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For assets and liabilities measured at fair value on a recurring basis, the fair value measure-
ment by levels within the fair value hierarchy used as of December 3 1, 2017 and 2016 were
as follows:

December 31, 2017

(in thousands) Total Level I Level 2 Level 3
Liabilities:
Interest rate swap $ (374) §$ - $ (374, §$ -

December 31, 2016

(in thousands) Total Level 1 Level 2 Level 3
Liabilities:
Interest rate swap $ (453) §$ - $ (453) $ -

The carrying value of certain financial instruments included in the accompanying Consoli-
dated Balance Sheets, along with the related fair value, as of December 31, 2017 and 2016
was as follows:

2017 2016
Carrying Fair Carrying Fair
(in thousands) Value Value Value Value
Liabilities:
Long-term debt $ (207,709) $ (234,509) $ (210,443) $ (264,700)
Interest rate swap liability $ (374) §$ (374) $ (453) §$ (453)

The fair value of long-term debt has been determined by discounting the future cash flows
using current market interest rates for similar financial instruments of the same duration. The
fair value for long-term debt shown above does not purport to represent the amounts at which
those debt obligations would be settled. The fair market value of the interest rate swap
represents the estimated cost to terminate this agreement as of December 31, 2017 and 2016
based upon the then-current interest rates and the related credit risk.

The carrying values of our Cash and Cash Equivalents, Accounts Receivable and Accounts
Payable approximate their fair values because of their short maturity dates. The carrying
value of our CIAC approximates its fair value because it is expected that this is the amount
that will be recovered in future rates.

Note 8 — Income Taxes

On December 22, 2017, the U.S. government enacted comprehensive tax legislation
commonly referred to as the Tax Cuts and Jobs Act (the TCJA). The TCJA makes broad and
complex changes to the U.S. tax code, including, but not limited to, (1) reducing the U.S.
federal corporate tax rate from 35 percent to 21 percent; (2) elimination of the corporate
alternative minimum tax (AMT) and changing how existing AMT credits can be realized; (3)
changing rules related to usage and limitation of net operating loss carryforwards created in

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tax years beginning after December 31, 2017; and (4) changing rules related to limitation of
interest expense deductions. Certain of TCJA’s provisions require interpretation, which may
be clarified through issuances of guidance by the U.S. Treasury Department, regulations, or
future technical corrections.

FASB ASC 740 requires companies to recognize the effects of tax law changes in the period
of enactment, which for the Company is for the year ended December 31, 2017, even though
the effective date of most provisions of TCJA is January 1, 2018.

The Company’s revaluation of federal deferred tax balances to reflect the 21% corporate
income tax rate resulted in a one-time, non-cash expense of approximately $2,500,000,
included in the Company’s provision for income taxes, offset by an increase in deferred
income tax liabilities.

The components of the federal and state income tax provision (benefit) as of December 31,
2017 and 2016 were as follows:

(in thousands) 2017 2016
Federal $ 1,057 $ 284
State 84 (116)
Amortization of investment tax credits (33) (33)
Total $ 1,108 $ 135
Current $ - $ -
Deferred 1,108 135
Total $ 1,108 $ 135

The following is a reconciliation between the statutory federal income tax rate and the
effective income tax rate for 2017 and 2016:

2017 2016
Statutory federal rate 34.0% 34.0%
State tax rate, net of federal benefits 6.2% 5.4%
Permanent differences -15.8% -54.8%
Tax rate change -45.8% 0.0%
Amortization of investment tax credits 0.6% 3.0%
Effective tax rate -20.8% -12.4%

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The temporary items that give rise to the net deferred tax liability as of December 31, 2017
and 2016 were as follows:

(in thousands) 2017 2016
Liabilities:
Property-related, net $ 19,967 $ 27,599
Other 373 363
Total liabilities 20,340 28,162
Assets:
Pension accrued liability 1,186 1,55$
Net operating loss carryforward 5,042 4,480
Alternative minimum tax credit 476 476
NH Business Enterprise Tax credits 853 727
Other 789 782
8,346 8,020
Less valuation allowance (853) (727)
Total assets 7,493 7,293
Net non-current deferred income tax liability $ 12,847 $ 20,869

The Company had a federal net operating loss in 2017 and 2016 in the amounts of
approximately $6.7 million and $1.6 million, respectively. The federal tax benefit of the
cumulative net operating loss is approximately $3.8 million which begins to expire in 2032,
and is included in deferred income taxes in the Consolidated Balance Sheet as of
December 31, 2017.

