# Global Water Resources, Inc. (GWRS) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Global Water Resources, Inc.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1434728/000143472823000086/gwrs-20221231.htm
Accession: 0001434728-23-000086
Filing date: 2023-03-09
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/GWRS/
All MD&A years: /company/GWRS/mda/
Previous year: /company/GWRS/mda/fy2021/ (FY 2021)
Next year: /company/GWRS/mda/fy2023/ (FY 2023)

ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following management’s discussion and analysis of Global Water Resources, Inc.'s (the "Company", "GWRI", "we", or "us") financial condition and results of operations (“MD&A”) relate to the year ended December 31, 2022 and should be read together with the consolidated financial statements and accompanying notes included in Part II, Item 8 of this report.

Overview

GWRI is a water resource management company that owns, operates, and manages twenty-nine water, wastewater, and recycled water systems in strategically located communities, principally in metropolitan Phoenix and Tucson, Arizona. The Company seeks to deploy an integrated approach, referred to as “Total Water Management." Total Water Management is a comprehensive approach to water utility management that reduces demand on scarce non-renewable water sources and costly renewable water supplies, in a manner that ensures sustainability and greatly benefits communities both environmentally and economically. This approach employs a series of principles and practices that can be tailored to each community:

•Reuse of recycled water, either directly or to non-potable uses, through aquifer recharge, or possibly direct potable reuse in the future;

•Regional planning;

•Use of advanced technology and data;

•Employing respected subject matter experts and retaining thought and application leaders;

•Leading outreach and educational initiatives to ensure all stakeholders including customers, development partners, regulators, and utility staff are knowledgeable on the principles and practices of our Total Water Management approach; and

•Establishing partnerships with communities, developers, and industry stakeholders to gain support of our Total Water Management principles and practices.

COVID-19 Update

Our water and wastewater services are essential services and we intend to continue to provide those services for our customers. We continue to monitor the impact of the COVID-19 pandemic on our business and operations, including how it will impact our customers, employees, suppliers, vendors, and business partners. While the COVID-19 pandemic did not have a material effect on our business operations, results of operations, cash flows, and financial position for the years ended December 31, 2022 and 2021, we are unable to predict the ultimate extent to which our business operations, results of operations, cash flows, and financial position will be impacted by the COVID-19 pandemic. The degree to which the COVID-19 pandemic impacts our business operations, results of operations, cash flows, and financial position will depend on future developments, which are highly uncertain, continuously evolving and cannot be predicted. This includes, but is not limited to, the duration and spread of the COVID-19 pandemic; its severity; the emergence and severity of its variants; the actions to contain the virus or treat its impact, such as the availability and efficacy of vaccines (particularly with respect to emerging strains of the virus) and potential hesitancy to utilize them; general economic factors, such as increased inflation; supply chain constraints; labor supply issues; restrictions on travel and transportation; and how quickly and to what extent normal economic and operating conditions can resume.

Further, our current results and financial condition discussed herein may not be indicative of future operating results and trends. Refer to “Risk Factors” included in Part I, Item 1A of this report for additional risks we face due to the COVID-19 pandemic.

Business Outlook

The trend of positive growth in new connections continued in 2021 and 2022. According to the 2020 U.S. Census Data, the Phoenix metropolitan statistical area (“MSA”) is the 11th largest MSA in the U.S. and had a population of 4.8 million, an increase of 14% over the 4.2 million people reported in the 2010 Census. Metropolitan Phoenix continues to grow due to its comparatively affordable housing, excellent weather, large and growing universities, a diverse employment base, and low taxes. The Employment and Population Statistics Department of the State of Arizona predicts that the Phoenix metropolitan area will have a population of 5.8 million people by 2030 and 6.5 million by 2040. During the twelve months ended December 31, 2022, Arizona’s employment rate increased by 3.1%, ranking the state in the top twenty nationally for job growth.

According to the W.P. Carey School of Business Greater Phoenix Blue Chip Real Estate Consensus Panel (the "Greater Phoenix Blue Chip Panel"), during 2022 the single-family housing market experienced a decline in permits issued with

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approximately 24,600 issued in 2022 as compared to approximately 31,000 issued in 2021. The Greater Phoenix Blue Chip Panel expects the decrease in annual single-family housing permits to continue into 2023 with recovery in 2024. However, according to the Greater Phoenix Blue Chip Panel, the outlook for multi-family activity is expected to be more stable, with 13,700 and 12,300 multi-family housing permits expected for 2023 and 2024, respectively. Despite the general slowdown in housing in the Phoenix metropolitan area primarily due to inflation and increased interest rates, management believes that we are well-positioned to benefit from the growth expected in the Phoenix metropolitan area due to the availability of lots and existing infrastructure in place within our services areas.

Factors Affecting our Results of Operations

Our financial condition and results of operations are influenced by a variety of industry-wide factors, including but not limited to:

•population and community growth;

•economic and environmental utility regulation;

•economic environment;

•the need for infrastructure investment;

•production and treatment costs;

•weather and seasonality; and

•access to and quality of water supply.

The COVID-19 pandemic may impact the degree to which these factors affect our financial condition and results of operations as discussed above under "COVID-19 Update."

We are subject to economic regulation by the state regulator, the ACC. The U.S. federal and state governments also regulate environmental, health and safety, and water quality matters. We continue to execute on our strategy to optimize and focus the Company in order to provide greater value to our customers and shareholders by aiming to deliver predictable financial results, making prudent capital investments, and focusing our efforts on earning an appropriate rate of return on our investments.

