Add
PNNW to Portfolio
Set Alert
Email to a
Friend
| |||
|
|
Quotes & Info
|
| PNNW > SEC Filings for PNNW > Form 10-Q on 5-Nov-2009 | All Recent SEC Filings |
5-Nov-2009
Quarterly Report
Introduction
The terms "we," "our," "our Company," and "us" refer, unless the context
suggests otherwise, to Pennichuck Corporation (the "Company") and its
subsidiaries, Pennichuck Water Works, Inc. ("Pennichuck Water"), Pennichuck East
Utility, Inc. ("Pennichuck East"), Pittsfield Aqueduct Company, Inc.
("Pittsfield Aqueduct"), Pennichuck Water Service Corporation ("Service
Corporation") and The Southwood Corporation ("Southwood").
Pennichuck Corporation is a non-operating holding company whose income is
derived from the earnings of our five wholly-owned subsidiaries. We are engaged
primarily in the collection, storage, treatment and distribution of potable
water for domestic, industrial, commercial and fire protection service in New
Hampshire through our three utility subsidiaries: Pennichuck Water, Pennichuck
East and Pittsfield Aqueduct. Our water utility revenues constituted 92% of our
consolidated revenues for the nine months ended September 30, 2009 and 2008.
Pennichuck Water, our principal subsidiary which was established in 1852,
accounted for 72% of our revenues for the nine months ended September 30, 2009
and 2008. Pennichuck Water's franchise area presently includes the City of
Nashua, New Hampshire and 10 surrounding municipalities.
Our water utility subsidiaries are regulated by the New Hampshire Public
Utilities Commission ("NHPUC") and must obtain NHPUC approval to increase their
water rates to recover increases in operating expenses and to obtain the
opportunity to earn a return on investment in plant and equipment. New Hampshire
law provides that utilities are entitled to charge rates that permit them to
earn a reasonable return on the cost of the property employed in serving their
customers, less accrued depreciation, contributed capital and deferred income
taxes ("Rate Base"). The cost of capital permanently employed by a utility in
its regulated business marks the rate of return that it is lawfully entitled to
earn on its Rate Base. Capital expenditures associated with complying with
federal and state water quality standards have historically been recognized and
approved by the NHPUC for inclusion in water rates, though there can be no
assurance that the NHPUC will approve future rate increases in a timely or
sufficient manner to cover our capital expenditures.
The businesses of our other two subsidiaries are non-regulated water management
services and real estate management and commercialization. Service Corporation
provides various non-regulated water-related monitoring, maintenance, testing
and compliance reporting services for water systems for various towns,
businesses and residential communities in New Hampshire and Massachusetts. Its
most significant contracts are with the towns of Hudson, New Hampshire and
Salisbury, Massachusetts.
Southwood is engaged in real estate management and commercialization activities.
Historically, most of Southwood's activities have been conducted through joint
ventures. Over the past 10 years, Southwood has participated in four joint
ventures with John P. Stabile II, a local developer. Southwood's earnings have
from time to time during that period contributed a significant percentage of our
net income, including in the nine months ended September 30, 2008 (i.e., the
January 2008 sale of the three commercial office buildings that comprised
substantially all of the assets of HECOP I, II, and III as more fully described
in Note 7, "Equity Investments in Unconsolidated Companies" in Part I, Item I,
in this Quarterly Report on Form 10-Q). Southwood's contributions from the sale
of real estate have increased the fluctuations in our net income during the
10-year period. While we expect that Southwood will contribute a smaller
proportion of our revenues and earnings over the next several years, we expect
it to pursue the orderly commercialization of the Company's 450 acres of
undeveloped land held outside the regulated utilities.
The pending eminent domain matter with the City of Nashua, New Hampshire (the
"City") that is described in more detail below and elsewhere in this report has
had a material adverse effect on our results of operations in recent years and
may have a material adverse effect on our financial condition, depending on the
outcome of appeals pending before the New Hampshire Supreme Court and the
ultimate outcome of settlement negotiations that have occurred, and are expected
to continue to occur, from time to time with the City.
As you read the Management's Discussion and Analysis, refer to our Condensed
Consolidated Financial Statements and the accompanying Notes to Condensed
Consolidated Financial Statements in Item 1 in this Quarterly Report on
Form10-Q.
