** **

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

** **

**(Mark One)**

 

**ý****                    ****Quarterly reportpursuant to Section 13 or 15(d) of the Securities Exchange Act of1934**

 

**for the quarterly period ended March 31,2006**

 

**or**

 

**o****                    ****Transition report pursuant to Section 13 or 15(d) ofthe Securities Exchange Act of 1934**

 

**for the transition period from                   to                       **

 

**Commissionfile number  001-14431**

 

**AmericanStates Water Company**

(Exact Name of Registrant as Specified in ItsCharter)

 
| **California**                                                  | ** ** | **95-4676679**                     |
|-----------------------------------------------------------------|------------|------------------------------------|
| (State  or Other Jurisdiction of Incorporation or Organization) |       | (IRS  Employer Identification No.) |
|                                                            |       |                               |
| **630 E. Foothill Blvd,  San Dimas, CA**                        | ** ** | **91773-1207**                     |
| (Address  of Principal Executive Offices)                       |       | (Zip  Code)                        |

 

**(909) 394-3600**

(Registrant’s Telephone Number, Including Area Code)

 

**Not Applicable**

(Former Name, Former Address and Former Fiscal Year,if Changed Since Last Report)

 

**Commissionfile number  001-12008**

 

**Golden StateWater Company**

(Exact Name of Registrant as Specified in Its Charter)

 
| **California**                                                  | ** ** | **95-1243678**                     |
|-----------------------------------------------------------------|------------|------------------------------------|
| (State  or Other Jurisdiction of Incorporation or Organization) |       | (IRS  Employer Identification No.) |
|                                                            |       |                               |
| **630 E. Foothill Blvd,  San Dimas, CA**                        | ** ** | **91773-1212**                     |
| (Address  of Principal Executive Offices)                       |       | (Zip  Code)                        |

 

**(909) 394-3600**

(Registrant’s Telephone Number, Including Area Code)

 

 

(Former Name, Former Address and Former Fiscal Year,if Changed Since Last Report)

 

Indicateby check mark whether Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

| American States Water Company |   | Yes ý  No o |
|-------------------------------|--------|----------------------------|
| Golden State Water Company    |   | Yes ý  No o |

 

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, or anonaccelerated file. See definition of “accelerated filer and large acceleratedfile” in Rule 12b-2 of the Exchange Act. (Check one):

 
| American States Water Company |   | Large accelerated filer o |   | Accelerated filer ý |   | Nonaccelerated filer o      |
|-------------------------------|--------|---------------------------|--------|--------------------------|--------|-----------------------------|
| Golden State Water Company    |   | Large accelerated filer o |   | Accelerated filer o      |   | Nonaccelerated filer ý |

 

Indicateby check mark whether the Registrant is a shell company (as defined in Rule 12b-2of the Exchange Act)

 

| American States Water Company |   | Yes o No ý |
|-------------------------------|--------|-----------------|
| Golden State Water Company    |   | Yes o No ý |

 

Asof May 10, 2006, the number of Common Shares outstanding, of AmericanStates Water Company was 16,825,639 shares.

 

Asof May 10, 2006, all of the 122 outstanding Common Shares of Golden StateWater Company were owned by American States Water Company.

 

 

----

 

**AMERICAN STATES WATER COMPANY**

**and**

**GOLDEN STATE WATER COMPANY**

**FORM 10-Q**

 

### **INDEX**

### ** **

| **Part I**  | **Financial  Information**                                                                                                      | ** ** |
|------------------|---------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **       | ** **                                                                                                                      | ** ** |
| Item 1:          | Financial Statements                                                                                                            |       |
|             |                                                                                                                            |       |
|             | Consolidated Balance  Sheets of American States Water Company as of March 31, 2006 and December 31,  2005             |       |
|             |                                                                                                                            |       |
|             | Consolidated  Statements of Income of American States Water Company for the Three Months  Ended March 31, 2006 and 2005    |       |
|             |                                                                                                                            |       |
|             | Consolidated  Statements of Cash Flow of American States Water Company for the Three Months  Ended March 31, 2006 and 2005 |       |
|             |                                                                                                                            |       |
|             | Balance Sheets of Golden State Water  Company as of March 31, 2006 and December 31, 2005                              |       |
|             |                                                                                                                            |       |
|             | Statements of Income of Golden  State Water Company for the Three Months Ended March 31, 2006 and 2005                     |       |
|             |                                                                                                                            |       |
|             | Statements of Cash Flow of  Golden State Water Company for the Three Months Ended March 31, 2006 and  2005                 |       |
|             |                                                                                                                            |       |
|             | Notes to Consolidated  Financial Statements                                                                                     |       |
|             |                                                                                                                            |       |
| Item  2:         | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                     |       |
|             |                                                                                                                            |       |
| Item  3:         | Quantitative  and Qualitative Disclosures About Market Risk                                                                     |       |
|             |                                                                                                                            |       |
| Item 4:          | Controls  and Procedures                                                                                                        |       |
|             |                                                                                                                            |       |
| **Part II** | **Other Information**                                                                                                           | ** ** |
| ** **       | ** **                                                                                                                      | ** ** |
| Item 1:          | Legal  Proceedings                                                                                                              |       |
|             |                                                                                                                            |       |
| Item 1A:         | Risk Factors                                                                                                                    |       |
|             |                                                                                                                            |       |
| Item  2:         | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                    |       |
|             |                                                                                                                            |       |
| Item  3:         | Defaults  Upon Senior Securities                                                                                                |       |
|             |                                                                                                                            |       |
| Item  4:         | Submission  of Matters to a Vote of Security Holders                                                                            |       |
|             |                                                                                                                            |       |
| Item 5:          | Other  Information                                                                                                              |       |
|             |                                                                                                                            |       |
| Item 6:          | Exhibits                                                                                                                        |       |
|             |                                                                                                                            |       |
|             | Signatures                                                                                                                      |       |

 

1

----

 

#### **PART I**

 

**Item 1. Financial Statements**

 

General

 

Thebasic financial statements included herein have been prepared by Registrant,without audit, pursuant to the rules and regulations of the Securities andExchange Commission.

 

Certain information and footnote disclosuresnormally included in financial statements, prepared in accordance withaccounting principles generally accepted in the United States of America, havebeen condensed or omitted pursuant to such rules and regulations. In theopinion of management, all adjustments consisting of normal recurring items andestimates necessary for a fair statement of results for the interim period havebeen made.

 

It is suggested that these financial statements beread in conjunction with the financial statements and notes thereto in thelatest Annual Report on Form 10-K of American States Water Company and itswholly-owned subsidiary, Golden State Water Company.

 

Filing Format

 

This quarterly report on Form 10-Q is acombined report being filed by two separate Registrants: American States WaterCompany (hereinafter “AWR”) and Golden State Water Company (hereinafter “GSWC”)(formerly known as Southern California Water Company). For more information,please see Note 1 to the Notes to Consolidated Financial Statements and theheading entitled General in Item 2 - Management’s Discussion and Analysis ofFinancial Condition and Results of Operations. References in this report to “Registrant”are to AWR and GSWC collectively, unless otherwise specified. GSWC makes no representationsas to the information contained in this report relating to AWR and itssubsidiaries, other than GSWC.

 

**Forward-Looking Information**

 

Certain matters discussed in this report (includingthe documents incorporated herein by reference) are forward-looking statementsintended to qualify for the “safe harbor” from liability established by thePrivate Securities Litigation Reform Act of 1995. These forward-lookingstatements can generally be identified as such because the context of thestatement will include words such as Registrant “believes,” “anticipates,” “expects”or words of similar import. Similarly, statements that describe Registrant’sfuture plans, objectives, estimates or goals are also forward-lookingstatements. Such statements address future events and conditions concerningcapital expenditures, earnings, litigation, rates, water quality and otherregulatory matters, adequacy of water supplies, GSWC’s ability to recoverelectric, natural gas and water supply costs from ratepayers, contractoperations, liquidity and capital resources, and accounting matters. Actualresults in each case could differ materially from those currently anticipatedin such statements, by reason of factors such as changes in utility regulation,including ongoing local, state and federal activities; recovery of regulatoryassets not yet included in rates; future economic conditions, including changesin customer demand and changes in water and energy supply costs; futureclimatic conditions; and legislative, legal proceedings, regulatory and othercircumstances affecting anticipated revenues and costs.

 

2

----

 

**AMERICAN STATES WATER COMPANY**

**CONSOLIDATED BALANCESHEETS**

**ASSETS**

**(Unaudited)**

 
| ** **                                                                                              | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(in thousands)**                                                                                 | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| ** **                                                                                              | ** ** | ** **         | ** ** | ** **            | ** ** |
| **Utility  Plant, at cost**                                                                             |       |               |       |                  |       |
|                                                                                                    |       |               |       |                  |       |
| Water                                                                                                   |       | $                  | 871,120    |                  | $          | 869,471 |   |
| Electric                                                                                                |       | 61,494             |       | 61,386                |       |
|                                                                                                    |       | 932,614            |       | 930,857               |       |
| Less -  Accumulated depreciation                                                                        |       | (267,098           | )          | (259,915              | )          |
|                                                                                                    |       | 665,516            |       | 670,942               |       |
| Construction  work in progress                                                                          |       | 58,288             |       | 42,283                |       |
| Net utility  plant                                                                                      |       | 723,804            |       | 713,225               |       |
|                                                                                                    |       |               |       |                  |       |
| **Other  Property and Investments**                                                                     |       |               |       |                  |       |
| Goodwill                                                                                                |       | 11,820             |       | 11,841                |       |
| Other  property and investments                                                                         |       | 9,738              |       | 9,740                 |       |
| Total other  property and investments                                                                   |       | 21,558             |       | 21,581                |       |
|                                                                                                    |       |               |       |                  |       |
| **Current  Assets**                                                                                     |       |               |       |                  |       |
| Cash and  cash equivalents                                                                              |       | 14,400             |       | 13,032                |       |
| Accounts  receivable-customers (less allowance for doubtful accounts of $757 in 2006  and $789 in 2005) |       | 10,024             |       | 13,341                |       |
| Unbilled  revenue                                                                                       |       | 15,722             |       | 15,195                |       |
| Other  accounts receivable (less allowance for doubtful accounts of $313 in 2006 and  $337 in 2005)     |       | 10,151             |       | 10,844                |       |
| Income taxes  receivable                                                                                |       | 110                |       | 822                   |       |
| Materials  and supplies, at average cost                                                                |       | 1,409              |       | 1,421                 |       |
| Regulatory  assets - current                                                                            |       | 5,782              |       | 6,104                 |       |
| Prepayments  and other current assets                                                                   |       | 2,394              |       | 2,998                 |       |
| Unrealized  gain on purchased power contracts                                                           |       | 1,262              |       | 3,417                 |       |
| Costs and  estimated earnings in excess of billings on uncompleted contracts                            |       | 3,883              |       | —                |       |
| Deferred  income taxes - current                                                                        |       | 2,644              |       | 1,692                 |       |
| Total  current assets                                                                                   |       | 67,781             |       | 68,866                |       |
|                                                                                                    |       |               |       |                  |       |
| **Regulatory  and Other Assets**                                                                        |       |               |       |                  |       |
| Regulatory  assets                                                                                      |       | 57,789             |       | 55,866                |       |
| Other  accounts receivable                                                                              |       | 8,928              |       | 8,820                 |       |
| Deferred  income taxes                                                                                  |       | 36                 |       | —                |       |
| Other                                                                                                   |       | 8,074              |       | 8,419                 |       |
| Total  regulatory and other assets                                                                      |       | 74,827             |       | 73,105                |       |
|                                                                                                    |       |               |       |                  |       |
| **Total  Assets**                                                                                       |       | $                  | 887,970    |                  | $          | 876,777 |   |

 

*The accompanying notes are an integral part ofthese consolidated financial statements*

 

3

----

 

**AMERICAN STATES WATER COMPANY**

**CONSOLIDATED BALANCE SHEETS**

**CAPITALIZATION AND LIABILITIES**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(in thousands)**                                                      | ** ** | **2006**           | ** ** | **2005**              | ** ** |
|                                                                         |       |               |       |                  |       |
| **Capitalization**                                                           |       |               |       |                  |       |
| Common  shares, no par value, no stated value                                |       | $                  | 167,388    |                  | $          | 166,529 |   |
| Earnings  reinvested in the business                                         |       | 103,239            |       | 101,121               |       |
| Accumulated  other comprehensive loss                                        |       | (3,556             | )          | (3,556                | )          |
| Total common  shareholders’ equity                                      |       | 267,071            |       | 264,094               |       |
| Long-term  debt                                                              |       | 268,266            |       | 268,405               |       |
| Total  capitalization                                                        |       | 535,337            |       | 532,499               |       |
|                                                                         |       |               |       |                  |       |
| **Current  Liabilities**                                                     |       |               |       |                  |       |
| Notes  payable to banks                                                      |       | 31,000             |       | 27,000                |       |
| Long-term  debt - current                                                    |       | 635                |       | 635                   |       |
| Accounts  payable                                                            |       | 19,996             |       | 19,653                |       |
| Income taxes  payable                                                        |       | 1,962              |       | 1,534                 |       |
| Accrued  employee expenses                                                   |       | 4,721              |       | 5,879                 |       |
| Accrued  interest                                                            |       | 5,264              |       | 2,254                 |       |
| Regulatory  liabilities - current                                            |       | 5,400              |       | 5,592                 |       |
| Deferred  income taxes - current                                             |       | —             |       | 86                    |       |
| Other                                                                        |       | 11,394             |       | 14,952                |       |
| Total  current liabilities                                                   |       | 80,372             |       | 77,585                |       |
|                                                                         |       |               |       |                  |       |
| **Other  Credits**                                                           |       |               |       |                  |       |
| Advances for  construction                                                   |       | 87,150             |       | 85,168                |       |
| Contributions  in aid of construction - net                                  |       | 84,701             |       | 83,976                |       |
| Deferred  income taxes                                                       |       | 71,193             |       | 69,669                |       |
| Unamortized  investment tax credits                                          |       | 2,496              |       | 2,518                 |       |
| Accrued  pension and other postretirement benefits                           |       | 15,468             |       | 13,562                |       |
| Regulatory  liabilities                                                      |       | 760                |       | 1,823                 |       |
| Billings in  excess of costs and estimated earnings on uncompleted contracts |       | 2,649              |       | 2,207                 |       |
| Other                                                                        |       | 7,844              |       | 7,770                 |       |
| Total other  credits                                                         |       | 272,261            |       | 266,693               |       |
|                                                                         |       |               |       |                  |       |
| **Commitments  and Contingencies (Note 8)**                                  |       | —             |       | —                |       |
|                                                                         |       |               |       |                  |       |
| **Total  Capitalization and Liabilities**                                    |       | $                  | 887,970    |                  | $          | 876,777 |   |

 

*The accompanying notes are an integral part ofthese consolidated financial statements*

 

4

----

 

