Monarch Utilities I, L.P. Rate Application Overview

Appendix 1

Monarch Utilities I, L.P.

Rate Application Overview

Introduction

This Application for a Water and Sewer Rate/Tariff Change for Monarch Utilities I, L.P.
(“Monarch” or “Company”) filed with the Texas Commission on Environmental Quality
(“TCEQ”) is the first filing for water and sewer rates for Monarch’s new consolidated customer
base. This application is filed pursuant to Texas Water Code § 13.145(b) and proposes to
consolidate more than one system under a single tariff. The parent company of Monarch,
SouthWest Water Company (“SWWC”), filed an application in February 2011 to combine eight
of its regulated water and sewer utilities into Monarch. Monarch in this overview refers to the
consolidated water and sewer utility, which serves approximately 46,000 water and sewer
customers throughout the state of Texas.

All of the most recent rate applications filed by each of the nine individual companies
indicated that each company’s revenue requirement exceeded the current revenues of the
companies. However, SWWC settled all of those proceedings with its customers at amounts
lower than the necessary revenue requirement to reduce the impact on its customers, allowing
them to enjoy service at rates lower than the cost to serve them and that do not provide SWWC a
reasonable return on its investment. As a result, the rates collected over the past several years
have created a significant shortfall in revenue for SWWC.

While the recent consolidation of companies into Monarch will assist with stabilizing
costs in the future because of economies of scale in numerous aspects of the business, increased
expenses related to system improvements and higher quality customer service have increased
costs for Monarch. This rate application seeks to help Monarch recover the rising cost to serve
its customers with reliable and quality water and sewer services. This application supports an
increase in the revenue requirement for the test year ending December 31, 2010 for Monarch for
water service of $16.7 million or 62.3% and for sewer service of $3.2 million or 33.6%.
However, to moderate the impact of this rate increase on water customers, Monarch proposes a
two-step increase in water rates over 11 months. Monarch has included support for an overall
rate of return of 10.25%.

Consolidation of SouthWest Water Company’s Water and Sewer Systems

In 2008, SWWC, the parent company of Monarch, divided the company into 4 distinct
business units: Texas Utilities, Texas Services, Operations & Maintenance, and Western
Utilities. The components of Texas Utilities included ten regulated water utilities within Texas,
one regulated water and sewer utility in Oklahoma, and the Metro H2O wholesale water
company. The objective of this new structure was to create corporate synergy with operations,
management, and employees in an effort to better serve the customers.

SWWC’s Customer Care Department was restructured in late 2009, separating the
customer care center related to the water and sewer services from the rest of the shared services,
to promote a “utility only” customer care focus. Furthering this goal, SWWC filed an

application with the TCEQ in February 2011 to combine eight of its Texas regulated utilities into
Monarch. This consolidation will allow the customer care representatives to more efficiently
respond to customer inquiries, while creating a common brand utility company.

Additionally, the application includes significant known and measurable corporate
overhead cost reductions of test year expenses due to their non-recurring nature and SWWC’s
new private ownership. As a result, Monarch is proposing an adjustment to reduce test year
corporate management fees by nearly $1.78 million. Further, Monarch plans to see lower
insurance costs in the amount of $238,499, of which, $214,451 relates to a reduction in director
and officer insurance, which is another benefit of the Company’s transition from public to
private ownership.

System Improvements

SWWC adheres to stringent water quality testing and monitoring requirements to ensure
that water delivered to Monarch customers meets state and federal drinking water standards and
that wastewater discharged by Monarch to receiving bodies meets state and federal discharge
permit requirements. To meet this commitment to maintaining high water and wastewater
quality standards, Monarch must dedicate the necessary human and technological resources to
quality assurance programs. In response to comments received from its customer base, Monarch
aggressively launched initiatives to identify and address operational, compliance, and customer
service concerns. While all of these improvements were necessary and greatly benefited
Monarch’s customers, they also required significant capital investment by the Company.

Monarch has worked diligently over the past few years to address operational deficiency
issues existing in the water and sewer systems acquired by the Company over the last ten years.
Striving for full compliance in its operations, the in-house engineering and health and safety
team members have worked closely with the TCEQ in an attempt to resolve any compliance
issues in a timely manner. For example, Monarch entered into two voluntary compliance orders,
which contained approximately 123 compliance items that needed to be addressed. As of this
filing, only eight compliance items remain unresolved. As depicted in Exhibit A, 14 of the 19
agreed orders have been resolved. Additionally, of the five compliance agreements that have
been issued, all but one has been resolved. Furthermore, as shown in Exhibit B, Monarch has
reduced the number of systems with noncompliant well capacity from 22 in January 2008 to only
seven in April 2011.