Population and Community Growth

Population and community growth in the metropolitan Phoenix area served by our utilities have a direct impact on our earnings. An increase or decrease in our active service connections will affect our revenues and variable expenses in a corresponding manner. As of December 31, 2022, active service connections increased 2,388, or 4.4%, to 56,270 compared to 53,882 active service connections as of December 31, 2021, primarily due to organic growth in our service areas. Approximately 91.0% of the 56,270 active service connections are serviced by our Global Water - Santa Cruz Water Company, Inc. (“Santa Cruz”) and Global Water - Palo Verde Utilities Company, Inc. (“Palo Verde”) utilities as of December 31, 2022.

The graph below presents the historical change in active and total connections for our ongoing operations over the past five years.

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Economic and Environmental Utility Regulation

We are subject to extensive regulation of our rates by the ACC, which is charged with establishing rates based on the provision of reliable service at a reasonable cost while also providing an opportunity to earn a fair rate of return on rate base for investors of utilities. The ACC uses a historical test year to evaluate whether the plant in service is used and useful, to assess whether costs were prudently incurred, and to set “just and reasonable” rates. Rate base is typically the depreciated original cost of the plant in service (net of contributions in aid of construction (“CIAC”) and advances in aid of construction (“AIAC”) which are funds or property provided to a utility under the terms of a main extension agreement, the value of which may be refundable), that has been determined to have been “prudently invested” and “used and useful”, although the reconstruction cost of the utility plant may also be considered in determining the rate base. The ACC also decides on an applicable capital structure based on actual or hypothetical analyses. The ACC determines a “rate of return” on that rate base, which includes the approved capital structure and the actual cost of debt and a fair and reasonable cost of equity based on the ACC's judgment. The overall revenue requirement for rate making purposes is established by multiplying the rate of return by the rate base and adding “prudently” incurred operating expenses for the test year, depreciation, and any applicable pro forma adjustments.

To ensure an optimal combination of access to water and water conservation balanced with a fair rate of return for investors, our water utility operating revenue is based on two components: a fixed fee and a consumption or volumetric fee. For our water utilities, the fixed fee, or “basic service charge,” provides access to water for residential usage and has generally been set at a level to produce approximately 50% of total water revenue. The volumetric fee is based on the total volume of water supplied to a given customer after the minimum number of gallons, if any, covered by the basic service charge, multiplied by a price per gallon set by a tariff approved by the ACC. A discount to the volumetric rate applies for customers that use less than an amount specified by the ACC. For all investor-owned water utilities, the ACC requires the establishment of inverted tier conservation-oriented rates, meaning that the price of water increases as consumption increases. For wastewater utilities, wastewater collection, and treatment can be based on volumetric or fixed fees. Our wastewater utility services are billed based solely on a fixed fee, determined by the size of the water meter installed. Recycled water is sold on a volumetric basis with no fixed fee component.

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We are required to file rate cases with the ACC to obtain approval for a change in rates. Rate cases and other rate-related proceedings can take a year or more to complete. As a result, there is frequently a delay, or regulatory lag, between the time of a capital investment or incurrence of an operating expense increase and when those costs are reflected in rates. We believe it is common industry practice to file for a rate increase every three to five years. Refer to “—Rate Case Activity” below and Note 2 – “Regulatory Decision and Related Accounting and Policy Changes” of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this report for additional information.

Environmental, health and safety, and water quality regulations are complex and change frequently, and they have tended to become more stringent over time. Although it is difficult to project the ultimate costs of complying with pending or future requirements, we do not expect current requirements under current regulation to have a material impact on our operations or financial condition, although it is possible new methods of treating drinking water may be required if additional regulations become effective in the future. As newer or stricter standards are introduced, they could increase our operating expenses. We would generally expect to recover expenses associated with compliance for environmental and health and safety standards through rate increases, but this recovery may be affected by regulatory lag.

Infrastructure Investment

Capital expenditures for infrastructure investment are a component of the rate base on which our regulated utility subsidiaries are allowed to earn an equity rate of return. Capital expenditures for infrastructure provide a basis for earnings growth by expanding our “used and useful” rate base, which is a component of our permitted return on investment and revenue requirement. We are generally able to recover a rate of return on these capital expenditures (return on equity and debt), together with debt service and certain operating costs, through the rates we charge.

We have an established capital improvement plan to make targeted capital investments to repair and replace existing infrastructure as needed, address operating redundancy requirements, improve our overall financial performance and expand our infrastructure in areas where growth is occurring.

Production and Treatment Costs

Our water and wastewater services require significant production resources and therefore result in significant production costs. Although we are permitted to recover these costs through the rates we charge, regulatory lag can decrease our margins and earnings if production costs or other operating expenses increase significantly before we are able to recover them through increased rates. Our most significant costs include labor, chemicals used to treat water and wastewater, and power used to operate pumps and other equipment. Power and chemical costs can be volatile. However, we employ a variety of technologies and methodologies to minimize costs and maximize operational efficiencies.

Cybersecurity Risks

In the regular course of our business, we manage a range of sensitive security, customer, and business systems information. A security breach of our information systems such as theft or the inappropriate release of certain types of information, including confidential customer, employee, financial or system operating information, could have a material adverse impact on our financial condition, results of operations or cash flows. We operate in a highly regulated industry that requires the continued operation of sophisticated information technology systems and network infrastructure. Despite implementation of security measures, our technology systems are vulnerable to disability, failures or unauthorized access. Our facilities, information technology systems and other infrastructure facilities and systems and physical assets could be targets of such unauthorized access. Failures or breaches of our systems could impact the reliability of our systems and also subject us to financial harm. If our technology systems were to fail or be breached and if we are unable to recover in a timely way, we may not be able to fulfill critical business functions and sensitive confidential data could be compromised, which could have a material adverse impact on our financial condition, results of operations or cash flows.