**AMERICAN STATES WATER COMPANY**

**CONSOLIDATED STATEMENTS OFINCOME**

**FOR THE THREE MONTHS**

**ENDED MARCH 31, 2006 AND 2005**

**(Unaudited)**

 
| ** **                                                            | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                            | ** ** | **March 31,**               | ** ** |
| **(in thousands, except per share amounts)** | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                                                  |       |                             |       |   |   |
| **Operating  Revenues**                                               |       |                             |       |   |   |
| Water                                                                 |       | $                                | 48,149     |   | $ | 41,497 |   |
| Electric                                                              |       | 8,346                            |       | 7,470 |   |
| Other                                                                 |       | 4,118                            |       | 851 |   |
| Total  operating revenues                                             |       | 60,613                           |       | 49,818 |   |
|                                                                  |       |                             |       |   |   |
| **Operating  Expenses**                                               |       |                             |       |   |   |
| Water  purchased                                                      |       | 8,344                            |       | 7,686 |   |
| Power  purchased for pumping                                          |       | 1,604                            |       | 1,487 |   |
| Groundwater  production assessment                                    |       | 2,083                            |       | 1,921 |   |
| Power  purchased for resale                                           |       | 4,563                            |       | 4,137 |   |
| Unrealized  loss (gain) on purchased power contracts                  |       | 2,155                            |       | (3,015 | ) |
| Supply cost  balancing accounts                                       |       | 487                              |       | 1,078 |   |
| Other  operating expenses                                             |       | 4,700                            |       | 5,069 |   |
| Administrative  and general expenses                                  |       | 10,832                           |       | 10,174 |   |
| Depreciation  and amortization                                        |       | 6,483                            |       | 5,664 |   |
| Maintenance                                                           |       | 2,755                            |       | 2,466 |   |
| Property and  other taxes                                             |       | 2,547                            |       | 2,299 |   |
| Gain on  settlement for removal of wells                              |       | —                           |       | (760 | ) |
| Total  operating expenses                                             |       | 46,553                           |       | 38,206 |   |
|                                                                  |       |                             |       |   |   |
| **Operating  Income**                                                 |       | 14,060                           |       | 11,612 |   |
|                                                                  |       |                             |       |   |   |
| Interest  expense                                                     |       | (5,256                           | )          | (4,725 | ) |
| Interest  income                                                      |       | 899                              |       | 21 |   |
|                                                                  |       |                             |       |   |   |
| **Income  from operations before income tax expense**                 |       | 9,703                            |       | 6,908 |   |
|                                                                  |       |                             |       |   |   |
| Income tax  expense                                                   |       | 3,804                            |       | 3,144 |   |
|                                                                  |       |                             |       |   |   |
| **Net  Income**                                                       |       | $                                | 5,899      |   | $ | 3,764 |   |
|                                                                  |       |                             |       |   |   |
| **Weighted  Average Number of Shares Outstanding**                    |       | 16,806                           |       | 16,761 |   |
| **Basic  Earnings Per Common Share**                                  |       | $                                | 0.35       |   | $ | 0.22 |   |
|                                                                  |       |                             |       |   |   |
| **Weighted  Average Number of Diluted Shares**                        |       | 16,909                           |       | 16,805 |   |
| **Fully  Diluted Earnings Per Share**                                 |       | $                                | 0.35       |   | $ | 0.22 |   |
|                                                                  |       |                             |       |   |   |
| **Dividends  Declared Per Common Share**                              |       | $                                | 0.225      |   | $ | 0.225 |   |

 

*The accompanying notes are an integral part ofthese consolidated financial statements*

 

5

----

 

**AMERICAN STATES WATER COMPANY**

**CONSOLIDATED STATEMENTS OFCASH FLOW**

**FOR THE THREE MONTHS ENDED MARCH 31,2006 AND 2005**

**(Unaudited)**

 
| ** **                                                        | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                        | ** ** | **March 31,**               | ** ** |
| **(in thousands)**                                           | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                                              |       |                             |       |   |   |
| **Cash  Flows From Operating Activities:**                        |       |                             |       |   |   |
| Net income                                                        |       | $                                | 5,899      |   | $ | 3,764 |   |
| Adjustments  for non-cash items:                                  |       |                             |       |   |   |
| Depreciation  and amortization                                    |       | 6,483                            |       | 5,664 |   |
| Provision  for doubtful accounts                                  |       | 176                              |       | 145 |   |
| Deferred  income taxes and investment tax credits                 |       | 220                              |       | 1,554 |   |
| Unrealized  loss (gain) on purchased power contracts              |       | 2,155                            |       | (3,015 | ) |
| Stock based  compensation expense                                 |       | 68                               |       | 8 |   |
| Other - net                                                       |       | 323                              |       | 516 |   |
| Changes in  assets and liabilities:                               |       |                             |       |   |   |
| Accounts  receivable - customers                                  |       | 3,141                            |       | 1,661 |   |
| Unbilled  revenue                                                 |       | (527                             | )          | 883 |   |
| Other  accounts receivable                                        |       | 585                              |       | 1,250 |   |
| Materials  and supplies                                           |       | 12                               |       | 45 |   |
| Prepayments  and other current assets                             |       | 604                              |       | 968 |   |
| Regulatory  assets - supply cost balancing accounts               |       | 487                              |       | 1,078 |   |
| Other assets                                                      |       | (5,170                           | )          | 741 |   |
| Accounts  payable                                                 |       | 343                              |       | (3,746 | ) |
| Income taxes  receivable/payable                                  |       | 1,140                            |       | 1,594 |   |
| Other  liabilities                                                |       | 833                              |       | 4,699 |   |
| Net cash  provided                                                |       | 16,772                           |       | 17,809 |   |
|                                                              |       |                             |       |   |   |
| **Cash  Flows From Investing Activities:**                        |       |                             |       |   |   |
| Construction  expenditures                                        |       | (19,399                          | )          | (18,826 | ) |
| Net cash  used                                                    |       | (19,399                          | )          | (18,826 | ) |
|                                                              |       |                             |       |   |   |
| **Cash  Flows From Financing Activities:**                        |       |                             |       |   |   |
| Proceeds  from issuance of common shares                          |       | 529                              |       | 318 |   |
| Proceeds  from stock option exercises                             |       | 190                              |       | — |   |
| Tax benefits  from exercise of stock-based awards                 |       | 45                               |       | — |   |
| Receipt of  advances for and contributions in aid of construction |       | 2,841                            |       | 4,031 |   |
| Refunds on  advances for construction                             |       | (357                             | )          | (484 | ) |
| Repayments  of long-term debt                                     |       | (139                             | )          | (222 | ) |
| Net change  in notes payable to banks                             |       | 4,000                            |       | 2,000 |   |
| Cash  received on financing portion of purchased power contracts  |       | 667                              |       | 667 |   |
| Dividends  paid                                                   |       | (3,781                           | )          | (3,771 | ) |
| Net cash  provided                                                |       | 3,995                            |       | 2,539 |   |
|                                                              |       |                             |       |   |   |
| **Net  increase in cash and cash equivalents**                    |       | 1,368                            |       | 1,522 |   |
| **Cash and  cash equivalents, beginning of period**               |       | 13,032                           |       | 4,303 |   |
| **Cash and  cash equivalents, end of period**                     |       | $                                | 14,400     |   | $ | 5,825 |   |

 

*The accompanying notes are an integral part ofthese consolidated financial statements*

 

6

----

 

**GOLDEN STATE WATER COMPANY**

**BALANCE SHEETS**

**ASSETS**

**(Unaudited)**

 
| ** **                                                                                              | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(in thousands)**                                                                                 | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| ** **                                                                                              | ** ** | ** **         | ** ** | ** **            | ** ** |
| **Utility  Plant, at cost**                                                                             |       |               |       |                  |       |
|                                                                                                    |       |               |       |                  |       |
| Water                                                                                                   |       | $                  | 821,215    |                  | $          | 819,958 |   |
| Electric                                                                                                |       | 61,494             |       | 61,386                |       |
|                                                                                                    |       | 882,709            |       | 881,344               |       |
| Less -  Accumulated depreciation                                                                        |       | (253,348           | )          | (246,649              | )          |
|                                                                                                    |       | 629,361            |       | 634,695               |       |
| Construction  work in progress                                                                          |       | 55,923             |       | 38,334                |       |
| Net utility  plant                                                                                      |       | 685,284            |       | 673,029               |       |
|                                                                                                    |       |               |       |                  |       |
| **Other  Property and Investments**                                                                     |       |               |       |                  |       |
| Other  property and investments                                                                         |       | 7,357              |       | 7,364                 |       |
| Total other  property and investments                                                                   |       | 7,357              |       | 7,364                 |       |
|                                                                                                    |       |               |       |                  |       |
| **Current  Assets**                                                                                     |       |               |       |                  |       |
| Cash and  cash equivalents                                                                              |       | 10,828             |       | 8,788                 |       |
| Accounts  receivable-customers (less allowance for doubtful accounts of $723 in 2006  and $765 in 2005) |       | 9,730              |       | 12,919                |       |
| Unbilled  revenue                                                                                       |       | 15,302             |       | 14,856                |       |
| Inter-company  receivable                                                                               |       | 648                |       | 263                   |       |
| Other  accounts receivable (less allowance for doubtful accounts of $310 in 2006 and  $334 in 2005)     |       | 5,455              |       | 6,106                 |       |
| Materials  and supplies, at average cost                                                                |       | 1,392              |       | 1,404                 |       |
| Regulatory  assets - current                                                                            |       | 5,711              |       | 6,033                 |       |
| Prepayments  and other current assets                                                                   |       | 2,201              |       | 2,795                 |       |
| Unrealized  gain on purchased power contracts                                                           |       | 1,262              |       | 3,417                 |       |
| Deferred  income taxes - current                                                                        |       | 2,627              |       | 1,693                 |       |
| Total  current assets                                                                                   |       | 55,156             |       | 58,274                |       |
|                                                                                                    |       |               |       |                  |       |
| **Regulatory  and Other Assets**                                                                        |       |               |       |                  |       |
| Regulatory  assets                                                                                      |       | 57,566             |       | 55,627                |       |
| Other  accounts receivable                                                                              |       | 8,928              |       | 8,820                 |       |
| Other                                                                                                   |       | 7,252              |       | 7,575                 |       |
| Total  regulatory and other assets                                                                      |       | 73,746             |       | 72,022                |       |
|                                                                                                    |       |               |       |                  |       |
| **Total  Assets**                                                                                       |       | $                  | 821,543    |                  | $          | 810,689 |   |

 

*The accompanying notes are an integral part ofthese financial statements*

 

7

----

 

**GOLDEN STATE WATER COMPANY**

**BALANCE SHEETS**

### **CAPITALIZATION AND LIABILITIES**

**(Unaudited)**

 
| ** **                                         | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(in thousands)**                            | ** ** | **2006**           | ** ** | **2005**              | ** ** |
|                                               |       |               |       |                  |       |
| **Capitalization**                                 |       |               |       |                  |       |
| Common  shares, no par value, no stated value      |       | $                  | 159,852    |                  | $          | 159,531 |   |
| Earnings  reinvested in the business               |       | 100,692            |       | 99,645                |       |
| Accumulated  other comprehensive loss              |       | (3,556             | )          | (3,556                | )          |
| Total common  shareholder’s equity            |       | 256,988            |       | 255,620               |       |
| Long-term  debt                                    |       | 261,471            |       | 261,540               |       |
| Total  capitalization                              |       | 518,459            |       | 517,160               |       |
|                                               |       |               |       |                  |       |
| **Current  Liabilities**                           |       |               |       |                  |       |
| Long-term  debt - current                          |       | 295                |       | 295                   |       |
| Accounts  payable                                  |       | 17,871             |       | 17,914                |       |
| Inter-company  payable                             |       | 3,915              |       | —                |       |
| Income taxes  payable to Parent                    |       | 3,279              |       | 2,268                 |       |
| Accrued  employee expenses                         |       | 4,399              |       | 5,507                 |       |
| Accrued  interest                                  |       | 5,153              |       | 2,218                 |       |
| Regulatory  liabilities - current                  |       | 5,400              |       | 5,592                 |       |
| Deferred  income taxes - current                   |       | —             |       | 109                   |       |
| Other                                              |       | 10,798             |       | 12,390                |       |
| Total  current liabilities                         |       | 51,110             |       | 46,293                |       |
|                                               |       |               |       |                  |       |
| **Other  Credits**                                 |       |               |       |                  |       |
| Advances for  construction                         |       | 76,795             |       | 74,790                |       |
| Contributions  in aid of construction - net        |       | 83,593             |       | 83,055                |       |
| Deferred  income taxes                             |       | 66,801             |       | 65,469                |       |
| Unamortized  investment tax credits                |       | 2,496              |       | 2,518                 |       |
| Accrued  pension and other postretirement benefits |       | 15,468             |       | 13,562                |       |
| Regulatory  liabilities                            |       | —             |       | 1,063                 |       |
| Other                                              |       | 6,821              |       | 6,779                 |       |
| Total other  credits                               |       | 251,974            |       | 247,236               |       |
|                                               |       |               |       |                  |       |
| **Commitments  and Contingencies (Note 8)**        |       | —             |       | —                |       |
|                                               |       |               |       |                  |       |
| **Total  Capitalization and Liabilities**          |       | $                  | 821,543    |                  | $          | 810,689 |   |

 

*The accompanying notes are an integral part ofthese financial statements*

 

8

----

 

**GOLDEN STATE WATER COMPANY**

**STATEMENTS OF INCOME**

**FOR THE THREE MONTHS**

**ENDED MARCH 31, 2006 AND 2005**

**(Unaudited)**

 
| ** **                                            | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                            | ** ** | **March 31,**               | ** ** |
| **(in thousands)**                               | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                                  |       |                             |       |   |   |
| **Operating  Revenues**                               |       |                             |       |   |   |
| Water                                                 |       | $                                | 46,367     |   | $ | 40,154 |   |
| Electric                                              |       | 8,346                            |       | 7,470 |   |
| Other                                                 |       | 2,600                            |       | 20 |   |
| Total  operating revenues                             |       | 57,313                           |       | 47,644 |   |
|                                                  |       |                             |       |   |   |
| **Operating  Expenses**                               |       |                             |       |   |   |
| Water  purchased                                      |       | 8,174                            |       | 7,570 |   |
| Power  purchased for pumping                          |       | 1,515                            |       | 1,412 |   |
| Groundwater  production assessment                    |       | 2,083                            |       | 1,921 |   |
| Power  purchased for resale                           |       | 4,563                            |       | 4,137 |   |
| Unrealized  loss (gain) on purchased power contracts  |       | 2,155                            |       | (3,015 | ) |
| Supply cost  balancing accounts                       |       | 487                              |       | 1,078 |   |
| Other  operating expenses                             |       | 4,527                            |       | 4,613 |   |
| Administrative  and general expenses                  |       | 9,918                            |       | 8,861 |   |
| Depreciation  and amortization                        |       | 6,031                            |       | 5,386 |   |
| Maintenance                                           |       | 2,584                            |       | 2,309 |   |
| Property and  other taxes                             |       | 2,428                            |       | 2,185 |   |
| Total  operating expenses                             |       | 44,465                           |       | 36,457 |   |
|                                                  |       |                             |       |   |   |
| **Operating  Income**                                 |       | 12,848                           |       | 11,187 |   |
|                                                  |       |                             |       |   |   |
| Interest  expense                                     |       | (4,803                           | )          | (4,419 | ) |
| Interest  income                                      |       | 797                              |       | 17 |   |
|                                                  |       |                             |       |   |   |
| **Income  from operations before income tax expense** |       | 8,842                            |       | 6,785 |   |
|                                                  |       |                             |       |   |   |
| Income tax  expense                                   |       | 3,495                            |       | 3,106 |   |
|                                                  |       |                             |       |   |   |
| **Net  Income**                                       |       | $                                | 5,347      |   | $ | 3,679 |   |

 

*The accompanying notes are an integral part ofthese financial statements*

 

9

----

 

**GOLDEN STATE WATER COMPANY**

**CASH FLOW STATEMENTS**

**FOR THE THREE MONTHS ENDED MARCH 31,2006 AND 2005**

**(Unaudited)**

 
| ** **                                                        | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                        | ** ** | **March 31,**               | ** ** |
| **(in thousands)**                                           | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                                              |       |                             |       |   |   |
| **Cash  Flows From Operating Activities:**                        |       |                             |       |   |   |
| Net income                                                        |       | $                                | 5,347      |   | $ | 3,679 |   |
| Adjustments  for non-cash items:                                  |       |                             |       |   |   |
| Depreciation  and amortization                                    |       | 6,031                            |       | 5,386 |   |
| Provision  for doubtful accounts                                  |       | 163                              |       | 139 |   |
| Deferred  income taxes and investment tax credits                 |       | 45                               |       | 1,154 |   |
| Unrealized  loss (gain) on purchased power contracts              |       | 2,155                            |       | (3,015 | ) |
| Stock based  compensation expense                                 |       | 67                               |       | 8 |   |
| Other - net                                                       |       | 93                               |       | 321 |   |
| Changes in  assets and liabilities:                               |       |                             |       |   |   |
| Accounts  receivable - customers                                  |       | 3,026                            |       | 1,623 |   |
| Unbilled  revenue                                                 |       | (446                             | )          | 901 |   |
| Other  accounts receivable                                        |       | 543                              |       | 1,140 |   |
| Materials  and supplies                                           |       | 12                               |       | 48 |   |
| Prepayments  and other current assets                             |       | 594                              |       | 920 |   |
| Regulatory  assets - supply cost balancing accounts               |       | 487                              |       | 1,078 |   |
| Other assets                                                      |       | (1,332                           | )          | 950 |   |
| Accounts  payable                                                 |       | (43                              | )          | (3,489 | ) |
| Inter-company  receivable/payable                                 |       | 1,030                            |       | (2,655 | ) |
| Income taxes  receivable/payable from/to Parent                   |       | 1,011                            |       | 4,953 |   |
| Other  liabilities                                                |       | 531                              |       | 3,727 |   |
| Net cash  provided                                                |       | 19,314                           |       | 16,868 |   |
|                                                              |       |                             |       |   |   |
| **Cash  Flows From Investing Activities:**                        |       |                             |       |   |   |
| Construction  expenditures                                        |       | (18,808                          | )          | (18,127 | ) |
| Net cash  used                                                    |       | (18,808                          | )          | (18,127 | ) |
|                                                              |       |                             |       |   |   |
| **Cash  Flows From Financing Activities:**                        |       |                             |       |   |   |
| Proceeds  from stock option exercises                             |       | 190                              |       | — |   |
| Tax benefits  from exercise of stock-based awards                 |       | 45                               |       | — |   |
| Receipt of  advances for and contributions in aid of construction |       | 2,835                            |       | 3,359 |   |
| Refunds on  advances for construction                             |       | (334                             | )          | (489 | ) |
| Repayments  of long-term debt                                     |       | (69                              | )          | (53 | ) |
| Net change  in inter-company borrowings                           |       | 2,500                            |       | 1,800 |   |
| Cash  received on financing portion of purchased power contracts  |       | 667                              |       | 667 |   |
| Dividends  paid                                                   |       | (4,300                           | )          | (4,000 | ) |
| Net cash  provided                                                |       | 1,534                            |       | 1,284 |   |
|                                                              |       |                             |       |   |   |
| **Net  increase in cash and cash equivalents**                    |       | 2,040                            |       | 25 |   |
| **Cash and  cash equivalents, beginning of period**               |       | 8,788                            |       | 2,702 |   |
| **Cash and  cash equivalents, end of period**                     |       | $                                | 10,828     |   | $ | 2,727 |   |

