Item 1. BUSINESS
Overview
Pennichuck Corporation (the "Company") is a holding company based in
Nashua, New Hampshire. Its principal operating subsidiaries are engaged
primarily in the collection, storage, treatment, distribution and sale of
potable water throughout southern and central New Hampshire. These subsidiary
corporations - Pennichuck Water Works, Inc. ("Pennichuck"), Pennichuck East
Utility, Inc. ("Pennichuck East") and Pittsfield Aqueduct Company, Inc.
("Pittsfield"), are each engaged in business as a regulated public utility,
subject to the jurisdiction of the New Hampshire Public Utilities Commission
(the "NHPUC"). They collectively serve approximately 29,400 residential and
commercial and industrial customers. The Company was formed in 1983 following
the reorganization of Pennichuck Water Works, which was first established in
1852, into a dedicated water utility. At the same time several tracts of land,
formerly held for watershed protection purposes, were transferred to The
Southwood Corporation ("Southwood"). Southwood is involved in the development of
commercial and residential real estate. The Company also conducts non-regulated,
water-related management services and contract operations through another
subsidiary, Pennichuck Water Service Corporation (the "Service Corporation").
Our Water Business
Pennichuck is franchised by the NHPUC to gather and distribute water in
the City of Nashua, New Hampshire and in portions of the towns of Amherst,
Bedford, Derry, Epping, Hollis, Merrimack, Milford and Plaistow, New Hampshire.
Pennichuck has transmission mains which directly interconnect its core system in
Nashua with the surrounding towns of Amherst, Hudson, Merrimack and Milford. Its
core system, which services nearly 22,100 customers, accounts for 95% of
Pennichuck's revenues. Its franchises in the remaining towns consist of
stand-alone satellite water systems serving over 2,100 customers. Pennichuck has
no competition in its core franchise area. Currently, approximately 25% of its
water revenues are derived from commercial and industrial customers and
approximately 57% from residential customers, with the balance being derived
from fire protection and other billings to municipalities, principally the City
of Nashua and the towns of Amherst, Merrimack and Milford. Pennichuck's annual
water revenues were approximately $14.75 million for calendar year 2003.
Pennichuck East was organized in 1998 to acquire certain water utility
assets from the Town of Hudson, New Hampshire ("Hudson"), following its
acquisition of those assets from an investor-owned water utility which
previously served Hudson and surrounding communities. Pennichuck East is
franchised to gather and distribute water in the New Hampshire towns of
Litchfield, Pelham, Windham, Londonderry, Derry, Raymond and Hooksett, which are
areas adjacent to the service franchise served by Pennichuck. Pennichuck East
has no competition in its core franchise area. The water utility assets owned by
Pennichuck East consist principally of water transmission and distribution
mains, hydrants, wells, pump stations and pumping equipment, water services and
meters, easements and certain tracts of land. Pennichuck East serves
approximately 4,450 customers and annual water revenues were approximately $2.98
million for calendar year 2003.
Pittsfield was acquired by the Company in 1998 and serves approximately
640 customers in and around Pittsfield, New Hampshire with annual water revenues
of approximately $447,000. Pittsfield has no competition in its franchise area.
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Regulation
The Company's water utilities are regulated by the NHPUC with respect to
their water rates, financings and provision of service. New Hampshire law
provides that utilities are entitled to charge rates which permit them to earn a
reasonable return on the cost of the property employed in serving its customers,
less accrued depreciation, contributed capital and deferred income taxes ("Rate
Base"). The cost of capital permanently employed by a utility in its utility
business marks the minimum rate of return which a utility is lawfully entitled
to earn on its Rate Base. Pennichuck's water rates that were in effect during
2003 were based on a March 2002 NHPUC order in which Pennichuck was granted an
overall permanent rate increase of 14.43% based on an overall rate of return of
8.58% and an approved rate base of approximately $43.1 million. Pennichuck East
is authorized an overall rate of return of 8.37% on an approved rate base of
approximately $7.5 million. Pittsfield is authorized an overall rate of return
of 8.42% on an approved rate base of approximately $1.6 million.
