Search

Rate Covenant Test - If during any fiscal year, the EBITDA of Pennichuck Water
shall not equal at least 1.1 times all amounts paid or required to be paid during that year
(“Amounts Paid’), then the Company shall undertake reasonable efforts to initiate a
rate-making proceeding with the NH Public Utilities Commission, to rectify this
coverage requirement in the succeeding fiscal years. Thereby, the ratio of EBITDA to
Amounts Paid must be equal to or greater than 1.1; as of December 31, 2018 and 2017,
the Rate Covenant coverage ratio was 1.48 and 1.41, respectively.

Pennichuck East’s loan agreement for its unsecured notes payable to a bank of $8.1 million
and $8.1 million at December 31, 2018 and 2017, respectively, contains a minimum debt
service coverage ratio requirement of 1.10. At December 31, 2018 and 2017, this ratio was
0.89 and 0.92, respectively. This covenant has not been met, and the Bank has waived such
noncompliance. Also, Pennichuck East is required to maintain a maximum ratio of total debt
to total capitalization of 65%; at December 31, 2018 and 2017, this ratio was 65% and 59%,
respectively.

As of December 31, 2018 and 2017, the Company had a $2.9 million and $3.1 million,
respectively, interest rate swap which qualifies as a derivative. This financial derivative is
designated as a cash flow hedge. This financial instrument is used to mitigate interest rate risk
associated with our outstanding $2.9 million loan which has a floating interest rate based on
the three-month London Interbank Offered Rate (“LIBOR”) plus 1.75% as of December 31,
2018. The combined effect of the LIBOR-based borrowing formula and the swap produces an
“all-in fixed borrowing cost” equal to 5.95%. The fair value of the financial derivative, as of
December 31, 2018 and 2017, included in our Consolidated Balance Sheets under “Other
Liabilities and Deferred Credits” as “Derivative instrument” was $263,000 and $374,000,
respectively. Changes in the fair value of this derivative were deferred in accumulated other
comprehensive income.

Swap settlements are recorded in the statement of income (loss) with the hedged item as
interest expense. During the years ended December 31, 2018 and 2017, $59,000 and $76,000,
respectively, was reclassified pre-tax from accumulated other comprehensive income to
interest expense as a result of swap settlements. The Company expects to reclassify
approximately $66,000, pre-tax, from accumulated other comprehensive income to interest
expense as a result of swap settlements, over the next twelve months.

Note 11 — Lines of Credit

In April of 2018, the Company’s existing Line of Credit, which had a $6 million limit for
borrowings was replaced by a new $4 million Working Capital Line of Credit, and two new
Fixed Asset Lines of Credit for Pennichuck Water Works, Inc. ($10 million FALOC) and
Pennichuck East Utility, Inc. ($3 million FALOC), to be used to fund Construction Work in
Progress on capital projects, which will be refinanced into long-term debt term loan obligations
or issued bond indebtedness, annually.

34

Short-term borrowing activity under Pennichuck Corp.’s Working Capital Line of Credit for

the years ended December 31, 2018 and 2017 was:

(in thousands)

Established line as of December 31, $
Maximum amount outstanding during period

Average amount outstanding during period

Amount outstanding as of December 31,

Weighted average interest rate during period

Interest rate as of December 3 I,

2018 2017
4,000 $ 6,000
5,981 5,574
1,701 228

361 5,574
3.45% 3.01%
4.27% 3.10%

Short-term borrowing activity under Pennichuck Water’s Fixed Asset Line of Credit for the

year ended December 31, 2018 was:

(in thousands)

Established line as of December 31,
Maximum amount outstanding during period
Average amount outstanding during period
Amount outstanding as of December 31,
Weighted average interest rate during period
Interest rate as of December 31,

2018

$ 10,000
5,574
1,821
5,574
3.05%
4.27%

Short-term borrowing activity under Pennichuck East’s Fixed Asset Line of Credit for the year

ended December 31, 2018 was:

(in thousands)

Established line as of December 31,

Maximum amount outstanding during period

Average amount outstanding during period
Amount outstanding as of December 31,
Weighted average interest rate during period
Interest rate as of December 31,

2018

$ 3,000
691

113

691

3.11%
4.71%

The Company’s revolving credit loan facilities with TD Bank contain certain covenant

obligations upon Pennichuck Water, which are as follows:

Debt to Capital Covenant - Pennichuck Water cannot create, issue, incur, assume or
guarantee any short-term debt if (1) the sum of the short-term debt plus its funded debt
(“Debt”) shall exceed 85% of the sum of its short-term debt, funded debt and capital
stock plus surplus accounts (“Capital”), unless the short-term debt issued in excess of
the 85% is subordinated to the loan facility. Thereby, the ratio of Debt to Capital must
be equal to or less than 1.0. As of December 31, 2018, Pennichuck Water Works has a

Debt to Capital Coverage ratio of 0.5.