 

*The accompanying notes are an integral part ofthese financial statements*

 

10

----

 

**AMERICAN STATES WATER COMPANY**

**AND**

**GOLDEN STATE WATER COMPANY**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**Note 1 – Summary of Significant Accounting Policies:**

 

General / Nature of Operations: American States Water Company (“AWR”) isthe parent company of Golden State Water Company (“GSWC”), American StatesUtility Services, Inc. (“ASUS”) (and its subsidiaries, Fort Bliss WaterServices Company (“FBWS”), Terrapin Utility Services, Inc. (“TUS”) and OldDominion Utility Services, Inc. (“ODUS”)), and Chaparral City WaterCompany (“CCWC”). More than 90% of AWR’s assets consist of the common stock ofGSWC and its revenues and operations are primarily those of GSWC. GSWC is apublic utility engaged principally in the purchase, production, distributionand sale of water in California serving approximately 253,000 water customers.GSWC also distributes electricity in several California mountain communitiesserving approximately 23,000 electric customers. The California PublicUtilities Commission (“CPUC”) regulates GSWC’s water and electric business,including properties, rates, services, facilities and other matters. CCWC is apublic utility regulated by the Arizona Corporation Commission (“ACC”) servingapproximately 13,000 customers in the town of Fountain Hills, Arizona and aportion of the City of Scottsdale, Arizona. ASUS performs water relatedservices and operations on a contract basis. There is no direct regulatoryoversight by either the CPUC or the ACC of the operation or rates of thecontracted services provided by ASUS and its wholly owned subsidiaries or byAWR.

 

On October 1, 2004, ASUS’s wholly-owned subsidiary,FBWS, commenced operation of the water and wastewater systems at Fort Blisslocated near El Paso, Texas pursuant to the term of a 50-year contract with theU.S. Government. FBWS holds a certificate of convenience and necessity from theTexas Commission on Environmental Quality (“TCEQ”). In addition, ASUS’swholly-owned subsidiary, TUS, took over the operation and maintenance of thewater and wastewater systems at Andrews Air Force Base on February 1, 2006and commenced operation of these systems through TUS on that date pursuant tothe terms of a 50-year contract with the U.S. Government. Furthermore, ODUS,also an ASUS wholly-owned subsidiary, took over the operation and maintenanceof the wastewater systems at Fort Lee on February 23, 2006 and commencedoperation of these systems on that date. ODUS also took over the operation andmaintenance of the water and wastewater systems at Fort Eustis, Fort Monroe andFort Story on April 3, 2006.

 

Basis of Presentation: The consolidated financial statements of AWR include the accounts of AWR and its subsidiaries, all of which are wholly owned. These financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. Inter-company transactions and balances have been eliminated in the AWR consolidated financial statements. The consolidated financial statements included herein have been prepared by Registrant, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America for annual financial statements have been condensed or omitted pursuant to such rules and regulations. The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of management, all adjustments, consisting of normal recurring items and estimates necessary for a fair statement of the results for the interim periods, have been made. It is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Form 10-K for the year ended December 31, 2005 filed with the SEC. Certain prior-period amounts were reclassified to conform to the March 31, 2006 financial statement presentation.

 

GSWC’s Related Party Transactions: GSWC and other subsidiaries provide andreceive various services to and from their parent, AWR, and among themselves.In addition, AWR has an $85 million syndicated credit facility. AWR borrowsunder this facility and provides funds to its subsidiaries, including GSWC, insupport of their operations. Amounts owed to AWR for borrowings under thisfacility represent the majority of GSWC’s inter-company payables on GSWC’sbalance sheets as of March 31, 2006 and December 31, 2005. Theinterest rate charged to GSWC is sufficient to cover AWR’s interest cost underthe credit facility. GSWC also allocates certain corporate officeadministrative and general costs to its affiliates using agreed upon allocationfactors.

 

11

----

 

**Note 2 – Regulatory Matters:**

 

In accordance with accounting principles forrate-regulated enterprises, Registrant records regulatory assets, whichrepresent probable future revenues associated with certain costs that will berecovered from customers through the ratemaking process, and regulatoryliabilities, which represent probable future reductions in revenues associatedwith amounts that are to be credited to customers through the ratemakingprocess. AtMarch 31, 2006, Registrant had $8.4 million of regulatory assets not accruingcarrying costs. Of this amount, regulatory assets not accruing carrying costsinclude a deferred income tax balance of $7.2 million representing acceleratedtax benefits previously flowed-through to ratepayers, which will be included inrates concurrently with recognition of the associated tax expense. In addition,$1.2 million in deferred charges for rate case applications was recorded asother regulatory assets that Registrant recovers in rates over a short periodthat do not provide for recovery of carrying costs.

 

Regulatory assets, less regulatory liabilities,included in the consolidated balance sheets are as follows:

 
| ** **                                             | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(In thousands)**                                | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| **GSWC**                                               |       |               |       |                  |       |
| Supply cost  balancing accounts                        |       | $                  | 19,168     |                  | $          | 19,624 |   |
| Supply cost  memorandum accounts net under-collections |       | 3,151              |       | 3,151                 |       |
| Costs  deferred for future recovery on Aerojet case    |       | 21,366             |       | 21,109                |       |
| Flow-through  taxes, net                               |       | 7,168              |       | 6,939                 |       |
| Electric  transmission line abandonment costs          |       | 3,397              |       | 3,428                 |       |
| Asset retirement  obligations                          |       | 3,015              |       | 2,928                 |       |
| Low income  balancing accounts                         |       | 3,011              |       | 2,846                 |       |
| General rate  case memorandum accounts                 |       | 55                 |       | 209                   |       |
| Refund of  water rights lease revenues                 |       | (4,046             | )          | (6,474                | )          |
| Other  regulatory assets                               |       | 1,592              |       | 1,245                 |       |
| Total GSWC                                             |       | $                  | 57,877     |                  | $          | 55,005 |   |
| **CCWC**                                               |       |               |       |                  |       |
| Asset  retirement obligations                          |       | 45                 |       | 44                    |       |
| Other  regulatory assets/liabilities, net              |       | (511               | )          | (494                  | )          |
| Total AWR                                              |       | $                  | 57,411     |                  | $          | 54,555 |   |

 

***Supply Cost Balancing and Memorandum Accounts******:***

 

***Electric SupplyCost Balancing Account*** – Electricpower costs incurred by GSWC’s Bear Valley Electric division continue to becharged to its electric supply cost balancing account. The under-collection inthe electric supply cost balancing account is $21.0 million at March 31,2006. The balance in the electric supply balancing account is primarilyimpacted by (i) a surcharge to decrease previously under-collected energycost; (ii) changes in purchased energy cost, and (iii) changes inpower system delivery costs.

 

The CPUC has authorized GSWC to collect a surchargefrom its customers of 2.2¢ per kilowatt hour through August 2011, toenable GSWC to recover an under-collection of approximately $23.1 million atthe end of 2001 which had been incurred during the energy crisis in late 2000and 2001. GSWC sold 42,694,078 and 40,194,547 kilowatt hours of electricity toits Bear Valley Electric division customers for the three months ended March 31,2006 and 2005, respectively. As a result, the supply cost balancing account wasreduced by $955,000 and $895,400 for the three months ended March 31, 2006and 2005, respectively. GSWC anticipates the surcharge based on electricitysales to be sufficient for it to recover the amount of the under-collectedbalance incurred during the energy crisis by August 2011.

 

The purchased energy costs that are recorded in thesupply cost balancing account are subject to a price cap by terms of thesettlement with the CPUC. GSWC is allowed to include only up to a weightedannual energy purchase cost of $77 per MWh through August 2011 in itselectric supply cost balancing account for purchased energy costs. To theextent that the actual weighted average annual cost for power purchased exceedsthe $77 per MWh amount, GSWC will not be able to include these amounts in itsbalancing account and such amounts will be expensed. During the three monthsended March 31, 2006 and 2005, GSWC expensed approximately$40,000 and $101,000, respectively, for costs over $77 per MWh.

 

12

----

 

Southern California Edison’s (“Edison”) authorizedtariff setting forth rates to be charged to GSWC to cover all of the variouscosts associated with the transportation of energy over Edison’s power deliverysystem was approved by Federal Energy Regulatory Commission (“FERC”) in August of2004. Included in this tariff are certain charges associated with theabandonment of a transmission line upgrade that was not constructed due toincreasing environmental costs. Charges to GSWC for power system delivery costshave increased under this tariff to levels that exceed the amounts authorizedby the CPUC in Bear Valley Electric’s retail power rates to its customers. Theincremental cost increase to GSWC from this tariff is $114,000 for the threemonths ending March 31, 2006 and 2005, respectively, and these increaseshave been included in the balancing account for subsequent recovery fromcustomers. The incoming power system delivery costs are not subject toany price caps.

 

Other components, such as interest accrued oncumulative under-collected balance and power loss during transmission, wouldalso affect the balance of the electric supply cost balancing account.

 

***Water Supply Cost Memorandum/Balancing Accounts -***In a CPUC decision issued on June 19, 2003 related to memorandum supplycost accounts, all water utilities regulated by the CPUC were required to seekreview of under- and over- collections by filing an advice letter annually andthe utility’s recovery of such expenses has been reduced by the amountexceeding the authorized rate of return. Upon approval by the CPUC, thememorandum accounts are transferred to water supply cost balancing accounts. Forthe three months ended March 31, 2006 and 2005, $237,000 and $342,000,respectively, were recorded in the water supply cost memorandum/balancingaccounts. On April 13, 2006, the CPUC approved a decision eliminating theearnings test adopted in the June 2003 decision. The decision alsoeliminated the need to make an annual filing. Pursuant to this order, GSWC will recognize a cumulativeunder-collection of approximately $714,000 to the supply cost memorandumaccount provisions in the second quarter of 2006 for the under-collectedbalances not recognized at March 31, 2006 and will be recording under- andover- collections on a monthly basis thereafter commencing the second quarterof 2006.

 

***Costs Deferred for Future Recovery******:***

 

In 1999, GSWC sued Aerojet-General Corporation (“Aerojet”)for contaminating the Sacramento County Groundwater Basin, which affectedcertain GSWC wells. On a related matter, GSWC also filed a lawsuit against theState of California (the “State”). The CPUC authorized memorandum accounts toallow for recovery, from customers, of costs incurred by GSWC in prosecutingthe cases against Aerojet and the State, less any recovery from the defendantsor others. On October 30, 2003, GSWC, in its Region I abbreviatedgeneral rate case, filed for recovery of the cumulative balance ofapproximately $22 million in its memorandum account. This balance consistedprimarily of deferred litigation costs, interest, and carrying costs forcapital investments. The filing with the CPUC requested recovery of the balanceover a 20-year amortization period.

 

On July 21, 2005, the CPUC authorized GSWCto collect approximately $21.3 million of the Aerojet litigation memorandumaccount, through a rate surcharge, which will continue for no longer than 20years. Beginning in October 2005, new rates went into effect to beginamortizing the memorandum account over a 20-year period. A rate surcharge generatingapproximately $210,000 was billed to customers during the three months ended March 31,2006. GSWC will keep the Aerojet memorandum account open until it is fullyamortized. However, no costs will be added to the memorandum account, otherthan on-going interest charges approved by the decision. It is management’sintention to offset any settlement proceeds from Aerojet that may occurpursuant to the settlement agreement against the balance in the memorandumaccount, with the exception of an $8 million payment (for capital investments) withinterest due GSWC guaranteed by Aerojet, to be paid in full over 5 years,beginning in 2009.

 

***Refund of Water Rights Lease Revenues******:***

 

In 1994, GSWC entered into a contract to leaseto the City of Folsom, 5,000 acre-feet per year of water rights from theAmerican River. GSWC included all associated revenues in a nonoperating incomeaccount. In a decision issued on March 16, 2004, the CPUC ordered GSWC torefund 70 percent of the total amount of lease revenues received since 1994,plus interest, to customers. Pursuant to the order, GSWC recorded a $6.2million regulatory liability with a corresponding charge against nonoperatingincome, net of taxes, during the fourth quarter of 2003. A final amount of therefund was approved by the CPUC in June 2004 and GSWC adjusted itsestimate to the approved refund amount of $5.2 million. Refunds ofapproximately $111,000 and $119,000 were provided to customers during the threemonths ended March 31, 2006 and 2005, respectively. The refunds will bemade over a 9-year period.

 

13

----

 

Pursuant to the March 2004 CPUC order, theapportionment of any lease revenues that GSWC may collect commencing in January 2004was to be determined by a later decision. Pending that later decision andbeginning in the first quarter of 2004, all amounts billed to the City ofFolsom had been included in a regulatory liability account and no amounts wererecognized as revenue until uncertainties about this matter were resolved withthe CPUC. On April 13, 2006, the CPUC authorized GSWC to reinvest alllease revenues received from the City of Folsom since January, 2004, inclusiveof the balances in the regulatory liability accounts, in water systeminfrastructure and to include such investments in the rate base upon which GSWCearns a rate of return. As a result, GSWC transferred about $2.3 million ofwater rights lease revenues received from the City of Folsom in 2004 and 2005from the regulatory liability account into other operating revenues in thefirst quarter of 2006. GSWC also recorded additional other operating revenues of$299,000 reflecting the first quarter of 2006 water rights revenues.