In resolving all of these issues to meet the terms of the agreements with the TCEQ,
Monarch has made significant investments in plant and equipment. While Monarch sought to
correct all compliance issues in the most cost-effective manner possible, recovery of these costs
will necessarily be reflected in the users’ rates.

Although Monarch has made numerous expenditures to improve service, the Company
continues to look for ways to decrease the cost to serve its customers. For example, Monarch
was able to renegotiate its contract for sludge hauling, resulting in a reduction of $334,066 for
that expense. Additionally, Monarch’s investment in advanced meters has allowed the Company
to eliminate the need for two meter readers as well as their related expenses, amounting to a
$77,143 reduction.

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Monarch places safety, public health, and the environment first above all other
objectives, taking responsibility for the vital water resources entrusted to it. The safety of the
community as well as SWWC employees is very important to Monarch. Because of this focus
on safety, Monarch falls well below industry averages for recordable injuries and lost-time
accident rates, as shown in Exhibit C. Monarch will strive to maintain this high safety rating in
the coming years.

Customer Service Improvements

In addition to the customer service benefits that result from the consolidation of
companies, Monarch has spent significant funds in recent years to achieve excellent service for
its customers. Monarch has committed to provide its customers with quality, courteous, and
responsive service.

Specific Investments in Meters and Billing Systems

Striving to provide better customer service, Monarch hired a Customer Service Manager
dedicated to focusing on the unique issues surrounding Monarch’s role in providing quality
water and sewer service to customers in over 100 systems across Texas. SWWC sought to
remedy existing issues that would improve each customer’s experience. Some of these
corrective measures included:

 Monarch invested in advanced meter technology that will remove the possibility
of oversight due to human error resulting in higher accuracy in billing and fewer
customer complaints. Monarch is currently implementing this automated meter
reading in 2011.

 The meter replacement project is also a key element of Monarch’s water loss
program.

 In response to complaints surrounding large bills caused by unexpected leaks in
pipes, Monarch established a water Leak Relief Program (“LRP”) that allows
Monarch to set up scheduled payment arrangements using the lowest level of the
volume tiers.

 Monarch has made payment easier by allowing customers to pay via credit card
and checking account balances over the phone using an integrated voice response
(“IVR”) system installed in 2008. Additionally, the Monarch website now allows
customers to check account balances and pay bills online.

 In 2009, another method of payment was introduced that allows customers to pay
at various convenience store locations across Texas as a result of Monarch’s
agreement with Fidelity Express, a walk-in bill payment company.

 In this application, Monarch also seeks approval of a paperless bill option for
customers who choose to participate.

As a result of these improvements, Monarch has already seen a decrease in customer wait
times and a lower call volume. The wait time improvement is depicted on Exhibit D. As a
result, Monarch has been more responsive to the remaining incoming calls, increasing customer
satisfaction overall.

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Monarch has sought to better address customer concerns, issues, and changes relevant to
the company through the creation of a customer advisory panel called the Blue Ribbon Panel
(“BRP”) and designation of a Communications Manager to serve as a liaison between SWWC
and the customers, community groups, and media. The BRP provides a platform for discussions
between the Company and customers. The panelists serve a 2-year term and meet quarterly with
Monarch’s management team. As a result of their involvement, the panelists also benefit from
learning the complexities involved in providing reliable water and sewer services to their
communities, gaining important insight into the tradeoffs between quality customer service and
rates. Monarch has found the BRP and Communications Manager to be invaluable assets in its
efforts to provide the best customer service possible.

Operations

Monarch has also made investments in its operations to improve customer service, such
as the reorganization of the field offices to enable personnel to more effectively respond to
customer service issues and requests. As a result of these improved procedures, service outage
hours declined 37% between 2009 and 2010, as depicted in Exhibit E, and are now less than 60
minutes per customer per year. Additionally, Exhibit F shows the 27% reduction in water
quality complaints received as a result of the newly implemented operational techniques.
Finally, as an important preventative measure for our customers in the Gulf Coast region,
Monarch has invested in back-up power for facilities to enable recovery from hurricanes and
other natural disasters.

Future Improvements

Even with the substantial improvements Monarch has made to its systems since the last
rate filing for Monarch in 2007, Monarch plans to continue striving to improve service to its
customers. Currently, SWWC is in the process of installing an enterprise-wide SAP based
computer software system that will streamline billing and collections, asset management, and
service order and inventory management. Further automating these processes will result in
improved customer service as well as stabilizing operating costs over time. Monarch looks
forward to ensuring the continuity of the quality water service provided to its customers for
many years to come.

