amounts. On the other hand, a ratings upgrade (e.g., from BBB/Baa2 to BBB+/Baa1) would result in a commitment fee decrease of 2 basis points and an interest rate decrease of 10 basis points on any drawn amounts. The agreement does not contain clauses that would affect access to the lines by reason of a ratings downgrade, nor does it have a broad “material adverse change” clause. However, the agreement does contain customary conditions which must be met in order to draw on it, such as the accuracy of certain of its representations at the time of a draw and compliance with its covenants (such as covenants preventing its subsidiaries from entering into agreements that restrict the ability of the subsidiaries to pay dividends to, or to repay borrowings from, HEI). In addition to customary defaults, HEI’s failure to maintain its financial ratio, as defined in the agreement, or meet other requirements will result in an event of default. For example, under the agreement, it is an event of default if HEI fails to maintain a nonconsolidated “Capitalization Ratio” (funded debt) of 50% or less (ratio of 26% as of September 30, 2007, as calculated under the agreement) and “Consolidated Net Worth” of $850 million (Net Worth of $1.3 billion as of September 30, 2007, as calculated under the agreement), if there is a “Change in Control” of HEI, if any event or condition occurs that results in any “Material Indebtedness” of HEI being subject to acceleration prior to its scheduled maturity, if any “Material Subsidiary Indebtedness” actually becomes due prior to its scheduled maturity, or if ASB fails to remain well capitalized and to maintain specified minimum capital ratios. HEI’s syndicated credit facility is maintained to support the issuance of commercial paper, but may also be drawn to make investments in and advances to its subsidiaries, and for the Company’s working capital and general corporate purposes. As of November 1, 2007, the $100 million credit facility remained undrawn.

See Note 10 of HECO’s “Notes to Consolidated Financial Statements” for a discussion of HECO’s credit facility.

Hawaiian Electric Company, Inc. and Subsidiaries

Consolidated Statements of Income (unaudited)


	Three months ended September 30						Nine months ended September 30
(in thousands, except for ratio of earnings to fixed charges)	2007			2006			2007			2006
Operating revenues	$	561,720		$	568,236		$	1,499,766		$	1,545,557

Operating expenses
Fuel oil		222,721			227,288			549,771			594,940
Purchased power		144,918			138,758			390,161			378,916
Other operation		54,113			46,612			154,949			136,565
Maintenance		28,594			23,653			85,799			63,087
Depreciation		34,273			32,539			102,812			97,614
Taxes, other than income taxes		51,389			51,985			138,839			142,726
Income taxes		4,976			14,665			15,974			38,909

		540,984			535,500			1,438,305			1,452,757

Operating income		20,736			32,736			61,461			92,800

Other income
Allowance for equity funds used during construction		1,336			1,838			3,770			4,974
Other, net		3,819			1,379			(1,330	)		2,809

		5,155			3,217			2,440			7,783

Income before interest and other charges		25,891			35,953			63,901			100,583

Interest and other charges
Interest on long-term debt		11,478			10,777			34,364			32,331
Amortization of net bond premium and expense		621			565			1,813			1,651
Other interest charges		1,075			1,285			4,090			5,424
Allowance for borrowed funds used during construction		(656	)		(838	)		(1,840	)		(2,259	)
Preferred stock dividends of subsidiaries		228			228			686			686

		12,746			12,017			39,113			37,833

Income before preferred stock dividends of HECO		13,145			23,936			24,788			62,750
Preferred stock dividends of HECO		270			270			810			810

Net income for common stock	$	12,875		$	23,666		$	23,978		$	61,940

Ratio of earnings to fixed charges (SEC method)								1.84			3.36

HEI owns all the common stock of HECO. Therefore, per share data with respect to shares of common stock of HECO are not meaningful.

See accompanying “Notes to Consolidated Financial Statements” for HECO.

Hawaiian Electric Company, Inc. and Subsidiaries

Consolidated Balance Sheets (unaudited)


(in thousands, except par value)	September 30, 2007			December 31, 2006
Assets
Utility plant, at cost
Land	$	38,297		$	35,242
Plant and equipment		4,091,436			4,002,929
Less accumulated depreciation		(1,636,002	)		(1,558,913	)
Plant acquisition adjustment, net		54			93
Construction in progress		124,699			95,619

Net utility plant		2,618,484			2,574,970

Current assets
Cash and equivalents		9,265			3,859
Customer accounts receivable, net		143,228			125,524
Accrued unbilled revenues, net		100,191			92,195
Other accounts receivable, net		8,792			4,423
Fuel oil stock, at average cost		100,216			64,312
Materials and supplies, at average cost		34,960			30,540
Other		10,621			9,695

Total current assets		407,273			330,548

Other long-term assets
Regulatory assets		142,675			112,349
Unamortized debt expense		15,915			13,722
Other		39,783			31,545

Total other long-term assets		198,373			157,616

	$	3,224,130		$	3,063,134

Capitalization and liabilities
Capitalization
Common stock, $6²/3 par value, authorized 50,000 shares; outstanding 12,806 shares	$	85,387		$	85,387
Premium on capital stock		299,214			299,214
Retained earnings		710,103			700,252
Accumulated other comprehensive loss, net of income tax benefits		(103,090	)		(126,650	)

Common stock equity		991,614			958,203
Cumulative preferred stock – not subject to mandatory redemption		34,293			34,293
Long-term debt, net		872,949			766,185

Total capitalization		1,898,856			1,758,681

Current liabilities
Short-term borrowings–nonaffiliates		29,625			113,107
Accounts payable		147,059			102,512
Interest and preferred dividends payable		16,970			10,645
Taxes accrued		164,221			152,182
Other		47,489			43,120

Total current liabilities		405,364			421,566

Deferred credits and other liabilities
Deferred income taxes		109,867			118,055
Regulatory liabilities		257,817			240,619
Unamortized tax credits		59,328			57,879
Other		206,495			189,606

Total deferred credits and other liabilities		633,507			606,159

Contributions in aid of construction		286,403			276,728

	$	3,224,130		$	3,063,134

See accompanying “Notes to Consolidated Financial Statements” for HECO.

Hawaiian Electric Company, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholder’s Equity (unaudited)


(in thousands, except per share amounts)	Common stock			Premium on capital stock		Retained earnings			Accumulated other comprehensive loss			Total
(in thousands, except per share amounts)	Shares	Amount		Premium on capital stock		Retained earnings			Accumulated other comprehensive loss			Total
Balance, December 31, 2006	12,806	$	85,387	$	299,214	$	700,252		$	(126,650	)	$	958,203
Comprehensive income:
Net income	—		—		—		23,978			—			23,978
Defined benefit retirement plans—amortization of net loss, prior service cost and transition obligation included in net periodic benefit cost, net of taxes of $3,410	—		—		—		—			5,355			5,355

Comprehensive income	—		—		—		23,978			5,355			29,333

Adjustment to initially apply a PUC interim D&O related to defined benefit retirement plans, net of taxes of $11,595	—		—		—		—			18,205			18,205
Adjustment to initially apply FIN 48	—		—		—		(620	)		—			(620	)
Common stock dividends	—		—		—		(13,507	)		—			(13,507	)

Balance, September 30, 2007	12,806	$	85,387	$	299,214	$	710,103		$	(103,090	)	$	991,614

Balance, December 31, 2005	12,806	$	85,387	$	299,214	$	654,686		$	(28	)	$	1,039,259
Net income	—		—		—		61,940			—			61,940
Common stock dividends	—		—		—		(29,381	)		—			(29,381	)

Balance, September 30, 2006	12,806	$	85,387	$	299,214	$	687,245		$	(28	)	$	1,071,818

See accompanying “Notes to Consolidated Financial Statements” for HECO.