 

**Note 3 – Earnings per Share/Capital Stock:**

 

In March 2004, the Emerging Issues Task Force (“EITF”)issued EITF No. 03-06, *“Participating Securitiesand the Two-Class Method under FASB Statement No. 128”.*EITFNo. 03-06 was effective in the second quarter of 2004 and provided newaccounting guidance for the effect of participating securities on earnings pershare (“EPS”) calculations and the use of the “two-class” method. The newguidance requires the use of the “two-class” method of computing EPS forcompanies with participating securities. The “two-class” method is an earningsallocations formula that determines EPS for each class of common stock andparticipating security. AWR has participating securities related to stockoption and restricted stock units that earn dividend equivalents on an equalbasis with Common Shares that have been issued under AWR’s 2000 Stock IncentivePlan and 2003 Non-Employee Directors Stock Plan. In applying the “two-class”method, undistributed earnings are allocated to both Common Shares andparticipating securities. The following is a reconciliation of Registrant’s netincome and weighted average Common Shares outstanding for calculating basic netincome per share:

 
| **Basic**                                                             | ** ** | **For The Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **2006**                                                               | ** ** | **2005** | ** ** |
| Net income                                                            |       | $                                                                      | 5,899      |   | $ | 3,764 |   |
| Less:  distributed earnings to common shareholders (a)                |       | 3,781                                                                  |       | 3,771 |   |
| Undistributed  earnings                                               |       | 2,118                                                                  |       | (7 | ) |
|                                                                  |       |                                                                   |       |   |   |
| Undistributed  earnings allocated to common (b)                       |       | 2,075                                                                  |       | (7 | ) |
| Undistributed  earnings allocated to participating                    |       | 43                                                                     |       | — |   |
|                                                                  |       |                                                                   |       |   |   |
| Total income  available to common shareholders, basic (a)+(b)         |       | $                                                                      | 5,856      |   | $ | 3,764 |   |
|                                                                  |       |                                                                   |       |   |   |
| Weighted  average Common Shares outstanding, basic                    |       | 16,806                                                                 |       | 16,761 |   |
| **Basic  earnings per Common Share**                                  |       | $                                                                      | 0.35       |   | $ | 0.22 |   |

 

Diluted EPS is based upon the weighted averagenumber of Common Shares including both outstanding shares and sharespotentially issuable in connection with stock options and restricted stockunits granted under Registrant’s 2000 Stock Incentive Plan and 2003Non-Employee Directors Stock Plan, and net income. At March 31, 2006 and2005 there were 770,977 and 673,045 options outstanding, respectively, underthese Plans. At March 31, 2006 and 2005, there were also approximately 46,279and 26,934 restricted stock units outstanding, respectively. The following is areconciliation of Registrant’s net income and weighted average Common Sharesoutstanding for calculating diluted net income per share:

 
| **Diluted**                                                           | ** ** | **For The Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| **(in thousands, except per share amounts)** | ** ** | **2006**                                                               | ** ** | **2005** | ** ** |
| Common shareholders  earnings, basic                                  |       | $                                                                      | 5,856      |   | $ | 3,764 |   |
| Undistributed earnings for  dilutive stock options (1)                |       | —                                                                 |       | — |   |
| Total common shareholders  earnings, diluted                          |       | $                                                                      | 5,856      |   | $ | 3,764 |   |
|                                                                  |       |                                                                   |       |   |   |
| Weighted average common  shares outstanding, basic                    |       | 16,806                                                                 |       | 16,761 |   |
| Stock-based compensation  (2)                                         |       | 103                                                                    |       | 44 |   |
| Weighted average common  shares outstanding, diluted                  |       | 16,909                                                                 |       | 16,805 |   |
| **Diluted earnings per Common  Share**                                |       | $                                                                      | 0.35       |   | $ | 0.22 |   |

 

14

----

 

----

(1)          Undistributed earnings allocated to participating securities were notincluded due to their antidilutive effect on diluted earnings per share.

 

(2)          In applying the treasury stock method of reflecting the dilutive effectof outstanding stock-based compensation in the calculation of diluted EPS, 366,610stock options at March 31, 2006 were deemed to be outstanding inaccordance with SFAS No. 128. All of the stock options and restrictedstock units at March 31, 2005 were included in the calculation of dilutedEPS for the three months ended March 31, 2005.

 

Stock options of 94,917 were outstanding at March 31,2006, but not included in the computation of diluted EPS because the optionexercise prices were greater than the average market price. Stock options of309,450 and restricted stock units of 46,279 were outstanding at March 31,2006, but not included in the computation of diluted EPS because they wereantidilutive.

 

The Company has a Shareholder Rights Plan designedto protect the Company’s shareholders in the event of an unsolicited unfairoffer to acquire the Company. The rights for Junior Participating PreferredShares (the “Rights”) are exercisable based solely on “a non-market-basedcontingency”, and are not contingent upon the market price of the Company’sstocks. Therefore, the shares that would be issued if the Rights are exercisedare not included in the calculation of diluted earnings per share.

 

During the three months ended March 31, 2006and 2005, Registrant issued 24,101 and 12,097 Common Shares, for approximately$719,503 and $318,000, respectively, under the Registrant’s Common SharePurchase and Dividend Reinvestment Plan, the 401(k) Plan, and the stockincentive plans. In addition during the three months ended March 31, 2006and 2005, Registrant purchased 14,084 and 8,609, respectively, Common Shares onthe open market under the Registrant’s Common Share Purchase and DividendReinvestment Plan and 401(k) Plan, which were used to satisfy the requirementsof these plans and programs.

 

In each of the three months ended March 31, 2006and 2005, AWR paid quarterly dividends to the shareholders of approximately $3.8million, or $0.225 per share.

 

**Note 4 – Derivative Instruments:**

 

Registranthas certain block-forward purchase power contracts that are subject to SFAS No. 133,*“Accounting for Derivative Instruments and HedgingActivities”*, as amended by SFAS Nos. 138 and 149. A derivativefinancial instrument or other contract derives its value from anotherinvestment or designated benchmark. SFAS No. 133 requires companies torecord derivatives on the balance sheet as assets and liabilities, and tomeasure those instruments at their fair value. Certain of these contractsqualify as an exception provided under SFAS No. 133 for activities thatare considered normal purchases and normal sales. These contracts are reflectedin the statements of income at the time of contract settlement.

 

During2002, GSWC became a party to block-forward purchase power contracts thatqualified as derivative instruments under SFAS No. 133. Contracts withPinnacle West Capital Corporation which became effective in November 2002have not been designated as normal purchases and normal sales. As a result, ona monthly basis, the related asset or liability is adjusted to reflect the fairmarket value at the end of the month. For the three months ended March 31,2006 and March 31, 2005, GSWC recognized a pretax unrealized loss of $2.2million and a pretax gain of $3.0 million, respectively.

 

Asthis contract is settled, the realized gains or losses are recorded in powerpurchased for resale, and the unrealized gains or losses are reversed. Thesecontracts have been recognized at fair market value on the balance sheetsresulting in a cumulative unrealized gain of $1.3 million as of March 31,2006 since the inception of the contracts.

 

The market prices used to determinethe fair value for this derivative instrument were estimated based onindependent sources such as broker quotes and publications. Settlement of thiscontract occurs on a cash or net basis through 2006 and by physical deliverythrough 2008. Registrant hasno other derivative financial instruments.

 

15

----

 

**Note 5 – Income Taxes:**

 

As a regulated utility, GSWCtreats certain temporary differences as flow-through adjustments incomputing its income tax provision consistent with the income taxapproach approved by the CPUC for ratemaking purposes. Flow-through adjustmentsincrease or decrease tax expense in one period, with anoffsetting increase or decrease occurring in another period. Giving effectto these temporary differences as flow-through adjustmentstypically results in a greater variance between the effectivetax rate (“ETR”) and the statutory federal income tax rate in any givenperiod than would otherwise exist if GSWC were not requiredto account for its income taxes as a regulated enterprise. During thesecond quarter of 2005, the recognition of the federal effect of state taxeswas adjusted to conform to the flow-through method reflected in the taxcalculation for ratemaking purposes, which partially defers the recognition ofthe effect to the subsequent tax year. This reduced income tax expense by $141,000for the three months ended March 31, 2006.

 

**Note 6 – Stock-Based Compensation:**

 

***Summary Description of Stock Incentive Plans***

 

AWRcurrently has two primary stock incentive plans for employee and non-employeedirectors: the 2000 Stock Incentive Plan (the “2000 Employees Plan”) and the2003 Non-Employee Directors Stock Plan (the “Directors Plan”), more fullydescribed below.

 

*2000 EmployeesPlan***–AWR adopted the 2000 Employees Plan at the annual meeting of shareholders in2000 to provide stock-based incentive awards in the form of stock options,and restricted stock to employees as a means of promoting the success of theCompany by attracting, retaining and aligning the interests of employees withthose of shareholders generally. The 2000 Employees Plan was amended in January 2006to also permit the grant of restricted stock units. There are 1,050,000 CommonShares reserved for issuance under the 2000 Employees Plan, 278,600 of whichremain available for issuance. The 2000 Employees Plan is administered by theCompensation Committee of the Board of Directors (the “Committee”). For stockoptions, the Committee determines, among other things, the form, term, optionexercise price, vesting and exercise terms of each option. Stock optionsgranted by AWR have been in the form of nonqualified stock options, expireten years from the date of grant, vest over a period of three years and aresubject to earlier termination as provided in the form of option agreementapproved by the Committee.

 

Theoption price per share is determined by the Committee at the time of grant, butmay not be less than 100% of the fair market value of AWR’s Common Shareson the date of grant. In addition, AWR may grant employees receiving agrant of stock options the right to receive cash dividends pursuant to theterms of a dividend equivalent rights agreement for a period of up to threeyears from the date of the option grant. For restricted stock, the Committeedetermines, among other things, the dividend, voting and other rights prior tovesting and the restrictions (which may be based on performance criteria,passage of time or other factors) imposed on the shares. For restricted stockunits, the Committee determines, among other things, the vesting terms and form ofpay-out. Each employee who receives a grant of a restricted stock unit is alsogenerally entitled to dividend equivalents rights in the form ofadditional restricted stock units until vesting of the restricted stock units.The restricted stock units are a non-voting unit of measurement relate to oneAWR Common Share.

 

*Directors Plan***–**On May 20, 2003, the Board of Directors adopted the Directors Plan,subject to shareholder approval. The shareholders approved the Directors Planat the May 2004 Annual Meeting. The Directors Plan provides thenon-employee directors with supplemental stock-based compensation and encouragesthem to increase their stock ownership in AWR. There are 250,000 Common Sharesreserved for issuance under the Directors Plan, 185,700 of which remainavailable for issuance. Pursuant to the Directors Plan, non-employee directorsare entitled to receive options to purchase 3,000 AWR Common Shares at eachannual meeting of shareholders commencing with the 2005 annual meeting ofshareholders. AWR also granted options to each non-employee director topurchase 1,000 AWR Common Shares at its annual shareholder meetings in 2003 and2004. In addition, each non-employee director with no more than ten years ofservice with AWR is entitled to receive restricted stock units at each annualmeeting in an amount equal to the then current annual retainer payable by AWR toeach non-employee director divided by the fair market value of AWR CommonShares on the last trading day prior to the annual meeting. All grants of stockoptions and restricted stock units are entitled to dividend equivalents payablein the form of additional restricted stock units under the terms of theDirectors Plan.

 

16

----

 

The stock options granted under the Directors Planare 10-year nonqualified stock options. The exercise price of the stock optionsmust be 100% of the fair market value of AWR’s Common Shares on the date ofgrant. Stock options granted under the Directors Plan are fully vested andexercisable upon the date of grant. The restrictedstock units are a non-voting unit of measurement relative to one CommonShare. Restricted stock units with respect todividend equivalent rights on stock options credited to the non-employeedirector are payable in AWR Common Shares on the earlier of the date on whichthe stock option is exercised and three years from the date of grant of thestock option. Restricted stock units granted at each annual meeting ofshareholders and restricted stock units with respect to dividend equivalentrights with respect thereto payable solely in Common Shares of AWR onthe date that the participant terminates service as a director. Restricted stock units credited to each non-employee director’s account are atall times fully vested and non-forfeitable.

 

***Change in Accounting Principle***

 

EffectiveJanuary 1, 2006, the Company adopted the provisions of Statement ofFinancial Accounting Standards No. 123(R), (“SFAS 123(R)”) “Share-BasedPayment,” which requires the recognition of compensation expense relatedto the fair value of stock-based compensation awards. Under the provisions ofSFAS 123(R), share-based compensation cost is measured by the Registrantat the grant date, based on the calculated fair value of the award, and isrecognized as an expense over the employee’s requisite service period(generally the vesting period of the equity grant). Prior to January 1,2006, Registrant accounted for share-based compensation to employees inaccordance with Accounting Principles Board Opinion (“APB”) No. 25, “Accountingfor Stock Issued to Employees,” and related interpretations. Registrant alsofollowed the disclosure requirements of SFAS 123(R), “Accounting forStock-Based Compensation”, as amended by SFAS 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure”. Registrant elected to adopt themodified prospective transition method as provided by SFAS 123(R) and,accordingly, financial statement amounts for the prior periods presented inthis Form 10-Q have not been restated to reflect the fair value method ofexpensing share-based compensation.

 

Registranthad previously adopted the “disclosure-only” provisions of SFAS 123, as amendedby SFAS No. 148. Had Registrant accounted for stock-based compensationplans using the fair value based accounting method described by SFAS 123for the periods prior to fiscal year 2006, Registrant’s net income and earningsper share for the three months ended March 31, 2005 would have beenchanged to the pro forma amounts indicated below:

 

| **(dollars in thousands, except EPS)**                                            | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| Net income, as reported                                                                               |       | $                                                          | 3,764      |   |
| Add: Stock-based compensation expense  included in reported net income, net of tax                    |       | 5                                                          |       |
| Less: Stock-based compensation expense  determined under the fair-value accounting method, net of tax |       | (566                                                       | )          |
| Pro forma                                                                                             |       | $                                                          | 3,203      |   |
|                                                                                                  |       |                                                       |       |
| Basic earnings per share:                                                                             |       |                                                       |       |
| As reported                                                                                           |       | $                                                          | 0.22       |   |
| Pro forma                                                                                             |       | $                                                          | 0.19       |   |
|                                                                                                  |       |                                                       |       |
| Diluted earnings per share:                                                                           |       |                                                       |       |
| As reported                                                                                           |       | $                                                          | 0.22       |   |
| Pro forma                                                                                             |       | $                                                          | 0.19       |   |

 

Thefollowing table presents share-based compensation expenses included inadministrative and general expenses in Registrant’s consolidated statements ofincome resulting from stock options, restricted stock and restricted stockunits:

 

17

----

 
| ** **                                                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(in thousands)**                                                    | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Stock-based compensation related to:                                       |       |                                             |       |   |   |
| Stock options granted to employees and  directors                          |       | $                                                | 37         |   | $ | — |   |
| Restricted stock units granted to employees                                |       | 22                                               |       | — |   |
| Restricted stock units granted to directors                                |       | 9                                                |       | 8 |   |
| Stock-based compensation recognized in the  income statement, before taxes |       | $                                                | 68         |   | $ | 8 |   |
| Income tax benefit                                                         |       | (28                                              | )          | (3 | ) |
| Total stock-based compensation after income  taxes                         |       | $                                                | 40         |   | $ | 5 |   |

 

Withthe adoption of SFAS 123(R), Registrant elected to amortize stock-basedcompensation for awards granted on or after the adoption of SFAS 123(R) on January 1,2006 on a straight-line basis over the requisite (vesting) period for theentire award. Registrant did not recognize compensation expense for employeeshare-based awards for the three months ended March 31, 2005, when theexercise price of Registrant’s employee stock awards equaled the market priceof the underlying stock on the date of grant. Registrant did recognizecompensation expense under APB No. 25 relating to restricted stock unitsgranted to directors. Non-vested stock options granted to employees prior to January 1,2006 have terms that provide for the continuation of vesting upon terminationof employment. Accordingly, these awards were deemed to be granted for pastservices from an accounting standpoint and any measured compensation cost wasrecognized in full in the pro forma disclosures at the date of grant. Therefore,upon implementation of SFAS 123(R), there was no remaining compensation cost tobe recognized for these options granted prior to, but not yet vested as of January 1,2006.

 

Registrantestimated the fair value of stock options granted during the three months endedMarch 31, 2006 and 2005 using the Black-Scholes valuation model. Key inputassumptions used to estimate the fair value of stock options include theexercise price of the award, the expected option term, the expected volatilityof the Company’s stock over the option’s expected term, the risk-free interestrate over the option’s expected term, and the Company’s expected annualdividend yield. The Company believes that the valuation technique and theapproach utilized to develop the underlying assumptions are appropriate incalculating the fair values of Registrant’s stock options granted during thethree months ended March 31, 2006 and 2005. Estimates of fair value arenot intended to predict actual future events or the value ultimately realizedby persons who receive equity awards. The fair value of stock units andrestricted stock was determined based on the closing trading price of AWR’s CommonShares on the grant date.

 

Thefair value of each option grant during the three months ended March 31,2006 and 2005 was estimated on the grant date using the Black-Scholesoption-pricing model with the following assumptions:

 

| ** **                                     | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Weighted-average fair value of option  granted |       | $                                                | 8.01       |   | $ | 5.63 |   |
| Risk-free interest rate                        |       | 4.40                                             | %          | 3.93 | % |
| Expected annual dividend yield                 |       | 3.08                                             | %          | 3.68 | % |
| Expected volatility factor                     |       | 26.40                                            | %          | 26.23 | % |
| Expected option term (in years)                |       | 6                                                |       | 7 |   |
|                                                |            |                                                  |            |  |  |  |  |

 

*Summary of key assumptions***–** The risk-free interest rate for periods equal to theexpected term of the share option was based on the U.S. Treasury yieldcurve in effect at the time of grant. Dividend yield reflects current dividendof $0.225 per share per quarter. The stock volatility for each grant ismeasured using the weighted average of historical monthly and daily pricechanges of AWR’s Common Shares over the most recent period equal to theexpected option life of the grant. For the three months ended March 31,2006, the option term was determined using the simplified method for estimatingexpected option life, which qualify as “plain-vanilla” options and is derivedfrom the average midpoint between vesting and the contractual term, asdescribed in SEC’s Staff Accounting Bulletin No. 107, “Share-BasedPayment.”

