California Water Service Group Q3 FY2022 Earnings Call

Hello, and thank you for joining. My name is Regina, and I will be your conference operator today. I would like to welcome everyone to the California Water Service Group Third Quarter 2022 Earnings Conference Call. I will now turn the conference over to David Healey, Vice President, Corporate Controller. Please proceed.

Thank you, Regina. Welcome, everyone, to the 2022 Third Quarter Earnings Results Call for California Water Service Group. With me today is Marty Kropelnicki, our President and CEO; Tom Smegal, our Vice President, Chief Financial Officer; Paul Townsley, Vice President, Corporate Development; and Greg Milleman, Vice President, Rates and Regulatory Affairs. Replay dial-in information for this call can be found in our third quarter earnings release, which was issued earlier today. The replay will be available until December 26, 2022. As a reminder, before we begin, the company has a slide deck to accompany the earnings call this quarter. The slide deck was furnished with an 8-K this morning and is also available at the company's website at www.calwatergroup.com. Before looking at this quarter's results, we'd like to take a few moments to cover forward-looking statements. During the course of the call, the company 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. Because of this, the company strongly advises all current shareholders as well as interested parties to carefully read and understand the company's disclosures on risks and uncertainties found in our Form 10-K, Form 10-Q, press releases, and other reports filed from time to time with the Securities and Exchange Commission. I'm going to pass it over to Tom to begin.

Thank you, Dave, and welcome, everyone, to our third quarter earnings call. All of our presenters will reference the slide deck with page numbers, so you can follow along, and I believe the webcast slides will match our presentation. I'll begin on Page 5 of the slide deck with a quick summary of our third quarter financial results. Our operating revenue increased by $9.6 million, or 3.7%. Our operating expenses rose by $15.8 million, or 8.5%. Consequently, our net income fell by $6.5 million, or 10.5%, and our earnings per share decreased by $0.17 from $1.20 to $1.03. I want to point out that our CapEx increased this quarter from $69.2 million to $77.5 million. On Slide 6, we can see our year-to-date financial results. Our net income is down $21.2 million year-to-date, which translates to a $0.50 reduction in earnings per share. Turning to Slide 7 for more details on the quarter, we've previously discussed our unbilled revenue and the valuation changes of our nonqualified plan assets. This quarter, we experienced an increase in our unbilled revenue accrual, primarily because the accrual was very low last quarter. However, we continued to see a decline in the mark-to-market valuation of our nonqualified plan assets, resulting in a $2 million change. Operating expenses increased mainly due to inflationary pressures, with wage increases and rising costs for goods and services. We also noted some volatility in our uninsured loss expense, which rose this quarter, as well as an increase in our reserve for bad debt compared to Q3 of 2021. For the year-to-date, the primary drivers of the changes in earnings relate to unbilled revenue and the valuation changes of our nonqualified plan assets. Out of the $21.2 million decline in net income attributable to CWT, $9.4 million was due to unbilled revenue reduction, and $11.4 million was related to planned assets. We anticipate that unbilled revenue will normalize by the end of the year, with fluctuations expected to be no more than plus or minus $2 million. I want to highlight that our financing program has been very successful. We issued 470,000 shares during Q3 and 2.2 million shares over the past 12 months through our ATM programs, and we're pleased with those results. Moving on to our regulatory affairs, particularly in California, on Slide 11, I will provide an update on the California cost of capital case. There has been no update from the administrative law judge during the quarter. As previous participants in our calls are aware, the case was submitted in June, and all parties have completed their testimony and documentation. We are currently waiting for the administrative law judge's proposed decision and the commission's decision. The timeline is getting tight; for the CPUC to issue a final decision this year, we would likely need a proposed decision from the judge within the next two and a half weeks, as the commission's voting schedule in December is light due to the holidays. If a proposed decision comes after November 15, it’s unlikely we will receive a final decision in 2022. Due to the delay in issuing a decision, many analysts have been focused on rising interest rates in the economy. Since we submitted our case, we cannot determine how the commission will evaluate these changes. While the June testimonies included evidence of inflation and interest rate changes up to that time, we are uncertain about potential impacts and whether the water cost of capital adjustment mechanism would be triggered based on the case outcome. Importantly, given our financing program, the proposed cost of debt in our application was significantly lower than the last adopted cost of debt. This will result in approximately an $11 million reduction in debt cost when the case is ultimately decided, which we expect will be passed on to customers. However, we do not yet know the timing for the effective date of a decision, and we have not reserved for that amount or any other amounts related to potential outcomes of the cost of capital case. Now, I'll turn it over to Greg Milleman for Slide 12 to provide an update on our general rate case.

