Hawaiian Electric Industries Inc (HE) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the third quarter 2006 Hawaiian Electric Industries Inc. earnings conference call. My name is Enrique, and I will be the audio operator for today. At this time, all participants are in a listen-only mode. We will be conducting a Question and Answer Session towards the end of this conference. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded for replay purposes.

I would like the turn the presentation over to your host for today's call, Ms. Suzy Hollinger. Please proceed.

Thank you. Aloha, and good afternoon or good morning, depending on where you are in the world. Thank you for joining us on an update for HEI. I am Suzy Hollinger, I am HEI's Manager of Treasury and Investor Relations.

Here with me from senior management and speaking today are Connie Lau, HEI and ASB President and CEO, Mike May, HECO President and CEO, and Eric Yeaman, HEI Financial Vice President, Treasurer and CFO. Tayne Sekimura, HECO Financial Vice President is also on today's call.

Connie will start the presentation with a recap of third quarter earnings, and then Mike will follow with an update on the utility. Connie will come back to discuss the bank, and then Eric will cover the holding company. Connie will make some closing remarks and open it up for your questions.

Before I hand the call over to Connie, I would like to alert you that forward-looking statements will be made on today's presentation. Please reference roman IV of our third quarter Form 10-Q, which was filed last week Wednesday, for information about forward-looking statements.

With that, I turn it over to Connie to begin the formal comments.

Thank you, Suzy, and Aloha and good day to all of you. Hopefully most of had you a chance to read through the third quarter earnings that we released last week. For those of you that didn't, let me briefly summarize the results for the quarter.

Third quarter earnings were $32 million, or $0.40 per share, down compared with the third quarter of 2005. This was primarily due to $3.8 million of lower investment gains at the holding and other companies.

At our operating companies, a $1.1 million increase in utility earnings was offset by $2.4 million of lower bank earnings. Quarter-over-quarter higher operations in maintenance expenses substantially offset increased revenues from rate relief granted to our Oahu utility in September 2005. Kilowatt hour sales were essentially flat. Our bank's earnings continued to be challenged by margin compression and rising interest costs, which cause its earnings to be lower quarter-over-quarter.

Now let me hand the call to Mike to update you on the utility.

Thanks, Connie. Aloha and good afternoon or good day. In the third quarter we continued to experience flat kilowatt hour sales. Cooler, less humid weather, and conservation have been the main drivers. Although the improving economy has resulted in slightly higher commercial sales, that has been offset by lower residential usage on Oahu. We expect the sales trend to continue in the fourth quarter.

For the year, kilowatt hour sales are forecasted to be slightly down by 0.3% compared to 2005. In 2007 and 2008, we are currently estimating sales to be moderately higher over the prior year, by 1.2 and 1.6% respectively. We will update you with any changes to our sales forecast on our year end earnings call. Although sales are expected to be down slightly this year, several years of economic growth in our state have increased overall demand for electricity.

This growth has caused a tightening of our generation reserve margins on Oahu and Maui during the peak usage periods. As a result, we have been running our units harder, which has required more extensive and frequent maintenance and repairs to our systems. Also contributing to the rising O&M expenses are increased retirement benefit expenses. In 2006 these expenses net of capitalization and taxes have been running about 1.4 million higher each quarter compared with 2005.

We generally expect our rising O&M expenses to continue, and that they will increase significantly in the fourth quarter. Repairs and maintenance scheduled for earlier in the year were pushed out, and are now expected to be increased in the fourth quarter. The timing of these repairs was affected by changes in our overhaul schedules. Rainy weather, especially a period of 41 consecutive days of rain earlier this year, has also increased [vegetation] management expenses.

Another factor anticipated to impact O&M in the fourth quarter is cost related to two earthquakes with 6.7 and 6.0 magnitudes. This led to island-wide outages on Maui and Oahu, and extensive outages on the island of Hawaii. To protect the electrical grid and avoid even longer outages, power was restored methodically and incrementally on each island. Electric service was restored to almost all customers within 18 hours. Thankfully, damage to our utility system does not appear to be significant. We are conducting a comprehensive impact assessment.

The trend of increasing O&M over the past several years, is a big reason why we are underearning our allowed rates of return. I might just point out on the charge that the HECO, or the HELCO & MECO numbers, are okay. Operationally, capital investments are being made to address the need for additional generation and to modernize our facilities. These investments are translating into rate-based growth.

Over the next five years, we are forecasting over 912 million in gross capital expenditures. We are currently reviewing our capital expenditures forecast, and expect that this number may increase. We will report our final forecast at our year-end earnings call.

In recent years, we have been able to finance almost all of our capital expenditures with internal sources of funds, and still expect a majority of our capital expenditures to be financed in that manner. However, with our larger investment in reliability projects, we expect our borrowing levels to increase.

We recently filed an amended financing application with the PUC, seeking its approval to have the state of Hawaii issue up to 160 million of revenue bonds on behalf of our utilities. To address our underearning situation, we are executing a strategic plan that focuses on recovery of increased costs and reliability investments through a rate case process.