We are subject to laws and rules issued by multiple government agencies concerning safeguarding and maintaining the confidentiality of our security, customer, and business information. The increasing promulgation of rules and standards will increase our compliance costs and our exposure to the potential risk of violations of the standards.

We have experienced, and expect to continue to experience, these types of threats and attempted intrusions. The implementation of additional security measures could increase costs and have a material adverse impact on our financial results. We have obtained cyber insurance to provide coverage for a portion of the losses and damages that may result from a security breach of our information technology systems, but such insurance may not cover the total loss or damage caused

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by a breach. These types of events could also require significant management attention and resources, and could adversely affect Global Water Resources’ reputation with customers and the public.

Weather and Seasonality

Our ability to meet the existing and future water demands of our customers depends on an adequate supply of water. Drought, overuse of sources of water, the protection of threatened species or habitats, or other factors may limit the availability of ground and surface water.

Also, customer usage of water and recycled water is affected by weather conditions, particularly during the summer. Our water systems generally experience higher demand in the summer due to the warmer temperatures and increased usage by customers for irrigation and other outdoor uses. However, summer weather that is cooler or wetter than average generally suppresses customer water demand and can have a downward effect on our operating revenue and operating income. Conversely, when weather conditions are extremely dry, our business may be affected by government-issued drought-related warnings and/or water usage restrictions that would artificially lower customer demand and reduce our operating revenue.

The limited geographic diversity of our service areas makes the results of our operations more sensitive to the effect of local weather extremes. The second and third quarters of the year are generally those in which water services revenue and wastewater services revenues are highest. For additional information and risks associated with weather and seasonality, see “Risk Factors,” included in Part I, Item 1A of this report.

Access to and Quality of Water Supply

In many areas of Arizona (including certain areas that we service), water supplies are limited and, in some cases, current usage rates exceed sustainable levels for certain water resources. We currently rely predominantly (and are likely to continue to rely) on the pumping of groundwater and the generation and delivery of recycled water for non-potable uses to meet future demands in our service areas. At present, groundwater (and recycled water derived from groundwater) is the primary water supply available to us. In addition, regulatory restrictions on the use of groundwater and the development of groundwater wells, lack of available water rights, drought, overuse of local or regional sources of water, protection of threatened species or habitats, or other factors, including climate change, may limit the availability of ground or surface water. Notwithstanding the foregoing, we believe that we have an adequate supply of water to service our current demand and growth for the foreseeable future. For additional information and risks associated with the access to and quality of water supply, see “Risk Factors,” included in Part I, Item 1A of this report.

Rate Case Activity

On July 27, 2022, the ACC issued Rate Decision No. 78644 relating to the Company's recent rate case involving 12 of the Company's regulated utilities, consisting of approximately 96% of the Company's active service connections at the time of the rate case application filing. Pursuant to Rate Decision No. 78644, the ACC approved, among other things, a collective annual revenue requirement increase of approximately $2.2 million (including the acquisition premiums discussed below) based on 2019 test year service connections, and phased-in over approximately two years, as follows:

[[GREPCENT_TABLE]]
[["","Incremental","","Cumulative"],["August 1, 2022","$","1,457,462","","","$","1,457,462"],["January 1, 2023","$","675,814","","","$","2,133,277"],["January 1, 2024","$","98,585","","","$","2,231,861"]]
[[/GREPCENT_TABLE]]

To the extent that the number of active service connections has increased and continues to increase from 2019 levels, the additional revenues may be greater than the amounts set forth above. On the other hand, if active connections decrease or the Company experiences declining usage per customer, the Company may not realize all of the anticipated revenues.

The ACC also approved: (i) the consolidation of water and/or wastewater rates to create economies of scale that are beneficial to all customers when rates are consolidated; (ii) acquisition premiums relating to the Company’s acquisitions of its Red Rock and Turner Ranches utilities, which increase the rate base for such utilities and result in an increase in the annual collective revenue requirement included in the table above; (iii) the Company’s ability to annually adjust rates to flow through changes in property tax expense and/or changes in income tax expense, without the necessity of a rate case proceeding; and (iv) a sustainable water surcharge, which will allow semiannual surcharges to be added to customer bills based on verified costs of new water resources.

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Finally, Rate Decision No. 78644 requires the Company to work with ACC staff and the Residential Utility Consumer Office to prepare a Private Letter Ruling request to the Internal Revenue Service (“IRS”) to clarify whether the failure to eliminate the deferred taxes attributable to assets condemned in a transaction governed by Section 1033 of the Internal Revenue Code ("IRC") would violate the normalization provisions of Section 168(i)(9) of the IRC. If the IRS accepts the request and issues its ruling, a copy must be provided to the ACC. Within 90 days after providing the ruling to the ACC, ACC Staff shall prepare, for ACC consideration, a memorandum and proposed order regarding guidance issued within the Private Letter Ruling. This may result in further action by the ACC, which we are unable to predict due to the uncertainties involved, that could have an adverse impact on our financial condition, results of operations and cash flows.

Refer to Note 2 – “Regulatory Decision and Related Accounting and Policy Changes” of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this report for additional information.