Thank you, Tom. As you can see a lot on the slide already, we did reach a settlement with the public advocates office primarily on non-revenue items that was filed with the commission. The case is now in the hands of the ALJ to write the decision, but it's unlikely we will get that decision before the end of this year. Because of that, we plan to file for interim rates in the fourth quarter to be effective January 2023. Those rates are subject to refund and will be trued up based on the final outcome in the decision. Moving to Slide 13 with a focus on decoupling. A significant change for Cal Water starting in 2023 is the loss of the mechanism to decouple sales from revenue known as the RAM. The bad end, the settlement with public advocates reduces our revenue volatility and has realistic water production costs. Further, in the event that the drought persists, the commission has the mechanism that allows water companies without sufficient resources to track lost revenues and lost revenues due to the drought in a memorandum account for potential future recovery. So we'll be filing to open that as well before the end of the year. And then with that, I'll turn it over to you, Marty.

Great. Thanks, Greg. I want to highlight some significant news from the end of the quarter on September 30, when Governor Newsom signed California Senate Bill 1469 into law. This bill, which we worked on over the past couple of years, was largely unopposed and represents a major victory for our water industry in California. While the bill does not require decoupling, it clearly expresses the legislature's intent for Class A water corporations to create revenue adjustment mechanisms that allow for full decoupling of sales and revenue to encourage conservation. We collaborated with other major water companies in California on this legislation, and it was gratifying to see the governor sign it into law. Following that, on the 21st, the CPUC filed a motion with the California Supreme Court to dismiss our court case regarding decoupling. It’s important to note that our case is not primarily about the decision to eliminate the pilot decoupling program. Instead, it's focused on the lack of due process, as the commission failed to follow its own protocols when making that decision. We believe this affected our ability to present adequate information for an informed decision regarding decoupling. While the CPUC is attempting to have our case dismissed, we still believe that the case will proceed since the court accepted our argument concerning due process. In summary, we achieved a significant win with Senate Bill 1469, and we are continuing our court case concerning due process. Now, looking at the drought, in 2021 the Governor declared a drought emergency, which allowed us to create a memo account to track additional costs associated with our drought response. For Q3, our drought-related expenses were approximately $400,000, bringing the total in the memo account to about $1.4 million since its inception. We plan to seek recovery for these expenses in the future. On the conservation front, customer usage in California has decreased by about 19% in Q3 compared to our projected figures, a decline of 7% compared to 2021. Earlier this week, we reported that average consumption in September dropped by about 10%. Notably, specific districts reported significant decreases: Westlake's consumption was down 36.6%, Palos Verdes saw a 25% reduction, and Los Altos experienced a 26% drop in September. This reinforces the importance of decoupling. Due to the consumption declines and our drought response program, our decoupling account now sits at $94.8 million, which we will be looking to recover in the future. Looking ahead at the NOAA forecast for fall and winter, they predict warmer conditions, potentially leading to reduced snowfall and rainfall. While we remain optimistic for a wetter winter, the current indicators suggest otherwise, making decoupling mechanisms even more crucial for promoting conservation and ensuring the resilience of our water supply. As we head into 2023, we expect drought conditions to persist, highlighting the importance of decoupling and water resilience. Our ongoing commitment to conservation is detailed in our ESG reports as we work to secure a resilient water supply for the years ahead. Now, turning to our capital program, despite several economic challenges, our capital investment program remains largely on course, showing a 12% year-over-year increase and a 6.9% increase year-to-date. We're pleased with the progress but acknowledge that ongoing supply chain issues could eventually impact our investments. Our procurement team is actively working to manage these supply chains, particularly with challenges around ductile iron pipes, which now have a 12-month lead time. This situation presents challenges when executing our main replacement program. We are exploring ways to mitigate risk in our supply chain, including the stockpiling of raw materials for future projects. As we enter the fourth quarter, weather conditions could affect our construction activities, but I believe we are positioned to see a satisfactory capital investment quarter. Now, I'll turn it over to Tom for updates on customer COVID debt.