Forward-Looking Statements
Certain statements in this Quarterly Report on Form 10-Q, including Management's
Discussion and Analysis, are forward-looking statements intended to qualify for
safe harbors from liability under the Private Securities Litigation Reform Act
of 1995, as amended (and codified in Section 27A of the Securities Act of 1933
and Section 21E of the Securities Exchange Act of 1934). The statements are made
based upon, among other things, our current assumptions, expectations and
beliefs concerning future developments and their potential effect on us. These
forward-looking statements involve risks, uncertainties and other factors, many
of which are outside our control which may cause our actual results, performance
or achievements to be materially different from any future results, performance
or achievements expressed or implied by these forward-looking statements. In
some cases you can identify forward-looking statements where statements are
preceded by, followed by, or include the words "in the future," "believes,"
"expects," "anticipates," "plans" or similar expressions, or the negative
thereof.
Forward-looking statements involve risks and uncertainties, and there are
important factors that could cause actual results to differ materially from
those expressed or implied by these forward-looking statements. Such factors
include, among other things, whether eminent domain proceedings are ultimately
successful against some or all of our water utility assets, the success of
applications for rate relief, changes in governmental regulations, changes in
the economic and business environment that may impact demand for our water,
services and real estate products, changes in capital requirements that may
affect our level of capital expenditures, changes in business strategy or plans
and fluctuations in weather conditions that impact water consumption. For a
complete discussion of our risk factors, see Part I, Item 1A, "Risk Factors", in
our 2008 Annual Report on Form 10-K, as supplemented by Part II, Item 1A, "Risk
Factors", in this Quarterly Report on Form 10-Q. We undertake no obligation to
publicly update or revise any forward-looking statement, whether as a result of
new information, future events or otherwise.
City of Nashua's Ongoing Eminent Domain Proceeding
On March 25, 2004, the City filed a petition with the NHPUC under the New
Hampshire utility municipalization statute, NHRSA Ch. 38, seeking to take by
eminent domain all of the utility assets of our Company's three utility
subsidiaries. Under NHRSA Ch. 38, if the NHPUC makes a finding that it is in the
public interest to do so, a municipality may take the assets of a utility
providing service in that municipality. The NHPUC, which is comprised of three
Commissioners, is also charged with determining the amount of compensation for
the assets that it finds are in the public interest for the municipality to
take.
There can be no assurance that the City would choose to complete an eminent
domain taking of all or any portion of our utility assets. The Company expects
that the City would finance the amount of compensation that the City would have
to pay us for our utility assets, which we sometimes refer to as the purchase
price, as well as its other related costs, through the sale of debt securities.
The issuance of that debt would require the approval of two-thirds of the City's
Board of Aldermen. Accordingly, a decision by the City ultimately to proceed
with an eminent domain taking in effect requires the approval of two-thirds of
the City's Board of Aldermen after there is a final determination permitting the
City to acquire our utility assets by eminent domain and fixing the amount of
compensation that the City must pay for those assets, and the terms of the
related financing are finalized. The City would have 90 days to make a decision
regarding an eminent domain taking after such a final determination.
Summarized below are the principal NHPUC rulings in the eminent domain
proceeding, the pending appeal before the New Hampshire Supreme Court (the
"Supreme Court"), and the Company's perspective on why a negotiated settlement
with the City could be more advantageous for each party than an eminent domain
taking.
Principal NHPUC rulings
In January 2005, the NHPUC ruled that the City could not use the eminent domain
procedure to acquire any of the assets of Pennichuck East or Pittsfield
Aqueduct, and that, with regard to the assets of Pennichuck Water, the question
of which assets, if any, could be taken by the City was dependent on a
determination to be made after a hearing as to what was in the public interest.
On July 25, 2008, the NHPUC issued an order that the taking of the assets of
Pennichuck Water is in the public interest provided certain conditions are met,
and that the amount of compensation to be paid to Pennichuck Water for such
assets is $203 million determined as of December 31, 2008. The conditions
included a requirement that the City pay an additional $40 million into a
mitigation fund to protect the interests of the customers of Pennichuck East and
Pittsfield Aqueduct from the costs associated with operational inefficiencies
and the loss of use of shared assets resulting from the taking of the assets by
the City. Consequently, under the terms of the NHPUC order, the City would be
required to pay a total of $243 million determined as of December 31, 2008.
Another condition was that the City submit to the NHPUC, for its advance
approval, the final operating contracts between the City and its planned
contractors. The remaining conditions covered various aspects of the operation
and oversight of the water system under City ownership.
