California Water Service Group (CWT) Q3 2026 Earnings Call Transcript

Operator: Ladies and gentlemen, welcome to the California Water Service Group Q3 2026 earnings call. All lines have been placed on mute to prevent any background noise, and after the speaker's remarks, we will conduct a question and answer session. If you would like to ask a question at that time, please press star then the number one on your telephone keypad to raise your hand and enter the queue. If you would like to withdraw your question at any time, simply press star one again. I will now turn the call over to Jim Lynch. You may begin.

Jim Lynch: Thank you, Colby. Welcome everyone to the third quarter 2026 results call for the California Water Service Group. With me today is Marty Kropelnicki, our Chairman and CEO. Replay of dial information for this call can be found in our quarterly results earnings release, which was issued earlier today. The call replay will be available until December 28th, 2026. As a reminder, before we begin, the company has a slide deck to accompany today's earnings call. The slide deck was furnished with an 8-K and is also available on the company's website at www.calwatergroup.com. Before looking at our third quarter 2026 result, I would like to cover forward-looking statements. During our call, we may make certain forward-looking statements. Because these statements deal with future events, they are subject to various risks and uncertainties, and actual results could differ materially from the company's current expectations. As a result, we strongly advise all current shareholders and interested parties to carefully read the company's disclosures on risks and uncertainties found in our Form 10-K, Form 10-Qs, press releases, and other reports filed with the Securities and Exchange Commission. Now I will turn the call over to Marty.

Marty Kropelnicki: Thanks, Jim. Good morning, everyone, and thank you for joining us today. We are pleased with our continued execution of our 2026 business plan as we are currently three quarters into the year with one quarter to go. There are five major areas that we want to talk about today to provide an update on. First, Jim will give you an update on the financials for the quarter, which include the results of our 2024 general rate case, which rates took effect this year in 2026. Second, we want to talk about our record infrastructure investment that brings us up to just under $425 million year to date, while we continue to balance system needs with affordability. Three, we want to talk about our progress on closing our announced acquisition of the Oregon and Nevada assets that we are acquiring from Nexus Water Group. Yesterday, the board of directors declared our 327th consecutive quarterly dividend, which puts our anticipated dividend for the year at $1.34, which is up 8.1% year-over-year. Finally, I want to take a few moments to talk about emergency preparedness, emergency response. I think as we know, the super El Niño has gotten a lot of press time, and we'll talk about some of the efforts we have underway to prepare for the winter that's coming ahead. Prior to going through some of the other topic items I just outlined, I'm going to turn it over to Jim to talk about the financials for the quarter. Jim?

Jim Lynch: Thanks, Marty. Our third quarter net income was $65.4 million, or $1.05 per diluted share. That compares to $61.2 million or $1.03 per diluted share in the third quarter of 2025. Revenue increased $21 million, or 6.7%, to $332.2 million, compared to $311.2 million last year. The primary revenue drivers included $22.1 million from rate changes and new customers and $3.9 million from changes in the Drought Response Memorandum Account or the DREMA. These increases were partially offset by a $4.4 million reduction related to lower customer water usage. Operating expenses increased $8.9 million or 3.7% to $249.5 million. Water production costs for the third quarter were largely unchanged as wholesale water costs were partially offset by lower customer usage. Other operations expenses increased $4.1 million, primarily driven by a $2.8 million increase in water conservation program expenditures. Income taxes on operating income increased $7.1 million, and that reflects higher pre-tax income and a scheduled reduction in the Tax Cuts and Jobs Act refund or the TCJA refund. We also experienced a $3.9 million decline in gains on our non-qualified benefit plan investment assets. On slide six, you can see the impact of this activity on our change in Q3 diluted earnings per share. Of note, the diluted earnings per share impacts include the issuance of new shares during the quarter through our ATM program to partially fund our ongoing capital investment, our planned acquisition activities, and to pay down balances on our bank lines of credit. I'll discuss this funding in more detail later in the call. Turning to slide seven, year-to-date net income through the end of the third quarter was $125.9 million, or $2.07 per diluted share. This compares to net income of $116.7 million, or $1.96 per diluted share for the same period in 2025. Revenue was $855.3 million, which is an increase of $75.1 million or 9.6% compared to $780.2 million year-to-date in 2025. The primary revenue drivers included rate increases and new customers, which added $51.9 million, interim rates memorandum account revenue which is associated with the California 2024 GRC, which added $15.7 million. Recognition of the remaining deferred Water Revenue Adjustment Mechanism or WRAM revenue, which added $9.9 million and DREMA revenue, which contributed $3.9 million. Operating expenses increased $48.2 million or to $683.6 million or 7.63%, compared to $635 million in 2025. Key contributors to the change included water production costs that increased 14.1% due to higher wholesale water costs, which were partially offset by a lower customer usage. Other operations expense increased $19.9 million, and that increase was primarily due to the recognition of $8.1 million in deferred WRAM costs and higher water conservation program expenses of $5.5 million. In addition, income taxes increased $13.1 million due to higher pre-tax operating income and the scheduled reduction of the TCJA refunds. We also experienced a $3 million decline in gains on our non-qualified benefit plan investment assets year-over-year and an increase in business acquisition expenses related to the two acquisitions Marty just referred to of $4.1 million. On slide eight, you can see the impact of this activity on our change in Q3 year-to-date diluted earnings per share. Looking at our infrastructure investments on slide nine, third quarter CapEx spend was $148 million and year-to-date, we have invested $425 million. Our 10-year compounded annual growth rate of growth capital is hovering right around 11%.