Thank you, Marty. So as you'll recall us saying at the end of the second quarter, we were authorized finally by the California Public Utilities Commission and by the governor to start the process of shutting off customers for nonpayment. Remember that during the COVID pandemic, we had been held to not shutting anyone off from March of 2020 until the summer. And while we had gotten California State aid to pay a number of customer bills last year, that reduced the number of delinquent accounts. It's still going to take us months and maybe many months to address the remaining 90-day delinquent accounts. And so we are working through that process now, starting that process late this summer. We did have some success in the quarter, reducing the balance that is 90 days past due by $3.5 million. That's an important step for us. It's a good sign for our program. In comparing our third quarter of 2022 to the third quarter of 2021, however, in that quarter last year, we had recorded the State aid. And therefore, the customer delinquency balances had dropped dramatically in the third quarter of 2021. And that's why you see an increase in our bad debt reserve this year. And we're very encouraged by the collection program that we have in place now. We do expect that to continue and accelerate as we get into the fourth quarter and into the first quarter of 2023, and we look forward to talking about how successful we are in bringing down that bad debt balance next year. Next, I'd like to turn it over to Paul Townsley to give us a business development update.

Thank you, Tom. I'm on the next slide, which is an exciting slide. We continue to maintain a very brisk pace in our utility acquisitions with 10 announced deals in process. As you can see on this slide, we have five new announced deals this year, including the Camino Real Utility in Texas, the Kukui'ula South Shore Community Services in Kauai, Hawaii, the Monterey Water System in New Mexico, the Bethel Greenacres system in Washington, and the Stroh's Water System also in Washington. In addition to those five, we have three other deals approved by the respective state public utility commissions that are in the final closing process. These include HOH utilities in Hawaii, Keauhou Wastewater on the Big Island in Hawaii, and the Skylonda Water System in California. So far this year, we have closed two deals, which are the Animas Valley System, also known as Morningstar Water in New Mexico, and the Rail Yard Utility in Texas. Together, these represent approximately 8,600 new water connections and about 10,000 new wastewater connections in progress this year. We are seeing growth in each of the states where we operate utilities, and our recent entry into Texas appears promising for growth. Our acquisition pipeline remains strong, and we expect continued opportunities in the coming year. And with that, Tom, I will hand it back to you.

Thanks, Paul. So as per usual, I've included in our slide deck for the quarter, the projection and progress of our CapEx and our rate base. Once again, the yellow bars on Slide 18 and 19 represent what we filed for in the California General Rate Case. And so obviously, with that case pending and no settlement on CapEx for the case, we don't have a way yet to adjust those numbers to what might be authorized by the commission. But I do show and reflect here, the $222 million year-to-date CapEx in our total systems throughout 2022. Marty, I'll send it over to you for a wrap up.