Corporate Transactions

Recent Acquisitions

On April 14, 2022, the Company signed a definitive agreement to acquire Farmers Water Co., an operator of a water utility with service area in Pima County, Arizona. On February 1, 2023, the Company completed the acquisition of Farmers Water Co. Refer to Note 16 - "Subsequent Event" of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this report for additional information.

On January 20, 2022, the Company acquired the assets of Rincon Water Company, Inc., a water utility in Pima County, Arizona. The acquisition added an additional 73 connections and approximately 8.6 square miles of service area at the time of acquisition.

On January 13, 2022, the Company acquired the assets of Twin Hawks Utility, Inc., a water utility in Pinal County, Arizona. The acquisition added an additional 18 connections and approximately 0.5 square miles of service area at the time of acquisition.

On November 3, 2021, the Company completed the stock acquisition by merger of Las Quintas Serenas Water Company, Inc. ("Las Quintas"), an operator of a water utility with service area in Pima County, Arizona, adding. 1,100 connections with approximately 2.5 square miles of service area at the time of acquisition.

On February1, 2023 the Company completed the acquisition of Farmers Water Co., an operator of a water utility with service area in Sahuarita, Arizona and in unincorporated Pima County, Arizona. The acquisition added approximately 3,300 active water connections and 21.5 square miles of service area. Refer to Note 16 - "Subsequent Events" of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this report for additional details.

ACC Tax Docket

On September 20, 2018, the ACC issued Rate Decision No. 76901, which set forth the reductions in revenue for our Santa Cruz, Palo Verde, Greater Tonopah, and Northern Scottsdale utilities due to lower corporate tax rates under the TCJA.  Rate Decision No. 76901 adopted a phase-in approach for the reductions to match the phase-in of our revenue requirement under Rate Decision No. 74364 enacted in February 2014. In 2021, the final year of the phase-in, the aggregate annual reductions in revenue for our Santa Cruz, Palo Verde, Greater Tonopah, and Northern Scottsdale utilities were approximately $415,000, $669,000, $16,000, and $5,000, respectively. The ACC also approved a carrying cost of 4.25% on regulatory liabilities resulting from the difference of the fully phased-in rates to be applied in 2021 versus the years leading up to 2021 (i.e., 2018 through 2020).

On July 27, 2022, the ACC issued Rate Decision No. 78644, which approved an adjustor mechanism for income taxes. The adjustor mechanism permits the Company to flow through potential changes to state and federal income tax rates as well as refund or collect funds related to TCJA. The Company expects any remaining TCJA recovery to be addressed through the income tax adjustor. Refer to Note 2 – “Regulatory Decision and Related Accounting and Policy Changes” of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this report for additional information.

On November 27, 2018, February 20, 2019, February 28, 2019, and January 23, 2020, the ACC adopted orders relating to the funding for income taxes on CIAC and AIAC, which became taxable for our regulated utilities under the TCJA. However, effective January 1, 2021, CIAC and AIAC for regulated water and sewage disposal facility companies are excluded from income under IRC Section 118.

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Stipulated Condemnation of the Operations and Assets of Valencia

On July 14, 2015, the Company closed the stipulated condemnation to transfer the operations and assets of Valencia to the City of Buckeye. Terms of the condemnation were agreed upon through a settlement agreement and stipulated final judgment of condemnation wherein the City of Buckeye acquired all the operations and assets of Valencia and assumed operation of the utility upon close. The City of Buckeye is obligated to pay the Company a growth premium equal to $3,000 for each new water meter installed within Valencia’s prior service areas in the City of Buckeye, for a 20-year period ending December 31, 2034, subject to a maximum payout of $45.0 million over the term of the agreement.

Public Offering of Common Stock

On August 1, 2022, the Company completed a public offering of 1,150,000 shares of common stock at a public offering price of $13.50 per share, which included 150,000 shares issued and sold to the underwriter following the exercise in full of its option to purchase additional shares of common stock. The Company received net proceeds of approximately $14.9 million from the offering after deducting underwriting discounts and commissions and offering expenses paid by the Company.

Segment Reporting

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing operating performance. In consideration of the Financial Accounting Standards Board’s Accounting Standards Codification 280, Segment Reporting, we are not organized around specific products and services, geographic regions, or regulatory environments. We currently operate in one geographic region within the State of Arizona, wherein each operating utility operates within the same regulatory environment.

While we report revenue, disaggregated by service type, on the face of our statement of operations, we do not manage the business based on any performance measure at the individual revenue stream level. We do not have any customers that contribute more than 10% to our revenues or revenue streams. Additionally, the chief operating decision maker uses consolidated financial information to evaluate our performance, which is the same basis on which he communicates our results and performance to our board of directors. It is upon this consolidated basis from which he bases all significant decisions regarding the allocation of our resources on a consolidated level. Based on the information described above and in accordance with the applicable literature, management has concluded that we are currently organized and operated as one operating and reportable segment.