The Company's water utilities are subject to the water quality regulations
issued by the United States Environmental Protection Agency ("USEPA") and the
New Hampshire Department of Environmental Services ("NHDES"). The USEPA is
required to periodically set new maximum contaminant levels for certain
chemicals as required by the federal Safe Drinking Water Act ("SDWA"). The
quality of the Company's water utilities' treated water currently meets or
exceeds all current standards set by the USEPA and the NHDES.
Pennichuck's filtration plant in Nashua is impacted by the Interim
Enhanced Surface Water Treatment Rule ("IESWTR") which established a new
turbidity standard of 0.3 NTU. Pennichuck will complete its evaluation of
alternatives to meet the new IESWTR turbidity standard and it expects to
determine what modifications will be required to its filtration plant by the end
of March 2004.
Two of Pennichuck's small community water systems have wells that produce
water with arsenic levels in excess of the new standard of 10 ppb. It will be
necessary for Pennichuck to install arsenic treatment systems at these
locations. Pennichuck's and Pennichuck East's remaining community water systems
have wells that produce water meeting the new arsenic standard.
Capital expenditures associated with federal and state water quality
standards have historically been recognized and approved by the NHPUC for
inclusion in our utilities' water rates.
Contract and Real Estate Operations
The Company formed the Service Corporation to conduct its non-regulated,
water-related activities. Its activities initially included providing contract
operations and maintenance, water testing and billing services to
municipalities. In 1998, the Service Corporation entered into a long-term
agreement with the Town of Hudson to provide operations and maintenance contract
services to the town with respect to the water utility assets it acquired from
an investor-owned water utility. In September 2001, the Service Corporation also
entered into a long-term agreement with the Town of Salisbury, Massachusetts to
perform similar operations and maintenance services.
The NHDES has mandated water quality standards for non-transient,
non-community water systems ("NTNCWS") - defined as public facilities such as
schools, apartment and office buildings accommodating more than 25 persons and
served by a community well. There are an estimated 600 such NTNCWS in New
Hampshire which will require the services of a certified water operator, such as
the Service Corporation, in order to meet the mandates of the NHDES.
Accordingly, the Service Corporation is actively pursuing new contracts under
which it would serve as a certified water operator and provide
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various water-related monitoring, maintenance, testing and compliance reporting
services for these systems in New Hampshire. During 2003, the Service
Corporation provided such services pursuant to 67 operating contracts.
Southwood, the Company's real estate subsidiary, was organized for the
purpose of owning, developing, selling and managing approximately 1,088 acres of
undeveloped land in Nashua and Merrimack, New Hampshire formerly owned by
Pennichuck Water Works for watershed protection purposes.
Since 1988, Southwood has been involved in the planning and development of
Southwood Corporate Park, a 65-acre commercially zoned land parcel located in
Nashua, New Hampshire. From 1988 through 2001, Southwood sold four lots totaling
25 acres in the Corporate Park. In January 2002, Southwood sold the remaining 40
acres to Winstanley Enterprises, Inc. ("Winstanley"), a regional real estate
developer, under the terms of an option agreement between Southwood and
Winstanley. Under that 1995 agreement, Winstanley paid to Southwood an option
fee each year equal to the annual carrying costs associated with that land.
In September 1997, Southwood and Winstanley formed Westwood Park LLC
("Westwood") to develop a 404-acre tract of land in northwest Nashua zoned for
park-industrial use. Southwood conveyed the land to Westwood in exchange for a
60% interest in Westwood. Since 1997, Westwood has sold four parcels totaling
approximately 364 acres to third parties, leaving a balance of approximately 40
acres which are restricted in use for future groundwater supplies.
Southwood holds a 50% ownership interest in HECOP I, LLC, HECOP II, LLC
and HECOP III, LLC, which are limited liability corporations formed to construct
and own a 39,000 square foot, a 42,000 square foot and a 66,000 square foot
office building, respectively, located in Merrimack, New Hampshire. As of
December 31, 2003, approximately 121,000 square feet had been leased to third
parties under long-term lease agreements. Southwood also holds a 50% ownership
interest in HECOP IV, LLC formed in May 2002. As of December 31, 2003, HECOP
IV's principal asset was approximately 9.1 acres of raw land available for
future commercial development. The remaining 50% ownership interest in each of
these four LLC's is held by John Stabile, a local developer, with whom Southwood
has participated in four residential joint ventures during the past 10 years.