Marty Kropelnicki: Jim, it's probably noteworthy too, as some of you that know California regulation, we have the ability to earn what's called a step increase, in the outbound years of the rate case. So year one of the rate case, you have your new rates and that's 2026. In 2027 and 2028, we have the ability to earn what's called a step increase, but it's subject to an earnings test and that earnings test is based on our ability to get the capital that was pre-approved in the rate case into ground. Given the success of our 2026 capital program, this sets us up very well to capture a big chunk of the $49 million step increase that's available. Obviously, we're closing the quarter now and around November 15th, we will be filing for that step increase. I anticipate that we're going to do very well on that step increase for 2027 rates.

Jim Lynch: Thanks, Marty. You can see in addition to the step rate increase on slide 10, the impact that the growth in our capital investment program is having on our rate base. We are projecting a compounded annual rate base growth of nearly 12%, reaching approximately $3.5 billion by the end of 2028, assuming we complete our planned capital investments on schedule. Overall, we are really pleased with the progress we are making in our capital program and on our future rate base growth opportunity. Moving to slide 11, at quarter end, we had $45.1 million in cash and cash equivalents and $45.8 million in restricted cash. We also had $200 million of available short-term borrowing capacity at Group and $225 million at Cal Water. Those debt borrowing capacity is subject to our credit line borrowing conditions. Regarding our financing activities during the quarter, we raised $49.8 million through our at-the-market equity program. We also entered into forward sales agreements that we can settle up to 12 months from the agreement dates that will generate an additional $77.8 million in net proceeds. At quarter end, we also signed agreements for $125 million in unsecured debt at Group and $150 million in mortgage bonds at Cal Water with maturities that range from 2031-2056. With the long-term debt agreements and equity forward agreements in place, our retained earnings and the equity issuances that we did in Q3, we believe we have the resources necessary now to pay down our existing short-term debt balances and to finance our ongoing initiatives into the first half of 2027, including the acquisitions of the Oregon and Nevada systems. Lastly, recall that Cal Water's current cost of capital decision includes an adjustment mechanism tied to movement in the Moody's Utility Bond Index. The adjustment mechanism was not triggered during the most recent measurement period, and as a result, our current authorized 10.27% return on equity at Cal Water will remain in effect through 2027. In addition, the authorized return on rate base will remain at 7.46% and the authorized capital structure at 53.4% equity and 46.6% debt. With that, I will turn the call back over to Marty.