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Comparison of Results of Operations for the Years Ended December 31, 2022 and 2021

The following table summarizes our results of operations for the years ended December 31, 2022 and 2021 (in thousands, except for share amounts):

[[GREPCENT_TABLE]]
[["","For the Year Ended December 31,"],["","2022","","2021"],["Revenues","$","44,728","","","$","41,914"],["Operating expenses","36,909","","","34,935"],["Operating income","7,819","","","6,979"],["Total other expense","(1,379)","","","(2,220)"],["Income before income taxes","6,440","","","4,759"],["Income tax expense","(934)","","","(1,150)"],["Net income","$","5,506","","","$","3,609"],["Basic earnings per common share","$","0.24","","","$","0.16"],["Diluted earnings per common share","$","0.24","","","$","0.16"]]
[[/GREPCENT_TABLE]]

Revenues – The following table summarizes our revenues for the years ended December 31, 2022 and 2021 (in thousands):

[[GREPCENT_TABLE]]
[["","For the Year Ended December 31,"],["","2022","","2021"],["Water services","$","20,885","","","$","18,944"],["Wastewater and recycled water services","23,843","","","22,241"],["Unregulated revenues","\u2014","","","729"],["Total revenues","$","44,728","","","$","41,914"]]
[[/GREPCENT_TABLE]]

Total revenues increased $2.8 million, or 6.7%, to $44.7 million for the year ended December 31, 2022 compared to $41.9 million for the year ended December 31, 2021. The increase in revenue reflects the 4.4% increase in active service connections due to organic growth, combined with new connections associated with the acquisition of Las Quintas Serenas in November 2021, as well as the increase in rates related to Rate Decision No. 78644. The increase in revenue was partially offset by the ICFA revenue recognized in 2021 that did not recur in 2022.

Water Services – Water services revenue increased $1.9 million, or 10.2%, to $20.9 million for the year ended December 31, 2022 compared to $18.9 million for the year ended December 31, 2021. The increase in water services revenue was primarily related to organic growth in connections, the acquisition of Las Quintas Serenas, and an increase in rates related to Rate Decision No. 78644.

Water services revenue based on consumption increased $0.6 million, or 7.3%, to $9.2 million for the year ended December 31, 2022 compared to $8.6 million for the year ended December 31, 2021. The increase was primarily driven by the acquisition of Las Quintas Serenas, growth in connections and an increase in rates related to Rate Decision No. 78644.

Active water connections increased 4.4% to 29,855 as of December 31, 2022 from 28,594 as of December 31, 2021, primarily due to organic growth in our service areas.

Water consumption increased 7.8% to 3.5 billion gallons for the year ended December 31, 2022, compared to 3.2 billion gallons for the year ended December 31, 2021. The increase in water consumption was primarily due to organic growth in our service areas combined with new connections associated with the acquisition of Las Quintas Serenas.

Water services revenue associated with the basic service charge, excluding miscellaneous charges, increased $1.2 million, or 11.9%, to $11.1 million for the year ended December 31, 2022 compared to $9.9 million for the year ended December 31, 2021. The increase was primarily due to the increase in active service connections, which included organic growth combined with new connections associated with the acquisition of Las Quintas, as well as an increase in rates due to Rate Decision No. 78644.

Wastewater and Recycled Water Services – Wastewater and recycled water services revenue increased $1.6 million, or 7.2%, for the year ended December 31, 2022 compared to the year ended December 31, 2021. The increase in wastewater and recycled water services revenue was primarily driven by a $1.5 million increase in wastewater services revenue. The increase in

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wastewater services revenue reflects the increase in active wastewater connections, which increased 4.5% to 26,415 as of December 31, 2022 from 25,288 as of December 31, 2021, combined with an increase in rates due to Rate Decision No. 78644.

Recycled water services revenue, which is based on the number of gallons delivered, increased by approximately $0.1 million or 9.7%, to $1.2 million for the year ended December 31, 2022 compared to $1.1 million for the year ended December 31, 2021. The increase in recycled water services revenue was primarily driven by the increase in number of gallons consumed combined with an increase in rates due to Rate Decision No. 78644. The volume of recycled water delivered increased 44 million gallons, or 6.4%, to 727 million gallons for the year ended December 31, 2022 compared to 683 million gallons for the year ended December 31, 2021.

Operating Expenses – The following table summarizes our operating expenses for the year ended December 31, 2022 and 2021 (in thousands):

[[GREPCENT_TABLE]]
[["","For the Year Ended December 31,"],["","2022","","2021"],["Operations and maintenance","$","10,889","","","$","10,299"],["General and administrative","16,130","","","15,146"],["Depreciation","9,890","","","9,490"],["Total operating expenses","$","36,909","","","$","34,935"]]
[[/GREPCENT_TABLE]]

Operations and Maintenance – Operations and maintenance costs, consisting of personnel costs, production costs (primarily chemicals and purchased electrical power), maintenance costs, and property tax, increased $0.6 million, or 5.7%, for the year ended December 31, 2022 compared to the year ended December 31, 2021.

Total personnel expenses increased $0.1 million, or 2.0%, to $3.5 million for the year ended December 31, 2022 compared to $3.4 million for the year ended December 31, 2021. The increase in personnel expenses was primarily related salary and wage increases, partially offset by lower medical expenses.

Utilities power and related expenses increased $0.3 million, or 13.3%, to $2.3 million for the year ended December 31, 2022 compared to $2.0 million for the year ended December 31, 2021. The increase was attributable to higher electric utility expense due to increased pump usage from additional connections and escalated consumption.

Contract services increased $0.2 million, or 14.4%, to $1.4 million for the year ended December 31, 2022 compared to $1.2 million for the year ended December 31, 2021. The increase was primarily due to increased costs for billing software related to the additional connections year over year.

General and Administrative – General and administrative costs include the day-to-day expenses of office operations, personnel costs, legal and other professional fees, insurance, rent, and regulatory fees. These costs increased $1.0 million, or 6.5%, for the year ended December 31, 2022 compared to the year ended December 31, 2021.