Hawaiian Electric Company, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (unaudited)


Nine months ended September 30	2007			2006
(in thousands)
Cash flows from operating activities
Income before preferred stock dividends of HECO	$	24,788		$	62,750
Adjustments to reconcile income before preferred stock dividends of HECO to net cash provided by operating activities
Depreciation of property, plant and equipment		102,812			97,614
Other amortization		6,450			5,907
Writedown of utility plant		11,701			—
Deferred income taxes		(17,925	)		(7,851	)
Tax credits, net		1,944			2,990
Allowance for equity funds used during construction		(3,770	)		(4,974	)
Changes in assets and liabilities
Increase in accounts receivable		(22,073	)		(7,189	)
Increase in accrued unbilled revenues		(7,996	)		(7,368	)
Increase in fuel oil stock		(35,904	)		(10,520	)
Increase in materials and supplies		(4,420	)		(3,323	)
Decrease in prepaid pension benefit cost		—			15,026
Increase in regulatory assets		(2,129	)		(2,296	)
Increase (decrease) in accounts payable		44,547			(14,853	)
Increase in taxes accrued		12,039			30,313
Changes in other assets and liabilities		17,515			(2,719	)

Net cash provided by operating activities		127,579			153,507

Cash flows from investing activities
Capital expenditures		(135,090	)		(137,345	)
Contributions in aid of construction		13,112			13,227
Other		5,259			407

Net cash used in investing activities		(116,719	)		(123,711	)

Cash flows from financing activities
Common stock dividends		(13,507	)		(29,381	)
Preferred stock dividends		(810	)		(810	)
Proceeds from issuance of long-term debt		230,421			—
Repayment of long-term debt		(126,000	)		—
Net increase (decrease) in short-term borrowings from nonaffiliates and affiliate with original maturities of three months or less		(83,482	)		8,915
Decrease in cash overdraft		(12,076	)		(4,245	)

Net cash used in financing activities		(5,454	)		(25,521	)

Net increase in cash and equivalents		5,406			4,275
Cash and equivalents, beginning of period		3,859			143

Cash and equivalents, end of period	$	9,265		$	4,418

See accompanying “Notes to Consolidated Financial Statements” for HECO.

Hawaiian Electric Company, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) Basis of presentation

The accompanying unaudited consolidated financial statements have been prepared in conformity with GAAP for interim financial information, the instructions to SEC Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the balance sheet and the reported amounts of revenues and expenses for the period. Actual results could differ significantly from those estimates. The accompanying unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto incorporated by reference in HECO’s Form 10-K for the year ended December 31, 2006 and the unaudited consolidated financial statements and the notes thereto in HECO’s Quarterly Reports on SEC Form 10-Q for the quarters ended March 31, 2007 and June 30, 2007.

In the opinion of HECO’s management, the accompanying unaudited consolidated financial statements contain all material adjustments required by GAAP to present fairly the financial position of HECO and its subsidiaries as of September 30, 2007 and December 31, 2006 and the results of their operations for the three and nine months ended September 30, 2007 and 2006 and their cash flows for the nine months ended September 30, 2007 and 2006. All such adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q or other referenced material. Results of operations for interim periods are not necessarily indicative of results for the full year. When required, certain reclassifications are made to the prior period’s consolidated financial statements to conform to the current presentation.

(2) Unconsolidated variable interest entities

HECO Capital Trust III

HECO Capital Trust III (Trust III) was created and exists for the exclusive purposes of (i) issuing in March 2004 2,000,000 6.50% Cumulative Quarterly Income Preferred Securities, Series 2004 (2004 Trust Preferred Securities) ($50 million aggregate liquidation preference) to the public and trust common securities ($1.5 million aggregate liquidation preference) to HECO, (ii) investing the proceeds of these trust securities in 2004 Debentures issued by HECO in the principal amount of $31.5 million and issued by each of Hawaii Electric Light Company, Inc. (HELCO) and Maui Electric Company, Limited (MECO) in the respective principal amounts of $10 million, (iii) making distributions on the trust securities and (iv) engaging in only those other activities necessary or incidental thereto. The 2004 Trust Preferred Securities are mandatorily redeemable at the maturity of the underlying debt on March 18, 2034, which maturity may be extended to no later than March 18, 2053; and are redeemable at the issuer’s option without premium beginning on March 18, 2009. The 2004 Debentures, together with the obligations of HECO, HELCO and MECO under an expense agreement and HECO’s obligations under its trust guarantee and its guarantee of the obligations of HELCO and MECO under their respective debentures, are the sole assets of Trust III. Trust III has at all times been an unconsolidated subsidiary of HECO. Since HECO, as the common security holder, does not absorb the majority of the variability of Trust III, HECO is not the primary beneficiary and does not consolidate Trust III in accordance with FIN 46R, “Consolidation of Variable Interest Entities.” Trust III’s balance sheets as of September 30, 2007 and December 31, 2006 each consisted of $51.5 million of 2004 Debentures; $50.0 million of 2004 Trust Preferred Securities; and $1.5 million of trust common securities. Trust III’s income statements for nine months ended September 30, 2007 and 2006 each consisted of $2.5 million of interest income received from the 2004 Debentures; $2.4 million of distributions to holders of the Trust Preferred Securities; and $0.1 million of common dividends on the trust common securities to HECO. So long as the 2004 Trust Preferred Securities are outstanding, HECO is not entitled to receive any funds from Trust III other than pro rata distributions, subject to certain subordination provisions, on the trust common securities. In the event of a default by HECO in the performance of its obligations under the 2004 Debentures or under its Guarantees, or in the event HECO, HELCO or

MECO elect to defer payment of interest on any of their respective 2004 Debentures, then HECO will be subject to a number of restrictions, including a prohibition on the payment of dividends on its common stock.

Purchase power agreements

As of September 30, 2007, HECO and its subsidiaries had six PPAs for a total of 540 megawatts (MW) of firm capacity, and other PPAs with smaller IPPs and Schedule Q providers that supplied as-available energy. Approximately 91% of the 540 MW of firm capacity is under PPAs, entered into before December 31, 2003, with AES Hawaii, Inc. (AES Hawaii), Kalaeloa Partners, L.P. (Kalaeloa), Hamakua Energy Partners, L.P. (HEP) and HPOWER. Purchases from all IPPs for the nine months ended September 30, 2007 totaled $390 million, with purchases from AES Hawaii, Kalaeloa, HEP and HPOWER totaling $106 million, $136 million, $51 million and $25 million, respectively. The primary business activities of these IPPs are the generation and sale of power to HECO and its subsidiaries (and municipal waste disposal in the case of HPOWER). Current financial information about the size, including total assets and revenues, for many of these IPPs is not publicly available.

Under FIN 46R, an enterprise with an interest in a variable interest entity (VIE) or potential VIE created before December 31, 2003 (and not thereafter materially modified) is not required to apply FIN 46R to that entity if the enterprise is unable to obtain, after making an exhaustive effort, the necessary information.

HECO reviewed its significant PPAs and determined in 2004 that the IPPs at that time had no contractual obligation to provide such information. In March 2004, HECO and its subsidiaries sent letters to all of their IPPs, except the Schedule Q providers, requesting the information that they need to determine the applicability of FIN 46R to the respective IPP, and subsequently contacted most of the IPPs to explain and repeat its request for information. (HECO and its subsidiaries excluded their Schedule Q providers from the scope of FIN 46R because their variable interest in the provider would not be significant to the utilities and they did not participate significantly in the design of the provider.) Some of the IPPs provided sufficient information for HECO to determine that the IPP was not a VIE, or was either a “business” or “governmental organization” (HPOWER) as defined under FIN 46R, and thus excluded from the scope of FIN 46R. Other IPPs, including the three largest, declined to provide the information necessary for HECO to determine the applicability of FIN 46R, and HECO was unable to apply FIN 46R to these IPPs.

As required under FIN 46R, HECO has continued after 2004 its efforts to obtain from the IPPs the information necessary to make the determinations required under FIN 46R. In January 2005, 2006 and 2007, HECO and its subsidiaries again sent letters to the IPPs that were not excluded from the scope of FIN 46R, requesting the information required to determine the applicability of FIN 46R to the respective IPP. All of these IPPs again declined to provide necessary information, except that Kalaeloa provided the information pursuant to the amendments to the PPA (see below) and Kaheawa Wind Power, LLC (KWP) provided information as required under the PPA. Management has concluded that MECO does not have to consolidate KWP (which began selling power to MECO in June 2006 from its 30 MW windfarm) as MECO does not have a variable interest in KWP because the PPA does not require MECO to absorb variability of KWP.

If the requested information is ultimately received from the other IPPs, a possible outcome of future analysis is the consolidation of one or more of such IPPs in HECO’s consolidated financial statements. The consolidation of any significant IPP could have a material effect on HECO’s consolidated financial statements, including the recognition of a significant amount of assets and liabilities, and, if such a consolidated IPP were operating at a loss and had insufficient equity, the potential recognition of such losses. If HECO and its subsidiaries determine they are required to consolidate the financial statements of such an IPP and the consolidation has a material effect, HECO and its subsidiaries would retrospectively apply FIN 46R in accordance with SFAS No. 154, “Accounting Changes and Error Corrections.”