The $203 million compensation amount was set by two-thirds majority vote of the
NHPUC Commissioners, with one Commissioner dissenting. The dissenting
Commissioner argued for a $151 million compensation amount. The separate
$40 million mitigation reserve amount was set by unanimous vote of the
Commissioners.
It is our understanding that in the event of an eminent domain taking pursuant
to the July 25, 2008 NHPUC order, the actual amount of compensation the City
would have to pay would include compensating Pennichuck Water for capital
additions from and after the end of 2008 through the ultimate asset acquisition
closing date.
The NHPUC July 2008 order and the opinion of the dissenting Commissioner are
available on the NHPUC web site (Docket No. 04-048).
Pending Supreme Court appeal
The Company and the City submitted motions to the NHPUC requesting
reconsideration or rehearing as to its July 25, 2008 order. On March 13, 2009,
the NHPUC issued an order denying the motions of both parties in their entirety
on the basis that neither party had presented any new arguments or evidence that
the NHPUC had not previously considered.
Subsequently, both the Company and the City filed appeals with the Supreme
Court. The City filed its appeal brief with the Supreme Court on August 14,
2009. The Company filed its appeal brief, and its initial reply to the City's
brief, on September 29, 2009. Additional reply briefs were filed by the City on
October 29, 2009 and are expected to be filed by the Company by November 18,
2009. Oral arguments before the Supreme Court are expected to take place in
either December 2009 or January 2010.
The Company's Supreme Court appeal is principally focused on legal issues
relating to the NHPUC's "public interest" determination. The Company has also
appealed the adequacy of the $40 million mitigation reserve required by the
NHPUC to protect the interests of the customers of Pennichuck East and
Pittsfield Aqueduct.
The City's Supreme Court appeal focuses principally on the compensation amount
for Pennichuck Water's assets, arguing that the $151 million proposed by the
dissenting NHPUC Commissioner is the appropriate amount of compensation for the
assets of Pennichuck Water as of December 31, 2008. The City has also appealed
certain legal issues relating to the decision by the NHPUC on January 21, 2005
denying the City the right to take the assets of Pennichuck East and Pittsfield
Aqueduct by eminent domain, and the size of the mitigation reserve, which the
City argues should be substantially reduced.
The Company expects that the Supreme Court will likely not render its decision
before early 2010. The outcome of the Supreme Court appeals cannot be predicted.
If the Company prevails in its public interest appeal, the NHPUC's July 25, 2008
order could be reversed by the Supreme Court and the case could be dismissed. On
the other hand, if the Company does not prevail in its public interest appeal
and the City prevails in its appeals on valuation and/or the taking of
Pennichuck East and Pittsfield Aqueduct, or if either party is successful in its
appeal of the $40 million mitigation reserve, the Supreme Court would likely
remand the case to the NHPUC for further determination.
Potential advantages of a negotiated settlement
The Company believes a negotiated settlement between the Company and the City
could be more advantageous for each party than an eminent domain taking pursuant
to the NHPUC's July 25, 2008 order.
Based upon the public statements of the City's Mayor and various members of the
City's Board of Aldermen, as well as the positions taken in filings with the
NHPUC and the Supreme Court, we believe that:
• the City would like to acquire the operating assets of Pennichuck Water
and would prefer to pay not more than $151 million for those assets;
• the City would prefer to acquire the assets of Pennichuck East and Pittsfield Aqueduct as part of the eminent domain proceeding, instead of funding a $40 million mitigation reserve as provided in the NHPUC's July 25, 2008 order;
• the City would prefer that if a mitigation reserve is required (in lieu of it being allowed to acquire the assets of Pennichuck East and Pittsfield Aqueduct), it should be substantially less than the $40 million determined by the NHPUC; and
• the City would prefer to outsource to a third party the operation of any water systems the City acquires.
In addition, the City has stated publicly that it would also like to acquire the
Company's approximately 450 acres of undeveloped non-utility landholdings that
would not be includible in any eminent domain taking.
If the Supreme Court upholds the NHPUC's July 25, 2008 order that (i) a taking
of the assets of Pennichuck Water is in the public interest provided certain
conditions are met, (ii) the amount of compensation to be paid to Pennichuck
Water for such assets is $203 million as of December 31, 2008, and (iii) the
City must pay an additional $40 million into a mitigation fund, we believe that
the total cost to the City to accomplish its stated objectives, including the
acquisition of the undeveloped land, would likely be at least $250 million. Of
course, for the reasons described above, the City would not be obligated to
proceed with an acquisition on those terms, and we expect that the City would
not continue to pursue an eminent domain acquisition on those terms.