In July 1998, Southwood entered into a joint venture known as Heron Cove
at Bowers Pond LLC ("Heron Cove") for the development of an 87 unit,
single-family community located in Merrimack, New Hampshire. Under the terms of
the joint venture agreement, Southwood conveyed the related land parcel to Heron
Cove in exchange for a non-interest bearing note secured by a second mortgage on
the real estate conveyed. Southwood holds a 50% ownership interest in this joint
venture. The remaining 50% ownership interest is held by John Stabile, a local
developer. As of December 31, 2001, all 87 units had been constructed and sold
to third parties and this LLC was closed out in 2002.
Financial Information About Industry Segments
The business segment data of the Company and its subsidiaries for the
latest three years is presented in "Note 12 - Business Segment Information" in
the accompanying Notes to the Consolidated Financial Statements included in Item
8 of this Form 10-K Report.
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Employees
The Company, through its principal subsidiary Pennichuck, employs 82
permanent, full-time employees and officers. Of these, there are 43 management
and clerical employees who are non-union. The remaining employees are members of
the United Steelworkers Union. The current union contract, which was
re-negotiated in February 2002, expires in February 2007. In the opinion of
management, employee relations are satisfactory.
Additional Information
The Company's Internet address is www.pennichuck.com. The Company's web
site provides a hyperlink to a third party web site through which the Company's
annual, quarterly and current reports, and amendments to those reports, are
available free of charge. The Company believes these reports are made available
as soon as reasonably practicable after it electronically files them with, or
furnishes them to, the Securities and Exchange Commission ("SEC"). The Company
does not maintain or provide any information directly to the third-party web
site, and does not check its accuracy. The public can also obtain access to such
reports at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington,
DC 20549, by calling the SEC at 1-800-SEC-0330 or by accessing the SEC's web
site which is www.sec.gov.
RISK FACTORS
Risks Related to the Company's Business
The City of Nashua's use of the power of eminent domain to acquire certain
of the water utility assets of the Company may result in material, adverse
consequences to the Company and its shareholders.
The Company is involved in ongoing proceedings with the City of Nashua
(the "City") regarding the City's desire to acquire all or a portion of the
Company's water utility assets. The City has determined to pursue such
acquisition pursuant to its power of eminent domain. Separately, several other
communities whose residents are served by one or more of the Company's
subsidiaries have expressed interest in forming a regional water authority for
the purposes of acquiring and operating a substantial portion of the Company's
water related assets. The acquisition of Company assets by eminent domain would
be highly uncertain and likely involve protracted proceedings before the New
Hampshire Public Utilities Commission ("NHPUC"). The Company's shareholders are
not required to ratify or approve any such forced sale of assets, or the price
thereof, if so approved by the NHPUC. Given the highly integrated nature of the
Company's businesses, a forced sale of some or all of the Company's water
related assets may result in increased costs and operating inefficiencies borne
by the remaining assets of the Company not so acquired. Additionally, the
Service Corporation's ability to service its existing contracts as well as
pursue additional operating contracts may be impaired. There is no assurance
that the City or a regional water authority, if any, would be successful in
acquiring some or all of the Company's assets by eminent domain, nor in such
case is there any assurance as to the price determined by the NHPUC to be paid
for those assets.
Risks Related to Water Business
The Company's main source of revenues and earnings is its water utility
operations. The water supply and distribution industry is subject to regulations
and uncertainties which affect the Company and its financial operations in
varying degrees.
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Rate Regulation. The Company's water utility subsidiaries, Pennichuck,
Pennichuck East and Pittsfield are regulated by the NHPUC with respect to the
rates we charge our customers for water and the amount of our capital and debt
financing. The profitability of our water operations is largely dependent on the
timeliness and adequacy of rate relief allowed by the NHPUC.
Regulatory Lag. The NHPUC generally provides our water utilities with the
opportunity to earn a rate of return on our capital invested in property used to
serve our customers. However, a delay, known as "regulatory lag," normally
occurs between the time capital is invested and the effective date of increased
water rates, which reflect that investment.