Let me turn to the status of our rate cases. For our 2005 rate case, our Oahu utility received an interim increase of 3.3% in September of 2005. Since then, we have been recovering about 10 to 11 million of increased revenue per quarter, or about 7 million net of taxes. We are awaiting a final decision and order. There is no statutory deadline for the PUC to issue a final order. Details of the case are shown on this slide.

As some of you may remember, when we originally filed our rate case for the Oahu rate case, it included proposed cost recovery for our energy efficiency programs. The PUC bifurcated that issue out of the original case, and opened a separate Energy Efficiency Docket. In April the PUC issued an interim order in the Energy Efficiency Docket, including interim approval of our request to offer additional programs for our customers, while our regulators continue to review the larger energy efficiency policy issues. The PUC ruling has eliminated the collection of loss margin and shareholder incentives.

Accordingly, HECO stopped accruing loss margins and shareholder incentives in May of 2006. Effective September 27, 2006, we stopped accruing shareholder incentives and loss margins for HELCO and MECO. The estimated impact to HECO consolidated in 2006 net income is 2.1 million. Again, this is an interim decision.

The larger policy issues including alternative cost recovery and incentive mechanisms are still being extensively reviewed by the PUC, and the Energy Efficiency Docket. As that review is far from finished, we think it is premature to draw any long-term conclusions at this time. Hearings of this Docket were held in August, timing of the final D&O is not yet known.

In May of this year, we filed a rate case for our Hawaii island subsidiary, HELCO, with a 2006 test year. We are requesting 30 million, or a 9.24% increase in revenues, as well as an 11.25% return on common equity. The case also proposes a tiered rate structure to encourage energy efficiency. Other details of that filing are included on this slide.

As part of the case, the Commission also reviewed HELCO's energy cost adjustment clause. The clause is reviewed in every rate case, but this review will also look at the specific factors included in a state law passed last session. In addition, the Commission will review the concept of time of use rates for HELCO. Evidentiary hearings are scheduled for May 2007. This filing is a positive step toward helping HELCO get the rate relief it needs to recover its reliability investments, including the Keahole expansion project.

Also on the regulatory front, we have seen a number of changes with our regulators. While the PUC Chairman remains the same, John Cole, the former consumer advocate, was confirmed as a Commissioner, filling one of two vacancies. The third commissioned post was vacated, and no appointment has yet been made. Replacing John Cole as Consumer Advocate is Catherine Awakuni, our former PUC counsel.

To sum up, a growing Hawaiian economy has impacted our utilities reserve margins, and from a financial perspective our earnings. We expect the earnings pressure from increased O&M to continue, and expect a significant increase in the fourth quarter in O&M, due to items I noted earlier.

We are increasing our capital expenditure program to increase generation capacity and maintain an improved reliable electric service for Hawaii. We are focused on improving our earnings rates, our earned rates of return to get closer to our allowed returns. I want to emphasize that our plan is a multi-year, multi-jurisdictional process, and therefore cannot be fixed over night. We are confident that over time that we will meet our earnings goal.

Now I would like to turn it back to Connie Lau to discuss the bank.

Thanks, Mike. The bank's performance in the third quarter was impacted by the challenging operating environment. As we discussed in previous presentations, the key factors impacting bank earnings are the shape of the yield curve, funding costs, loan growth, and credit quality. As expected, the bank's cost of funds increased in the third quarter, due to planned increases in deposit rates, designed to retain deposit balances.

While the increase in deposit costs in the third quarter was greater than in prior quarters, this chart shows how the increases in our deposit costs have significantly lagged the increases in overnight interest rates. This was the result of our strategy to control overall deposit costs by selectively repricing certain deposit products, rather than the entire deposit base. The repricing action that we took was in response to the reversal in total deposit flows that we experienced in the second quarter, when we had a net outflow of $64 million.

As a result of our actions, we were able to significantly slow the outflow of deposits, and hold total deposits relatively stable during the third quarter. At the end of the third quarter, total deposits were only down $6.7 million from the end of the second quarter. On a year-to-date basis, total deposits are down less than 0.5%, or $17 million. Going forward, even if the Federal Reserve stops increasing the overnight rate, the spread between our deposit costs and the overnight rate remains fairly large, and will continue to put pressure on our deposit costs.

In addition to the tactical repricing of deposits, other strategies that the bank executed in order to strengthen our deposit franchise, included the introduction of new programs and enhancing features on existing products, in order to provide additional value to our customers.

During the quarter, we became the first bank in Hawaii to offer a combined rewards program for personal and business, check and credit cards. What makes this program unique, is that in addition to earning points through credit card use, customers can also earn rewards points using their check card, and these points are combined with their credit card points.

Also during the quarter, we began providing a comprehensive identity theft recovery program, free of charge to all personal checking account holders. Not only do these programs provide additional value to our customers, they also represent opportunities for the banks to deepen our relationships with them, which is one of our long-term retail banking strategies.