35

All Bonds Test - Additionally, Pennichuck Water cannot create, issue, incur, assume
or guarantee any new funded debt, if the total outstanding funded debt (“Total Funded
Debt”) will exceed the sum of MARA {as defined in Note | of these consolidated
financial statements) and 85% of its Net Capital Properties (“MARA and Capital
Properties”), and unless net revenues or EBITDA (earnings before interest, taxes,
depreciation and amortization) shall equal or exceed for at least 12 consecutive months
out of the 15 months preceding the issuance of the new funded debt by 1.1 times the
maximum amount for which Pennichuck Water will be obligated to pay in any future
year (“Max Amount Due”), as a result of the new funded debt being incurred. Thereby,
the ratio of Total Funded Debt to MARA and Capital Properties must be equal to or
less than 1.0; as of December 31, 2018, this coverage ratio was 0.4. Also, the ratio of
EBITDA to the Max Amount Due must be equal to or greater than 1.1; as of
December 31, 2018 this ratio was 1.6.

Rate Covenant Test - If during any fiscal year, the EBITDA of Pennichuck Water
shall not equal at least 1.1 times all amounts paid or required to be paid during that year
(“Amounts Paid”), then the Company shall undertake reasonable efforts to initiate a
rate-making proceeding with the NH Public Utilities Commission, to rectify this
coverage requirement in the succeeding fiscal years. Thereby, the ratio of EBITDA to
Amounts Paid must be equal to or greater than 1.1; as of December 31, 2018, the Rate
Covenant coverage ratio was 1.48.

Note 12 — Accumulated Other Comprehensive Income

The following table presents changes in accumulated other comprehensive income by
component for the years ended December 31, 2018 and 2017:

Interest Rate Contract

(in thousands) 2018 2017
Beginning balance $ 305 $ 258
Other comprehensive income (loss) before reclassifications 32 l
Amounts reclassified from accumulated other
comprehensive income 35 46
Net current period other comprehensive income 67 47
Ending balance $ 372, $ 305

36

The following table presents reclassifications out of accumulated other comprehensive income
for the years ended December 31, 2018 and 2017:

Amounts Reclassified Affected Line Item in

Details about Accumulated Other from Accumulated Other the Statement Where
Comprehensive Income Components Comprehensive Income Net Income is Presented
(in thousands) 2018 2017
Gain (loss) on cash flow hedges

Interest rate contracts $ 59 § 77 Interest expense

(24) (31) Tax expense

Amounts reclassified from accumulated

other comprehensive income $ 35. $ 46 Net of tax

Note 13 — Transaction with the City of Nashua

On January 25, 2012, in full settlement of an ongoing Eminent Domain lawsuit filed by the
City of Nashua (“City”) and with the approval of the New Hampshire Public Utilities
Commission (““NHPUC”), the City acquired all of the outstanding shares of Pennichuck
Corporation (“Pennichuck’”) and, thereby, indirect acquisition of its regulated subsidiaries. The
total amount of the acquisition was $150.6 million (“Acquisition Price”) of which $138.4
million was for the purchase of the outstanding shares, $5.0 million for the establishment of a
Rate Stabilization Fund, $2.6 million for legal and due diligence costs, $2.3 million for
severance costs, $1.3 million for underwriting fees, and $1.0 million for bond discount and
issue costs. The entire purchase of $150.6 million was funded by General Obligation Bonds
(“Bonds”) issued by the City of Nashua. Pennichuck is not a party to the Bonds and has not
guaranteed nor is obligated in any manner for the repayment of the Bonds. Pennichuck remains
an independent corporation with an independent Board of Directors, with the City of Nashua
as its sole shareholder.