Great. Thanks, Tom. In closing, Q3 was about in line with what our expectations were within the company. Obviously, we're not immune to the inflationary issues that we're all experiencing, and we're seeing inflationary creep move into our P&L. That, coupled with the regulatory lag that we would typically see in the third year of the rate case. It certainly is affecting our profitability, but we are performing where we have budgeted to. So we're very happy with the outcome where we are in the third quarter. The market headwinds, we expect that to continue as the press release and as Tom mentioned, we do have certain planned assets associated with the nonqualified retirement plan, while the changes get recorded below the line, we're still required to essentially evaluate and value those assets at the end of and it flows through below the line on our P&L. So there's no buying and selling of assets there; it's just the change in asset value given that we're seeing in the market. And we expect that's going to continue into 2023 as we deal with some of these strong economic headwinds that we're dealing with. As we go into the fourth quarter and into 2023, what are we going to be focused on. Obviously, concluding the cost of capital and general rate case are at the top of the list. Those are two very important proceedings for us and affect the biggest book of business that we have, which is our California utility. As I mentioned earlier, we expect the drought to continue into 2023 and our strong drought response and also dealing with the supply chain issues. Again, the team has done a great job on the supply chain side. As long as these headwinds continue, the more likely they are to start affecting us at some point here in the future. In addition, as Paul mentioned, we want to continue to execute on our growth plans and our business development pipeline. So while we're all dealing with the economic uncertainties that are around us each and every day right now, our balance sheet has remained strong. We have plenty of cash. We have been able to continue our growth in our capital program as well as our business development pipeline. And we remain mission-driven serving our customers and doing what we do best, which is being a water and wastewater utility. So going into the fourth quarter strong, and we'll go into 2023 strong despite all the headwinds that we're facing as a company. I want to take a moment and close out on setting a little different for this quarter. One, I just want to point out, I hope everyone saw the press release that we appointed Ms. Terry Bayer to be our Lead Director. Terry is an outstanding leader, seasoned executive and has been on the Board since 2014. She started to chair our Capital and Investment Committee in 2019. In September, we nominated her to be our Lead Director. She's just an outstanding person. We're very fortunate to have someone of Terry's caliber on the Board. She has a strong background in public health, and she also has her degree from Stanford University. And I hope all of you will get a chance to meet Terry at some point here in the future because we're very, very honored to have her as our Lead Director. And then lastly, this is Dave Healey, our Corporate Vice President, Corporate Controller's last conference call with us. Dave was going to be retiring at the end of December. And Dave started with us over 13 years ago as our Director of Financial Reporting. He was promoted to our Corporate Controller, and then ultimately, he was promoted to our Vice President, Corporate Controller and Principal Accounting Officer. Dave has done an outstanding job for Cal Water, not just on the financial reporting side, but also on the tax strategy side. Dave is one of the where individuals in the accounting world that is excellent in taxes and also excellent financially, and he is going to be dearly, dearly missed. And we will anticipate announcing Dave's replacement hopefully by the end of the year. But Dave, I just want to say thank you for all you've done at Cal Water, and it's been an honor to have you on our team.

Welcome. It's been a blast.

So with that, Regina, we will open up the line for questions, please.

Our first question will come from Angie Storozynski with Seaport.

Lots of questions, but let me maybe first start with taxes now that you mentioned them. So there seems to be a pretty substantial increase in year-to-date income taxes, like, I think, close to $3 million. Is it just timing related? And is there some true-up happening in the fourth quarter?

So I'll go ahead and answer that. This is Dave Healey. When the corporate income tax rate decreased to 21% in 2017, utilities moved the reduction to a long-term liability to be refunded to ratepayers, and the timing of these refunds is important. The refunds for 2018 and 2019 were paid to ratepayers in 2021 and 2022. In 2022, the amount refunded was $4 million less than in 2021, which is what accounts for the $4 million decrease. This is a component of our effective tax rate calculation, and that's the reason for the change.

But is it a decrease because there is an increase in the operating costs? You're basically asking what is...

Right. So when we do the tax refunds, how it's recorded as a reduction to income tax expense. So there's more of a reduction in 2021 than in 2022.

I understand. So it's fair to assume that this $4 million year-over-year delta persists through the end of the year?

Yes. So it will continue through the end of the year, and then it flattens out for the next three years. So there was just a little catch-up. The catch-up was for the years 2018 and 2019, and it only was in years 2021 and 2022.

I understand. There appears to be a significant increase in nonregulated expenses when comparing year-over-year results. I assume part of this is related to uninsured losses, but it shows a $10 million rise year-to-date compared to the previous year. Could you clarify what this increase entails?

So when we talk about the unrealized loss on our nonqualified pension plan investments, it's recorded in nonregulated expenses, and that's what's driving that change.

That's the mark-to-market, yes.

Okay. That's understandable. So I have a question about the regulatory proceedings that are still pending. Regarding the General Rate Case, considering the inflation you're experiencing in your cost structure, how much of that is already included in the pending General Rate Case? Is there a possibility to adjust some of the costs you're observing before the final decision is made?