Marty Kropelnicki: Thanks, Jim. I am on slide 12 of the deck, and I want to provide everyone an update on recent regulatory approvals that support our continued investment in safe, reliable, and affordable water service. There are really three things that happened in the quarter that are noteworthy. First, the Washington UTC approved a $4.1 million revenue increase effective October 1st for our subsidiary company in Washington. In addition, the Hawaii Public Utilities Commission approved a $1.94 million increase for our Kapalua systems in Hawaii. Additionally, during the quarter, the State of California, the California Public Utilities Commission authorized an advice letter process to seek approximately $113 million of capital costs associated with our PFAS program that was driven by the application that was filed for PFAS recovery and an additional $2.5 million in expenses for certain PFAS projects. Going on to slide 13, we continue to advance our PFAS compliance program with approximately $228 million of planned investment. That's a gross planned investment number. I will come back to that in just a minute. The investments will be made in California, New Mexico, and Washington. This includes anticipated treatment and new well construction as well. Through the third quarter, we invested $23.3 million in treatment and well replacement with a total program investment to date totaling $47.5 million. We currently have 65 projects planned, including 18 California sites currently under construction. In addition, I think as many of you know, we have been a very active participant representing the water industry on recovery of costs from the polluters that helped put PFAS and PFOA into the water systems. To date, we have recovered a net $59.4 million in litigation proceeds, and that amount will be used to offset the $228 million. As of right now, if you take the 228 minus the 59.4, you get about $169 million of net rate base addition for the PFAS project. Moving on to slide 14, and I think this is a real important slide, is the company has always had a keen eye on affordability, and we have been able to maintain a 10% compounded annual growth rate on our capital investment line while keeping rates affordable. Affordability, given inflation and what's happening in the U.S. today, as well as it's a pretty hot political topic, we like to show this slide because it shows the company has actually done a really good job at balancing affordability with our maintained 10% compounded annual growth rate on our capital investment line. What this slide really shows is that the median Cal Water bill represents about 0.88% of the median household income. The EPA, Environmental Protection Agency, publishes some guidelines on rate affordability, and water rates that are generally below 2% of an average household income is considered affordable. Here on this slide, we show from 2021, 2022, 2023, 2024, and 2025, how we have been able to keep that rate right around 1% while we continue to grow our asset and rate base. We think that's a very important point and a key cornerstone of our strategy as we balance affordability with the needs of the system. Number of ways we do the balance of affordability, obviously the litigation with the PFAS project is a good example of that. We actively pursue grants. We do invest heavily in conservation programs. Then we try to do a number of things for our customers, including we have a Rate Support Fund. We have a great online tool that if a customer cannot afford to pay the bill, they can spread it out over multiple months and do it through the portal itself. All these things kind of work together in terms of helping us balance affordability with the needs of maintaining safe and reliable water service. Moving on to slide 15. Many of you have seen this slide before. I think it best represents our commitment to our shareholders as it reflects our 59 years of consecutive dividend increases. Obviously, 2027 will be a new year, and as we move into the new year, Jim and I will start our dialogue with our board of directors in looking at what should our dividend be for 2027. Yesterday, our board of directors declared our 327th quarterly dividend at $0.34 a share, and that sets up our indicated dividend for 2026 at $1.34 a share, which is an increase of 8.1% over 2025. Moving on to slide 16. I want to give everyone an update on our strategic initiatives. We continue to advance the Oregon and Nevada acquisitions from Nexus Water Group. The integration planning remains on schedule and within budget. Yesterday, we received approval for our change in control applications from the Oregon Public Utility Commission. This is on top of the approval we received from the Nevada Commission in August. This sets us up to close these acquisitions before the end of the year. Integration planning and cooperation among the two companies has gone very, very well. In fact, I don't think we could ask for a better partner to work on an acquisition with than what we have with Nexus Water Group. We estimate our total integration costs, these will be one-time costs that we incur as we move the assets over and bring them onto our platform, to be between $7 million and $9 million. Part of that will be incurred this