Personnel related costs increased $0.4 million, or 7.0%, to $6.4 million for the year ended December 31, 2022 compared to $5.9 million for the year ended December 31, 2021. The increase was primarily related salary and wage increases, partially offset by lower medical expenses.

Deferred compensation expense decreased $1.0 million, or 39.0%, to $1.6 million for the year ended December 31, 2022 compared to $2.6 million for the year ended December 31, 2021. The decrease was primarily due to the impact of the change in our stock price, used in the valuation of options that are accounted for as liability awards, where our stock price decreased during the year ended December 31, 2022 as compared to an overall increase in stock price during the year ended December 31, 2021. Refer to Note 14 — “Deferred Compensation Awards” of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this report for additional information.

Board compensation expense decreased $0.4 million, or 50.4%, to $0.3 million for the year ended December 31, 2022 compared to $0.7 million for the year ended December 31, 2021. The decrease was primarily due to the decrease in our stock price during the year ended December 31, 2022 compared to the year ended December 31, 2021.

Regulatory expense increased $0.3 million, or 20.3%, to $0.4 million for the year ended December 31, 2022 compared to $0.1 million for the year ended December 31, 2021. The increase is primarily related to expenses incurred relating to the rate case activity during 2022.

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Rent expenses increased $0.1 million, or 67.8%, to $0.3 million for the year ended December 31, 2022 compared to $0.2 million for the year ended December 31, 2021. The increase was primarily related to a new corporate office lease agreement that commenced May 2022.

Professional fees expenses increased $0.6 million, or 30.2%, to $2.6 million for the year ended December 31, 2022 compared to $2.0 million for the year ended December 31, 2021. The increase was primarily related to legal fees incurred in connection with the rate case and acquisition related matters.

Depreciation and amortization - Depreciation and amortization expense increased $0.4 million, or 4.2%, to $9.9 million for the year ended December 31, 2022, compared to $9.5 million for the year ended December 31, 2021. The increase was primarily driven by increased depreciation due to the increase in fixed assets, partially offset by a reduction in amortization of intangible assets.

Other Expense – Other expense totaled $1.4 million for the year ended December 31, 2022 compared to $2.2 million for the year ended December 31, 2021. The improvement of $0.8 million in other expense was related to the $1.1 million increase in income associated with Buckeye growth premiums, as a result of increased meter connections in the area, combined with a decrease in interest expense of $1.2 million primarily attributable to an increase in capitalized interest for the year ended December 31, 2021. This was partially offset by $1.5 million of income recognized on the sale of a wireless communication tower in 2021 that did not recur in 2022.

Income Tax Expense – Income tax expense of $0.9 million was recorded for the year ended December 31, 2022 compared to $1.2 million for the year ended December 31, 2021. The decrease was primarily driven by the 2017 TCJA reversal of approximately $0.7 million, offset by an increase in pre-tax net income for the year ended December 31, 2022.

Net Income – Our net income totaled $5.5 million for the year ended December 31, 2022 compared to net income of $3.6 million for the year ended December 31, 2021. The $1.9 million increase was primarily attributable to organic growth, the acquisition of Las Quintas Serenas in November 2021, the recognition of approximately $0.5 million in allowance for funds used during construction ("AFUDC"), offset by an increase in operational expenses of approximately $0.6 million and an increase in approximately $1.0 million in general and administrative expenses, primarily driven by personnel related costs and increased regulatory expenses incurred due to rate case activity during 2022.

Outstanding Share Data

As of March 8, 2023, there were 23,871,046 shares of our common stock outstanding and stock based awards to acquire an additional 517,980 shares of our common stock outstanding.

Liquidity and Capital Resources

Our capital resources are provided by internally generated cash flows from operations as well as debt and equity financing. Additionally, our regulated utility subsidiaries receive advances and contributions from customers, home builders, and real estate developers to partially fund construction necessary to extend service to new areas. We use our capital resources to:

•fund operating costs;

•fund capital requirements, including construction expenditures;

•pay dividends;

•fund acquisitions;

•make debt and interest payments; and

•invest in new and existing ventures.

Our utility subsidiaries operate in rate-regulated environments in which the amount of new investment recovery may be limited. Such recovery will take place over an extended period of time because recovery through rate increases is subject to regulatory lag.

As of December 31, 2022, we have no notable near-term cash expenditures, other than the principal payments for our Series B senior secured notes in the amount of $1.9 million due in each of June and December of 2023. While specific facts and circumstances could change, we believe that we have sufficient cash on hand, the ability to draw on our $15.0 million revolving line of credit (which reflects the increased borrowing amount under this recently amended facility as discussed below), and will be able to generate sufficient cash flows to meet our operating cash flow requirements and capital expenditure plan, as well as remain in compliance with our debt covenants, for the next twelve months and beyond.

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In March 2014, we initiated a dividend program to declare and pay a monthly dividend. On November 30, 2022, we announced a monthly dividend increase from $0.02458 per share ($0.29496 per share annually) to $0.02483 per share ($0.29796 per share annually). Although we expect monthly dividends will be declared and paid for the foreseeable future, the declaration of any dividends is at the discretion of our board of directors and is subject to legal requirements and debt service ratio covenant requirements (refer to “—Senior Secured Notes" and "—Revolving Credit Line").

Cash from Operating Activities

Cash flows provided by operating activities are used for operating needs and to meet capital expenditure requirements. Our future cash flows from operating activities will be affected by economic utility regulation, infrastructure investment, growth in service connections, customer usage of water, compliance with environmental health and safety standards, production costs, weather, and seasonality.