 

18

----

 

SFAS 123(R)requires entities to estimate the number of forfeitures expected to occur andrecord expense based upon the number of awards expected to vest. Prior toadoption, the Company accounted for forfeitures as they occurred as permittedunder previous accounting standards. The cumulative effect of adopting thechange in estimating forfeitures was not material to the Company’s financialstatements for the quarter ended March 31, 2006.

 

*StockOptions*****–**Asummary of stock option activity as of March 31, 2006, and changes duringthe three months ended March 31, 2006, is presented below:

 
| ** **                                  | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted Average  Remaining  Contractual Term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|--------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------|------------|
| Options outstanding at January 1, 2006 |       | 684,304                     |       | $                                          | 24.32      |                                                        |       |                                |       |   |
| Granted                                     |       | 94,917                      |       | 33.73                                      |       |                                                        |       |                                |       |
| Exercised                                   |       | (8,244                      | )          | 23.04                                      |       |                                                        |       |                                |       |
| Forfeited or expired                        |       | —                      |       | —                                     |       |                                                        |       |                                |       |
| Options outstanding at March 31, 2006  |       | 770,977                     |       | $                                          | 25.48      |                                                        | 7.43       |                                | $          | 9,159,000 |   |
| Options exercisable at March 31, 2006  |       | 504,308                     |       | $                                          | 23.85      |                                                        | 6.63       |                                | $          | 6,811,000 |   |

 

Theweighted-average grant-date fair value of options granted by Registrant duringthe three months ended March 31, 2006 was $8.01. The aggregate intrinsicvalue in the table above represents the total pretax intrinsic value (i.e., thedifference between AWR’s closing price on the last trading day of the firstquarter of 2006 and the exercise price, times the number of shares) that wouldhave been received by the option holders had all option holders exercised theiroption on March 31, 2006. This amount changes if the fair market value ofAWR’s stock changes. The total intrinsic value of options exercised during thethree months ended March 31, 2006 was $110,045. During the three monthsended March 31, 2006, Registrant received $189,966 in cash proceeds fromthe exercise of its stock options and realized $44,839 of tax benefit for thetax deduction from awards exercised. As of March 31, 2006, approximately $710,000of total unrecognized compensation cost related to stock options is expected tobe recognized over a weighted-average period of 2.83 years.

 

*Restricted Stock and StockUnits**-*A summary of the status of Registrant’s restricted stock units toemployees and directors as of March 31, 2006, and changes during the threemonths ended March 31, 2006, is presented below:

 
| ** **                                      | ** ** | **Number of  Restricted Share  Units** | ** ** | **Weighted Average  Grant-Date Value** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| Restricted share units at January 1,  2006 |       | 31,166                                           |       | $                                                | 25.02      |   |
| Granted                                         |       | 15,113                                           |       | 33.65                                            |       |
| Vested                                          |       | —                                           |       | —                                           |       |
| Forfeited                                       |       | —                                           |       | —                                           |       |
| Restricted share units at March 31,2006    |       | 46,279                                           |       | $                                                | 27.84      |   |

 

Asof March 31, 2006, there was approximately $465,000 of total unrecognizedcompensation cost related to restricted stock units granted under Registrant’semployee and director’s stock plans. That cost is expected to be recognizedover a weighted-average period of 2.83 years.

 

19

----

 

**Note 7 – Employee Benefit Plans:**

 

The components of net periodic benefit costs, beforeallocation to the overhead pool, for Registrant’s pension plan, postretirementplan, and Supplemental Executive Retirement Plan (“SERP”) for the three monthsended March 31, 2006 and 2005 are as follows:

 
| ** **                                     | ** ** | **Pension Benefits** | ** ** | **Other  Postretirement  Benefits** | ** ** | **SERP** | ** ** |
|------------------------------------------------|------------|---------------------------|------------|-------------------------------------|------------|----------|------------|
| **(dollars in thousands)**           | ** ** | **2006**                  | ** ** | **2005**                            | ** ** | **2006** | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Components  of Net Periodic Benefits Cost:** |       |                      |       |                                |       |     |       |   |   |   |   |   |   |
| Service Cost                                   |       | $                         | 991        |                                | $          | 927      |       | $ | 107 |   | $ | 109 |   | $ | 32 |   | $ | 32 |   |
| Interest  Cost                                 |       | 1,175                     |       | 1,044                               |       | 155      |       | 151 |   | 35 |   | 28 |   |
| Expected  Return on Plan Assets                |       | (984                      | )          | (918                                | )          | (50      | )          | (74 | ) | — |   | — |   |
| Amortization  of Transition                    |       | —                    |       | —                              |       | 105      |       | 105 |   | — |   | — |   |
| Amortization  of Prior Service Cost            |       | 41                        |       | 41                                  |       | (50      | )          | (50 | ) | 37 |   | 38 |   |
| Amortization  of Actuarial (Gain) Loss         |       | 292                       |       | 260                                 |       | 37       |       | 41 |   | (3 | ) | (10 | ) |
| Net Periodic  Pension Cost                     |       | $                         | 1,515      |                                | $          | 1,354    |       | $ | 304 |   | $ | 282 |   | $ | 101 |   | $ | 88 |   |

 

Registrant expects to contribute approximately $4,414,000and $800,000 to pension and postretirement plans in 2006, respectively. Nocontributions were made during the three months ended March 31, 2006.

 

**Note 8 – Contingencies:**

 

***Water Quality-Related Litigation******:***

 

In 1997, GSWC was named as a defendant innineteen lawsuits that alleged that GSWC and other water utilities deliveredunsafe water to their customers in the San Gabriel Valley and Pomona Valleyareas of Los Angeles County. Plaintiffs in these actions sought damages,including general, special, and punitive damages, as well as attorney’s fees oncertain causes of action, costs of suit, and other unspecified relief.

 

On August 4, 2004, GSWC was dismissed fromall nineteen Los Angeles County cases. The order was issued by the Trial Judgepresiding over these matters, and followed a lengthy legal proceeding datingback to April 1997 when the first of the cases was filed by over 140customers in the San Gabriel Valley. The Court found GSWC did not violate establishedwater quality standards and dismissed the cases after allowing reasonable timeand opportunity for the plaintiffs to prove otherwise. GSWC has long assertedthat it meets or exceeds the requirements to provide water within the standardsestablished by the health authorities. On September 21, 2004, GSWCreceived notice that several plaintiffs filed an appeal to the trial court’sorder to dismiss GSWC. Briefs and reply briefs on the appeal have been filed.On February 7, 2006, the Second Appellate District in which the briefswere filed moved the California Supreme Court to transfer the appeal to theFirst Appellate District, the District in which prior appeals regarding thesecases had been heard. GSWC is unable to predict the outcome of this appeal.

 

GSWC issubject to self-insured retention (deductible) provisions in its applicableinsurance policies and has either expensed the self-insured amounts or hasreserved against payment of these amounts as appropriate. GSWC’s variousinsurance carriers have, to date, provided reimbursement for much of the costsincurred above the self-insured amounts for defense against these lawsuits,subject to a reservation of rights. In addition, the CPUC has issued certain decisions, whichauthorize GSWC to establish a memorandum account to accumulate costs for futurerecovery.

 

Perchlorate and/or Volatile Organic Compounds (“VOC”)have been detected in five wells servicing GSWC’s San Gabriel System. GSWCfiled suit in federal court, along with two other affected water purveyors andthe San Gabriel Basin Water Quality Authority (“WQA”), against some of thoseallegedly responsible for the contamination. Some of the other potentialdefendants settled with GSWC, other water purveyors and the WQA (the “WaterEntities”) on VOC related issues prior to the filing of the lawsuit. Inresponse to the filing of the Federal lawsuit, the Potentially ResponsibleParty (“PRP”) defendants filed motions to dismiss the suit or strike certainportions of the suit. The judge issued a ruling on April 1, 2003 grantingin part and denying in part the defendant’s motions.

 

20

----

 

A key ruling of the court was that the waterpurveyors, including the Registrant, by virtue of their ownership of wellscontaminated with hazardous chemicals are themselves PRPs under theComprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”).

 

Registrant has, pursuant to permission of the court,amended its suit to claim certain affirmative defenses as an “innocent” partyunder CERCLA. Registrant is presently unable to predict the outcome of thisruling on its ability to fully recover from the PRPs future costs associatedwith the treatment of these wells. In this same suit, the PRPs have filedcross-complaints against the Water Entities, the Metropolitan Water District,the Main San Gabriel Basin Watermaster and others on the theory that theyarranged for and did transport contaminated water into Main San Gabriel Basinfor use by Registrant and the other two affected water purveyors and for otherrelated claims.

 

OnAugust 29, 2003, the US Environmental Protection Agency (“EPA”) issuedUnilateral Administrative Orders (“UAO”) against 41 parties deemed responsiblefor polluting the groundwater in that portion of the San Gabriel Valley fromwhich two of GSWC’s impacted wells draw water. GSWC was not named as a party tothe UAO. The UAO requires that these parties remediate the contamination. Thejudge in the Federal lawsuit has appointed a special master to overseemandatory settlement discussions between the PRPs and the Water Entities. EPAis also conducting settlement discussions with several PRPs regarding the UAO.The Water Entities and EPA are working to coordinate their settlementdiscussions under the special master in order to arrive at a completeresolution of all issues affecting the Federal lawsuits and the UAO. Registrantis presently unable to predict the ultimate outcome of these settlementdiscussions.

 

Registrantis unable to predict an estimate of the loss, if any, resulting from thesewater-quality related litigations.

 

***Condemnation of Properties******:***

 

The laws of the State of California and the State ofArizona provide for the acquisition of public utility property by governmentalagencies through their power of eminent domain, also known as condemnation,where doing so is in the public interest. In addition, however, the laws of theState of California also provide: (1) that the owner of the utilityproperty may contest whether the condemnation is actually in the publicinterest; and (2) that the owner is entitled to receive the fair marketvalue of its property if the property is ultimately taken.

 

Although the City of Claremont, California locatedin GSWC’s Region III, has not initiated the formal condemnation processpursuant to California law, the City has expressed various concerns to GSWCabout the rates charged by GSWC and the effectiveness of the CPUC’s ratesetting procedures. The City hired a consultant to perform an appraisal ofthe value of Registrant’s water system serving the City. The value was estimatedin 2004 by the consultant at $40 - $45 million. GSWC disagrees with the City’svaluation assessment. As of March 31, 2006, management believes that thefair market value of the system exceeds the $37.6 million recorded net bookvalue and also exceeds the consultant’s estimates of the Claremont watersystem.

 

On April 12, 2005, the Town Council of the Townof Apple Valley voted 5-0 to authorize Town staff to prepare a Request forProposal for an evaluation of the feasibility and potential cost of and atimeframe for the potential takeover of GSWC’s Apple Valley water systems aswell as the water systems of another utility serving the Town. On April 11,2006 the Town Council unanimously decided to move forward with efforts toacquire all the water systems serving the Town, based on a study authorized bythe Town Council. GSWC has not received any formal notice from the Town of itsintention to condemn the Registrant’s Apple Valley water systems. However, GSWCwill vigorously defend itself. As of March 31, 2006, management believesthat the fair market value of GSWC’s system exceeds the recorded net book valueof the Apple Valley water systems.

 

Except for the City of Claremont and the Town ofApple Valley, Registrant has not been, within the last three years, involved inactivities related to the condemnation of any of its water customer serviceareas or in its Bear Valley Electric customer service area.

 

***Santa Maria Groundwater Basin Adjudication******:***

 

In 1997, the Santa Maria Valley Water ConservationDistrict (“plaintiff”) filed a lawsuit against multiple defendants, includingGSWC, the City of Santa Maria, and several other public water purveyors. Theplaintiff’s lawsuit seeks an adjudication of the Santa MariaGroundwater Basin.

 

21

----

 

As of March 31, 2006, GSWC has incurred costsof approximately $5.9 million in defending its rights in the Santa MariaBasin, including legal and expert witness fees, which have been deferred inUtility Plant for rate recovery. In February 2006, GSWC filed with theCPUC for recovery of these costs. Management believes that the recovery ofthese costs through rates is probable. However, management is required to go tothe CPUC to seek recovery of these costs that have been incurred by GSWC inthis lawsuit. A settlement of the lawsuit has been reached, subject to CPUCapproval. The settlement, among other things, if approved, would preserve GSWC’shistorical pumping rights and secure supplemental water rights for use in caseof drought or other reductions in the natural yield of the Basin. There arealso a small number of nonsettling parties, and the case is going forward as tothese parties. The stipulation, if approved, would preserve GSWC’s positionwith the settling parties independent of the outcome of the case as it movesforward with the nonsettling parties. GSWC cannot predict the outcome of thecase as to the nonsettling parties.

 

***Other Litigation******:***

 

Registrant is also subject to ordinary routinelitigation incidental to its business. Other than those disclosed above, noother legal proceedings are pending, which are believed to be material.Management believes that rate recovery, proper insurance coverage and reservesare in place to insure against property, general liability and workers’compensation claims incurred in the ordinary course of business.

 

**Note 9 – Business Segments:**

 

AWRhas three principal business units: water and electric distribution units, throughGSWC, a water-service utility operation conducted through CCWC, and acontracted services unit through ASUS and its subsidiaries. All activities ofGSWC are geographically located within California. All activities of CCWC arelocated in the state of Arizona. All activities of ASUS are conducted in Arizona,California, Maryland, New Mexico, Texas and Virginia. Both GSWC and CCWC areregulated utilities. On a stand-alone basis, AWR has no material assets otherthan its investments in its subsidiaries. The tables below set forthinformation relating to GSWC’s operating segments, CCWC and other matters whichincludes ASUS and its subsidiaries. Certain assets, revenues and expenses havebeen allocated in the amounts set forth. The identifiable assets are net ofrespective accumulated provisions for depreciation. Capital additions reflectcapital expenditures paid in cash and exclude property installed by developersand conveyed to GSWC or CCWC.

 
| ** **                             | ** ** | **As of and for The Three Months Ended March 31, 2006** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **GSWC**                                                                                                  | ** ** | **CCWC** | ** ** | ** ** | ** ** | **Consolidated** | ** ** |
| **(dollars in thousands)**   | ** ** | **Water**                                                                                                 | ** ** | **Electric** | ** ** | **Water** | ** ** | **Other*** | ** ** | **AWR** | ** ** |
| Operating  revenues                    |       | $                                                                                                         | 48,967     | (1) | $ | 8,346 |   | $ | 1,782 |   | $ | 1,518 |   | $ | 60,613 |   |
| Operating  income (loss)               |       | 13,944                                                                                                    |       | (1,096 | )(2) | 333 |   | 879 |   | 14,060 |   |
| Interest  expense, net                 |       | 3,660                                                                                                     |       | 346 |   | 121 |   | 230 |   | 4,357 |   |
| Identifiable  assets                   |       | 643,975                                                                                                   |       | 41,309 |   | 37,567 |   | 953 |   | 723,804 |   |
| Depreciation  and amortization expense |       | 5,496                                                                                                     |       | 535 |   | 416 |   | 36 |   | 6,483 |   |
| Capital  additions                     |       | 17,975                                                                                                    |       | 833 |   | 318 |   | 273 |   | 19,399 |   |
|                                        |            |                                                                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                             | ** ** | **As of and for The Three Months  Ended March 31, 2005** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                             | ** ** | **GSWC**                                                      | ** ** | **CCWC** | ** ** | ** ** | ** ** | **Consolidated** | ** ** |
| **(dollars in thousands)**             | ** ** | **Water**                                                     | ** ** | **Electric** | ** ** | **Water** | ** ** | **Other*** | ** ** | **AWR** | ** ** |
| Operating  revenues                    |       | $                                                             | 40,174     | (1) | $ | 7,470 |   | $ | 1,343 |   | $ | 831 |   | $ | 49,818 |   |
| Operating  income (loss)               |       | 7,735                                                         |       | 3,452 | (2) | 980 |   | (555 | ) | 11,612 |   |
| Interest  expense, net                 |       | 3,998                                                         |       | 404 |   | 120 |   | 182 |   | 4,704 |   |
| Identifiable  assets                   |       | 601,032                                                       |       | 39,929 |   | 35,317 |   | 461 |   | 676,739 |   |
| Depreciation  and amortization expense |       | 4,891                                                         |       | 495 |   | 261 |   | 17 |   | 5,664 |   |
| Capital  additions                     |       | 17,449                                                        |       | 678 |   | 588 |   | 111 |   | 18,826 |   |
|                                        |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

** Includesamounts from AWR and ASUS’s contracted services (including FBWS, ODUS and TUSfor the three months ended March 31, 2006 and FBWS for the three months endedMarch 31, 2005.)*

 

(1) For the three monthsended March 31, 2006, it includes $2,600,000 of GSWC other operatingrevenues, $2,580,000 of which reflects water rights lease revenues receivedfrom the City of Folsom (Note 2). For the three months ended March 31, 2005, it alsoincludes $20,000 of GSWC other operating revenues.

