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Note 9 — Income Taxes

The components of the federal and state income tax provision (benefit) as of December 31,
2016 and 2015 were as follows:

(in thousands) 2016 2015
Federal $ 284 $ (79)
State (116) 420
Amortization of investment tax credits (33) (33)
Total $ 135 $ 308
Current $ - $ (1)
Deferred 135 309
Total $ 135 $ 308

The following is a reconciliation between the statutory federal income tax rate and the
effective income tax rate for 2016 and 2015:

2016 2015
Statutory federal rate 34.0% 34.0%
State tax rate, net of federal benefits 5.4% 5.6%
Permanent differences 54.8% -56.8%
Amortization of investment tax credits 3.0% 1.7%
Effective tax rate -12.4% -15.5%

The temporary items that give rise to the net deferred tax liability as of December 31, 2016
and 2015 were as follows:

(in thousands) 2016 2015
Liabilities:
Property-related, net $ 27,599 $ 26,890
Other 563 443
Total liabilities 28,162 27,333
Assets:
Pension accrued liability 1,555 1,426
Net operating loss carryforward 4,480 3,884
Alternative minimum tax credit 476 476
NH Business Enterprise Tax credits 727 369
Other 782 905
8,020 7,060
Less valuation allowance (727) (369)
Total assets 7,293 6,691
Net non-current deferred income tax liability $ 20,869 $ 20,642

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The Company had a federal net operating loss in 2016 and 2015 in the amounts of
approximately $1.6 million and $3.5 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, 2016.

The Company also had a New Hampshire net operating loss in 2016 and 2015 in the amounts
of approximately $2.5 million and $4.4 million, respectively. The New Hampshire tax benefit
of the cumulative net operating loss is approximately $637,000 which begins to expire in
2022, and is included in deferred income taxes in the Consolidated Balance Sheet as of
December 31, 2016.

As of December 31, 2016 and 2015, 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, 2016 and 2015, the Company had New Hampshire Business Enterprise
Tax (““NHBET”) credits of approximately $727,000 and $369,000, respectively. NHBET
credits begin to expire in 2017. 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 $358,000 and $369,000 in the years
ended December 31, 2016 and 2015, respectively.

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 $760,000
and $781,000 as of December 31, 2016 and 2015, 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
retum, 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
2016 and 2015. We incurred $0 and $3,000 of penalties during the years ended December 31,
2016 and 2015, respectively.

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Note 10 — Debt

Long-term debt as of December 31, 2016 and 2015 consisted of the following:

2016
Unamortized
Debt Issuance
(in thousands) Principal Costs
Unsecured note payable to City of Nashua, 5.75%,
due 12/25/2041 $ 110,970 $ -
Unsecured senior note payable due to an insurance company
7.40%, due March 1, 2021 4,000 36
Unsecured Business Finance Authority:
Revenue Bonds (Series 2015A), interest rates from 4.00% to 5.00%,
due January 1, 2046 20,555 1,614
Revenue Bonds (Series 2015B), 5.00%, due January 1, 2046 2,035 272
Revenue Bonds (Series 2014<A), interest rates from 3.00% to 4.125%,
due January 1, 2045 40,930 2,114
Revenue Bonds (Series 2014B), 4.50%, due January 1, 2045 5,215 123
Unsecured notes payable to bank, floating-rate, due March 1, 2030 3,332 17
Unsecured notes payable to bank, 3.62%, due June 20, 2023 1,505 11
Unsecured notes payable to bank, 4.20%, due December 20, 2041 1,250 7
Unsecured notes payable to bank, 4.83%, due December 20, 2041 950 5
Unsecured notes payable to bank, 4.25%, due June 20, 2033 815 7
Unsecured notes payable to bank, 4.90%, due March 6, 2040 602 38
Unsecured New Hampshire State Revolving Fund (“SRF”) notes (1) 18,284 168
Unamortized debt issuance costs for defeased obligations,
allowed by regulation - 111
Total 210,443 $ 4,523
Less current portion (5,162)
Less unamortized debt issuance costs (4,523)
Total long-term debt, net of current portion
and unamortized debt issuance costs $ 200,758

(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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(in thousands)

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 2014), interest rates from 3.00% to 4.125%,
due January 1, 2045
Revenue Bonds (Series 2014B), 4.50%, due January 1, 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, 4.25%, 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, net of current portion
and unamortized debt issuance costs

2015

Unamortized
Debt Issuance
Principal Costs
$ 112,864 -
4,400 44
20,555 1,682
2,035 292
41,885 2,277
5,300 127
3,523 19
1,570 12
848 8
616 40
16,576 138
- 130
210,172 4,769
(4,120)
(4,769)
$ 201,283

(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, 2016 are as
follows:

(in thousands) Amount

2017 $ 5,162
2018 5,422
2019 5,663
2020 5,932
2021 8,208
2022 and thereafter 180,056
Total $ 210,443

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, 2016 and 2015, Pennichuck Water’s net worth
was $122.1 and $124.6 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, 2016 and 2015,
Pennichuck Water Works has a Debt to Capital Coverage ratio of 0.5 and 0.4,
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 12 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, 2016 and 2015, 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, 2016 and 2015, this
ratio was 1.8 and 1.6, 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,
2016 and 2015, the Rate Covenant coverage ratio was 1.93 and 2.10, respectively.