Rate Design and Bill Impacts

Monarch has proposed a new rate design that will create a two-step gallonage charge.
This new rate design promotes conservation by increasing as larger quantities of water are
consumed, but does not overly penalize those customers who are higher volume users of water.

In the application, Monarch proposes to increase the base rate, or the basic minimum
monthly charge, for each of the companies. Monarch will increase each company’s water base
rate through a two-step phase. Monarch’s first increase in water rates will occur on August 1,
2011 for all companies other than the former Windermere Utility Company. Under the
provisions of a current rate order, the rates of Windermere may not change until January 1, 2012;
therefore, the first phase of the increase will begin for that system on January 1, 2012. The
second increase will occur on July 1, 2012 for all water customers. The sewer base rate will be

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increased in one step on August 1, 2011 except for Windermere, which will be January 1, 2012.
Sewer rates will also include a gallonage charge component based on winter average water usage
rates.

Revisions to Current Tariff Service Provisions

Monarch seeks to substitute the proposed tariffs for each of the existing tariffs in all
affected systems and subdivisions.

Change in Depreciation

In the Application, Monarch requests to change its depreciation service lives and to
implement group depreciation by NARUC account pursuant to 30 TAC §291.31(c)(2)(B). As a
result of the recent TCEQ rule changes, Monarch seeks to move from an item-based depreciation
approach to a group depreciation approach. Accordingly, average lives with retirement
dispersions were applied to each asset group. Additionally, because the TCEQ rules specifically
provide for setting net salvage rates when moving to group accounting, Monarch seeks to change
its processes to capture and record removal cost to the depreciation reserve with the
implementation of group accounting. Overall, the study completed by depreciation consultants
engaged by Monarch recommends a decrease of $215,488 in annual depreciation expenses when
compared to the item-based depreciation rates currently in effect.

Rate of Return

Monarch engaged the services of a financial consultant, ValueScope, Inc., to study the
appropriate return on equity for Monarch. After a thorough analysis, ValueScope recommends a
return on equity of 11.2%. Because Monarch’s current debt to equity ratio of 20/80, this 11.2%
ROE and a weighted average cost of debt of 1.30% result in Monarch’s requested 10.25% rate of
return on invested capital.

Purchased Water

We have contracted to purchase water as part of our efforts to maintain an adequate,
reliable supply of high-quality water to our customers statewide. This purchased water will
provide a long term supply of quality groundwater for Monarch customers through its contract
with Blue Water 130 Project LP. One of Monarch’s suppliers, Mustang SUD, has recently
imposed a significant increase to the contract for purchased water, amounting to a $78,261
increase to the test year costs. While the Company is continuing to work with suppliers to secure
water supplies, efforts are being made to reduce costs where supply sources are changing. An
example is the MGS contract, where the daily minimum was renegotiated thereby lowering costs
compared to 2010.

Statewide Rates

As a consolidated entity, Monarch seeks to consolidate more than one system under a
single tariff, pursuant to Texas Water Code § 13.145(b). The implementation of statewide rates
will make Monarch’s water rates easier to understand for all consumers and simplify the

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customer service processes for Monarch, thereby enhancing customer service for customers
statewide.
Request for Rate Base Determination

Monarch is seeking to have the TCEQ determine its rate base amount during the review
of this application. The appropriate determination of rate base is important as it plays a
considerable part in the determination of revenue for the Company.

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Exhibit A – Regulatory Compliance Improvements

Since Acquisition Regulatory Compliance Agreements
Number Issued Number Resolved Systems Covered
Agreed Orders
19 14 30
Compliance
Agreements 5 45

#1 signed

2005: 78 of 78

Voluntary 2 resolved 30
Compliance
Agreements #2 signed
2009: 37 of 45
27
resolved

Exhibit B – Systems with Inadequate Well Capacity

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Exhibit C - Exceeding Industry Safety Standards

LTI Rate = Number of lost time incidents per 200,000 manhours worked.
RI Rate = Number of reportable incidents per 200,000 manhours worked.

Exhibit D - Customer Call Handling

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Exhibit E – Reduced Service Outages

 Service Hour Outages are March to December because the Company began tracking
in March 2009

 Example: 1 hour and 100 connections in system impacted equals 100 service hour
outages

Exhibit F - Fewer Water Quality Complaints

3176/00/1306596

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