As we discussed on our previous call, we expected loan balances to remain relatively flat in the second half of the year, because of the expected paydown of several large commercial loans, as well as lower mortgage origination levels, because of the lower level of activity in the real estate market. Loans outstanding grew by 1.2% in the third quarter.

We continue to expect loan balances to remain relatively flat through the rest of the year. While our net interest margin did fall in the third quarter, our strategy to transform from a thrift to a full service community bank, has enabled us to avoid margin compression longer than most financial institutions.

According to the FDIC, the net interest margin for all insured financial institutions has been trending downward for some time now, and fell to a 15-year low earlier this year. On a year-to-date basis, our net interest margin through September 30 is 3.23% compared to 3.25% for the same period last year. Our credit quality remains excellent, and given the outlook for the Hawaii economy, we do not expect credit costs to increase significantly in the near future. While we are continuing to monitor the impact of the earthquake, based on our preliminary assessments, we do not expect credit quality to be adversely impacted.

Going forward, we expect the operating environment to continue to be challenging. While the yield curve remains inverted, we will continue to face upward pressure on our deposit costs, while flat long-term interest rates will limit the increases in yield on new assets, resulting in ongoing margin compression pressure. Our strategy is to continue to focus on growing our low cost deposits, both retail and commercial, growing our loan portfolio, maintaining credit quality, and controlling expenses.

Now let me ask Eric to speak about holding and other company results, and update you on newly issued accounting rules for defined benefit plans that may affect our year end financial condition.

Thanks, Connie, and aloha to all of you. As Connie mentioned earlier in the call, third quarter results were significantly affected by approximately $3.8 million in lower investment gains at the holding and other companies. Unrealized gains on investments net of taxes in the third quarter of 2005 were 4.2 million, compared to 0.4 million in realized and unrealized gains recorded in the third quarter of 2006.

These gains related to our investment in Hoku Scientific, which went public in the third quarter of last year. Because the stock is held for trading, it is mark-to-market at quarter end with unrealized gains and losses being recognized in our quarterly earnings. We began trading the Hoku stock in February of 2006 when our lock-up agreement expired.

As a reminder, we recorded a $1.3 million unrealized loss net of tax in the fourth quarter of last year related to this investment, but will also affect comparative results for the fourth quarter is a $9 million net of tax gain that we recorded in the fourth quarter of 2005, related to the sale of an nonstrategic leveraged lease investment. We do not expect a similar gain in the fourth quarter of 2006.

Every year at this time, we update on you the potential financial statement impacts related to our retirement benefit plans. As Connie mentioned earlier this year, the Financial Accounting Standards Board issued its new statement number 158, which changes the measurement of our retirement benefit plans obligations, and requires recognition of the funded status as of year end.

On a consolidated basis, we estimate that we will record a non-cash charge to accumulated other comprehensive income of between 143 and $189 million net of taxes, depending on the discount rate assumption adopted, and the level of plan assets at the end of 2006. As you can see from this slide, the majority of the charge will be at the utility. We filed an application with the Hawaii PUC in December 2005, seeking regulatory after-treatment for this charge, and we will be filing an update to this application soon, to consider the provisions of statement 158. We hope to obtain a decision from the PUC on this before year end.

In addition, assuming no changes to the assumptions listed on the slide, we don't expect a significant change in retirement benefits expenses in 2007 compared with 2006. These matters are more fully described on pages 40 and 41 of our Form 10-Q that we filed last Wednesday.

Now let me turn the presentation back to Connie for some closing remarks.

Thanks, Eric. Our dividend yield has been a key reason for investing in HEI, and maintaining a healthy dividend continues to be a top priority. We have an attractive dividend yield of about 4.4%. You may have seen our dividend release last week, announcing the Board's approval of a $0.31 per share dividend on our common stock. The dividend is payable on December 12th to shareholders of record on November 15th, and the X dividend date is November 13th. For the nine months ended September 30, 2006, our payout ratio was 82%.

In summary, several key factors will continue to affect our core businesses. Continued cooler and less humid weather and conservation are expected to keep 2006 utility kilowatt hour sales below 2005 levels. This is coupled with rising O&M, especially in the fourth quarter, due to the factors that Mike covered in detail. The utilities are seeking rate relief, and hope to earn closer to their allowed rates of return over time.

At the bank, the inverted yield curve and higher funding costs have put pressure on net interest margins. Loan balances will likely remain relatively flat for the rest of 2006, as expected paydowns offset originations. The bank's focus remains on gathering low cost deposits, growing the loan portfolio, maintaining credit quality, and controlling expenses.

This now concludes our formal comments, and we will open it up for questions.

Thank you. [OPERATOR INSTRUCTIONS] Ms. Lau, at this time you have no questions. I would like to turn the call back to you for closing remarks.

If there are no questions, we are going to say aloha to everyone, and end the call here. If you do have follow-on questions that you would like to get answered, please contact me. This is Suzy Hollinger, and I can be reached at 808-543-7385. Aloha and good afternoon.

Aloha to everyone and thank you for listening to our call.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes our presentation. You may now disconnect. Have a good day.