From the Company's perspective, even if the Supreme Court upholds the NHPUC's
compensation determination, an eminent domain taking is undesirable primarily
because it would result in the recognition of a substantial taxable gain at the
corporate level that would adversely affect shareholder value. An eminent domain
taking also would likely have an adverse effect on the value of Pennichuck East
and Pittsfield Aqueduct, if, as we believe is appropriate, the City is not
permitted to acquire the assets of those companies in the eminent domain
proceeding. In addition, the Company would likely incur material additional
costs in connection with any eminent domain taking and related matters. For
these reasons, which are described in more detail below, we remain opposed to an
eminent domain taking of the assets of Pennichuck Water pursuant to the terms of
the July 2008 NHPUC order.
An eminent domain taking of the assets of Pennichuck Water pursuant to the
July 25, 2008 NHPUC order would result in a significant taxable gain at the
corporate level based on the difference between the eminent domain taking price
as finally determined and the tax basis of the assets taken. That tax basis was
approximately $60 million as of September 30, 2009. The resulting
corporate-level income tax liability would substantially reduce the Company's
net worth after an eminent domain taking (i.e., before distribution to our
shareholders) unless we were able to defer the tax liability by reinvesting all
or a substantial portion of the eminent domain proceeds in other water utility
assets in accordance with certain provisions of the Internal Revenue Code.
However, considering the current geographic concentration of our operations, the
time limit within which the reinvestment must occur and the large dollar amount
that would have to be reinvested in order to substantially mitigate the tax
consequences, we believe it would likely be difficult to find suitable
replacement property that would be priced fairly and that otherwise would be
prudent for us to purchase. For these reasons, we do not expect that the
reinvestment of all or a substantial portion of the eminent domain proceeds
would be a viable strategy for the Company to defer the payment of the tax
liability due as a result of the sale of assets in an eminent domain taking.
A taking by eminent domain could also result in our Company incurring various
other costs depending on the final terms of the eminent domain taking and
decisions that our Company may make regarding its remaining operations. These
costs may include expenditures associated with termination and/or funding of
health and retirement plans, certain debt redemption premiums, severance costs
and professional fees. In addition, if the Company were to sell some or all of
its remaining businesses or assets as a consequence of an eminent domain taking,
it could be forced to accept prices below their current carrying values as a
result of then-current market conditions, a limited number of potential buyers,
and/or other factors.
We have stated publicly that because we believe an eminent domain taking
pursuant to the July 25, 2008 NHPUC order would not be in the best interests of
either the City or the Company, the parties instead should attempt to negotiate
a purchase of Pennichuck Corporation (parent-level) stock as part of a
comprehensive settlement of the eminent domain dispute. From our shareholders'
perspective, the principal advantage of a Pennichuck Corporation stock sale
would be the elimination of a corporate-level income tax that effectively would
be absorbed by our shareholders (an eminent domain taking is treated as an asset
sale for tax purposes and would result in a substantial income tax liability for
the company that sells the assets).
From the City's perspective, the acquisition of Pennichuck Corporation stock
would include the assets of Pennichuck East and Pittsfield Aqueduct and
therefore, under certain circumstances, could eliminate the need for or at least
substantially reduce the size of the mitigation reserve. In addition, by
acquiring Pennichuck Corporation stock, the City would also acquire the 450
acres of undeveloped land. Moreover, due to the differing tax treatment of an
asset versus stock purchase, we believe that the City's acquisition of
Pennichuck Corporation stock would likely result in the City paying materially
less in total (for more assets) than it likely would have to pay if the Supreme
Court upholds the NHPUC's July 25, 2008 ruling.
Conversely, from the City's perspective, an asset taking transaction may have
certain advantages not available in a stock acquisition transaction. For
example, in the case of an eminent domain taking, the City would be able to
finance the purchase cost with tax-exempt debt. By comparison, we believe that
the City would be required to finance a stock purchase with higher cost taxable
debt. Also, in the case of an eminent domain taking by a municipality, the
acquired operations would automatically become part of the tax-exempt entity. By
comparison, in the case of a stock acquisition, we believe that under current
law the City would need to operate the acquired operations through one or more
for-profit subsidiaries in order to avoid the risk of triggering a substantial
taxable gain chargeable to the City that could result if the operations were
converted to tax exempt status.