Water Quality Concerns; Changes in Regulatory Standards. Water utility companies
are always subject to certain water quality risks related to environmental
contamination. Our water systems have water treatment and alternate water source
and storage facilities available as short-term sources of supply in the event of
contamination of one of our water sources. While our treated water currently
meets or exceeds all standards set by federal and state authorities, it is
possible that new or stricter standards could be imposed that will raise our
operating costs significantly. Although these costs would likely be recovered in
the form of higher rates, there can be no assurance that the NHPUC would approve
a rate increase to recover such costs.
Dam Safety. Pennichuck initiated an engineering study of two of its eight dams
in 2002. The two dams being studied, the Supply and Harris Pond dams, were the
last ones remaining to be studied to insure that the dams, crucial to the
operation of Pennichuck, meet all current dam safety standards. The results of
the completed study indicated that certain upgrades to the dams' spillways and
earthen embankments were required in order to meet current NHDES and Federal
standards. The engineering plans and permitting were completed in the fall of
2003 and the required construction will be completed in 2004. The estimated cost
of the required dam repairs and upgrades will be about $950,000.
The proposed dam and repair upgrade time frame has been accepted by the
NHDES. Pennichuck could face adverse regulatory actions in the event it is
unable to remedy the dam deficiencies within this time period.
Threats to Nation's Health and Security. Water utility companies have generally
been on a heightened state of alert since the threats to the nation's health and
security in the fall of 2001. The USEPA recently issued a set of instructions to
describe what community water systems must do to comply with the Public Health
Security and Bioterrorism Preparedness and Response Act of 2002. The Act
requires all community drinking water systems that serve more than 3,300 people
to certify and submit assessments to the EPA no later than June 2004. We have
taken steps to increase security at our water utility facilities, heightened
employee awareness of threats to our water supplies, and added security measures
regarding the delivery and handling of certain chemicals used in our business.
We are not aware of any specific threats to our water utility businesses or
other operations.
Impact of Weather and Seasonal Demands. The demand for our water and our
revenues is impacted by weather and is seasonal in nature. Normally, our most
profitable quarters are the second and third calendar year quarters due to
increased water consumption during the late spring and summer months. Demand is
normally lower during cool, wet springs and summers than it is during warm, hot
springs and summers.
Dependence on Certain Industrial Customers. Approximately $3.66 million of our
operating revenues are derived from commercial and industrial customers.
Pennichuck's largest water customer, Anheuser
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Busch ("AB"), was responsible for about 16.1% of its demand in 2003. In the
short term, our profitability would be adversely impacted were AB to
significantly reduce its water requirements in the future or if our other
commercial and industrial customers materially reduce their use of our water.
Pennichuck and AB have entered into a ten-year contract that provides the
terms and conditions under which AB receives service from Pennichuck. The
contract provides for a supply of up to 2 million gallons per day for the AB
plant in Merrimack, New Hampshire. AB pays a cost-of-service based rate that is
approximately 52% of the retail volumetric rate. The contract contains a
"minimum payment obligation" clause that requires AB to pay, each year, at least
90% of the volumetric charges of the prior year. The contract provides that,
should AB opt for early termination, there is a minimum annual charge to AB of
90%, 66.67% and 33.3% in the first, second and third year following the year of
notification of early termination, respectively, based on the annual charge in
the year of notification. In such case, we would seek the approval of the NHPUC
to increase the rates of our remaining customers to recover any lost revenues
from the loss of such a major industrial customer. Any increase in our rates and
improvement in our profitability from a loss of a major customer could take at
least 12 months to realize, an example of regulatory lag. In addition, there can
be no assurance that the NHPUC would approve such a rate increase request.
Risks Related to Real Estate Business
Development Risks. Southwood, our real estate subsidiary, is the owner of
several tracts of land located in southern New Hampshire which are planned for
development. The demand and prices for Southwood's real estate are dependent
upon interest rates and construction costs as well as general economic
conditions.
Carrying Costs. Real estate assets are subject to ongoing maintenance costs and
property taxes. Reductions in demand for our properties may cause us to continue
to incur operating costs without any offsetting income.
Building Vacancies. Southwood has a 50% ownership interest in three separate
joint ventures owning commercial office buildings located in Merrimack, New
Hampshire. Southwood's share of the net operating income from leases associated
with those buildings could be adversely impacted by a downturn in the local
economy and commercial real estate market.
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