That's a great question. Greg, do you want to take a first crack at that about how we incorporate new inflation into the GRC process?

Absolutely. As part of the settlement and undisputed items, we made a request with the commission that at the time the proposed decision is put forth that it reflects the most current inflation factors on all of our expenses, and that would be the mechanism that we would address the rising inflation that's going on right now from when we filed the case in July 2021.

And then...

There is still an update, so you're about to file an update before the proposed decision is issued?

No...

At the time, I think...

Go ahead, Greg.

I was just going to say at the time we filed the case, we estimated what inflation would be for the years 2023 and it has significantly changed. But as part of the original filing, we made a special request that has not been disputed by public advocates that says when the commission puts forth the proposed decision, that they will update all the expenses based on the most current inflation factors at the time. So, okay.

Angie, the other thing to add there that Greg didn't mention is remember that in California, we have escalation increases in the second and third year of the GRC, and those also incorporate the most recent inflation factors. And so while Greg is talking about incorporating this into 2023 calculations for rates, there's also a 2024 and potentially '25 if this continues to be a high rate of inflation.

Understood. Moving on to the cost of capital proceeding, I acknowledge there is a delay. However, is there really a debate about when the new cost of capital takes effect? I believed it was clear that it starts on January 1, 2022, and is not reliant on the exact timing of the final decision. Essentially, the review period runs from January 1, 2022, to December 31, 2024, correct?

So it's an interesting question. I think that you have to look also at what's going on with the California energy cost of capital and the pending case there, what's happening with the proposed decision from the administrative law judge and the alternate proposed decision of the President of the Commission. The issue that we have and the reason that we are not recording the reliability associated with the lower cost of debt is that the procedural steps that the commission would normally take to ensure that rates could be made retroactive have not been done. There was no filing for interim rates. There's no memorandum account to track interim rates. Those are the normal procedural processes that would allow the commission to go back in time. And so right now, that's the situation in the process. So we're still waiting to see what that decision says. And obviously, we'll look to whatever that decision ends up saying, but we don't have any evidence one way or another at this point. We're obviously disclosing the amount in case it does go back. And so you have that in the slide deck, and it's in the 10-Q as well.

Okay. My last question is about the $11 million related to the lower cost of debt, and I've noticed that you're issuing equity quite a bit. What do you expect the equity layer at the California subsidiary to be by the end of the year? If this cost of capital proceeding results in a lower allowed equity layer that aligns with the year-end number, what reduction in revenue could we expect?

So Greg, I'm not sure if we have calculated the decrease in revenue related to adopting the ratepayer advocates' position. And Angie, I apologize for that. However, it could be several additional million that might be deducted from the return. Regarding the first part of your question, if you examine the financials in the 10-Q, we're currently at about a 50-50 split in California with our existing equity capital structure. This is likely as high or higher than what the commission staff had suggested. There will always be an opportunity to comment on the decision whenever we receive a proposed decision. We will certainly mention that the cap structure was said to be below 50%, but it's already at 50% as of the time that decision comes out. We anticipate that with the ATM program, this percentage will continue to increase. We have a clear plan to reach the 53.4% equity and have conveyed this to the commission. The staff is relying solely on a historic evaluation, which we believe is not suitable at this point.

Our next question will come from the line of Jonathan Reeder with Wells Fargo.

Yes. Just wondering, do you have any insight if the ALJ is currently drafting the decision? Or is there still potentially other high-profile cases still sequenced be for it?

Jonathan, it's hard to say. The administrative law judges operate independently at the commission. For those unfamiliar, I was the Head of Regulatory for Cal Water for a considerable time and worked with the commission prior to that. Therefore, I believe I have some understanding of how ALJs function. You would need to assess what other cases this specific ALJ is handling. Additionally, you would need to consider whether there are factors, like a commissioner managing other issues, that might affect the judge's ability to issue a decision in this particular case. At this moment, we do not have answers to those questions. The energy cost of capital case could influence their perspective on our case to some extent, but that involves a different judge and a different commissioner. So, I don’t think that will hinder this case from progressing.