Kalaeloa Partners, L.P. In October 1988, HECO entered into a PPA with Kalaeloa, subsequently approved by the PUC, which provided that HECO would purchase 180 MW of firm capacity for a period of 25 years beginning in May 1991. In October 2004, HECO and Kalaeloa entered into amendments to the PPA, subsequently approved by the PUC, which together effectively increased the firm capacity from 180 MW to 208 MW. The energy payments that HECO makes to Kalaeloa include: 1) a fuel component, with a fuel price adjustment based on the cost of low sulfur fuel oil, 2) a fuel additives cost component and 3) a non-fuel component, with an adjustment based on changes in the

Gross National Product Implicit Price Deflator. The capacity payments that HECO makes to Kalaeloa are fixed in accordance with the PPA.

Kalaeloa is a Delaware limited partnership formed on October 13, 1988 for the purpose of designing, constructing, owning and operating a 200 MW cogeneration facility on Oahu, which includes two 75 MW oil-fired combustion turbines, two waste heat recovery steam generators, a 50 MW turbine generator and other electrical, mechanical and control equipment. The two combustion turbines were upgraded during 2004 resulting in an increase in the facility’s nominal output rating to approximately 220 MW. Kalaeloa has a PPA with HECO (described above) and a steam delivery contract with another customer, the term of which coincides with the PPA. The facility has been certified by the Federal Energy Regulatory Commission as a Qualifying Facility under the Public Utility Regulatory Policies Act of 1978.

Pursuant to the provisions of FIN 46R, HECO is deemed to have a variable interest in Kalaeloa by reason of the provisions of HECO’s PPA with Kalaeloa. However, management has concluded that HECO is not the primary beneficiary of Kalaeloa because HECO does not absorb the majority of Kalealoa’s expected losses nor receive a majority of Kalaeloa’s expected residual returns and, thus, HECO has not consolidated Kalaeloa in its consolidated financial statements. A significant factor affecting the level of expected losses HECO would absorb is the fact that HECO’s exposure to fuel price variability is limited to the remaining term of the PPA as compared to the facility’s remaining useful life. Although HECO absorbs fuel price variability for the remaining term of the PPA, the PPA does not currently expose HECO to losses as the fuel and fuel related energy payments under the PPA have been approved by the PUC for recovery from customers through base electric rates and through HECO’s ECAC to the extent the fuel and fuel-related energy payments are not included in base energy rates.

Apollo Energy Corporation. In October 2004, HELCO and Apollo Energy Corporation (Apollo) executed a restated and amended PPA which enables Apollo to repower its 7 MW facility, and install additional capacity, for a total allowed capacity of 20.5 MW. In December 2005, Apollo assigned the PPA to a subsidiary, which voluntarily, unilaterally and irrevocably waived and relinquished its right and benefit under the PPA to collect the floor rate for the entire term of the PPA. The 20.5 MW facility began commercial operations in April 2007. Based on information available, management concluded that HELCO does not have to consolidate Apollo as HELCO does not have a variable interest in Apollo because the PPA does not require HELCO to absorb any variability of Apollo.

(3) Revenue taxes

HECO and its subsidiaries’ operating revenues include amounts for various revenue taxes. Revenue taxes are generally recorded as an expense in the period the related revenues are recognized. HECO and its subsidiaries’ payments to the taxing authorities are based on the prior year’s revenues. For the nine months ended September 30, 2007 and 2006, HECO and its subsidiaries included approximately $134 million and $137 million, respectively, of revenue taxes in “operating revenues” and in “taxes, other than income taxes” expense.

(4) Retirement benefits

For the first nine months of 2007, HECO and its subsidiaries contributed $8.2 million to their retirement benefit plans, compared to $7.4 million in the first nine months of 2006. HECO and its subsidiaries’ current estimate of contributions to their retirement benefit plans in 2007 is $12.1 million, compared to contributions of $9.8 million in 2006. In addition, HECO and its subsidiaries expect to pay directly $0.5 million of benefits in 2007, compared to $0.6 million paid in 2006.

The components of net periodic benefit cost were as follows:


(in thousands)	Three months ended September 30												Nine months ended September 30
	Pension benefits						Other benefits						Pension benefits						Other benefits
	2007			2006			2007			2006			2007			2006			2007			2006
Service cost	$	6,418		$	6,749		$	1,137		$	1,244		$	19,109		$	19,970		$	3,516		$	3,721
Interest cost		12,951			12,111			2,515			2,547			38,637			36,237			7,998			7,790
Expected return on plan assets		(15,311	)		(16,208	)		(2,580	)		(2,445	)		(45,789	)		(48,257	)		(7,201	)		(7,312	)
Amortization of unrecognized transition obligation		—			1			783			782			1			2			2,348			2,347
Amortization of prior service gain		(191	)		(193	)		—			—			(572	)		(578	)		—			—
Recognized actuarial loss		2,625			2,655			—			39			7,861			8,043			—			349

Net periodic benefit cost	$	6,492		$	5,115		$	1,855		$	2,167		$	19,247		$	15,417		$	6,661		$	6,895

HECO and its subsidiaries recorded retirement benefits expense of $20 million and $16 million in the first nine months of 2007 and 2006, respectively. The electric utilities charged a portion of the net periodic benefit costs to plant. Also, in its interim decisions for HELCO’s 2006 test year rate case and HECO’s 2007 test year rate case (discussed below), the PUC approved the adoption of pension tracking mechanisms on an interim basis. The mechanisms are intended to smooth the impact to ratepayers of potential fluctuations in pension costs. In the interim decisions, the amount of HELCO’s and HECO’s net periodic benefit costs to be recovered in rates was established. Thus, any HELCO or HECO costs determined under SFAS No. 87, as amended, that are over/under those amounts subsequent to the interim orders, are charged/credited to a regulatory asset/liability. Under HELCO’s interim order, a regulatory asset (representing HELCO’s $12.8 million prepaid pension asset as of December 31, 2006 prior to the adoption of SFAS No. 158) was allowed to be recovered (and is being amortized) over a period of five years.

The HELCO pension tracking mechanism generally requires HELCO to make contributions to the pension trust in the amount of the actuarially calculated net periodic pension cost that would be allowed without penalty by the tax laws. A similar tracking mechanism for OPEB was also approved on an interim basis. As a result of these approvals, which are subject to the PUC’s final decision and order (D&O), HELCO reclassified, beginning April 5, 2007, to a regulatory asset the $18 million charge for retirement benefits that would otherwise be recorded in accumulated other comprehensive income pursuant to SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (which amount includes the prepaid pension asset, net of taxes, as well as other pension and OPEB charges related to SFAS No. 158). Retirement benefits expense for HELCO for the first nine months of 2007 was $3.5 million, but would have been $2.5 million if the pension and OPEB tracking mechanisms had not been adopted.

The HECO pension tracking mechanism, which will be effective in the fourth quarter of 2007 pursuant to the interim decision in HECO’s 2007 test year rate case, will allow HECO to recognize its actuarially calculated net periodic pension costs for ratemaking purposes. HECO is required to fund only the minimum level required under the law until the existing pension asset is reduced to zero, at which time HECO would make contributions to the pension trust in the amount of the actuarially calculated net periodic pension costs, except when limited by the ERISA minimum contribution requirements or the maximum contribution limitation on deductible contributions imposed by the Internal Revenue code. The issue of whether to amortize the pension asset (accumulated contributions to its pension fund in excess of accumulated net periodic pension cost (NPPC)), if any, is deferred until HECO’s next rate case proceeding. The pension tracking mechanism requires HECO to create a regulatory asset or regulatory liability, as appropriate, for the difference between the amount of the NPPC included in rates and the actual NPPC recorded. A similar tracking mechanism for OPEB was approved on an interim basis. The tracking mechanisms allow the

reclassification to a regulatory asset of the charge for retirement benefits that would otherwise be recorded in accumulated other comprehensive income.

(5) Commitments and contingencies

Interim increases

On September 27, 2005, the PUC issued an interim D&O in HECO’s 2005 test year rate case granting a general rate increase on Oahu of 4.36%, or $53.3 million (3.33%, or a net increase of $41.1 million excluding the transfer of certain costs from a surcharge line item on electric bills into base electricity charges), which was implemented on September 28, 2005.