For the year ended December 31, 2022, our net cash provided by operating activities totaled $23.3 million compared to $20.4 million for the year ended December 31, 2021. The $3.0 million increase in cash from operating activities was primarily driven by the improvement in net income for the year ended December 31, 2022 compared to the year ended December 31, 2021.

Cash from Investing Activities

Our net cash used in investing activities totaled $34.2 million for the year ended December 31, 2022 compared to $20.3 million for the year ended December 31, 2021. The $13.9 million increase in cash used in investing activities was primarily driven by the increase in capital expenditures of $15.7 million, offset by a decrease of approximately $1.9 million in cash paid for acquisitions for the year ended December 31, 2022 compared to the year ended December 31, 2021.

We continue to invest capital prudently in our existing, core service areas where we are able to deploy our Total Water Management model as this includes any required maintenance capital expenditures and the construction of new water and wastewater treatment and delivery facilities. Our projected capital expenditures and other investments are subject to periodic review and revision to reflect changes in economic conditions and other factors. As a result, we may reduce capital expenditures to correspond with any decreases in demand for housing in our service areas.

Cash from Financing Activities

Our net cash provided by financing activities totaled $5.0 million for the year ended December 31, 2022, a $12.9 million change as compared to the $7.9 million in cash used in financing activities for the year ended December 31, 2021. This change was primarily driven by the $14.9 million in net proceeds received from our public offering of common stock in August 2022, partially offset by a $1.9 million principal payment for our Series B senior secured notes for the year ended December 31, 2022.

Senior Secured Notes

On June 24, 2016, we issued two series of senior secured notes with a total principal balance of $115.0 million at a blended interest rate of 4.55%. Series A carries a principal balance of $28.8 million and bears an interest rate of 4.38% over a twelve-year term, with the principal payment due on June 15, 2028. Series B carries a principal balance of $86.3 million and bears an interest rate of 4.58% over a 20-year term. Series B was interest only for the first five years, with $1.9 million principal payments paid semiannually thereafter beginning December 2021. The proceeds of the senior secured notes were primarily used to refinance our long-term tax exempt bonds, pursuant to an early redemption option at 103%, plus accrued interest, as a result of the initial public offering of our common stock in May 2016.

The senior secured notes require the Company to maintain a debt service coverage ratio of consolidated EBITDA to consolidated debt service of at least 1.10 to 1.00. Consolidated EBITDA is calculated as net income plus depreciation and amortization, taxes, interest, and other non-cash charges net of non-cash income. Consolidated debt service is calculated as interest expense, principal payments, and dividend or stock repurchases. The senior secured notes also contain a provision limiting the payment of dividends if the Company falls below a ratio of 1.25. However, for the quarter ended June 30, 2021 through the quarter ending March 31, 2024, the debt service ratio drops to 1.20. The debt service ratio increases to 1.25 for any fiscal quarter during the period from and after June 30, 2024. As of December 31, 2022, the Company was in compliance with its financial debt covenants.

Debt issuance costs as of both December 31, 2022 and 2021 were $0.5 million.

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Revolving Credit Line

On April 30, 2020, the Company entered into an agreement with The Northern Trust Company, an Illinois banking corporation (the “Northern Trust Loan Agreement”), for a two-year revolving line of credit initially up to $10.0 million with an initial maturity date of April 30, 2022. This credit facility, which may be used to refinance existing indebtedness, to acquire assets to use in and/or expand the Company’s business, and for general corporate purposes, initially bore an interest rate equal to the London Interbank Offered Rate (LIBOR) plus 2.00% and has no unused line fee. This credit facility replaced the previous revolving line of credit with MidFirst Bank, which was terminated in April 2020. As of December 31, 2022, we had no outstanding borrowings under this credit line.

On April 30, 2021, the Company and The Northern Trust Company entered into an amendment to the Northern Trust Loan Agreement pursuant to which, among other things, the maturity date for the revolving line of credit was extended to April 30, 2024.

On July 26, 2022, the Company and The Northern Trust Company entered into a second amendment to the Northern Trust Loan Agreement, which, among other things, further extended the maturity date for the revolving line of credit to July 1, 2024, increased the maximum principal amount available for borrowing to $15.0 million and replaced the LIBOR interest rate provisions. Refer to Note 1 – “Basis of Presentation, Corporate Transactions, Significant Accounting Policies, and Recent Accounting Pronouncements - Corporate Transactions - Revolving Line of Credit" of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this report for additional information.

Similar to the senior secured notes, the Northern Trust Loan Agreement requires the Company to maintain a debt service coverage ratio of consolidated EBITDA to consolidated debt service of at least 1.10 to 1.00. The Northern Trust Loan Agreement also contains a provision limiting the payment of dividends if the Company falls below a debt service ratio of 1.25. However, for the quarter ended June 30, 2021 through the quarter ending March 31, 2024, the debt service ratio drops to 1.20. Additionally, the Northern Trust Loan Agreement contains certain restrictive covenants that limit, among other things, the Company’s ability to: create liens and other encumbrances; incur additional indebtedness; merge, liquidate or consolidate with another entity; dispose of or transfer assets; make distributions or other restricted payments (including dividends); engage in certain affiliate transactions; and change the nature of the business. The foregoing covenants are subject to various qualifications and limitations as set forth in the Northern Trust Loan Agreement. Pursuant to the Northern Trust Loan Agreement, the revolving credit facility is subject to certain customary events of default after which the revolving credit facility could be declared due and payable if not cured within the grace period or, in certain circumstances, could be declared due and payable immediately. Refer to Note 11 — "Debt" of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this report for additional information. As of December 31, 2022, the Company was in compliance with its financial debt covenants.

