Global Water Resources, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Amounts are in U.S. dollars; financial statement figures below are in millions unless stated otherwise.
Business context
Global Water owns and operates water, wastewater, and recycled-water utilities, principally in metropolitan Phoenix, Arizona. It reports one operating segment. At September 30, 2018, it had 41,546 active service connections, up 7.8% year over year; growth reflected organic additions and the May acquisition of Turner Ranches Water and Sanitation Company.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $9.00 | $8.47 | $27.26 | $23.41 |
| Operating income | $2.06 | $2.81 | $7.52 | $5.62 |
| Net income | $0.63 | $1.20 | $3.21 | $1.82 |
| Diluted EPS | $0.03 | $0.06 | $0.16 | $0.09 |
| Operating margin | 22.8% | 33.2% | 27.6% | 24.0% |
Q3 revenue rose 6.2%, but operating income fell 26.8% and net income fell 47.4%. For the first nine months, revenue increased 16.5% and net income increased 76.6%. Nine-month revenue included $2.4 million of ICFA revenue recognized after additional wastewater-plant capacity was completed; this significantly contributed to the year-over-year improvement.
Q3 operating expenses increased to $6.94 million from $5.66 million. General and administrative expense rose 46.2%, principally due to higher deferred-compensation expense tied to the share price, as well as personnel and professional costs. Nine-month operating expenses increased 11.0% to $19.74 million.
Cash flow and liquidity: Nine-month operating cash flow was $10.18 million, compared with $8.28 million. Investing cash outflow was $6.03 million, including $3.40 million of capital expenditures and $2.62 million for the Turner acquisition. Cash and cash equivalents were $20.17 million at September 30, versus $5.25 million at year-end 2017. Current assets were $25.47 million and current liabilities $11.10 million.
Debt and capital: Carrying value of debt and capital leases was approximately $114.6 million; senior secured notes had $115.0 million aggregate principal and a 4.55% blended rate. The company had no borrowings on its $8.0 million revolving facility, which expires April 2020, and reported compliance with debt covenants. The July public offering of 1.72 million shares generated approximately $14.6 million net proceeds. Dividends paid during the first nine months were $4.31 million.
Material changes and notable items
- The ACC’s September 2018 decision phased in reductions to regulated revenues associated with the Tax Cuts and Jobs Act (TCJA). The company estimated annual 2018 reductions of approximately $0.78 million in total, increasing to approximately $1.11 million in 2021. The Q3 and nine-month comparisons included estimated revenue reductions of approximately $0.2 million and $0.6 million, respectively.
- Turner was acquired for $2.8 million in May 2018, adding 963 irrigation connections. Subsequent to quarter-end, Red Rock Utilities was acquired for $6.1 million on October 17, adding more than 1,600 connections.
- The IRS approved an extension, through the end of 2019, for the company’s tax deferral related to the former Valencia utility condemnation. Approximately $3.8 million of related tax liability remained at September 30, 2018.
- Q3 net income was also affected by lower Valencia growth-premium income and higher compensation expense. The company recorded $0.5 million of Valencia earnout income in the first nine months, down from $1.1 million in the comparable period.
Outlook, risks, and contingencies
Management expected 2018 capital expenditures of $4.0 million to $5.0 million and anticipated higher capital expenditures in 2019 to seek deferral of the remaining Valencia-related tax liability. If the required qualifying investment is not made by the applicable deadline, the related tax could be material; management expected capital expenditures to decline in 2020 and beyond if deferral is achieved.
Management stated it expected available cash, the undrawn revolver, and operating cash flows to cover operating needs and its capital plan for at least the next 12 months. This is subject to regulatory recovery, growth, operating costs, weather, and other conditions. The business is seasonal, with demand generally higher in the second and third quarters, and is concentrated in Arizona, where groundwater availability and regulation are material risks.
The ACC’s TCJA-related treatment of accumulated deferred income taxes remained unresolved; the company was to submit a proposal by December 19, 2018. The ACC also adopted amended approaches for taxing construction contributions, with further action possible. The company stated that it knew of no legal proceeding expected to have a material effect. No material change to previously disclosed risk factors was reported beyond TCJA-related uncertainty and the risk of failing to defer the remaining Valencia gain.
On November 8, 2018, the company announced a monthly dividend increase to $0.023861 per share. Future dividends remain subject to board discretion, financial condition, legal requirements, and debt covenants.
Key facts for investors to verify
- Whether recurring utility growth and rates can offset TCJA-related revenue reductions and rising operating costs.
- How much of nine-month revenue and earnings growth is attributable to the $2.4 million ICFA revenue recognition versus ongoing utility operations.
- Whether the company makes sufficient qualifying 2019 investments to defer the remaining approximately $3.8 million Valencia-related tax liability.
- The eventual ACC treatment of deferred taxes and taxable construction contributions, and any resulting effects on customer rates, cash flow, and earnings.
- Post-quarter acquisition integration, financing needs, covenant headroom, and the sustainability of the increased dividend alongside capital spending.