On October 25, 2007, the PUC issued an amended proposed final D&O, authorizing an increase of 3.74%, or $45.7 million (or a net increase of $34 million or 2.7%), in annual revenues, based on a 10.7% return on average common equity (and an 8.66% return on rate base of $1.060 billion). The amended proposed final D&O, if issued in final form, would reverse the portion of the interim D&O related to the inclusion of HECO’s approximately $50 million pension asset, net of deferred income taxes, in rate base, and would require a refund of the $15 million of revenues associated with that reversal, including interest, retroactive to September 28, 2005 (the date the interim increase became effective). In the third quarter of 2007, HECO accrued $15 million for the potential customer refunds, reducing third quarter 2007 net income by $8.3 million. The potential additional refund to customers for the amounts recorded under interim rates in excess of the amount in the amended proposed final D&O from October 1, 2007 through October 21, 2007 with interest, is approximately $0.5 million.

Under state law, if one or more of the Commissioners were not present at the evidentiary hearings in the proceeding, and the decision is adverse to a party in the proceeding, a proposed final D&O is required before a final D&O can be issued. The parties adversely affected by the proposed final D&O have ten days to file exceptions and present arguments to the PUC, before a final D&O is rendered. HECO will not be filing exceptions or seeking to present arguments with respect to the amended proposed final D&O.

On April 4, 2007, the PUC issued an interim D&O in HELCO’s 2006 test year rate case granting a general rate increase on the island of Hawaii of 7.58%, or $24.6 million, which was implemented on April 5, 2007.

Through September 30, 2007, HECO and its subsidiaries had recognized $116 million of revenues with respect to interim orders ($14 million related to interim orders regarding certain integrated resource planning costs and $102 million related to interim orders, net of the $15 million accrual to reflect the PUC’s proposed final D&O in the 2005 HECO rate case, with respect to HECO’s and HELCO’s general rate increase requests based on a 2005 and a 2006 test year, respectively, and HECO’s interim surcharge to recover DG fuel and fuel trucking costs), which revenues are subject to refund, with interest, if and to the extent they exceed the amounts allowed in final D&Os.

On October 22, 2007, the PUC issued, and HECO implemented, an interim D&O granting HECO an increase of $69.997 million in annual revenues over current effective rates at the time of the interim decision, subject to refund, with interest. The interim increase is consistent with a settlement agreement (executed and filed on September 6, 2007 by HECO, the Consumer Advocate and the federal Department of Defense).

Energy cost adjustment clauses

On June 19, 2006, the PUC issued an order in HECO’s 2005 test year rate case indicating that the record in the pending case has not been developed for the purpose of addressing the factors in Act 162, signed into law by the Governor of Hawaii on June 2, 2006. Act 162 states that any automatic fuel rate adjustment clause requested by a public utility in an application filed with the PUC shall be designed, as determined in the PUC’s discretion, to (1) fairly share the risk of fuel cost changes between the public utility and its customers, (2) provide the public utility with sufficient incentive to reasonably manage or lower its fuel costs and encourage greater use of renewable energy, (3) allow the public utility to mitigate the risk of sudden or frequent fuel cost changes that cannot otherwise reasonably be mitigated through other commercially available means, such as through fuel hedging contracts, (4) preserve, to the extent reasonably possible, the public utility’s financial integrity, and (5) minimize, to the extent reasonably possible, the public utility’s need to apply for frequent applications for general rate increases to account for the changes to its fuel costs. While the PUC already reviewed the automatic fuel rate adjustment clause in rate cases, Act 162 required that these five specific factors be addressed in the record. The PUC’s order requested the parties in the rate case proceeding to meet informally to determine a procedural schedule to address the issues relating to HECO’s ECAC that are raised by Act 162. The parties in the rate case proceeding are HECO, the Division of Consumer Advocacy, Department of Commerce and Consumer Affairs of the State of Hawaii (Consumer Advocate), and the federal Department of Defense (DOD).

On June 30, 2006, HECO and the Consumer Advocate filed a stipulation requesting that the PUC not review the Act 162 ECAC issues in the pending rate case based on a 2005 test year since HECO’s application was filed and the record in the proceeding was completed before Act 162 was signed into law, and the settlement agreement entered into by the parties in the rate case included a provision allowing the existing ECAC to be continued. On August 7, 2006, an amended stipulation was filed in substantially the same form as the June 30, 2006 stipulation, but also included the DOD. In October 2007, the PUC issued an amended proposed final D&O in HECO’s 2005 test year rate case in which the PUC stated it would not require the parties to file a stipulated procedural schedule on this issue, but that it expects HECO and HELCO to develop information relating to the Act 162 factors for examination during their next rate case proceedings.

The ECAC provisions of Act 162 were reviewed in the HELCO rate case based on a 2006 test year and are being reviewed in the HECO and MECO rate cases based on 2007 test years. In the HELCO 2006 test year rate case, the filed testimony of the Consumer Advocate’s consultant concluded that HELCO’s ECAC provides a fair sharing of the risks of fuel cost changes between HELCO and its ratepayers in a manner that preserves the financial integrity of HELCO without the need for frequent rate filings. On April 4, 2007 the PUC issued an interim D&O in the HELCO 2006 test year rate case which reflected the continuation of HELCO’s ECAC, consistent with a settlement agreement reached between HELCO and the Consumer Advocate.

In an order issued on August 24, 2007, the PUC added as an issue to be addressed in HECO’s 2007 test year rate case whether HECO’s ECAC complies with the requirements of Hawaii Revised Statutes §269-16(g). On September 6, 2007, HECO, the Consumer Advocate and the DOD (the parties) executed and filed an agreement on most of the issues in HECO’s 2007 test year rate case proceeding. The agreement is subject to approval by the PUC, which may accept or reject the agreement in part or in full. If the PUC does not accept the material terms of the agreement, any (and all) of the parties may withdraw from the agreement and pursue their respective positions in the proceeding without prejudice. In the settlement agreement, the parties agreed that the ECAC should continue in its present form for purposes of an interim rate increase and stated that they are continuing discussions with respect to the final design of the ECAC to be proposed for approval in the final D&O in this proceeding. On October 22, 2007 the PUC issued an interim D&O in HECO’s 2007 test year rate case which reflected the continuation of HECO’s ECAC for purposes of the interim increase, consistent with the agreement reached among the parties. The parties will file proposed findings of fact and conclusions of law on all issues in this proceeding, including the ECAC, and the schedule for that filing is being determined. The parties have agreed that their resolution of the ECAC issue will not affect their agreement regarding revenue requirements in the proceeding.

Management cannot predict the ultimate effect of the required Act 162 analysis on the continuation of the electric utilities’ existing ECACs.

On April 23, 2007, the PUC issued an order denying HECO’s proposal to recover DG fuel and trucking and low sulfur fuel oil (LFSO) trucking costs since January 1, 2006 through the reconciliation process for the ECAC. However, the PUC allowed HECO to establish and implement a new and separate interim surcharge to recover its additional DG and LFSO costs on a going forward basis. HECO implemented an interim surcharge to recover such costs incurred from May 1, 2007.

HELCO power situation

In 1991, HELCO began planning to meet increased electric generation demand forecast for 1994. It planned to install at its Keahole power plant two 20 MW combustion turbines (CT-4 and CT-5), followed by an 18 MW heat recovery steam generator (ST-7), at which time these units would be converted to a 56 MW (net) dual-train combined-cycle unit. In January 1994, the PUC approved expenditures for CT-4. In 1995, the PUC allowed HELCO to pursue construction of and commit expenditures for CT-5 and ST-7, but noted that such costs are not to be included in rate base until the project is installed and “is used and useful for utility purposes.” As a result of the final resolution of various proceedings, CT-4 and CT-5 became operational in mid-2004, there are no pending lawsuits involving the project, and work on ST-7 is proceeding. Noise mitigation equipment has been installed on CT-4 and CT-5 and additional noise mitigation work is ongoing to ensure compliance with the night-time noise standard applicable to the plant. Currently, HELCO can operate the generating units at Keahole as required to meet its system needs. Construction of a noise barrier is scheduled for completion by the end of 2007, which should allow the units to operate full time.