year as we're doing all the integration planning and set-up work now, and part of it will be incurred next year as we actually bring them onto our platform and bring them live onto our systems. It's looking very good, as Jim indicated. We got the financing lined up, and we will be working hard to close this out before the end of the year. At BVRT, the consolidated rate case has been returned to the commission for approval with interim rates that still remain in effect. One of the nice things about Texas is you get interim rates while you're waiting for regulatory approval. In addition, the change in control application has been reviewed and is deemed "complete," and sent back to the commission for final approval that we are expecting to get sometime soon. It's not on the docket yet. Texas is a little different to the other states. It can take a little longer to get through the approval process, but the application itself was deemed complete, and now we're just waiting for final approval. In addition, BVRT continues to grow at a very healthy rate. This year to date, we've increased 12% new customers during the third quarter. We are continued happy to see the growth that we're seeing in that Texas corridor, and we expect that will continue well into the new year. Looking at some other highlights during the third quarter, we continued to celebrate and recognize the century of service. On October 14th was our actual 100-year anniversary. October 14th, 1926, our founders acquired the water system in Chico, followed by acquiring the water systems in Visalia and Bakersfield on October 15th. All three of these systems are still owned and operated by California Water Service Group and still growing, which I think is fantastic. We had a number of customer and community outreach events to help celebrate our 100-year anniversary. It's been very well received, and it's been a fun year reflecting on 100 years of service to our customers. During the quarter, we also started providing water service to approximately 400 students at Indianola Elementary School, which is outside our service territory in Selma. They were having a lot of water quality problems, so we built the connection from our system to their school. I think this is a good example of projects we do in the community where we can help a disadvantaged community that does not have access to clean, reliable water by connecting them to our existing system. It helps lower the marginal cost for all the participants, but helps expand the service territory to places where they may not have good quality drinking water. Lastly, I want to take a moment to talk about emergency preparedness and response in light of it being a forecasted super El Niño year. For many of you that know us, Cal Water does spend a lot of time on emergency preparedness and emergency planning. Over the years, we have developed a set of standing operating procedures that we use and work off of, as we prepare for and respond to certain disasters, whether it's a wildfire, whether it's a hurricane, whether it's a flood, whether it's red flag conditions that you'll get down in Southern California with the Santa Ana winds, which you've probably read about the last couple weeks. There's a whole set of policies and procedures that we follow as we deal with these events, and it's really about the preparation behind the event, and then it's about the methodology of responding to the event. For example, we have had three hurricanes in Hawaii, one of which was a direct hit on the island of Kauaʻi in the area of Ni'ihau, which we serve. I am very happy to report that, yes, it was a direct hit. Yes, we had probably a couple million dollars worth of damage. We had no service outages because the team did a good job preparing and responding to the event. Obviously going into an El Niño year, we've spent a lot of time with our field operations, which is led by Michael S. Mares, and he's done a great job making sure everyone's ready, all of our systems are in place, all of our backup generators are working, and we have the extra equipment and tools needed to respond to things that may happen as we go into what is anticipated to be a pretty strong winter for the West Coast. Looking ahead, what to watch for in the fourth quarter. Obviously, the step increase that I mentioned, there's an estimated $49 million in the bucket that's available depending on how well we did on our capital program. I am feeling very comfortable about that, and we will file for that around November 15th. We anticipate the planning of the transaction with Nexus Water before the end of the year. As Jim said, financially things are lined up. The teams are working very well together, and I anticipate that closing before the end of the year. We have a lot of CapEx to get in the ground during the fourth quarter. With the anticipated rains that might come with El Niño, we want to try to accelerate as much CapEx as we can in the fourth quarter, because in the event of heavy rains, it will certainly slow down the capital program as we move into Q1. All the emergency preparedness and emergency response things that we are doing. With that, Colby, that ends the formal part of our presentation. Let's go ahead and open up for Q&A, please.