Pennichuck East’s loan agreement for its unsecured notes payable to a bank of $8.5 million
and $6.5 million at December 31, 2016 and 2015, respectively, contains a minimum debt
service coverage ratio requirement of 1.25. At December 31, 2016 and 2015, this ratio was
1.29 and 1.64, respectively. Also, Pennichuck East is required to maintain a maximum ratio
of total debt to total capitalization of 65%; at December 31, 2016 and 2015, this ratio was
56% and 50%, 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, 2016 and 2015, the fixed charge coverage ratio was 1.05 and 1.07, respectively. The
Company is also required to maintain an equity capitalization ratio of not less than 35%; at
December 31, 2016 and 2015, the equity capitalization ratio was 36% and 37%, respectively.

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 2016 or 2015.

Short-term borrowing activity under this revolving credit loan facility for the years ended
December 31, 2016 and 2015 was:

(in thousands) 2016 2015

Established line as of December 31, $ 10,000 $ 10,000
Maximum amount outstanding during period 1,118 229
Average amount outstanding during period 73 1
Amount outstanding as of December 31, - -

Weighted average interest rate during period 2.22% 2.01%
Interest rate as of December 31, 2.251% 1.981%

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As of December 31, 2016 and 2015, the Company had a $3.3 million and $3.5 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 $3.3 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, 2016. 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, 2016 and 2015, included in our Consolidated
Balance Sheets under “Other Liabilities and Deferred Credits” as “Derivative instrument” was
$453,000 and $548,000, 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, 2016 and 2015, $123,000 and
$144,000, 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 11 — Accumulated Other Comprehensive Income

The following table presents changes in accumulated other comprehensive income by
component for the years ended December 31, 2016 and 2015:

Interest Rate Contract

(in thousands) 2016 2015
Beginning balance $ 201 §$ 180
Other comprehensive income
before reclassifications (17) (65)
Amounts reclassified from
accumulated other
comprehensive income 74 86
Net current period other
comprehensive income 357 21
Ending balance $ 258 = §$ 201

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The following table presents reclassifications out of accumulated other comprehensive
income for the years ended December 31, 2016 and 2015:

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) 2016 2015
Gain (loss) on cash flow hedges

Interest rate contracts § 123 § 144 Interest expense

(49) (58) Tax expense

Amounts reclassified from accumulated

other comprehensive income $ 14 § 86 Net of tax

Note 12 — 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, 2016 and 2015 was approximately
$111.0 million and $112.9 million, respectively, as disclosed in Note 10 to these consolidated

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financial statements. During 2016 and 2015, dividends of approximately $280,000 and
$278,000, respectively, were declared and paid to the City. The dividends paid to the City
during 2016 comprised approximately $280,000 of regular quarterly dividends declared and
paid; and no special dividend was declared or paid in 2016. The dividends paid to the City
during 2015 comprised approximately $278,000 of regular quarterly dividends declared and
paid; and no special dividend was declared or paid in 2015.

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, 2016 and 2015, respectively,
approximately $3.1 million and $3.1 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
$2.8 million for the year ended December 31, 2016, and approximately $2.7 million for the
year ended December 31, 2015.

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, 2016 was approximately $79.5 million, reduced by
the non-regulated credit of approximately $4.4 million.

Aggregate amortization expense for the years ended December 31, 2016 and 2015 totaled
approximately $1,884,000 and $1,857,000, respectively.

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The following table represents the total estimated amortization of MARA:

Estimated

Amortization

(in thousands) Expense
2017 $ 1,917
2018 1,958
2019 2,006
2020 2,061
2021 2,119
2022 and thereafter 65,083
Total $ 75,144

Note 13 — Segment Reporting

The Company is comprised of Pennichuck Corporation and its five wholly-owned
subsidiaries, as described in Note 1 to these consolidated financial statements. For the years
ended December 31, 2016 and 2015, and as of those dates, the following financial results
were generated by the segments of the Company:

(in thousands) 2016 2015
Operating Revenues:
Pennichuck Water Works, Inc. $ 30,923 $ 29,677
Pennichuck East Utility, Inc. 7,411 7,229
Pittsfield Aqueduct Company, Inc. 789 761
Subtotal Regulated Segment 39,123 37,667
Water Management Services 3,574 3,171
Other - 2
Total Operating Revenues $ 42,697 §$ 40,840
Depreciation and Amortization Expense:
Pennichuck Water Works, Inc. $ 5,931 §$ 5,629
Pennichuck East Utility, Inc. 1,009 979
Pittsfield Aqueduct Company, Inc. 112 110
Subtotal Regulated Segment 7,052 6,718
Water Management Services ” -
Other (110) (108)
Total Depreciation and Amortization Expense $ 6,942 § 6,610

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