Pennichuck Water Works, Inc. (“PWW”), Pennichuck East Utility, Inc. (“PEU”), Pittsfield
Aqueduct Company, Inc. (“PAC”), Pennichuck Water Service Corporation, and The
Southwood Corporation will continue as subsidiaries of Pennichuck Corporation and PWW,
PEU and PAC will continue as regulated companies under the jurisdiction of the New
Hampshire Public Utilities Commission. The terms of the merger and the requisite accounting
and rate-setting mechanisms were agreed to in the NHPUC Order 25,292 (“PUC Order”) dated
November 23, 2011.

37

Transactions with Related Party — City of Nashua

Pennichuck issued a promissory note to the City of Nashua in the amount of approximately
$120 million to be repaid over a thirty (30) year period with monthly payments of
approximately $707,000, including interest at 5.75%. Pennichuck recorded an additional
amount of approximately $30.6 million as contributed capital. The remaining outstanding
balance of the note payable to the City at December 31, 2018 and 2017 was approximately
$107 million and $109 million, respectively, as disclosed in Note 10 to these consolidated
financial statements. During 2018 and 2017, dividends of approximately $280,000 and
$279,000, respectively, were declared and paid to the City. The dividends paid to the City
during 2018 comprised approximately $280,000 of regular quarterly dividends declared and
paid; and no special dividend was declared or paid in 2018. The dividends paid to the City
during 2017 comprised approximately $279,000 of regular quarterly dividends declared and
paid; and no special dividend was declared or paid in 2017.

Additional ongoing transactions occur in the normal course of business, between the Company
and the City, related to municipal water usage, fire protection and sewer billing support
services, and property taxes related to real property owned by the Company within the City of
Nashua. For the years ended December 31, 2018 and 2017, respectively, approximately $3.4
million and $3.2 million were paid to the Company by the City for municipal water
consumption, fire protection charges, and sewer billing support services. Conversely, the
Company paid property taxes to the City of Nashua of approximately $2.6 million for the year
ended December 31, 2018, and approximately $2.9 million for the year ended December 31,
2017.

Rate Stabilization Fund — Restricted Cash

As a part of the acquisition, Pennichuck agreed to contribute $5,000,000 of the proceeds from
the settlement transaction to PWW, which was used to establish a Rate Stabilization Fund
(“RSF”), allowing for the maintenance of stable water utility rates and providing a mechanism
to ensure the Company’s continued ability to meet its obligations under the promissory note to
the City, in the event of adverse revenue developments. Restricted cash consists of amounts
set aside in the RSF account and is adjusted monthly as required in the PUC Order, as discussed
in Note | of these financial statements.

Municipal Acquisition Regulatory Asset (“MARA”)

Pursuant to the PUC Order, Pennichuck established a new Regulatory asset (MARA) which
represents the amount that the Acquisition Price exceeded the net book assets of Pennichuck’s
regulated subsidiaries (PWW, PEU, and PAC) at December 31, 2011. The initial amount of the
MARA was approximately $89 million for the regulated companies, offset by a non-regulated
amount of approximately $4.8 million. The MARA is to be amortized over a thirty (30) year
period in the same manner as the repayment of debt service for the City’s acquisition bonds. The
balance in the MARA at December 31, 2018 was approximately $75.4 million, reduced by the
non-regulated credit of approximately $4.1 million.

Aggregate amortization expense for the years ended December 31, 2018 and 2017 totaled
approximately $1,958,000 and $1,917,000, respectively.

38

The following table represents the total estimated amortization of MARA:

Estimated

Amortization

(in thousands) Expense
2019 $ 2,006
2020 2,061
2021 2,119
2022 2,183
2023 2,253
2024 and thereafter 60,646
Total $ 71,268

Note 14 — Segment Reporting

The Company is comprised of Pennichuck Corporation and its five wholly-owned subsidiaries,
as described in Note | to these consolidated financial statements. For the years ended
December 31, 2018 and 2017, and as of those dates, the following financial results were
generated by the segments of the Company:

39

(in thousands) 2018 2017
Operating Revenues:
Pennichuck Water Works, Inc. 32,391 29,584
Pennichuck East Utility, Inc. 8,724 7,198
Pittsfield Aqueduct Company, Inc. 791 792
Subtotal Regulated Segment 41,906 37,574
Water Management Services 3,347 3,308
Other 12 1]
Total Operating Revenues 45,265 40,893
Depreciation and Amortization Expense:
Pennichuck Water Works, Inc. 6,978 6,685
Pennichuck East Utility, Inc. 1,134 1,072
Pittsfield Aqueduct Company, Inc. 115 116
Subtotal Regulated Segment 8,227 7,873
Water Management Services - -
Other (114) (111)
Total Depreciation and Amortization Expense 8,113 7,762
(continued)