The Company also had a New Hampshire net operating loss in 2017 and 2016 in the amounts
of approximately $7.3 million and $2.5 million, respectively. The New Hampshire tax benefit
of the cumulative net operating loss is approximately $1.2 million which begins to expire in
2022, and is included in deferred income taxes in the Consolidated Balance Sheet as of
December 31, 2017.

As of December 31, 2017 and 2016, it is estimated that approximately $476,000 and
$476,000, respectively, of cumulative federal alternative minimum tax credits may be carried
forward indefinitely as a credit against our regular tax liability.

As of December 31, 2017 and 2016, the Company had New Hampshire Business Enterprise
Tax (“NHBET”) credits of approximately $853,000 and $727,000, respectively. NHBET
credits begin to expire in 2018. It is anticipated that these NHBET credits will not be fully
utilized before they expire; therefore, a valuation allowance has been recorded related to
these credits. The valuation allowance increased by $126,000 and $358,000 in the years
ended December 31, 2017 and 2016, respectively.

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Investment tax credits resulting from utility plant additions are deferred and amortized. The
unamortized investment tax credits are being amortized through the year 2033.

The Company had a regulatory liability related to income taxes of approximately $9,955,000
and $760,000 as of December 31, 2017 and 2016, respectively. This represents the estimated
future reduction in revenues associated with deferred taxes which were collected at rates
higher than the currently enacted rates and the amortization of deferred investment tax
credits.

A review of the portfolio of uncertain tax positions was performed. In this regard, an
uncertain tax position represents the expected treatment of a tax position taken in a filed tax
return, or planned to be taken in a future tax return, that has not been reflected in measuring
income tax expense for financial reporting purposes. As a result of this review, it was
determined that the Company had no material uncertain tax positions, and tax planning
strategies will be used, if required and when possible, to avoid the expiration of any future
net operating loss and/or tax credits.

The Company’s practice is to recognize interest and/or penalties related to income tax
matters in “Other, Net” in the Consolidated Statements of Income. We incurred no interest in
2017 and 2016. We incurred $0 and $0 of penalties during the years ended December 31,
2017 and 2016, respectively.

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Note 9— Debt

Long-term debt as of December 31, 2017 and 2016 consisted of the following:

2017
Unamortized
Debt Issuance
(in thousands) Principal Costs
Unsecured note payable to City of Nashua, 5.75%,
due 12/25/2041 $ 108,960 3 -
Unsecured senior note payable due to an insurance company
7.40%, due March 1, 2021 3,600 27
Unsecured Business Finance Authority:
Revenue Bonds (Series 201 5A), interest rates from 4.00% to 5.00%,
due January 1, 2046 20,035 1,527
Revenue Bonds (Series 201 5B), 5.00%, due January 1, 2046 1,940 251
Revenue Bonds (Series 20144), interest rates from 3.00% to 4.125%,
due January 1, 2045 39,935 1,949
Revenue Bonds (Series 2014B), 4.50%, due January 1, 2045 5,125 118
Unsecured notes payable to bank, floating-rate, due March 1, 2030 3,134 16
Unsecured notes payable to bank, 3.62%, due June 20, 2023 1,438 9
Unsecured notes payable to bank, 4.20%, due December 20, 2041 1,221 7
Unsecured notes payable to bank, 4.83%, due December 20, 2041 930 5
Unsecured notes payable to bank, 4.25%, due June 20, 2033 780 7
Unsecured notes payable to bank, 4.90%, due March 6, 2040 588 36
Unsecured New Hampshire State Revolving Fund (“SRF”) notes (1) 20,023 182
Unamortized debt issuance costs for defeased obligations,
allowed by regulation - 95
Total 207,709 $ 4,229
Less current portion (5,575)
Less unamortized debt issuance costs (4,229)
Total long-term debt, less current portion
and unamortized debt issuance costs $ 197,905

(1) SRF notes are due through 2048 at interest rates ranging from 1% to 3.8%. These notes are payable in 120 to 240
consecutive monthly installments of principal and interest. The 1% rate applies to construction projects still in process
until the earlier of (i) the date of substantial completion of the improvements, or (ii) various dates specified in the note
(such earlier date being the interest rate change date). Commencing on the interest rate change date, the interest rate
changes to the lower of (i) the rate as stated in the nole or (ii) 80% of the established 11 General Obligations Bond
Index published during the specified time period before the interest rate change date.