Settlement Agreement; ST-7 costs incurred. In 2003, the parties opposing the plant expansion project (other than Waimana Enterprises, Inc. (Waimana), which did not participate in the settlement discussions and opposed the settlement) entered into a settlement agreement with HELCO and several Hawaii regulatory agencies, intended in part to permit HELCO to complete CT-4 and CT-5 (Settlement Agreement). The Settlement Agreement required HELCO to undertake a number of actions including expediting efforts to obtain the permits and approvals necessary for installation of ST-7 with selective catalytic reduction emissions control equipment, assisting the Department of Hawaiian Home Lands in installing solar water heating in its housing projects, supporting the Keahole Defense Coalition’s participation in certain PUC cases, and cooperating with neighbors and community groups (including adding a Hot Line service). While certain of these actions have been completed, and required payments to other parties to the settlement agreement were timely made, a number of these actions are ongoing.

HELCO’s plans for ST-7 are progressing. In November 2003, HELCO filed a boundary amendment petition (to reclassify the Keahole plant site from conservation land use to urban land use) with the State of Hawaii Land Use Commission, which boundary amendment was approved in October 2005. In May 2006, HELCO obtained the County of Hawaii rezoning to a “General Industrial” classification, and in June 2006, received approval for a covered source permit amendment to include selective catalytic reduction with the installation of ST-7. Management believes that any other required permits will be obtained and anticipates an in-service date for ST-7 in mid-2009. HELCO has commenced engineering, design and certain construction work for ST-7. HELCO has made about $31 million in commitments for materials, equipment and outside services, a substantial portion of which are subject to cancellation charges. HELCO’s current cost estimate for ST-7 is approximately $92 million, of which approximately $7 million has been incurred through September 30, 2007.

CT-4 and CT-5 costs incurred. HELCO’s capitalized costs incurred in its efforts to put CT-4 and CT-5 into service and to support existing units (excluding costs for pre-air permit facilities) amounted to approximately $110 million. The $110 million of costs was reclassified from construction in progress to plant and equipment in 2004 ($103 million) and 2005 ($7 million) and depreciated beginning January 1, 2005 and 2006, respectively, and HELCO sought recovery of these costs as part of its 2006 test year rate case.

In March 2007, HELCO and the Consumer Advocate reached a settlement of the issues in the HELCO 2006 rate case proceeding, subject to PUC approval. Under the settlement, HELCO agreed to write-off approximately $12 million of plant-in-service costs, net of average accumulated depreciation, relating to CT-4 and CT-5, resulting in an after-tax charge to net income in the first quarter of 2007 of approximately $7 million (included in “Other, net” under “Other income (loss)” on HECO’s consolidated statement of income).

In April 2007, the PUC issued an interim D&O granting HELCO a 7.58% increase in rates, which reflects the settlement agreement reached between HELCO and the Consumer Advocate, including the agreement to write-off a portion of CT-4 and CT-5 costs. However, the interim order does not commit the PUC to accept any of the amounts in the interim increase in its final order. If it becomes probable that the PUC, in its final order, will disallow additional costs incurred for CT-4 and CT-5 for ratemaking purposes, HELCO will be required to record an additional write-off.

East Oahu Transmission Project (EOTP)

HECO transmits bulk power to the Honolulu/East Oahu area over two major transmission corridors (Northern and Southern). HECO had planned to construct a partial underground/partial overhead 138 kilovolt (kV) line from the Kamoku substation to the Pukele substation, which serves approximately 16% of Oahu’s electrical load, including Waikiki, in order to close the gap between the Southern and Northern corridors and provide a third transmission line to the Pukele substation. In total, this additional transmission capacity would benefit an area that comprises approximately 56% of the power demand on Oahu. However, in June 2002, an application for a permit which would have allowed construction in the originally planned route through conservation district lands was denied.

HECO continued to believe that the proposed reliability project (the East Oahu Transmission Project) was needed and, in December 2003, filed an application with the PUC requesting approval to commit funds (currently estimated at $69.6 million; see costs incurred below) for a revised EOTP using a 46 kV system. In March 2004, the PUC granted intervenor status to an environmental organization and three elected officials (collectively treated as one party), and a more limited participant status to four community organizations. The environmental review process for the revised EOTP was completed and the PUC issued a Finding of No Significant Impact in April 2005.

In written testimony filed in June 2005, the consultant for the Consumer Advocate contended that HECO should always have planned for a project using only the 46 kV system and recommended that HECO be required to expense the $12 million incurred prior to the denial in 2002 of the approval necessary for the partial underground/partial overhead 138 kV line, and the related allowance for funds used during construction (AFUDC) of $5 million. In rebuttal testimony filed in August 2005, HECO contested the consultant’s recommendation, emphasizing that the originally proposed 138 kV line would have been a more comprehensive and robust solution to the transmission concerns the project addressed. The PUC held an evidentiary hearing on HECO’s application in November 2005, and post-hearing briefing was completed in March 2006. Just prior to the November 2005 evidentiary hearing, the PUC approved that part of a stipulation between HECO and the Consumer Advocate providing that (i) this proceeding should determine whether HECO should be given approval to expend funds for the EOTP, but with the understanding that no part of the EOTP costs may be recovered from ratepayers unless and until the PUC grants HECO recovery in a rate case (which is consistent with other projects) and (ii) the issue as to whether the pre-2003 planning and permitting costs, and related AFUDC, should be included in the project costs is reserved to, and may be raised in, the next HECO rate case (or other proceeding) in which HECO seeks approval to recover the EOTP costs. In October 2007, the PUC issued a final D&O approving HECO’s request to expend funds for a revised EOTP using a 46 kV system, but stating that the issue of recovery of the EOTP costs would be determined in a subsequent rate case.

Subject to obtaining other construction permits, HECO plans to construct the revised project, none of which is in conservation district lands, in two phases. The first phase is currently projected to be completed in 2010 and the completion date of the second phase is being evaluated.

As of September 30, 2007, the accumulated costs recorded for the EOTP amounted to $32 million, including (i) $12 million of planning and permitting costs incurred prior to 2003, (ii) $5 million of planning and permitting costs incurred after 2002 and (iii) $15 million for AFUDC. Management believes no adjustment to project costs is required as of September 30, 2007. However, if it becomes probable that the PUC will disallow some or all of the incurred costs for ratemaking purposes, HECO may be required to write off a material portion or all of the project costs incurred in its efforts to put the project into service whether or not it is completed.

Environmental regulation

HEI and its subsidiaries are subject to environmental laws and regulations that regulate the operation of existing facilities, the construction and operation of new facilities and the proper cleanup and disposal of hazardous waste and toxic substances.

HECO, HELCO and MECO, like other utilities, periodically identify petroleum or other chemical releases into the environment associated with current operations and report and take action on these releases when and as required by applicable law and regulations. Except as otherwise disclosed herein, the Company believes the costs of responding to its subsidiaries’ releases identified to date will not have a material adverse effect, individually or in the aggregate, on the Company’s or consolidated HECO’s financial statements.

Additionally, current environmental laws may require HEI and its subsidiaries to investigate whether releases from historical operations may have contributed to environmental impacts, and, where appropriate, respond to such releases, even if they were not inconsistent with law or standard industrial practices prevailing at the time when they occurred. Such releases may involve area-wide impacts contributed to by multiple potentially responsible parties.

Honolulu Harbor investigation. In 1995, the Department of Health of the State of Hawaii (DOH) issued letters indicating that it had identified a number of parties, including HECO, who appeared to be potentially responsible for historical subsurface petroleum contamination and/or operated their facilities upon petroleum-contaminated land at or near Honolulu Harbor in the Iwilei district of Honolulu. Certain of the identified parties formed a work group to determine the nature and extent of any contamination and appropriate response actions, as well as to identify additional potentially responsible parties (PRPs). The U.S. Environmental Protection Agency (EPA) became involved in the investigation in June 2000. Later in 2000, the DOH issued notices to additional PRPs. The parties in the work group and some of the new PRPs (collectively, the Participating Parties) entered into a joint defense agreement and signed a voluntary response agreement with the DOH. The Participating Parties agreed to fund investigative and remediation work using an interim cost allocation method (subject to a final allocation) and have organized a limited liability company to perform the work.

In 2001, management developed and expensed a preliminary estimate of HECO’s share of costs for continuing investigative work, remedial activities and monitoring at the Iwilei Unit of $1.1 million. Since 2001, subsurface investigation and assessment have been conducted and several preliminary oil removal tasks have been performed at the Iwilei Unit in accordance with notices of interest issued by the EPA and the DOH.