Okay. Yes. And I know all the ins and outs. I was hoping you guys might know because I certainly have a harder time piecing the puzzle together on that.

I think in reference back to Angie's question, I think that the company would really appreciate it if the commission at least issued a proposed decision before we have to release earnings in February of next year so that we just have some guidance on that question about the effective date. I know there's a lot of folks that just assume that, that effective date is back to the start, and we're not convinced of that at this point. So I think we'd like to get that answer on the books, at least in terms of the PD. I think that would be very helpful to us.

And I would really hope there's a PD, but...

Yes, we do too. We do too.

Okay. In terms of the decoupling legislation that was passed, does it specify that the requests must be made as part of like a GRC? Or could it be requested as a stand-alone item, either just by Cal Water by all the utilities together?

Yes. I believe it specifies it's picked up in the next GRC filing, Jonathan.

Greg might have some insight into that.

Greg, you're still on the call, right?

Yes, yes. Actually, it specifies a GRC filing or by mutual agreement of the company and commission by an application between GRCs. So there is an opportunity to file through something before our 2024 GRC.

Okay. And so have you guys, I guess, formulated a strategy based on that? Like, is it wait to see how the Supreme Court case kind of plays out? Or might you do that separate avenue of requesting in between?

Well, I mean...

Go ahead, Greg. I'll let you go first.

I was just going to say what we're going to do, Jonathan, starting in 2023, has put together our case for re-request decoupling that we would either file in our 2024 GRC, which would be July or make the decision based on how things are going with the Supreme Court or other companies if we want to try and file it earlier through an application. But the decision hasn't yet been made actually when we would file it.

And Jonathan, I think the critical element here is that if you recall back to the decision, which wiped out the decoupling, there we didn't have an opportunity to put in any evidentiary testimony, and the commission really railroaded us in that case. And so we don't want to go off half cocked and file something that doesn't have robust information behind it about how effective the program is and has been. And so that's why we're not likely to go file next week. As Greg said, we're going to spend some time working on our testimony, making sure that we have the facts all lined up before we put that out.

And I think we are keenly interested in the State Supreme Court case. There was a 1% chance they would take the case, and they accepted the case. And the case was on the merits of lack of due process. So I think we want to get into that a little bit to see how the State Supreme Court is going to look at it and consider that.

Yes. So what is the, I guess, kind of the timeframe on resolution from the Supreme Court now? Is there any statutory timeframe? And then two, if they do decide that your due process rights were violated, does that just strike the order by the commission, and you have decoupling like decoupling just is automatically back in? Or what exactly are the impacts if the Supreme Court rules in your favor?

Well, it's a State Supreme Court. So I don't think they are locked into a schedule per se. I mean, we had to go through an application process that had to be reviewed, then they had to accept the case, and then we'll do oral arguments, sometime hopefully in the first quarter. And then I think they tend to move fairly quickly. The question of what happens next is a good question. I don't think we know because I don't think we've had too many water cases in front of the State Supreme Court. I think we're on a little bit of uncharted ground. I think they could null and void the commission's decision and send it back to them. They could say, this isn't binding; you need to go back and open that particular case to get evidence on the record. I think we're kind of in a new zone here. But again, we're very happy that the State Supreme Court took the case on the basis of our argument, which is lack of due process.

Right. And obviously, there's been some turnover at the commission since that other order originally handed down. Any sense how the newer commissioners feel about decoupling?

Not yet. When we discuss the new paradigm, that's what we mean. The commission has primarily operated remotely and remains in a pandemic mindset, resulting in limited face time. There are also regulations in place that prevent discussions about open cases with the commissioner. We are beginning to have slightly more face time with some of the commissioners, which is encouraging. However, we are still not permitted to discuss current open cases.

Our next question is a follow-up from Angie Storozynski with Seaport.

Thank you. I'm persistent today. Anyway, so just a couple of other things. So on billed revenues, you mentioned that you think that there's going to be some catch-up before the end of the year. So should I assume that there's a meaningful benefit to fourth quarter earnings associated with those changes in the balance of unbilled revenues?