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2016

(in thousands) Principal

Unsecured note payable to City of Nashua, 5.75%,

due 12/25/2041 $
Unsecured senior note payable due to an insurance company

7.40%, due March 1, 2021

Unsecured Business Finance Authority:
Revenue Bonds (Series 2015A), interest rates from 4.00% to 5.00%,
due January 1, 2046
Revenue Bonds (Series 2015B), 5.00%, due January 1, 2046
Revenue Bonds (Series 2014A), interest rates from 3.00% to 4.125%,
due January 1, 2045
Revenue Bonds (Series 2014B), 4.50%, due January |, 2045
Unsecured notes payable to bank, floating-rate, due March 1, 2030
Unsecured notes payable to bank, 3.62%, due June 20, 2023
Unsecured notes payable to bank, 4.20%, due December 20, 2041
Unsecured notes payable to bank, 4.83%, due December 20, 2041
Unsecured notes payable to bank, 4.25%, due June 20, 2033
Unsecured notes payable to bank, 4.90%, due March 6, 2040
Unsecured New Hampshire State Revolving Fund (“SRF”) notes (1)
Unamortized debt issuance costs for defeased obligations,
allowed by regulation

Total
Less current portion
Less unamortized debt issuance costs

Total long-term debt, less current portion
and unamortized debt issuance costs $

200,758

Unamortized
Debt Issuance
Costs
110,970 $ -

4,000 36

20,555 1,614

2,035 272

40,930 2,114

5,215 123

3,332 17

1,505 11

1,250 7

950 5

815 7

602 38

18,284 168

- 111

210,443 $ 4,523
(5,162)
___ 4,523)

(1) SRF notes are due through 2035 at interest rates ranging from 1% to 4.488%, These notes are payable in 120 to 240
consecutive monthly installments of principal and interest. The 1% rate applies to construction projects still in process
until the earlier of (i) the date of substantial completion of the improvements, or (ii) various dates specified in the note
(such earlier date being the interest rate change date). Commencing on the interest rate change date, the interest rate
changes to the lower of (i) the rate as stated in the note or (ii) 80% of the established 11 General Obligations Bond

Index published during the specified time period before the interest rate change date.

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The aggregate principal payment requirements subsequent to December 31, 2017 are as
follows:

(in thousands) Amount

2018 $ 5,576
2019 5,911
2020 6,169
2021 8,450
2022 6,343
2023 and thereafter 175,260
Total $ 207,709

Several of Pennichuck Water’s loan agreements contain a covenant that prevents Pennichuck
Water from declaring dividends if Pennichuck Water does not maintain a minimum net
worth of $4.5 million. As of December 31, 2017 and 2016, Pennichuck Water’s net worth
was $118.0 million and $122.1 million, respectively.

The 2014A, 2014B, 2015A and 2015B bonds were issued under a new bond indenture and
loan and trust agreement, established with the issuance of the 2014 Series Bonds, which
contains 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 Series 2014 bonds. Thereby, the ratio of
Debt to Capital must be equal to or less than 1.0. As of December 31, 2017 and 2016,
Pennichuck Water Works has a Debt to Capital Coverage ratio of 0.5 and 0.5,
respectively.

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 11 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, 2017 and 2016, this coverage
ratio was 0.4 and 0.4, respectively. Also, the ratio of EBITDA to the Max Amount
Due must be equal to or greater than 1.1; as of December 31, 2017 and 2016, this
ratio was 1.5 and 1.8, respectively.

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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,
2017 and 2016, the Rate Covenant coverage ratio was 1.41 and 1.93, respectively.