(continued)

(in thousands) 2018 2017
Operating Income:
Pennichuck Water Works, Inc. $ 6,247 $ 5,348
Pennichuck East Utility, Inc. 780 113
Pittsfield Aqueduct Company, Inc. 45 55
Subtotal Regulated Segment 7,072 5,516
Water Management Services 31 (93)
Other - 53
Total Operating Income $ 7,103 $ 5,476
Interest Expense:
Pennichuck Water Works, Inc. $ 3,455 § 3,512
Pennichuck East Utility, Inc. 753 695
Pittsfield Aqueduct Company, Inc. 48 61
Subtotal Regulated Segment 4,256 4,268
Water Management Services 7 3
Other 6,647 6,562
Total Interest Expense $ 10,910 $ 10,833
Income Taxes Provision (Benefit):
Pennichuck Water Works, Inc. $ 2,351 = $ 1,366
Pennichuck East Utility, Inc. 771 66
Pittsfield Aqueduct Company, Inc. 1 17
Subtotal Regulated Segment 3,233 1,449
Water Management Services 7 (3)
Other (1,548) (338)
Total Income Taxes Provision (Benefit) $ 1,692 § 1,108
Net Income (Loss):
Pennichuck Water Works, Inc. $ 459 $§ 490
Pennichuck East Utility, Inc. (540) (508)
Pittsfield Aqueduct Company, Inc. (114) 24
Subtotal Regulated Segment (195) 6
Water Management Services 16 (100)
Other (5,103) (6,347)
Total Net Income (Loss) $ (5,282) $ (6,441)

(continued)

40

(continued)

(in thousands) 2018 2017
Total Net Assets:
Pennichuck Water Works, Inc. $ 279,467 = $ 267,689
Pennichuck East Utility, Inc. 55,942 51,915
Pittsfield Aqueduct Company, Inc. 3,332 3,499
Subtotal Regulated Segment 338,741 323,103
Water Management Services (13) (28)
Other (15,594) (8,284)
Total Net Assets $ 323,134 $§ 314,791
Total Liabilities:
Pennichuck Water Works, Inc. $ 167,107 §$ 149,688
Pennichuck East Utility, Inc. 45,693 40,293
Pittsfield Aqueduct Company, Inc. 1,534 1,458
Subtotal Regulated Segment 214,334 191,439
Water Management Services 35 37
Other 100,355 109,410

Total Liabilities $ 314,724 §$ 300,886

Total Long-Term Debt (including current portion):

Pennichuck Water Works, Inc. $ 80,838 $ 78,096
Pennichuck East Utility, Inc. 18,435 16,273
Pittsfield Aqueduct Company, Inc. 146 15]
Subtotal Regulated Segment 99,419 94,520
Water Management Services - -
Other 106,825 108,960

Total Long-Term Debt $ 206,244 § 203,480

4l

Note 15 — Rate Cases

Pennichuck Water Works, Inc.

On September 23, 2016, Pennichuck Water Works, Inc. (“PWW’”) filed a request with the New
Hampshire Public Utilities Commission (“NHPUC”) for a rate increase of 17.21% over its
current rates for the test year 2015, for which 7.86% was related to a permanent rate increase,
and 9.35% was related to a prospective step increase (associated with capital investments and
other allowable expenditures in the twelve months following the test year). The overall rate
increase is subject to the normal regulatory filing process with the NHPUC, as followed for all
prior rate case filings, and as such, the final permanent rate increase granted will be effective
retroactive back to the filing date, once approved by the NHPUC. The step increase, once
approved and granted, would be earned on a forward-looking basis, as of the date of the order
granting such increase. In addition, PWW requested that a temporary rate increase of 6.21%
be granted as a subset of the final permanent rate increase, with the intention that this temporary
rate increase would be approved very early in 2017. The Company, NHPUC Staff and the
Office of Consumer Advocate (OCA) agreed to a temporary rate increase at “current rates,”
and as such, there was no impact on ratepayers for any temporary rate increases.