In 2003, HECO and other Participating Parties with active operations in the Iwilei area investigated their operations to evaluate whether their facilities were active sources of petroleum contamination in the area. HECO’s investigation concluded that its facilities were not then releasing petroleum. Routine maintenance and inspections of HECO facilities since then confirm that they are not currently releasing petroleum.

During 2006 and the beginning of 2007, the PRPs developed analyses of various remedial alternatives for two of the four remedial subunits of the Iwilei Unit. The DOH will use the analyses to make a final determination of which remedial alternatives the PRPs will be required to implement. The DOH is scheduled to complete the final remediation determinations for all remedial subunits of the Iwilei Unit by the end of 2007 or first quarter of 2008. HECO management developed an estimate of HECO’s share of the costs associated with implementing the PRP recommended remedial approaches for the two subunits covered by the analyses of $1.2 million, which was expensed in 2006. Subsequently, based on the estimated costs for the remaining two subunits, as well as updated estimates for total remediation costs, HECO management expensed an additional $0.6 million in the third quarter of 2007.

As of September 30, 2007, the accrual (amounts expensed less amounts expended) related to the Honolulu Harbor investigation was $1.9 million. Because (1) the full scope of additional investigative work, remedial activities

and monitoring remain to be determined, (2) the final cost allocation method among the PRPs has not yet been established and (3) management cannot estimate the costs to be incurred (if any) for the sites other than the Iwilei Unit (such as its Honolulu power plant, which is located in the “Downtown” unit of the Honolulu Harbor site), the cost estimate may be subject to significant change and additional material investigative and remedial costs may be incurred.

Regional Haze Rule amendments. In June 2005, the EPA finalized amendments to the July 1999 Regional Haze Rule that require emission controls known as best available retrofit technology (BART) for industrial facilities emitting air pollutants that reduce visibility in National Parks by causing or contributing to regional haze. States must develop BART implementation plans and schedules in accordance with the amended regional haze rule by December 2007. After Hawaii adopts its plan, HECO, HELCO and MECO will evaluate the plan’s impacts, if any, on them. If any of the utilities’ generating units are ultimately required to install post-combustion control technologies to meet BART emission limits, the resulting capital and operation and maintenance costs could be significant.

Clean Water Act. Section 316(b) of the federal Clean Water Act requires that the EPA ensure that existing power plant cooling water intake structures reflect the best technology available for minimizing adverse environmental impacts. Effective September 9, 2004, the EPA issued a rule, which established location and technology-based design, construction and capacity standards for existing cooling water intake structures. These standards applied to HECO’s Kahe, Waiau and Honolulu generating stations, unless the utility could demonstrate that at each facility implementation of these standards would result in costs either significantly higher than projected costs the EPA considered in establishing the standards for the facility (cost-cost test) or significantly greater than the benefits of meeting the standards (cost-benefit test). In either case, the EPA would then make a case-by-case determination of an appropriate performance standard. The regulation also would have allowed restoration of aquatic organism populations in lieu of meeting the standards. The rule required covered facilities to demonstrate compliance by March 2008. HECO had retained a consultant that was developing a cost effective compliance strategy and a preliminary assessment of technologies and operational measures under the rule.

On January 25, 2007, the U.S. Circuit Court for the Second Circuit issued a decision in Riverkeeper, Inc. v. EPA that remanded for further consideration and proceedings significant portions of the rule and found other portions of the rule to be impermissible. In particular, the court determined that restoration and the cost-benefit test were impermissible under the Clean Water Act. It also remanded the best technology available determination to permit the EPA to provide a reasoned explanation for its decision or a new determination. It remanded the cost-cost test for the EPA’s further consideration based on the best technology available determination and to afford adequate notice. The EPA is considering an appeal of the decision to the U.S. Supreme Court. If the decision stands, the Court of Appeals ruling reduces the compliance options available to HECO. In addition, the EPA has not issued a schedule for rulemaking, which would be necessary to comply with the court’s decision. On March 20, 2007, the EPA announced it had “suspended” the rule pending appeal or additional rulemaking. On July 9, 2007, the EPA formalized its determination to suspend the rule in a Federal Register notice. In the announcement, the EPA provided guidance to federal and state permit writers that they should use their “best professional judgment” in determining permit conditions regarding cooling water intake requirements at existing power plants. Currently, this guidance does not affect the HECO facilities subject to the cooling water intake requirements because none of the facilities are subject to permit renewal until mid-2009. Due to the uncertainties raised by the court’s decision as well as the need for further rulemaking by the EPA, management is unable to predict which compliance options, some of which could entail significant capital expenditures to implement, will be applicable to its facilities.

Collective bargaining agreements

As of September 30, 2007, approximately 58% of the electric utilities’ employees are members of the International Brotherhood of Electrical Workers, AFL-CIO, Local 1260, Unit 8, which is the only union representing employees of the Company. The four-year collective bargaining and benefit agreements with the union covered a term from November 1, 2003 to October 31, 2007, but have been extended to November 7, 2007. The agreements provided for non-compounded wage increases (3% on November 1, 2003; 1.5% on November 1, 2004, May 1, 2005, November 1, 2005 and May 1, 2006; and 3% on November 1, 2006). Negotiations for new agreements began in the third quarter of 2007 and are continuing.

(6) Cash flows

Supplemental disclosures of cash flow information

For the nine months ended September 30, 2007 and 2006, HECO and its subsidiaries paid interest (net of amounts capitalized) amounting to $33 million and $30 million, respectively.

For the nine months ended September 30, 2007 and 2006, HECO and its subsidiaries paid income taxes amounting to $6 million and $17 million, respectively.

Supplemental disclosure of noncash activities

The allowance for equity funds used during construction, which was charged to construction in progress as part of the cost of electric utility plant, amounted to $3.8 million and $5.0 million for the nine months ended September 30, 2007 and 2006, respectively.

(7) Recent accounting pronouncements and interpretations

For a discussion of recent accounting pronouncements and interpretations, see Note 9 of HEI’s “Notes to Consolidated Financial Statements.”

(8) Income taxes

The electric utilities record interest on income taxes in “Interest and other charges.” Interest accrued on income taxes was insignificant in the first nine months of 2006 and $0.5 million in the first nine months of 2007.

As of January 1, 2007, the total amount of accrued interest related to uncertain tax positions and recognized on the balance sheet was $0.6 million.

As of January 1, 2007, the total amount of unrecognized tax benefits was $4.7 million, and of this amount, $0.2 million, if recognized, would affect the electric utilities’ effective tax rate. Management concluded that it is reasonably possible that the unrecognized tax benefits will significantly decrease within the next 12 months due to the resolution of issues under examination by the Internal Revenue Service. Management cannot estimate the range of the reasonably possible change.

Tax years 2003 to 2006 currently remain subject to examination by the Internal Revenue Service and Department of Taxation of the State of Hawaii.

The electric utilities had an effective tax rate for the first nine months of 2007 of 34%, compared to 38% for the first nine months of 2006), primarily due to the domestic production activities deductions related to the generation of electricity and the impact of state tax credits (including the acceleration of the state tax credits associated with the write off of a portion of CT-4 and CT-5 costs) recognized against a smaller income tax expense base.

(9) Reconciliation of electric utility operating income per HEI and HECO consolidated statements of income


(in thousands)	Three months ended September 30						Nine months ended September 30
(in thousands)	2007			2006			2007			2006
Operating income from regulated and nonregulated activities before income taxes (per HEI consolidated statements of income)	$	31,366		$	48,651		$	73,147		$	134,077
Deduct:
Income taxes on regulated activities		(4,976	)		(14,665	)		(15,974	)		(38,909	)
Revenues from nonregulated activities		(5,895	)		(1,602	)		(8,239	)		(3,304	)
Add: Expenses from nonregulated activities		241			352			12,527			936

Operating income from regulated activities after income taxes (per HECO consolidated statements of income)	$	20,736		$	32,736		$	61,461		$	92,800

(10) Credit agreement

Effective April 3, 2006, HECO entered into a revolving unsecured credit agreement establishing a line of credit facility of $175 million with a syndicate of eight financial institutions. On March 14, 2007 the PUC issued a D&O approving HECO’s request to maintain the credit facility for five years (until March 31, 2011), to borrow under the credit facility with maturities in excess of 364 days, to use the proceeds from any borrowings with maturities in excess of 364 days to finance capital expenditures and/or to repay short-term or other borrowings used to finance or refinance capital expenditures and to use an expedited approval process to obtain PUC approval to increase the facility amount, renew the facility, refinance the facility or change other terms of the facility if such changes are required or desirable.