Operator: Thank you. We will now begin the question and answer session. Again, if you would like to ask a question, please press star then the number one on your telephone keypad to raise your hand and enter the queue. If you would like to withdraw your question at any time, simply press star one again. We will pause just for a moment to compile the Q&A roster.

Marty Kropelnicki: Hey, Colby, while we are waiting for that roster to come in, we just got some news that just came in from the Texas Commission that our rate case decision is on the agenda for approval on November 5th. That literally just came in across the wire. We want to share that information as well.

Operator: Okay. Thank you. Our first question is going to come from Davis Sunderland from Baird. Your line is open.

Davis Sunderland: Good morning, guys.

Marty Kropelnicki: Good morning.

Davis Sunderland: That has got to be the most real-time update I think I have ever heard on a conference call. Congrats on that. That is great news. Maybe two questions from me today, and appreciate the time. Obviously, the pushback against utility rate cases and just this general environment we are in of inflation and heightened focus on affordability has been well covered. I guess on the flip side of that, I wanted to focus a bit more on inflation just impacting expenses for you guys. Specifically, if you could just talk about what you are seeing on the OpEx and CapEx fronts, if there has been any material changes in supply chain or other expense items. I guess I will leave it there for my first question.

Marty Kropelnicki: Yeah. On the supply chain side, obviously, we are not immune to inflationary increases. One of the things I pointed out to our board yesterday when Jim and I were updating them on the financials, we are paying essentially 20%-30% more for fuel year-over-year, and we have almost 1,000 vehicles that we roll on a daily basis. So we have been able to absorb the inflationary increases into our operating budgets. So it is there, it is real. That step increase that we have in California is really important. One of the nice things about California is they do approve the capital in advance, which means it is in the tariff rates, and that is why it is subject to an earnings test. With California being our largest subsidiary, that is why that pot of money is so big, that $49 million. And so, obviously getting that step increase and getting a big piece of that $49 million will go a long way to offset a lot of the inflation that we're seeing in California. I would say we haven't seen anything that's a line item buster when you look at the operating budgets and the line items. But certainly, fuel costs are up, material costs are up. I don't think, from an economist perspective, you've seen the full oil shock effect or the diesel shock effect of what's going to happen to inflation here in the rest of the fourth quarter. If you saw the producer price index, it had its largest increase that it's had since 2022, which that increase in 2022 was driven by really the COVID and the excess government spending on the COVID response. I don't think we're through the worst of it yet, but I will say from a company perspective, we've been able to manage it and work within the budget lines, and generally speaking, the management team at Cal Water does a very good job hitting their budget targets. We're just pivoting and turning and saving where we can, realizing we got to spend more in other areas like fuel.

Jim Lynch: Yeah, I think the other part of your question, Davis, with regards to supplies, we did a really good job during COVID to strengthen our supply chain and to advance purchase certain inventory that was hard to get. We've kept a pretty keen eye on that since. I think we're pretty well positioned relative to our supply chain. It's really a cost issue that Marty was talking about.

Davis Sunderland: That's great perspective. Thank you guys very much. Then maybe, I guess I'll direct the second one to you, Jim, but also, of course, Marty, if you have any thoughts. Just wondering how you guys are thinking about equity and debt needs for 2027 or starting to do the planning process for next year. Obviously, inflation is one thing, but we've also got a higher interest rate environment and I guess linked to one another there. But just wondering how you guys are thinking about the outlook for next year or any other financing considerations. And thank you very much.

Jim Lynch: Yeah, I think we're pretty well set going into the first half of next year. The debt offering that we did, we've not taken yet possession of the proceeds, if you will, and it's not reflected yet in our results, and so it's not included in Q3. It was a really successful offering. We were oversubscribed 6x, 7x, 8x, depending upon where in the structure you're looking at. We got really good spreads on it, with the understanding that T-bills, which the debt is tied to, is higher now than it was this time last year. But we, I think, did a good job in terms of raising the amount that we're going to need into the first half of 2027, maybe into the first three quarters of 2027. From an equity perspective, we have 12 months to draw down on the equity that we raised through the forwards. We're already reflecting the equity that was raised during the Q3 through our results, and that'll continue. So I think we're looking pretty good into Q3 of next year, and then as we go into 2027 and start to put together our capital budgets, we'll assess when we think we might need to be back in the market. But I'm pretty confident that going into the first half of the year, we're pretty well situated, and we're not going to be looking to raise much going forward during that period.

Davis Sunderland: Great stuff. Appreciate it, guys. Thank you very much.

Jim Lynch: Bye, Davis. Thank you.

Operator: Our next question comes from the line of Matvey Tayts with Freedom Broker. Your line is open.

Jim Lynch: Hey, Matt. How are you?

Marty Kropelnicki: Good morning.

Matvey Tayts: Very good. Thank you. Thank you for the call. Strong operating results. Congratulations. The question is just about the CapEx line. I see that with the forecast of $627 million and your actual nine-month result, pretty much left for Q4, which is a bit higher share of nine months. Do you think your plan is still intact, or we can expect some slip into 2027 from what expected? How is it overall going on with the CapEx, if everything is smooth enough? Thank you so much.