(2) Includes $2,155,000 and($3,015,000) unrealized loss (gain) on purchased power contracts for the threemonths ended March 31, 2006 and 2005, respectively.

 

22

----

 

**Item 2. Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

# **General**

 

American States Water Company (“AWR”) is the parentcompany of Golden State Water Company (“GSWC”), Chaparral City Water Company (“CCWC”)and American States Utility Services, Inc. (“ASUS”) and its subsidiaries,Fort Bliss Water Services Company (“FBWS”), Terrapin Utility Services, Inc.(“TUS”) and Old Dominion Utility Services, Inc. (“ODUS”). AWR wasincorporated as a California corporation in 1998 as a holding company for GSWC.

 

GSWC is a California public utility company engagedprincipally in the purchase, production and distribution of water (SIC No. 4941).GSWC also distributes electricity in one customer service area (SIC No. 4911).GSWC is regulated by the Public Utilities Commission of the State of California(“CPUC”) and was incorporated as a California corporation on December 31,1929. GSWC is organized into one electric customer service area and three waterservice regions operating within 75 communities in 10 counties in the State ofCalifornia and provides water service in 21 customer service areas. Region Iconsists of 7 customer service areas in northern and central California; RegionII consists of 4 customer service areas located in Los Angeles County; andRegion III consists of 10 customer service areas in eastern Los Angeles County,and in Orange, San Bernardino and Imperial counties. GSWC also provideselectric service to the City of Big Bear Lake and surrounding areas in SanBernardino County through its Bear Valley Electric Service division.

 

GSWC served 253,369 water customers and 22,993electric customers at March 31, 2006, or a total of 276,362 customers,compared with 274,390 total customers at March 31, 2005. GSWC’s utilityoperations exhibit seasonal trends. Although GSWC’s water utilityoperations have a diversified customer base, residential and commercialcustomers account for the majority of GSWC’s water sales and revenues. Revenuesderived from commercial and residential water customers accounted forapproximately 90% oftotal water revenues for the three months ended March 31,2006, as compared to 94.4% for the threemonths ended March 31, 2005.

 

CCWC is an Arizona public utility company serving 13,117customers as of March 31, 2006, compared with 12,681 customers at March 31,2005. Located in the town of Fountain Hills, Arizona and a portion of the Cityof Scottsdale, Arizona, the majority of CCWC’s customers are residential. TheArizona Corporation Commission (“ACC”) regulates CCWC.

 

ASUS contracts, either directly or through wholly-ownedsubsidiaries, with various municipalities, the U.S. Government and privateentities to provide water and wastewater services, including billing and meterreading, water marketing and the operation and maintenance of water andwastewater systems. On October 1, 2004, ASUS commenced operation of thewater and wastewater systems at Fort Bliss located near El Paso, Texas, throughFBWS, pursuant to the terms of a 50 year contract with the U.S. Government. ASUScommenced operation and maintenance of the water and wastewater systems atAndrews Air Force Base in Maryland on February 1, 2006 through TUSpursuant to the terms of a 50 year contract. ASUS commenced operation andmaintenance of the wastewater systems at Fort Lee in Virginia through ODUS on February 23,2006 pursuant to the terms of a 50 year contract. ASUS also commenced operationof the water and wastewater systems at Fort Eustis, Fort Story and Fort Monroein Virginia through ODUS on April 6, 2006 pursuant to the terms of a 50year contract. These contracts are each subject to termination for convenienceby the U.S. Government. The contract price for each of these contracts issubject to re-determination two years after commencement of operations andevery three years thereafter to the extent provided in each of the contracts.Prices are also subject to equitable adjustment based upon changes incircumstances and changes in wages and fringe benefits to the extent providedin each of the contracts.

 

ASUS has been pursuing an opportunity to provideretail water services within the service area of the Natomas Central MutualWater Company (“Natomas”). Natomas is a California mutual water company whichcurrently provides water service to its shareholders, primarily foragricultural irrigation and habitat maintenance, in portions of Sacramento andSutter counties in northern California. In August 2004, Natomas grantedASUS the exclusive right to market water that has become “temporarily surplus”that may arise under water rights permits and contracts owned orcontrolled by it, to third parties outside the Natomas service area. On January 31,2006, ASUS entered into a water purchase agreement to acquire 5,000 acre-feetof permanent Sacramento River water diversion rights from Natomas. Pursuant tothe terms of this agreement, Natomas will sell, transfer and convey to ASUS, inperpetuity, water rights and entitlements to divert from the Sacramento Riverup to 5,000 acre-feet of water per year, subject to certain regulatoryapprovals. Terms of the acquisition, among other things, include a base priceof $2,500 per acre-foot of water, with payments contingent on meeting specificmilestones and events over a 10-year period.

 

23

----

 

Natomaswill pay to ASUS a commission of 16% of the sale price over the same 10-yearperiod under an existing agreement between the two companies. At the same timethat the water sale agreement was completed, Natomas and ASUS also entered intoa settlement agreement that released Natomas from previously establishedreimbursement obligations under existing agreements. ASUS may use this5,000 acre-feet of water rights acquired from Natomas to engage intransactional opportunities with developers. Under another water transferagreement with Natomas, 30,000 acre-feet of water is to be used exclusively byGSWC in a CPUC regulated system in Sutter County, California. GSWC will seekapproval from the CPUC for a Certificate of Public Convenience and Necessity toprovide water service in Sutter County, California. Both agreements are subjectto and become effective upon various regulatory approvals.

 

**Overview**

 

Our revenues, income, and cash flows are earnedprimarily through delivering drinking water to homes and businesses. Ratescharged to customers of GSWC and CCWC are determined by either the CPUC or ACC.These rates are intended to allow recovery of operating costs and a reasonablerate of return on capital. Factors recently affecting our financial performanceinclude the process and timing of setting rates charged to customers; ourability to recover, and the process for recovering, the costs of water andelectricity in rates; weather; the impact of increased water quality standardson the cost of operations and capital expenditures; pressures on water supplycaused by population growth, more stringent water quality standards,deterioration in water quality and water supply from a variety of causes;capital expenditures needed to upgrade water systems and increased costs andrisks associated with litigation relating to water quality and water supply,including suits initiated by the Company to protect its water supply.

 

For the three months ended March 31, 2006, netincome was $5.9 million compared to $3.8 million for the same period in 2005,an increase of 56.7%. Basic and diluted earnings per share for the firstquarter of 2006 were $0.35, compared to $0.22 for the first quarter of 2005. Theincrease in earnings per share was primarily due to a decision issued by theCPUC regarding GSWC’s water rights lease revenues received from the City ofFolsom, increased rates approved by the CPUC and ACC, and an increase in waterconsumption over that in the prior period. Partially offsetting the increaseswas a significant decline in the cumulative unrealized gain on purchased powercontracts in the first quarter of 2006 related to our Bear Valley Electricdivision due to decreased energy prices since December 31, 2005.

 

We plan to continue to seek additional rateincreases in future years to recover our operating and supply costs and receivereasonable returns on invested capital. Capital expenditures in future yearsare expected to remain at much higher levels than depreciation expense. Cashsolely from operations is not expected to be sufficient to fund our needs forcapital expenditures, dividends, investments in our contract business and othercash needs. We expect to fund these needs through a combination of debt andcommon stock offerings in the next five years.

 

Unless specifically noted, the following discussionand analysis provides information on AWR’s consolidated operations and assets.For the three months ended March 31, 2006 and 2005, there is generally nomaterial difference between the consolidated operations and assets of AWR andthe operations and assets of GSWC. However, where necessary, the followingdiscussion and analysis includes references specifically to AWR’s othersubsidiaries – CCWC and ASUS and its subsidiaries.

 

24

----

 

***Consolidated Results of Operations – Three MonthsEnded March 31, 2006 and 2005***

 
| ** **                                           | ** ** | **3 MOS** | ** ** | **3 MOS** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|----------------|------------|----------------|------------|------------|------------|------------|------------|
| ** **                                           | ** ** | **ENDED**      | ** ** | **ENDED**      | ** ** | **$**      | ** ** | **%**      | ** ** |
| ** **                                           | ** ** | **3/31/2006**  | ** ** | **3/31/2005**  | ** ** | **CHANGE** | ** ** | **CHANGE** | ** ** |
| OPERATING  REVENUES                                  |       |           |       |           |       |       |       |       |       |
| Water                                                |       | $              | 48,149     |           | $          | 41,497     |       | $          | 6,652      |   | 16.0 | % |
| Electric                                             |       | 8,346          |       | 7,470          |       | 876        |       | 11.7       | %          |
| Other                                                |       | 4,118          |       | 851            |       | 3,267      |       | 383.9      | %          |
| Total  operating revenues                            |       | 60,613         |       | 49,818         |       | 10,795     |       | 21.7       | %          |
|                                                 |       |           |       |           |       |       |       |       |       |
| OPERATING  EXPENSES                                  |       |           |       |           |       |       |       |       |       |
| Water  purchased                                     |       | 8,344          |       | 7,686          |       | 658        |       | 8.6        | %          |
| Power  purchased for pumping                         |       | 1,604          |       | 1,487          |       | 117        |       | 7.9        | %          |
| Groundwater  production assessment                   |       | 2,083          |       | 1,921          |       | 162        |       | 8.4        | %          |
| Power  purchased for resale                          |       | 4,563          |       | 4,137          |       | 426        |       | 10.3       | %          |
| Unrealized  loss (gain) on purchased power contracts |       | 2,155          |       | (3,015         | )          | 5,170      |       | -171.5     | %          |
| Supply cost  balancing accounts                      |       | 487            |       | 1,078          |       | (591       | )          | -54.8      | %          |
| Other  operating expenses                            |       | 4,700          |       | 5,069          |       | (369       | )          | -7.3       | %          |
| Administrative  and general expenses                 |       | 10,832         |       | 10,174         |       | 658        |       | 6.5        | %          |
| Depreciation  and amortization                       |       | 6,483          |       | 5,664          |       | 819        |       | 14.5       | %          |
| Maintenance                                          |       | 2,755          |       | 2,466          |       | 289        |       | 11.7       | %          |
| Property and  other taxes                            |       | 2,547          |       | 2,299          |       | 248        |       | 10.8       | %          |
| Gain on  setlement for removal of wells              |       | —         |       | (760           | )          | 760        |       | -100.0     | %          |
| Total  operating expenses                            |       | 46,553         |       | 38,206         |       | 8,347      |       | 21.8       | %          |
|                                                 |       |           |       |           |       |       |       |       |       |
| OPERATING  INCOME                                    |       | 14,060         |       | 11,612         |       | 2,448      |       | 21.1       | %          |
|                                                 |       |           |       |           |       |       |       |       |       |
| Interest  expense                                    |       | (5,256         | )          | (4,725         | )          | (531       | )          | 11.2       | %          |
| Interest  income                                     |       | 899            |       | 21             |       | 878        |       | 4181.0     | %          |
| INCOME FROM  OPERATIONS BEFORE INCOME TAX EXPENSE    |       | 9,703          |       | 6,908          |       | 2,795      |       | 40.5       | %          |
|                                                 |       |           |       |           |       |       |       |       |       |
| Income tax  expense                                  |       | 3,804          |       | 3,144          |       | 660        |       | 21.0       | %          |
|                                                 |       |           |       |           |       |       |       |       |       |
| NET INCOME                                           |       | $              | 5,899      |           | $          | 3,764      |       | $          | 2,135      |   | 56.7 | % |

 

Net income for the first quarter ended March 31,2006 increased by 56.7% to $5.9 million, equivalent to $0.35 per common shareon both a basic and fully diluted basis, compared to $3.8 million or $0.22 pershare for the three months ended March 31, 2005. Impacting thecomparability in the results of the two periods are the following significantitems:

 

•                  A decisionissued by the CPUC on April 13, 2006 regarding the treatment of GSWC’s waterrights lease revenues added about $2.6 million to pretax income in March 2006,or approximately $0.09 per share. Pursuant to a March 2004 CPUC order, theapportionment of any lease revenues that GSWC may collect commencing in January 2004was to be determined by a later decision. Pending that later decision andbeginning in the first quarter of 2004, all amounts billed to the City ofFolsom had been included in a regulatory liability account and no amounts wererecognized as revenue until uncertainties about this matter were resolved withthe CPUC. On April 13, 2006, the CPUC authorized GSWC to reinvest alllease revenues since January 2004, inclusive of the balances in theregulatory liability accounts established by GSWC for this matter, in watersystem infrastructure. These investments will be included in the rate base uponwhich GSWC earns a rate of return. In accordance

 

25

----

 

with California law, GSWC has 8 years in whichto reinvest the proceeds. As a result, GSWC transferred about $2.3 million of waterrights lease revenues received from the City of Folsom in 2004 and 2005 fromthe regulatory liability account into other operating revenues. GSWC also recordedpretax income of $299,000 to reflect the first quarter of the 2006 water rightslease revenues.

 

•                  Asignificant decline in the cumulative unrealized gain on purchased powercontracts due to decreasing energy prices. The reduction in the cumulative unrealizedgain on purchased power contracts decreased pretax income by approximately $2.2million, or $0.08 per share, for the three months ended March 31, 2006, ascompared to an increase in the cumulative unrealized gain on purchased powercontracts of $3.0 million, or $0.11 per share, for the same period in 2005.

 

•                  Waterrate increases contributed approximately $3.5 million to revenues, or $0.09 pershare for the first quarter of 2006.

 

•                  A13.6% increase in billed water consumption in the three months ended March 2006as compared to the same period in 2005 due to near record rainfall in SouthernCalifornia in early 2005. The higher consumption improved earnings byapproximately $0.07 per share in 2006.

 

•                  Anincrease in ASUS’s pretax operating income of $1.4 million, or $0.05 per share,as compared to the same period of 2005 by operating and maintaining the waterand wastewater systems for the U.S. Government. The increases included revenuerecognized for certain special projects and reimbursement of various operatingcosts incurred during the transition periods.

 

***Operating Revenues***

 

For thethree months ended March 31, 2006, revenues from water operationsincreased by 16.0% to $48.1 million, compared to $41.5 million for the threemonths ended March 31, 2005. Higher water revenues reflect rate increases sincethe second quarter of 2005 covering almost all of water customers, whichcontributed $3.5 million in increased revenues. In addition, an increase of 13.6%in billed water consumption resultingfrom changes in weather conditions increased revenues by approximately $2.8 million.Differences in temperature and rainfall in Registrant’s service areas impactsales of water to customers, causing fluctuations in Registrant’s revenues andearnings between comparable periods.

 

Forthe three months ended March 31, 2006, revenues from electric operations increasedby 11.7% to $8.3 million compared to $7.5 million for the three months ended March 31,2005. The increase reflects primarily a 6.3% increase in kilowatt-hourconsumption due to recent weather conditions which increased the usage of snow-makingmachines. New rates authorized in April 2005 for the 8.4 MW naturalgas-fueled generation facility also contributed to the increase.

 

Registrant relies upon rate approvals by stateregulatory agencies in California and Arizona, in order to recover operatingexpenses and provide for a return on invested and borrowed capital used to fundutility plant. Without such adequate rate relief granted in a timely manner,revenues and earnings can be negatively impacted.

 

Forthe three months ended March 31, 2006, other operating revenues increasedby 383.9% to $4.1 million compared to $851,000 for the three months ended March 31,2005 due primarily to a decision issued by the CPUC on April 13, 2006 enablingthe Company to record water rights lease revenues from the City of Folsom from January 2004to March 2006 of $2.6 million in total, as revenues. Prior to thisdecision, the apportionment of any lease revenues that GSWC collected in 2004and 2005, totaling $2.3 million, had been included in a regulatory liabilityaccount and no amounts were recognized as revenues until uncertainties aboutthis matter were resolved. Registrant also recorded additional revenue of $299,000,reflecting the first quarter of the 2006 water rights lease revenues. In addition,an increase of $685,000 in revenues as compared to the first three months of2005 reflects (i) recording of FBWS revenue of $517,000 in the firstquarter of 2006 based on the percentage of completion method for contractrevenue recognition for several projects at Fort Bliss, and (ii) additionalrevenues generated from operating the water and wastewater systems at AndrewsAir Force Base and the wastewater systems at Fort Lee starting February 2006.