Let me put it this way. If you look at the fourth quarter of 2021, we had that enormous amount of unbilled revenue that had built up in the second and third quarter, and that dropped off to a normal level at the end of the year. And so in this year, we have much less peak unbilled revenue, and that really hit us in the second quarter, but we do continue to expect, and we've stated that we expect the unbilled revenue to come back down to a normal level at the end of the year. So I guess I'm trying to say that we would expect less of a decline in unbilled revenue in the fourth quarter of '22 as compared to the fourth quarter of '21. So I think the answer to your question is yes.

Okay. And then again, not to be overly persistent here, but just going back to the P&L. So I asked about nonregulated expenses, but instead, I wanted to ask about the other components of net periodic benefit credit, which is up about $4 million year-to-date, year-over-year. I mean, could you explain to me what this is?

We use the spot rate method to value our defined pension plan, and this has led to an increase in our credit. This includes the service cost of pension plans and the non-service cost, specifically a change in the non-service cost.

And just an important reminder that both the service and the non-service cost of the California pension expense is tracked in a balancing account in California, the bulk of our business, and it doesn't affect net income because there's a revenue offset associated with the balancing account.

the smaller part that's out of California.

Okay. To conclude on the cost of capital discussion, I understand you are drawing some conclusions about the 2022 cost of capital for electric or energy companies. However, that relates specifically to the cost of capital adjustment mechanism, not a full cost of capital review, which only applies from 2023 onwards. Therefore, I'm not certain how much of an implication this has. Additionally, you mentioned uncertainty regarding the ROE step-up related to the adjustment mechanism, which was triggered for water utilities at the end of September. I understand that there needs to be a filing for this increase to take effect, but I haven't seen that filing. Please explain how this will affect the timing of when the 50 basis points step-up would be implemented.

Sure. Let’s discuss a few points. As I understand it, there is a case regarding energy capital that serves as a good example of the commission's considerations. There are two decisions available: one from the administrative law judge and an alternate proposed by President Reynolds. The alternate maintains that it waives the triggering of the mechanism. However, the key difference between these two proposals is whether there would be a comprehensive investigation of the 2022 cost of capital. This is the unanswered question I referred to. President Reynolds' alternate indicates that there will not be a revisit. I found that noteworthy, as it might provide some insight for our situation, though it could lead to different outcomes for energy and water sectors. Regarding the triggering, the challenge is the absence of a proposed decision. Consequently, we cannot file based on a non-existent order, as there is no guideline indicating we should apply for an adjustment. If the commission were to issue a proposed and final decision stating the cost of capital for 2022, I would anticipate that they would permit us to file for the 2023 adjustment within that rate order. This filing would, of course, not occur in October or November since those months will have already passed by the time the commission releases its decision. Typically, in circumstances where the deadline for a triggered filing has been missed, the commission allows for late submissions. Hypothetically, if they finalize the cost of capital decision for 2022 on January 15, there will likely be a directive in that final order to file for the 2023 triggered cost of capital either in that same submission or in a subsequent one. We would see that take place. Additionally, some analysts have suggested that the commission may take the information that might have triggered the adjustment and instead propose a general change to the cost of equity, effectively indicating that both parties consented to the adjustment. This uncertainty about how the commission will respond to its own delays is why we remain unclear on the situation.

The adjustment is expected to begin on January 1, 2023, while the review of the cost of capital, meaning changes to all components, took effect on January 1, 2022. I understand your concern that there is no definite timeline for when the adjustment will actually take effect.

Right. There's no certainty as to how the commission is going to react to the new information about the changed economic environment. That's the gist of it. We just don't know what they're going to say in their decision. And I don't mean to speak over Greg. I know Greg is an expert on this as well. So Greg, if you had any other insights on this, I'd be happy to hear that.

That's how you've addressed all the issues. I would have brought up the same points.

And we have no further questions at this time. I'll turn the conference back over for any closing remarks.

Great. Well, thanks for joining us on this nice fall day. We'll look forward to communicating our year-end results with you at the end of February. In the meantime, be safe, and thank you. Have a good day.

Ladies and gentlemen, that will conclude today's call. Thank you all for joining. You may now disconnect.