Marty Kropelnicki: Yeah. I think the easiest way to think about our CapEx, especially in California, which is 90% of our company, is California. The best way to think about it is really looking at the three-year rate cycle. I say that because capital will get pushed and pulled year to year given a number of issues, one of which I talked about, which is El Niño. Sometimes permits take longer. The permitting process and the CEQA process, which is the environmental review in California, can be very cumbersome. We plan for, as Jim said, that nice 10%-11% growth year over year. We also say capital can be lumpy based on factors that the company can't control, like weather and permitting and so forth. We have a pretty long planned out capital plan. When something slows down, we try to accelerate something else on it. Generally speaking, we do plan for that 10%, 11% growth year over year in trying to anticipate where some of the capital projects may get hung up. There's a very important proposition in California that's on the ballot called Prop 45, which is the Affordable California Act. Cal Water has been a leading company involved in that with the State Chamber of Commerce. If that bill passes, it will essentially expedite the permitting process, which is one of the biggest bottlenecks that we face. Believe it or not, Southern California, which is a very water-constrained area, we've had cases where it's taken us up to almost 10 years just to get permits. If Prop 45 passes, it essentially starts a shot clock when you file for your application. The government agency, whether it's a city or local county or state, have to issue that permit within a certain timeline. Watch Prop 45 because that will be a nice benefit for any utility that does construction in the state of California.

Matvey Tayts: Okay, great. Thank you so much. Yeah, thank you.

Marty Kropelnicki: Thank you. Have a good day.

Operator: Again, if you would like to ask a question, please press star then the number one on your telephone keypad to raise your hand and enter the queue. Our next question comes from Angie Storozynski from Seaport. Your line is open.

Angie Storozynski: Thank you. Okay. A couple of questions. One is that you guys had pretty high unregulated costs. I am actually looking at the year-to-date results. Is it just some sort of an aberration and it is going to get recognized in the unregulated revenues in the fourth quarter?

Jim Lynch: Angie, thanks for the question. The real things driving the unregulated costs are the fact that that is where we are housing our business acquisition expenses. We also have the lower gains than normal that we have recently experienced anyway from our non-qualified investments for our non-qualified benefit plan. Those are kind of the two key drivers in non-operating income that are bringing that number down a bit in terms of net non-regulated income. I think that we are going to have to wait and see if the market rebounds a little bit. You remember we took a pretty good rate shock in Q3 in the bond financing market and what have you. Our fixed income investments did not perform as well as what they were. From an integration standpoint, we will continue to experience costs related to the Nexus acquisition into Q1. To date, we have reported almost $4 million there. Those are temporary and we do recognize that once we get the integration activities behind us, that the acquisition will be accretive for us going forward.

Angie Storozynski: Okay. The other question about your dividend growth, and granted that the board hasn't set the growth rate for next year. But I'm just wondering if there is some sort of a targeted payout ratio, at least a cap on it. I'm just looking at the estimates. You would be approaching 60% in the payout over the next couple of years, and I'm just wondering what's the comfort zone?

Marty Kropelnicki: Yeah. Good question, Angie. Jim and I have started saying this publicly, and this is something really we started doing, I think, over the last 12 months. We've set the floor for the dividend growth at 7%. If you set that as a target that we drive for and then look at, we try to have between a 50% and 60% payout ratio. Recognizing again over a rate case cycle like in California, it's three years. That'll shift around a little bit depending on where you are on the rate case cycle. But, a 50%-60% payout ratio with a 7% growth target is what we plan off of.

Angie Storozynski: Awesome. Thank you.

Marty Kropelnicki: Thank you. Hey Jim, it's probably noteworthy, too, because Angie asked a very good question about where those integration costs are going, and it's going below the. It's in the non-regulated line below the utility line. We were very happy with both approvals we got from Nevada and Oregon with not a whole lot of issues other than the integration cost. We have to bear those by the company. You can't pass those on to customers. There's no stay out provisions in Oregon and Washington are some of the things that you've seen in other states, excuse me. They're very clean approvals that were passed. We're really happy with how those came out with both Oregon and Washington.

Jim Lynch: Absolutely.

Operator: There are no further questions in queue. At this time, I'd like to turn the conference back over to Marty Kropelnicki.

Marty Kropelnicki: Great. Thanks, Colby. Thanks everyone for joining us today. Jim and I are around today. If you have any further questions, feel free to reach out to us. Thank you for your continued interest in the company and we'll look forward to finishing the year strong and being back in touch about the earnings test as well as when we close the Nexus Water Group deal here before the end of the year. Thank you. Everyone have a great day.

Operator: This concludes today's earnings call. You may now disconnect.