 

26

----

 

***Operating Expenses***

 

For thethree months ended March 31, 2006, 43.2% of the Company’s supply mix waspurchased water as compared to 43.7% purchased water for the three months endedMarch 31, 2005. Purchased water costs increased by 8.6% to $8.3 million comparedto $7.7 million for the three months ended March 31, 2005. The increase isdue primarily to an increase in customer demand resulting from higherconsumption and increased water rates by purchased water suppliers, offset by aslight change in the supply mix caused by less purchased water needed toreplace groundwater supply lost.

 

Forthe three months ended March 31, 2006, the cost of power purchased forpumping increased by 7.9% to $1.6 million compared to $1.5 million for thethree months ended March 31, 2005 due to an increase in KWh usage by theCompany caused by higher customer water demand and a slight increase in pumpingvolume due to the supply mix change.

 

For thethree months ended March 31, 2006, groundwater production assessmentsincreased by 8.4% to $2.1 million as compared to $1.9 million for the threemonths ended March 31, 2005 due to increases in well production to meethigher customer demand. There were also increases in assessment rates leviedagainst groundwater production, effective July 2005. Average pump taxrates increased in Regions II and III by approximately 5% and 11%,respectively.

 

Changes in the water resource mix between watersupplied from purchased sources and that supplied from Registrant’s own wellscan increase/decrease actual supply-related costs relative to that approved forrecovery through rates, thereby impacting earnings either negatively orpositively. Registrant has the opportunity to change the supply-related costsrecovered through rates by application to the appropriate regulatory body.Registrant believes that its applications for recovery of supply-related costsaccurately reflect the water supply situation as it is known at the time.However, it is impossible to adequately protect earnings from adverse changesin supply costs related to unforeseen contamination or other loss of watersupply.

 

Forthe three months ended March 31, 2006, cost of power purchased for resaleto customers in GSWC’s Bear Valley Electric division increased by 10.3% to $4.6million compared to $4.1 million for the three months ended March 31, 2005,reflecting higher customer demand during the first quarter of 2006.

 

Unrealizedgain and loss on purchased power contracts represents gains and losses recordedfor GSWC’s purchased power agreements with Pinnacle West Capital Corporation (“PWCC”), which qualify as derivativeinstruments under SFAS No. 133, *“Accounting for DerivativeInstruments and Hedging Activities”*. The $2.2 million pretaxunrealized loss on purchased power contract for the three months ended March 31,2006 is due to a decrease in the current forward market prices since December 31,2005. There was a $3.0 million pretax unrealized gain on purchased powercontracts for the three months ended March 31, 2005. Unrealized gains andlosses at Bear Valley Electric will continue to impact earnings during the lifeof the contract with PWCC, which terminates in 2008.

 

A decreaseof $591,000 during the three months ended March 31, 2006 in the provisionfor supply cost balancing accounts as compared to the three months ended March 31,2005 was primarily due to (i) the recording of an over-collection of$223,000 in the first quarter of 2005 as a regulatory liability with acorresponding charge booked to the supply cost balancing account provision; (ii) adecrease of $308,000 in the amortization of the previously authorized surchargeprimarily related to pre-November 2001 water supply cost balancingaccounts and the electric balancing account, and (iii) a decrease of$60,000 expensed in the electric supply cost balancing account resulting fromamounts in excess of the $77 per MWh recovery cap authorized by the CPUC.

 

For thethree months ended March 31, 2006, other operating expenses decreased by 7.3%to $4.7 million compared to $5.1 million for the three months ended March 31,2005 due primarily to the reimbursement of $433,000 by the U.S. Government anda contractor for operating expenses incurred at Fort Bliss. FBWS was hired as asubcontractor for certain special projects requested by the U.S. Government, inaddition to the services provided under the terms of the primary contract.

 

Forthe three months ended March 31, 2006, administrative and general expensesincreased by 6.5% to $10.8 million compared to $10.2 million for the three monthsended March 31, 2005 due to (i) an approximate $578,000 increase inpensions and benefits due to actuarial assumption changes in the mortalitytables, and increases

 

27

----

 

in various benefit costs; (ii) anapproximate $455,000 increase in labor costs; (iii) an increase of $115,000in general liability related cost; (iv) an increase of about $384,000 invarious office expenses and travel expenses, and (v) an increase of about$90,000 in other miscellaneous administrative expenses. The increases wereoffset by (i) the recovery of transition period operating expenses of about $672,000at various military bases, operating under TUS and ODUS, and (ii) reimbursementof indirect capital cost of $288,000 incurred by FBWS in the first quarter of2006.

 

For the threemonths ended March 31, 2006, depreciation and amortization expense increased by14.5% to $6.5 million compared to $5.7 million for the three months ended March31, 2005 reflecting, among other things, the effects of closing approximately$99.7 million of additions to utility plant during 2005, depreciation on whichbegan in January 2006. Registrant anticipates that depreciation expense willcontinue to increase due to Registrant’s on-going construction program at itsregulated subsidiaries. Registrant believes that depreciation expense relatedto property additions approved by the appropriate regulatory agency will berecovered through water and electric rates.

 

For thethree months ended March 31, 2006, maintenance expense increased by 11.7%to $2.8 million compared to $2.5 million for the three months ended March 31,2005 due principally to an increase in required maintenance on GSWC’s wells andwater supply sources.

 

Forthe three months ended March 31, 2006, property and other taxes increasedby 10.8% to $2.5 million compared to $2.3 million for the three months ended March 31,2005 reflecting additional property taxes resulting from higher assessedvalues, and increases in payroll taxes based on increased labor costs.

 

Forthe three months ended March 31, 2005, Registrant recorded a net pre-taxgain of $760,000 on a settlement reached with the Fountain Hills SanitaryDistrict (“FHSD”) in February 2005 for the capping of two CCWC wells inorder to facilitate FHSD’s ability to secure certain permits. Pursuant to thesettlement agreement, CCWC agreed to permanently remove from service and capone of its wells, and cap another well which had never been used as a potablesource of supply. There was no similar gain in the same period of 2006.

 

***Interest Expense***

 

For thethree months ended March 31, 2006, interest expense increased by 11.2% to$5.3 million compared to $4.7 million for the three months ended March 31,2005 reflecting primarily increases in long-term debt interest expense of$497,000 due to $40,000,000 of additional private placement notes issued in October 2005.Partially offsetting this increase was a decrease in short-term cash borrowings.Average bank loan balances outstanding under an AWR credit facility for the firstquarter of 2006 were approximately $28 million, as compared to an average of$48 million during the same period of 2005. However, the decrease in short-termbank loan balances was also partially offset by higher interest rates.

 

***Interest Income***

 

Interestincome of $899,000 for the three months ended March 31, 2006 was due to (i) interestincome of $108,000 with respect to the receivable interest accrued on an $8.0 millionsettlement with Aerojet General Corporation (“Aerojet”) which will be paid overa five year period beginning in December 2009; (ii) interest accruedon the uncollected balance of the Aerojet litigation memorandum accountauthorized by the CPUC of $593,000, and (iii) interest earned onshort-term cash surplus.

 

***Income Tax Expense***

 

For the three months ended March 31,2006, income tax expense increased by 21.0% to $3.8 millioncompared to $3.1 million for the three months ended March 31, 2005 due, inpart, to an increase in pretax income of 40.5%. In addition, theeffective tax rate (“ETR”) for the three months ended March 31,2006 decreased to 39.2% as compared to a 45.5% ETR applicable to the threemonths ended March 31, 2005. The variance between the ETR and thestatutory tax rate is primarily the result of differences between book andtaxable income that are treated as flow-through adjustments in accordance withregulatory requirements. Flow-through adjustments increase or decrease taxexpense in one period, with an offsetting increase or decrease occurring in anotherperiod. During the second quarter of 2005, the recognition of the federaleffect of state taxes was adjusted to conform to the flow-through methodreflected in the tax calculation for ratemaking purposes, which partiallydefers the recognition of the effect to the subsequent tax year. This reducedincome tax expense by $141,000 for the three months ended March 31, 2006.

 

28

----

 

**Critical Accounting Policies and Estimates**

 

Critical accounting policies and estimates are thosethat are important to the portrayal of AWR’s financial condition, results ofoperations and cash flows, and require the most difficult, subjective orcomplex judgments of AWR’s management. The need to make estimates about theeffect of items that are uncertain is what makes these judgments difficult,subjective and/or complex. Management makes subjective judgments about theaccounting and regulatory treatment of many items. These judgments are based onAWR’s historical experience, terms of existing contracts, and AWR’s observanceof trends in the industry, information provided by customers and informationavailable from other outside sources, as appropriate. Actual results may differfrom these estimates under different assumptions or conditions.

 

The critical accounting policies used in the preparation of the Registrant’s financial statements that we believe affect the more significant judgments and estimates used in the preparation of our consolidated financial statements presented in this report are described in *“Management’s Discussion and Analysis of Financial Condition and Results of Operation”* included in our Annual Report on Form 10-K for the year ended December 31, 2005. Except for the adoption of SFAS 123(R), *“Share-Based Payment”*, there have been no material changes to the critical accounting policies. Effective January 1, 2006, Registrant began accounting for employee and directors stock-based compensation costs in accordance with SFAS 123(R) which requires the recognition of compensation expense in the financial statements based on fair values of the stock awards. Registrant elected to adopted the modified prospective transition method as provided by SFAS 123(R) and, accordingly, financial statement amounts for the prior periods presented in the Form 10-Q have not been restated to reflect the fair value method of expensing share-based compensation. Registrant utilized the Black-Scholes option pricing model to estimate the fair value of employee stock based compensation at the date of grant, which requires the input of highly subjective assumptions, including expected volatility and expected life. Further, as required under SFAS 123(R), Registrant now estimates forfeitures for options granted, which are not expected to vest. The cumulative effect of adopting the change in estimating forfeitures is not material to Registrant’s financial statements for the quarter ended March 31, 2006. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of Registrants share-based compensation. The adoption of SFAS 123(R) did not have a material affect on Registrant’s consolidated financial position, results of operations and cash flows for the three months ended March 31, 2006.

 

**Liquidity and Capital Resources**

 

***AWR***

 

AWR funds its operating expenses and pays dividendson its outstanding Common Shares primarily through dividends from GSWC.

 

Net cash provided by operating activities was $16.8 millionfor the quarter ended March 31, 2006 as compared to $17.8 million for thesame period ended March 31, 2005. The decrease of $1.0 million wasprimarily attributable to approximately $3.9 million of costs and estimatedearnings in excess of billings on uncompleted contracts at Fort Bliss, offset partiallyby improved earnings for the first quarter of 2006. The timing of cash receiptsand disbursements related to working capital items also affected the changes innet cash provided by operating activities.

 

Net cash used in investing activities increased slightly to $19.4million for the three months ended March 31, 2006 as compared to $18.8 millionfor the three months ended March 31, 2005.

 

Net cash provided by financing activities was $4.0 million for the quarterended March 31, 2006 as compared to $2.5 million for the same period in2005. The increase in net cash provided by financing activities was primarilycaused by (i) a $2 million net increase in notes payable to banks, and (ii) a$400,000 increase in proceeds from stock option exercises and the issuance ofCommon Shares under the Registrant’s Common Share Purchase and DividendReinvestment Plan and 401(k) Plan, offset by a decrease of about $1.2 million inadvances for and contributions in aid of construction.

 

In June 2005, AWR amended and restated its credit agreement whichincreased its borrowing limit under this facility to $85 million and extendedthe maturity date to June 2010. Up to $20 million of this facility may beused for letters of credit. As of March 31, 2006, an aggregate of $31million in cash borrowings were included in current liabilities andapproximately $11.2 million of letters of credit were outstanding under thisfacility. AWR also

 

29

----

 

has a Registration Statement on file with theSecurities and Exchange Commission for the sale from time to time of debt andequity securities. As of March 31, 2006, approximately $6.5 million wasavailable for issuance under this Registration Statement.

 

Registrantanticipates that interest costs will increase in future periods due to potentialmarket interest rate increases and the need for additional external capital tofund its construction program. In April 2004 Standard & Poor’sRatings Service (“S&P”)downgraded AWR’s credit rating from A+ to A- with a negative outlook. In December of2005, S&P revised AWR’s rating from A- negative to A- stable. S&P debtratings range from AAA (highest rating possible) to D (obligation is indefault). Securities ratings are not recommendations to buy, sell or hold asecurity and are subject to change or withdrawal at any time by the ratingagency. Registrant believes that costs associated with capital used to fundconstruction at its regulated subsidiaries will continue to be recovered inwater and electric rates charged to customers.

 

***GSWC***

 

Net cash provided by operating activities was $19.3million for the quarter ended March 31, 2006 as compared to $16.9 millionfor the same period in 2005. The increase of $2.4 million was primarilyattributable to improved net income for the first quarter of 2006 as comparedto the same period of 2005, and the timing of cash receipts and disbursementsrelated to working capital items.

 

Net cash used in investing activities increased slightlyto $18.8 million for the quarter ended March 31, 2006 as compared to $18.1million for the same period in 2005.

 

Net cash provided by financing activities was $1.5 million for the threemonths ended March 31, 2006 as compared to net cash provided by financingactivities of $1.3 million for the same period in 2005. The increase reflectsprimarily a $700,000 increase in intercompany borrowings and $190,000 proceedsfrom stock options exercises in the first quarter of 2006. The increase waspartially offset by a $369,000 decrease in the receipt of advances for andcontributions in aid of construction net of refunds, and an increase of$300,000 in the dividend payment from GSWC to AWR in the first quarter of 2006.

 

GSWC funds the majority of its operating expenses, payments on itsdebt, and dividends on its outstanding common shares through internal sources.Internal sources of cash flow are provided primarily by retention of a portionof earnings from operating activities. Internal cash generation is influencedby factors such as weather patterns, environmental regulation, litigation,changes in supply costs and regulatory decisions affecting GSWC’s ability torecover these supply costs, and timing of rate relief.

 

GSWCalso relies on external sources, including equity investments and short-termborrowings from AWR, long-term debt, contributions in aid of construction,advances for construction and install-and-convey advances to fund the majorityof its construction expenditures. GSWC has a Registration Statement on filewith the SEC for issuance from time to time, of up to $100 million of debtsecurities. As of March 31, 2006, $50 million remained for issuance underthis Registration Statement, subject to regulatory approval from the CPUC forissuance of additional debt.

 

OnOctober 11, 2005, CoBank, ACB purchased a 5.87% Senior Note due December 20,2028 in the aggregate principal amount of $40,000,000 from GSWC. The proceedswere used to pay down GSWC’s intercompany short-term borrowings.

 

In February 2005, Moody’s Investor Services(“Moody’s”) changed the rating outlook for $175 million of senior unsecureddebt at GSWC from A2 negative to A2 stable. Moody’s debt ratings range from Aaa(best quality) to C (lowest quality). In December 2005, S&P changedits debt rating for GSWC from A- negative to A- stable. Securities ratings arenot recommendations to buy, sell or hold a security and are subject to changeor withdrawal at any time by the rating agency.

 

***CCWC***

 

CCWCfunds the majority of its operating expenses, payments on its debt anddividends, if any, through internal operating sources or short-term borrowingsfrom AWR. CCWC also relies on external sources, including long-term debt,contributions in aid of construction, advances for construction andinstall-and-convey advances, to fund the majority of its construction expenditures.

 

30

----

 

***ASUS***

 

ASUS funds its operating expenses primarily throughmanagement fees and investments by or loans from AWR. ASUS, in turn, providesfunding to its subsidiaries.

 

**Contractual Obligations and OtherCommitments**

 

Registrant has various contractual obligations whichare recorded as liabilities in the consolidated financial statements. Otheritems, such as certain purchase commitments and operating leases are notrecognized as liabilities in the consolidated financial statements, but arerequired to be disclosed.

 

In addition to contractual maturities, Registrant hascertain debt instruments that contain annual sinking fund or other principalpayments. Registrant believes that it will be able to refinance debtinstruments at their maturity through public issuance, or private placement, ofdebt or equity. Annual principal and interest payments are generally made fromcash flow from operations.

 

There have been no material changes to AWR’s contractual obligations and other commitments since December 31, 2005. See*”Managements’ Discussion and Analysis of Financial Condition and Results of Operation—Contractual Obligations and Other Commitments”*section of the Registrant’s Form 10-K for the year-ended December 31, 2005  for a detailed discussion of contractual obligations and other commitments.