The request for the overall permanent rate increase was based upon increases in PWW’s
operating costs since the last allowed rate increase in 2010/2011 (for the 2009 test year), as
well as revenues needed to pay the debt service on over $40 million of infrastructure
replacements made since the last rate case, with those dollars being invested in its real property
assets, distribution and treatment systems, and other necessary capital items, to ensure
continued compliance with the Safe Drinking Water Act and prudent ongoing replacement of
aging infrastructure to properly maintain the company’s operating systems.

On November 7, 2017, the PUC issued Order No. 26,070 approving a permanent rate increase
of 3.12% and a 7.69% step increase for its customers. The permanent rate increase was
effective on a bills-rendered basis on and after December 7, 2016. The step increase is effective
the date of the order, November 7, 2017.

In addition to the rate increases granted in the order the NHPUC approved the following
modifications to PWW’s rate structure:

e the establishment of a five-year average of revenues versus the previous test-year
revenues methodology for allowed revenue calculations, and
e the creation of the following additional revenue requirements:
o Operating Expense Revenue Requirement (OERR), and
o Debt Service Revenue Requirement (DSRR)
e the establishment of dedicated Rate Stabilization Funds (RSFs) in support of the new
revenue requirement structure, and

e the establishment of a QCPAC (Qualified Capital Project Annual Adjustment Charge)
that will assess annual surcharges between rate cases for capital expenditures placed in
service in the prior year to fund the annual principal and interest payments of the
associated new debt, in addition to the incremental property taxes associated with that
capital.

42

Pennichuck East Utility. Inc.

On October 18, 2017, Pennichuck East Utility, Inc. (““PEU”) filed a request with the NHPUC
for a rate increase of 20.78% over its current rates for the test year 2016, for which 19.36% of
this increase is related to a permanent rate increase and 1.42% is related to a prospective step
increase (associated with capital investments and other allowable expenditures in the twelve
months following the test year). The overall rate increase is subject to the normal regulatory
filing process with the NHPUC, as followed for all prior rate case filings, and as such, the final
permanent rate increase granted will be effective retroactive back to the filing date, once
approved by the NHPUC. The step increase, once approved and granted, would be earned on
a forward-looking basis, as of the date of the order granting such increase. As a part of this
overall rate setting process, PEU entered into a settlement agreement with the NHPUC staff
and the OCA staff, requesting a temporary rate increase of 12.24% be granted as a subset of
the final permanent rate increase, with the intention that this temporary rate increase would be
approved in early 2018, and with permanent rates being set in the summer or fall of 2018.

The last general rate increase for PEU was in 2014, based upon 2012 as a test year. Since then,
PEU’s operating expenses have increased ratably, and for some items like local property taxes,
well above the rate of inflation. Additionally, since the beginning of 2013, the Company has
borrowed and invested over $7.5 million in new capital assets to serve its customers through
ongoing investments in infrastructure replacements and system improvements. The rate increase
being requested would allow PEU to pay the debt service attributable to these new capital
investments, pay its necessary operating costs, and continue to meet the needs of its customers.

On May 31, 2018, the NHPUC issued Order No. 26,136 approving the requested 12.24%
increase in temporary rates effective on a bills-rendered basis as of January 8, 2018.

On October 4, 2018, the NHPUC issued Order No. 26,179 approving an overall permanent rate
increase of 17.86%, inclusive of the 12.24% increase in temporary rates previously approved
on May 31, 2018 on a bills-rendered basis as of January 8, 2018. This overall rate increase also
includes a 1.43% Step increase earned on a forward-looking basis for bills rendered on or after
November 16, 2018.

In addition to the rate increases granted in the order the NHPUC approved the following
modifications to PEU’s rate structure:

e the establishment of a five-year average of revenues versus the previous test-year
revenues methodology for allowed revenue calculations, and

e the creation of the following additional revenue requirements as similarly adopted for
PWW in 2017:

o Operating Expense Revenue Requirement (OERR), and
o Debt Service Revenue Requirement (DSRR)

e the establishment of dedicated Rate Stabilization Funds (RSFs) in support of the
revenue requirement structure, and

e the establishment of aQCPAC (Qualified Capital Project Annual Adjustment Charge) that
will assess annual surcharges between rate cases for capital expenditures placed in service
in the prior year to fund the annual principal and interest payments of the associated new
debt, in addition to the incremental property taxes associated with that capital.

43