Pennichuck East’s loan agreement for its unsecured notes payable to a bank of $8.1
million and $8.5 million at December 31, 2017 and 2016, respectively, contains a minimum
debt service coverage ratio requirement of 1.25. At December 31, 2017 and 2016, this ratio
was 0.92 and 1.29, 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, 2017 and 2016, this ratio was 59% and
56%, respectively.

The Company’s revolving credit loan facility with TD Bank contains a covenant that requires
the Company to maintain a minimum fixed charge coverage ratio of at least 1.0; at
December 31 2017 and 2016, the fixed charge coverage ratio was 0.81 and 1.05,
respectively. The Company is also required to maintain an equity capitalization ratio of not
less than 35%; at December 31, 2017 and 2016, the equity capitalization ratio was 34% and
36%, respectively. These covenants have not been met, and TD Bank has waived such
noncompliance.

Under this agreement, the Company is also precluded from declaring or paying dividends, or
making any other payment or distribution of its equity without the bank’s prior written
consent, except for: (1) its obligations under Rate Order No. 25,292 as it pertains to the
Company’s specific obligations under the City Bond Fixed Revenue Requirement
(“CBFRR”) which provides for payments of approximately $707,000 per month of the note
payable to the City of Nashua (the “City”), and quarterly dividends to the City for the
remainder of this annual obligation, as defined by the order; and (2) a specific allowance,
under Rate Order No. 25,292, whereby the Company is allowed to make distributions to the
City from current earnings and profits in excess of the CBFRR, to provide funds to allow the
City to reimburse itself for the costs incurred by the City relating to its efforts in pursuing the
eminent domain proceedings from January 2002 through August 2009; provided, however,
that such amount shall not exceed $500,000 in any fiscal year, or $5,000,000 in the aggre-
gate, of all such distributions. No special dividend was declared or paid in 2017 or 2016.

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Short-term borrowing activity under this revolving credit loan facility for the years ended
December 31, 2017 and 2016 was:

(in thousands) 2017 2016

Established line as of December 31, $ 6,000 $ 10,000
Maximum amount outstanding during period 5,574 1,118
Average amount outstanding during period 228 73
Amount outstanding as of December 31, 5,574 -

Weighted average interest rate during period 3.01% 2.22%
Interest rate as of December 31, 3.10% 2.251%

As of December 31, 2017 and 2016, the Company had a $3.1 million and $3.3 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 $3.1 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, 2017. 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, 2017 and 2016, included in our Consolidated
Balance Sheets under “Other Liabilities and Deferred Credits” as “Derivative instrument” was
$374,000 and $453,000, respectively. Changes in the fair value of this derivative were deferred
in accumulated other comprehensive income (loss).

Swap settlements are recorded in the statement of income (loss) with the hedged item as
interest expense. During the years ended December 31, 2017 and 2016, $76,000 and
$123,000, respectively, was reclassified pre-tax from accumulated other comprehensive
income (loss) to interest expense as a result of swap settlements. The Company expects to
reclassify approximately $109,000, pre-tax, from accumulated other comprehensive income
(loss) to interest expense as a result of swap settlements, over the next twelve months.

Note 10 — Accumulated Other Comprehensive Income
The following table presents changes in accumulated other comprehensive income by

component for the years ended December 31, 2017 and 2016:
Interest Rate Contract

(in thousands) 2017 2016
Beginning balance $ 258 8=6$ 201
Other comprehensive income (loss) before reclassifications 1 (17)

Amounts reclassified from accumulated other

comprehensive income 46 74
Net current period other comprehensive income 47 37
Ending balance $ 305 $ 258

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The following table presents reclassifications out of accumulated other comprehensive
income for the years ended December 31, 2017 and 2016:

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) 2017 2016
Gain (loss) on cash flow hedges

Interest rate contracts $ 77 = § 123 Interest expense

(31) (49) Tax expense

Amounts reclassified from accumulated

other comprehensive income $ 46 $ 74 Net of tax

Note 11 — 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 account-
ing and rate-setting mechanisms were agreed to in the NHPUC Order 25,292 (“PUC Order”)
dated November 23, 2011.

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, 2017 and 2016 was approximately
$109 million and $111 million, respectively, as disclosed in Note 9 to these consolidated
financial statements. During 2017 and 2016, dividends of approximately $279,000 and

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