 

**Regulatory Matters**

 

GSWC is subject to regulation by the CPUC, which hasbroad powers with respect to service and facilities, rates, classification ofaccounts, valuation of properties, the purchase, disposition and mortgaging ofproperties necessary or useful in rendering public utility service, theissuance of securities, the granting of certificates of public convenience andnecessity as to the extension of services and facilities and various othermatters. CCWC is subject to regulation by the ACC.

 

Rates that GSWC and CCWC are authorized to chargeare determined by the CPUC and the ACC, respectively, in general rate cases andare derived using rate base, cost of service and cost of capital, as projectedfor a future test year in California and using an historical test year, asadjusted, in Arizona. Rates charged to customers vary according to customer class andrate jurisdiction and are generally set at levels allowing for recovery ofprudently incurred costs, including a fair return on rate base. Rate basegenerally consists of the original cost of utility plant in service, pluscertain other assets, such as working capital and inventory, less accumulateddepreciation on utility plant in service, deferred income tax liabilities andcertain other deductions.

 

California statutes requires GSWC to file a generalrate case (“GRC”) application every three years for each of its water rate-makingareas according to a schedule established by the CPUC. GRC’s typicallyinclude an increase in year one and step increases for the second and thirdyears. Rates are based on a forecast of expenses and capital costs. GRC’s havea typical regulatory processing time of one year. In California, rates may beincreased by offsets for certain expense increases, including but not limitedto supply cost offset and balancing account amortization, and advice letterfilings related to certain plant additions and other operating cost increases.Offset rate increases and advice letter filings typically have a two to fourmonth regulatory lag.

 

Neither the operations nor rates of AWR and ASUS aredirectly regulated by the CPUC or the ACC. The CPUC and the ACC do howeverregulate certain transactions between GSWC and its affiliates. The amountscharged by the subsidiaries of ASUS for water and wastewater services at militarybases are based upon the terms of a 50-year contract with the U.S. Government.Prices will be re-determined at the end of two years after commencement ofoperations at each military base and every three years thereafter. In addition,prices may be equitably adjusted for changes in law, wage and benefitincreases and other circumstances.

 

***Recent Changes in Rates***

 

On January 12, 2006, the CPUC approvedRegion III’s rate case. The authorized rate increases for 2006 were madeeffective January 19, 2006 and is expected to provide GSWC additionalannual revenue approximating $5.4 million in 2006 based on a return on equityof 9.8%. For the second and the third year of this three-year GRC, the CPUCapproved an annual increase of approximately $1.9 million and $2.3 million,respectively, subject to

 

31

----

 

certainearnings tests.

 

***Pending Rate Changes in 2006***

 

In February 2006,GSWC filed an application with the CPUC for rate increases in Region II and tocover general office expenses. If approved as filed, the rate increases are expected to generateapproximately $14.9 million in annual revenues starting in 2007, withadditional increases of $4.7 million in 2008 and $6.9 million in 2009. Adecision on this application is expected in late 2006. Management is unable topredict the ultimate outcome of this rate case.

 

***Other Regulatory Matters***

 

*Memorandum Supply Cost Accounts*

 

In a CPUCdecision issued on June 19, 2003 related to memorandum supply costaccounts, all water utilities regulated by the CPUC were required to seekreview of under- and over- collections by filing an advice letter annually. Inaddition, the utility’s recovery of such expenses was reduced by the amountexceeding the authorized rate-of return (earnings test). On April 13, 2006, the CPUC issued adecision to remove these requirements. Pursuant to this order, GSWC willrecognize a cumulative under-collection of approximately $714,000 to the supplycost memorandum account provisions in the second quarter of 2006 for the under-collectedbalances not recognized at March 31, 2006 and will be recording under- andover- collections on a monthly basis thereafter commencing the second quarterof 2006.

 

GSWC intends to file for recovery of the netunder-collected supply costs with the CPUC in 2006 or in subsequent generalrate case proceedings. Management believes that it is probable that the CPUCwill permit GSWC to recover in rates the 2005 net under-collections in supplycosts.

 

*Santa Maria Groundwater BasinAdjudication*

 

In 1997, the Santa Maria Valley Water ConservationDistrict (“plaintiff”) filed a lawsuit against multiple defendants, includingGSWC, the City of Santa Maria, and several other public water purveyors. Theplaintiff’s lawsuit seeks an adjudication of the Santa Maria GroundwaterBasin. As of March 31, 2006, GSWC has incurred costs of approximately $5.9million in defending its rights in the Santa Maria Basin, including legaland expert witness fees, which have been deferred in Utility Plant for raterecovery. In February 2006, GSWC filed for recovery of these costs withthe CPUC. Management believes that the recovery of these costs through rates isprobable. A settlement of the lawsuit has been reached, subject to CPUCapproval. The settlement, among other things, if approved by the CPUC, wouldpreserve GSWC’s historical pumping rights and secure supplemental water rightsfor use in case of drought or other reductions in the natural yield of theSanta Maria Basin. There are also a small number of nonsettling parties, andthe case is going forward as to their claims. The Court date is currently setfor June 5, 2006. The stipulation, if approved, would preserve GSWC’sposition with the settling parties independent of the outcome of the case as itmoves forward with the nonsettling parties. GSWC can not predict the outcome ofthe case as to the nonsettling parties.

 

*Refund of Water Rights LeaseRevenues*

 

In 1994, GSWC entered into a contract to leaseto the City of Folsom, 5,000 acre-feet per year of water rights from theAmerican River. GSWC included all associated revenues in a nonoperating incomeaccount. In a decision issued on March 16, 2004, the CPUC ordered GSWC torefund 70 percent of the total amount of lease revenues received since 1994,plus interest, to customers. Pursuant to the order, GSWC recorded a $6.2million regulatory liability with a corresponding charge against nonoperatingincome, net of taxes, during the fourth quarter of 2003. A final amount of therefund was approved by the CPUC in June 2004 and GSWC adjusted itsestimate to the approved refund amount of $5.2 million.

 

Pursuant to the order, the apportionment of anylease revenues that GSWC may collect commencing in January 2004 wasto be determined by a later decision. Pending that later decision and beginningin the first quarter of 2004, all amounts billed to the City of Folsom had beenincluded in a regulatory liability account and no amounts were recognized asrevenue until uncertainties about this matter were resolved with the CPUC. On April 13,2006, the CPUC authorized GSWC to reinvest all lease revenues received from theCity of Folsom since January, 2004, inclusive of the balances in the regulatoryliability accounts, in water system infrastructure and to include such

 

32

----

 

investmentsin the rate base upon which GSWC earns a rate of return. As a result, GSWCtransferred about $2.3 million of water rights lease revenues received from theCity of Folsom in 2004 and 2005 from the regulatory liability account intoincome and recorded an additional pretax income of $299,000 reflecting thefirst quarter of 2006 water rights lease revenues.

 

*Recovery of cost of tree removaland mitigation for Bark Beetle Infestation*

 

In a Proclamation issued on March 7, 2003 formerGovernor Gray Davis declared a State of Emergency with respect to a severe firerisk caused by dead and dying trees plagued by drought and a major bark beetleinfestation in the counties of Riverside, San Bernardino, and San Diego. On April 3,2003, the CPUC issued an order requiring Southern California Edison Company,San Diego Gas & Electric Company and Bear Valley Electric to take allreasonable and necessary actions to mitigate the increased fire hazard byremoving dead, dying or diseased trees from falling or contacting distributionand transmission lines within their rights of way and to ensure compliance withexisting vegetation clearance statutes and regulations. The utilities,including Bear Valley Electric, are authorized to make annual advice letterfilings requesting recovery of the costs of complying with this order. On April 13,2006, the CPUC approved GSWC’s request for the amortization of about $351,000for costs incurred at June 30, 2005 plus interest in the Bark BeetleCatastrophic Event Memorandum Account. At March 31, 2006, approximately$650,000 has been incurred and is recorded as a regulatory asset on the balancesheets.

 

**Environmental Matters**

 

Our subsidiaries are subject to increasingly stringent environmentalregulations including the 1996 amendments to the Federal Safe Drinking WaterAct; enhanced surface water treatment rules; regulationof disinfectant/disinfection by-products; and the long-term enhanced surface water treatment rules; ground water treatment rule; contaminant regulationof radon and arsenic; and unregulated contaminants monitoring rule.

 

Additional information on these requirements andother significant environmental matters are described in *“Management’sDiscussion and Analysis of**Financial Condition andResults of Operation”* included in our 2005 Annual Report on Form 10-Kfor the year ended December 31, 2005. There have been no material changesin any of the environmental matters discussed in the Form 10-K since December 31,2005.

 

**Water Supply**

 

The adequacy of our watersupplies varies from year to year depending upon a variety of factors,including rainfall, availability of Colorado River water and imported waterfrom northern California, the amount of water stored in reservoirs andgroundwater basins, the amount of water used by our customers and others, waterquality and legal limitations on use.

 

Population growth and increases in the amountof water used have increased limitations on use in order to preventover-drafting of groundwater basins. The importation of water from the ColoradoRiver, one of GSWC’s important sources of supply, is expected to decrease infuture years due to the requirements of the Central Arizona Project (“CAP”) andother limitations on the amount of water that the Metropolitan Water Districtof Southern California (“MWD”) is entitled to take from the Colorado River. MWDis expected to increase its efforts to secure additional supplies fromconservation, desalination and water exchanges with the agricultural waterusers.

 

CCWC obtains its water supply from operatingwells and from the Colorado River through the CAP. CCWC’s water supply may besubject to interruption or reduction if there is an interruption or reductionin CAP water. In addition, CCWC’s ability to provide water service to new realestate developments is dependent upon its ability to meet the requirements ofthe Arizona Department of Water Resources regarding its assured water supplyaccount.

 

The U.S. Government is responsible forsupplying water on military bases under the terms of contracts of thesubsidiaries of ASUS with the U.S. Government.

 

33

----

 

**Item 3. Quantitative andQualitative Disclosures About Market Risk**

 

Registrantis exposed to certain market risks, including fluctuations in interest rates,and commodity price risk primarily relating to changes in the market price ofelectricity. Market risk is the potential loss arising from adverse changes inprevailing market rates and prices. There have been no material changes regarding Registrant’smarket risk position from the information provided in its Annual Report on Form 10-Kfor the year ended December 31, 2005. The quantitative and qualitativedisclosures about market risk are discussed in *Item7A-Quantitative and Qualitative Disclosures About Market Risk*,contained in Registrant’s Annual Report on Form 10-K.

 

**Item4. Controls and Procedures**

 

**(a) Evaluation of Disclosure Controls and Procedures**

 

As required by Rule 13a-15(b) under theSecurities and Exchange Act of 1934 (the “Exchange Act”), we have carried outan evaluation, under the supervision and with the participation of ourmanagement, including our Chief Executive Officer (“CEO”) and our ChiefFinancial Officer (“CFO”), of the effectiveness, as of the end of the fiscalquarter covered by this report, of the design and operation of our “disclosurecontrols and procedures” as defined in Rule 13a-15(e) and 15d-15(e) promulgatedby the Securities and Exchange Commission (SEC) under the Exchange Act. Basedupon that evaluation, the CEO and the CFO concluded that disclosure controlsand procedures, as of the end of such fiscal quarter, were adequate andeffective to ensure that information required to be disclosed by us in thereports that we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms and that such information is accumulated and communicated to ourmanagement, including our CEO and CFO, as appropriate to allow timely decisionsregarding required disclosure.

 

**(b) Changes in Internal Controls over Financial Reporting**

 

There has been no change in our internal controlover financial reporting during the quarter ended March 31, 2006, that hasmaterially affected or is reasonably likely to materially affect our internalcontrol over financial reporting.

 

34

----

 

**PART II**

 

**Item 1.Legal Proceedings**

 

Therehave been no material developments in any of the legal proceedings described inour 2005 Annual Report onForm 10-K.

 

Registrantis subject to ordinary routine litigation incidental to its business. Otherthan those disclosed in Registrant’s Form 10-K for the year ended December 31,2005, no other legal proceedings are pending, which are believed to bematerial. Managementbelieves that rate recovery, proper insurance coverage and reserves are inplace to insure against property, general liability and workers’ compensationclaims incurred in the ordinary course of business.

 

**Item1A. Risk Factors**

 

There have been no significant changes in the risk factorsdisclosed in our 2005 Annual Report on Form 10-K.

 

## **Item 2. Unregistered Sales of Equity Securities and Use of Proceeds**

 

Theshareholders of AWR have approved the material features of all equitycompensation plans under which AWR directly issues equity securities. AWR didnot directly issue any unregistered equity securities during the first quarterof 2006.

 

Thefollowing table provides information about repurchases of Common Shares by AWRduring the first quarter of 2006:

 
| **Period**                  | ** ** | **Total Number of  Shares  Purchased** | ** ** | **Average Price Paid  per Share** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs(1)** | ** ** | **Maximum Number  of Shares That May  Yet Be Purchased  under the Plans or  Programs** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| January 1 -  31, 2006  |       | 3,750                                            | (2)        | $                                                | 31.98      |                                                                                                                                | —     |                                                                                                                                | NA         | (4) |
| February 1 -  28, 2006 |       | 10,153                                           | (2)        | $                                                | 30.85      |                                                                                                                                | —     |                                                                                                                                | NA         | (4) |
| March 1 -  31, 2006    |       | 181                                              | (3)        | $                                                | 35.47      |                                                                                                                                | —     |                                                                                                                                | NA         | (4) |
| Total                       |       | 14,084                                           |       | $                                                | 31.21      |                                                                                                                                | —     |                                                                                                                                | NA         | (4) |

 

----

(1)   None of the Common Shares were purchasedpursuant to any publicly announced stock repurchase program.

(2)   Of this amount, 13,500 Common Shares wereacquired on the open market for employees pursuant to the Company’s 401(k)plan. The remainder of the Common Shares was acquired on the open market fornew participants in the Company’s Common Share Purchase and DividendReinvestment Plan.

(3)   All of these Common Shares were acquired onthe open market for new participants in the Company’s Common Share Purchase andDividend Reinvestment Plan.

(4)   None of these plans contain a maximum numberof Common Shares that may be purchased in the open market under the plans.

 

**Item 3. Defaults Upon SeniorSecurities**

 

None

 

**Item 4.Submission of Matters to a Vote of Security Holders**

 

No items were submitted during the first quarter ofthe fiscal year covered by this report to a vote of security holders throughthe solicitation of proxies or otherwise.

 

35

----

 

**Item 5. Other Information**

 

(a) OnApril 28, 2006, the Board of Directors of AWR declared a regular quarterlydividend of $0.225 per Common Share. The dividend will be paid June 1, 2006to shareholders of record as of the close of business on May 15, 2006.

 

(b) Therehave been no material changes during the first quarter of 2006 to theprocedures by which shareholders may nominate persons to the Board ofDirectors of AWR.

 

## **Item 6. Exhibits**

 

(a) Thefollowing documents are filed as Exhibits to this report:

 
| 10.1   |   | Form of NonQualified Stock Option Agreement with respect to  grants in 2006(1)(3)                                |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                  |
| 31.1   |   | Certification of Chief Executive Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 for AWR (1)  |
|   |   |                                                                                                                  |
| 31.1.1 |   | Certification of Chief Executive Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 for GSWC (1) |
|   |   |                                                                                                                  |
| 31.2   |   | Certification of Chief Financial Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 for AWR (1)  |
|   |   |                                                                                                                  |
| 31.2.1 |   | Certification of Chief Financial Officer pursuant to Section 302  of the Sarbanes-Oxley Act of 2002 for GSWC (1) |
|   |   |                                                                                                                  |
| 32.1   |   | Certification of Chief Executive Officer pursuant to Section 906  of the Sarbanes-Oxley Act of 2002 (2)          |
|   |   |                                                                                                                  |
| 32.2   |   | Certification  of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002 (2)         |

 

----

(1) Filedconcurrently herewith

(2) Furnishedconcurrently herewith

(3) Compensatorybenefit agreement

 

36

----

 

#### **SIGNATURE**

 

Pursuant to the requirements of Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized and as its principal financialofficer.

 

 
|   | AMERICAN STATES WATER COMPANY  and its subsidiaryGOLDEN STATE WATER COMPANY |
|--------|-----------------------------------------------------------------------------|
|   |                                                                        |
|   |                                                                        |
|   | By:                                                                         | /s/ Robert J. Sprowls |
|   |                                                                        | Robert J. Sprowls

Senior Vice President-Finance, Chief  Financial Officer,  Treasurer and Corporate Secretary |

 

 

Dated:May 10, 2006

 

37

----