Any draws on the facility bear interest, at the option of HECO, at either the “Adjusted LIBO Rate” plus 40 basis points or the greater of (a) the “Prime Rate” and (b) the sum of the “Federal Funds Rate” plus 50 basis points, as defined in the agreement. The annual fee is 8 basis points on the undrawn commitment amount. The agreement contains provisions for revised pricing in the event of a ratings change. For example, a ratings downgrade of HECO’s Senior Debt Rating (e.g., from BBB+/Baa1 to BBB/Baa2 by S&P and Moody’s, respectively) would result in a commitment fee increase of 2 basis points and an interest rate increase of 10 basis points on any drawn amounts. On the other hand, a ratings upgrade (e.g., from BBB+/Baa1 to A-/A3) would result in a commitment fee decrease of 1 basis point and an interest rate decrease of 10 basis points on any drawn amounts. The agreement does not contain clauses that would affect access to the lines by reason of a ratings downgrade, nor does it have a broad “material adverse change” clause. However, the agreement does contain customary conditions that must be met in order to draw on it, such as the accuracy of certain of its representations at the time of a draw and compliance with its covenants (such as covenants preventing its subsidiaries from entering into agreements that restrict the ability of the subsidiaries to pay dividends to, or to repay borrowings from, HECO, and restricting HECO’s ability, as well as the ability of any of its subsidiaries, to guarantee indebtedness of the subsidiaries if such additional debt would cause the subsidiary’s “Consolidated Subsidiary Funded Debt to Capitalization Ratio” to exceed 65% (ratios of 47% for HELCO and 44% for MECO as of September 30, 2007, as calculated under the agreement)). In addition to customary defaults, HECO’s failure to maintain its financial ratios, as defined in its agreement, or meet other requirements will result in an event of default. For example, under the agreement, it is an event of default if HECO fails to maintain a “Consolidated Capitalization Ratio” (equity) of at least 35% (ratio of 54% as of September 30, 2007, as calculated under the agreement), if HECO fails to remain a wholly-owned subsidiary of HEI or if any event or condition occurs that results in any “Material Indebtedness” of HECO or any of its significant subsidiaries being subject to acceleration prior to its scheduled maturity. HECO’s syndicated credit facility is maintained to support the issuance of commercial paper, but it may also be drawn for general corporate purposes and capital expenditures. As of November 1, 2007, the $175 million credit facility remained undrawn.

On May 23, 2007, S&P lowered the long-term corporate credit and unsecured debt ratings on HECO, HELCO and MECO to BBB from BBB+ and stated that the downgrade “is the result of sustained weak bondholder protection parameters compounded by the financial pressure that continuous need for regulatory relief, driven by heightened capital expenditure requirements, is creating for the next few years.” The pricing for future borrowings under the line of credit facility did not change since the pricing level is “determined by the higher of the two” ratings by S&P and Moody’s, and Moody’s ratings did not change.

(11) Special Purpose Revenue Bonds (SPRBs)

On March 27, 2007, the Department of Budget and Finance of the State of Hawaii (the Department) issued (pursuant to a 2005 legislative authorization), at par, Series 2007A SPRBs in the aggregate principal amount of $140 million, with a maturity of March 1, 2037 and a fixed coupon interest rate of 4.65%, and loaned the proceeds to HECO ($100 million), HELCO ($20 million) and MECO ($20 million). Payment of the principal and interest on the SPRBs are insured by a surety bond issued by Financial Guaranty Insurance Company. Proceeds will be used to finance capital expenditures, including reimbursements to the electric utilities for previously incurred capital expenditures which, in turn, will be used primarily to repay short-term borrowings. As of September 30, 2007, approximately $35 million of proceeds from the Series 2007A SPRBs had not yet been drawn and were held by the construction fund trustee. HECO, HELCO and MECO’s long-term debt will increase from time to time as these remaining proceeds are drawn down.

On March 27, 2007, the Department issued, at par, Refunding Series 2007B SPRBs in the aggregate principal amount of $125 million, with a maturity of May 1, 2026 and a fixed coupon interest rate of 4.60%, and loaned the proceeds to HECO ($62 million), HELCO ($8 million) and MECO ($55 million). Proceeds from the sale were applied, together with other funds provided by the electric utilities, to the redemption at par on May 1, 2007 of the $75 million aggregate principal amount of 6.20% Series 1996A SPRBs (which had an original maturity of May 1, 2026) and to the redemption at a 2% premium on April 27, 2007 of the $50 million aggregate principal amount of 5⁷/8% Series 1996B SPRBs (which had an original maturity of December 1, 2026). Payment of the principal and interest on the refunding SPRBs are insured by a surety bond issued by Financial Guaranty Insurance Company.

(12) Sale of non-electric utility property

In August 2007, HECO sold land and a building that executives and management had been using as a recreational facility. The sale of the non-electric utility property resulted in an after-tax gain in the third quarter of 2007 of approximately $2.9 million (reflected in “Other, net” under “Other income” on HECO’s consolidated statement of income).

(13) Consolidating financial information

HECO is not required to provide separate financial statements or other disclosures concerning HELCO and MECO to holders of the 2004 Debentures issued by HELCO and MECO to Trust III since all of their voting capital stock is owned, and their obligations with respect to these securities have been fully and unconditionally guaranteed, on a subordinated basis, by HECO. Consolidating information is provided below for these and other HECO subsidiaries for the periods ended and as of the dates indicated. As of the dates and for the periods presented, there were no amounts for Uluwehiokama Biofuels Corp., a newly-formed, unregulated HECO subsidiary.

HECO also unconditionally guarantees HELCO’s and MECO’s obligations (a) to the State of Hawaii for the repayment of principal and interest on Special Purpose Revenue Bonds issued for the benefit of HELCO and MECO and (b) relating to the trust preferred securities of Trust III. Also, see Note 2. HECO is also obligated, after the satisfaction of its obligations on its own preferred stock, to make dividend, redemption and liquidation payments on HELCO’s and MECO’s preferred stock if the respective subsidiary is unable to make such payments.

Hawaiian Electric Company, Inc. and Subsidiaries

Consolidating Statement of Income (unaudited)

Three months ended September 30, 2007


(in thousands)	HECO			HELCO		MECO		RHI		Reclassifications and eliminations		HECO consolidated
Operating revenues	$	369,937		97,294		94,489		—		—		$	561,720

Operating expenses
Fuel oil		157,568		17,983		47,170		—		—			222,721
Purchased power		97,025		38,143		9,750		—		—			144,918
Other operation		37,595		8,359		8,159		—		—			54,113
Maintenance		15,309		6,381		6,904		—		—			28,594
Depreciation		19,746		7,523		7,004		—		—			34,273
Taxes, other than income taxes		33,803		8,877		8,709		—		—			51,389
Income taxes		414		3,003		1,559		—		—			4,976

		361,460		90,269		89,255		—		—			540,984

Operating income		8,477		7,025		5,234		—		—			20,736

Other income
Allowance for equity funds used during construction		1,078		167		91		—		—			1,336
Equity in earnings of subsidiaries		7,545		—		—		—		(7,545	)		—
Other, net		4,196		175		34		(29	)	(557	)		3,819

		12,819		342		125		(29	)	(8,102	)		5,155

Income (loss) before interest and other charges		21,296		7,367		5,359		(29	)	(8,102	)		25,891

Interest and other charges
Interest on long-term debt		7,393		1,919		2,166		—		—			11,478
Amortization of net bond premium and expense		394		107		120		—		—			621
Other interest charges		891		670		71		—		(557	)		1,075
Allowance for borrowed funds used during construction		(527	)	(86	)	(43	)	—		—			(656	)
Preferred stock dividends of subsidiaries		—		—		—		—		228			228

		8,151		2,610		2,314		—		(329	)		12,746

Income (loss) before preferred stock dividends of HECO		13,145		4,757		3,045		(29	)	(7,773	)		13,145
Preferred stock dividends of HECO		270		133		95		—		(228	)		270

Net income (loss) for common stock	$	12,875		4,624		2,950		(29	)	(7,545	)	$	12,875

Hawaiian Electric Company, Inc. and Subsidiaries

Consolidating Statement of Income (unaudited)