As of December 31, 2022, the Company had no outstanding borrowings under this credit line with The Northern Trust Company. The Company incurred $0 and $95,000 in debt issuance costs relating to the Northern Trust Loan Agreement as of December 31, 2022 and December 31, 2021, respectively.

Financing Activity

On August 1, 2022, the Company completed a public offering of 1,150,000 shares of common stock at a public offering price of $13.50 per share, which included 150,000 shares issued and sold to the underwriter following the exercise in full of its option to purchase additional shares of common stock. The Company received net proceeds of approximately $14.9 million from the offering after deducting underwriting discounts and commissions and offering expenses paid by the Company.

Contractual Obligations

In the course of normal business activities, the Company enters into a variety of contractual obligations and commitments. Some result in direct obligations on the Company's balance sheet while others are firm commitments or commitments based on uncertainties and undetermined execution times.

The following table summarizes our contractual cash obligations as of December 31, 2022 (in thousands):

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(1) Interest on the long-term debt is based on the fixed rates of the Company’s senior secured notes.

(2) In addition to these obligations, the Company pays annual refunds on AIAC over a specific period of time based on operating revenues generated from developer-installed infrastructure. The refund amounts are considered an investment in infrastructure and eligible for inclusion in future rate base. These refund amounts are not included in the above table because the refund amounts and timing are dependent upon several variables, including new customer connections, customer consumption levels, and future rate increases, which cannot be accurately estimated. Portions of these refund amounts are payable annually over the next two decades, and amounts not paid by the contract expiration dates become nonrefundable and are transferred to CIAC.

Insurance Coverage

We carry various property, casualty, and financial insurance policies with limits, deductibles, and exclusions consistent with industry standards. However, insurance coverage may not be adequate or available to cover unanticipated losses or claims. We are self-insured to the extent that losses are within the policy deductible or exceed the amount of insurance maintained. Such losses could have a material adverse effect on our short-term and long-term financial condition and the results of operations and cash flows.

Critical Accounting Policies, Judgments, and Estimates

The application of critical accounting policies is particularly important to our financial condition and results of operations and provides a framework for management to make significant estimates, assumptions, and other judgments. Additionally, our financial condition, results of operations, and cash flow are impacted by the methods, assumptions, and estimates used in the application of critical accounting policies. Although our management believes that these estimates, assumptions, and other judgments are appropriate, they relate to matters that are inherently uncertain and that may change in subsequent periods. Accordingly, changes in the estimates, assumptions, and other judgments applied to these accounting policies could have a significant impact on our financial condition and results of operations as reflected in our financial statements.

Accounting for Rate Regulation

Because the Company’s subsidiaries are regulated businesses, the Company is subject to the authoritative guidance for accounting for the effects of certain types of regulation. Application of this guidance requires accounting for certain transactions in accordance with regulations adopted by the ACC. Utility companies defer costs and credits on the balance sheet as regulatory assets and liabilities when it is probable that those costs and credits will be recognized in the ratemaking process in a period different from the period in which they would have been reflected in income by an unregulated company. These deferred regulatory assets and liabilities are then reflected in the income statement in the period in which the same amounts are reflected in the rates charged for service.

When our regulated subsidiaries file rate cases, their capital assets, operating costs and other matters are subject to review, and disallowances may occur, and the Company may be required to write-off related regulatory assets that are not specifically recoverable and determine if other assets might be impaired. See Note 2 – “Regulatory Decision

and Related Accounting and Policy Changes” of the Notes to the Consolidated Financial Statements included in Part II,

Item 8 of this report for more information regarding our rate proceedings. Management continually evaluates the anticipated recovery, settlement or refund of regulatory assets, liabilities, and revenues subject to refund and provides for allowances and/or reserves that it believes to be necessary. In the event that management’s assessment as to the probability of the inclusion in the ratemaking process is incorrect, the associated regulatory asset or liability will be adjusted to reflect the change in assessment or the impact of regulatory approval of rates.

Income Taxes

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Estimation of income taxes includes an evaluation of the recoverability of deferred tax assets based on an assessment of the Company’s ability to utilize the underlying future tax deductions against future taxable income before they expire. The Company’s assessment is based upon existing tax laws and estimates of future taxable income. If the assessment of the Company’s ability to utilize the underlying future tax deductions changes, the Company would be required to recognize fewer of the tax deductions as assets, which would increase the income tax expense in the period in which the determination is made. Additionally, an evaluation of the recoverability of deferred tax gains is based on an assessment of the Company's ability to fully utilize the deferred tax gain before it expires. The Company's assessment is based upon the ability to acquire qualifying properties. If the assessment of the Company's ability to fully utilize the deferred tax gain changes, the Company would be required to recognize income tax expense in the period in which the deferred tax gain expires.

Recent Accounting Pronouncements

A discussion of recently issued and recently issued but not yet adopted accounting pronouncements is included in Note 1 – “Basis of Presentation, Corporate Transactions, Significant Accounting Policies, and Recent Accounting Pronouncements - Corporate Transactions - Revolving Line of Credit" of the Notes to the Consolidated Financial Statements included in Part II, Item 8 of this report and is incorporated herein by reference.

Off Balance Sheet Arrangements

As of December 31, 2022 and 2021, we did not have any off-balance sheet arrangements.