Settlement discussions to date have been inconclusive
Notwithstanding the continued adversarial proceedings regarding the eminent
domain case, including the pending appeals before the Supreme Court, the Company
has engaged in settlement discussions with the City, as previously disclosed,
including discussions regarding a comprehensive settlement involving the
acquisition of Pennichuck Corporation stock. We must emphasize, however, that
any comprehensive settlement, especially one involving the acquisition of
Pennichuck Corporation stock, would require the negotiation and resolution of
many complex issues and, therefore, no assurance can be given that the City and
the Company would ultimately be able to reach a settlement agreement. Moreover,
in addition to the approval of two-thirds of the City's Board of Aldermen, a
definitive settlement agreement could also be subject to approval by the NHPUC
and, depending on the terms of any settlement, the Company's shareholders.
Further, any such settlement agreement would also depend on the availability of
financing at terms acceptable to the City.
In November 2008, the City announced that it was hiring an investment banking
firm to assist it in exploring all possible ways that it might acquire the
assets of Pennichuck Water by means other than eminent domain. In February 2009,
we announced the engagement of the investment banking firm of Boenning &
Scattergood, Inc. to advise us regarding possible settlement with the City. The
Company and the City, and their respective representatives, have engaged in, and
are expected to continue to engage in from time to time, settlement discussions
that could lead to the purchase by the City, directly or indirectly, of all of
the stock of Pennichuck Corporation, or all or substantially all of our utility
assets, in resolution of the eminent domain dispute.
The terms of our confidentiality agreement with the City preclude us from
disclosing details of our settlement discussions, though through the date of
this report, those discussions have been inconclusive. We do not have an
agreement or understanding with the City regarding any of the material terms of
a comprehensive settlement, including the structure of such a settlement and the
valuation of Pennichuck Corporation's material assets. Consequently, we have no
reason to believe that a comprehensive settlement is imminent. Moreover, we
believe that it is likely that neither the City nor the Company will be willing
to make significant concessions in any settlement negotiations before the
Supreme Court renders its decision. Regardless of the outcome of the Supreme
Court decision, however, and in recognition of the City's interest in acquiring
the water system that serves its residents, the Company is willing to consider
any and all credible acquisition proposals by the City.
Critical Accounting Policies, Significant Estimates and Judgments
We have identified the accounting policies below as those policies critical to
our business operations and an understanding of our results of operations. The
preparation of financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
revenues and expenses. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances. Changes in the estimates or other judgments reflected in these
accounting policies could result in significant changes to the condensed
consolidated financial statements. Our critical accounting policies are as
follows:
Regulatory Accounting. ASC Topic 980 "Regulated Operations" (formerly SFAS
No. 71, "Accounting for the Effects of Certain Types of Regulation"), prescribes
generally accepted accounting principles for companies whose rates are
established by or are subject to approval by an independent third-party
regulator such as the NHPUC. Accordingly, we defer costs and credits on the
condensed consolidated balance sheets as regulatory assets and liabilities when
it is probable that these costs and credits will be recognized in the
rate-making process in a period different from when the costs and credits are
incurred. These deferred amounts, both assets and liabilities, are then
recognized in the condensed consolidated statements of income in the same period
that they are reflected in rates charged to our water utilities' customers. In
the event that the inclusion in the rate-making process is disallowed, the
associated regulatory asset or liability would be adjusted to reflect the change
in our assessment or change in regulatory approval.
We have not deferred costs incurred to defend against the City of Nashua's
ongoing eminent domain proceeding against our Pennichuck Water subsidiary.
Revenue Recognition. The revenues of our water utility subsidiaries are based on
authorized rates approved by the NHPUC. Estimates of water utility revenues for
water delivered to customers but not yet billed are accrued at the end of each
accounting period. We read our customer meters on a monthly basis and record
revenues based on those readings. Unbilled revenues from the last meter-reading
date to the end of the accounting period are estimated based on historical usage
and the effective water rates. Actual results could differ from those estimates.
Accrued unbilled revenues recorded in the accompanying condensed consolidated
financial statements as of September 30, 2009 and December 31, 2008 were
approximately $2.8 million and $2.9 million, respectively.
Our non-utility revenues are recognized when services are rendered. Revenues are
based, for the most part, on long-term contractual rates.
Pension and Other Postretirement Benefits. Our pension and other postretirement
benefit costs are dependent upon several factors and assumptions, such as
employee demographics, plan design, the level of cash contributions made to the
plans, return on plan assets, discount rate, the expected long-term rate of
. . .
|
|