Three months ended September 30, 2006


(in thousands)	HECO			HELCO		MECO		RHI		Reclassifications and eliminations		HECO consolidated
Operating revenues	$	376,925		94,088		97,223		—		—		$	568,236

Operating expenses
Fuel oil		150,868		24,723		51,697		—		—			227,288
Purchased power		96,038		33,315		9,405		—		—			138,758
Other operation		32,344		6,935		7,333		—		—			46,612
Maintenance		14,494		5,062		4,097		—		—			23,653
Depreciation		18,702		7,429		6,408		—		—			32,539
Taxes, other than income taxes		34,492		8,584		8,909		—		—			51,985
Income taxes		9,388		2,160		3,117		—		—			14,665

		356,326		88,208		90,966		—		—			535,500

Operating income		20,599		5,880		6,257		—		—			32,736

Other income
Allowance for equity funds used during construction		1,009		63		766		—		—			1,838
Equity in earnings of subsidiaries		8,375		—		—		—		(8,375	)		—
Other, net		1,630		111		467		(32	)	(797	)		1,379

		11,014		174		1,233		(32	)	(9,172	)		3,217

Income (loss) before interest and other charges		31,613		6,054		7,490		(32	)	(9,172	)		35,953

Interest and other charges
Interest on long-term debt		6,741		1,809		2,227		—		—			10,777
Amortization of net bond premium and expense		354		108		103		—		—			565
Other interest charges		1,034		600		448		—		(797	)		1,285
Allowance for borrowed funds used during construction		(452	)	(29	)	(357	)	—		—			(838	)
Preferred stock dividends of subsidiaries		—		—		—		—		228			228

		7,677		2,488		2,421		—		(569	)		12,017

Income (loss) before preferred stock dividends of HECO		23,936		3,566		5,069		(32	)	(8,603	)		23,936
Preferred stock dividends of HECO		270		133		95		—		(228	)		270

Net income (loss) for common stock	$	23,666		3,433		4,974		(32	)	(8,375	)	$	23,666

Hawaiian Electric Company, Inc. and Subsidiaries

Consolidating Statement of Income (unaudited)

Nine months ended September 30, 2007


(in thousands)	HECO			HELCO		MECO		RHI		Reclassifications and eliminations		HECO consolidated
Operating revenues	$	978,279		262,747		258,740		—		—		$	1,499,766

Operating expenses
Fuel oil		368,405		53,688		127,678		—		—			549,771
Purchased power		267,744		98,625		23,792		—		—			390,161
Other operation		107,925		23,681		23,343		—		—			154,949
Maintenance		49,326		17,354		19,119		—		—			85,799
Depreciation		59,230		22,570		21,012		—		—			102,812
Taxes, other than income taxes		90,769		24,184		23,886		—		—			138,839
Income taxes		5,469		5,867		4,638		—		—			15,974

		948,868		245,969		243,468		—		—			1,438,305

Operating income		29,411		16,778		15,272		—		—			61,461

Other income
Allowance for equity funds used during construction		3,209		300		261		—		—			3,770
Equity in earnings of subsidiaries		10,372		—		—		—		(10,372	)		—
Other, net		6,931		(6,517	)	291		(58	)	(1,977	)		(1,330	)

		20,512		(6,217	)	552		(58	)	(12,349	)		2,440

Income (loss) before interest and other charges		49,923		10,561		15,824		(58	)	(12,349	)		63,901

Interest and other charges
Interest on long-term debt		21,842		5,691		6,831		—		—			34,364
Amortization of net bond premium and expense		1,142		312		359		—		—			1,813
Other interest charges		3,715		2,035		317		—		(1,977	)		4,090
Allowance for borrowed funds used during construction		(1,564	)	(151	)	(125	)	—		—			(1,840	)
Preferred stock dividends of subsidiaries		—		—		—		—		686			686

		25,135		7,887		7,382		—		(1,291	)		39,113

Income (loss) before preferred stock dividends of HECO		24,788		2,674		8,442		(58	)	(11,058	)		24,788
Preferred stock dividends of HECO		810		400		286		—		(686	)		810

Net income (loss) for common stock	$	23,978		2,274		8,156		(58	)	(10,372	)	$	23,978

Hawaiian Electric Company, Inc. and Subsidiaries

Consolidating Statement of Income (unaudited)

Nine months ended September 30, 2006


(in thousands)	HECO			HELCO		MECO		RHI		Reclassifications and eliminations		HECO consolidated
Operating revenues	$	1,034,483		254,275		256,799		—		—		$	1,545,557

Operating expenses
Fuel oil		397,360		62,860		134,720		—		—			594,940
Purchased power		268,019		91,479		19,418		—		—			378,916
Other operation		92,754		21,947		21,864		—		—			136,565
Maintenance		39,880		12,755		10,452		—		—			63,087
Depreciation		56,097		22,291		19,226		—		—			97,614
Taxes, other than income taxes		95,464		23,527		23,735		—		—			142,726
Income taxes		25,373		4,564		8,972		—		—			38,909

		974,947		239,423		238,387		—		—			1,452,757

Operating income		59,536		14,852		18,412		—		—			92,800

Other income
Allowance for equity funds used during construction		3,002		156		1,816		—		—			4,974
Equity in earnings of subsidiaries		21,408		—		—		—		(21,408	)		—
Other, net		3,789		239		978		(134	)	(2,063	)		2,809

		28,199		395		2,794		(134	)	(23,471	)		7,783

Income (loss) before interest and other charges		87,735		15,247		21,206		(134	)	(23,471	)		100,583

Interest and other charges
Interest on long-term debt		20,225		5,425		6,681		—		—			32,331
Amortization of net bond premium and expense		1,032		309		310		—		—			1,651
Other interest charges		5,072		1,832		583		—		(2,063	)		5,424
Allowance for borrowed funds used during construction		(1,344	)	(71	)	(844	)	—		—			(2,259	)
Preferred stock dividends of subsidiaries		—		—		—		—		686			686

		24,985		7,495		6,730		—		(1,377	)		37,833

Income (loss) before preferred stock dividends of HECO		62,750		7,752		14,476		(134	)	(22,094	)		62,750
Preferred stock dividends of HECO		810		400		286		—		(686	)		810

Net income (loss) for common stock	$	61,940		7,352		14,190		(134	)	(21,408	)	$	61,940

Hawaiian Electric Company, Inc. and Subsidiaries

Consolidating Balance Sheet (unaudited)

September 30, 2007


(in thousands)	HECO			HELCO		MECO		RHI	Reclassifications and eliminations		HECO consolidated
Assets
Utility plant, at cost
Land	$	28,969		4,982		4,346		—	—		$	38,297
Plant and equipment		2,490,617		817,229		783,590		—	—			4,091,436
Less accumulated depreciation		(992,110	)	(317,638	)	(326,254	)	—	—			(1,636,002	)
Plant acquisition adjustment, net		—		—		54		—	—			54
Construction in progress		91,490		23,213		9,996		—	—			124,699

Net utility plant		1,618,966		527,786		471,732		—	—			2,618,484

Investment in subsidiaries, at equity		393,669		—		—		—	(393,669	)		—

Current assets
Cash and equivalents		4,290		1,161		3,577		237	—			9,265
Advances to affiliates		36,100		—		7,000		—	(43,100	)		—
Customer accounts receivable, net		92,611		27,743		22,874		—	—			143,228
Accrued unbilled revenues, net		69,347		16,517		14,327		—	—			100,191
Other accounts receivable, net		6,385		2,150		2,939		—	(2,682	)		8,792
Fuel oil stock, at average cost		74,034		11,418		14,764		—	—			100,216
Materials and supplies, at average cost		16,169		5,323		13,468		—	—			34,960
Other		7,621		2,016		984		—	—			10,621

Total current assets		306,557		66,328		79,933		237	(45,782	)		407,273

Other long-term assets
Regulatory assets		83,079		43,793		15,803		—	—			142,675
Unamortized debt expense		10,751		2,490		2,674		—	—			15,915
Other		29,558		4,771		5,454		—	—			39,783

Total other long-term assets		123,388		51,054		23,931		—	—			198,373

	$	2,442,580		645,168		575,596		237	(439,451	)	$	3,224,130

Capitalization and liabilities
Capitalization
Common stock equity	$	991,614		195,831		197,631		207	(393,669	)	$	991,614
Cumulative preferred stock–not subject to mandatory redemption		22,293		7,000		5,000		—